**UNITED STATES**

**SECURITIES ANDEXCHANGE 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 MARCH 31, 2007**                                                      |
| ** ** | ** **                                                                                    |
| **o******  | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**COMMISSION FILENUMBER: 814-00237**

**GLADSTONE CAPITALCORPORATION**

(Exact name of registrant as specified inits charter)

 

| **MARYLAND**                                                   |   | **54-2040781**                       |
|----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                           |   |                                 |
| **1521 WESTBRANCH DRIVE, SUITE 200**                           |
| **MCLEAN, VIRGINIA 22102**                                     |
| (Address of principal executive office)                        |
|                                                           |
| **(703) 287-5800**                                             |
| (Registrant’s telephone number, including area code)      |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months and (2) has been subject to such filing requirements for the past 90days. Yes x   No o.

Indicate by check mark whether theregistrant is large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12 b-2 of the ExchangeAct. (Check One):

Large accelerated filer o      Accelerated filer x      Non-accelerated filer o.

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

Yes o   No x .

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.  The number of shares of the issuer’s CommonStock, $0.001 par value, outstanding as of April 27, 2007 was 12,249,683.

 

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**GLADSTONE CAPITALCORPORATION**

**TABLE OF CONTENTS**

 
| PART I.    |   | FINANCIAL  INFORMATION                                                                             |
|------------|--------|----------------------------------------------------------------------------------------------------|
|       |   |                                                                                               |
| Item 1.    |   | Financial  Statements (Unaudited)                                                                  |
|       |   |                                                                                               |
|       |   | Consolidated Statements of Assets and Liabilities as  of March 31, 2007 and September 30, 2006     |
|       |   | Consolidated Schedules of Investments as of March 31,  2007 and September 30, 2006                 |
|       |   | Consolidated Statements of Operations for the three  months ended March 31, 2007 and 2006          |
|       |   | Consolidated Statements of Operations for the six  months ended March 31, 2007 and 2006            |
|       |   | Consolidated Statements of Changes in Net Assets for  the six months ended March 31, 2007 and 2006 |
|       |   | Consolidated Statements of Cash Flows for the six  months ended March 31, 2007 and 2006            |
|       |   | Financial Highlights for the three months ended March  31, 2007 and 2006                           |
|       |   | Financial Highlights for the six months ended March  31, 2007 and 2006                             |
|       |   | Notes to Consolidated Financial Statements                                                         |
|       |   |                                                                                               |
| Item 2.    |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations        |
|       |   |                                                                                               |
|       |   | Overview                                                                                           |
|       |   | Results  of Operations                                                                             |
|       |   | Liquidity and Capital Resources                                                                    |
|       |   |                                                                                               |
| Item 3.    |   | Quantitative and Qualitative Disclosure About Market  Risk                                         |
|       |   |                                                                                               |
| Item 4.    |   | Controls and Procedures                                                                            |
|       |   |                                                                                               |
| PART  II.  |   | OTHER  INFORMATION                                                                                 |
|       |   |                                                                                               |
| Item  1.   |   | Legal  Proceedings                                                                                 |
|       |   |                                                                                               |
| Item  1A.  |   | Risk  Factors                                                                                      |
|       |   |                                                                                               |
| Item 2.    |   | Unregistered Sales of Equity Securities and Use of  Proceeds                                       |
|       |   |                                                                                               |
| Item 3.    |   | Defaults Upon Senior Securities                                                                    |
|       |   |                                                                                               |
| Item 4.    |   | Submission of Matters to a Vote of Security Holders                                                |
|       |   |                                                                                               |
| Item  5.   |   | Other  Information                                                                                 |
|       |   |                                                                                               |
| Item 6.    |   | Exhibits                                                                                           |
|       |   |                                                                                               |
| SIGNATURES |

 

 

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES(Unaudited)**
| ** **                                                                                                                              | ** ** | **March 31,** | ** **  | **September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|------------------------|------------|
| ** **                                                                                                                              | ** ** | **2007**           | ** **  | **2006**               | ** ** |
| ASSETS                                                                                                                                  |       |               |        |                   | ** ** |
| Investments at fair value (Cost 3/31/2007: $281,525,450;  9/30/2006: $216,202,986)                                                      |       | $                  | 280,242,688 |                   | $          | 217,642,750 | ** ** |
| Cash and cash equivalents                                                                                                               |       | 2,973,135          |        | 731,744                | ** ** |
| Interest receivable – investments in debt securities                                                                               |       | 2,116,813          |        | 1,394,942              | ** ** |
| Interest receivable – employees                                                                                                    |       | 45,359             |        | 37,396                 | ** ** |
| Due from custodian                                                                                                                      |       | 4,828,847          |        | 3,587,152              | ** ** |
| Deferred financing fees                                                                                                                 |       | 50,466             |        | 145,691                | ** ** |
| Prepaid assets                                                                                                                          |       | 241,088            |        | 226,747                | ** ** |
| Fees due from Adviser (Refer to Notes 4 and 5)                                                                                          |       | 28,768             |        | —                 | ** ** |
| Due from employees                                                                                                                      |       | —             |        | 1,803,283              | ** ** |
| Other assets                                                                                                                            |       | 488,790            |        | 213,510                | ** ** |
| TOTAL ASSETS                                                                                                                            |       | $                  | 291,015,954 |                   | $          | 225,783,215 | ** ** |
|                                                                                                                                    |       |               |        |                   | ** ** |
| LIABILITIES                                                                                                                             |       |               |        |                   | ** ** |
| Accounts payable                                                                                                                        |       | $                  | 5,005       |                   | $          | 4,072 | ** ** |
| Interest payable                                                                                                                        |       | 528,736            |        | 247,530                | ** ** |
| Administration fee due to Administrator                                                                                                 |       | 168,766            |        | —                 | ** ** |
| Fees due to Adviser (Refer to Notes 4 and 5)                                                                                            |       | —             |        | 240,363                | ** ** |
| Borrowings under line of credit                                                                                                         |       | 120,300,000        |        | 49,993,000             | ** ** |
| Withholding taxes payable                                                                                                               |       | —             |        | 1,803,283              | ** ** |
| Accrued expenses and deferred liabilities                                                                                               |       | 486,330            |        | 721,287                | ** ** |
| Funds held in escrow                                                                                                                    |       | 203,222            |        | 203,193                | ** ** |
| TOTAL LIABILITIES                                                                                                                       |       | 121,692,059        |        | 53,212,728             | ** ** |
| NET ASSETS                                                                                                                              |       | $                  | 169,323,895 |                   | $          | 172,570,487 | ** ** |
|                                                                                                                                    |       |               |        |                   | ** ** |
| ANALYSIS OF NET ASSETS                                                                                                                  |       |               |        |                   | ** ** |
| Common stock, $0.001 par value, 50,000,000 shares authorized and  12,249,683 and 12,305,008 shares issued and outstanding, respectively |       | $                  | 12,250      |                   | $          | 12,305 | ** ** |
| Capital in excess of par value                                                                                                          |       | 179,782,427        |        | 181,270,565            | ** ** |
| Notes receivable – employees                                                                                                       |       | (9,947,366         | )           | (10,248,308            | **)**      |
| Net unrealized appreciation on investments                                                                                              |       | (1,282,764         | )           | 1,439,764              | ** ** |
| Unrealized depreciation on derivative                                                                                                   |       | (279,329           | )           | (253,716               | **)**      |
| Realized loss on sale of investments                                                                                                    |       | (775,176           | )           | (861,695               | **)**      |
| Realized gain on settlement of derivative                                                                                               |       | 37,807             |        | 15,014                 | ** ** |
| Accumulated undistributed net investment income                                                                                         |       | 1,776,046          |        | 1,196,558              | ** ** |
| TOTAL NET ASSETS                                                                                                                        |       | $                  | 169,323,895 |                   | $          | 172,570,487 | ** ** |
| NET ASSETS PER SHARE                                                                                                                    |       | $                  | 13.82       |                   | $          | 14.02 | ** ** |

 

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

2

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**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTSAS OF MARCH 31, 2007(UNAUDITED)**
| **Company (1)**               | ** ** | **Industry**                      | ** ** | **Investment (2)**                | ** ** | **Cost**   | ** ** | **Fair Value** | ** ** |
|------------------------------------|------------|-----------------------------------|------------|----------------------------------------|------------|------------|------------|---------------------|------------|
|                               |       |                              |       |                                   |       |       |       |                |       |
| ActivStyle Acquisition  Co.        |       | Service-medical  products         |       | Line  of Credit (5) (9)                |       | $          | 450,000    |                | $          | 448,875 |   |
| ActivStyle, Inc.                   |       | distribution                      |       | (9.6%,  Due 7/2009)                    |       |       |       |                |       |
|                               |       |                              |       | Senior  Term Debt (5)                  |       | 3,040,000  |       | 3,040,000           |       |
|                               |       |                              |       | (9.6%,  Due 7/2011)                    |       |       |       |                |       |
|                               |       |                              |       | Senior  Term Debt (3) (5)              |       | 2,500,000  |       | 2,500,000           |       |
|                               |       |                              |       | (11.9%,  Due 7/2011)                   |       |       |       |                |       |
|                               |       |                              |       |                                   |       |       |       |                |       |
| Advanced Homecare                  |       | Service-home  health nursing      |       | Senior  Subordinated Term Debt (5) (6) |       | 6,300,000  |       | 6,300,000           |       |
| Management, Inc.                   |       | services                          |       | (11.8%,  Due 12/2013)                  |       |       |       |                |       |
|                               |       |                              |       |                                   |       |       |       |                |       |
| Allied Extruders, LLC              |       | Manufacturing-polyethylene        |       | Senior  Real Estate Term Debt          |       | 1,000,000  |       | 1,000,000           |       |
| P&O Packaging  Acquisition LLC |       | film                              |       | (9.8%,  Due 3/2011)                    |       |       |       |                |       |
|                               |       |                              |       | Senior  Term Debt (3) (5) (19)         |       | 8,000,000  |       | 8,170,800           |       |
|                               |       |                              |       | (11.3%,  Due 3/2011)                   |       |       |       |                |       |
|                               |       |                              |       |                                   |       |       |       |                |       |
| Anitox Acquisition  Company        |       | Manufacturing-preservatives  for  |       | Senior  Real Estate Term Debt          |       | 3,415,828  |       | 3,360,000           |       |
| Anitox Holding, Inc.               |       | animal  feed                      |       | (8.8%,  Due 1/2012)                    |       |       |       |                |       |
|                               |       |                              |       | Senior  Term Debt (5)                  |       | 2,750,000  |       | 2,750,000           |       |
|                               |       |                              |       | (9.6%,  Due 1/2012)                    |       |       |       |                |       |
|                               |       |                              |       | Senior  Term Debt (3) (5)              |       | 2,750,000  |       | 2,750,000           |       |
|                               |       |                              |       | (11.8%,  Due 1/2012)                   |       |       |       |                |       |
|                               |       |                              |       |                                   |       |       |       |                |       |
| Badanco Acquisition  Corp.         |       | Service-luggage  design and       |       | Senior  Subordinated Term Debt (5)     |       | 9,750,000  |       | 9,762,188           |       |
|                               |       | distribution                      |       | (12.1%,  Due 7/2012)                   |       |       |       |                |       |
|                               |       |                              |       |                                   |       |       |       |                |       |
| Benetech, Inc.                     |       | Service  & Manufacturing-dust |       | Senior  Term Debt (5)                  |       | 1,787,500  |       | 1,816,547           |       |
|                               |       | management  systems for the       |       | (10.3%,  Due 5/2009)                   |       |       |       |                |       |
|                               |       | coal  and electric utility        |       | Senior  Term Debt (3) (5)              |       | 2,965,625  |       | 3,028,645           |       |
|                               |       | industries                        |       | (13.3%,  Due 5/2009)                   |       |       |       |                |       |
|                               |       |                              |       |                                   |       |       |       |                |       |
| Bresnan Communications,  LLC       |       | Service-telecommunications        |       | Senior  Term Debt (6)                  |       | 1,001,958  |       | 1,000,000           |       |
|                               |       |                              |       | (7.1%,  Due 9/2013)                    |       |       |       |                |       |
|                               |       |                              |       | Senior  Subordinated Term Debt (6)     |       | 1,510,780  |       | 1,530,000           |       |
|                               |       |                              |       | (9.9%,  Due 3/2014)                    |       |       |       |                |       |
|                               |       |                              |       |                                   |       |       |       |                |       |
| CHG Companies, Inc.                |       | Service-healthcare  staffing      |       | Letter  of Credit (5) (6)              |       | 400,000    |       | 404,500             |       |
| CHG Medical Staffing,  Inc.        |       |                              |       | (7.9%,  Due 12/2012)                   |       |       |       |                |       |
|                               |       |                              |       | Senior  Term Debt (5) (6)              |       | 1,596,000  |       | 1,613,955           |       |
|                               |       |                              |       | (7.9%,  Due 12/2012)                   |       |       |       |                |       |
|                               |       |                              |       | Senior  Subordinated Term Debt (5) (6) |       | 500,000    |       | 507,500             |       |
|                               |       |                              |       | (11.3%,  Due 12/2012)                  |       |       |       |                |       |
|                               |       |                              |       |                                   |       |       |       |                |       |
| Clinton Holdings, LLC              |       | Distribution-aluminum  sheets     |       | Senior  Subordinated Term Debt (5)     |       | 15,500,000 |       | 15,538,750          |       |
| Clinton Aluminum  Acquisition, LLC |       | and  stainless steel              |       | (12.6%,  Due 1/2013)                   |       |       |       |                |       |
| Metal Transportation,  LLC         |       |                              |       | Common  Stock Warrants (7)             |       | 109,124    |       | 109,124             |       |
| Clinton Distribution  Center, LLC  |       |                              |       |                                   |       |       |       |                |       |
|                               |       |                              |       |                                   |       |       |       |                |       |
|                                    |            |                                   |            |                                        |            |            |            |                     |            |  |  |

3

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF MARCH 31, 2007(UNAUDITED)**
| **Company (1)**                         | ** ** | **Industry**                      | ** ** | **Investment (2)**                | ** ** | **Cost**  | ** ** | **Fair Value** | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|----------------------------------------|------------|-----------|------------|---------------------|------------|
| Consolidated Bedding, Inc.                   |       | Manufacturing-mattresses          |       | Senior  Subordinated Term Debt (5)     |       | $         | 2,340,538  |                | $          | 1,858,050 |   |
|                                         |       |                              |       | (14.4%,  Due 3/2009)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Country Road                                 |       | Service-telecommunications        |       | Senior  Subordinated Term Debt (5) (6) |       | 5,964,420 |       | 6,030,000           |       |
| Communications LLC                           |       |                              |       | (13.2%,  Due 7/2013)                   |       |      |       |                |       |
| Country Road Management,  Inc.               |       |                              |       |                                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Critical Healthcare  Solutions, Inc.         |       | Service-home  therapy and         |       | Senior  Term Debt (8)                  |       | 1,987,500 |       | 1,986,258           |       |
|                                         |       | respiratory  therapy              |       | (8.6%,  Due 1/2012)                    |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Dealer Computer  Services, Inc.              |       | Manufacturing  & Service-     |       | Senior  Term Debt (8)                  |       | 947,240   |       | 954,936             |       |
| (d/b/a Reynolds &  Reynolds)             |       | Systems  for automotive retailers |       | (7.4%,  Due 10/2012)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Defiance Acquisition  Corporation            |       | Manufacturing-trucking  parts     |       | Senior  Term Debt (3) (5)              |       | 6,325,000 |       | 6,317,094           |       |
|                                         |       |                              |       | (13.3%,  Due 4/2010)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Doe & Ingalls  Management LLC            |       | Distributor-specialty  chemicals  |       | Senior  Term Debt (5)                  |       | 4,300,000 |       | 4,310,750           |       |
| Doe & Ingalls of  North Carolina         |       |                              |       | (9.8%,  Due 11/2010)                   |       |      |       |                |       |
| Operating LLC                                |       |                              |       | Senior  Term Debt (3) (5)              |       | 4,477,500 |       | 4,483,097           |       |
| Doe & Ingalls of  Florida Operating LLC  |       |                              |       | (13.3%,  Due 11/2010)                  |       |      |       |                |       |
| Doe & Ingalls of  Virginia Operating LLC |       |                              |       |                                   |       |      |       |                |       |
| Doe & Ingalls of  Maryland Operating LLC |       |                              |       |                                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Emdeon Business  Services, Inc.              |       | Service-healthcare  technology    |       | Senior  Term Debt (6)                  |       | 2,479,803 |       | 2,486,483           |       |
|                                         |       | solutions                         |       | (7.6%,  Due 11/2013)                   |       |      |       |                |       |
|                                         |       |                              |       | Senior  Subordinated Term Debt (6)     |       | 2,013,952 |       | 2,030,000           |       |
|                                         |       |                              |       | (10.4%,  Due 5/2014)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Employment Solutions                         |       | Service-specialty  staffing       |       | Senior  Term Debt (8)                  |       | 2,992,989 |       | 2,996,241           |       |
| Management, Inc.                             |       |                              |       | (8.3%,  Due 10/2012)                   |       |      |       |                |       |
| Employbridge                                 |       |                              |       | Senior  Subordinated Term Debt (8)     |       | 3,000,495 |       | 3,000,000           |       |
|                                         |       |                              |       | (12.3%,  Due 10/2013)                  |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Express Courier  International, Inc.         |       | Service-ground  delivery and      |       | Line  of Credit (10)                   |       | 200,000   |       | 200,000             |       |
|                                         |       | logistics                         |       | (9.6%,  Due 6/2009)                    |       |      |       |                |       |
|                                         |       |                              |       | Senior  Term Debt (5)                  |       | 4,465,000 |       | 4,470,581           |       |
|                                         |       |                              |       | (9.6%,  Due 6/2011)                    |       |      |       |                |       |
|                                         |       |                              |       | Senior  Term Debt (3) (5)              |       | 3,950,000 |       | 3,954,938           |       |
|                                         |       |                              |       | (11.8%,  Due 6/2011)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Finn Corporation                             |       | Manufacturing-landscape           |       | Common  Stock Warrants                 |       | 37,000    |       | 826,061             |       |
|                                         |       | equipment                         |       |                                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| FR X Ohmstede Holdings,  LLC                 |       | Service  & Manufacturing-heat |       | Senior  Term Debt (6)                  |       | 2,739,130 |       | 2,749,402           |       |
| FR X Ohmstede  Acquisitions Co.              |       | exchangers                        |       | (7.9%,  Due 8/2013)                    |       |      |       |                |       |
|                                         |       |                              |       | Senior  Subordinated Term Debt (6)     |       | 3,011,583 |       | 3,052,500           |       |
|                                         |       |                              |       | (12.4%,  Due 8/2014)                   |       |      |       |                |       |
|                                              |            |                                   |            |                                        |            |           |            |                     |            |  |  |

4

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF MARCH 31, 2007(UNAUDITED)**
| **Company (1)**                     | ** ** | **Industry**                      | ** ** | **Investment (2)**            | ** ** | **Cost**  | ** ** | **Fair Value** | ** ** |
|------------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|-----------|------------|---------------------|------------|
| Generac Acquisition  Corp.               |       | Manufacturing-standby  power      |       | Senior  Term Debt (8)              |       | $         | 2,356,200  |                | $          | 2,375,344 |   |
|                                     |       | products                          |       | (7.9%,  Due 11/2013)               |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| Global Materials                         |       | Manufacturing-steel  wool         |       | Senior  Term Debt (3) (5)          |       | 5,200,000 |       | 5,018,000           |       |
| Technologies, Inc.                       |       | products  and metal fibers        |       | (14.3%,  Due 11/2009)              |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| GTM Holdings, Inc.                       |       | Manufacturing-socks               |       | Senior  Term Debt (6)              |       | 498,750   |       | 501,244             |       |
| Gold Toe Investment  Corp.               |       |                              |       | (8.1%,  Due 10/2013)               |       |      |       |                |       |
|                                     |       |                              |       | Senior  Subordinated Term Debt (6) |       | 500,000   |       | 507,500             |       |
|                                     |       |                              |       | (11.4%,  Due 4/2014)               |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| Greatwide Logistics                      |       | Service  - logistics and          |       | Senior  Term Debt (6)              |       | 3,990,000 |       | 4,009,950           |       |
| Services, Inc.                           |       | transportation                    |       | (8.6%,  Due 12/2013)               |       |      |       |                |       |
|                                     |       |                              |       | Senior  Subordinated Term Debt (6) |       | 4,000,000 |       | 3,960,000           |       |
|                                     |       |                              |       | (11.9%,  Due 6/2014)               |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| Harrington Holdings,  Inc.               |       | Service  - healthcare products    |       | Senior  Term Debt (6)              |       | 2,500,000 |       | 2,506,250           |       |
| Harrington Acquisition  Corp.            |       | distribution                      |       | (7.8%,  Due 1/2014)                |       |      |       |                |       |
|                                     |       |                              |       | Senior  Subordinated Term Debt (6) |       | 5,000,000 |       | 5,025,000           |       |
|                                     |       |                              |       | (11.3%,  Due 1/2014)               |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| Hudson Products  Holdings, Inc.          |       | Manufacturing-heat  transfer      |       | Senior  Term Debt (8)              |       | 2,141,257 |       | 2,148,664           |       |
|                                     |       | solutions                         |       | (8.1%,  Due 12/2013)               |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| IPC Information Systems,  LLC            |       | Manufacturing-specialized         |       | Senior  Term Debt (6)              |       | 236,810   |       | 238,290             |       |
|                                     |       | telephony  systems                |       | (7.9%,  Due 9/2013)                |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| It’s Just Lunch  International, LLC |       | Service-dating  service           |       | Line  of Credit (5) (11)           |       | 550,000   |       | 545,875             |       |
|                                     |       |                              |       | (9.3%,  Due 6/2009)                |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (5)              |       | 3,300,000 |       | 3,275,250           |       |
|                                     |       |                              |       | (9.6%,  Due 6/2011)                |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (3) (5) (11)     |       | 500,000   |       | 496,250             |       |
|                                     |       |                              |       | (11.8%,  Due 6/2011)               |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| John Henry Holdings,  Inc.               |       | Manufacturing-packaging           |       | Senior  Subordinated Term Debt (6) |       | 8,000,000 |       | 8,000,000           |       |
| Multi Packaging  Solutions, Inc.         |       | products                          |       | (12.3%,  Due 6/2011)               |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| Kinetek Acquisition  Corp.               |       | Manufacturing-custom              |       | Senior  Term Debt (6)              |       | 1,505,605 |       | 1,507,157           |       |
|                                     |       | engineered  motors & controls |       | (7.8%,  Due 11/2013)               |       |      |       |                |       |
|                                     |       |                              |       | Senior  Subordinated Term Debt (6) |       | 1,509,548 |       | 1,515,000           |       |
|                                     |       |                              |       | (10.8%,  Due 5/2014)               |       |      |       |                |       |
|                                     |       |                              |       |                               |       |      |       |                |       |
| LocalTel, Inc.                           |       | Service-yellow  pages             |       | Line  of Credit (5) (12)           |       | 1,035,000 |       | 983,250             |       |
|                                     |       | publishing                        |       | (9.8%,  Due 6/2009)                |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (5)              |       | 2,687,500 |       | 2,418,750           |       |
|                                     |       |                              |       | (9.8%,  Due 6/2011)                |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (3) (5)          |       | 2,750,000 |       | 2,337,500           |       |
|                                     |       |                              |       | (12.3%,  Due 6/2011)               |       |      |       |                |       |
|                                          |            |                                   |            |                                    |            |           |            |                     |            |  |  |

5

----

**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF MARCH 31, 2007(UNAUDITED)**
| **Company (1)**                 | ** ** | **Industry**                      | ** ** | **Investment (2)**               | ** ** | **Cost**  | ** ** | **Fair Value** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|-----------|------------|---------------------|------------|
| MediMedia USA Inc.                   |       | Service-healthcare  and           |       | Senior  Term Debt (8)                 |       | $         | 1,074,835  |                | $          | 1,075,667 |   |
|                                 |       | pharmaceutical  marketing         |       | (7.8%,  Due 10/2013)                  |       |      |       |                |       |
|                                 |       |                              |       |                                  |       |      |       |                |       |
| Meteor Holding  Corporation          |       | Manufacturing-bar  code scanning  |       | Senior  Term Debt (6)                 |       | 997,500   |       | 1,002,488           |       |
| Metrologic Instruments,  Inc.        |       | and  data capture                 |       | (8.1%,  Due 12/2013)                  |       |      |       |                |       |
|                                 |       |                              |       | Senior  Subordinated Term Debt (6)    |       | 500,000   |       | 505,000             |       |
|                                 |       |                              |       | (11.8%,  Due 12/2013)                 |       |      |       |                |       |
|                                 |       |                              |       |                                  |       |      |       |                |       |
| Northern Contours                    |       | Manufacturing-veneer  and         |       | Senior  Subordinated Term Debt (5)    |       | 7,000,000 |       | 7,026,250           |       |
| Northern Contours of  Kentucky, Inc. |       | laminate  components              |       | (12.3%,  Due 5/2010)                  |       |      |       |                |       |
| Norcon Holding LLC                   |       |                              |       |                                  |       |      |       |                |       |
| Norcon Lewis LLC                     |       |                              |       |                                  |       |      |       |                |       |
|                                 |       |                              |       |                                  |       |      |       |                |       |
| Pinnacle Treatment  Centers, Inc.    |       | Service-Addiction  treatment      |       | Line  of Credit (13)                  |       | —    |       | —              |       |
|                                 |       | centers                           |       | (9.6%,  Due 12/2009)                  |       |      |       |                |       |
|                                 |       |                              |       | Senior  Term Debt (5)                 |       | 2,500,000 |       | 2,500,000           |       |
|                                 |       |                              |       | (9.6%,  Due 12/2011)                  |       |      |       |                |       |
|                                 |       |                              |       | Senior  Term Debt (3)(5)              |       | 4,500,000 |       | 4,500,000           |       |
|                                 |       |                              |       | (12.3%,  Due 12/2011)                 |       |      |       |                |       |
|                                 |       |                              |       |                                  |       |      |       |                |       |
| Precision Acquisition  Group         |       | Manufacturing-consumable          |       | Equipment  Note (14)                  |       | —    |       | —              |       |
| Holdings, Inc.                       |       | components  for the aluminum      |       | (9.8%,  Due 10/2011)                  |       |      |       |                |       |
| Precision Asset  Acquisition         |       | industry                          |       | Senior  Term Debt (5)                 |       | 5,000,000 |       | 5,012,500           |       |
| Company, LLC                         |       |                              |       | (9.8%,  Due 10/2010)                  |       |      |       |                |       |
|                                 |       |                              |       | Senior  Term Debt (3)(5)              |       | 4,200,000 |       | 4,210,500           |       |
|                                 |       |                              |       | (11.8%,  Due 10/2010)                 |       |      |       |                |       |
|                                 |       |                              |       |                                  |       |      |       |                |       |
| PROFITSystems Acquisition  Co.       |       | Service-design  and develop       |       | Line  of Credit (15)                  |       | —    |       | —              |       |
| PROFITSystems, Inc.                  |       | ERP  software                     |       | (9.6%,  Due 7/2009)                   |       |      |       |                |       |
|                                 |       |                              |       | Senior  Term Debt (5)                 |       | 2,950,000 |       | 2,957,375           |       |
|                                 |       |                              |       | (9.6%,  Due 7/2011)                   |       |      |       |                |       |
|                                 |       |                              |       | Senior  Term Debt (3)(5)              |       | 2,900,000 |       | 2,907,250           |       |
|                                 |       |                              |       | (11.8%,  Due 7/201)                   |       |      |       |                |       |
|                                 |       |                              |       |                                  |       |      |       |                |       |
| Puerto Rico Cable                    |       | Service-telecommunications        |       | Senior  Subordinated Term Debt (5)(6) |       | 7,805,906 |       | 7,794,524           |       |
| Acquisition Company,  Inc.           |       |                              |       | (11.6%,  Due 1/2012)                  |       |      |       |                |       |
|                                 |       |                              |       |                                  |       |      |       |                |       |
| Rally Parts, Inc.                    |       | Manufacturing-aftermarket         |       | Senior  Term Debt (8)                 |       | 1,193,021 |       | 1,198,153           |       |
| Motorsport Aftermarket  Group, Inc.  |       | motorcycle  parts and accessories |       | (7.9%,  Due 11/2013)                  |       |      |       |                |       |
|                                 |       |                              |       |                                  |       |      |       |                |       |
|                                 |       |                              |       |                                  |       |      |       |                |       |
| RCS Management Holding  Co.          |       | Service-healthcare  supplies      |       | Senior  Term Debt (3) (5)             |       | 3,000,000 |       | 2,925,000           |       |
|                                 |       |                              |       | (9.8%,  Due 1/2011)                   |       |      |       |                |       |
|                                 |       |                              |       | Senior  Term Debt (4) (5)             |       | 3,000,000 |       | 2,910,000           |       |
|                                 |       |                              |       | (12.3%,  Due 1/2011)                  |       |      |       |                |       |
|                                      |            |                                   |            |                                       |            |           |            |                     |            |  |  |

6

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF MARCH 31, 2007(UNAUDITED)**
| **Company (1)**             | ** ** | **Industry**                   | ** ** | **Investment (2)**            | ** ** | **Cost**   | ** **      | **Fair Value** | ** ** |
|----------------------------------|------------|--------------------------------|------------|------------------------------------|------------|------------|-----------------|---------------------|------------|
| RedPrairie Holding, Inc.         |       | Service-design  and develop    |       | Senior  Term Debt (6)              |       | $          | 4,480,000       |                | $          | 4,480,000 |   |
| RedPrairie Corporation           |       | supply  chain software         |       | (8.4%,  Due 7/2012)                |       |       |            |                |       |
| Blue Cube Software, Inc.         |       |                           |       | Senior  Subordinated Term Debt (6) |       | 3,000,000  |            | 3,030,000           |       |
|                             |       |                           |       | (11.9%,  Due 1/2013)               |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| RiskMetrics Group  Holdings, LLC |       | Service  - develop risk and    |       | Senior  Term Debt (6)              |       | 2,000,000  |            | 2,012,500           |       |
|                             |       | wealth  management solutions   |       | (7.6%,  Due 1/2014)                |       |       |            |                |       |
|                             |       |                           |       | Senior  Subordinated Term Debt (6) |       | 500,000    |            | 507,500             |       |
|                             |       |                           |       | (10.6%,  Due 7/2014)               |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| RMK Acquisition  Corporation     |       | Service  - vending services    |       | Letter  of Credit (8)              |       | 65,841     |            | 66,171              |       |
| ARAMARK Corporation              |       |                           |       | (7.5%,  Due 1/2014)                |       |       |            |                |       |
|                             |       |                           |       | Senior  Term Debt (8)              |       | 921,289    |            | 925,895             |       |
|                             |       |                           |       | (7.5%,  Due 1/2014)                |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| SCPH Holdings, Inc.              |       | Manufacturing-underwater       |       | Credit  Facility (5) (16)          |       | 500,000    |            | 500,000             |       |
| Sea Con Phoenix, Inc.            |       | and  harsh environment         |       | (9.8%,  Due 2/2008)                |       |       |            |                |       |
| Phoenix Optix, Inc.              |       | components                     |       | Senior  Term Debt (5)              |       | 2,275,000  |            | 2,277,844           |       |
|                             |       |                           |       | (10.3%,  Due 2/2010)               |       |       |            |                |       |
|                             |       |                           |       | Senior  Term Debt (3) (5) (20)     |       | 2,812,500  |            | 2,913,750           |       |
|                             |       |                           |       | (13.3%,  Due 2/2010)               |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| SCS Acquisition Corp.            |       | Service-chemically  treated    |       | Senior  Term Debt (5) (17)         |       | 5,625,000  |            | 5,632,031           |       |
| (d/b/a Specialty  Coatings       |       | equipment  distribution        |       | (9.3%,  Due 12/2011)               |       |       |            |                |       |
| Systems)                         |       |                           |       | Senior  Term Debt (3) (5) (17)     |       | 6,550,000  |            | 6,558,188           |       |
|                             |       |                           |       | (11.3%,  Due 12/2011)              |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| Thibaut Acquisition Co.          |       | Service-design  and disbribute |       | Credit  Facility (5) (18)          |       | 500,000    |            | 500,000             |       |
|                             |       | wall  covering                 |       | (9.8%,  Due 1/2011)                |       |       |            |                |       |
|                             |       |                           |       | Senior  Term Debt (5)              |       | 3,062,500  |            | 3,066,328           |       |
|                             |       |                           |       | (9.8%,  Due 1/2011)                |       |       |            |                |       |
|                             |       |                           |       | Senior  Term Debt (3) (5)          |       | 3,000,000  |            | 3,003,750           |       |
|                             |       |                           |       | (12.3%,  Due 1/2011)               |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| Visual Edge Technology,  Inc.    |       | Service-office  equipment      |       | Senior  Subordinated Term Debt (5) |       | 5,000,000  |            | 3,750,000           |       |
| Graphic Enterprises,  Inc.       |       | distribution                   |       | (13.3%,  Due 8/2011)               |       |       |            |                |       |
| Copeco, Inc.                     |       |                           |       |                               |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| Wesco Holdings, Inc.             |       | Service-aerospace  parts and   |       | Senior  Term Debt (6)              |       | 2,525,125  |            | 2,518,750           |       |
| Wesco Aircraft Hardware  Corp.   |       | distribution                   |       | (7.6%,  Due 9/2013)                |       |       |            |                |       |
|                             |       |                           |       | Senior  Subordinated Term Debt (6) |       | 2,272,298  |            | 2,295,000           |       |
|                             |       |                           |       | (11.1%,  Due 3/2014)               |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| Westlake Hardware, Inc.          |       | Retail-hardware  and variety   |       | Senior  Subordinated Term Debt (5) |       | 15,000,000 |            | 14,943,750          |       |
| WHI Holding Corp.                |       |                           |       | (12.6%,  Due 1/2011)               |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| Winchester Electronics           |       | Manufacturing-high  bandwidth  |       | Senior  Term Debt (3) (5)          |       | 6,000,000  |            | 6,015,000           |       |
|                             |       | connectors  and cables         |       | (12.3%,  Due 6/2012)               |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| WP Evenflo Group  Holdings Inc.  |       | Manufacturing-infant  and      |       | Senior  Term Debt (6)              |       | 1,995,000  |            | 2,004,975           |       |
| WP Evenflo Acquisition,  Inc.    |       | juvenile  products             |       | (7.8%,  Due 2/2013)                |       |       |            |                |       |
|                             |       |                           |       | Senior  Subordinated Term Debt (6) |       | 2,000,000  |            | 2,010,000           |       |
|                             |       |                           |       | (11.3%,  Due 2/2014)               |       |       |            |                |       |
|                             |       |                           |       |                               |       |       |            |                |       |
| **Total:**                       | ** ** | ** **                     | ** ** | ** **                         | ** ** | **$**      | **281,525,450** | ** **          | **$**      | **280,242,688** | ** ** |

 

7

----

 

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

(2) Percentage represents interest rates in effect at March 31,2007 and due date represents the contractual maturity date.

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

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

(5) Fair value was based on opinions of value submitted byStandard & Poor’s Securities Evaluations, Inc.

(6) Marketable securities, such as syndicated loans, are valuedbased on the indicative bid price, as of March 30, 2007, from the respectiveoriginating syndication agent’s trading desk.

(7)  Investment valued atcost due to recent acquisition.

(8)  Investment valued atpending trade amount.

(9) Availability under the credit facility totals $1,500,000.  Borrowings of $450,000 were outstanding atMarch 31, 2007.

(10) Availability under the credit facility totals$1,500,000.  Borrowings of $200,000 wereoutstanding at March 31, 2007.

(11) Remaining availability under the revolving credit facilitytotals $200,000, borrowings of $550,000 were outstanding at March31, 2007.  The company may borrow an additional$1,750,000 of the senior term debt facility, subject to certain conditionsincluding Gladstone Capital’s approval, borrowings of $500,000 were outstandingat March 31, 2007.

(12) Availability under the credit facility totals $2,000,000.  Borrowings of $1,035,000 were outstanding atMarch 31, 2007.

(13) Availability under the credit facility totals $500,000.  There were no borrowings outstanding at March31, 2007.

(14) The company may borrow up to $1,000,000 for purposes of acquiringequipment. There were no borrowings outstanding at March 31, 2007.

(15) Availability under the credit facility totals$1,250,000.  There were no borrowingsoutstanding at March 31, 2007.

(16) Availability under the credit facility totals $500,000.  Borrowings of $500,000 were outstanding atMarch 31, 2007.

(17) The company may borrow up to an additional $875,000 tofinance capital expenditures.

(18)  Availability under thecredit facility totals $1,000,000. Borrowings of $500,000 were outstanding at March 31, 2007.

(19)  Includes a success feewith a $180,800 fair value and no cost basis.

(20)  Includes a success feewith a $94,219 fair value and no cost basis.

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PARTOF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

 

8

----

**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTSAS OF SEPTEMBER 30, 2006**
| **Company (1)**                         | ** ** | **Industry**                      | ** ** | **Investment (2)**                | ** ** | **Cost**  | ** ** | **Fair Value** | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|----------------------------------------|------------|-----------|------------|---------------------|------------|
|                                         |       |                              |       |                                   |       |      |       |                |       |
| ActivStyle Acquisition  Co.                  |       | Service-medical  products         |       | Line  of Credit (16)                   |       | $         | —     |                | $          | — |   |
| ActivStyle, Inc.                             |       | distribution                      |       | (9.6%,  Due 7/2009)                    |       |      |       |                |       |
|                                         |       |                              |       | Senior  Term Debt (5)                  |       | 3,200,000 |       | 3,200,000           |       |
|                                         |       |                              |       | (9.6%,  Due 7/2011)                    |       |      |       |                |       |
|                                         |       |                              |       | Senior  Term Debt (3) (5)              |       | 2,500,000 |       | 2,500,000           |       |
|                                         |       |                              |       | (11.8%,  Due 7/2011)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Advanced Homecare  Management, Inc.          |       | Service-home  health nursing      |       | Senior  Subordinated Term Debt(5)(6)   |       | 5,000,000 |       | 5,000,000           |       |
|                                         |       | services                          |       | (11.33%,  Due 12/2013)                 |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Allied Extruders, LLC                        |       | Manufacturing-polyethylene        |       | Senior  Real Estate Term Debt          |       | 1,000,000 |       | 1,000,000           |       |
| P&O Packaging  Acquisition LLC           |       | film                              |       | (9.8%,  Due 3/2011)                    |       |      |       |                |       |
|                                         |       |                              |       | Senior  Term Debt (3) (5)              |       | 8,000,000 |       | 8,030,000           |       |
|                                         |       |                              |       | (11.3%,  Due 3/2011)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Badanco Acquisition  Corp.                   |       | Manufacturing-luggage             |       | Senior  Term Debt (5)                  |       | 5,145,019 |       | 5,157,881           |       |
|                                         |       |                              |       | (10.8%,  Due 2/2010)                   |       |      |       |                |       |
|                                         |       |                              |       | Senior  Term Debt (3) (5)              |       | 8,585,125 |       | 8,628,051           |       |
|                                         |       |                              |       | (13.8%,  Due 2/2010)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Benetech, Inc.                               |       | Service  & Manufacturing-dust |       | Senior  Term Debt (5)                  |       | 2,112,500 |       | 2,144,187           |       |
|                                         |       | management  systems for the       |       | (10.3%,  Due 5/2009)                   |       |      |       |                |       |
|                                         |       | coal  and electric utility        |       | Senior  Term Debt (3) (5)              |       | 3,046,875 |       | 3,107,813           |       |
|                                         |       | industries                        |       | (13.3%,  Due 5/2009)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Bresnan Communications,  LLC                 |       | Service-telecommunications        |       | Senior  Term Debt (6)                  |       | 1,002,115 |       | 997,500             |       |
|                                         |       |                              |       | (7.2%,  Due 9/2013)                    |       |      |       |                |       |
|                                         |       |                              |       | Senior  Subordinated Term Debt         |       | 1,511,554 |       | 1,533,750           |       |
|                                         |       |                              |       | (9.9%,  Due 3/2014)                    |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Consolidated Bedding,  Inc.                  |       | Manufacturing-mattresses          |       | Senior  Subordinated Term Debt (5)     |       | 2,438,359 |       | 2,306,991           |       |
|                                         |       |                              |       | (14.4%,  Due 3/2009)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Country Road                                 |       | Service-telecommunications        |       | Senior  Subordinated Term Debt (5) (6) |       | 5,961,594 |       | 6,015,000           |       |
| Communications LLC                           |       |                              |       | (13.3%,  Due 7/2013)                   |       |      |       |                |       |
| Country Road Management,  Inc.               |       |                              |       |                                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Defiance Stamping Company                    |       | Manufacturing-trucking  parts     |       | Senior  Term Debt (3) (5)              |       | 6,325,000 |       | 6,332,906           |       |
|                                         |       |                              |       | (13.3%,  Due 4/2010)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Doe & Ingalls  Management LLC            |       | Distributor-specialty  chemicals  |       | Senior  Term Debt (5)                  |       | 4,700,000 |       | 4,723,500           |       |
| Doe & Ingalls of  North Carolina         |       |                              |       | (9.8%,  Due 11/2010)                   |       |      |       |                |       |
| Operating LLC                                |       |                              |       | Senior  Term Debt (3) (5)              |       | 4,500,000 |       | 4,516,875           |       |
| Doe & Ingalls of  Florida Operating LLC  |       |                              |       | (13.3%,  Due 11/2010)                  |       |      |       |                |       |
| Doe & Ingalls of  Virginia Operating LLC |       |                              |       |                                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Express Courier  International, Inc.         |       | Service-ground  delivery and      |       | Line  of Credit (7)                    |       | —    |       | —              |       |
|                                         |       | logistics                         |       | (9.6%,  Due 6/2009)                    |       |      |       |                |       |
|                                         |       |                              |       | Senior  Term Debt (5)                  |       | 4,700,000 |       | 4,700,000           |       |
|                                         |       |                              |       | (9.6%,  Due 6/2011)                    |       |      |       |                |       |
|                                         |       |                              |       | Senior  Term Debt (3) (5)              |       | 3,950,000 |       | 3,950,000           |       |
|                                         |       |                              |       | (11.8%,  Due 6/2011)                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
| Finn Corporation                             |       | Manufacturing-landscape           |       | Common  Stock Warrants                 |       | 37,000    |       | 709,431             |       |
|                                         |       | equipment                         |       |                                   |       |      |       |                |       |
|                                         |       |                              |       |                                   |       |      |       |                |       |
|                                              |            |                                   |            |                                        |            |           |            |                     |            |  |  |

9

----

**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF SEPTEMBER 30, 2006**
| **Company (1)**                     | ** ** | **Industry**                      | ** ** | **Investment (2)**               | ** ** | **Cost**  | ** ** | **Fair Value** | ** ** |
|------------------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|-----------|------------|---------------------|------------|
| FR X Ohmstede Holdings,  LLC             |       | Service  & Manufacturing-heat |       | Senior  Term Debt (6)                 |       | $         | 3,000,000  |                | $          | 3,026,250 |   |
| FR X Ohmstede  Acquisitions Co.          |       | exchangers                        |       | (8.5%,  Due 8/2013)                   |       |      |       |                |       |
|                                     |       |                              |       | Senior  Subordinated Term Debt (6)    |       | 3,012,369 |       | 3,030,000           |       |
|                                     |       |                              |       | (12.5%,  Due 8/2014)                  |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| Global Materials                         |       | Manufacturing-steel  wool         |       | Senior  Term Debt (3) (5)             |       | 5,300,000 |       | 5,233,750           |       |
| Technologies, Inc.                       |       | products  and metal fibers        |       | (14.3%,  Due 11/2009)                 |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| It’s Just Lunch  International, LLC |       | Service-dating  service           |       | Line  of Credit (12) (5)              |       | 200,000   |       | 199,500             |       |
|                                     |       |                              |       | (9.2%,  Due 6/2009)                   |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (13) (5)            |       | 3,300,000 |       | 3,291,750           |       |
|                                     |       |                              |       | (9.6%,  Due 6/2011)                   |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (3) (14)            |       | —    |       | —              |       |
|                                     |       |                              |       | (11.8%,  Due 6/2011)                  |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| John Henry Holdings,  Inc.               |       | Manufacturing-packaging           |       | Senior  Subordinated Term Debt (6)    |       | 8,000,000 |       | 8,000,000           |       |
| Multi Packaging  Solutions, Inc.         |       | products                          |       | (12.5%,  Due 6/2011)                  |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| LocalTel, Inc.                           |       | Service-yellow  pages             |       | Line  of Credit (5) (15)              |       | 350,000   |       | 343,000             |       |
|                                     |       | publishing                        |       | (9.8%,  Due 6/2009)                   |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (5)                 |       | 2,687,500 |       | 2,633,750           |       |
|                                     |       |                              |       | (9.8%,  Due 6/2011)                   |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (3) (5)             |       | 2,750,000 |       | 2,695,000           |       |
|                                     |       |                              |       | (12.3%,  Due 6/2011)                  |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| Mistras Holdings Corp.                   |       | Service  & Manufacturing-     |       | Senior  Term Debt (3) (5)             |       | 9,499,999 |       | 9,737,499           |       |
|                                     |       | nondestructive  testing           |       | (11.5%,  Due 8/2008)                  |       |      |       |                |       |
|                                     |       | instruments,  systems             |       | Senior  Term Debt (4) (5) (18)        |       | 5,250,001 |       | 5,620,124           |       |
|                                     |       | and  services                     |       | (12.5%,  Due 8/2008)                  |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| Network Solutions LLC                    |       | Service-internet  domain registry |       | Senior  Term Debt (6)                 |       | 4,464,358 |       | 4,499,747           |       |
|                                     |       | and  host                         |       | (10.4%,  Due 1/2012)                  |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| Northern Contours                        |       | Manufacturing-veneer  and         |       | Senior  Subordinated Term Debt (5)    |       | 7,000,000 |       | 7,017,500           |       |
| Northern Contours of  Kentucky, Inc.     |       | laminate  components              |       | (12.3%,  Due 5/2010)                  |       |      |       |                |       |
| Norcon Holding LLC                       |       |                              |       |                                  |       |      |       |                |       |
| Norcon Lewis LLC                         |       |                              |       |                                  |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| PROFITSystems  Acquisition Co.           |       | Service-design  and develop       |       | Line  of Credit (17)                  |       | —    |       | —              |       |
| PROFITSystems, Inc.                      |       | ERP  software                     |       | (9.6%,  Due 7/2009)                   |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (5)                 |       | 3,100,000 |       | 3,100,000           |       |
|                                     |       |                              |       | (9.6%,  Due 7/2011)                   |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (5)                 |       | 2,900,000 |       | 2,900,000           |       |
|                                     |       |                              |       | (11.8%,  Due 7/201) (3)               |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| Puerto Rico Cable                        |       | Service-telecommunications        |       | Senior  Subordinated Term Debt (5)(6) |       | 7,813,274 |       | 7,775,183           |       |
| Acquisition Company,  Inc.               |       |                              |       | (11.6%,  Due 1/2012)                  |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
| QCE, LLC (d/b/a Quiznos  Corp.)          |       | Service-restaurant  franchisor    |       | Senior  Term Debt (6)                 |       | 3,010,713 |       | 2,977,538           |       |
|                                     |       |                              |       | (7.6%,  Due 5/2013)                   |       |      |       |                |       |
|                                     |       |                              |       | Senior  Term Debt (3) (6)             |       | 3,045,560 |       | 3,033,750           |       |
|                                     |       |                              |       | (11.1%,  Due 11/2013)                 |       |      |       |                |       |
|                                     |       |                              |       |                                  |       |      |       |                |       |
|                                          |            |                                   |            |                                       |            |           |            |                     |            |  |  |

10

----

**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF SEPTEMBER 30, 2006**
| **Company (1)**          | ** ** | **Industry**                   | ** ** | **Investment (2)**            | ** ** | **Cost**   | ** **      | **Fair Value** | ** ** |
|-------------------------------|------------|--------------------------------|------------|------------------------------------|------------|------------|-----------------|---------------------|------------|
| RCS Management Holding  Co.   |       | Service-healthcare  supplies   |       | Senior  Term Debt (3) (5)          |       | $          | 3,000,000       |                | $          | 3,003,750 |   |
|                          |       |                           |       | (9.8%,  Due 1/2011)                |       |       |            |                |       |
|                          |       |                           |       | Senior  Term Debt (4) (5)          |       | 3,000,000  |            | 3,003,750           |       |
|                          |       |                           |       | (12.3%,  Due 1/2011)               |       |       |            |                |       |
|                          |       |                           |       |                               |       |       |            |                |       |
| RedPrairie Holding, Inc.      |       | Service-design  and develop    |       | Senior  Term Debt (6)              |       | 3,990,000  |            | 3,990,000           |       |
| RedPrairie Corporation        |       | supply  chain software         |       | (8.4%,  Due 7/2012)                |       |       |            |                |       |
| Blue Cube Software, Inc.      |       |                           |       | Senior  Subordinated Term Debt (6) |       | 2,000,000  |            | 2,005,000           |       |
|                          |       |                           |       | (11.9%,  Due 1/2013)               |       |       |            |                |       |
|                          |       |                           |       |                               |       |       |            |                |       |
| SCPH Holdings, Inc.           |       | Manufacturing-underwater       |       | Credit  Facility (8)               |       | —     |            | —              |       |
| Sea Con Phoenix, Inc.         |       | and  harsh environment         |       | (9.8%,  Due 2/2007)                |       |       |            |                |       |
| Phoenix Optix, Inc.           |       | components                     |       | Senior  Term Debt (5)              |       | 2,625,000  |            | 2,631,563           |       |
|                          |       |                           |       | (10.3%,  Due 2/2010)               |       |       |            |                |       |
|                          |       |                           |       | Senior  Term Debt (3) (5)          |       | 2,887,500  |            | 2,898,328           |       |
|                          |       |                           |       | (13.3%,  Due 2/2010)               |       |       |            |                |       |
|                          |       |                           |       |                               |       |       |            |                |       |
| SCS Acquisition Corp.         |       | Service-chemically  treated    |       | Senior  Term Debt (3) (5) (9)      |       | 6,250,000  |            | 6,257,812           |       |
|                          |       | equipment  distribution        |       | (9.3%,  Due 12/2011)               |       |       |            |                |       |
|                          |       |                           |       | Senior  Term Debt (3) (5) (10)     |       | 6,568,750  |            | 6,576,961           |       |
|                          |       |                           |       | (11.3%,  Due 12/2011)              |       |       |            |                |       |
|                          |       |                           |       |                               |       |       |            |                |       |
| Thibaut Acquisition Co.       |       | Design  and Disbtribution-wall |       | Credit  Facility (11)              |       | —     |            | —              |       |
|                          |       | coverings                      |       | (9.8%,  Due 1/2011)                |       |       |            |                |       |
|                          |       |                           |       | Senior  Term Debt (5)              |       | 3,325,000  |            | 3,325,000           |       |
|                          |       |                           |       | (9.8%,  Due 1/2011)                |       |       |            |                |       |
|                          |       |                           |       | Senior  Term Debt (3) (5)          |       | 3,000,000  |            | 3,000,000           |       |
|                          |       |                           |       | (12.3%,  Due 1/2011)               |       |       |            |                |       |
|                          |       |                           |       |                               |       |       |            |                |       |
| Visual Edge Technology,  Inc. |       | Service-office  equipment      |       | Senior  Subordinated Term Debt (5) |       | 5,000,000  |            | 4,987,500           |       |
| Graphic Enterprises,  Inc.    |       | distribution                   |       | (13.3%,  Due 8/2011)               |       |       |            |                |       |
| Copeco, Inc.                  |       |                           |       |                               |       |       |            |                |       |
|                          |       |                           |       |                               |       |       |            |                |       |
| Westlake Hardware, Inc.       |       | Retail-hardware  and variety   |       | Senior  Subordinated Term Debt (5) |       | 15,000,000 |            | 14,981,250          |       |
| WHI Holding Corp.             |       |                           |       | (12.6%,  Due 1/2011)               |       |       |            |                |       |
|                          |       |                           |       |                               |       |       |            |                |       |
| Winchester Electronics        |       | Manufacturing-high  bandwidth  |       | Senior  Term Debt (3) (5)          |       | 6,000,000  |            | 6,007,500           |       |
|                          |       | connectors  and cables         |       | (12.3%,  Due 6/2012)               |       |       |            |                |       |
|                          |       |                           |       |                               |       |       |            |                |       |
| Xspedius Communications LLC   |       | Service-telecommunications     |       | Senior  Subordinated Term Debt (5) |       | 5,157,821  |            | 5,306,110           |       |
|                          |       |                           |       | (15.8%,  Due 3/2010)               |       |       |            |                |       |
|                          |       |                           |       |                               |       |       |            |                |       |
| **Total:**                    |       |                           |       |                               |       | **$**      | **216,202,986** |                | **$**      | **217,642,750** |   |

----

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

(2) Percentage represents interest rates in effect at September30, 2006 and due date represents the contractual maturity date.

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

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

(5) Fair value was based on opinions of value submitted byStandard & Poor’s Securities Evaluations, Inc.

(6) Marketable securities, such as syndicated loans, are valuedbased on the indicative bid price, as of September 30, 2006 from the respectiveoriginating syndication agent’s trading desk.

(7) Availability under the credit facility totals $1,500,000.  There were no borrowings outstanding atSeptember 30, 2006.

(8) Availability under the credit facility totals $500,000.  There were no borrowings outstanding atSeptember 30, 2006.

(9) Availability under the debt facility totals $7,500,000. Theoutstanding balance of the debt facility was $6,250,000 at September 30, 2006.

(10) Availability under the debt facility totals $7,500,000. Theoutstanding balance of the debt facility was $6,568,750 at September 30, 2006.

(11) Availability under the credit facility totals$1,000,000.  There were no borrowingsoutstanding at September 30, 2006.

11

----

(12) Availability under the credit facility totals $750,000.  Borrowings of $200,000 were outstanding atSeptember 30, 2006.

(13) The company may borrow an additional $500,000 under thesenior term debt facility, subject to certain conditions including GladstoneCapital’s approval.

(14) The company may borrow an additional $2,250,000 under thesenior term debt facility, subject to certain conditions including GladstoneCapital’s approval.

(15) Availability under the credit facility totals$3,000,000.  Borrowings of $350,000 wereoutstanding at September 30, 2006.

(16) Availability under the credit facility totals$1,500,000.  There were no borrowingsoutstanding at September 30, 2006

(17) Availability under the credit facility totals$1,250,000.  There were no borrowingsoutstanding at September 30, 2006

(18) Includes asuccess fee with a fair value of $742,000 and no cost basis.

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PARTOF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

 

12

----

 

**GLADSTONE CAPITALCORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| INVESTMENT INCOME                                                            |       |                                                 |       |   |   |
| Interest income –  investments                                          |       | $                                                    | 8,254,459  |   | $ | 6,875,264 |   |
| Interest income –  cash and cash equivalents                            |       | 31,645                                               |       | 4,624 |   |
| Interest income –  notes receivable from employees                      |       | 132,931                                              |       | 107,033 |   |
| Prepayment fees  and other income                                            |       | 224,743                                              |       | 13,779 |   |
| Total investment  income                                                     |       | 8,643,778                                            |       | 7,000,700 |   |
|                                                                         |       |                                                 |       |   |   |
| EXPENSES                                                                     |       |                                                 |       |   |   |
| Interest expense                                                             |       | 1,811,019                                            |       | 948,166 |   |
| Loan servicing  (Refer to Notes 4 and 5)                                     |       | 760,623                                              |       | 734,644 |   |
| Base management  fee (Refer to Note 4)                                       |       | 450,484                                              |       | 352,379 |   |
| Incentive fee  (Refer to Note 4)                                             |       | 1,158,995                                            |       | — |   |
| Administration  fee (Refer to Note 4)                                        |       | 168,766                                              |       | — |   |
| Professional  fees                                                           |       | 109,081                                              |       | 110,887 |   |
| Amortization of  deferred financing fees                                     |       | 68,200                                               |       | 32,286 |   |
| Stockholder  related costs                                                   |       | 87,288                                               |       | 115,864 |   |
| Directors fees                                                               |       | 56,970                                               |       | 30,212 |   |
| Insurance  expense                                                           |       | 62,398                                               |       | 50,590 |   |
| Stock option  compensation                                                   |       | —                                               |       | 34,065 |   |
| Other expenses                                                               |       | 48,975                                               |       | 60,791 |   |
| Expenses before  credit from Adviser                                         |       | 4,782,799                                            |       | 2,469,884 |   |
| Credit to base  management and incentive fees from Adviser (Refer to Note 4) |       | (1,863,378                                           | )          | (673,000 | ) |
| Total expenses  net of credits to base management and incentive fees         |       | 2,919,421                                            |       | 1,796,884 |   |
|                                                                         |       |                                                 |       |   |   |
| NET INVESTMENT INCOME  BEFORE INCOME TAXES                                   |       | 5,724,357                                            |       | 5,203,816 |   |
| Income tax  expense                                                          |       | —                                               |       | — |   |
| NET INVESTMENT INCOME                                                        |       | 5,724,357                                            |       | 5,203,816 |   |
|                                                                         |       |                                                 |       |   |   |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS:                         |       |                                                 |       |   |   |
| Realized gain on  sale of investments                                        |       | 84,205                                               |       | 377,500 |   |
| Realized gain on  settlement of derivative                                   |       | 10,239                                               |       | — |   |
| Unrealized  (depreciation) appreciation on derivative                        |       | (15,801                                              | )          | 24,658 |   |
| Net unrealized  depreciation on investments                                  |       | (1,718,149                                           | )          | (15,593 | ) |
| Net (loss) gain  on investments                                              |       | (1,639,506                                           | )          | 386,565 |   |
|                                                                         |       |                                                 |       |   |   |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS                        |       | $                                                    | 4,084,851  |   | $ | 5,590,381 |   |
|                                                                         |       |                                                 |       |   |   |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS PER  COMMON SHARE:     |       |                                                 |       |   |   |
| Basic                                                                        |       | $                                                    | 0.33       |   | $ | 0.49 |   |
| Diluted                                                                      |       | $                                                    | 0.33       |   | $ | 0.48 |   |
|                                                                         |       |                                                 |       |   |   |
| WEIGHTED AVERAGE SHARES  OF COMMON STOCK OUTSTANDING:                        |       |                                                 |       |   |   |
| Basic                                                                        |       | 12,249,683                                           |       | 11,308,510 |   |
| Diluted                                                                      |       | 12,249,683                                           |       | 11,536,360 |   |

 

*THE ACCOMPANYINGNOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

13

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                                   | ** ** | **Six Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| INVESTMENT  INCOME                                                           |       |                                               |       |   |   |
| Interest income – investments                                           |       | $                                                  | 16,153,059 |   | $ | 12,722,371 |   |
| Interest income – cash and cash equivalents                             |       | 68,914                                             |       | 13,536 |   |
| Interest income – notes receivable from employees                       |       | 271,122                                            |       | 214,126 |   |
| Prepayment fees and other income                                             |       | 384,401                                            |       | 80,986 |   |
| Total investment income                                                      |       | 16,877,496                                         |       | 13,031,019 |   |
|                                                                         |       |                                               |       |   |   |
| EXPENSES                                                                     |       |                                               |       |   |   |
| Interest expense                                                             |       | 2,931,276                                          |       | 1,600,244 |   |
| Loan servicing (Refer to Notes 4 and 5)                                      |       | 1,479,775                                          |       | 1,450,059 |   |
| Base management fee (Refer to Note 4)                                        |       | 848,916                                            |       | 621,080 |   |
| Incentive fee (Refer to Note 4)                                              |       | 2,307,478                                          |       | — |   |
| Administration fee (Refer to Note 4)                                         |       | 294,851                                            |       | — |   |
| Professional fees                                                            |       | 220,001                                            |       | 233,353 |   |
| Amortization of deferred financing fees                                      |       | 126,500                                            |       | 58,536 |   |
| Stockholder related costs                                                    |       | 151,016                                            |       | 244,799 |   |
| Directors fees                                                               |       | 111,220                                            |       | 54,212 |   |
| Insurance expense                                                            |       | 125,092                                            |       | 101,367 |   |
| Stock option compensation                                                    |       | —                                             |       | 77,322 |   |
| General and administrative exepnses                                          |       | 137,460                                            |       | 116,580 |   |
| Expenses before credit from Adviser                                          |       | 8,733,585                                          |       | 4,557,552 |   |
| Credit to base management and incentive fees from  Adviser (Refer to Note 4) |       | (2,743,372                                         | )          | (1,223,000 | ) |
| Total expenses net of credits to base management and  incentive fees         |       | 5,990,213                                          |       | 3,334,552 |   |
|                                                                         |       |                                               |       |   |   |
| NET INVESTMENT  INCOME BEFORE INCOME TAXES                                   |       | 10,887,283                                         |       | 9,696,467 |   |
| Income tax expense                                                           |       | —                                             |       | 50,237 |   |
| NET INVESTMENT  INCOME                                                       |       | 10,887,283                                         |       | 9,646,230 |   |
|                                                                         |       |                                               |       |   |   |
| REALIZED AND  UNREALIZED GAIN (LOSS) ON INVESTMENTS:                         |       |                                               |       |   |   |
| Net realized gain (loss) on sale of investments                              |       | 86,519                                             |       | (803,095 | ) |
| Realized gain on settlement of derivative                                    |       | 22,793                                             |       | — |   |
| Unrealized (depreciation) appreciation on derivative                         |       | (25,613                                            | )          | 23,766 |   |
| Net unrealized (depreciation) appreciation on  investments                   |       | (2,722,528                                         | )          | 4,956,829 |   |
| Net (loss) gain on investments                                               |       | (2,638,829                                         | )          | 4,177,500 |   |
|                                                                         |       |                                               |       |   |   |
| NET INCREASE IN  NET ASSETS RESULTING FROM OPERATIONS                        |       | $                                                  | 8,248,454  |   | $ | 13,823,730 |   |
|                                                                         |       |                                               |       |   |   |
| NET INCREASE IN  NET ASSETS RESULTING FROM OPERATIONS PER  COMMON SHARE:     |       |                                               |       |   |   |
| Basic                                                                        |       | $                                                  | 0.67       |   | $ | 1.22 |   |
| Diluted                                                                      |       | $                                                  | 0.67       |   | $ | 1.20 |   |
|                                                                         |       |                                               |       |   |   |
| WEIGHTED AVERAGE  SHARES OF COMMON STOCK OUTSTANDING:                        |       |                                               |       |   |   |
| Basic                                                                        |       | 12,272,012                                         |       | 11,307,510 |   |
| Diluted                                                                      |       | 12,272,012                                         |       | 11,555,479 |   |

 

*THE ACCOMPANYINGNOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS*.

14

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS(UNAUDITED)**
| ** **                                                 | ** ** | **Six Months Ended March 31,** | ** **  |
|------------------------------------------------------------|------------|----------------------------------------------------|-------------|
| ** **                                                 | ** ** | **2007**                                           | ** **  | **2006** | ** ** |
| *Operations:*                                              |       |                                               |        |   |   |
| Net investment income                                      |       | $                                                  | 10,887,283  |   | $ | 9,646,230 |   |
| Net realized gain (loss) on sale of investments            |       | 86,519                                             |        | (803,095 | ) |
| Realized gain on settlement of derivative                  |       | 22,793                                             |        | — |   |
| Unrealized (depreciation) appreciation on  derivatives     |       | (25,613                                            | )           | 23,766 |   |
| Net unrealized (depreciation) appreciation on  investments |       | (2,722,528                                         | )           | 4,956,829 |   |
| Net increase in net assets from operations                 |       | 8,248,454                                          |        | 13,823,730 |   |
|                                                       |       |                                               |        |   |   |
| *Capital  transactions:*                                   |       |                                               |        |   |   |
| Distributions to stockholders                              |       | (10,307,794                                        | )           | (9,159,218 | ) |
| Repayment of principal on employee notes                   |       | 300,941                                            |        | 23,094 |   |
| Stock option compensation                                  |       | —                                             |        | 77,322 |   |
| Issuance of common stock under stock option plan           |       | —                                             |        | 85,900 |   |
| Stock surrendered in settlement of withholding tax         |       | (1,488,193                                         | )           | — |   |
| Decrease in net assets from capital share  transactions    |       | (11,495,046                                        | )           | (8,972,902 | ) |
|                                                       |       |                                               |        |   |   |
| Total (decrease)  increase in net assets                   |       | (3,246,592                                         | )           | 4,850,828 |   |
| Net assets at  beginning of year                           |       | 172,570,487                                        |        | 151,610,683 |   |
| Net assets at end of period                                |       | $                                                  | 169,323,895 |   | $ | 156,461,511 |   |

 

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PARTOF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

15

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**
| ** **                                                                                                                              | ** ** | **Six Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                              | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                                                                               | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| ** **                                                                                                                              | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Net increase in  net assets resulting from operations                                                                                   |       | $                                                  | 8,248,454  |   | $ | 13,823,730 |   |
| Adjustments to  reconcile net increase in net assets resulting from operations to  net cash (used in) provided by operating activities: |       |                                               |       |   |   |
| Purchase of  investments                                                                                                                |       | (127,641,175                                       | )          | (65,159,566 | ) |
| Principal  repayments on investments                                                                                                    |       | 62,230,246                                         |       | 63,517,133 |   |
| Net amortization  of premiums and discounts                                                                                             |       | 19,351                                             |       | (121,151 | ) |
| Amortization of  deferred financing fees                                                                                                |       | 126,500                                            |       | 58,536 |   |
| Stock  compensation expense                                                                                                             |       | —                                             |       | 77,322 |   |
| Realized loss on  investments                                                                                                           |       | 69,114                                             |       | 1,180,595 |   |
| Unrealized  depreciation (appreciation) on derivative                                                                                   |       | 25,613                                             |       | (23,766 | ) |
| Change in net  unrealized depreciation (appreciation) on investments                                                                    |       | 2,722,528                                          |       | (4,956,829 | ) |
| (Increase)  decrease in interest receivable                                                                                             |       | (729,834                                           | )          | 356,566 |   |
| Increase in  funds due from custodian                                                                                                   |       | (1,241,695                                         | )          | (6,627,901 | ) |
| (Increase)  decrease in prepaid assets                                                                                                  |       | (14,343                                            | )          | 32,812 |   |
| Increase in due  from affiliate                                                                                                         |       | (28,768                                            | )          | (320,621 | ) |
| (Increase)  decrease in other assets                                                                                                    |       | (300,893                                           | )          | 26,054 |   |
| Increase  (decrease) in accounts payable                                                                                                |       | 933                                                |       | (17,304 | ) |
| Increase in  interest payable                                                                                                           |       | 281,206                                            |       | 95,244 |   |
| Decrease in  accrued expenses and deferred liabilities                                                                                  |       | (234,957                                           | )          | (101,379 | ) |
| Decrease in fees  due to affiliate                                                                                                      |       | (240,363                                           | )          | (161,140 | ) |
| Increase in  administration fee due to Gladstone Administration                                                                         |       | 168,766                                            |       | — |   |
| Increase in  funds held in escrow                                                                                                       |       | 29                                                 |       | 40 |   |
| Increase in  investment balance due to payment in kind interest                                                                         |       | —                                             |       | (74,701 | ) |
| Net cash (used  in) provided by operating activities                                                                                    |       | (56,539,288                                        | )          | 1,603,674 |   |
|                                                                                                                                    |       |                                               |       |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                                                                                               | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| ** **                                                                                                                              | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Receipt of  principal on notes receivable - employees                                                                                   |       | 300,941                                            |       | 23,094 |   |
| Net cash  provided by investing activities                                                                                              |       | 300,941                                            |       | 23,094 |   |
|                                                                                                                                    |       |                                               |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                                                                                               | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| ** **                                                                                                                              | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Borrowings from  the lines of credit                                                                                                    |       | 146,900,000                                        |       | 69,780,000 |   |
| Repayments on  the lines of credit                                                                                                      |       | (76,593,000                                        | )          | (62,514,064 | ) |
| Distributions  paid                                                                                                                     |       | (10,307,794                                        | )          | (9,159,218 | ) |
| Exercise of  employee stock options                                                                                                     |       | —                                             |       | 85,900 |   |
| Deferred  financing fees                                                                                                                |       | (31,275                                            | )          | (12,072 | ) |
| Stock  surrendered to settle withholding tax obligation                                                                                 |       | (1,488,193                                         | )          | — |   |
| Net cash  provided by (used in) financing activities                                                                                    |       | 58,479,738                                         |       | (1,819,454 | ) |
|                                                                                                                                    |       |                                               |       |   |   |
| **NET INCREASE (DECREASE) IN CASH  AND CASH EQUIVALENTS (1)**                                                                           |       | 2,241,391                                          |       | (192,686 | ) |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**                                                                                     |       | 731,744                                            |       | 503,776 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**                                                                                           |       | $                                                  | 2,973,135  |   | $ | 311,090 |   |
|                                                                                                                                    |       |                                               |       |   |   |
| **CASH PAID DURING PERIOD FOR  INTEREST**                                                                                               |       | $                                                  | 2,650,071  |   | $ | 1,505,000 |   |

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(1)             Cash and cash equivalents consistof demand deposits and highly liquid investments with original maturities ofthree months or less when purchased.

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PARTOF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

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**GLADSTONE CAPITALCORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**
| ** **                                                                             | ** ** | **Three Months Ended March 31,** | ** **  |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------------|-------------|
| ** **                                                                             | ** ** | **2007**                                             | ** **  | **2006** | ** ** |
| Per Share Data  (1)                                                                    |       |                                                 |        |   |   |
| Net asset value at beginning of period                                                 |       | $                                                    | 13.88       |   | $ | 13.74 |   |
| *Income from investment operations:*                                                   | * *   | * *                                             | * *    | * * | * * |
| Net investment income (2)                                                              |       | 0.47                                                 |        | 0.46 |   |
| Realized gain on sale of investments (2)                                               |       | —                                               |        | 0.03 |   |
| Net unrealized loss on investments (2)                                                 |       | (0.14                                                | )           | — |   |
| Total from investment operations                                                       |       | 0.33                                                 |        | 0.49 |   |
| Less distributions:                                                                    |       |                                                 |        |   |   |
| Distributions from net investment income                                               |       | (0.42                                                | )           | (0.41 | ) |
| Total distributions                                                                    |       | (0.42                                                | )           | (0.41 | ) |
| Repayment of principal on notes receivable                                             |       | 0.02                                                 |        | — |   |
| Effect of antidilution (3)                                                             |       | —                                               |        | 0.02 |   |
| Net asset value at end of period                                                       |       | $                                                    | 13.82       |   | $ | 13.84 |   |
|                                                                                   |       |                                                 |        |   |   |
| Per share market value at beginning of period                                          |       | $                                                    | 23.86       |   | $ | 21.38 |   |
| Per share market value at end of period                                                |       | 23.68                                                |        | 21.55 |   |
| Total return (4)(5)                                                                    |       | 1.08                                                 | %           | 2.78 | % |
| Shares outstanding at end of period                                                    |       | 12,249,683                                           |        | 11,308,510 |   |
|                                                                                   |       |                                                 |        |   |   |
| Ratios/Supplemental  Data                                                              |       |                                                 |        |   |   |
| Net assets at end of period                                                            |       | $                                                    | 169,323,895 |   | $ | 156,461,511 |   |
| Average net assets (6)                                                                 |       | $                                                    | 169,055,526 |   | $ | 154,397,504 |   |
| Ratio of expenses to average net assets – annualized  (7)                         |       | 11.32                                                | %           | 6.40 | % |
| Ratio of net expenses to average net assets – annualized  (8)                     |       | 6.91                                                 | %           | 4.66 | % |
| Ratio of expenses net of voluntary waiver to average  net assets – annualized (9) |       | 8.74                                                 | %           | n/a |   |
| Ratio of net investment income to average net assets  – annualized                |       | 13.54                                                | %           | 13.48 | % |

----

(1)             Based on actual shares outstandingat the end of the corresponding period.

(2)             Based on weighted average basic pershare data.

(3)             This represents the antidilutiveimpact of other components in changes in net assets and the different shareamounts used in calculating per share data as a result of calculating certainper share data based upon the weighted average basic shares outstanding duringthe period and certain per share data based on the shares outstanding as of aperiod end.

(4)             Total return equals the increase ofthe ending market value over the beginning market value plus monthly dividendsdivided by the monthly beginning market value, assuming monthly dividendreinvestment.

(5)             Amounts were not annualized.

(6)             Average net assets are computedusing the average of the balance of net assets at the end of each month of thereporting period.

(7)             Ratio of expenses to average netassets is computed using expenses before credits from Adviser to the basemanagement and incentive fees and including income tax expense.

(8)             Ratio of net expenses to averagenet assets is computed using total expenses net of credits from Adviser to thebase management and incentive fees and including income tax expense.

(9)             Ratio of expenses net of voluntarywaiver to average net assets is computed using expenses before credits fromAdviser and including income tax expense then deducting only the amount of thecredit applicable to the waiver for the incentive fee.

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PARTOF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

17

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**GLADSTONE CAPITALCORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**
| ** **                                                                             | ** ** | **Six Months Ended March 31,** | ** **  |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------------|-------------|
| ** **                                                                             | ** ** | **2007**                                           | ** **  | **2006** | ** ** |
| Per Share Data  (1)                                                                    |       |                                               |        |   |   |
| Net asset value at beginning of period                                                 |       | $                                                  | 14.02       |   | $ | 13.41 |   |
| *Income from investment operations:*                                                   | * *   | * *                                           | * *    | * * | * * |
| Net investment income (2)                                                              |       | 0.89                                               |        | 0.85 |   |
| Realized loss on sale of investments (2)                                               |       | —                                             |        | (0.07 | ) |
| Net unrealized (loss) gain on investments (2)                                          |       | (0.22                                              | )           | 0.44 |   |
| Total from investment operations                                                       |       | 0.67                                               |        | 1.22 |   |
| Less distributions:                                                                    |       |                                               |        |   |   |
| Distributions from net investment income                                               |       | (0.84                                              | )           | (0.81 | ) |
| Total distributions                                                                    |       | (0.84                                              | )           | (0.81 | ) |
| Issuance of common stock under stock option plan                                       |       | —                                             |        | 0.01 |   |
| Repayment of principal on notes receivable                                             |       | 0.02                                               |        | — |   |
| Stock surrendered to settle withholding tax  obligation                                |       | (0.06                                              | )           | — |   |
| Effect of antidilution (3)                                                             |       | —                                             |        | 0.01 |   |
| Net asset value at end of period                                                       |       | $                                                  | 13.82       |   | $ | 13.84 |   |
|                                                                                   |       |                                               |        |   |   |
| Per share market value at beginning of period                                          |       | $                                                  | 22.01       |   | $ | 22.55 |   |
| Per share market value at end of period                                                |       | 23.68                                              |        | 21.55 |   |
| Total return (4)(5)                                                                    |       | 11.50                                              | %           | -0.75 | % |
| Shares outstanding at end of period                                                    |       | 12,249,683                                         |        | 11,308,510 |   |
|                                                                                   |       |                                               |        |   |   |
| Ratios/Supplemental  Data                                                              |       |                                               |        |   |   |
| Net assets at end of period                                                            |       | $                                                  | 169,323,895 |   | $ | 156,461,511 |   |
| Average net assets (6)                                                                 |       | $                                                  | 169,693,656 |   | $ | 152,679,547 |   |
| Ratio of expenses to average net assets – annualized  (7)                         |       | 10.29                                              | %           | 6.04 | % |
| Ratio of net expenses to average net assets – annualized  (8)                     |       | 7.06                                               | %           | 4.43 | % |
| Ratio of expenses net of voluntary waiver to average  net assets – annualized (9) |       | 8.34                                               | %           | n/a |   |
| Ratio of net investment income to average net assets  – annualized                |       | 12.83                                              | %           | 12.64 | % |

----

(1)             Based on actual shares outstandingat the end of the corresponding period.

(2)             Based on weighted average basic pershare data.

(3)             This represents the antidilutiveimpact of other components in changes in net assets and the different share amountsused in calculating per share data as a result of calculating certain per sharedata based upon the weighted average basic shares outstanding during the periodand certain per share data based on the shares outstanding as of a period end.

(4)             Total return equals the increase ofthe ending market value over the beginning market value plus monthly dividendsdivided by the monthly beginning market value, assuming monthly dividendreinvestment.

(5)             Amounts were not annualized.

(6)             Average net assets are computedusing the average of the balance of net assets at the end of each month of thereporting period.

(7)             Ratio of expenses to average netassets is computed using expenses before credits from Adviser to the basemanagement and incentive fees and including income tax expense.

(8)             Ratio of net expenses to averagenet assets is computed using total expenses net of credits from Adviser to thebase management and incentive fees and including income tax expense.

(9)             Ratio of expenses net of voluntarywaiver to average net assets is computed using expenses before credits fromAdviser and including income tax expense then deducting only the amount of thecredit applicable to the waiver for the incentive fee.

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PARTOF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

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**GLADSTONE CAPITALCORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTSMARCH 31, 2007(UNAUDITED)**

NOTE1.  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, or 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 investmentobjectives are to achieve a high level of current income by investing in debtand equity securities of established private businesses.

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. The financialstatements of the subsidiaries are consolidated with those of the Company.

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

NOTE2.  SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

*UnauditedInterim 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 accompanying annual financialstatements prepared in accordance with GAAP are omitted.  In the opinion of management, alladjustments, consisting solely of normal recurring accruals, necessary for thefair statement of financial statements for the interim periods have beenincluded.  The current period’s resultsof operations are not necessarily indicative of results that ultimately may beachieved for the year.  The interimfinancial statements and notes thereto should be read in conjunction with thefinancial statements and notes thereto included in the Company’s Form 10-K forthe fiscal year ended September 30, 2006, as filed with the Securities andExchange Commission (the “SEC”) on December 6, 2006.

*Useof Estimates*

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

*InvestmentValuation*

The Company carries itsinvestments at fair value, as determined by its Board of Directors.  Securities that are publicly traded arevalued at the closing price on the valuation date.  Securities for which a limited market exists,such as participations in syndicated loans, are valued at the indicative bidprice on the valuation date from the respective originating syndication agent’strading desk.  Debt and equity securitiesthat are not publicly traded are valued at fair value. The Company’s Board ofDirectors has established a valuation policy and consistently applied valuationprocedures used to determine the fair value of these securities quarterly.  These procedures for the determination ofvalue of many of the Company’s debt securities rely on the opinions of valuesubmitted to us by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”).SPSE will only evaluate the debt portion of the Company’s investments for whichthe Company specifically requests evaluation, and may decline to make requestedevaluations for any reason at its sole discretion.  SPSE opinions of value are submitted to theBoard of Directors along with the Adviser’s supplemental assessment andrecommendation regarding valuation of each of these investments. The Board ofDirectors then reviews whether the Adviser has followed its establishedprocedures for determinations of fair value, and votes whether to accept therecommended valuation of the Company’s investment portfolio. The Company’s fairvaluation procedures provide for valuation of non-convertible debt securitiesat cost plus amortized original issue discount plus paid in kind (“PIK”)interest, if any, unless adverse factors lead to a determination of a lesservaluation.  The fair value of convertibledebt, equity, success or exit fees or other equity-like securities isdetermined based on the collateral, the enterprise value of the issuer, theissuer’s ability to make payments, the earnings of the issuer, sales to thirdparties of similar securities, the comparison to publicly traded securities,discounted cash flow and other pertinent factors.  Due to the uncertainty inherent in thevaluation process, such estimates of fair value may differ significantly fromthe values that would have 

19

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resulted had a readymarket for the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains or losses ultimately realizedon these investments to be different than the valuation currentlyassigned.  Because there is a delaybetween when the Company closes an investment and when the investment can beevaluated by SPSE, new investments are not valued immediately by SPSE; rather,the Adviser makes its own determination about the recommended value of theseinvestments in accordance with the Company’s valuation policy without the inputof SPSE during the specific quarter in which the investment is made.  Because SPSE does not currently performindependent valuations of mortgage loans or equity securities for the Company,the Adviser also determines a recommendation for the fair value of theseinvestments without the input of SPSE. The Adviser considers a number of qualitative and quantitative factorsin current market conditions when performing valuations.  The Board of Directors then determineswhether or not to accept the Adviser’s recommendations for the aggregatevaluation of the Company’s portfolio of investments.  The Board of Directors is ultimatelyresponsible for setting the fair value and disclosure of investments in thefinancial statements.

*InterestIncome Recognition*

Interest income,adjusted for amortization of premiums and accretion of discounts, is recorded onthe accrual basis to the extent that such amounts are expected to be collected.The Company stops accruing interest on its investments when it is determinedthat interest is no longer collectible. There were no uncollectible accounts at March 31, 2007.  Conditional interest or a success fee isrecorded when earned upon full repayment of a loan investment.

*Paidin Kind Interest*

TheCompany seeks to avoid PIK interest, however the Company had one loan in itsportfolio during the three and six months ended March 31, 2006 that contained aPIK provision. A PIK provision requires the borrower to accrue a payment to theCompany but the borrower does not have to pay that interest until the loan ispaid in full. The PIK interest is added to the principal balance of the loanand recorded as income to the Company even though the cash has not beenreceived.  To maintain the Company’sstatus as a RIC (as discussed in Note 10), this non-cash source of income mustbe paid out to stockholders in the form of cash dividends, even though theCompany has not yet collected the cash. The Company recorded no PIK interestincome for the three and six months ended March 31, 2007 and $30,707 and$63,217, respectively, for the three and six months ended March 31, 2006.

*ServicesProvided to Portfolio Companies*

The1940 Act requires that a business development company make available managerialassistance to its portfolio companies by providing significant guidance andcounsel concerning the management, operations, or business objectives andpolicies of the respective portfolio company. The Company provides these and other services to its portfolio companiesthrough its Adviser.  Currently, neitherthe Company nor the Adviser charges a fee for managerial assistance.

TheAdviser receives fees for other services it provides to portfoliocompanies.  These other fees are typically non-recurring, are recognizedas revenue when earned and are generally paid directly to the Adviser by theborrower or potential borrower upon closing of the investment.  Theservices the Adviser provides to portfolio companies vary by investment, butgenerally include a broad array of services, such as investment bankingservices, arranging bank and equity financing, structuring financing frommultiple lenders and investors, reviewing existing credit facilities,restructuring existing loans, raising equity and debt capital, turnaroundmanagement, merger and acquisition services and recruiting new managementpersonnel.   When the Adviserreceives fees for these services, all of those fees are credited to the basemanagement fees due to the Adviser from the Company.  Any services of this nature subsequent to theclosing would typically generate a separate fee at the time of completion.

TheAdviser also receives fees for monitoring and reviewing portfolio companyinvestments.  These fees are recurringand are generally paid annually or quarterly in advance to the Adviserthroughout the life of the investment. Fees of this nature are recorded as revenue by the Adviser when earnedand are not credited against the base management fees.

Whilethe Adviser receives all fees in connection with the Company’s investments,such fees received by the Adviser, with the exception of monitoring and reviewfees, are entirely credited to the Company as a reduction of the advisory feepayable under the advisory agreement between the Company and the Adviser.  For the three and six months ended March 31,2007, the Adviser received $775,000 and $1,086,000, respectively, of such fees,as compared to $673,000 and $1,223,000, respectively, for the three and sixmonths ended March 31, 2006 and the advisory fee payable by the Company to theAdviser was reduced by these amounts. None of these fees were for managerial assistance even though the Adviserprovided managerial assistance to many of the Company’s portfolio companies.

20

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*Cashand Cash Equivalents*

Cashand cash equivalents consist of demand deposits and highly liquid investmentswith original maturities of three months or less when purchased. Cash and cashequivalents are carried at cost which approximates fair value as ofMarch 31, 2007 and September 30, 2006.

*RealizedGain or Loss and Unrealized Appreciation or Depreciation of PortfolioInvestments*

Realizedgain or loss is recognized when an investment is disposed of and is computed asthe difference between the Company’s cost basis in the investment at thedisposition date and the net proceeds received from such disposition.  Unrealized appreciation or depreciationdisplays the difference between the fair market value of the investment and thecost basis of such investment.

*Federaland State Income Taxes*

TheCompany intends to continue to qualify for treatment as a RIC under SubchapterM of the Code. As a RIC, the Company is not subject to federal or state incometax on the portion of its taxable income and gains distributed to stockholders.To qualify as a RIC, the Company is required to distribute to its stockholdersat least 90% of investment company taxable income, as defined by the Code and,as such, no income tax provisions have been recorded for the individualcompanies of Gladstone Capital Corporation and Gladstone Business Loan LLC.

During the six monthsended March 31, 2006, Gladstone Capital Corporation recorded approximately$50,000 in connection with penalties incurred on misclassified revenue on itsfiscal year 2004 corporate tax return.

*RecentAccounting Pronouncements*

InMay 2005, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards (“SFAS”) No. 154, *“AccountingChanges and Error Corrections,”* a replacement of APB Opinion No. 20,*“Accounting Changes,”* and SFAS No. 3, *“Reporting Accounting Changes in Interim Financial Statements”*and changed the requirements for the accounting for and reporting of a changein accounting principle.  SFAS No. 154applies to all voluntary changes in accounting principle and also applies tochanges required by an accounting pronouncement in the unusual instance that thepronouncement does not include specific transition provisions.  SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple.  SFAS No. 154 is effective foraccounting changes and corrections of errors made in fiscal years beginning afterDecember 15, 2005.  The Company adoptedthe provisions of SFAS No. 154, as applicable, on October 1, 2006.

InFebruary 2006, the FASB issued SFAS No. 155, *“Accountingfor Certain Hybrid Financial Instruments, an amendment of FASB statementsNo. 133 and 140”* (“SFAS No. 155”). SFAS No. 155 allowsfinancial instruments that have embedded derivatives to be accounted for as awhole (eliminating the need to bifurcate the derivative from its host) as longas the entire instrument is valued on a fair value basis. The statement alsoresolves and clarifies other specific SFAS No. 133 and SFAS No. 140related issues. SFAS No. 155 is effective for all financial instrumentsacquired or issued after the beginning of an entity’s first fiscal year thatbegins after September 15, 2006. The Company adopted SFAS No. 155 onOctober 1, 2006 and has not realized a material impact of the financialstatements since all investments are valued on a fair value basis.

InJune 2006, the FASB issued FASB Interpretation No. 48, *“Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109,”* which clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, *“Accounting for Income Taxes.”*This Statement shall be effective as of the beginning of an entity’s firstfiscal year that begins after December 15, 2006. The Company will adoptthis Interpretation effective October 1, 2007. The Company is currentlyevaluating the impact of this pronouncement on its consolidated financialstatements.

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InSeptember 2006, the FASB issued SFAS No. 157, *“Fair ValueMeasurements”* (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuringfair value in accordance with GAAP, and expands disclosures about fair valuemeasurements.  SFAS No. 157 appliesbroadly to securities and other types of assets and liabilities.  SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007 andinterim periods within that fiscal year. The Company will be required to adopt SFAS No. 157 on October 1, 2008and is currently evaluating the impact of this pronouncement on itsconsolidated financial statements.

InSeptember 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”).SAB 108 addresses how the effects of prior year uncorrected misstatementsshould be considered when quantifying misstatements in current year financialstatements and requires registrants to consider the effect of all carry overand reversing effects of prior year misstatements when quantifying errors incurrent year financial statements. SAB 108 does not change the SEC’s previousguidance in SAB No. 99, *“Materiality,”*on evaluating the materiality of misstatements. A registrant applying the newguidance for the first time that identifies material errors in existence at thebeginning of the first fiscal year ending after November 15, 2006, maycorrect those errors through a one-time cumulative effect adjustment to beginning-of-yearretained earnings. The cumulative effect alternative is available only if theapplication of the new guidance results in a conclusion that a material errorexists as of the beginning of the first fiscal year ending afterNovember 15, 2006, and those misstatements were determined to beimmaterial based on a proper application of the registrant’s previous methodfor quantifying misstatements. The adoption of SAB 108 did not have an impacton the Company’s consolidated financial statements.

In February 2007, theFASB issued SFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment ofFASB Statement No. 115”* which is effective for fiscal yearsbeginning after November 15, 2007. This pronouncement permits an entity tochoose to measure many financial instruments and certain other items at fairvalue at specified election dates. Subsequent unrealized gains and losses onitems for which the fair value option has been elected will be reported in earnings.The Company is currently evaluating the potential impact of this pronouncementon its consolidated financial statements.

NOTE3. INVESTMENTS

Investmentsat fair value consisted of the following industry classifications as of March31, 2007 and September 30, 2006:
| ** **                                    | ** ** | **March 31, 2007** | ** **  | **September 30, 2006** | ** ** |
|-----------------------------------------------|------------|------------------------------|-------------|----------------------------------|------------|
| ** **                                    | ** ** | ** **                   | ** **  | **% of Total**         | ** ** | **% of** | ** ** | ** ** | ** ** | **% of Total** | ** ** | **% of** | ** ** |
| **Industry Classification**              | ** ** | ** **                   | ** **  | **Fair Value**              | ** ** | **Investments** | ** ** | **Net Assets** | ** ** | **Fair Value** | ** ** | **Investments** | ** ** | **Net Assets** | ** ** |
|                                          |       |                         |        |                             |       |   |   |   |   |   |   |   |   |
| Aerospace & Defense                       |       | $                            | 10,505,344  |                             | 3.7        | % | 6.2 | % | $ | 5,529,891 |   | 2.5 | % | 3.2 | % |
| Automobile                                    |       | 7,515,247                    |        | 2.7                              | %          | 4.4 | % | 6,332,906 |   | 2.9 | % | 3.7 | % |
| Cargo Transport                               |       | 16,595,469                   |        | 5.9                              | %          | 9.8 | % | 8,650,000 |   | 4.0 | % | 5.0 | % |
| Chemicals, Plastics & Rubber              |       | 30,154,866                   |        | 10.8                             | %          | 17.8 | % | 31,105,148 |   | 14.3 | % | 18.0 | % |
| Diversified/Conglomerate Manufacturing        |       | 4,014,975                    |        | 1.4                              | %          | 2.4 | % | — |   | 0.0 | % | 0.0 | % |
| Diversified/Conglomerate Service              |       | 992,066                      |        | 0.4                              | %          | 0.6 | % | — |   | 0.0 | % | 0.0 | % |
| Electronics                                   |       | 24,874,206                   |        | 8.9                              | %          | 14.7 | % | 33,360,123 |   | 15.4 | % | 19.3 | % |
| Entertainment                                 |       | —                       |        | 0.0                              | %          | 0.0 | % | 3,491,250 |   | 1.6 | % | 2.0 | % |
| Farming & Agriculture                     |       | 9,686,061                    |        | 3.5                              | %          | 5.7 | % | 709,431 |   | 0.3 | % | 0.4 | % |
| Finance                                       |       | 2,520,000                    |        | 0.9                              | %          | 1.5 | % | — |   | 0.0 | % | 0.0 | % |
| Healthcare, Education & Childcare         |       | 41,683,822                   |        | 15.0                             | %          | 24.6 | % | 16,707,500 |   | 7.7 | % | 9.7 | % |
| Home & Office Furnishings                 |       | 19,204,379                   |        | 6.9                              | %          | 11.3 | % | 20,636,991 |   | 9.5 | % | 12.0 | % |
| Leisure, Amusement & Movies               |       | 4,317,375                    |        | 1.5                              | %          | 2.5 | % | — |   | 0.0 | % | 0.0 | % |
| Machinery                                     |       | 11,598,344                   |        | 4.1                              | %          | 6.8 | % | — |   | 0.0 | % | 0.0 | % |
| Mining, Steel, Iron & Non-precious Metals |       | 20,665,874                   |        | 7.4                              | %          | 12.2 | % | 5,233,750 |   | 2.4 | % | 3.0 | % |
| Oil & Gas                                 |       | 7,950,566                    |        | 2.8                              | %          | 4.7 | % | 6,056,250 |   | 2.8 | % | 3.5 | % |
| Personal, Food and Miscellaneous Services     |       | 5,996,241                    |        | 2.1                              | %          | 3.5 | % | 6,011,288 |   | 2.8 | % | 3.5 | % |
| Printing, Publishing & Broadcasting       |       | 31,169,691                   |        | 11.1                             | %          | 18.4 | % | 16,203,000 |   | 7.4 | % | 9.4 | % |
| Retail Stores                                 |       | 14,943,750                   |        | 5.3                              | %          | 8.8 | % | 14,981,250 |   | 6.9 | % | 8.7 | % |
| Telecommunications                            |       | 238,290                      |        | 0.1                              | %          | 0.1 | % | 23,596,040 |   | 10.8 | % | 13.7 | % |
| Textiles & Leather                        |       | 10,770,931                   |        | 3.8                              | %          | 6.4 | % | 13,785,932 |   | 6.3 | % | 8.0 | % |
| Utilities                                     |       | 4,845,191                    |        | 1.7                              | %          | 2.9 | % | 5,252,000 |   | 2.4 | % | 3.0 | % |
| **Total**                                     |       | $                            | 280,242,688 |                             | 100.0      | % |   |   | $ | 217,642,750 |   | 100.0 | % |   |   |
|                                               |            |                              |             |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

22

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Theinvestments at fair value consisted of the following geographic regions of theUnited States at March 31, 2007 and September 30, 2006:

 
| ** **                 | ** ** | **March 31, 2007** | ** **  | **September 30, 2006** | ** ** |
|----------------------------|------------|------------------------------|-------------|----------------------------------|------------|
| ** **                 | ** ** | ** **                   | ** **  | **% of Total**         | ** ** | ** ** | ** ** | **% of Total** | ** ** |
| **Geographic Region** | ** ** | ** **                   | ** **  | **Fair Value**              | ** ** | **Investments** | ** ** | **Fair Value** | ** ** | **Investments** | ** ** |
|                       |       |                         |        |                             |       |   |   |   |   |
| Midwest                    |       | $                            | 147,240,494 |                             | 52.5       | % | $ | 99,413,970 |   | 45.7 | % |
| Mid-Atlantic               |       | 49,382,834                   |        | 17.6                             | %          | 53,044,805 |   | 24.4 | % |
| Southeast                  |       | 39,658,884                   |        | 14.2                             | %          | 24,697,113 |   | 11.3 | % |
| West                       |       | 18,719,858                   |        | 6.7                              | %          | 15,502,538 |   | 7.1 | % |
| Northeast                  |       | 17,446,094                   |        | 6.2                              | %          | 17,209,141 |   | 7.9 | % |
| US Territory               |       | 7,794,524                    |        | 2.8                              | %          | 7,775,183 |   | 3.6 | % |
|                       |       | $                            | 280,242,688 |                             |       |   | $ | 217,642,750 |   |   |   |
|                            |            |                              |             |                                  |            |  |  |  |  |  |  |  |  |

 

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

NOTE4. RELATED PARTY TRANSACTIONS

*Loansto Employees*

TheCompany provided loans to employees of the Adviser for the exercise of optionsunder the Amended and Restated 2001 Equity Incentive Plan (the “2001 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 and six months ended March 31, 2007 and theCompany received $300,789 and $300,941, respectively, of principalrepayments.  During the six months endedMarch 31, 2006, the Company received principal repayments of $23,094 inconnection with the full repayment of one loan and a partial repayment ofanother loan.  The Company recognizedinterest income from all employee stock option loans of $132,931 and $271,122for the three and six months ended March 31, 2007, as compared to $107,033 and$214,126, respectively, for the three and six months ended March 31, 2006.

*InvestmentAdvisory and Management and Administration Agreements*

TheCompany is externally managed by the Adviser, which is controlled by ourchairman and chief executive officer, under a contractual investment advisoryagreement.  On October 1, 2006, theCompany entered into an amended and restated investment advisory agreement (the“Amended Advisory Agreement”).  Prior toOctober 1, 2006, the relationship was governed by the initial advisoryagreement (the “Initial Advisory Agreement”).

*Termsof the Amended Advisory Agreement*

Underthe Amended Advisory Agreement, the Company pays the Adviser an annual basemanagement fee of 2% of its average gross assets, which is defined as totalassets less cash and cash equivalents pledged to creditors calculated as of theend of the two most recently completed fiscal quarters and also consists of atwo-part incentive fee.

Thefirst part of the incentive fee is an income-based incentive fee which rewardsthe Adviser if the Company’s quarterly net investment income (before givingeffect to any incentive fee) exceeds 1.75% of the Company’s net assets (the “hurdlerate”). The Company pays the Adviser an income incentive fee with respect toits pre-incentive fee net investment income in each calendar quarter asfollows:

·             no incentive fee inany calendar quarter in which pre-incentive fee net investment income does notexceed the hurdle rate (7% annualized);

·             100% of pre-incentivefee net investment income with respect to that portion of such pre-incentivefee net investment income, if any, that exceeds the hurdle rate but is lessthan 2.1875% in any calendar quarter (8.75% annualized); and

·             20% of the amount ofpre-incentive fee net investment income, if any, that exceeds 2.1875% in anycalendar quarter (8.75% annualized).

23

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Thesecond part of the incentive fee is a capital gains incentive fee that isdetermined and payable in arrears as of the end of each fiscal year (or upontermination of the Amended Advisory Agreement, as of the termination date) andequals 20% of the Company’s realized capital gains as of the end of the fiscalyear. In determining the capital gains incentive fee payable to the Adviser,the Company calculates the cumulative aggregate realized capital gains andcumulative aggregate realized capital losses since its inception, and theaggregate unrealized capital depreciation as of the date of the calculation, asapplicable, with respect to each of the investments in its portfolio.

TheAdviser’s board of directors voluntarily waived, for the fiscal quarter endedMarch 31, 2007, the annual 2.0% base management fee to 0.5% for seniorsyndicated loan participations and also waived a portion of the incentive feedue.

Inaddition to the base management and incentive fees under the Amended AdvisoryAgreement, certain fees received by the Adviser from the Company’s portfoliocompanies were credited against the investment advisory fee under the InitialAdvisory Agreement, and will continue to be paid to the Adviser and creditedunder the Amended Advisory Agreement.  Inaddition, the Company will continue to pay its direct expenses including, butnot limited to, directors’ fees, legal and accounting fees, stockholder relatedexpenses, and directors and officers insurance under the Amended AdvisoryAgreement.

Forthe three months ended March 31, 2007, the Company recorded a gross basemanagement fee of $450,484, less a credit of $775,000 for fees received by theAdviser, for a net base management fee credit of $324,516 as compared to agross base management fee of $352,379, less a credit of $673,000 for feesreceived by the Adviser, for a net base management fee credit of $320,621 forthe three months ended March 31, 2006. For the six months ended March 31, 2007, the Company recorded a grossbase management fee of $848,916, less a credit of $1,086,000 for fees receivedby the Adviser, for a net base management fee credit of $237,084 as compared toa gross base management fee of $621,080, less a credit of $1,223,000 for feesreceived by the Adviser, for a net base management fee credit of $601,920 forthe six months ended March 31, 2006.  TheCompany also recorded a gross incentive fee of $1,158,995 and $2,307,478, forthe three and six months ended March 31, 2007, respectively, offset by a creditfrom a voluntary waiver issued by the Adviser’s board of directors of$1,088,378 and $1,657,372, for the three and six months ended March 31, 2007,respectively, for a net incentive fee of $70,617 and $650,106, respectively,for the three and six months ended March 31, 2007.  There was no incentive fee in effect at March31, 2006.  As of March 31, 2007, theCompany was owed $324,516 of unpaid base management fee credit due from theAdviser and owed $70,617 of unpaid incentive fees to the Adviser, presented inthe net fees due from Adviser in the accompanying consolidated statements ofassets and liabilities.

*Termsof the Initial Advisory Agreement*

Ascompensation for its services, the Company paid the Adviser an annual advisoryfee of 1.25% of total assets (as reduced by cash and cash equivalents pledgedto creditors), payable in quarterly computed increments of 0.3125%, and anannual administrative fee of 0.75% of total assets (as reduced by cash and cashequivalents pledged to creditors), payable in quarterly computed increments of 0.1875%,for a total annual management fee of 2.0% (0.50% quarterly) of total assets (asreduced by cash and cash equivalents pledged to creditors).  The Company also paid all of its directexpenses including, but not limited to, directors’ fees, legal and accountingfees, stockholder related expenses, and directors and officers insurance.

*LoanServicing 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 are also treated as reductions directlyagainst the 2% management fee, under both the Initial and Amended AdvisoryAgreements.  Effective in April 2006, theAdviser’s board of directors voluntarily agreed to waive, on a temporary basis,and reduce the annual servicing fee rate for senior syndicated loans to 0.5%.For the three and six months ended March 31, 2007, these loan servicing feestotaled $760,623 and $1,479,775, respectively, as compared to the loanservicing fees for the three and six months ended March 31, 2006 of $734,644and $1,450,059, respectively, all of which were deducted against the 2% basemanagement fee in order to derive the base management fee which is presented asthe line item base management fee in the consolidated statements ofoperations.  At March 31, 2007, theCompany owed $217,631 of unpaid loan servicing fees to the Adviser, which arenetted and recorded in fees due from Adviser. At September 30, 2006, the Company owed $214,608 in loan servicing feesto the Adviser, recorded in fees due to Adviser in the consolidated statementsof assets and liabilities.  Under theInitial and Amended Advisory Agreements, the Adviser also provides managerialassistance and other services to the Company’s portfolio companies and mayreceive fees for services other than managerial assistance services.  To the extent that the Adviser receives anyfees directly from a portfolio company for such services, it credits these feesdirectly against the 2% base management fee. For the three and six months ended March 31, 2007, the Adviser recorded$775,000 and $1,086,000, respectively of such fees and credited this amountagainst the 2% base management fee received from the Company, as compared tosuch fees for the three and six months ended March 31, 2006 of $673,000 and$1,223,000, respectively, these credits are reflected on the consolidatedstatement of operations as credits to base management and incentive fees.  Overall, the base management fee due to theAdviser cannot exceed 2% of total assets (as reduced by cash and cashequivalents pledged to creditors) during any given fiscal year.

24

 

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*AdministrationAgreement*

OnOctober 1, 2006, the Company entered into an administration agreement (the “AdministrationAgreement”) with Gladstone Administration, LLC (the “Administrator”), awholly-owned subsidiary of the Adviser. Under the Administration Agreement, the Company pays separately foradministrative services.  TheAdministration Agreement provides for payments equal to the Company’s allocableportion of the Administrator’s overhead expenses in performing its obligationsunder the Administration Agreement, including, but not limited to, rent foremployees of the Administrator, and the allocable portion of salaries andbenefits expenses of the Company’s chief financial officer, controller, chiefcompliance officer, treasurer and their respective staffs.  The Company recorded an administration fee of$168,766 and $294,851, respectively, for the three and six months ended March31, 2007.  The administration fee was notin effect during the three and six months ended March 31, 2006.

*Saleof Investments to Affiliate*

During the three monthsended March 31, 2007, the Company sold to its affiliate, Gladstone InvestmentCorporation (“Gladstone Investment”), certain of its investments in syndicatedloan participations totaling $12,215,594. An independent broker was engaged to execute these transactions betweenthe Company and Gladstone Investment. The independent broker accepted the quotes from the respective agentbank for each syndicated loan and then executed these transactions between theCompany and Gladstone Investment.  Thecumulative effect of these transactions, net of any unamortized premiums ordiscounts associated with the loans, resulted in a realized net gain of$56,218.

NOTE5. LINE OF CREDIT

Through BusinessLoan, the Company has a $170 million revolving credit facility (the “DBFacility”) with Deutsche Bank AG, as administrative agent, pursuant to whichBusiness Loan pledges the loans it holds to secure future advances by certaininstitutional lenders. The interest rate charged on the advances under the DBFacility is based on the London Interbank Offered Rate (“LIBOR”), the PrimeRate or the Federal Funds Rate, depending on market conditions, and adjustsperiodically. The DB Facility is in effect through May 25, 2007.  As of March 31, 2007, the outstandingprincipal balance under the DB Facility was approximately $120.3 million at aninterest rate of approximately 5.3%. Available borrowings are subject to various constraints imposed underthe credit agreement, based on the aggregate loan balance pledged by BusinessLoan, which varies as loans are added and repaid, regardless of whether suchrepayments are early prepayment or are made as contractually required.  At March 31, 2007, the remaining borrowingcapacity available under the DB Facility was approximately $49.7 million.

The DB Facilitycontains covenants that require Business Loan to maintain its status as aseparate entity; prohibit certain significant corporate transactions (such asmergers, consolidations, liquidations or dissolutions); and restrict materialchanges to the Company’s credit and collection policies.  The DB Facility also restricts some of theterms and provisions (including interest rates, terms to maturity and paymentsschedules) and limits the borrower and industry concentrations of loans thatare eligible to secure advances.  As ofMarch 31, 2007, Business Loan was in compliance with all of the facilitycovenants.

The administrativeagent also requires that any interest or principal payments on pledged loans beremitted directly by the borrower into a lockbox account with the Bank of NewYork as custodian.  Deutsche Bank AG isalso the trustee of the account and once a month remits the collected funds tothe Company. At March 31, 2007, the amount due from custodian was $4,828,847and at September 30, 2006, the amount due from custodian was $3,587,152.

The Adviser alsoservices the loans pledged under the DB Facility.  As a condition to this servicing arrangement,the Company executed a performance guaranty pursuant to which it guaranteedthat the Adviser would comply fully with all of its obligations under the DBFacility.  The performance guarantyrequires that the Company maintain a minimum net worth of $100 million andmaintain “asset coverage” with respect to “senior securities representingindebtedness” of at least 200%, in accordance with Section 18 of the 1940Act.  As of March 31, 2007, the Companywas in compliance with all covenants under the performance guaranty.

NOTE6. INTEREST RATE CAP AGREEMENT

Pursuant to the DBFacility, the Company has an interest rate cap agreement that effectivelylimits the interest rate on a portion of the borrowings under the line ofcredit.

The use of a cap involvesrisks that are different from those associated with ordinary portfoliosecurities transactions.  Cap agreementsmay be considered to be illiquid. Although the Company will not enter into any such agreements unless itbelieves that the other party to the transaction is creditworthy, the Companydoes bear the risk of loss of the amount expected to be received under suchagreements in the event of default or bankruptcy of the agreement counterparty.

25

 

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In February 2004, theCompany entered into an interest rate cap agreement with a notional amount of$35.0 million at a cost of $304,000.  Theinterest rate cap agreement’s current notional amount is $10.9 million and ithas a current fair value of approximately $24,671 which is recorded in otherassets on the Company’s consolidated balance sheet at March 31, 2007.  At September 30, 2006, the interest rate capagreement had a fair market value of $50,284. The Company records changes in the fair market value of the interestrate cap agreement monthly based on the current market valuation at month endas unrealized depreciation or appreciation on derivative on the Company’sconsolidated statement of operations. The interest rate cap agreement expiresin February 2009. The agreement provides that the Company’s floating interestrate or cost of funds on a portion of the portfolio’s borrowings will be cappedat 5% when the LIBOR rate is in excess of 5%. During the three and six months ended March 31, 2007, the Companyrecorded $10,239 and $22,793, respectively, of income from the interest ratecap agreement recorded as a realized gain on the settlement of derivative onthe Company’s consolidated statements of operations.  The Company did not recognize any income fromthe interest rate cap agreement during the three and six months ended March 31,2006.

NOTE7.  COMMON STOCK TRANSACTIONS

Asof March 31, 2006 and March 31, 2007, 50,000,000 shares of $0.001 par valuecommon stock were authorized and 11,308,510 and 12,249,683 shares wereoutstanding, respectively.

Transactionsin common stock were as follows:

|                                                       | ** ** | **Common Stock** | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **Shares**            | ** ** | **Amount** | ** ** |
| Balance at  September 30, 2005                        |       | 11,303,510            |       | $ | 11,304 |   |
| Issuance of  Common Stock Under Stock Option Plan     |       | 5,000                 |       | 5 |   |
| Balance at March  31, 2006                            |       | 11,308,510            |       | $ | 11,309 |   |
|                                                  |       |                  |       |   |   |
| Balance at  September 30, 2006                        |       | 12,305,008            |       | $ | 12,305 |   |
| Issuance of  Common Stock Under Stock Option Plan     |       | 5,000                 |       | 5 |   |
| Shares  surrendered for settlement of withholding tax |       | (60,325               | )          | (60 | ) |
| Balance at March 31,  2007                            |       | 12,249,683            |       | $ | 12,250 |   |

 

InOctober 2006, 5,000 shares of common stock were issued as a result of an optionexercise which took place on the last business day of the prior fiscalyear.  These shares were issued by thetransfer agent at the start of the current fiscal year.  Also during the six months ended March 31,2007, 60,325 shares of stock were surrendered to the Company from certainoptionees who exercised non-qualified stock options during the third and fourthquarters of fiscal year 2006 in order to satisfy settlement of withholdingtaxes that were paid by the Company with respect to the shares underlying theexercise of such options.

NOTE8. STOCK OPTIONS

There were no stock options outstanding at March 31,2007.  Prior to its termination onSeptember 30, 2006, the Company had in place the 2001 Plan. The Company hadauthorized 2,000,000 shares of capital stock for the issuance of options underthe 2001 Plan to employees and directors. Options granted under the 2001 Planoriginally could have been exercised during a term not to exceed ten years fromthe date of grant. Only employees of the Company and its affiliates wereeligible to receive incentive stock options and both employees and non-employeedirectors were eligible to receive nonstatutory stock options under the 2001Plan.  Options granted under the 2001Plan were either incentive stock options or nonstatutory stock options.  The option exercise price was equal to themarket price on the date of the grant. In connection with the externalization of the Company’s management, allof the Company’s officers and employees became direct employees of the Adviser,as of October 1, 2004.  However, theseindividuals continued to be eligible to receive stock options under the 2001Plan.  Effective October 1, 2004, theCompany accounted for any options granted to employees of the Adviser, whoqualify as leased employees of the Company under FASB Interpretation No. 44, *“Accounting for Certain Transactions Involving Stock Compensation, anInterpretation of APB Opinion No. 25.”*

On October 1, 2005, the Company adopted SFASNo. 123 (revised 2004) “*Share-based Payment”*(“SFAS No. 123(R)”) using the modified prospective approach. Under themodified prospective approach, stock-based compensation expense was recordedfor the unvested portion of previously issued awards that remained outstandingat October 1, 2005 using the same estimate of the grant date fair valueand the same attribution method previously used to determine the pro formadisclosure under SFAS No. 123. SFAS No. 123(R) also requires that allshare-based payments to employees after October 1, 2005, includingemployee stock options, be recognized in the financial statements asstock-based compensation expense based on the fair value on the date of grant.

For the three and sixmonths ended March 31, 2006, the Company recorded stock option compensationexpense for the cost of stock options issued under the 2001 Plan of $34,065 and$77,322, respectively. The Company’s expensing of stock options decreased bothbasic and diluted net increase to net assets resulting from operations pershare by $0.003 and $0.01 for the three and six months ended 

26

 

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March 31, 2006,respectively.  Additionally, SFASNo. 123(R) states that any potential tax benefits associated withincentive stock options should be recognized only at the time of settlement ifthose options settle through a disqualifying disposition. Thus, the relatedstock-based compensation expense must be treated as a permanent differenceuntil that time which, in turn, results in an increase to the Company’seffective tax rate.  The Company does notrecord tax benefits associated with the expensing of stock options since theCompany intends to qualify as a RIC under Subchapter M of the Code and as suchthe Company is not subject to federal income tax on the portion of its taxableincome and gains distributed to stockholders, provided that at least 90% of thetaxable income is distributed.

NOTE9. INCREASE IN NET ASSETS PER SHARE RESULTING FROM OPERATIONS

Thefollowing table sets forth the computation of basic and diluted net increase innet assets per share resulting from operations for the three and six monthsended March 31, 2007 and March 31, 2006:
| ** **                                                                                       | ** ** | **Three Months Ended March 31,** | ** ** | **Six Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2007**                                             | ** ** | **2006**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                                             |       |                                                 |       |                                               |       |   |   |   |   |
| Numerator for  basic and diluted net increase in net assets resulting from operations per  share |       | $                                                    | 4,084,851  |                                               | $          | 5,590,381 |   | $ | 8,248,454 |   | $ | 13,823,730 |   |
|                                                                                             |       |                                                 |       |                                               |       |   |   |   |   |
| Denominator for  basic weighted average shares                                                   |       | 12,249,683                                           |       | 11,308,510                                         |       | 12,272,012 |   | 11,307,510 |   |
| Dilutive effect  of stock options                                                                |       | —                                               |       | 227,850                                            |       | — |   | 247,969 |   |
| Denominator for  diluted weighted average shares                                                 |       | 12,249,683                                           |       | 11,536,360                                         |       | 12,272,012 |   | 11,555,479 |   |
|                                                                                             |       |                                                 |       |                                               |       |   |   |   |   |
| Basic net  increase in net assets resulting from operations per share                            |       | $                                                    | 0.33       |                                               | $          | 0.49 |   | $ | 0.67 |   | $ | 1.22 |   |
|                                                                                             |       |                                                 |       |                                               |       |   |   |   |   |
| Diluted net  increase in net assets resulting from operations per share                          |       | $                                                    | 0.33       |                                               | $          | 0.48 |   | $ | 0.67 |   | $ | 1.20 |   |

 

Therewere 1,300,498 options outstanding to purchase common stock at March 31, 2006.Of these, 338,500 and 336,000 options were not included in the computation ofdiluted earnings per share for the three and six months ended March 31, 2006,respectively, because the options’ exercise prices were greater than theaverage market price of the common shares for the period and, therefore, wereanti-dilutive.  There were no stockoptions outstanding at March 31, 2007.

NOTE10. DIVIDENDS

TheCompany is required to pay out as a dividend 90% of its ordinary income andshort-term capital gains for each taxable year in order to maintain its statusas a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code.  It is the policy of the Company to pay out asa dividend up to 100% of those amounts. The amount to be paid out as a dividend is determined by the Board ofDirectors each quarter and is based on the annual earnings estimated by themanagement of the Company.  Based on thatestimate, three monthly dividends are declared each quarter.  At year-end the Company may pay a bonusdividend, in addition to the monthly dividends, to ensure that it has paid outat least 90% of its ordinary income and realized net short-term capital gainsfor the year.  Long-term capital gainsare composed of success fees, prepayment fees and gains from the sale ofsecurities held for one year or more. The Company intends to retain long-termcapital gains from the sale of securities, if any, and not pay them out asdividends, however, the Board of Directors may decide to declare and pay outcapital gains during any fiscal year.  Ifthe Company decides to retain long-term capital gains, the portion of theretained capital gains will be subject to 35% tax.  The tax characteristics of all dividends willbe reported to stockholders on Form 1099 at the end of each calendar year.  The following table lists the per sharedividends paid for the six months ended March 31, 2007 and 2006:

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| Fiscal Year | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend  per Share** | ** ** |
|------------------|------------|----------------------|------------|-----------------------|------------|------------------------------|------------|
| 2007             |       | March  22, 2007      |       | March  30, 2007       |       | $0.14                        |       |
|             |       | February  20, 2007   |       | February  28, 2007    |       | $0.14                        |       |
|             |       | January  23, 2007    |       | January  31, 2007     |       | $0.14                        |       |
|             |       | December  20, 2006   |       | December  29, 2006    |       | $0.14                        |       |
|             |       | November  21, 2006   |       | November  30, 2006    |       | $0.14                        |       |
|             |       | October  23, 2006    |       | October  31, 2006     |       | $0.14                        |       |
|             |       |                 |       | Total                 |       | $0.84                        |       |
|             |       |                 |       |                  |       |                         |       |
| 2006             |       | March  23, 2006      |       | March  31, 2006       |       | $0.135                       |       |
|             |       | February  20, 2006   |       | February  28, 2006    |       | $0.135                       |       |
|             |       | January  19, 2006    |       | January  31, 2006     |       | $0.135                       |       |
|             |       | December  21, 2005   |       | December  30, 2005    |       | $0.135                       |       |
|             |       | November  21, 2005   |       | November  30, 2005    |       | $0.135                       |       |
|             |       | October  21, 2005    |       | October  31, 2005     |       | $0.135                       |       |
|             |       |                 |       | Total                 |       | $0.810                       |       |

 

NOTE11. CONTRACTUAL OBLIGATIONS

Asof March 31, 2007, the Company was a party to signed and non-binding termsheets for two loan originations for $14.0 million.  The Company expects to fund these potentialinvestments as follows:
| ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Payment Due by Period** | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | ** ** | ** ** | **Total**  | ** ** | **Less than 1 Year**      | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than 5 Years** | ** ** |
|                             |       |       |       |       |       |                                     |       |   |   |   |   |
| Investments                      |       | 14,000,000 |       | 14,000,000 |       | —                                   |       | — |   | — |   |
| Total                            |       | $          | 14,000,000 |       | $          | 14,000,000                               |       | $ | — |   | $ | — |   | $ | — |   |
|                                  |            |            |            |            |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

Allprospective investments are subject to, among other things, the satisfactorycompletion of the Company’s due diligence investigation of each borrower,acceptance of terms and structure and receipt of necessary consents. Withrespect to each prospective loan, the Company will only agree to provide theloan if, among other things, the results of its due diligence investigationsare satisfactory, the terms and conditions of the loan are acceptable and allnecessary consents are received. The Company has initiated its due diligenceinvestigations of the potential borrowers, however there can be no guarantee thatfacts will not be discovered in the course of completing the due diligence thatwould render a particular investment imprudent or that any of these investmentswill actually be made.

NOTE12. SUBSEQUENT EVENTS

In April 2007, theCompany sold either outright or to Gladstone Investment at market value via anindependent broker approximately $16.9 million of syndicated loanparticipations and the Company was repaid in full on one loan originationinvestment of approximately $5.6 million and received a success fee ofapproximately $195,000.

In April 2007, the Company’s Board of Directors declared thefollowing monthly cash dividends:

| Fiscal Year | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend  per Share** | ** ** |
|------------------|------------|----------------------|------------|-----------------------|------------|------------------------------|------------|
| 2007             |       | April  20, 2007      |       | April  30, 2007       |       | $0.14                        |       |
|             |       | May  22, 2007        |       | May  31, 2007         |       | $0.14                        |       |
|             |       | June 21, 2007        |       | June 29, 2007         |       | $0.14                        |       |

 

On May 2, 2007, the Company completed apublic offering of 2,000,000 shares of its common stock, at a price of $24.25per share, under a shelf registration statement on Form N-2 (FileNo. 333-100385), and pursuant to the terms set forth in a prospectus datedApril 16, 2007, as supplemented by a final prospectus dated April 27,2007.  Net proceeds of the offering,after underwriting discounts and offering expenses, were approximately$45,625,000 and were used to repay outstanding borrowings under the Company’sline of credit.

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

**All statements containedherein, other than historical facts, may constitute “forward-looking statements”within the meaning of Section 27A of the Securities Act of 1933, as amended,and Section 21E of the Securities Exchange Act of 1934, as amended. Thesestatements may relate to, among other things, future events or our futureperformance or financial condition. In some cases, you can identifyforward-looking statements by terminology such as “may,” “might,” “believe,” “will,”“provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,”“should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or thenegative of such terms or comparable terminology. These forward-lookingstatements involve known and unknown risks, uncertainties and other factorsthat may cause our actual results, levels of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by suchforward-looking statements. Such factors include, among others: (1) adversechanges in interest rates; (2) our failure or inability to establish ormaintain referral arrangements with leveraged buyout funds and venture capitalfunds to generate loan opportunities; (3) the loss of one or more of ourexecutive officers, in particular David Gladstone, Terry Lee Brubaker, orGeorge Stelljes III; (4) our inability to extend, refinance or maintain ourcredit facilities on terms reasonably acceptable to us, if at all in futureequity capital resources; (5) our inability to successfully securitize our loanportfolio on terms reasonably acceptable to us, if at all; (6) the decision ofour competitors to aggressively seek to make senior and subordinated loans tosmall and medium-sized businesses on terms more favorable than we intend toprovide; and (7) those factors listed under the caption “Risk Factors” of theAnnual Report on Form 10-K as filed with the Securities and Exchange Commissionon December 6, 2006. We caution readers not to place undue reliance on any suchforward-looking statements, which are made pursuant to the Private SecuritiesLitigation Reform Act of 1995 and, as such, speak only as of the date made. Weundertake no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise,after the date of this Form 10-Q**.

*Thefollowing analysis of our financial condition and results of operations shouldbe read in conjunction with our consolidated financial statements and the notesthereto contained elsewhere in this report and our annual report on Form10-K for the fiscal year ended September 30, 2006**.*

**OVERVIEW**

We were incorporatedunder the General Corporation Laws of the State of Maryland on May 30, 2001.Our investment objectives are to achieve a high level of current income byinvesting in debt securities, consisting primarily of senior notes, second liennotes, and senior subordinated notes of established private businesses that arebacked by leveraged buyout funds, venture capital funds or others, with aparticular emphasis on second lien and senior subordinated notes.  In addition, we may acquire existing loans,which meet this profile, from leveraged buyout funds, venture capital funds andothers. We also seek to provide our stockholders with long-term capital growththrough the appreciation in the value of warrants, or other equity instrumentsthat we may receive when we extend loans. We operate as a closed-end,non-diversified management investment company, and have elected to be treatedas a business development company under the Investment Company Act of 1940, asamended (the “1940 Act”).

We seek to invest insmall and medium-sized businesses that meet certain criteria, including some orall of the following:  (1) the potentialfor growth in cash flow, (2) adequate assets for loan collateral, (3)experienced management teams with a significant ownership interest in theborrower, (4) profitable operations based on the borrower’s cash flow, (5)reasonable capitalization of the borrower (usually by buyout funds or venturecapital funds) and (6) the potential to realize appreciation and gain liquidityin our equity position, if any. We anticipate that liquidity in our equityposition will be achieved through a merger or acquisition of the borrower, apublic offering by the borrower or by exercise of our right to require theborrower to buy back its warrants. We lend to borrowers that need funds to,among other things, effect a change of control, restructure their balancesheets, or finance growth, including acquisitions.

Our loans typically rangefrom $5 million to $15 million, although this investment size may varyproportionately as the size of our capital base changes, generally mature in nomore than seven years and accrue interest at fixed or variable rates. Some ofour loans may contain a provision that calls for some portion of the interestpayments to be deferred and added to the principal balance so that the interestis paid, together with the principal, at maturity. This form of deferredinterest is often called “paid in kind” or “PIK” interest, and, when earned, werecord PIK interest as interest income and add the PIK interest to theprincipal balance of the loans. We seek to avoid PIK interest with allpotential investments under review. We currently do not hold any investmentswith PIK and, therefore, there was no PIK accrued on our balance sheet as of March31, 2007.

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Because the majority ofour portfolio loans consist of term debt of private companies who typicallycannot or will not expend the resources to have their debt securities rated bya credit rating agency, we expect that most of the debt securities we acquirewill be unrated. We cannot accurately predict what ratings these loans mightreceive if they were in fact rated, and thus cannot determine whether or notthey could be considered “investment grade” quality.

To the extent possible,our loans generally are collateralized by a security interest in the borrower’sassets. Interest payments are generally made monthly or quarterly (except tothe extent of any PIK interest) with amortization of principal generally beingdeferred for several years. The principal amount of the loans and any accruedbut unpaid interest generally become due at maturity at five to seven years.When we receive a warrant to purchase stock in a borrower in connection with aloan, the warrant will typically have an exercise price equal to the fair valueof the portfolio company’s common stock at the time of the loan and entitle usto purchase a modest percentage of the borrower’s stock.

Original issue discounts(“OID”) arise when we extend a loan and receive an equity interest in theborrower at the same time.  To the extentthat the price paid for the equity is not at market value, we must allocatepart of the price paid for the loan, to the value of the equity.  Then the amount allocated to the equity, theOID, must be amortized over the life of the loan.  As with PIK interest, the amortization of OIDalso produces income that must be recognized for purposes of satisfying thedistribution requirements for a regulated investment company (“RIC”) underSubchapter M of the Internal Revenue Code of 1986, as amended (the “Code”),whereas the cash is received, if at all, when the equity instrument issold.  We seek to avoid OID and to datedo not hold any investments with OID.

In addition, as abusiness development company under the 1940 Act, we are required to makeavailable significant managerial assistance to our portfolio companies. Ourinvestment adviser, Gladstone Management Corporation (the “Adviser”) providesthese services on our behalf through its officers who are also our officers.  In addition, our Adviser provides otherservices to our portfolio companies, for which it receives fees, in connectionwith our investments.  The fees for theseservices are generally paid to the Adviser in part at the time a prospectiveportfolio company signs a non-binding term sheet with us (as further describedin the following paragraph), with the remainder paid at the closing of theinvestment. These fees are generally non-recurring, however in some instancesthey may have a recurring component which is also paid to the Adviser.  Any fees received for other services, withthe exception of recurring monitoring and review fees, by the Adviser arecurrently credited against the base management fee payable to the Adviserpursuant to the terms of our advisory agreement, which has the effect ofreducing our expenses to the extent of any such credits.  The specific other services the Adviserprovides vary by portfolio company, but generally include a broad array ofservices to the portfolio companies such as investment banking services,arranging bank financing, arranging equity financing, structuring financingfrom multiple lenders and investors, reviewing existing credit facilities,restructuring existing loans, raising equity and debt capital, turnaroundmanagement, merger and acquisition services and recruiting new managementpersonnel. To date the Adviser has not charged for managerial assistanceservices, however, if the Adviser does receive fees for such managerialassistance, the Adviser will credit the managerial assistance fees to the basemanagement fee due from us to the Adviser.

Prior to making aninvestment, we ordinarily enter into a non-binding term sheet with thepotential borrower. These non-binding term sheets are generally subject to anumber of conditions, including, but not limited to, the satisfactorycompletion of our due diligence investigations of the potential borrower’sbusiness, reaching agreement on the legal documentation for the loan, and thereceipt of all necessary consents. Upon execution of the non-binding termsheet, the potential borrower generally pays the Adviser a non-refundable feefor its services rendered through the date of the non-binding term sheet. Thesefees are received by the Adviser and are offset against the base management feepayable to the Adviser, which has the effect of reducing our expenses to theextent of any such fees received by the Adviser.

In the event that weexpend significant effort in considering and negotiating a potential investmentthat ultimately is not consummated, we generally will seek reimbursement fromthe proposed borrower for our reasonable expenses incurred in connection withthe transaction, including legal fees. Any amounts collected for expenses incurred by the Adviser in connectionwith unconsummated investments will be reimbursed to the Adviser.   Amounts collected for these expensesincurred by us will be reimbursed to us and will be recognized in the period inwhich such reimbursement is received, however, there can be no guarantee thatwe will be successful in collecting any such reimbursements.

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During the six monthsended March 31, 2007, we extended, directly or through participations,approximately $127.6 million of new loans to a total of 32 companies.  Also, during the six months ended March 31,2007, one borrower repaid its loans ahead of contractual maturity, one borrowerrefinanced its investment and we sold or were repaid in full on 11 syndicatedloans of approximately $56.9 million, and we received scheduled contractualprincipal repayments of approximately $5.1 million, for total principalrepayments of approximately $62.0 million. Since our initial public offering in August 2001, we have made 190different loans to, or investments in, 100 companies for a total ofapproximately $622.2 million, before giving effect to principal repayments oninvestments and divestitures.

We are continuouslyworking toward the consummation of more loan origination and syndicatedinvestments in an effort to grow our loan portfolio. These prospective loansare subject to, among other things, the satisfactory completion of our duediligence investigation of each borrower, acceptance of terms and structure andattainment of necessary consents. With respect to each prospective loan, wewill only agree to provide the loan if, among other things, the results of ourdue diligence investigations are satisfactory, the terms and conditions of theloan are acceptable and all necessary consents are received. Our management hasinitiated its due diligence investigations of the potential borrowers, howeverwe cannot assure you that we will not discover facts in the course ofcompleting our due diligence that would render a particular investmentimprudent or that any of these loans will actually be made.

**Our Investment Adviser and Administrator**

Our Adviser is led by amanagement team which has extensive experience in our lines of business. OurAdviser is controlled by David Gladstone, our chairman and chief executiveofficer. Mr. Gladstone is also the chairman and chief executive officer ofour Adviser. Terry Lee Brubaker, our vice chairman, chief operating officer,secretary and director, is a member of the board of directors of our Adviserand its vice chairman and chief operating officer. George Stelljes III,our president, chief investment officer and director, is a member of the boardof directors of our Adviser and its president and chief investment officer.Harry Brill, our chief financial officer, is also the chief financial officerof our Adviser. Our Adviser also has a wholly-owned subsidiary, GladstoneAdministration, LLC (the “Administrator”), which employs our chief financialofficer, chief compliance officer, controller, treasurer and their respectivestaffs.

Our Adviser andAdministrator also provide investment advisory and administrative services toour affiliates, Gladstone Commercial Corporation, a publicly traded real estateinvestment trust; Gladstone Investment Corporation, a publicly traded businessdevelopment company; and Gladstone Land Corporation, an agricultural realestate company owned by Mr. Gladstone. All of our directors and executiveofficers serve as either directors or executive officers, or both, of GladstoneCommercial Corporation and Gladstone Investment Corporation. In the future, ourAdviser may provide investment advisory and administrative services to otherfunds, both public and private, of which it is the sponsor.

We have been externallymanaged by our Adviser pursuant to an investment advisory and management agreementsince October 1, 2004. Our Adviser was organized as a corporation under thelaws of the State of Delaware on July 2, 2002, and is a registeredinvestment adviser under the Investment Advisers Act of 1940, as amended. OurAdviser is headquartered in McLean, Virginia, a suburb of Washington D.C., andalso has offices in New York, New Jersey, Pennsylvania, Illinois, Texas,Kentucky and Washington.

**Investment Advisory andManagement Agreement**

On December 2, 2005, ourstockholders approved a proposal to enter into an amended and restatedinvestment advisory agreement (the “Amended Advisory Agreement”) with theAdviser and an administration agreement (the “Administration Agreement”)between us and our Administrator, both of which became effective on October 1,2006.  The Amended Advisory Agreementreplaced the original advisory agreement (the “Initial Advisory Agreement”),which terminated on September 30, 2006. We will continue to pay our direct expenses including, but not limitedto, directors’ fees, legal and accounting fees, stockholder related expenses,and directors and officers insurance under the Amended Advisory Agreement.

Pursuant to the InitialAdvisory Agreement, we paid the Adviser an annual advisory fee of 1.25% of ourtotal assets (as reduced by cash and cash equivalents pledged to creditors),payable in quarterly computed increments of 0.3125%, and an annualadministrative fee of 0.75% of our total assets (as reduced by cash and cashequivalents pledged to creditors), payable in quarterly computed increments of0.1875%, for a total annual base management fee of 2%. This fee was thendirectly reduced by the amount of loan servicing fees paid to the Adviser andany other fees received by the Adviser from our borrowers and potentialborrowers.

Under the AmendedAdvisory Agreement, we pay the Adviser an annual base management fee of 2% ofour average gross assets, which is defined as total assets less cash and cashequivalents pledged to creditors calculated as of the end of the two mostrecently completed fiscal quarters and also consists of a two-part incentivefee.

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The first part of theincentive fee is an income-based incentive fee which rewards the Adviser if ourquarterly net investment income (before giving effect to any incentive fee)exceeds 1.75% of our net assets (the “hurdle rate”). We will pay the Adviser anincome incentive fee with respect to our pre-incentive fee net investmentincome in each calendar quarter as follows:

·             no incentive fee inany calendar quarter in which our pre-incentive fee net investment income doesnot exceed the hurdle rate (7% annualized);

·             100% of ourpre-incentive fee net investment income with respect to that portion of suchpre-incentive fee net investment income, if any, that exceeds the hurdle ratebut is less than 2.1875% in any calendar quarter (8.75% annualized); and

·             20% of the amount ofour pre-incentive fee net investment income, if any, that exceeds 2.1875% inany calendar quarter (8.75% annualized).

The second part ofthe incentive fee is a capital gains incentive fee that will be determined andpayable in arrears as of the end of each fiscal year (or upon termination ofthe Amended Advisory Agreement, as of the termination date), commencing onOctober 1, 2006, and will equal 20% of our realized capital gains as of the endof the fiscal year. In determining the capital gains incentive fee payable tothe Adviser, we will calculate the cumulative aggregate realized capital gainsand cumulative aggregate realized capital losses since our inception, and theaggregate unrealized capital depreciation as of the date of the calculation, asapplicable, with respect to each of the investments in our portfolio.

The Adviser’sboard of directors has agreed to voluntarily waive 1.5% of the annual 2.0% basemanagement fee to 0.5% for senior syndicated loans for the three months endedMarch 31, 2007.

In addition to thebase management and incentive fees under the Amended Advisory Agreement,certain fees received by the Adviser from our portfolio companies were creditedagainst the investment advisory fee under the Initial Advisory Agreement, andwill continue to be paid to the Adviser and credited under the Amended AdvisoryAgreement.

The Adviserservices our loan portfolio pursuant to a loan servicing agreement withGladstone Business Loan, LLC (“Business Loan”) in return for a 1.5% annual fee,based on the monthly aggregate outstanding loan balance of the loans pledgedunder our credit facility.  Effective inApril 2006, the Adviser’s board of directors voted to reduce the portion of theannual fee to 0.5% for senior syndicated loans. This fee directly reduces the amount of fee payable under both theInitial and Amended Advisory Agreements. For the three months ended March 31, 2007 and 2006, we incurred $760,623and $734,644, respectively, and for the six months ended March 31, 2007 and2006 we incurred $1,479,775 and $1,450,059, respectively, in loan servicingfees.

For the three monthsended March 31, 2007, the gross base management fee, based on the Amended AdvisoryAgreement, before reductions for loan servicing and other fees was $1,211,108,as compared to $1,087,023 for the three months ended March 31, 2006. Afterbeing reduced by loan servicing fees of $760,623 and other fees received by theAdviser of $775,000, our net base management fee was a credit of $324,516 forthe three months ended March 31, 2007, as compared to reductions for loanservicing fees of $734,644 and other fees received by the Adviser of $673,000,our net base management fee was a credit of $320,621 for the three months endedMarch 31, 2006. For the six months ended March 31, 2007, the gross basemanagement fee, based on the Amended Advisory Agreement, before reductions forloan servicing fees and other fees was $2,328,692.  After being reduced by loan servicing fees of$1,479,775 and other fees received by the Adviser of $1,086,000, our net basemanagement fee for the six months ended March 31, 2007 was a credit of$237,084.  For the six months ended March31, 2006, the gross base management fee, before reductions for loan servicingfees and other fees was $2,071,139. After being reduced by loan servicing fees of $1,450,059 and other feesreceived by the Adviser of $1,223,000, our net base management fee for the sixmonths ended March 31, 2006 was a credit of $601,920.  At March 31, 2007, $217,631 of unpaid loanservicing fees and $324,516 of base management fee due to us was recorded netin fees due from Adviser in the accompanying consolidated statement of assetsand liabilities.

For the three and sixmonths ended March 31, 2007, we recorded a gross incentive fee of $1,158,995and $2,307,478, respectively, which was offset by a waiver voluntarily issuedby the Adviser’s board of directors of $1,088,378 and $1,657,372, respectively,which resulted in a net incentive fee due to the Adviser of $70,617 and$650,106, respectively, of which $70,617 is unpaid and is netted and recordedin fees due from Adviser on our consolidated statements of assets andliabilities.  There was no incentive feerecorded for the three and six months ended March 31, 2006 as the AmendedAdvisory Agreement was not in effect.

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**AdministrationAgreement**

Under theAdministration Agreement, we pay separately for administrative services. TheAdministration Agreement provides for payments equal to our allocable portionof the Administrator’s overhead expenses in performing its obligations underthe Administration Agreement including, but not limited to, rent for employeesof the Administrator, and our allocable portion of the salaries and benefitsexpenses of our chief financial officer, controller, chief compliance officer,treasurer and their respective staffs. Our allocable portion of expenses is derived by multiplying ourAdministrator’s total expenses by the percentage of our average total assets(the total assets at the beginning and end of each quarter) in comparison tothe average total assets of all companies managed by our Adviser.  For the three and six months ended March 31,2007, we incurred $168,766 and $294,851, respectively, for the administrationfee and since the Administration Agreement was not in effect at March 31, 2006,no such expense was recorded.

**Off-Balance Sheet Arrangements**

We do not have anysignificant off-balance sheet arrangements as defined in Item 303(a)(4)(ii) ofSecurities and Exchange Commission (“SEC”) Regulation S-K as of March 31,2007.

**Recent Accounting Pronouncements**

InMay 2005, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards (“SFAS”) No. 154, *“AccountingChanges and Error Corrections,”* a replacement of APB Opinion No. 20,*“Accounting Changes,”* and SFAS No. 3, *“Reporting Accounting Changes in Interim Financial Statements”*and changes the requirements for the accounting for and reporting of a changein accounting principle.  SFAS No. 154applies to all voluntary changes in accounting principle and also applies tochanges required by an accounting pronouncement in the unusual instance thatthe pronouncement does not include specific transition provisions.  SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple.  SFAS No. 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005.  We adopted theprovisions of SFAS No. 154, as applicable, on October 1, 2006.

InFebruary 2006, the FASB issued SFAS No. 155, *“Accountingfor Certain Hybrid Financial Instruments, an amendment of FASB statementsNo. 133 and 140”* (SFAS No. 155). SFAS No. 155 allowsfinancial instruments that have embedded derivatives to be accounted for as awhole (eliminating the need to bifurcate the derivative from its host) as longas the entire instrument is valued on a fair value basis. The statement alsoresolves and clarifies other specific SFAS No. 133 and SFAS No. 140related issues. SFAS No. 155 is effective for all financial instrumentsacquired or issued after the beginning of an entity’s first fiscal year thatbegins after September 15, 2006. We adopted SFAS No. 155 onOctober 1, 2006 and have not realized a material impact of the financialstatements since all investments are valued on a fair value basis.

InJune 2006, the FASB issued FASB Interpretation No. 48, *“Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109,”* which clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, *“Accounting for IncomeTaxes.”* This Statement shall be effective as of the beginning of anentity’s first fiscal year that begins after December 15, 2006. We willadopt this Interpretation effective October 1, 2007, and are currentlyevaluating the impact of this pronouncement on the consolidated financial statements.

InSeptember 2006, the FASB issued SFAS No. 157, *“Fair ValueMeasurements”* (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuringfair value in accordance with GAAP, and expands disclosures about fair valuemeasurements.  SFAS No. 157 appliesbroadly to securities and other types of assets and liabilities.  SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007 andinterim periods within that fiscal year. We will be required to adopt SFAS No. 157 on October 1, 2008 and arecurrently evaluating the impact of this pronouncement on the consolidatedfinancial statements.

InSeptember 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”).SAB 108 addresses how the effects of prior year uncorrected misstatementsshould be considered when quantifying misstatements in current year financialstatements and requires registrants to consider the effect of all carry overand reversing effects of prior year misstatements when quantifying errors incurrent year financial statements. SAB 108 does not change the SEC’s previousguidance in SAB No. 99, *“Materiality,”*on evaluating the materiality of misstatements. A registrant applying the newguidance for the first time that identifies material errors in existence at thebeginning of the first fiscal year ending after November 15, 2006, maycorrect those errors through a one-time cumulative effect adjustment tobeginning-of-year retained earnings. The cumulative effect alternative isavailable only if the application of the new guidance results in a conclusionthat a material error exists as of the beginning of the first fiscal yearending after November 15, 2006, and those misstatements were determined tobe immaterial based on a proper application of the registrant’s previous methodfor quantifying misstatements. The adoption of SAB 108 did not have an impacton the consolidated financial statements.

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In February 2007, theFASB issued SFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment ofFASB Statement No. 115”* which is effective for fiscal yearsbeginning after November 15, 2007. This pronouncement permits an entity tochoose to measure many financial instruments and certain other items at fairvalue at specified election dates. Subsequent unrealized gains and losses onitems for which the fair value option has been elected will be reported in earnings.We are currently evaluating the potential impact of this pronouncement on theconsolidated financial statements.

**CriticalAccounting Policies**

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

***InvestmentValuation***

The most significantestimate inherent in the preparation of our consolidated financial statementsis the valuation of investments and the related amounts of unrealizedappreciation and depreciation of investments recorded.

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

Debt and equitysecurities that are not publicly traded, for which a limited market does notexist, or for which a limited market exists but that have not been rated by a NRSRO(or for which we have various degrees of trading restrictions) are valued atfair value as determined in good faith by or under the direction of our Boardof Directors. In making the good faith determination of the value of thesesecurities, we start with the cost basis of the security, which includes theamortized OID and PIK interest, if any. We then apply the methods set out belowin *“Valuation Methods.”* Members of ourAdviser’s portfolio management team prepare the valuations of our investmentsin portfolio companies using the most recent portfolio company financialstatements and forecasts. These individuals also consult with portfolio companysenior management and ownership to obtain further updates on the portfoliocompany’s performance, including information such as industry trends, newproduct development, and other operational issues. Due to the uncertaintyinherent in the valuation process, such estimates of fair value may differsignificantly from the values that would have been obtained had a ready marketfor the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains or losses ultimatelyrealized on these investments to be different than the valuations currentlyassigned. There is no single standard for determining fair value in good faith,as fair value depends upon circumstances of each individual case. In general,fair value is the amount that we might reasonably expect to receive upon thecurrent sale of the security.

At March 31, 2007, weengaged Standard & Poor’s Securities Evaluations, Inc. (“SPSE”) to submitopinions of value for most of our loan securities. We request that SPSE alsoevaluate and assign values to success fees (conditional interest included insome loan securities) when we determine that the probability of receiving asuccess fee on a given loan is above 6-8%, a threshold of significance. Uponcompleting our collection of data with respect to the investments (includingthe information described under *“Credit Information,”*the risk ratings of the loans described under *“LoanGrading and Risk Rating”* and the factors described under *“Valuation Methods”*), this valuation data is forwarded alongto SPSE for review and analysis. SPSE makes its independent assessment of thedata that we have assembled and assesses its independent data to form anopinion as to what they consider to be the market values for the securities.With regard to its work, 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 factorsbeyond its control, SPSE cannot guarantee these evaluations. The evaluationsreflect the market prices, or estimates thereof, on the date specified. Theprices are based on comparable market prices for similar securities. Marketinformation has been obtained from reputable secondary market sources. Althoughthese sources are considered reliable, SPSE cannot guarantee their accuracy.

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SPSE opinions of valueare submitted 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 the Board assessment, our Adviser’s conclusions as to value maydiffer from the opinion of value delivered by SPSE. Our Board of Directors thenreviews whether our Adviser has followed its established procedures fordeterminations of fair value, and votes whether to accept the recommendedvaluation of our investment portfolio. Our Adviser and our managementrecommended, and the Board of Directors elected to accept, the opinions ofvalue delivered by SPSE on the loans in our portfolio as denoted on theschedule of investments as of March 31, 2007 and September 30, 2006, includedin our consolidated financial statements.

Because there is a delaybetween when we close an investment and when the investment can be evaluated bySPSE, new loans are not valued immediately by SPSE; rather, management makesits own determination about the value of these investments in accordance withour valuation policy. Because SPSE does not provide values for equitysecurities, our Adviser determines the fair value of these investments usingvaluation policies approved by our Board of Directors.

*Credit Information:*** **OurAdviser monitors a wide variety of key credit statistics that provideinformation regarding our portfolio companies to help us assess credit qualityand portfolio performance. If we held a controlled or affiliate investment, weand our Adviser would participate in periodic board meetings of such portfoliocompanies and also require them to provide annual audited and monthly unauditedfinancial statements. Using these statements and board discussions, our Adviserwould calculate and evaluate the credit statistics.

*Loan Grading and Risk Rating:*****As part of our valuation procedures werisk rate all of our investments in debt securities. For syndicated loans thathave been rated by a NRSRO (as defined in Rule 2a-7 under the 1940 Act), we usethe NRSRO’s risk rating for such security. For all other debt securities, weuse a proprietary risk rating system. Our risk rating system uses a scale of 0to 10, with 10 being the lowest probability of default. This system is used toestimate the probability of default on debt securities and the probability ofloss if there is a default. These types of systems are referred to as riskrating systems and are used by banks and rating agencies. The risk ratingsystem covers both qualitative and quantitative aspects of the business and thesecurities we hold.

For the debt securitiesfor which we do not use a third-party NRSRO risk rating, we seek to have ourrisk rating system mirror the risk rating systems of major risk ratingorganizations, such as those provided by a NRSRO. While we seek to mirror theNRSRO systems, we cannot provide any assurance that our risk rating system willprovide the same risk rating as a 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 the NRSROset out below is accurate. We believe our risk rating would be significantlyhigher than a typical NRSRO risk rating because the risk rating of the typicalNRSRO is designed for larger businesses. However, our risk rating has beendesigned to risk rate the securities of smaller businesses that are not ratedby a typical NRSRO. Therefore, when we use our risk rating on larger businesssecurities, the risk rating is higher than a typical NRSRO rating. The primarydifference between our risk rating and the rating of a typical NRSRO is thatour risk rating uses more quantitative determinants and includes qualitativedeterminants that we believe are not used in the NRSRO rating. It is ourunderstanding that most debt securities of medium-sized companies do not exceedthe grade of BBB on a NRSRO scale, so there would be no debt securities in themiddle market that would meet the definition of AAA, AA or A. Therefore, ourscale begins with the designation 10 as the best risk rating which may beequivalent to a BBB from a NRSRO, however, no assurance can be given that a 10on our scale is equal to a BBB on a NRSRO scale.

 
| 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)**          Thedefault rates set here are for a ten year term debt security.  If the company’s debt security is less than tenyears then the probability of default is adjusted to a lower percentage for theshorter period which may move the security higher on our risk rating scale.*

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The above scale gives anindication of the probability of default and the magnitude of the loss if thereis a default.  Our policy is to stopaccruing interest on an investment if we determine that interest is no longercollectible.  Currently, none of ourinvestments are on non-accrual.  At March31, 2007, no payments were past due on any of our debt securities.  Additionally, we do not risk rate our equitysecurities.

The following table liststhe risk ratings for all non-syndicated loans in our portfolio at March 31,2007 and September 30, 2006, representing approximately 64% and 73%,respectively, of all loans in our portfolio:

| Rating           | ** ** | ** ** | ** ** | **Mar. 31, 2007** | ** ** | **Sept. 30, 2006** | ** ** |
|------------------|------------|------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **7.1**    | ** ** | **7.2**                     | ** ** |
| Weighted Average | ** ** | **7.0**    | ** ** | **7.2**                     | ** ** |
| Highest          | ** ** | **10.0**   | ** ** | **9.0**                     | ** ** |
| Lowest           | ** ** | **5.0**    | ** ** | **6.0**                     | ** ** |

 

The following table liststhe risk ratings for syndicated loans in our portfolio that are not currentlyrated by an NRSRO at March 31, 2007 and September 30, 2006, representingapproximately 14% and 17%, respectively, of all loans in our portfolio:

| Rating           | ** ** | ** ** | ** ** | **Mar. 31, 2007** | ** ** | **Sept. 30, 2006** | ** ** |
|------------------|------------|------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **6.2**    | ** ** | **6.1**                     | ** ** |
| Weighted Average | ** ** | **6.1**    | ** ** | **6.3**                     | ** ** |
| Highest          | ** ** | **9.0**    | ** ** | **8.0**                     | ** ** |
| Lowest           | ** ** | **4.0**    | ** ** | **4.0**                     | ** ** |

 

For syndicated loans thatare currently rated by an NRSRO, we risk rate such loans in accordance with therisk rating systems of major risk rating organizations such as those providedby a NRSRO. The following table lists the risk ratings for all syndicated loansin our portfolio that are currently rated by an NRSRO at March 31, 2007 andSeptember 30, 2006, representing approximately 22% and 10%, respectively, ofall loans in our portfolio:

| Rating           | ** ** | ** **    | ** ** | **Mar. 31, 2007** | ** ** | **Sept. 30, 2006** |
|------------------|------------|---------------|------------|-------------------|------------|--------------------|
| Average          | ** ** | **B-/B3**     | ** ** | **CCC+/Caa1**     |
| Weighted Average | ** ** | **CCC+/Caa1** | ** ** | **CCC+/Caa1**     |
| Highest          | ** ** | **BB-/Ba2**   | ** ** | **B-/B3**         |
| Lowest           | ** ** | **CCC/Caa3**  | ** ** | **CCC/Caa1**      |

 

*Valuation Methods:*  We determine the value of publicly-tradeddebt securities based on the closing price for the security on the exchange orsecurities market on which it is listed on the valuation date. We value debtsecurities that are not publicly traded, but for which a limited market for thesecurity exists, such as participations in syndicated loans, at the indicativebid price offered by the syndication agent on the valuation date.  At March 31, 2007, none of the debtsecurities in our portfolio were publicly traded and there was a limited marketfor 31 debt securities in our portfolio. At September 30, 2006, none of the debt securities in our portfolio werepublicly traded and there was a limited market for 9 debt securities in our portfolio.

For debt securities thatare not publicly traded, for which there is no market, or for which there is amarket but have not been rated by a NRSRO, we begin with the risk ratingdesignation of the security as described above. Using this risk rating designation, we seek to determine the value ofthe security as if we currently intended to sell the security and consider someor all of the following factors:

·                  the cost basisand the type of the security;

·                  the nature andrealizable value of the collateral;

·                  the portfoliocompany’s ability to make payments and discounted cash flow;

·                  reports fromportfolio company senior management and board meetings;

·                  reported valuesof similar securities of the portfolio company or comparable companies; and

·                  changes in theeconomy affecting the portfolio company.

We value convertibledebt, equity, success fees or other equity-like securities for which there is amarket based on the market prices for such securities, even if that market isnot robust. At March 31, 2007 and September 30, 2006, there was no marketfor any of the equity securities we owned. To value equity securities for whichno market exists, we use the same information we would use for a debt securityvaluation described above, except risk-rating, as well as standard valuationtechniques used by major valuation firms to value the equity securities ofprivate companies. These valuation techniques consist of discounted cash flowof the expected sale price in the future, valuation of the securities based onrecent sales in comparable transactions, and a review of similar companies thatare publicly traded and the market multiple of their equity securities.  At March 31, 2007 and September 30, 2006, wehad $146,124 and $37,000, respectively, invested, at cost, in equity securitiescompared to our debt portfolio with a cost basis of $281,379,326 and$216,165,986, respectively.

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At March 31, 2007, we hadtotal unrealized depreciation of $3,037,674, which was mainly comprised ofunrealized deprecation of $1,250,000 on our senior subordinated term debtinvestment in Visual Edge Technology, Inc., unrealized depreciation of$733,000, on the aggregate of our investments in LocalTel, Inc. and unrealizeddepreciation of $482,488 on our senior subordinated term debt investment inConsolidated Bedding, Inc.  Unrealizedappreciation of $1,754,910 was primarily composed of unrealized appreciation of$789,061 on our warrants in Finn Corporation, a $180,800 success fee value onour senior term debt investment in Allied Extruders, Inc. and a $94,219 successfee value on our senior term debt investment in SCPH Holdings, Inc.  In the aggregate, we recorded net unrealizeddepreciation of $1,282,764 on our total investment portfolio as of March 31,2007.

At September 30, 2006, wehad total unrealized appreciation of $2,015,198, which was mainly comprised ofunrealized appreciation of $672,431 on our warrants of Finn Corporation,unrealized appreciation of $607,625 on our senior term debt in Mistras HoldingCorporation and unrealized appreciation of $148,287 on our senior subordinatedterm debt investment in Xspedius Communications, LLC.  This unrealized appreciation was offset byunrealized depreciation of $575,434, most notably composed of unrealizeddepreciation of $131,367 on our senior subordinated term debt investment inConsolidated Bedding, Inc. and unrealized depreciation of $115,750 on oursenior term debt in LocalTel Inc. In the aggregate, we recorded net unrealizedappreciation of $1,439,764 on our total investment portfolio as of September30, 2006.

***Tax Status***

*Federal Income Taxes*

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 are required to distribute to stockholders at least 90% ofinvestment company taxable income, as defined by the Code.  We have a policy to pay out as a dividend upto 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 the sum of (1) 98% of ourordinary income for the calendar year, (2) 98% of our capital gains in excessof capital losses for the one-year period ending on October 31 of the calendaryear and (3) any ordinary income and net capital gains for preceding years thatwere not distributed during such years.

***Revenue Recognition***

*Interest Income Recognition*

Interest income isrecorded on the accrual basis to the extent that such amounts are expected tobe collected. We will stop accruing interest on investments and write off anypreviously accrued and uncollected interest when it is determined that interestis no longer collectible. Conditional interest or a success fee is recordedwhen earned upon full repayment of a loan investment.

*Paid in Kind Interest*

In the future, wemay hold loans in our portfolio which contain a PIK interest provision. The PIKinterest, computed at the contractual rate specified in each loan agreement, isadded to the principal balance of the loan and recorded as interest income. Tomaintain our status as a RIC, this non-cash source of income must be paid outto stockholders in the form of dividends, even though we have not yet collectedthe cash.

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**RESULTS OF OPERATIONS**

*Comparisonof the Three Months Ended March 31, 2007 to the Three Months Ended March 31,2006*

**Investment Income**

Investment income for thethree months ended March 31, 2007 was $8,643,778, as compared to $7,000,700 forthe three months ended March 31, 2006. Interest income from our investment portfolio increased from March 31,2006 due to the increase in new loans of $127,641,175, offset by principalrepayments and investment sales of approximately $62,230,246.

Interest income from ourinvestments in debt securities of private companies was $8,254,459 for thethree months ended March 31, 2007, as compared with $6,875,264 for the threemonths ended March 31, 2006, which included approximately $31,000 of PIKinterest.  This increase consisted ofapproximately $65.4 million of net new investments.  As a result of a refinancing by BadancoAcquisition Corp. in January 2007, we recorded a success fee of approximately$533,000.

The annualized weightedaverage yield on our portfolio for the three months ended March 31, 2007 was12.0%; there was no PIK interest accrued during the three months ended March31, 2007. The annualized weighted average yield on our portfolio for the threemonths ended March 31, 2006 was 12.7% (with and without giving effect to PIKinterest).

Interest income frominvested cash and cash equivalents for the three months ended March 31, 2007was $31,645, as compared to $4,624 for the three months ended March 31, 2006.

For the three monthsended March 31, 2007 and March 31, 2006, we recorded $132,931 and $107,033,respectively, in interest income from loans to our employees in connection withthe exercise of employee stock options. The increase is the result ofadditional loans issued in connection with employee stock option exercisesduring the fourth quarter of the previous fiscal year.

For the three monthsended March 31, 2007, we recorded $224,743 of prepayment fees and other income,as compared to $13,779 for the three months ended March 31, 2006.  The income for both periods consisted ofprepayment penalty fees received upon the full repayment of certain loaninvestments ahead of contractual maturity and prepayment fees received upon theearly unscheduled principal repayments which, in both instances, were based ona percentage of the outstanding principal amount of the loan at the date ofprepayment.

**OperatingExpenses**

Operating expenses, priorto credits from the Adviser, for the three months ended March 31, 2007 were$4,782,799, as compared to $2,469,884 for the three months ended March 31,2006. Operating expenses for the three months ended March 31, 2007 reflected asignificant increase in interest expense and management fees, prior to credits,as well as the addition of the incentive and administration fees, prior to credits,under the Amended Advisory and Administration Agreements.

Loan servicingfees of $760,623 were incurred for the three months ended March 31, 2007, ascompared to $734,644 for the three months ended March 31, 2006.  These fees were incurred in connection with aloan servicing agreement between Business Loan and our Adviser, which is basedon the size of the portfolio.  These feeswere reduced against the amount of the base management fee due to our Adviser.

For the threemonths ended March 31, 2007, we incurred a gross base management fee of$450,484 less credits for fees received by our Adviser of $775,000, for a netbase management fee credit of $324,516 as compared to the three months endedMarch 31, 2006, in which we incurred a gross base management fee of $352,379,less credits for fees received by our Adviser of $673,000, for a net basemanagement credit of $320,621. The base management fee is computed quarterly asdescribed under *“Investment Advisory and ManagementAgreement.”*  The feesincreased in the current period due to the growth of the investment portfolioas compared to the same period of the prior year and fewer credits for feesreceived by our Adviser which reduce the base management fee.

Effective October1, 2006, the income based incentive fee became effective and as such werecorded a gross incentive fee of $1,158,995, which was reduced by a voluntarywaiver issued by our Adviser’s board of directors of $1,088,378, which resultedin a net incentive fee of $70,617, which is recorded in fees due to Adviser onour consolidated statements of assets and liabilities.  There was no incentive fee recorded for thethree months ended March 31, 2006, as the Amended Advisory Agreement was not ineffect.

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EffectiveOctober 1, 2006, the Administration Agreement became effective in which weprovide payments equal to our allocable portion of our Administrator’s overheadexpenses in performing its obligations under the Administration Agreementincluding, but not limited to, rent for employees of our Administrator, and ourallocable portion of the salaries and benefits expenses of our chief financialofficer, chief compliance officer and controller and their respectivestaffs.  We incurred an administrationfee of $168,766 for the three months ended March 31, 2007.  There was no administration fee recordedduring the three months ended March 31, 2006, as the Administration Agreementwas not in effect.

Professional fees,consisting primarily of legal and audit fees, for the three months ended March31, 2007 were $109,081, as compared to $110,887 for the three months endedMarch 31, 2006.  The slight decrease isdue to the reimbursement of certain legal fees at the time of the investmentfunding.

Amortization of deferredfinancing costs, in connection with our line of credit, was $68,200 for thethree months ended March 31, 2007 and $32,286 for the three months ended March31, 2006.  The increase is due to theamortization of additional fees incurred with our line of credit which were notin place during the prior year period.

Interest expense for thethree months ended March 31, 2007 was $1,811,019, as compared to $948,166 forthe three months ended March 31, 2006.  This increase is primarily a result of increased borrowings under our lineof credit during the three months ended March 31, 2007, which borrowings werepartially used to finance our increased investments, borrowings remainingoutstanding for longer periods of time and an increase in the interest rates onour borrowings.

Stockholder related costsfor the three months ended March 31, 2007 were $87,288, as compared to $115,864for the three months ended March 31, 2006. Stockholder related costs include such recurring items as transfer agentfees, NASDAQ listing fees, SEC filing fees and annual report printingfees.  These fees decreased during thethree months ended March 31, 2007 since there was a decline in filing fees.

Directors’ fees for thethree months ended March 31, 2007 were $56,970, as compared to $30,212 for thethree months ended March 31, 2006 due to the increase in annual stipend feesand their related monthly amortization.

Insurance expense for thethree months ended March 31, 2007 was $62,398, as compared to $50,590 for thethree months ended March 31, 2006. The increase was primarily the result of anincrease in the amortization of our directors and officers insurance policypremiums.

There was no stock optioncompensation expense recorded for the three months ended March 31, 2007 asthere was no longer a stock option plan in effect.  Stock option compensation expense for thethree months ended March 31, 2006 was $34,065 and was the result of theadoption of the SFAS No. 123 (revised 2004) “*Share-basedPayment.”*

Other expenses were$48,975 for the three months ended March 31, 2007, as compared to $60,791 forthe three months ended March 31, 2006. The expenses primarily represent direct expenses such as travel relatedspecifically to our portfolio companies, loan evaluation services for ourportfolio companies, press releases and backup servicer expenses.

**Net Realized Gain on Sale ofInvestments**

During the three monthsended March 31, 2007, we sold or were repaid in full on nine syndicate loaninvestments for a net gain of $84,205, as compared to a gain of $377,500 fromthe sale of a syndicate investment during the three months ended March 31,2006.

**Realized Gain on Settlement ofDerivative**

During the three monthsended March 31, 2007, we received interest rate cap agreement payments of$10,239 as a result of the one month LIBOR exceeding 5%.  There was no realization during the threemonths ended March 31, 2006 as the one month LIBOR was below 5%.

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**Net Unrealized Depreciation onDerivative**

During the three monthsended March 31, 2007, we recorded net unrealized depreciation of $15,801 due toa decrease in the fair market value of our interest rate cap agreement, ascompared to unrealized appreciation of $24,658 during the three months endedMarch 31, 2006.

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

For the three monthsended March 31, 2007, we recorded net unrealized depreciation on investments of$1,718,149, as compared to net unrealized depreciation of $15,593, for thethree months ended March 31, 2006.  Theunrealized depreciation is mainly attributable to the depreciated fair value oncertain investments.

**Net Increase in Net Assets from Operations**

Overall, we realized a net increase in net assets resulting fromoperations of $4,084,851 for the three months ended March 31, 2007.  Based on a weighted-average of 12,249,683basic and diluted shares outstanding, our net increase in net assets fromoperations per weighted-average common share for the three months ended March31, 2007 was $0.33, basic and diluted.

For the three months ended March 31,2006, werealized a net increase in net assets resulting from operations of$5,590,381.  Based on a weighted-averageof 11,308,510 (basic) and 11,536,360 (diluted) shares outstanding, our netincrease in net assets from operations per weighted-average common share forthe three months ended March 31, 2006 was $0.49 (basic) and $0.48 (diluted).

*Comparisonof the Six Months Ended March 31, 2007 to the Six Months Ended March 31, 2006*

**Investment Income**

Investment income for thesix months ended March 31, 2007 was $16,877,496, as compared to $13,031,019 forthe six months ended March 31, 2006. Interest income from our investment portfolio increased from March 31,2006 due to the increase in new loans of $127,641,175, offset by principalrepayments and investment sales of approximately $62,230,246.

Interest income from ourinvestments in debt securities of private companies was $16,153,059 for the sixmonths ended March 31, 2007 as compared with $12,722,371 for the six monthsended March 31, 2006, which included approximately $63,000 of PIK interest.  This increase consisted of net newinvestments of approximately $65.4 million for the six months ended March 31,2007, as compared to net new investments of approximately $1.6 million for thesix months ended March 31, 2006.  As aresult of a refinancing by Badanco Acquisition Corp. and a full repayment byMistras Holdings Corp., we recorded success fees of approximately $1,733,000during the six months ended March 31, 2007.

The annualized weightedaverage yield on our portfolio for the six months ended March 31, 2007 was12.6%; there was no PIK interest accrued during the six months ended March 31,2007. The annualized weighted average yield on our portfolio for the six monthsended March 31, 2006 was 12.6% (with and without giving effect to PIK interest).

Interest income frominvested cash and cash equivalents for the six months ended March 31, 2007 was$68,914, as compared to $13,536 for the six months ended March 31, 2006 due toan increase in cash held in the custodial account which is interest bearing.

For the six months endedMarch 31, 2007 and March 31, 2006, we recorded $271,122 and $214,126,respectively, in interest income from loans to our employees in connection withthe exercise of employee stock options. The increase is the result of additionalloans issued in connection with employee stock option exercises during thefourth quarter of the previous fiscal year.

For the six months endedMarch 31, 2007, we recorded $384,401 of prepayment fees and other income, ascompared to $80,986 for the six months ended March 31, 2006.  The income for both periods consisted ofprepayment penalty fees received upon the full repayment of certain loaninvestments ahead of contractual maturity and prepayment fees received upon theearly unscheduled principal repayments which, in both instances, were based ona percentage of the outstanding principal amount of the loan at the date ofprepayment.

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**OperatingExpenses**

Operating expenses, priorto credits from the Adviser, for the six months ended March 31, 2007 were$8,733,585, as compared to $4,557,552 for the six months ended March 31, 2006.Operating expenses for the six months ended March 31, 2007 reflected asignificant increase in interest expense and management fees, prior to credits,as well as the addition of the incentive and administration fees, prior tocredits, under the Amended Advisory and Administration Agreements.

Loan servicingfees of $1,479,775 were incurred for the six months ended March 31, 2007, ascompared to $1,450,059 for the six months ended March 31, 2006.  These fees were incurred in connection with aloan servicing agreement between Business Loan and our Adviser, which is basedon the size of the portfolio.  These feeswere reduced against the amount of the base management fee due to our Adviser.

For the six monthsended March 31, 2007, we incurred a gross base management fee of $848,916, lesscredits for fees received by our Adviser of $1,086,000, for a net basemanagement fee credit of $237,084, as compared to the six months ended March 31,2006, in which we incurred a gross base management fee of $621,080, lesscredits for fees received by our Adviser of $1,223,000, for a net basemanagement credit of $601,920. The base management fee is computed quarterly asdescribed under *“Investment Advisory and ManagementAgreement.”*  The feesincreased in the current period due to the growth of the investment portfolioas compared to the same period of the prior year and fewer credits for feesreceived by our Adviser which reduce the base management fee.

Effective October1, 2006, the income based incentive fee became effective and as such werecorded a gross incentive fee of $2,307,478, which was reduced by a voluntarywaiver issued by our Adviser’s board of directors of $1,657,372, which resultedin a net incentive fee of $650,106, which is recorded in fees due to Adviser onour consolidated statements of assets and liabilities.  There was no incentive fee recorded for thesix months ended March 31, 2006, as the Amended Advisory Agreement was not ineffect.

EffectiveOctober 1, 2006, the Administration Agreement became effective in which weprovide payments equal to our allocable portion of our Administrator’s overheadexpenses in performing its obligations under the Administration Agreementincluding, but not limited to, rent for employees of our Administrator, and ourallocable portion of the salaries and benefits expenses of our chief financialofficer, chief compliance officer and controller and their respective staffs.  We incurred an administration fee of $294,851for the six months ended March 31, 2007. There was no administration fee recorded during the six months endedMarch 31, 2006, as the Administration Agreement was not in effect.

Professional fees,consisting primarily of legal and audit fees, for the six months ended March31, 2007 were $220,001, as compared to $233,353 for the six months ended March31, 2006.  The slight decrease is due tothe reimbursement of certain legal fees at the time of investment funding.

Amortization of deferredfinancing costs, in connection with our line of credit, was $126,500 for thesix months ended March 31, 2007 and $58,536 for the six months ended March 31,2006.  The increase is due to theamortization of additional fees incurred with our line of credit which were notin place during the prior year period.

Interest expense for thesix months ended March 31, 2007 was $2,931,276, as compared to $1,600,244 forthe six months ended March 31, 2006.  This increase is primarily a result of increased borrowings under ourline of credit during the six months ended March 31, 2007, which borrowingswere partially used to finance our increased investments, borrowings remainingoutstanding for longer periods of time and an increase in the interest rates onour borrowings.

Stockholder related costsfor the six months ended March 31, 2007 were $151,016, as compared to $244,799for the six months ended March 31, 2006. Stockholder related costs include such recurring items as transfer agentfees, NASDAQ listing fees, SEC filing fees and annual report printingfees.  These fees decreased during thesix months ended March 31, 2007 since there was no special proxy solicitationfiled as there was during the six months ended March 31, 2006.

Directors’ fees for thesix months ended March 31, 2007 were $111,220, as compared to $54,212 for thesix months ended March 31, 2006 due to the increase in annual stipend fees andtheir related monthly amortization.

Insurance expense for thesix months ended March 31, 2007 was $125,092, as compared to $101,367 for thesix months ended March 31, 2006. The increase is primarily the result of anincrease in the amortization of our directors and officers insurance policypremiums.

There was no stock optioncompensation expense recorded for the six months ended March 31, 2007 as therewas no longer a stock option plan in effect. Stock option compensation expense for the six months ended March 31,2006 was $77,322 and was the result of the adoption of the SFAS No. 123(revised 2004) “*Share-based Payment*.”

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Other expenses were$137,460 for the six months ended March 31, 2007, as compared to $116,580 forthe six months ended March 31, 2006.  Theexpenses primarily represent direct expenses such as travel related specificallyto our portfolio companies, loan evaluation services for our portfoliocompanies, press releases and backup servicer expenses.

**Income Tax Expense**

During the six monthsended March 31, 2006, Gladstone Capital Corporation recorded approximately$50,000 in connection with penalties incurred on misclassified revenue on itsfiscal year 2004 corporate tax return.

**Net Realized Gain (Loss) on Saleof Investments**

During the six monthsended March 31, 2007, we sold or were repaid in full on eleven syndicate loaninvestments for a net gain of $86,519, as compared to an aggregate net loss of$803,095, which was composed of $1,180,595 loss from the sale of twoinvestments and a gain of $377,500 from the sale of a syndicate investmentduring the six months ended March 31, 2006.

**Realized Gain on Settlement ofDerivative**

During the six monthsended March 31, 2007, we received interest rate cap agreement payments of$22,793 as a result of the one month LIBOR exceeding 5%.  There was no realization during the sixmonths ended March 31, 2006 as the one month LIBOR was below 5%.

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

During the six monthsended March 31, 2007, we recorded net unrealized depreciation of $25,613 due toa decrease in the fair market value of our interest rate cap agreement, ascompared to unrealized appreciation of $23,766 during the six months endedMarch 31, 2006.

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

For the six months endedMarch 31, 2007, we recorded net unrealized depreciation on investments of $2,722,528,as compared to net unrealized appreciation of $4,956,829, for the six monthsended March 31, 2006.  The unrealizeddepreciation is mainly attributable to the depreciated fair value on certaininvestments.

**Net Increase in Net Assets from Operations**

Overall, we realized a net increase in net assets resulting fromoperations of $8,248,454 for the six months ended March 31, 2007.  Based on a weighted-average of 12,272,012basic and diluted shares outstanding, our net increase in net assets fromoperations per weighted-average common share for the six months ended March 31,2007 was $0.67, basic and diluted.

For the six months ended March 31, 2006,we realized anet increase in net assets resulting from operations of $13,823,730.  Based on a weighted-average of 11,307,510(basic) and 11,555,479 (diluted) shares outstanding, our net increase in netassets from operations per weighted-average common share for the six monthsended March 31, 2006 was $1.22 (basic) and $1.20 (diluted).

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**LIQUIDITY AND CAPITAL RESOURCES**

At March 31, 2007, we hadinvestments in debt securities of, or loans to, 51 private companies, totalingapproximately $281.5 million (cost basis) of total assets.

During the six monthsended March 31, 2007 and March 31, 2006, the following investment activityoccurred:

|                        | ** ** | ** ** | ** **  | ** **                 | ** ** | ** **                      | ** ** |
|------------------------|------------|------------|-------------|----------------------------|------------|---------------------------------|------------|
| **Quarter Ended** | ** ** | ** ** | ** **  | **New   Investments** | ** ** | **Principal   Repayments** | ** ** | **Net Gain/(Loss)  on Disposal** | ** ** |
| March 31, 2007         |       | $          | 75,330,167  |                       | $          | 38,263,017                      |       | $ | 84,205 |   |
| December 31,  2006     |       | 52,311,008 |        | 23,967,229                 |       | 2,314                           |       |
|                   |       | $          | 127,641,175 |                       | $          | 62,230,246                      |       | $ | 86,519 |   |
|                   |       |       |        |                       |       |                            |       |
| March 31, 2006         |       | $          | 38,471,109  |                       | $          | 24,815,067                      |       | $ | 377,500 |   |
| December 31,  2005     |       | 26,688,457 |        | 38,702,066                 |       | (1,180,595                      | )          |
|                   |       | $          | 65,159,566  |                       | $          | 63,517,133                      |       | $ | (803,095 | ) |
|                        |            |            |             |                            |            |                                 |            |  |  |  |  |  |

 

The following table summarizes the contractual principalamortization and maturity of our investment portfolio by fiscal year:

| Fiscal Year Ended September 30, | ** ** | ** **  | ** **  | **Amount** | ** ** |
|-----------------------------------------------------|------------|-------------|-------------|------------|------------|
| 2007                                                |       | $           | 3,467,481   |       |
| 2008                                                |       | 10,569,881  |        |
| 2009                                                |       | 18,976,253  |        |
| 2010                                                |       | 30,422,730  |        |
| 2011                                                |       | 80,548,730  |        |
| Thereafter                                          |       | 137,540,375 |        |
|                                                |       | $           | 281,525,450 |       |

 

Net cash used in operating activities for the six months endedMarch 31, 2007, consisting primarily of the items described in *“Results of Operations”* and the investment activitydescribed above, was approximately $56.5, million as compared to net cashprovided by operating activities of approximately $1.6 million for the sixmonths ended March 31, 2006.  Net cashprovided by investing activities consisted of $300,941 and $23,094 for the sixmonths ended March 31, 2007 and March 31, 2006, respectively, and consisted ofthe principal repayment of employee loans. Net cash provided by financing activities for the six months ended March31, 2007 was approximately $58.5 million and mainly consisted of borrowings onour line of credit of approximately $146.9 million, offset by repayments online of credit borrowings of approximately $76.6 million, and approximately$10.3 million for the payment of dividends. Net cash used in financing activities was approximately $1.8million for the six months ended March 31, 2006 and consisted primarily of netcash provided from borrowings on our line of credit, net of repayments, ofapproximately $7.3 million, offset by the payment of dividends of approximately$9.2 million.

During the six months ended March 31, 2007, cash and cashequivalents increased from approximately $732,000 to approximately $3.0million.

Subsequent to March 31, 2007, we sold either outright or toour affiliate Gladstone Investment approximately $16.9 million of syndicated loanparticipations via an independent broker and were repaid in full on one loanorigination investment of approximately $5.6 million.

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. In accordance with these requirements, wedeclared and paid monthly cash dividends of $0.14 per common share for July,August, September, October, November and December 2006 and January, February,and March 2007 and $0.135 per common share for January, February, March, April,May and June 2006, and October, November and December 2005.  In April 2007, our Board of Directorsdeclared a monthly dividend of $0.14 per common share for each of April, Mayand June 2007.

We anticipate continuingto borrow funds and, from time to time issuing additional equity securities, toobtain additional capital to make further investments.  On May 2, 2007, we completed a public offeringof 2,000,000 shares of our common stock, at a price of $24.25 per share, under ashelf registration statement on Form N-2 (File No. 333-100385), andpursuant to the terms set forth in a prospectus dated April 16, 2007, as 

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supplemented by a final prospectus dated April 27, 2007.  Net proceeds of the offering, afterunderwriting discounts and offering expenses were approximately $45,625,000 andwere used to repay outstanding borrowings under our line of credit. As a resultof the closing of this offering, we have no further capacity for issuingsecurities under any registration statements.

**Revolving Credit Facilities**

Through ourwholly-owned subsidiary, Business Loan, we have a $170 million revolving creditfacility (the “DB Facility”) with Deutsche Bank AG, as administrative agent,which is scheduled to mature on May 27, 2007. Pursuant to the DB Facility, Business Loan has pledged the loans itholds to secure future advances by certain institutional lenders.  Interest rates charged on the advances underthe DB Facility will be based on LIBOR, the Prime Rate or the Federal FundsRate, depending on market conditions, and will adjust periodically.  As of March 31, 2007, our outstandingprincipal balance under the DB Facility was approximately $120.3 million at aninterest rate of approximately 5.3%. Available borrowings are subject to various constraints imposed byDeutsche Bank AG, based on the aggregate loan balance pledged by Business Loan,which varies as loans are added and repaid, regardless of whether suchrepayments are early prepayment or are made as contractually required.  At March 31, 2007, the remaining borrowingcapacity available under the DB Facility was approximately $49.7 million.

The DB Facilitycontains covenants that, among other things, require Business Loan to maintainits status as a separate entity; prohibit certain significant corporatetransactions (such as mergers, consolidations, liquidations or dissolutions);and restrict material changes to our credit and collection policies.  The DB Facility also restricts some of theterms and provisions (including interest rates, terms to maturity and paymentsschedules) and limits the borrower and industry concentrations of loans thatare eligible to secure advances.  As ofMarch 31, 2007, Business Loan was in compliance with all of the DB Facilitycovenants.  We currently intend to securitizeall of the loans held by Business Loan and to use the proceeds from thesecuritization to pay down any amounts then outstanding under the revolvingcredit facility.  However, there can beno assurance that we will be able to successfully securitize any of these loanson terms acceptable to us, if at all.

The administrativeagent also requires that any interest or principal payments on pledged loans beremitted directly by the borrower into a lockbox account with the Bank of NewYork as custodian.  Deutsche Bank AG isalso the trustee of the account and once a month remits the collected funds tous. For the six months ended March 31, 2007, the amount due from custodianincreased by approximately $1.2 million.

Our Adviser,services the loans pledged under the DB Facility.  As a condition to this servicing arrangement,we executed a performance guaranty pursuant to which we guaranteed that ourAdviser would comply fully with all of its obligations under the facility. Theperformance guaranty requires us to maintain a minimum net worth of $100million and to maintain “asset coverage” with respect to “senior securitiesrepresenting indebtedness” of at least 200%, in accordance with Section 18of the 1940 Act.  As of March 31, 2007,we were in compliance with our covenants under the performance guaranty.

The DB facility isavailable for general corporate purposes.

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**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

We are subject tofinancial market risks, including changes in interest rates.  We estimatethat ultimately approximately 20% of the loans in our portfolio will be made atfixed rates and approximately 80% will be made at variable rates.  Currently our portfolio has approximately 56%of the total loan portfolio cost basis at variable rates with a floor,approximately 2% of the total loan portfolio cost basis at a variable rate witha floor and ceiling, approximately 40% of the total loan portfolio cost basisat variable rates without a floor or ceiling and approximately 1% of the totalloan portfolio cost basis is at a fixed rate.

We have a $170 millionrevolving credit facility, based on variable rates, with Deutsche Bank AG whichmatures May 2007.

In February 2004, we entered into an interest rate capagreement in order to fulfill an obligation under our line of credit to enterinto certain hedging transactions in connection with our borrowings under theline of credit.  We purchased this interest rate cap agreement with anotional amount of $35 million (which is amortized quarterly) for a one-time,up-front payment of $304,000.  The interest rate cap agreement entitles usto receive payments, if any, equal to the amount by which interest payments onthe current notional amount at onemonth LIBOR exceed the payments on the current notional amount at 5%. The cap expires in February 2009.  This interest rate cap agreementeffectively caps our interest payments on our line of credit borrowing, up tothe notional amount of the interest rate cap, at five percent.  Thismitigates our exposure to increases in interest rates on our borrowings on ourlines of credit, which are at variable rates. At March 31, 2007, the cap agreement had a fair market value of $24,671and a current notional amount of $10.9 million. At March31, 2007, the one month LIBOR rate was approximately 5.32%.

To illustrate the potential impact of changes ininterest rates on our net increase in net assets resulting from operations, wehave performed the following analysis, which assumes that our balance sheetremains constant and no further actions beyond the interest rate cap agreementare taken to alter our existing interest rate sensitivity.  Under this analysis, a hypothetical increasein the one month LIBOR by 1% would increase our net increase in net assetsresulting from operations by approximately $1.5 million or 8.2%, over the nexttwelve months, compared to the net increase in net assets resulting fromoperations for the twelve months ended March 31, 2007.  A hypothetical decrease in the one monthLIBOR by 1% would decrease net increase in net assets resulting from operationsby approximately $1.5 million, or 8.2%, over the next twelve months, comparedto the net increase in net assets resulting from operations for the twelvemonths ended March 31, 2007.  Althoughmanagement believes that this analysis is indicative of our existing interestrate sensitivity, it does not adjust for potential changes in credit quality,size and composition of our loan portfolio on the balance sheet and otherbusiness developments that could affect net increase in net assets resultingfrom operations.  Accordingly, noassurances can be given that actual results would not differ materially fromthe results under this hypothetical analysis.

In the event that wesecuritize a portion of our loan portfolio, we believe that we will likely berequired to enter into further hedging arrangements in the future with respectto securitized loans.  While hedgingactivities may mitigate our exposure to adverse fluctuations in interest rates,certain hedging transactions that we may enter into in the future, such as interestrate swap agreements, may also limit our ability to participate in the benefitsof lower interest rates with respect to our portfolio of investments.

We may also experiencerisk associated with investing in securities of companies with foreignoperations. We currently do not anticipate investing in debt or equity offoreign companies, however, some potential portfolio companies may haveoperations located outside the United States. These risks include, but are notlimited to, fluctuations in foreign currency exchange rates, imposition of foreigntaxes, changes in exportation regulations and political and social instability.

**ITEM 4. CONTROLS ANDPROCEDURES.**

As of March 31, 2007, we, including our Chief Executive Officerand Chief Financial Officer, evaluated the effectiveness of the design andoperation of our disclosure controls and procedures.  Based on that evaluation, our management,including the Chief Executive Officer and Chief Financial Officer, concludedthat our disclosure controls and procedures were effective in timely alertingmanagement, including the Chief Executive Officer and Chief Financial Officer,of material information about us required to be included in periodic Securitiesand Exchange Commission filings. However, in evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated can provide only reasonable assurance of achieving the desired controlobjectives, and management necessarily was required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.

There have been no changes in our internal control over financialreporting that occurred during the quarter ended March 31, 2007, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

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**PARTII—OTHER INFORMATION**

**ITEM 1. LEGALPROCEEDINGS.**

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

**ITEM 1A. RISKFACTORS.**

Our business is subjectto certain risks and events that, if they occur, could adversely affect ourfinancial condition and results of operations and the trading price of ourcommon stock. For a discussion of these risks, please refer to the “RiskFactors” section of our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2006, filed by us with the Securities and Exchange Commission onDecember 6, 2006.

*OurAdviser is not obligated to provide a waiver of the incentive fee, which couldnegatively impact our earnings and our ability to maintain our current levelof, or increase, distributions to our stockholders.*

On October 1, 2006, weimplemented an amended and restated investment advisory and managementagreement with our Adviser.  In additionto providing for a base management fee based on our total assets, thisagreement contemplates a quarterly incentive fee based on our pre-incentive feenet investment income and an annual incentive fee based on our capital gains,if any.  Our Adviser has the abilityto issue a full or partial waiver of the incentive fee for current and futureperiods, however our Adviser is not required to issue this waiver.  If ourAdviser does not issue this waiver in future quarters, it could negativelyimpact our earnings and may compromise our ability to maintain our currentlevel of, or increase, distributions to our stockholders, which could have amaterial adverse impact on our stock price.

**ITEM 2. UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

Not applicable.

**ITEM 3. DEFAULTS UPONSENIOR SECURITIES.**

Not applicable.

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

The 2007 Annual Meeting of Stockholderswas held on February 22, 2007.  Thestockholders voted and approved the election of three Class III directors tohold office until the 2010 Annual Meeting of Stockholders:

| Nominee         | ** ** | ** ** | ** ** | **Shares Voted For** | ** ** | **Authority Withheld** | ** ** |
|-----------------|------------|------------|------------|--------------------------------|------------|-----------------------------|------------|
| Paul Adelgren   |       | 10,985,059 |       | 200,228                        |       |
| David Gladstone |       | 11,061,166 |       | 124,121                        |       |
| John H. Outland |       | 11,021,844 |       | 163,443                        |       |

 

**ITEM 5. OTHERINFORMATION.**

Not applicable

**ITEM 6.  EXHIBITS**

See the exhibit index.

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**SIGNATURE**

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.
|            | ** ** | **GLADSTONE CAPITAL  CORPORATION** |
|------------|------------|------------------------------------|
| ** ** | ** ** | ** **                         |
|       |       |                               |   |   |
|       |       | By:                                |   | /s/ HARRY BRILL |
|       |       |                               |   | Harry Brill |
|       |       |                               |   | Chief Financial  Officer |

 

Date: May 2, 2007

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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.                              |
|    |       |                                                                                                                                                                                                                                      |
| 11      |       | Computation of  Per Share Earnings (included in the notes to the unaudited 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.                                                                                                                                     |

 

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

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