Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES ANDEXCHANGE COMMISSION**

**WASHINGTON, D.C.20549**

 

**FORM 10-Q**

 

**x****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**FOR THE QUARTER ENDEDJUNE 30, 2008**

 

**o****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**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, includingarea code)

 

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x No o.

 

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

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

 

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

 

Indicate the number of shares outstandingof each of the issuer’s classes of common stock, as of the latest practicabledate.  The number of shares of the issuer’sCommon Stock, $0.001 par value, outstanding as of August 4, 2008 was21,087,574.

 

 

 

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**TABLE OF CONTENTS**

 
| PART I.  | FINANCIAL INFORMATION                                                                                              |   |
|---------------|--------------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                               |   |
| Item 1.       | Financial Statements (Unaudited)                                                                                   |   |
|          |                                                                                                               |   |
|          | Condensed  Consolidated Statements of Assets and Liabilities as of June 30, 2008  and September 30, 2007 |   |
|          | Condensed  Consolidated Schedules of Investments as of June 30, 2008 and  September 30, 2007             |   |
|          | Condensed Consolidated Statements of Operations for  the three and nine months ended June 30, 2008 and 2007   |   |
|          | Condensed Consolidated Statements of Changes in Net  Assets for the nine months ended June 30, 2008 and 2007  |   |
|          | Condensed Consolidated Statements of Cash Flows for  the nine months ended June 30, 2008 and 2007             |   |
|          | Financial  Highlights for the three and nine months ended June 30, 2008 and 2007                              |   |
|          | Notes to Condensed 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    |                                                                                                               |

 

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES**

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

**(UNAUDITED)**

 
| ** **                                                                                                                                                                                  | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **2008**          | ** ** | **2007**               | ** ** |
| ASSETS                                                                                                                                                                                      |       |              |       |                   |       |
| Non-Control/Non-Affiliate  investments (Cost 6/30/08: $441,319; 9/30/07: $354,835)                                                                                                          |       | $                 | 411,069    |                   | $          | 348,921 |   |
| Control  investments (Cost 6/30/08: $3,881; 9/30/07: $924)                                                                                                                                  |       | 671               |       | 924                    |       |
| Total  investments at fair value (Cost 6/30/08: $445,200; 9/30/07 $355,759)                                                                                                                 |       | 411,740           |       | 349,845                |       |
| Cash and cash  equivalents                                                                                                                                                                  |       | 5,426             |       | 8,839                  |       |
| U.S. Treasury  bill                                                                                                                                                                         |       | —            |       | 2,484                  |       |
| Interest  receivable – investments in debt securities                                                                                                                                  |       | 3,301             |       | 2,426                  |       |
| Interest  receivable – employees (Refer to Note 4)                                                                                                                                     |       | 91                |       | 21                     |       |
| Due from  custodian                                                                                                                                                                         |       | 6,637             |       | 3,230                  |       |
| Deferred  financing fees                                                                                                                                                                    |       | 2,383             |       | 186                    |       |
| Prepaid assets                                                                                                                                                                              |       | 202               |       | 337                    |       |
| Other assets                                                                                                                                                                                |       | 462               |       | 361                    |       |
| TOTAL ASSETS                                                                                                                                                                                |       | $                 | 430,242    |                   | $          | 367,729 |   |
|                                                                                                                                                                                        |       |              |       |                   |       |
| LIABILITIES                                                                                                                                                                                 |       |              |       |                   |       |
| Accounts payable                                                                                                                                                                            |       | $                 | 8          |                   | $          | 6 |   |
| Interest payable                                                                                                                                                                            |       | 522               |       | 588                    |       |
| Fee due to  Administrator (Refer to Note 4)                                                                                                                                                 |       | 285               |       | 237                    |       |
| Fees due to  Adviser (Refer to Note 4)                                                                                                                                                      |       | 468               |       | 708                    |       |
| Borrowings under  lines of credit                                                                                                                                                           |       | 133,090           |       | 144,440                |       |
| Accrued expenses  and deferred liabilities                                                                                                                                                  |       | 905               |       | 791                    |       |
| Funds held in  escrow                                                                                                                                                                       |       | 290               |       | —                 |       |
| TOTAL LIABILITIES                                                                                                                                                                           |       | 135,568           |       | 146,770                |       |
| NET ASSETS                                                                                                                                                                                  |       | $                 | 294,674    |                   | $          | 220,959 |   |
|                                                                                                                                                                                        |       |              |       |                   |       |
| ANALYSIS OF NET  ASSETS                                                                                                                                                                     |       |              |       |                   |       |
| Common stock,  $0.001 par value, 50,000,000 shares authorized and 21,087,574 and 14,762,574  shares issued and outstanding at June 30, 2008 and September 30,  2007, respectively |       | $                 | 21         |                   | $          | 15 |   |
| Capital in  excess of par value                                                                                                                                                             |       | 341,281           |       | 235,907                |       |
| Notes receivable  – employees (Refer to Note 4)                                                                                                                                        |       | (9,179            | )          | (9,230                 | )          |
| Net unrealized  depreciation on investments                                                                                                                                                 |       | (33,460           | )          | (5,915                 | )          |
| Unrealized  depreciation on derivative                                                                                                                                                      |       | (304              | )          | (292                   | )          |
| (Distributions  in excess of) accumulated undistributed net investment income                                                                                                               |       | (3,685            | )          | 474                    |       |
| TOTAL NET ASSETS                                                                                                                                                                            |       | $                 | 294,674    |                   | $          | 220,959 |   |
| NET ASSETS PER  SHARE                                                                                                                                                                       |       | $                 | 13.97      |                   | $          | 14.97 |   |

 

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

 

2

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS**

**AS OF JUNE 30, 2008**

**(DOLLAR AMOUNTS INTHOUSANDS)**

**(UNAUDITED)**

 
| **Company**                                | ** ** | **Industry**                                      | ** ** | **Investment (1)**                                        | ** ** | **Cost**   | ** ** | **Fair Value** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|-----------------------------------------------------------|------------|------------|------------|----------------|------------|
| ** **                                 | ** ** | ** **                                        | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** **     | ** ** |
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS** | ** ** | ** **                                        | ** ** | ** **                                                | ** ** | ** ** | ** ** |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| Access Television Network, Inc.  (2)  |       | Service-cable airtime (infomercials)              |       | Senior Term Debt (6)  (10.5% Due 3/2009)                  |       | $          | 2,078      |           | $          | 1,960 |   |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| ACE Expediters, Inc                        |       | Service -  over-the-ground logistics              |       | Line of Credit, $850  available (6)  (6.0% Due 1/2011)    |       | 200        |       | 197            |       |
|                                       |       |                                              |       | Senior Term Debt (6)                                      |       | 12,544     |       | 12,356         |       |
|                                       |       |                                              |       | (9.5% Due 1/2012)                                         |       |       |       |           |       |
|                                       |       |                                              |       | Warrants (8)                                              |       | 200        |       | 157            |       |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| ActivStyle Acquisition  Co. (2)            |       | Service-medical  products distribution            |       | Line of Credit, $1,500  available (6)  (6.7%, Due 7/2009) |       | 1,100      |       | 1,078          |       |
|                                       |       |                                              |       | Senior Term Debt (6)                                      |       | 4,852      |       | 4,754          |       |
|                                       |       |                                              |       | (8.5%, Due 9/2012)                                        |       |       |       |           |       |
|                                       |       |                                              |       | Senior Term Debt  (3) (6)                            |       | 4,435      |       | 4,302          |       |
|                                       |       |                                              |       | (10.5%, Due 9/2012)                                       |       |       |       |           |       |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| Allison Publications,  LLC (2)             |       | Service-publisher of  consumer oriented magazines |       | Line of Credit, $4,000  available   (9.0%, Due 9/2010)    |       | —     |       | —         |       |
|                                       |       |                                              |       | Senior Term Debt (6)                                      |       | 11,070     |       | 10,615         |       |
|                                       |       |                                              |       | (9.0%, Due 9/2012)                                        |       |       |       |           |       |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| Anitox Acquisition  Company (2)            |       | Manufacturing-preservatives  for animal feed      |       | Line of Credit, $3,000  available (6)  (6.7%, Due 1/2010) |       | 2,000      |       | 1,940          |       |
|                                       |       |                                              |       | Senior Term Debt (6)                                      |       | 2,550      |       | 2,473          |       |
|                                       |       |                                              |       | (8.5%, Due 1/2012)                                        |       |       |       |           |       |
|                                       |       |                                              |       | Senior Term Debt  (3) (6)                            |       | 2,750      |       | 2,626          |       |
|                                       |       |                                              |       | (10.5%, Due 1/2012)                                       |       |       |       |           |       |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| Badanco Acquisition  Corp.                 |       | Service-luggage design  and distribution          |       | Senior Subordinated  Term Debt (6)  (11.5%, Due 7/2012)   |       | 9,506      |       | 9,150          |       |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| BAS Broadcasting                           |       | Service-radio station  operator                   |       | Senior Term Debt (5)  (11.5%, Due 7/2013)                 |       | 7,300      |       | 7,300          |       |
|                                       |       |                                              |       | Senior Term Debt  (3) (5)                            |       | 1,000      |       | 1,000          |       |
|                                       |       |                                              |       | (12.0%, Due 7/2009)                                       |       |       |       |           |       |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| Bresnan                               |       | Service-telecommunications                        |       | Senior Term Debt (7)                                      |       | 3,001      |       | 2,865          |       |
| Communications,                            |       |                                              |       | (5.0%, Due 9/2013)                                        |       |       |       |           |       |
| LLC                                        |       |                                              |       | Senior Subordinated  Term Debt (7)                        |       | 1,509      |       | 1,365          |       |
|                                       |       |                                              |       | (7.4%, Due 3/2014)                                        |       |       |       |           |       |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| CCS, LLC                                   |       | Service-cable tv  franchise owner                 |       | Senior Term Debt (6)  (9.0%, Due 8/2008)                  |       | 3,427      |       | 3,358          |       |
|                                       |       |                                              |       |                                                      |       |       |       |           |       |
| CHG  Companies, Inc. (2)              |       | Service-healthcare  staffing                      |       | Letter of Credit (7)  (5.1%, Due 12/2012)                 |       | 400        |       | 380            |       |
|                                       |       |                                              |       | Senior Term Debt (7)                                      |       | 1,580      |       | 1,501          |       |
|                                       |       |                                              |       | (4.9%, Due 12/2012)                                       |       |       |       |           |       |
|                                       |       |                                              |       | Senior Subordinated  Term Debt (7)                        |       | 500        |       | 445            |       |
|                                       |       |                                              |       | (8.7%, Due 12/2012)                                       |       |       |       |           |       |
|                                            |            |                                                   |            |                                                           |            |            |            |                |            |  |  |

 

3

----

Table of Contents

 
| **Company**                              | ** ** | **Industry**                                        | ** ** | **Investment (1)**                                        | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------------|------------|----------|------------|----------------|------------|
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Chinese Yellow Pages Company        |       | Service-publisher of  Chinese language directories  |       | Line of Credit, $950  available (6)  (9.0%, Due 9/2010)   |       | $        | 700        |           | $          | 667 |   |
|                                     |       |                                                |       | Senior Term Debt (6)                                      |       | 748      |       | 703            |       |
|                                     |       |                                                |       | (9.0%, Due 9/2010)                                        |       |     |       |           |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Clinton Holdings,                        |       | Distribution-aluminum sheets                        |       | Senior Subordinated  Term Debt (6)                        |       | 15,500   |       | 15,422         |       |
| LLC (2)                                  |       | and stainless steel                                 |       | (12.0%, Due 1/2013)                                       |       |     |       |           |       |
|                                     |       |                                                |       | Common Stock Warrants  (8)                                |       | 109      |       | —         |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| CMI Acquisition, LLC                     |       | Service-recycling                                   |       | Senior Subordinated  Term Debt (6)                        |       | 6,435    |       | 6,121          |       |
| (2)                                      |       |                                                |       | (10.2%, Due 11/2012)                                      |       |     |       |           |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Community Media  Corporation             |       | Service-publisher of  free weekly newspapers        |       | Senior Term Debt (6)  (7.0%, Due 8/2012)                  |       | 2,358    |       | 2,280          |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Country Road                             |       | Service-telecommunications                          |       | Senior Subordinated  Term Debt (7)                        |       | 5,971    |       | 5,820          |       |
| Communications LLC                       |       |                                                |       | (10.2%, Due 7/2013)                                       |       |     |       |           |       |
| (2)                                      |       |                                                |       |                                                      |       |     |       |           |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Defiance Acquisition                     |       | Manufacturing-trucking  parts                       |       | Senior Term Debt  (3) (6)                            |       | 6,245    |       | 5,496          |       |
| Corporation                              |       |                                                |       | (11.0%, Due 4/2010)                                       |       |     |       |           |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Doe & Ingalls                   |       | Distributor-specialty  chemicals                    |       | Senior Term Debt (6)                                      |       | 3,300    |       | 3,234          |       |
| Management LLC (2)                       |       |                                                |       | (6.0%, Due 11/2010)                                       |       |     |       |           |       |
|                                     |       |                                                |       | Senior Term Debt  (3) (6)                            |       | 4,421    |       | 4,311          |       |
|                                     |       |                                                |       | (7.0%, Due 11/2010)                                       |       |     |       |           |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Emdeon Business  Services, Inc.          |       | Service-healthcare  technology solutions            |       | Senior Term Debt (7)  (4.8%, Due 11/2013)                 |       | 2,365    |       | 2,239          |       |
|                                     |       |                                                |       | Senior Subordinated  Term Debt (7)                        |       | 2,011    |       | 1,860          |       |
|                                     |       |                                                |       | (7.8%, Due 5/2014)                                        |       |     |       |           |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Express Courier  International, Inc.     |       | Service-ground delivery  and logistics              |       | Line of Credit, $1,200  available (6)  (6.7%, Due 6/2009) |       | 900      |       | 884            |       |
|                                     |       |                                                |       | Senior Term Debt (6)                                      |       | 3,408    |       | 3,348          |       |
|                                     |       |                                                |       | (9.3%, Due 6/2011)                                        |       |     |       |           |       |
|                                     |       |                                                |       | Senior Term Debt  (3) (6)                            |       | 4,644    |       | 4,539          |       |
|                                     |       |                                                |       | (11.3%, Due 6/2011)                                       |       |     |       |           |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Finn Corporation                         |       | Manufacturing-landscape                             |       | Common Stock Warrants  (8)                                |       | 37       |       | 3,197          |       |
|                                     |       | equipment                                           |       |                                                      |       |     |       |           |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| GFRC Holdings LLC                        |       | Manufacturing-glass-fiber                           |       | Line of Credit, $3,000  available (6)                     |       | —   |       | —         |       |
|                                     |       | reinforced concrete                                 |       | (6.7%, Due 12/2010)                                       |       |     |       |           |       |
|                                     |       |                                                |       | Senior Term Debt (6)                                      |       | 7,362    |       | 7,252          |       |
|                                     |       |                                                |       | (9.8%, Due 12/2012)                                       |       |     |       |           |       |
|                                     |       |                                                |       | Senior Subordinated  Term Debt (3) (6)               |       | 6,716    |       | 6,565          |       |
|                                     |       |                                                |       | (12.3%, Due 12/2012)                                      |       |     |       |           |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| Global Materials Technologies, Inc. |       | Manufacturing-steel  wool products and metal fibers |       | Senior Term Debt  (3) (6)  (13.0%, Due 11/2009)      |       | 4,830    |       | 4,492          |       |
|                                     |       |                                                |       |                                                      |       |     |       |           |       |
| GTM Holdings, Inc.                  |       | Manufacturing-socks                                 |       | Senior Term Debt (7)                                      |       | 493      |       | 420            |       |
| (2)                                      |       |                                                |       | (5.4%, Due 10/2013)                                       |       |     |       |           |       |
|                                     |       |                                                |       | Senior Subordinated  Term Debt (7)                        |       | 500      |       | 400            |       |
|                                     |       |                                                |       | (8.7%, Due 4/2014)                                        |       |     |       |           |       |
|                                          |            |                                                     |            |                                                           |            |          |            |                |            |  |  |

 

4

----

Table of Contents

 
| **Company**                                             | ** **              | **Industry**                           | ** **                         | **Investment (1)**                      | ** ** | **Cost**   | ** ** | **Fair Value** |   |
|---------------------------------------------------------|-------------------------|----------------------------------------|------------------------------------|-----------------------------------------|------------|------------|------------|----------------|--------|
| ** **                                              | ** **              | ** **                             | ** **                         | ** **                              | ** ** | ** ** | ** ** | ** **     |   |
| Greatwide Logistics Services, Inc.                 |                    | Service - logistics and                |                               | Senior Term Debt (7)                    |       | $          | 3,950      |           | $      | 3,160 |   |
|                                                    | transportation          |                                   | (6.3%, Due 12/2013)                |                                    |       |       |       |           |
|                                                    |                    |                                   |                               | Senior Subordinated  Term Debt (7)      |       | 4,000      |       | 2,200          |   |
|                                                    |                    |                                   |                               | (9.3%, Due 6/2014)                      |       |       |       |           |   |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| GS Maritime  Intermediate Holdings LLC                  | Service-cargo transport |                                   | Senior Subordinated  Term Debt (7) |                                    | 1,000      |       | 990        |           |
|                                                    |                    | (10.0%, Due 12/2013)                   |                               |                                    |       |       |       |
|                                                    |                    |                                   |                               |                                    |       |       |       |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| Harrington  Holdings, Inc. (2)                     |                    | Service - healthcare  products         |                               | Senior Term Debt (7)                    |       | 2,469      |       | 2,271          |   |
|                                                    | distribution            |                                   | (4.7%, Due 1/2014)                 |                                    |       |       |       |           |
|                                                    |                    |                                   |                               | Senior Subordinated  Term Debt (7)      |       | 5,000      |       | 4,250          |   |
|                                                    |                    |                                   |                               | (8.5%, Due 1/2014)                      |       |       |       |           |   |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| Heartland  Communications Group, LLC (2)                |                    | Service-radio station  operator        |                               | Line of Credit, $500  available (6)     |       | 105        |       | 84             |   |
|                                                    |                    | (10.0%, Due 12/2008)                   |                               |                                    |       |       |       |
|                                                    |                    |                                   | Senior Term Debt (6)               |                                    | 4,606      |       | 3,651      |           |
|                                                    |                    |                                   |                               | (10.0%, Due 5/2011)                     |       |       |       |           |   |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| Interfilm Holdings, Inc.                           |                    | Service-slitter and  distributor of    |                               | Senior Term Debt (6)                    |       | 5,000      |       | 4,856          |   |
|                                                    | plastic films           |                                   | (10.5%, Due 10/2012)               |                                    |       |       |       |           |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| International Junior  Golf Training Acquisition Company |                    | Service-golf training                  |                               | Line of Credit, $1,500  available (6)   |       | 1,400      |       | 1,355          |   |
|                                                    |                    | (9.0%, Due 5/2010)                     |                               |                                    |       |       |       |
|                                                    |                    | Senior Term Debt (6)                   |                               | 2,650                                   |       | 2,564      |       |
|                                                    |                    |                                   |                               | (6.7%, Due 5/2012)                      |       |       |       |           |   |
|                                                    |                    |                                   |                               | Senior Term Debt  (3) (6)          |       | 2,500      |       | 2,400          |   |
|                                                    |                    |                                   |                               | (10.5%, Due 5/2012)                     |       |       |       |           |   |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| It’s Just Lunch  International, LLC                |                    | Service-dating service                 |                               | Line of Credit, $750  available (6)     |       | 550        |       | 303            |   |
|                                                    |                    | (6.5%, Due 6/2009)                     |                               |                                    |       |       |       |
|                                                    |                    |                                   |                               | Senior Term Debt (6)                    |       | 3,300      |       | 1,815          |   |
|                                                    |                    |                                   |                               | (6.7%, Due 6/2011)                      |       |       |       |           |   |
|                                                    |                    |                                   |                               | Senior Term Debt  (3) (6) (9) |       | 500        |       | 275            |   |
|                                                    |                    |                                   |                               | (10.5%, Due 6/2011)                     |       |       |       |           |   |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| John Henry  Holdings, Inc. (2)                     |                    | Manufacturing-packaging                |                               | Senior Subordinated  Term Debt (7)      |       | 8,000      |       | 7,760          |   |
|                                                    | products                |                                   | (11.6%, Due 6/2011)                |                                    |       |       |       |           |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| Kinetek Acquisition Corp.                               |                    | Manufacturing-custom                   |                               | Senior Term Debt (7)                    |       | 1,482      |       | 1,359          |   |
|                                                    |                    | engineered motors &  controls |                               | (5.3%, Due 11/2013)                     |       |       |       |           |   |
|                                                    |                    |                                   |                               | Senior Subordinated  Term Debt (7)      |       | 1,508      |       | 1,275          |   |
|                                                    |                    |                                   |                               | (8.0%, Due 5/2014)                      |       |       |       |           |   |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| KMBQ Corporation                                        |                    | Service-AM/FM radio                    |                               | Line of Credit, $200  available (6)     |       | 153        |       | 143            |   |
|                                                    |                    | broadcaster                            |                               | (10.0%, Due 3/2010)                     |       |       |       |           |   |
|                                                    |                    |                                   |                               | Senior Term Debt (6)                    |       | 1,794      |       | 1,663          |   |
|                                                    |                    |                                   |                               | (10.0%, Due 3/2010)                     |       |       |       |           |   |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| Legend Communications  of Wyoming LLC                   |                    | Service-operator of  radio stations    |                               | Line of Credit, $500  available (5)     |       | 200        |       | 200            |   |
|                                                    |                    | (11.0%, Due 6/2011)                    |                               |                                    |       |       |       |
|                                                    |                    |                                   | Senior Term Debt (5)               |                                    | 9,250      |       | 9,250      |           |
|                                                    |                    |                                   |                               | (11.0%, Due 6/2013)                     |       |       |       |           |   |
|                                                    |                    |                                   |                               |                                    |       |       |       |           |   |
| Lindmark Outdoor                                        |                    | Service-advertising                    |                               | Senior Subordinated  Term Debt (6)      |       | 10,000     |       | 9,350          |   |
| Advertising LLC                                         |                    |                                   |                               | (11.0%, Due 10/2012)                    |       |       |       |           |   |
|                                                         |                         |                                        |                                    |                                         |            |            |            |                |        |  |  |

 

5

----

Table of Contents

 
| **Company**             | ** ** | **Industry**                     | ** ** | **Investment (1)**                       | ** ** | **Cost** | ** ** | **Fair Value** |   |
|-------------------------|------------|----------------------------------|------------|------------------------------------------|------------|----------|------------|----------------|--------|
|                    |       |                             |       |                                     |       |     |       |           |   |
| LocalTel, Inc.     |       | Service-yellow pages             |       | Line of Credit, $3,000  available        |       | $        | 1,170      |           | $      | 234 |   |
|                    |       | publishing                       |       | (6) (10)                            |       |     |       |           |   |
|                    |       |                             |       | (non-accrual, Due  6/2009)               |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt  (6) (10)          |       | 2,688    |       | 538            |   |
|                    |       |                             |       | (non-accrual, Due  6/2011)               |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt  (3) (6) (10) |       | 2,750    |       | 550            |   |
|                    |       |                             |       | (non-accrual, Due  6/2011)               |       |     |       |           |   |
|                    |       |                             |       |                                     |       |     |       |           |   |
| Meteor Holding          |       | Manufacturing-bar code           |       | Senior Term Debt (7)                     |       | 2,330    |       | 2,330          |   |
| Corporation (2)         |       | scanning and data  capture       |       | (7.0%, Due 12/2013)                      |       |     |       |           |   |
|                    |       |                             |       | Senior Subordinated  Term Debt (7)       |       | 1,500    |       | 1,500          |   |
|                    |       |                             |       | (10.3%, Due 12/2013)                     |       |     |       |           |   |
|                    |       |                             |       |                                     |       |     |       |           |   |
| Multi-Ag Media LLC      |       | Service-dairy magazine           |       | Senior Term Debt (6)                     |       | 2,203    |       | 2,121          |   |
| (2)                     |       | publisher/ information  database |       | (9.0%, Due 12/2009)                      |       |     |       |           |   |
|                    |       |                             |       |                                     |       |     |       |           |   |
| Newhall                 |       | Service-distributor of  personal |       | Line of Credit, $4,000  available (6)    |       | 1,100    |       | 1,064          |   |
| Holdings, Inc. (2) |       | care products and  supplements   |       | (6.0%, Due 5/2010)                       |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt (6)                     |       | 4,320    |       | 4,190          |   |
|                    |       |                             |       | (8.3%, Due 5/2012)                       |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt  (3) (6)           |       | 4,500    |       | 4,343          |   |
|                    |       |                             |       | (11.3%, Due 5/2012)                      |       |     |       |           |   |
|                    |       |                             |       |                                     |       |     |       |           |   |
| Northern                |       | Manufacturing-veneer  and        |       | Senior Subordinated Term  Debt (6)       |       | 7,000    |       | 6,440          |   |
| Contours, Inc. (2) |       | laminate components              |       | (10.0%, Due 5/2010)                      |       |     |       |           |   |
|                    |       |                             |       |                                     |       |     |       |           |   |
| Pinnacle Treatment      |       | Service-Addiction  treatment     |       | Line of Credit, $500  available (6)      |       | —   |       | —         |   |
| Centers, Inc.      |       | centers                          |       | (6.7%, Due 12/2009)                      |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt (6)                     |       | 3,750    |       | 3,600          |   |
|                    |       |                             |       | (8.5%, Due 12/2011)                      |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt  (3) (6)           |       | 7,500    |       | 7,163          |   |
|                    |       |                             |       | (10.5%, Due 12/2011)                     |       |     |       |           |   |
|                    |       |                             |       |                                     |       |     |       |           |   |
| Precision Acquisition   |       | Manufacturing-consumable         |       | Equipment Note, $1,500  available (6)    |       | 1,000    |       | 999            |   |
| Group                   |       | components for the  aluminum     |       | (8.5%, Due 10/2011)                      |       |     |       |           |   |
| Holdings, Inc. (2) |       | industry                         |       | Senior Term Debt (6)                     |       | 4,875    |       | 4,869          |   |
|                    |       |                             |       | (8.5%, Due 10/2010)                      |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt  (3) (6)           |       | 4,179    |       | 4,174          |   |
|                    |       |                             |       | (11.5%, Due 10/2010)                     |       |     |       |           |   |
|                    |       |                             |       |                                     |       |     |       |           |   |
| PROFITSystems           |       | Service-design and  develop      |       | Line of Credit, $1,250  available (6)    |       | —   |       | —         |   |
| Acquisition Co. (2)     |       | ERP software                     |       | (6.7%, Due 7/2009)                       |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt (6)                     |       | 2,350    |       | 2,233          |   |
|                    |       |                             |       | (8.5%, Due 7/2011)                       |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt  (3) (6)           |       | 2,900    |       | 2,733          |   |
|                    |       |                             |       | (10.5%, Due 7/2011)                      |       |     |       |           |   |
|                    |       |                             |       |                                     |       |     |       |           |   |
| Puerto Rico Cable       |       | Service-telecommunications       |       | Senior Subordinated  Term Debt (7)       |       | 7,192    |       | 5,713          |   |
| Acquisition             |       |                             |       | (10.3%, Due 1/2012)                      |       |     |       |           |   |
| Company, Inc.      |       |                             |       |                                     |       |     |       |           |   |
|                    |       |                             |       |                                     |       |     |       |           |   |
| RCS Management          |       | Service-healthcare  supplies     |       | Senior Term Debt  (3) (6)           |       | 2,938    |       | 2,805          |   |
| Holding Co.             |       |                             |       | (8.5%, Due 1/2011)                       |       |     |       |           |   |
|                    |       |                             |       | Senior Term Debt  (4) (6)           |       | 3,060    |       | 2,869          |   |
|                    |       |                             |       | (10.5%, Due 1/2011)                      |       |     |       |           |   |
|                         |            |                                  |            |                                          |            |          |            |                |        |  |  |

 

6

----

Tableof Contents

 
| **Company**                | ** ** | **Industry**                    | ** ** | **Investment (1)**                    | ** ** | **Cost**   | ** ** | **Fair Value** |   |
|----------------------------|------------|---------------------------------|------------|---------------------------------------|------------|------------|------------|----------------|--------|
| ** **                 | ** ** | ** **                      | ** ** | ** **                            | ** ** | ** ** | ** ** | ** **     |   |
| RedPrairie                 |       | Service-design and  develop     |       | Senior Term Debt (7)                  |       | $          | 4,412      |           | $      | 4,148 |   |
| Holding, Inc. (2)     |       | supply chain software           |       | (5.7%, Due 7/2012)                    |       |       |       |           |   |
|                       |       |                            |       | Senior Subordinated  Term Debt (7)    |       | 3,000      |       | 2,580          |   |
|                       |       |                            |       | (9.3%, Due 1/2013)                    |       |       |       |           |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| Reliable                   |       | Manufacturing-pharmaceutical    |       | Line of Credit, $5,000  available (6) |       | 1,200      |       | 1,176          |   |
| Biopharmaceutical          |       | and biochemical  intermediates  |       | (6.0%, Due 10/2010)                   |       |       |       |           |   |
| Holdings, Inc.        |       |                            |       | Mortgage Note (6)                     |       | 7,422      |       | 7,311          |   |
|                       |       |                            |       | (9.5%, Due 10/2014)                   |       |       |       |           |   |
|                       |       |                            |       | Senior Term Debt (6)                  |       | 1,800      |       | 1,773          |   |
|                       |       |                            |       | (9.0%, Due 10/2012)                   |       |       |       |           |   |
|                       |       |                            |       | Senior Term Debt  (3) (6)        |       | 11,963     |       | 11,694         |   |
|                       |       |                            |       | (11.0%, Due 10/2012)                  |       |       |       |           |   |
|                       |       |                            |       | Senior Subordinated  Term Debt (6)    |       | 6,000      |       | 5,663          |   |
|                       |       |                            |       | (12.0%, Due 10/2013)                  |       |       |       |           |   |
|                       |       |                            |       | Common Stock Warrants  (8)            |       | 209        |       | —         |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| RiskMetrics Group          |       | Service - develop risk  and     |       | Senior Term Debt (7)                  |       | 1,937      |       | 1,874          |   |
| Holdings,                  |       | wealth management  solutions    |       | (4.8%, Due 1/2014)                    |       |       |       |           |   |
| LLC                        |       |                            |       |                                  |       |       |       |           |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| Saunders &        |       | Manufacturing-equipment         |       | Line of Credit, $2,500  available (5) |       | —     |       | —         |   |
| Associates                 |       | provider for frequency  control |       | (7.0%, Due 5/2009)                    |       |       |       |           |   |
|                       |       | devices                         |       | Senior Term Debt (5)                  |       | 11,000     |       | 10,973         |   |
|                       |       |                            |       | (9.8%, Due 5/2013)                    |       |       |       |           |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| SCI Cable, Inc.       |       | Service-cable,  internet, voice |       | Senior Term Debt (6)                  |       | 2,717      |       | 1,897          |   |
|                       |       | provider                        |       | (11.0%, Due 10/2008)                  |       |       |       |           |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| Sunburst Media -           |       | Service-radio station  operator |       | Senior Term Debt (6)                  |       | 7,862      |       | 7,020          |   |
| Louisiana, LLC             |       |                            |       | (9.5%, Due 6/2011)                    |       |       |       |           |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| Sunshine Media             |       | Service-publisher  regional B2B |       | Line of Credit, $3,000  available (6) |       | 700        |       | 661            |   |
| Holdings                   |       | trade magazines                 |       | (9.0%, Due 5/2010)                    |       |       |       |           |   |
|                       |       |                            |       | Senior Term Debt (6)                  |       | 17,000     |       | 16,108         |   |
|                       |       |                            |       | (9.0%, Due 5/2012)                    |       |       |       |           |   |
|                       |       |                            |       | Senior Term Debt  (3) (6)        |       | 10,000     |       | 9,300          |   |
|                       |       |                            |       | (11.5%, Due 5/2012)                   |       |       |       |           |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| Thibaut Acquisition        |       | Service-design and  disbribute  |       | Line of Credit, $2,000  available (6) |       | 2,000      |       | 1,920          |   |
| Co.                        |       | wall covering                   |       | (7.0%, Due 1/2011)                    |       |       |       |           |   |
|                       |       |                            |       | Senior Term Debt (6)                  |       | 2,188      |       | 2,100          |   |
|                       |       |                            |       | (7.0%, Due 1/2011)                    |       |       |       |           |   |
|                       |       |                            |       | Senior Term Debt  (3) (6)        |       | 3,000      |       | 2,820          |   |
|                       |       |                            |       | (10.5%, Due 1/2011)                   |       |       |       |           |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| Viapack, Inc. (2)     |       | Manufacturing-polyethylene      |       | Senior Real Estate Term  Debt         |       | 875        |       | 840            |   |
|                       |       | film                            |       | (7.0%, Due 3/2011)                    |       |       |       |           |   |
|                       |       |                            |       | Senior Term Debt  (3) (6)        |       | 4,117      |       | 3,922          |   |
|                       |       |                            |       | (11.3%, Due 3/2011)                   |       |       |       |           |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| Visual Edge                |       | Service-office  equipment       |       | Senior Subordinated  Term Debt (6)    |       | 5,000      |       | 3,000          |   |
| Technology, Inc.  (2) |       | distribution                    |       | (11.5%, Due 8/2011)                   |       |       |       |           |   |
|                       |       |                            |       |                                  |       |       |       |           |   |
| Wesco  Holdings, Inc. |       | Service-aerospace parts  and    |       | Senior Term Debt (7)                  |       | 2,452      |       | 2,346          |   |
| (2)                        |       | distribution                    |       | (5.1%, Due 9/2013)                    |       |       |       |           |   |
|                       |       |                            |       | Senior Subordinated  Term Debt (7)    |       | 2,268      |       | 2,199          |   |
|                       |       |                            |       | (8.6%, Due 3/2014)                    |       |       |       |           |   |
|                            |            |                                 |            |                                       |            |            |            |                |        |  |  |

 

7

----

Tableof Contents

 
| **Company**                                      | ** ** | **Industry**                  | ** ** | **Investment (1)**                   | ** **  | **Cost**   | ** **  | **Fair Value** |   |
|--------------------------------------------------|------------|-------------------------------|------------|--------------------------------------|-------------|------------|-------------|----------------|--------|
| ** **                                       | ** ** | ** **                    | ** ** | ** **                           | ** **  | ** ** | ** **  | ** **     |   |
| West Coast Yellow                                |       | Service-directory  publisher  |       | Senior Term Debt  (6) (10)      |        | $          | 1,555       |           | $      | 616 |   |
| Pages, Inc.                                 |       |                          |       | (non-accrual, Due  8/2010)           |        |       |        |           |   |
|                                             |       |                          |       |                                 |        |       |        |           |   |
| Westlake                                         |       | Retail-hardware and  variety  |       | Senior Subordinated  Term Debt (6)   |        | 15,000     |        | 14,325         |   |
| Hardware, Inc. (2)                          |       |                          |       | (9.0%, Due 1/2011)                   |        |       |        |           |   |
|                                             |       |                          |       | Senior Subordinated  Term Debt (6)   |        | 10,000     |        | 9,400          |   |
|                                             |       |                          |       | (10.3%, Due 1/2011)                  |        |       |        |           |   |
|                                             |       |                          |       |                                 |        |       |        |           |   |
| Winchester                                       |       | Manufacturing-high  bandwidth |       | Senior Term Debt (6)                 |        | 1,980      |        | 1,918          |   |
| Electronics                                      |       | connectors and cables         |       | (6.2%, Due 5/2013)                   |        |       |        |           |   |
|                                             |       |                          |       | Senior Subordinated  Term Debt (6)   |        | 9,975      |        | 9,576          |   |
|                                             |       |                          |       | (12.0%, Due 4/2013)                  |        |       |        |           |   |
|                                             |       |                          |       |                                 |        |       |        |           |   |
| WP Evenflo Group                                 |       | Manufacturing-infant  and     |       | Senior Term Debt (7)                 |        | 1,910      |        | 1,595          |   |
| Holdings Inc. (2)                                |       | juvenile products             |       | (5.1%, Due 2/2013)                   |        |       |        |           |   |
|                                             |       |                          |       | Senior Subordinated  Term Debt (7)   |        | 2,000      |        | 1,600          |   |
|                                             |       |                          |       | (8.6%, Due 2/2014)                   |        |       |        |           |   |
| **Total  Non-Control/Non-Affiliate Investments** | ** ** | ** **                    | ** ** | **$**                                | **441,319** | ** ** | **$**       | **411,069**    |   |
| * *                                         | * *   | * *                      | * *   | * *                             | * *    | * *   | * *    | * *       |   |
| **CONTROL  INVESTMENTS**                         | ** ** | ** **                    | ** ** | ** **                           | ** **  | ** ** |        |
|                                             |       |                          |       |                                 |        |       |        |           |   |
| BERTL, Inc.                                 |       | Service-web-based  evaluator  |       | Line of Credit, $700  available (11) |        | $          | 726         |           | $      | — |   |
|                                             |       | of digital imaging  products  |       | (8.7%, Due 10/2009)                  |        |       |        |           |   |
|                                             |       |                          |       | Common Stock (8)                     |        | 424        |        | —         |   |
|                                             |       |                          |       |                                 |        |       |        |           |   |
| U.S.  HealthCare, Inc.                      |       | Service-magazine  publisher/  |       | Line of credit, $200  available (10) |        | 30         |        | 30             |   |
|                                             |       | operator                      |       | (non-accrual, Due  3/2010)           |        |       |        |           |   |
|                                             |       |                          |       | Line of credit, $450  available (10) |        | 231        |        | 231            |   |
|                                             |       |                          |       | (non-accrual, Due  3/2010)           |        |       |        |           |   |
|                                             |       |                          |       | Common Stock (8)                     |        | 2,470      |        | 410            |   |
|                                             |       |                          |       |                                 |        |       |        |           |   |
| **Total  Control Investments**                   | ** ** | ** **                    | ** ** | **$**                                | **3,881**   | ** ** | **$**       | **671**        |   |
| ** **                                       | ** ** | ** **                    | ** ** | ** **                           | ** **  | ** ** | ** **  | ** **     |   |
| **Total  Investments**                           | ** ** | ** **                    | ** ** | ** **                           | ** **  | **$**      | **445,200** | ** **     | **$**  | **411,740** |   |

 

----

(1)  Percentage represents interest rates in effect at June 30,2008 and due date represents the contractual maturity date.

(2)  Certain of the listed securities are issued by affiliate(s) ofthe indicated portfolio company.

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

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

(5)  Investment valued at cost due to recent acquisition.

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

(7)  Marketable securities, such as syndicated loans, arevalued based on the indicative bid price, on or near June 30, 2008,offered by the respective originating syndication agent’s trading desk, orsecondary desk.

(8)  Security is non-income producing.

(9) It’s Just Lunch may borrow an additional $1,750 of thesenior term debt facility, subject to certain conditions including GladstoneCapital’s approval. Borrowings of $500 were outstanding at June 30, 2008.

(10) LocalTel, West Coast Yellow Pages and U.S.Healthcare are currently past due on interest payments and are on non-accrual.

(11) BERTL line of credit was overdrawn by $26 as of June 30,2008.  The Company is currentlyrestructuring the line of credit.  BERTLinterest is currently being capitalized as Paid in Kind (“PIK”) interest.  Please refer to Note 2 “Summary ofSignificant Accounting Policies.”

 

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

 

8

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS**

**AS OF SEPTEMBER 30,2007**

**(DOLLAR AMOUNTS INTHOUSANDS)**

 
| **Company**                                | ** ** | **Industry**                      | ** ** | **Investment (1)**                          | ** ** | **Cost**   | ** ** | **Fair Value** |   |
|--------------------------------------------|------------|-----------------------------------|------------|---------------------------------------------|------------|------------|------------|----------------|--------|
| ** **                                 | ** ** | ** **                        | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** **     |   |
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS** | ** ** | ** **                        | ** ** | ** **                                  | ** ** | ** ** |       |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| Access Television                          |       | Service-cable airtime             |       | Line of Credit, $500  available             |       | $          | —     |           | $      | — |   |
| Network, Inc. (2)                     |       | (infomercials)                    |       | (11.8% Due 3/2009)                          |       |       |       |           |   |
|                                       |       |                              |       | Senior Term Debt (6)                        |       | 2,616      |       | 2,558          |   |
|                                       |       |                              |       | (11.8% Due 3/2009)                          |       |       |       |           |   |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| ActivStyle Acquisition                     |       | Service-medical  products         |       | Line of Credit, $1,500  available (6)       |       | 600        |       | 597            |   |
| Co. (2)                                    |       | distribution                      |       | (10.0%, Due 7/2009)                         |       |       |       |           |   |
|                                       |       |                              |       | Senior Term Debt (6)                        |       | 5,245      |       | 5,219          |   |
|                                       |       |                              |       | (10.0%, Due 9/2012)                         |       |       |       |           |   |
|                                       |       |                              |       | Senior Term Debt  (3) (6)              |       | 4,435      |       | 4,407          |   |
|                                       |       |                              |       | (12.6%, Due 9/2012)                         |       |       |       |           |   |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| Allison Publications,                      |       | Service-publisher of  consumer    |       | Senior Term Debt (6)                        |       | 7,884      |       | 7,780          |   |
| LLC (2)                                    |       | oriented magazines                |       | (9.8%, Due 12/2011)                         |       |       |       |           |   |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| Anitox Acquisition                         |       | Manufacturing-preservatives  for  |       | Senior Real Estate Term  Debt               |       | 3,110      |       | 3,060          |   |
| Company (2)                                |       | animal feed                       |       | (8.8%, Due 1/2012)                          |       |       |       |           |   |
|                                       |       |                              |       | Line of Credit, $3,000  available           |       | —     |       | —         |   |
|                                       |       |                              |       | (10.0%, Due 1/2010)                         |       |       |       |           |   |
|                                       |       |                              |       | Senior Term Debt (6)                        |       | 2,750      |       | 2,736          |   |
|                                       |       |                              |       | (10.0%, Due 1/2012)                         |       |       |       |           |   |
|                                       |       |                              |       | Senior Term Debt  (3) (6)              |       | 2,750      |       | 2,736          |   |
|                                       |       |                              |       | (12.3%, Due 1/2012)                         |       |       |       |           |   |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| Badanco Acquisition                        |       | Service-luggage design  and       |       | Senior Subordinated  Term Debt (6)          |       | 9,653      |       | 9,628          |   |
| Corp.                                      |       | distribution                      |       | (12.4%, Due 7/2012)                         |       |       |       |           |   |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| Bresnan                                    |       | Service-telecommunications        |       | Senior Term Debt (7)                        |       | 3,002      |       | 2,910          |   |
| Communications,                            |       |                              |       | (7.4%, Due 9/2013)                          |       |       |       |           |   |
| LLC                                        |       |                              |       | Senior Subordinated  Term Debt (7)          |       | 1,510      |       | 1,485          |   |
|                                       |       |                              |       | (9.9%, Due 3/2014)                          |       |       |       |           |   |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| CCS, LLC                                   |       | Service-cable tv  franchise owner |       | Senior Term Debt (6)                        |       | 3,433      |       | 3,416          |   |
|                                       |       |                              |       | (11.8%, Due 10/2007)                        |       |       |       |           |   |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| CHG  Companies, Inc.                  |       | Service-healthcare  staffing      |       | Letter of Credit (6) (7)               |       | 400        |       | 385            |   |
| (2)                                        |       |                              |       | (7.1%, Due 12/2012)                         |       |       |       |           |   |
|                                       |       |                              |       | Senior Term Debt (6) (7)               |       | 1,588      |       | 1,528          |   |
|                                       |       |                              |       | (7.9%, Due 12/2012)                         |       |       |       |           |   |
|                                       |       |                              |       | Senior Subordinated  Term Debt (6) (7) |       | 500        |       | 480            |   |
|                                       |       |                              |       | (11.9%, Due 12/2012)                        |       |       |       |           |   |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| Chinese Yellow                             |       | Service-publisher of  Chinese     |       | Line of Credit, $950  available (6)         |       | 230        |       | 229            |   |
| Pages Company                         |       | language directories              |       | (11.8%, Due 9/2010)                         |       |       |       |           |   |
|                                       |       |                              |       | Senior Term Debt (6)                        |       | 1,071      |       | 1,051          |   |
|                                       |       |                              |       | (11.8%, Due 9/2010)                         |       |       |       |           |   |
|                                       |       |                              |       |                                        |       |       |       |           |   |
| Clinton Holdings,                          |       | Distribution-aluminum  sheets     |       | Senior Subordinated  Term Debt              |       | 15,500     |       | 15,500         |   |
| LLC (2)                                    |       | and stainless steel               |       | (13.0%, Due 1/2013)                         |       |       |       |           |   |
|                                       |       |                              |       | Common Stock Warrants  (8)                  |       | 109        |       | 223            |   |
|                                            |            |                                   |            |                                             |            |            |            |                |        |  |  |

 

9

----

Tableof Contents

 
| **Company**             | ** ** | **Industry**                      | ** ** | **Investment (1)**                          | ** ** | **Cost** | ** ** | **Fair Value** |   |
|-------------------------|------------|-----------------------------------|------------|---------------------------------------------|------------|----------|------------|----------------|--------|
| CMI Acquisition, LLC    |       | Service-recycling                 |       | Senior Subordinated  Term Debt (6)          |       | $        | 6,500      |           | $      | 6,451 |   |
| (2)                     |       |                              |       | (12.4%, Due 11/2012)                        |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Community Media         |       | Service-publisher of  free weekly |       | Senior Term Debt (6)                        |       | 2,511    |       | 2,482          |   |
| Corporation             |       | newspapers                        |       | (9.8%, Due 8/2012)                          |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Country Road            |       | Service-telecommunications        |       | Senior Subordinated  Term Debt (6) (7) |       | 5,967    |       | 5,880          |   |
| Communications LLC      |       |                              |       | (13.1%, Due 7/2013)                         |       |     |       |           |   |
| (2)                     |       |                              |       |                                        |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Defiance Acquisition    |       | Manufacturing-trucking  parts     |       | Senior Term Debt  (3) (6)              |       | 6,325    |       | 6,246          |   |
| Corporation             |       |                              |       | (13.8%, Due 4/2010)                         |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Doe & Ingalls  |       | Distributor-specialty  chemicals  |       | Senior Term Debt (6)                        |       | 3,900    |       | 3,900          |   |
| Management              |       |                              |       | (9.3%, Due 11/2010)                         |       |     |       |           |   |
| LLC (2)                 |       |                              |       | Senior Term Debt  (3) (6)              |       | 4,455    |       | 4,455          |   |
|                    |       |                              |       | (10.3%, Due 11/2010)                        |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Emdeon Business         |       | Service-healthcare  technology    |       | Senior Term Debt (7)                        |       | 2,434    |       | 2,383          |   |
| Services,               |       | solutions                         |       | (7.4%, Due 11/2013)                         |       |     |       |           |   |
| Inc.                    |       |                              |       | Senior Subordinated  Term Debt (7)          |       | 2,013    |       | 1,985          |   |
|                    |       |                              |       | (10.2%, Due 5/2014)                         |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Express Courier         |       | Service-ground delivery  and      |       | Line of Credit, $1,500  available (6)       |       | 900      |       | 899            |   |
| International,          |       | logistics                         |       | (10.0%, Due 6/2009)                         |       |     |       |           |   |
| Inc.                    |       |                              |       | Senior Term Debt (6)                        |       | 4,113    |       | 4,107          |   |
|                    |       |                              |       | (10.0%, Due 6/2011)                         |       |     |       |           |   |
|                    |       |                              |       | Senior Term Debt  (3) (6)              |       | 3,950    |       | 3,945          |   |
|                    |       |                              |       | (12.3%, Due 6/2011)                         |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Finn Corporation        |       | Manufacturing-landscape           |       | Common Stock Warrants  (8)                  |       | 37       |       | 3,005          |   |
|                    |       | equipment                         |       |                                        |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Global Materials        |       | Manufacturing-steel  wool         |       | Senior Term Debt  (3) (6)              |       | 5,100    |       | 4,883          |   |
| Technologies, Inc. |       | products and metal  fibers        |       | (14.8%, Due 11/2009)                        |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| GTM Holdings, Inc. |       | Manufacturing-socks               |       | Senior Term Debt (7)                        |       | 496      |       | 481            |   |
| (2)                     |       |                              |       | (8.1%, Due 10/2013)                         |       |     |       |           |   |
|                    |       |                              |       | Senior Subordinated  Term Debt (7)          |       | 500      |       | 495            |   |
|                    |       |                              |       | (11.4%, Due 4/2014)                         |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Greatwide Logistics     |       | Service - logistics and           |       | Senior Term Debt (7)                        |       | 3,970    |       | 3,454          |   |
| Services, Inc.     |       | transportation                    |       | (8.7%, Due 12/2013)                         |       |     |       |           |   |
|                    |       |                              |       | Senior Subordinated Term  Debt (7)          |       | 4,000    |       | 3,280          |   |
|                    |       |                              |       | (11.7%, Due 6/2014)                         |       |     |       |           |   |
|                    |       |                              |       |                                        |       |     |       |           |   |
| Harrington              |       | Service - healthcare  products    |       | Senior Term Debt (7)                        |       | 2,488    |       | 2,419          |   |
| Holdings, Inc. (2) |       | distribution                      |       | (7.4%, Due 1/2014)                          |       |     |       |           |   |
|                    |       |                              |       | Senior Subordinated  Term Debt (7)          |       | 5,000    |       | 4,825          |   |
|                    |       |                              |       | (11.2%, Due 1/2014)                         |       |     |       |           |   |
|                         |            |                                   |            |                                             |            |          |            |                |        |  |  |

 

10

----

Table of Contents

 
| **Company**             | ** ** | **Industry**                           | ** ** | **Investment (1)**                      | ** ** | **Cost** | ** ** | **Fair Value** |   |
|-------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|----------|------------|----------------|--------|
| Heartland               |       | Service-radio station  operator        |       | Line of Credit, $500  available (6)     |       | $        | 10         |           | $      | 10 |   |
| Communications          |       |                                   |       | (11.3%, Due 5/2008)                     |       |     |       |           |   |
| Group, LLC (2)          |       |                                   |       | Senior Term Debt (6)                    |       | 4,824    |       | 4,534          |   |
|                    |       |                                   |       | (11.3%, Due 5/2011)                     |       |     |       |           |   |
|                    |       |                                   |       |                                    |       |     |       |           |   |
| IJGT Acquisition        |       | Service-golf training                  |       | Line of Credit, $1,000  available (6)   |       | 500      |       | 498            |   |
| Company                 |       |                                   |       | (10.0%, Due 5/2010)                     |       |     |       |           |   |
|                    |       |                                   |       | Senior Term Debt (6)                    |       | 2,650    |       | 2,637          |   |
|                    |       |                                   |       | (10.0%, Due 5/2012)                     |       |     |       |           |   |
|                    |       |                                   |       | Senior Term Debt  (3) (6)          |       | 2,500    |       | 2,481          |   |
|                    |       |                                   |       | (12.3%, Due 5/2012)                     |       |     |       |           |   |
|                    |       |                                   |       |                                    |       |     |       |           |   |
| It’s Just Lunch    |       | Service-dating service                 |       | Line of Credit, $750  available (6)     |       | 550      |       | 492            |   |
| International,          |       |                                   |       | (9.8%, Due 6/2009)                      |       |     |       |           |   |
| LLC                     |       |                                   |       | Senior Term Debt (6)                    |       | 3,300    |       | 2,954          |   |
|                    |       |                                   |       | (10.0%, Due 6/2011)                     |       |     |       |           |   |
|                    |       |                                   |       | Senior Term Debt  (3) (6) (9) |       | 500      |       | 448            |   |
|                    |       |                                   |       | (12.3%, Due 6/2011)                     |       |     |       |           |   |
|                    |       |                                   |       |                                    |       |     |       |           |   |
| John Henry              |       | Manufacturing-packaging                |       | Senior Subordinated  Term Debt (7)      |       | 8,000    |       | 8,000          |   |
| Holdings, Inc. (2) |       | products                               |       | (12.8%, Due 6/2011)                     |       |     |       |           |   |
|                    |       |                                   |       |                                    |       |     |       |           |   |
| Kinetek Acquisition     |       | Manufacturing-custom                   |       | Senior Term Debt (7)                    |       | 1,494    |       | 1,444          |   |
| Corp.                   |       | engineered  motors & controls |       | (7.6%, Due 11/2013)                     |       |     |       |           |   |
|                    |       |                                   |       | Senior Subordinated  Term Debt (7)      |       | 1,509    |       | 1,440          |   |
|                    |       |                                   |       | (10.6%, Due 5/2014)                     |       |     |       |           |   |
|                    |       |                                   |       |                                    |       |     |       |           |   |
| KMBQ Corporation        |       | Service-AM/FM radio                    |       | Line of Credit, $200  available         |       | 152      |       | 151            |   |
|                    |       | broadcaster                            |       | (12.8%, Due 3/2010)                     |       |     |       |           |   |
|                    |       |                                   |       | Senior Term Debt (6)                    |       | 1,813    |       | 1,786          |   |
|                    |       |                                   |       | (12.8%, Due 3/2010)                     |       |     |       |           |   |
|                    |       |                                   |       |                                    |       |     |       |           |   |
| LocalTel, Inc.     |       | Service-yellow pages                   |       | Line of Credit, $3,000  available (6)   |       | 1,135    |       | 948            |   |
|                    |       | publishing                             |       | (10.3%, Due 6/2009)                     |       |     |       |           |   |
|                    |       |                                   |       | Senior Term Debt (6)                    |       | 2,688    |       | 2,244          |   |
|                    |       |                                   |       | (10.3%, Due 6/2011)                     |       |     |       |           |   |
|                    |       |                                   |       | Senior Term Debt  (3) (6)          |       | 2,750    |       | 2,200          |   |
|                    |       |                                   |       | (12.8%, Due 6/2011)                     |       |     |       |           |   |
|                    |       |                                   |       |                                    |       |     |       |           |   |
| Macfadden               |       | Service-magazine  publisher            |       | Line of Credit, $1,400  available (6)   |       | 516      |       | 510            |   |
| Performing Arts         |       |                                   |       | (10.8%, Due 6/2009)                     |       |     |       |           |   |
| Media, LLC              |       |                                   |       | Senior Term Debt (6)                    |       | 6,705    |       | 6,558          |   |
|                    |       |                                   |       | (10.8%, Due 6/2009)                     |       |     |       |           |   |
|                    |       |                                   |       |                                    |       |     |       |           |   |
| Meteor Holding          |       | Manufacturing-bar code                 |       | Senior Term Debt (7)                    |       | 2,348    |       | 2,325          |   |
| Corporation (2)         |       | scanning and data  capture             |       | (8.2%, Due 12/2013)                     |       |     |       |           |   |
|                    |       |                                   |       | Senior Subordinated  Term Debt (7)      |       | 1,500    |       | 1,425          |   |
|                    |       |                                   |       | (11.5%, Due 12/2013)                    |       |     |       |           |   |
|                         |            |                                        |            |                                         |            |          |            |                |        |  |  |

 

11

----

Tableof Contents

 
| **Company**               | ** ** | **Industry**                     | ** ** | **Investment (1)**                     | ** ** | **Cost** | ** ** | **Fair Value** |   |
|---------------------------|------------|----------------------------------|------------|----------------------------------------|------------|----------|------------|----------------|--------|
| Multi-Ag Media LLC        |       | Service-dairy magazine           |       | Senior Term Debt (6)                   |       | $        | 2,548      |           | $      | 2,523 |   |
| (2)                       |       | publisher/information  database  |       | (11.8%, Due 12/2009)                   |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| Newhall                   |       | Service-distributor of  personal |       | Line of Credit, $4,000  available (6)  |       | —   |       | —         |   |
| Holdings, Inc.(2)    |       | care products and  supplements   |       | (8.8%, Due 5/2010)                     |       |     |       |           |   |
|                      |       |                             |       | Senior Term Debt (3) (6)               |       | 4,500    |       | 4,489          |   |
|                      |       |                             |       | (9.5%, Due 5/2012)                     |       |     |       |           |   |
|                      |       |                             |       | Senior Term Debt  (3) (6)         |       | 4,500    |       | 4,489          |   |
|                      |       |                             |       | (11.8%, Due 5/2012)                    |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| Northern                  |       | Manufacturing-veneer  and        |       | Senior Subordinated  Term Debt (6)     |       | 7,000    |       | 6,983          |   |
| Contours, Inc. (2)   |       | laminate components              |       | (12.8%, Due 5/2010)                    |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| Pinnacle Treatment        |       | Service-Addiction  treatment     |       | Line of Credit, $500  available        |       | —   |       | —         |   |
| Centers, Inc.        |       | centers                          |       | (10.0%, Due 12/2009)                   |       |     |       |           |   |
|                      |       |                             |       | Senior Term Debt (6)                   |       | 2,500    |       | 2,488          |   |
|                      |       |                             |       | (10.0%, Due 12/2011)                   |       |     |       |           |   |
|                      |       |                             |       | Senior Term Debt  (3) (6)         |       | 4,500    |       | 4,466          |   |
|                      |       |                             |       | (12.8%, Due 12/2011)                   |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| Precision Acquisition     |       | Manufacturing-consumable         |       | Equipment Note, $1,000  available (6)  |       | 672      |       | 672            |   |
| Group Holdings, Inc. |       | components for the  aluminum     |       | (10.3%, Due 10/2011)                   |       |     |       |           |   |
| (2)                       |       | industry                         |       | Senior Term Debt (6)                   |       | 5,000    |       | 5,006          |   |
|                      |       |                             |       | (10.3%, Due 10/2010)                   |       |     |       |           |   |
|                      |       |                             |       | Senior Term Debt  (3) (6)         |       | 4,200    |       | 4,205          |   |
|                      |       |                             |       | (12.3%, Due 10/2010)                   |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| PROFITSystems             |       | Service-design and  develop      |       | Line of Credit, $1,250  available      |       | —   |       | —         |   |
| Acquisition Co. (2)       |       | ERP software                     |       | (10.0%, Due 7/2009)                    |       |     |       |           |   |
|                      |       |                             |       | Senior Term Debt (6)                   |       | 2,800    |       | 2,797          |   |
|                      |       |                             |       | (10.0%, Due 7/2011)                    |       |     |       |           |   |
|                      |       |                             |       | Senior Term Debt  (3) (6)         |       | 2,900    |       | 2,896          |   |
|                      |       |                             |       | (12.3%, Due 7/2011)                    |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| Puerto Rico Cable         |       | Service-telecommunications       |       | Senior Subordinated  Term Debt (6) (7) |       | 7,799    |       | 7,388          |   |
| Acquisition               |       |                             |       | (11.5%, Due 1/2012)                    |       |     |       |           |   |
| Company, Inc.        |       |                             |       |                                   |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| RCS Management            |       | Service-healthcare  supplies     |       | Senior Term Debt  (3) (6)         |       | 3,000    |       | 2,880          |   |
| Holding Co.               |       |                             |       | (10.3%, Due 1/2011)                    |       |     |       |           |   |
|                      |       |                             |       | Senior Term Debt  (4) (6)         |       | 3,000    |       | 2,865          |   |
|                      |       |                             |       | (12.8%, Due 1/2011)                    |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| Reading                   |       | Service-television  station      |       | Senior Term Debt (6)                   |       | 7,560    |       | 7,498          |   |
| Broadcasting, Inc.   |       | operator                         |       | (12.3%, Due 3/2008)                    |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| RedPrairie                |       | Service-design and  develop      |       | Senior Term Debt (7)                   |       | 4,458    |       | 4,235          |   |
| Holding, Inc. (2)    |       | supply chain software            |       | (8.5%, Due 7/2012)                     |       |     |       |           |   |
|                      |       |                             |       | Senior Subordinated  Term Debt (7)     |       | 3,000    |       | 2,850          |   |
|                      |       |                             |       | (11.9%, Due 1/2013)                    |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| RiskMetrics Group         |       | Service - develop risk  and      |       | Senior Term Debt (7)                   |       | 1,990    |       | 1,965          |   |
| Holdings, LLC             |       | wealth management  solutions     |       | (7.4%, Due 1/2014)                     |       |     |       |           |   |
|                      |       |                             |       | Senior Subordinated  Term Debt (7)     |       | 500      |       | 495            |   |
|                      |       |                             |       | (10.7%, Due 7/2014)                    |       |     |       |           |   |
|                      |       |                             |       |                                   |       |     |       |           |   |
| SCI Cable, Inc.      |       | Service-cable,  internet, voice  |       | Senior Term Debt (6)                   |       | 2,482    |       | 2,398          |   |
|                      |       | provider                         |       | (13.8%, Due 10/2008)                   |       |     |       |           |   |
|                           |            |                                  |            |                                        |            |          |            |                |        |  |  |

 

12

----

Tableof Contents

 
| **Company**                                      | ** ** | **Industry**                    | ** ** | **Investment (1)**                    | ** **        | **Cost**   | ** **  | **Fair Value**    |   |
|--------------------------------------------------|------------|---------------------------------|------------|---------------------------------------|-------------------|------------|-------------|-------------------|--------|
| SCS Acquisition Corp.                            |       | Service-chemically  treated     |       | Senior Term Debt (6)                  |              | $          |  5,117 |              | $      |  5,111 |   |
| (2)                                              |       | equipment distribution          |       | (9.8%, Due 12/2011)                   |              |       |        |              |   |
|                                             |       |                            |       | Senior Term Debt  (3) (6)        |              | 6,494      |        | 6,477             |   |
|                                             |       |                            |       | (11.8%, Due 12/2011)                  |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| Sunburst Media -                                 |       | Service-radio station  operator |       | Senior Term Debt (6)                  |              | 7,878      |        | 7,800             |   |
| Louisiana, LLC                                   |       |                            |       | (11.5%, Due 6/2011)                   |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| Sunshine Media                                   |       | Service-publisher  regional B2B |       | Line of Credit, $3,000  available (6) |              | 700        |        | 695               |   |
| Holdings                                         |       | trade magazines                 |       | (9.8%, Due 5/2010)                    |              |       |        |              |   |
|                                             |       |                            |       | Senior Term Debt (6)                  |              | 17,000     |        | 16,915            |   |
|                                             |       |                            |       | (9.8%, Due 5/2012)                    |              |       |        |              |   |
|                                             |       |                            |       | Senior Term Debt  (3) (6)        |              | 10,000     |        | 9,925             |   |
|                                             |       |                            |       | (12.3%, Due 5/2012)                   |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| Thibaut Acquisition                              |       | Service-design and  disbribute  |       | Line of Credit, $1,000  available (6) |              | 800        |        | 798               |   |
| Co.                                              |       | wall covering                   |       | (10.3%, Due 1/2011)                   |              |       |        |              |   |
|                                             |       |                            |       | Senior Term Debt (6)                  |              | 2,713      |        | 2,709             |   |
|                                             |       |                            |       | (10.3%, Due 1/2011)                   |              |       |        |              |   |
|                                             |       |                            |       | Senior Term Debt  (3) (6)        |              | 3,000      |        | 2,992             |   |
|                                             |       |                            |       | (12.8%, Due 1/2011)                   |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| U.S. HealthCare                                  |       | Service-magazine  publisher/    |       | Senior Term Debt  (6) (10)       |              | 2,244      |        | 1,809             |   |
| Communications,                                  |       | operator                        |       | (non-accrual, Due  4/2011)            |              |       |        |              |   |
| LLC                                              |       |                            |       |                                  |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| Viapack, Inc. (2)                           |       | Manufacturing-polyethylene      |       | Senior Real Estate Term  Debt         |              | 975        |        | 975               |   |
|                                             |       | film                            |       | (10.3%, Due 3/2011)                   |              |       |        |              |   |
|                                             |       |                            |       | Senior Term Debt  (3) (6)        |              | 4,223      |        | 4,192             |   |
|                                             |       |                            |       | (11.8%, Due 3/2011)                   |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| Visual Edge                                      |       | Service-office  equipment       |       | Senior Subordinated  Term Debt (6)    |              | 5,000      |        | 3,575             |   |
| Technology, Inc.  (2)                       |       | distribution                    |       | (13.8%, Due 8/2011)                   |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| Wesco  Holdings, Inc.                       |       | Service-aerospace parts  and    |       | Senior Term Debt (7)                  |              | 2,454      |        | 2,383             |   |
| (2)                                              |       | distribution                    |       | (7.5%, Due 9/2013)                    |              |       |        |              |   |
|                                             |       |                            |       | Senior Subordinated  Term Debt (7)    |              | 2,270      |        | 2,233             |   |
|                                             |       |                            |       | (11.0%, Due 3/2014)                   |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| West Coast Yellow                                |       | Service-directory  publisher    |       | Senior Term Debt (6)                  |              | 1,584      |        | 1,518             |   |
| Pages, Inc.                                 |       |                            |       | (13.3%, Due 8/2010)                   |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| Westlake                                         |       | Retail-hardware and  variety    |       | Senior Subordinated  Term Debt (6)    |              | 15,000     |        | 14,987            |   |
| Hardware, Inc. (2)                          |       |                            |       | (13.0%, Due 1/2011)                   |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| Winchester                                       |       | Manufacturing-high  bandwidth   |       | Senior Term Debt (6)                  |              | 1,995      |        | 1,990             |   |
| Electronics                                      |       | connectors and cables           |       | (9.5%, Due 5/2013)                    |              |       |        |              |   |
|                                             |       |                            |       | Senior Subordinated  Term Debt (6)    |              | 10,000     |        | 9,950             |   |
|                                             |       |                            |       | (12.8%, Due 4/2013)                   |              |       |        |              |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| WP Evenflo Group                                 |       | Manufacturing-infant  and       |       | Senior Term Debt (7)                  |              | 1,990      |        | 1,851             |   |
| Holdings Inc. (2)                                |       | juvenile products               |       | (8.0%, Due 2/2013)                    |              |       |        |              |   |
|                                             |       |                            |       | Senior Subordinated  Term Debt (7)    |              | 2,000      |        | 1,860             |   |
|                                             |       |                            |       | (11.5%, Due 2/2014)                   |              |       |        |              |   |
| **Total  Non-Control/Non-Affiliate Investments** | ** ** | ** **                      | ** ** | **$**                                 | ** 354,835** | ** ** | **$**       | ** 348,921** |   |
| * *                                         | * *   | * *                        | * *   | * *                              | * *          | * *   | * *    | * *          |   |
| **CONTROL  INVESTMENTS**                         | ** ** | ** **                      | ** ** | ** **                            | ** **        | ** ** |        |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| BERTL, Inc.                                 |       | Service-web-based  evaluator    |       | Common Stock  (5) (8)            |              |       |        |              |   |
|                                             |       | of digital imaging  products    |       |                                  |              | 924        |        | 924               |   |
|                                             |       |                            |       |                                  |              |       |        |              |   |
| **Total  Investments (11)**                      | ** ** | ** **                      | ** ** | **$**                                 | ** 355,759** | ** ** | **$**       | ** 349,845** |   |

 

13

----

Table of Contents

 

----

(1)  Percentage represents interest rates in effect at September 30,2007 and due date represents the contractual maturity date.

(2)  Certain of the listed securities are issued by affiliate(s) ofthe indicated portfolio company.

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

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

(5)  Investment valued at cost due to recent acquisition.

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

(7)  Marketable securities, such as syndicated loans, arevalued based on the indicative bid price, on or near September 28, 2007,offered by the respective originating syndication agent’s trading desk, orsecondary desk.

(8)  Security is non-income producing.

(9) It’s Just Lunch revolving may borrow an additional $1,750of the senior term debt facility, subject to certain conditions includingGladstone Capital’s approval. Borrowings of $500 were outstanding at September 30,2007.

(10) U.S. Healthcare Communications, LLC is currently pastdue on interest payments and is on non-accrual.

(11) Aggregate gross unrealized depreciation for federal incometax purposes is $9,107; aggregate gross unrealized appreciation for federal incometax purposes is $3,192.  Net unrealizeddepreciation is $5,915 based on a tax cost of $355,759.

 

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

 

14

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(UNAUDITED)**

 
| ** **                                                                         | ** ** | **Three Months Ended June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| INVESTMENT  INCOME                                                                 |       |                                                |       |                                               |       |   |   |   |   |
| Interest income –  investments                                                |       | $                                                   | 11,236     |                                               | $          | 8,912 |   | $ | 33,499 |   | $ | 25,065 |   |
| Interest income –  cash and cash equivalents                                  |       | 38                                                  |       | 109                                                |       | 285 |   | 178 |   |
| Interest income –  notes receivable from employees (Refer to Note 4)          |       | 118                                                 |       | 133                                                |       | 354 |   | 404 |   |
| Prepayment fees  and other income                                                  |       | 28                                                  |       | 47                                                 |       | 34 |   | 432 |   |
| Total investment  income                                                           |       | 11,420                                              |       | 9,201                                              |       | 34,172 |   | 26,079 |   |
|                                                                               |       |                                                |       |                                               |       |   |   |   |   |
| EXPENSES                                                                           |       |                                                |       |                                               |       |   |   |   |   |
| Interest expense                                                                   |       | 1,771                                               |       | 1,762                                              |       | 5,982 |   | 4,694 |   |
| Loan servicing  fee (Refer to Note 4)                                              |       | 1,598                                               |       | 898                                                |       | 4,541 |   | 2,377 |   |
| Base management  fee (Refer to Note 4)                                             |       | 529                                                 |       | 847                                                |       | 1,664 |   | 1,997 |   |
| Incentive fee  (Refer to Note 4)                                                   |       | 1,340                                               |       | 1,167                                              |       | 4,089 |   | 3,474 |   |
| Administration  fee (Refer to Note 4)                                              |       | 285                                                 |       | 187                                                |       | 737 |   | 482 |   |
| Professional  fees                                                                 |       | 167                                                 |       | 149                                                |       | 706 |   | 369 |   |
| Amortization of  deferred financing fees                                           |       | 572                                                 |       | 72                                                 |       | 830 |   | 199 |   |
| Stockholder  related costs                                                         |       | 34                                                  |       | 39                                                 |       | 292 |   | 190 |   |
| Directors fees                                                                     |       | 52                                                  |       | 56                                                 |       | 163 |   | 167 |   |
| Insurance expense                                                                  |       | 57                                                  |       | 66                                                 |       | 170 |   | 191 |   |
| Other expenses                                                                     |       | 103                                                 |       | 82                                                 |       | 263 |   | 220 |   |
| Expenses before  credit from Adviser                                               |       | 6,508                                               |       | 5,325                                              |       | 19,437 |   | 14,360 |   |
| Credit to base  management and incentive fees from Adviser (Refer to Note 4)       |       | (1,785                                              | )          | (1,829                                             | )          | (5,708 | ) | (4,873 | ) |
| Total expenses  net of credit to base management and incentive fees                |       | 4,723                                               |       | 3,496                                              |       | 13,729 |   | 9,487 |   |
|                                                                               |       |                                                |       |                                               |       |   |   |   |   |
| NET INVESTMENT  INCOME                                                             |       | 6,697                                               |       | 5,705                                              |       | 20,443 |   | 16,592 |   |
|                                                                               |       |                                                |       |                                               |       |   |   |   |   |
| REALIZED AND  UNREALIZED GAIN (LOSS) ON INVESTMENTS:                               |       |                                                |       |                                               |       |   |   |   |   |
| Realized (loss)  gain on sale of investments                                       |       | (86                                                 | )          | (5                                                 | )          | (86 | ) | 82 |   |
| Realized gain on  settlement of derivative                                         |       | —                                              |       | 8                                                  |       | 6 |   | 31 |   |
| Unrealized  depreciation on derivative                                             |       | —                                              |       | —                                             |       | (12 | ) | (26 | ) |
| Net unrealized  (depreciation) appreciation on investments                         |       | (3,802                                              | )          | 257                                                |       | (27,545 | ) | (2,466 | ) |
| Net (loss) gain  on investments                                                    |       | (3,888                                              | )          | 260                                                |       | (27,637 | ) | (2,379 | ) |
|                                                                               |       |                                                |       |                                               |       |   |   |   |   |
| NET INCREASE  (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS                   |       | $                                                   | 2,809      |                                               | $          | 5,965 |   | $ | (7,194 | ) | $ | 14,213 |   |
|                                                                               |       |                                                |       |                                               |       |   |   |   |   |
| NET INCREASE  (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE: |       |                                                |       |                                               |       |   |   |   |   |
| Basic and  Diluted                                                                 |       | $                                                   | 0.13       |                                               | $          | 0.44 |   | $ | (0.37 | ) | $ | 1.12 |   |
|                                                                               |       |                                                |       |                                               |       |   |   |   |   |
| WEIGHTED AVERAGE  SHARES OF COMMON STOCK OUTSTANDING:                              |       |                                                |       |                                               |       |   |   |   |   |
| Basic and  Diluted                                                                 |       | 21,087,574                                          |       | 13,561,511                                         |       | 19,237,203 |   | 12,701,845 |   |

 

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

 

15

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                             | ** ** | **Nine Months Ended June 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| *Operations:*                                          |       |                                               |       |   |   |
| Net investment  income                                 |       | $                                                  | 20,443     |   | $ | 16,592 |   |
| Net realized  (loss) gain on sale of investments       |       | (86                                                | )          | 82 |   |
| Realized gain on  settlement of derivative             |       | 6                                                  |       | 31 |   |
| Unrealized  depreciation on derivative                 |       | (12                                                | )          | (26 | ) |
| Net unrealized  depreciation on investments            |       | (27,545                                            | )          | (2,466 | ) |
| Net (decrease)  increase in net assets from operations |       | (7,194                                             | )          | 14,213 |   |
|                                                   |       |                                               |       |   |   |
| *Capital  transactions:*                               |       |                                               |       |   |   |
| Issuance of  common stock under shelf offering         |       | 106,226                                            |       | 46,075 |   |
| Distributions to  stockholders                         |       | (24,523                                            | )          | (16,013 | ) |
| Repayment of  principal on employee notes              |       | 51                                                 |       | 301 |   |
| Shelf offering  costs                                  |       | (845                                               | )          | (406 | ) |
| Stock  surrendered in settlement of withholding tax    |       | —                                             |       | (1,488 | ) |
| Increase in net  assets from capital transactions      |       | 80,909                                             |       | 28,469 |   |
|                                                   |       |                                               |       |   |   |
| Total increase  in net assets                          |       | 73,715                                             |       | 42,682 |   |
| Net assets at  beginning of year                       |       | 220,959                                            |       | 172,571 |   |
| Net assets at  end of period                           |       | $                                                  | 294,674    |   | $ | 215,253 |   |

 

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

 

16

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                                                        | ** ** | **Nine Months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                         |       |                                               |       |   |   |
| Net (decrease)  increase in net assets resulting from operations                  |       | $                                                  | (7,194     | ) | $ | 14,213 |   |
| Adjustments to  reconcile net (decrease) increase in net assets resulting from    |       |                                               |       |   |   |
| operations to  net cash used in operating activities:                             |       |                                               |       |   |   |
| Purchase of  investments                                                          |       | (137,502                                           | )          | (253,728 | ) |
| Principal  repayments on investments                                              |       | 47,802                                             |       | 99,803 |   |
| Net amortization  of premiums and discounts                                       |       | 215                                                |       | 30 |   |
| Increase in  investment balance due to payment in kind interest                   |       | (42                                                | )          | — |   |
| Amortization of  deferred financing fees                                          |       | 830                                                |       | 199 |   |
| Realized loss on  investments                                                     |       | 86                                                 |       | 123 |   |
| Unrealized  depreciation on derivative                                            |       | 12                                                 |       | 26 |   |
| Change in net  unrealized depreciation on investments                             |       | 27,545                                             |       | 2,466 |   |
| Increase in  interest receivable                                                  |       | (945                                               | )          | (822 | ) |
| (Increase)  decrease in funds due from custodian                                  |       | (3,406                                             | )          | 457 |   |
| Decrease in  prepaid assets                                                       |       | 135                                                |       | 40 |   |
| Increase in  other assets                                                         |       | (113                                               | )          | (165 | ) |
| Increase in  accounts payable                                                     |       | 2                                                  |       | 1 |   |
| (Decrease)  increase in interest payable                                          |       | (65                                                | )          | 269 |   |
| Increase in accrued  expenses and deferred liabilities                            |       | 114                                                |       | 133 |   |
| (Increase)  decrease in fees due to affiliate (Refer to Note 4)                   |       | (241                                               | )          | 164 |   |
| Increase in  administration fee due to Gladstone Administration (Refer to Note 4) |       | 47                                                 |       | 187 |   |
| Increase  (decrease) in funds held in escrow                                      |       | 290                                                |       | (1 | ) |
| Net cash used in  operating activities                                            |       | (72,430                                            | )          | (136,605 | ) |
|                                                                              |       |                                               |       |   |   |
| **CASH  FLOW FROM INVESTING ACTIVITIES**                                          |       |                                               |       |   |   |
| Redemption of  U.S. Treasury Bill                                                 |       | 2,484                                              |       | — |   |
| Net cash  provided by investing activities                                        |       | 2,484                                              |       | — |   |
|                                                                              |       |                                               |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                        |       |                                               |       |   |   |
| Net proceeds  from the issuance of common shares                                  |       | 106,226                                            |       | 45,669 |   |
| Borrowings from  the line of credit                                               |       | 151,418                                            |       | 277,800 |   |
| Repayments on  the line of credit                                                 |       | (162,768                                           | )          | (166,605 | ) |
| Distributions  paid                                                               |       | (24,523                                            | )          | (16,013 | ) |
| Receipt of  principal on notes receivable – employees (Refer to Note 4)      |       | 51                                                 |       | 301 |   |
| Deferred  financing fees                                                          |       | (3,026                                             | )          | (299 | ) |
| Shelf offering  costs                                                             |       | (845                                               | )          | — |   |
| Withholding tax  obligation settlement                                            |       | —                                             |       | (1,488 | ) |
| Net cash  provided by financing activities                                        |       | 66,533                                             |       | 139,365 |   |
|                                                                              |       |                                               |       |   |   |
| **NET  (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS**                         |       | (3,413                                             | )          | 2,760 |   |
| **CASH  AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                               |       | 8,839                                              |       | 731 |   |
| **CASH  AND CASH EQUIVALENTS, END OF PERIOD**                                     |       | $                                                  | 5,426      |   | $ | 3,491 |   |
|                                                                              |       |                                               |       |   |   |
| **CASH  PAID DURING PERIOD FOR INTEREST**                                         |       | $                                                  | 6,047      |   | $ | 4,424 |   |

 

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

 

17

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**FINANCIALHIGHLIGHTS**

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

**(UNAUDITED)**

 
| ** **                                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Per Share Data  (1)                                              |       |                                                |       |                                               |       |   |   |   |   |
| Net asset value  at beginning of period                          |       | $                                                   | 14.27      |                                               | $          | 13.82 |   | $ | 14.97 |   | $ | 14.02 |   |
| *Income  from investment operations:*                            |       |                                                |       |                                               |       |   |   |   |   |
| Net investment  income (2)                                       |       | 0.32                                                |       | 0.42                                               |       | 1.06 |   | 1.31 |   |
| Net unrealized  (depreciation) appreciation on investments (2)   |       | (0.19                                               | )          | 0.02                                               |       | (1.43 | ) | (0.19 | ) |
| Total from  investment operations                                |       | 0.13                                                |       | 0.44                                               |       | (0.37 | ) | 1.12 |   |
|                                                             |       |                                                |       |                                               |       |   |   |   |   |
| Distributions to  stockholders (3)                               |       | (0.42                                               | )          | (0.42                                              | )          | (1.26 | ) | (1.26 | ) |
| Issuance of  common stock under shelf offering                   |       | —                                              |       | 1.50                                               |       | 0.68 |   | 1.50 |   |
| Offering costs                                                   |       | (0.01                                               | )          | (0.23                                              | )          | (0.05 | ) | (0.23 | ) |
| Repayment of  principal on notes receivable                      |       | —                                              |       | —                                             |       | — |   | 0.02 |   |
| Stock  surrendered to settle withholding tax obligation          |       | —                                              |       | —                                             |       | — |   | (0.06 | ) |
| Net asset value  at end of period                                |       | $                                                   | 13.97      |                                               | $          | 15.11 |   | $ | 13.97 |   | $ | 15.11 |   |
|                                                             |       |                                                |       |                                               |       |   |   |   |   |
| Per share market  value at beginning of period                   |       | $                                                   | 18.71      |                                               | $          | 23.86 |   | $ | 19.52 |   | $ | 22.01 |   |
| Per share market  value at end of period                         |       | $                                                   | 15.24      |                                               | $          | 21.46 |   | $ | 15.24 |   | $ | 21.46 |   |
| Total return  (4)(5)                                             |       | -16.53                                              | %          | -7.69                                              | %          | -16.15 | % | 2.92 | % |
| Shares  outstanding at end of period                             |       | 21,087,574                                          |       | 14,249,683                                         |       | 21,087,574 |   | 14,249,683 |   |
|                                                             |       |                                                |       |                                               |       |   |   |   |   |
| Statement of  Assets and Liabilities Data:                       |       |                                                |       |                                               |       |   |   |   |   |
| Net assets at  end of period                                     |       | $                                                   | 294,674    |                                               | $          | 215,253 |   | $ | 294,674 |   | $ | 215,253 |   |
| Average net assets  (6)                                          |       | $                                                   | 295,405    |                                               | $          | 197,994 |   | $ | 284,641 |   | $ | 179,127 |   |
| Senior  Securities Data:                                         |       |                                                |       |                                               |       |   |   |   |   |
| Borrowings under  line of credit                                 |       | $                                                   | 133,090    |                                               | $          | 161,188 |   | $ | 133,090 |   | $ | 161,188 |   |
| Asset coverage  ratio (7)                                        |       | 323                                                 | %          | 235                                                | %          | 323 | % | 235 | % |
| Asset coverage  per unit (8)                                     |       | $                                                   | 4,278      |                                               | $          | 3,764 |   | $ | 4,278 |   | $ | 3,764 |   |
| Ratios/Supplemental  Data:                                       |       |                                                |       |                                               |       |   |   |   |   |
| Ratio of  expenses to average net assets-annualized (9)          |       | 8.81                                                | %          | 10.52                                              | %          | 9.10 | % | 10.55 | % |
| Ratio of net  expenses to average net assets-annualized (10)     |       | 6.40                                                | %          | 7.06                                               | %          | 6.43 | % | 7.06 | % |
| Ratio of net  investment income to average net assets-annualized |       | 9.07                                                | %          | 11.53                                              | %          | 9.58 | % | 12.35 | % |

 

----

(1)          Based on actual shares outstanding at theend of the corresponding period.

(2)          Based on weighted average basic per sharedata.

(3)          Distributionsare determined based on taxable income calculated in accordance with income taxregulations which may differ from amounts determined under accountingprinciples generally accepted in the United States of America.

(4)          Total return equals the change in the endingmarket value of the Company’s common stock from the beginning of the periodtaking into account dividends reinvested in accordance with the terms of ourdividend reinvestment plan. Total return does not take into account dividendsthat may be characterized as a return of capital. For further information onestimated character of our dividends please refer to Note 9.

(5)          Amounts were not annualized.

(6)          Average net assets are computed using theaverage of the balance of net assets at the end of each month of the reportingperiod.

(7)          Asa business development company, we are generally required to maintain a ratioof at least 200% of total assets to total borrowings.

(8)          Assetcoverage per unit is the ratio of the carrying value of our total consolidatedassets, less all liabilities and indebtedness not represented by seniorsecurities, to the aggregate amount of senior securities representingindebtedness. Asset coverage per unit is expressed in terms of dollar amountsper $100 of indebtedness.

(9)          Ratio of expenses to average net assets iscomputed using expenses before credits from Adviser to the base management andincentive fees and including income tax expense.

(10)    Ratio of net expenses to average net assets is computed usingtotal expenses net of credits from Adviser to the base management and incentivefees and including income tax expense.

 

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

 

18

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**JUNE 30, 2008**

**(DOLLAR AMOUNTS INTHOUSANDS, EXCEPT PER SHARE DATA AND AS OTHERWISE INDICATFD)**

**(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.

 

GladstoneSSBIC Corporation (“Gladstone SSBIC”), a wholly-owned subsidiary of theCompany, was established on November 21, 2006 for the purpose of holding alicense to operate as a Specialized Small Business Investment Company.  Gladstone SSBIC acquired this license in February 2007.  This will enable the Company, through thissubsidiary, to make investments in accordance with the United States SmallBusiness Administration guidelines for specialized small business investmentcompanies.  Currently, Gladstone SSBICholds approximately $2.6 million in a money market account from the proceedsfrom the Company’s initial stock purchase in Gladstone SSBIC.

 

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

 

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

 

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 accompanyingannual financial statements prepared in accordance with GAAP are omitted.  In the opinion of management, alladjustments, consisting solely of normal recurring accruals, necessary for thefair statement of financial statements for the interim periods have beenincluded.  The current period’s resultsof operations are not necessarily indicative of results that ultimately may beachieved for the year.  The interimfinancial statements and notes thereto should be read in conjunction with thefinancial statements and notes thereto included in the Company’s Form 10-Kfor the fiscal year ended September 30, 2007, as filed with the Securitiesand Exchange Commission (the “SEC”) on December 3, 2007.

 

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

 

*Reclassifications*

 

Certainamounts in the prior year’s financial statements have been reclassified toconform to the current year presentation with no effect to net increase in netassets resulting from operations.

 

*InvestmentValuation*

 

The Company carries itsinvestments at market value to the extent that market quotations are readilyavailable, and otherwise at fair value, as determined in good faith by itsBoard of Directors. In determining the fair value of the Company’s investments,the Adviser has established an investment valuation policy (the “policy”).  The policy has been approved by the Company’sBoard of Directors and each quarter the Board of Directors reviews whether theAdviser has applied the policy consistently, and votes whether or not to acceptthe recommended valuation of the Company’s investment portfolio.

 

19

----

Table of Contents

 

The Company uses generally accepted valuation techniques to value itsportfolio unless the Company has specific information about the value of aninvestment to determine otherwise. From time to time the Company may accept anappraisal of a business in which the Company holds securities. These appraisalsare expensive and occur infrequently but provide a third-party valuationopinion that may differ in results, techniques and scopes used to value theCompany’s investments.  When thesespecific third-party appraisals are engaged or accepted, the Company would usesuch appraisals to value the investment the Company has in that business if itwas determined that the appraisals were the best estimate of fair value.

 

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

 

**Publicly-tradedsecurities:** The Company determines the value ofpublicly-traded securities based on the closing price for the security on theexchange or securities market on which it is listed and primarily traded on thevaluation date.  To the extent that theCompany owns restricted securities that are not freely tradable, but for whicha public market otherwise exists, the Company will use the market value of thatsecurity adjusted for any decrease in value resulting from the restrictivefeature.

 

**Securitiesfor which a limited market exists:** The Company valuessecurities that are not traded on an established secondary securities market,but for which a limited market for the security exists, such as certainparticipations in, or assignments of, syndicated loans, at the quoted price.  Firm bid prices are requested; however, if afirm bid price is unavailable, the Company bases the value of the security uponthe indicative bid price offered by the respective originating syndicationagent’s trading desk, or secondary desk, on or near the valuation date.  To the extent that the Company uses theindicative bid price as a basis for valuing the security, the Adviser may takefurther steps to consider additional information to validate that price inaccordance with the policy.

 

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

 

(1)          **Portfolio investments comprised solely of debt securities:**The fair value of the Company’s debt securities that are not publicly traded,or for which a limited market does not exist (“Non-Public Debt Securities”),and that are issued by portfolio companies where the Company has no equity, orequity-like securities, or holds a non-control equity interest, rely onopinions of value submitted to it by Standard & Poor’s SecuritiesEvaluations, Inc. (“SPSE”). The Company may also submit paid in kind (“PIK”)interest to SPSE for valuation when it is determined the PIK interest is likelyto be received. SPSE will only evaluate the debt portion of the Company’sinvestments for which the Company specifically requests evaluation, and maydecline to make requested evaluations for any reason at its sole discretion.SPSE opinions of value are submitted to the Board of Directors along with theAdviser’s supplemental assessment and recommendation regarding valuation ofeach of these investments.

 

(2)          **Portfolio investments in controlled companies comprised of a bundle ofinvestments, which can include debt and equity securities:** TheCompany values Non-Public Debt Securities and equity or equity-like securities(e.g. preferred equity, equity, or other equity-like securities) that arepurchased together from the same “controlled” portfolio company, or issuer, aspart of a package based on the total enterprise value of the issuer, which iscalculated using a liquidity waterfall approach.  Under this approach, the Company firstcalculates the total enterprise value of the issuer by incorporating some orall of the following factors to determine the total enterprise value of theissuer:  the issuer’s ability to makepayments, the earnings of the issuer, recent sales to third parties of similarsecurities, the comparison to publicly traded securities, and discounted cashflow or other pertinent factors.

 

In gathering the sales to third parties of similar securities, theCompany may reference industry statistics and use outside experts. Once thetotal enterprise value of the issuer is estimated, the Company subtracts thevalue of all the debt securities of the issuer; which are valued at thecontractual principal balance. Fair values of these debt securities arediscounted for any shortfall of total enterprise value over the total debtoutstanding for the issuer. Once the values for all outstanding seniorsecurities (which include the debt securities) have been subtracted from thetotal enterprise value of the issuer, the remaining amount, if any, is used todetermine the value of the issuer’s equity or equity like securities.

 

(3)          **Portfolio investments in non-controlled companies comprised of a bundleof investments, which can include debt and equity securities:**TheCompany values Non-Public Debt Securities and equity or equity-like securitiesthat are purchased together from the same “non-controlled” portfolio company,or issuer, by valuing the debt portion with SPSE (as described above) andvaluing the equity portion based on the total enterprise value of the issuer,which is calculated using a liquidity waterfall approach as described above.

 

Due to the uncertainty inherent in the valuation process, suchestimates of fair value may differ significantly from the values that wouldhave resulted had a ready market for the securities existed, and thedifferences could be material. Additionally, changes in 

 

20

----

Table of Contents

 

the market environment and other events that may occur over the life ofthe investments may cause the gains or losses ultimately realized on theseinvestments to be different than the valuation currently assigned.  There is no single standard for determiningfair value in good faith, as fair value depends upon circumstances of eachindividual case.  In general, fair valueis the amount that we might reasonably expect to receive upon the current saleof the security in an arms-length transaction in the security’s principalmarket.  The Board of Directors isultimately responsible for setting the fair value and disclosure of investmentsin the financial statements.

 

*InterestIncome Recognition*

 

Interest income, adjusted for amortization of premiums and acquisitioncosts and for the accretion of discounts, is recorded on the accrual basis tothe extent that such amounts are expected to be collected. The Company stopsaccruing interest on its investments when it is determined that interest is nolonger collectible.  At June 30,2008, two Non-Control/Non-Affiliate investments were on non-accrual with anaggregate cost basis of approximately $8.2 million or 1.8% of the cost basis ofall investments in the Company’s portfolio. Also at June 30, 2008, one Control investment was on non-accrualwith a cost basis of approximately $0.3 million or 0.1% of the cost basis ofall investments in the Company’s portfolio. At September 30, 2007, one Non-Control/Non-Affiliate investment wason non-accrual with a cost basis of approximately $2.2 million or 0.6% of thecost basis of all investments in the Company’s portfolio.  Conditional interest, or a success fee, isrecorded upon full repayment of a loan investment.

 

*Paidin Kind Interest*

 

TheCompany seeks to avoid PIK interest; however, the Company currently has oneloan in its portfolio that contains a PIK provision. A PIK provision requiresthe borrower to accrue a payment to the Company but the borrower does not haveto pay that interest until the loan is paid in full. The PIK interest is addedto the principal balance of the loan and recorded as income to the Company eventhough the cash has not been received. To maintain the Company’s status as a RIC, this non-cash source ofincome must be paid out to stockholders in the form of cash dividends, eventhough the Company has not yet collected the cash. The Company recorded PIKinterest income of $16 and $46, respectively, for the three and nine monthsended June 30, 2008, from investments on the accompanying consolidatedstatement of operations. There were no PIK loans in the Company’s portfolioduring the three and nine months ended June 30, 2007.

 

*RecentAccounting Pronouncements*

 

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 is effective as of the beginning of an entity’sfirst fiscal year that begins after December 15, 2006. The Company adoptedthis Interpretation on October 1, 2007. The adoption did not have amaterial impact 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 formeasuring fair value in accordance with GAAP, and expands disclosures aboutfair value measurements.  SFAS No. 157applies broadly 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 1,2008 and is currently evaluating the impact of this pronouncement on itsconsolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, *“The Fair Value Option for Financial Assets and FinancialLiabilities — Including an Amendment of FASB Statement No. 115,”*which is effective for fiscal years beginning after November 15, 2007.This pronouncement permits an entity to choose to measure many financialinstruments and certain other items at fair value at specified election dates.Subsequent unrealized gains and losses on items for which the fair value optionhas been elected will be reported in earnings. The Company is currentlyevaluating the potential impact of this pronouncement on its consolidatedfinancial statements.

 

In November 2007, the SEC issued Staff Accounting Bulletin No. 109,*“Written Loan Commitments Recorded at Fair ValueThrough Earnings”* (“SAB 109”)*.* SAB 109provides guidance on the accounting for written loan commitments recorded atfair value under GAAP. Specifically, SAB 109 revises the Staff’s views onincorporating expected net future cash flows related to loan servicingactivities in the fair value measurement of a written loan commitment. SAB 109, which  supersedes  SAB  105,  “*Application  of  Accounting Principles  to  Loan Commitments,”* requires the  expected  net  future  cash  flows  relatedto the associated  servicing of the loan be included in the measurement ofall written loan commitments that are accounted for at fair value through earnings.SAB 109 is effective in fiscal quarters beginning after December 15, 2007.The Company has evaluated the implications of SAB 109 and determined that thereis no material impact on its consolidated financial statements.

 

21

----

Table of Contents

 

In December 2007,the FASB issued SFAS No. 141(R) *“Business Combinations”*(“SFAS No. 141(R)”). SFAS No. 141(R) establishes principles andrequirements for how an acquirer recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, anynoncontrolling interest in the acquiree and the goodwill acquired. SFAS No. 141(R) alsoestablishes disclosure requirements to enable the evaluation of the nature andfinancial effects of the business combination. SFAS No. 141(R) iseffective as of the beginning of an entity’s fiscal year that begins after December 15,2008.  The Company is required to adoptSFAS No. 141 (R) on October 1, 2009 and is currently evaluatingthe impact of this pronouncement on its consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, “*Disclosures about Derivative Instruments and Hedging Activities*”(“SFAS No. 161”), which is intended to help investors better understandhow derivative instruments and hedging activities affect an entity’s financialposition, financial performance and cash flows through enhanced disclosurerequirements.  The enhanced disclosuresprimarily surround disclosing the objectives and strategies for usingderivative instruments by their underlying risk as well as a tabular format ofthe fair values of the derivative instruments and their gains and losses.  SFAS No. 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008.  The Company is evaluating theimpact of this pronouncement on the reporting of its derivatives.

 

NOTE3. INVESTMENTS

 

*Non-Control/Non-AffiliateInvestments*

 

At June 30,2008 and September 30, 2007, the Company held investments inNon-Control/Non-Affiliate of approximately $441.3 million and $354.8 million,at cost, respectively.

 

*ControlInvestments*

 

At June 30,2008, the Company had two control investments: BERTL, Inc. (“BERTL”) andU.S. Healthcare, Inc. (“U.S. Healthcare”).

 

·                  *BERTL:* The Company originally purchased a past due debtinstrument in MCA Communications LLC, and the Company accepted a deed in lieuof foreclosure in satisfaction of BERTL’s obligations under the debt instrumenton September 28, 2007.  BERTL is aweb-based evaluator of digital imaging products.

 

·                  *U.S. Healthcare:* The Company offered at public sale certain assets of U.S. Healthcare on January 30,2008, consisting generally of all fixtures and all tangible and intangiblepersonal property.  The Company acquiredthese assets in the sale, through a newly formed subsidiary, and is continuingthe business of U.S. Healthcare under its control.  U.S. Healthcare is a service-magazinepublisher/operator.

 

Theinvestments in BERTL and U.S. Healthcare consisted of the following as of June 30,2008 and September 30, 2007:

 
| ** **                     | ** ** | ** **     | ** ** | **June 30, 2008** | ** ** | **September 30, 2007** | ** ** |
|--------------------------------|------------|----------------|------------|-----------------------------|------------|----------------------------------|------------|
| **Company**                    | ** ** | **Investment** | ** ** | **Cost**                    | ** ** | **Fair Value**              | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| BERTL, Inc.               |       | Line of credit |       | $                           | 726        |                             | $          | — |   | $ | — |   | $ | — |   |
|                           |       | Common stock   |       | 424                         |       | —                           |       | 924 |   | 924 |   |
|                           |       |           |       |                        |       |                             |       |   |   |   |   |
| U.S. Healthcare, Inc. (1) |       | Line of credit |       | 30                          |       | 30                               |       | — |   | — |   |
|                           |       | Line of credit |       | 231                         |       | 231                              |       | — |   | — |   |
|                           |       | Common stock   |       | 2,470                       |       | 410                              |       | — |   | — |   |
| **Total control investments**  | ** ** | ** **     | ** ** | **$**                       | **3,881**  | ** **                       | **$**      | **671** | ** ** | **$** | **924** | ** ** | **$** | **924** | ** ** |

 

----

(1) U.S.Healthcare, Inc. became a new control investment as of March 31,2008.

 

22

----

Table of Contents

 

Investmentsat fair value consisted of the following industry classifications as of June 30,2008 and September 30, 2007:

 
| ** **                                          | ** ** | **June 30, 2008** | ** ** | **September 30, 2007** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | ** **                  | ** ** | **Percentage**                   | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Industry Classification**                    | ** ** | **Fair Value**         | ** ** | **Total   Investments**     | ** ** | **Net   Assets** | ** ** | **Fair Value** | ** ** | **Total   Investments** | ** ** | **Net   Assets** | ** ** |
| Aerospace & Defense                        |       | $                           | 4,546      |                             | 1.1        | % | 1.5 | % | $ | 4,616 |   | 1.3 | % | 2.1 | % |
| Automobile                                          |       | 5,496                       |       | 1.3                              | %          | 1.9 | % | 6,246 |   | 1.8 | % | 2.8 | % |
| Broadcast (TV & Radio)                     |       | 56,820                      |       | 13.8                             | %          | 19.3 | % | 41,934 |   | 12.0 | % | 19.0 | % |
| Buildings and Real Estate                           |       | 13,817                      |       | 3.3                              | %          | 4.7 | % | — |   | — |   | — |   |
| Cargo Transport                                     |       | 27,831                      |       | 6.8                              | %          | 9.4 | % | 15,685 |   | 4.5 | % | 7.1 | % |
| Chemicals, Plastics & Rubber               |       | 17,163                      |       | 4.2                              | %          | 5.8 | % | 25,110 |   | 7.2 | % | 11.4 | % |
| Diversified/Conglomerate Manufacturing              |       | 3,195                       |       | 0.8                              | %          | 1.1 | % | 3,710 |   | 1.1 | % | 1.7 | % |
| Electronics                                         |       | 40,625                      |       | 9.9                              | %          | 13.8 | % | 31,351 |   | 9.0 | % | 14.2 | % |
| Farming & Agriculture                      |       | 10,237                      |       | 2.5                              | %          | 3.5 | % | 11,538 |   | 3.3 | % | 5.2 | % |
| Finance                                             |       | 1,874                       |       | 0.5                              | %          | 0.6 | % | 2,460 |   | 0.7 | % | 1.1 | % |
| Healthcare, Education & Childcare          |       | 67,134                      |       | 16.3                             | %          | 22.8 | % | 36,927 |   | 10.5 | % | 16.7 | % |
| Home & Office Furnishings                  |       | 16,280                      |       | 4.0                              | %          | 5.5 | % | 17,057 |   | 4.9 | % | 7.7 | % |
| Leisure, Amusement, Movies & Entertainment |       | 8,711                       |       | 2.1                              | %          | 3.0 | % | 9,509 |   | 2.7 | % | 4.3 | % |
| Machinery                                           |       | 10,041                      |       | 2.4                              | %          | 3.4 | % | 9,883 |   | 2.8 | % | 4.5 | % |
| Mining, Steel, Iron & Non-Precious Metals  |       | 26,036                      |       | 6.3                              | %          | 8.8 | % | 27,057 |   | 7.7 | % | 12.2 | % |
| Personal and Non-durable Consumer Products          |       | 9,597                       |       | 2.3                              | %          | 3.3 | % | 8,978 |   | 2.6 | % | 4.1 | % |
| Printing & Publishing                      |       | 58,643                      |       | 14.2                             | %          | 19.9 | % | 72,191 |   | 20.6 | % | 32.7 | % |
| Retail Stores                                       |       | 23,725                      |       | 5.8                              | %          | 8.0 | % | 14,986 |   | 4.3 | % | 6.8 | % |
| Textiles & Leather                         |       | 9,969                       |       | 2.4                              | %          | 3.4 | % | 10,605 |   | 3.0 | % | 4.8 | % |
| **Total**                                           |       | $                           | 411,740    |                             | 100.0      | % |   |   | $ | 349,845 |   | 100.0 | % |   |   |

 

Theinvestments at fair value were included in the following geographic regions ofthe United States at June 30, 2008 and September 30, 2007:

 
| ** **                   | ** ** | **June 30, 2008** | ** ** | **September 30, 2007** | ** ** |
|------------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | ** **                  | ** ** | **Percentage**                   | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Geographic   Region** | ** ** | **Fair Value**         | ** ** | **Total   Investments**     | ** ** | **Net   Assets** | ** ** | **Fair Value** | ** ** | **Total   Investments** | ** ** | **Net   Assets** | ** ** |
| Midwest                      |       | $                           | 204,558    |                             | 49.7       | % | 69.4 | % | $ | 152,928 |   | 43.7 | % | 69.2 | % |
| West                         |       | 85,444                      |       | 20.7                             | %          | 29.0 | % | 70,842 |   | 20.2 | % | 32.1 | % |
| Mid-Atlantic                 |       | 43,178                      |       | 10.5                             | %          | 14.7 | % | 56,866 |   | 16.3 | % | 25.7 | % |
| Southeast                    |       | 60,031                      |       | 14.6                             | %          | 20.4 | % | 44,488 |   | 12.7 | % | 20.1 | % |
| Northeast                    |       | 12,816                      |       | 3.1                              | %          | 4.3 | % | 17,331 |   | 5.0 | % | 7.8 | % |
| U.S. Territory               |       | 5,713                       |       | 1.4                              | %          | 1.9 | % | 7,388 |   | 2.1 | % | 3.3 | % |
|                         |       | $                           | 411,740    |                             | 100.0      | % |   |   | $ | 349,845 |   | 100.0 | % |   |   |

 

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

 

23

----

Table of Contents

 

*InvestmentPrincipal Repayment*

 

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

 
| ** **                                                | ** ** | ** **                        | ** ** | **Amount** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------|------------|------------|------------|
| For the remaining three months ending  September 30: |       | 2008                              |       | $          | 6,641      |   |
| For the year ending September 30:                    |       | 2009                              |       | 25,573     |       |
|                                                      |       | 2010                              |       | 48,070     |       |
|                                                      |       | 2011                              |       | 109,311    |       |
|                                                      |       | 2012                              |       | 91,878     |       |
|                                                      |       | 2013                              |       | 111,810    |       |
|                                                      |       | Thereafter                        |       | 48,469     |       |
| ** **                                                | ** ** | **Total Contractual Repayments**  |       | $          | 441,752    |   |
|                                                      |       | Investments in Equity  Securities |       | 3,448      |       |
| ** **                                                | ** ** | **Total**                         |       | $          | 445,200    |   |

 

NOTE4. RELATED PARTY TRANSACTIONS

 

*Loansto Employees*

 

TheCompany provided loans to employees of the Adviser, who at the time of theloans were joint employees of the Company and either the Adviser, or theCompany’s previous investment adviser, Gladstone Capital Advisers, Inc.,for the exercise of options under the Amended and Restated 2001 EquityIncentive Plan (the “2001 Plan”), which has since been terminated and is nolonger in operation.  The loans requirethe quarterly payment of interest at the market rate in effect at the date ofissue, have varying terms not exceeding ten years and have been recorded as areduction of net assets.  The loans areevidenced by full recourse notes that are due upon maturity or 60 daysfollowing termination of employment, and the shares of common stock purchasedwith the proceeds of the loan are posted as collateral.  No new loans were issued during the three andnine months ended June 30, 2008 or June 30, 2007. The Companyreceived $51 and $301 of principal repayments during the nine months ended June 30,2008 and 2007, respectively.  The Companyrecognized interest income from all employee stock option loans of $118 and$354 for the three and nine months ended June 30, 2008, respectively, ascompared to $133 and $404 for the three and nine months ended June 30,2007, respectively.

 

*InvestmentAdvisory and Management and Administration Agreements*

 

TheCompany is externally managed by the Adviser, which is controlled by itschairman and chief executive officer, under a contractual investment advisoryagreement.  On October 1, 2006, theCompany entered into the investment advisory agreement (the “Advisory Agreement”).

 

*Termsof the Advisory Agreement*

 

Underthe Advisory Agreement, the Company pays the Adviser an annual base managementfee of 2% of its average gross assets, which is defined as total assets lesscash and cash equivalents pledged to creditors calculated as of the end of thetwo most recently completed fiscal quarters and also consists of a two-partincentive 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 in any calendar quarterin which its pre-incentive fee net investment income does not exceed the hurdlerate (7% annualized);

 

·             100% of pre-incentive fee net investment incomewith respect to that portion of such pre-incentive fee net investment income,if any, that exceeds the hurdle rate but is less than 2.1875% in any calendarquarter (8.75% annualized); and

 

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

 

24

----

Table of Contents

 

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 Advisory Agreement, as of the termination date) and equals20% of the Company’s realized capital gains as of the end of the fiscal year.In determining the capital gains incentive fee payable to the Adviser, theCompany calculates the cumulative aggregate realized capital gains andcumulative aggregate realized capital losses since the Company’s inception, andthe aggregate unrealized capital depreciation as of the date of thecalculation, as applicable, with respect to each of the investments in itsportfolio.

 

TheAdviser’s board of directors voluntarily and irrevocably waived, for the threemonths ended June 30, 2008 and June 30, 2007, the annual 2.0% basemanagement fee to 0.5% for senior syndicated loan participations and alsowaived the entire incentive fee due for the three months ended June 30,2008 and a portion of the incentive fee due for the three months ended June 30,2007.

 

Inaddition to the base management and incentive fees under the AdvisoryAgreement, certain fees received by the Adviser from the Company’s portfoliocompanies are credited against the investment advisory fee.  Effective April 1, 2007, 50% of certainof the fees received by the Adviser have been voluntarily and irrevocablycredited against the base management fee. In addition, the Company will continue to pay its direct expensesincluding, but not limited to, directors’ fees, legal and accounting fees,stockholder related expenses, and directors and officers insurance under theAdvisory Agreement.

 

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

 
| ** **                                                                                                  | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                  | ** ** | **June 30,   2008**    | ** ** | **June 30,   2007**   | ** ** | **June 30,   2008** | ** ** | **June 30,   2007** | ** ** |
| Base management fee                                                                                         |       | $                                | 529        |                            | $          | 847 |   | $ | 1,664 |   | $ | 1,997 |   |
| Credit for investment advisory fees received by  Adviser                                                    |       | (348                             | )          | (531                            | )          | (1,320 | ) | (1,617 | ) |
| Fee reduction for the voluntary, irrevocable waiver  of 2% fee on senior syndicated loans to 0.5% per annum |       | (97                              | )          | (259                            | )          | (299 | ) | (560 | ) |
| Net base management fee                                                                                     |       | $                                | 84         |                            | $          | 57 |   | $ | 45 |   | $ | (180 | ) |
|                                                                                                        |       |                             |       |                            |       |   |   |   |   |
| Incentive fee                                                                                               |       | $                                | 1,340      |                            | $          | 1,167 |   | $ | 4,089 |   | $ | 3,474 |   |
| Credit from voluntary, irrevocable waiver issued by  Adviser’s board of directors                      |       | (1,340                           | )          | (1,039                          | )          | (4,089 | ) | (2,696 | ) |
| Net incentive fee                                                                                           |       | $                                | —     |                            | $          | 128 |   | $ | — |   | $ | 778 |   |
|                                                                                                        |       |                             |       |                            |       |   |   |   |   |
| Credit for investment advisory fees received by  Adviser                                                    |       | $                                | (348       | )                               | $          | (531 | ) | $ | (1,320 | ) | $ | (1,617 | ) |
| Fee reduction for the voluntary, irrevocable waiver  of 2% fee on senior syndicated loans to 0.5% per annum |       | (97                              | )          | (259                            | )          | (299 | ) | (560 | ) |
| Incentive fee credit                                                                                        |       | (1,340                           | )          | (1,039                          | )          | (4,089 | ) | (2,696 | ) |
| Credit to base management and incentive fees from  Adviser                                                  |       | $                                | (1,785     | )                               | $          | (1,829 | ) | $ | (5,708 | ) | $ | (4,873 | ) |

 

Asof June 30, 2008, the Company owed $84 of base management fee to theAdviser, presented in the Fees due to Adviser in the accompanying consolidatedstatements of assets and liabilities. Overall, the base management fee due to the Adviser cannot exceed 2% oftotal assets (as reduced by cash and cash equivalents pledged to creditors)during any given fiscal year.

 

*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 treated as reductions directly againstthe 2% base management fee under the Advisory Agreement.  Effective in April 2006, the Adviser’sboard of directors voluntarily reduced the annual servicing fee rate on thesenior syndicated loans to 0.5%. For the three and nine months ended June 30,2008, these loan servicing fees totaled $1,598 and $4,541, respectively, ascompared to loan servicing fees for the three and nine months ended June 30,2007 of $898 and $2,377, respectively, all of which were deducted against the2% base management fee in order to derive the base management fee which ispresented as the line item base management fee in the accompanying consolidatedstatements of operations.  At June 30,2008, the Company owed $384 of unpaid loan servicing fees to the Adviser, whichare netted and recorded in Fees due to Adviser. At September 30, 2007, the Company owed $267 in loan servicing feesto the Adviser, recorded in Fees due to Adviser in the accompanyingconsolidated statements of assets and liabilities.  Under the Advisory Agreement, the Adviseralso provides managerial assistance and other services to the Company’sportfolio companies and may receive fees for services other than managerialassistance services.

 

25

----

Table of Contents

 

*AdministrationAgreement*

 

OnOctober 1, 2006, the Company entered into an administration agreement (the“Administration Agreement”) with Gladstone Administration, LLC (the “Administrator”),a wholly-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$285 and $737, respectively, for the three and nine months ended June 30,2008, as compared to an administration fee of $187 and $482, respectively, forthe three and nine months ended June 30, 2007. As of June 30, 2008and September 30, 2007, $285 and $237, respectively, was unpaid andincluded in the Fee due to Administrator in the accompanying consolidatedstatements of assets and liabilities.

 

*LicenseAgreement*

 

The Company has entered into a license agreement with the Adviser,pursuant to which the Adviser has granted the Company a non-exclusive licenseto use the name “Gladstone” and the Diamond G trademark. This license agreementrequired us to pay the Adviser a royalty fee of $1 per quarter through December 19,2007. The amount of the fee is negotiated on an annual basis by the Company’scompensation committee, and must be approved by a majority of the Company’sindependent directors. The fee was increased to $10 per quarter effective atthe beginning of the current contract term, which began on December 20,2007, and as a result of the last negotiation, the fee will remain at $10 forthe next contract term, which will begin on December 20, 2008. The licensearrangement will terminate in the event that Gladstone Management Corporationis no longer the Company’s Adviser.

 

NOTE5. LINE OF CREDIT

 

Through BusinessLoan, the Company has a $300 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 Commercial Paper (“CP”) rate which is equivalent tothe weighted average per annum rates paid by the DB Facility’s CP lenders inrespect of CP notes issued by the CP lender during such period.  Business Loan also has the ability to borrowat an alternative rate from the committed lenders if CP lenders are unable tofund advances.  The alternative rate isthe London Interbank Offered Rate (“LIBOR”), or if LIBOR is unavailable, thePrime Rate or the Federal Funds Rate, plus 1.0%.  In February 2008, the Company increasedthe DB Facility from $220 million to $250 million, and in April 2008,increased the DB Facility to $300 million and added Branch Banking and TrustCompany (“BB&T”) as a committed lender. In June 2008, the Company renewed the DB Facility, which matures onMay 21, 2009.  The fees incurred forthe above amendments are recorded in deferred financing fees in theaccompanying consolidated statements of assets and liabilities.

 

As of June 30,2008, the outstanding principal balance under the DB Facility was approximately$133.1 million at a stated interest rate of approximately 2.71%, plus a 2.50%program fee.  The Company is also chargedan unused commitment fee of 0.75% per annum. 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 June 30, 2008, the remaining borrowingcapacity available under the DB Facility was approximately $166.9 million.  The weighted average borrowings outstandingunder the DB Facility for the nine months ended June 30, 2008 and 2007were $138.6 million and $96.2 million, respectively, at a weighted averageannual interest cost of 6.6% and 6.8%, respectively, which was computed byusing the annual stated interest rate plus commitment and other fees, plus theamortization of deferred financing fees divided by the weighted average debtoutstanding.

 

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 alsorestricts some of the terms and provisions (including terms to maturity andpayments schedules).  As of June 30,2008, Business Loan was in compliance with all of the facility covenants.

 

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 Mellon as custodian.  Deutsche BankAG is also the trustee of the account and once a month remits the collectedfunds to the Company. At June 30, 2008 and September 30, 2007, theamount due from custodian was $6,637 and $3,230, respectively.

 

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 $250 million and 75%of equity issuances after May 2008 and maintain “asset coverage” withrespect to “senior securities representing indebtedness” of at least 

 

26

----

Table of Contents

 

200%, inaccordance with Section 18 of the 1940 Act.  As of June 30, 2008, the Company was incompliance 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 capinvolves risks 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.

 

In February 2004,the Company entered into an interest rate cap agreement with a notional amountof $35.0 million at a cost of $304.  Theinterest rate cap agreement’s current notional amount is $4.7 million and ithas a nominal fair market value which is recorded in other assets on theCompany’s consolidated balance sheet at June 30, 2008.  At September 30, 2007, the interest ratecap agreement had a nominal fair market value. 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 floatinginterest rate or cost of funds on a portion of the portfolio’s borrowings willbe capped at 5% when the LIBOR rate is in excess of 5%.  During the three and nine months ended June 30,2008, the Company recorded $0 and $6, as compared to $8 and $31 for the threeand nine months ended June 30, 2007, of income from the interest rate capagreement, recorded as a realized gain on the settlement of derivative on theCompany’s consolidated statements of operations.

 

NOTE7.  COMMON STOCK TRANSACTIONS

 

Transactionsin common stock were as follows:

 
| ** **                                     | ** ** | **Shares** | ** ** | **Total value** | ** ** |
|------------------------------------------------|------------|------------|------------|----------------------|------------|
| Balance at September 30, 2007             |       | 14,762,574 |       | $                    | 235,922    |   |
| Issuance of Common Stock Under Shelf Offerings |       | 6,325,000  |       | 105,380              |       |
| Balance at June 30, 2008                  |       | 21,087,574 |       | $                    | 341,302    |   |

 

On October 19,2007, the Company completed an offering of 2,500,000 shares of its commonstock, at a price of $18.70 per share, less an underwriter’s discount of $1.03per share, under a shelf registration statement on Form N-2 (File No. 333-143027),and pursuant to the terms set forth in a prospectus dated July 5, 2007 (the“Registration Statement”), as supplemented by a final prospectus supplementdated October 15, 2007. The underwriter exercised its over-allotmentoption and the Company closed on an additional 375,000 shares of common stockon November 19, 2007  Net proceedsof the offering, after deducting underwriting discounts and offering expensesborne by the Company, were approximately $50.5 million and were used to repay aportion of outstanding borrowings under the Company’s line of credit.

 

On February 5,2008, the Company completed an offering of 3,000,000 shares of common stock ata price of $17.00 per share, less an underwriting discount of $0.935 per share,under the Registration Statement and as supplemented by a final prospectussupplement dated January 30, 2008. On February 26, 2008, theunderwriter exercised its over-allotment option and the Company closed on anadditional 450,000 shares of common stock. Net proceeds of the offering, after deducting underwriting discounts andoffering expenses borne by the Company, were approximately $55.0 million andwere used to repay a portion of outstanding borrowings under the Company’s lineof credit.

 

NOTE8. NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS PER SHARE

 

Thefollowing table sets forth the computation of basic and diluted net increase innet assets per share resulting from operations per share for the three and ninemonths ended June 30, 2008 and 2007:

 
| ** **                                                                                                 | ** ** | **Three Months Ended June 30** | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2008**                                           | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Numerator for basic and diluted net increase  (decrease) in net assets resulting from operations per share |       | $                                                  | 2,809      |                                               | $          | 5,965 |   | $ | (7,194 | ) | $ | 14,213 |   |
|                                                                                                       |       |                                               |       |                                               |       |   |   |   |   |
| Denominator for basic and diluted shares                                                                   |       | 21,087,574                                         |       | 13,561,511                                         |       | 19,237,203 |   | 12,701,845 |   |
| Basic and diluted net increase (decrease) in net  assets resulting from operations per share               |       | $                                                  | 0.13       |                                               | $          | 0.44 |   | $ | (0.37 | ) | $ | 1.12 |   |

 

27

----

Table of Contents

 

NOTE9. DIVIDENDS

 

***Dividends and Distributions***

 

Thefollowing table lists the per share dividends paid for the nine months ended June 30,2008 and 2007:

 
| **Declaration Date** | ** ** | **Record Date**   | ** ** | **Payment Date**  | ** ** | **Dividend   per Share** | ** ** |
|---------------------------|------------|------------------------|------------|------------------------|------------|------------------------------------|------------|
| April 8, 2008        |       | June 20, 2008     |       | June 30, 2008     |       | $                                  | 0.14       |   |
| April 8, 2008        |       | May 21, 2008      |       | May 30, 2008      |       | $                                  | 0.14       |   |
| April 8, 2008        |       | April 22, 2008    |       | April 30, 2008    |       | $                                  | 0.14       |   |
| January 8, 2008      |       | March 21, 2008    |       | March 31, 2008    |       | $                                  | 0.14       |   |
| January 8, 2008      |       | February 21, 2008 |       | February 29, 2008 |       | $                                  | 0.14       |   |
| January 8, 2008      |       | January 23, 2008  |       | January 31, 2008  |       | $                                  | 0.14       |   |
| October 9, 2007      |       | December 20, 2007 |       | December 31, 2007 |       | $                                  | 0.14       |   |
| October 9, 2007      |       | November 21, 2007 |       | November 30, 2007 |       | $                                  | 0.14       |   |
| October 9, 2007      |       | October 23, 2007  |       | October 31, 2007  |       | $                                  | 0.14       |   |
|                      |       |                   |       | Total                  |       | $                                  | 1.26       |   |
|                      |       |                   |       |                   |       |                               |       |
| April 11, 2007       |       | June 21, 2007     |       | June 29, 2007     |       | $                                  | 0.14       |   |
| April 11, 2007       |       | May 22, 2007      |       | May 31, 2007      |       | $                                  | 0.14       |   |
| April 11, 2007       |       | April 20, 2007    |       | April 30, 2007    |       | $                                  | 0.14       |   |
| January 9, 2007      |       | March 22, 2007    |       | March 31, 2007    |       | $                                  | 0.14       |   |
| January 9, 2007      |       | February 20, 2007 |       | February 28, 2007 |       | $                                  | 0.14       |   |
| January 9, 2007      |       | January 23, 2007  |       | January 31, 2007  |       | $                                  | 0.14       |   |
| October 10, 2006     |       | December 20, 2006 |       | December 29, 2006 |       | $                                  | 0.14       |   |
| October 10, 2006     |       | November 21, 2006 |       | November 30, 2006 |       | $                                  | 0.14       |   |
| October 10, 2006     |       | October 23, 2006  |       | October 31, 2006  |       | $                                  | 0.14       |   |
|                      |       |                   |       | Total                  |       | $                                  | 1.26       |   |

 

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

 

***Section 19(a) Disclosure***

 

TheCompany’s Board of Directors estimates the source of the distributions at thetime of their declaration as required by Section 19(a) of the 1940Act.  On a monthly basis, if requiredunder Section 19(a), the Company posts a Section 19(a) noticethrough the Depository Trust Company’s Legal Notice System (“LENS”) and alsosends to its registered stockholders a written Section 19(a) noticealong with the payment of dividends for any payment which includes a dividendestimated to be paid from any other source other than net investmentincome.  The estimates of the sourceof the distribution are interim estimates based on GAAPthat are subject to revision, and the exact character of thedistributions for tax purposes cannot be determined until the final books andrecords of the Company are finalized for the calendar year.  Following the calendar year end, afterdefinitive information has been determined by the Company, if the Company hasmade distributions of taxable income (or return of capital), the Company willdeliver a Form 1099-DIV to its stockholders specifying such amount and thetax characterization of such amount. Therefore, these estimates are made solely in order to comply with therequirements of Section 19(a) of the 1940 Act and should not berelied upon for tax reporting or any other purposes and could differsignificantly from the actual character of distributions for tax purposes.

 

Thefollowing GAAP estimates were made by the Board of Directors during the quarterended June 30, 2008:

 
| **Month Ended** | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Dividend** | ** ** |
|----------------------|------------|--------------------------|------------|---------------------------------|------------|-------------------------|------------|
| June 30, 2008   |       | $                        | 0.125      |                            | $          | 0.015                   |       | $ | 0.140 |   |
| May 31, 2008    |       | 0.121                    |       | 0.019                           |       | 0.140                   |       |
| April 30, 2008  |       | 0.120                    |       | 0.020                           |       | 0.140                   |       |
|                      |            |                          |            |                                 |            |                         |            |  |  |  |

 

28

----

Table of Contents

 

Becausethe Board of Directors declares dividends at the beginning of a quarter, it isdifficult to estimate how much of the Company’s monthly dividends anddistributions, based on GAAP, will come from ordinary income, capital gains,and returns of capital.  Subsequent tothe quarter ended June 30, 2008, the following corrections were made tothe above listed estimates for that quarter:

 
| **Month Ended** | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Dividend** | ** ** |
|----------------------|------------|--------------------------|------------|---------------------------------|------------|-------------------------|------------|
| June 30, 2008   |       | $                        | 0.086      |                            | $          | 0.054                   |       | $ | 0.140 |   |
| May 31, 2008    |       | 0.105                    |       | 0.035                           |       | 0.140                   |       |
| April 30, 2008  |       | 0.127                    |       | 0.013                           |       | 0.140                   |       |
|                      |            |                          |            |                                 |            |                         |            |  |  |  |

 

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

 
| **Month Ended**    | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Dividend** |   |
|-------------------------|------------|--------------------------|------------|---------------------------------|------------|-------------------------|--------|
| September 30, 2008 |       | $                        | 0.114      |                            | $          | 0.026                   |   | $ | 0.140 |   |
| August 31, 2008    |       | 0.118                    |       | 0.022                           |       | 0.140                   |   |
| July 31, 2008      |       | 0.112                    |       | 0.028                           |       | 0.140                   |   |
|                         |            |                          |            |                                 |            |                         |        |  |  |  |

 

NOTE10. COMMITMENT AND CONTINGENCIES

 

Asof June 30, 2008, the Company was a party to signed and non-binding termsheets for two loan originations for an aggregate of $26 million and, as of August 4,2008, funded one of those originations (see further discussion in footnote 11.Subsequent Events).  The Company expectsto fund the other potential investment within the next 12 months.  All prospective investments are subject to,among other things, the satisfactory completion of the Company’s due diligenceinvestigation of each borrower, acceptance of terms and structure and receiptof necessary consents. With respect to each prospective loan, the Company willonly agree to provide the loan if, among other things, the results of its duediligence investigations are satisfactory, the terms and conditions of the loanare acceptable and all necessary consents are received. The Company hasinitiated its due diligence investigations of the potential borrowers, howeverthere can be no guarantee that facts will not be discovered in the course ofcompleting the due diligence that would render a particular investmentimprudent or that any of these investments will actually be made.

 

NOTE11. SUBSEQUENT EVENTS

 

*Dividends*

 

In July 2008, the Company’s Board of Directors declared thefollowing monthly cash dividends:

 
| **Declaration Date** | ** ** | **Record Date**    | ** ** | **Payment Date**   | ** ** | **Dividend per   Share** | ** ** |
|---------------------------|------------|-------------------------|------------|-------------------------|------------|------------------------------------|------------|
| July 9, 2008         |       | September 22, 2008 |       | September 30, 2008 |       | $                                  | 0.14       |   |
| July 9, 2008         |       | August 21, 2008    |       | August 29, 2008    |       | $                                  | 0.14       |   |
| July 9, 2008         |       | July 23, 2008      |       | July 31, 2008      |       | $                                  | 0.14       |   |

 

*Investment Activity*

 

Subsequent to June 30, 2008, the Company funded oneinvestment for an aggregate of $13.1 million and also approximately $3.0million of revolver draws and additional investments to existing portfoliocompanies.  The Company also receivedapproximately $8.7 million of scheduled and unscheduled loan repayments.

 

On July 2, 2008, the Company acquired certain assets ofLocalTel, Inc., consisting generally of all fixtures and all tangible andintangible personal property.  TheCompany acquired these assets from the previous owner, through a newly formedsubsidiary, and intends to continue the business of LocalTel, Inc. underits control.

 

*Employee loans*

 

As noted in Note 4. Related Party Transactions – Loans toEmployees, the Company provided loans to joint employees of the Company andeither the Adviser, or the Company’s previous investment adviser,Gladstone Capital Advisers, Inc., for the exercise of options under the 2001 Plan, which plan is nolonger in effect.  The loans were fullycollateralized at issuance by pledged shares of the Company’s commonstock.  Subsequent to June 30, 2008,the Company’s share price fell below the exercise price of the sharescollateralizing the loans.  The Companytook prompt steps to increase the collateral on the loans, and obtainedborrower assurances to provide additional collateral in amounts sufficient tocollateralize the loans fully or to pay down the principal balance of the loans.

 

*Renewal of Advisory Agreement*

 

On July 9, 2008, the Company’s Board of Directors approved therenewal of the Advisory Agreement with the Adviser and its AdministrationAgreement with the Administrator through August 31, 2009.

 

29

----

Table of Contents

 

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

 

**All statements containedherein, other than historical facts, may constitute “forward-lookingstatements.” These statements may relate to, among other things, future eventsor our future performance or financial condition. In some cases, you canidentify forward-looking statements by terminology such as “may,” “might,” “believe,”“will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,”“expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” orthe negative of such terms or comparable terminology. These forward-lookingstatements involve known and unknown risks, uncertainties and other factorsthat may cause our actual results, levels of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by suchforward-looking statements. We caution readers not to place undue reliance onany such forward-looking statements. We undertake no obligation to publiclyupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise, after the date of this Form 10-Q**.

 

*The following analysis of our financialcondition and results of operations should be read in conjunction with ourconsolidated financial statements and the notes thereto contained elsewhere inthis report and our annual report on Form 10-K for the fiscal yearended September 30, 2007**.*

 

**OVERVIEW**

 

During the ninemonths ended June 30, 2008, we extended, directly or throughparticipations, $107.4 million of new loan originations, including a commonequity warrant, to 9 new portfolio companies and $30.1 million of investmentsto existing portfolio companies through revolver draws or the additions of newterm notes, for total new investments of $137.5 million. During the nine monthsended June 30, 2008, 3 borrowers made payments in full ahead ofcontractual maturity of $25.0 million, 2 borrowers made unscheduled partialpayoffs of $3.6 million, and we experienced contractual amortization, revolverrepayments and some principal payments received ahead of schedule of $19.2million, for total principal repayments of $47.8 million.  Since our initial public offering in August 2001,we have made 249 different loans to, or investments in, 129 companies for atotal of approximately $891.5 million, before giving effect to principalrepayments on investments and divestitures.

 

**RecentAccounting Pronouncements**

 

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 is effective as of the beginning of an entity’sfirst fiscal year that begins after December 15, 2006. We adopted thisInterpretation on October 1, 2007. The adoption did not have a materialimpact 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 formeasuring fair value in accordance with GAAP, and expands disclosures aboutfair value measurements.  SFAS No. 157applies broadly 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, 2008and are currently evaluating the impact of this pronouncement on theconsolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, *“The Fair Value Option for Financial Assets and FinancialLiabilities — Including an Amendment of FASB Statement No. 115,”*which is effective for fiscal years beginning after November 15, 2007.This pronouncement permits an entity to choose to measure many financialinstruments and certain other items at fair value at specified election dates.Subsequent unrealized gains and losses on items for which the fair value optionhas been elected will be reported in earnings. We will be required to adoptSFAS No. 159 on October 1, 2008 and are currently evaluating thepotential impact of this pronouncement on the consolidated financialstatements.

 

In November 2007, the SEC issued Staff Accounting Bulletin No. 109,*“Written Loan Commitments Recorded at Fair ValueThrough Earnings”* (“SAB 109”)*.* SAB 109provides guidance on the accounting for written loan commitments recorded atfair value under GAAP. Specifically, SAB 109 revises the Staff’s views onincorporating expected net future cash flows related to loan servicingactivities in the fair value measurement of a written loan commitment. SAB 109, which supersedes SAB 105,  “*Application of Accounting Principles to LoanCommitments,”* requires the expected net futurecash flows related to the associated servicing of the loan beincluded in the measurement of all written loan commitments that are accountingfor at fair value through earnings. SAB 109 is effective in fiscal quartersbeginning after December 15, 2007. We have evaluated the implications of SAB 109 and determined that thereis no material impact on the consolidated financial statements.

 

30

----

Table of Contents

 

In December 2007,the FASB issued SFAS No. 141(R) *“Business Combinations”*(“SFAS No. 141(R)”). SFAS No. 141(R) establishes principles andrequirements for how an acquirer recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, anynoncontrolling interest in the acquiree and the goodwill acquired. SFAS No. 141(R) alsoestablishes disclosure requirements to enable the evaluation of the nature andfinancial effects of the business combination. SFAS No. 141(R) iseffective as of the beginning of an entity’s fiscal year that begins after December 15,2008.  We will be required to adopt SFAS No. 141(R) onOctober 1, 2009 and are currently evaluating the impact of thispronouncement on the consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, “*Disclosures about Derivative Instruments and Hedging Activities*”(“SFAS No. 161”), which is intended to help investors better understandhow derivative instruments and hedging activities affect an entity’s financialposition, financial performance and cash flows through enhanced disclosurerequirements.  The enhanced disclosuresprimarily surround disclosing the objectives and strategies for usingderivative instruments by their underlying risk as well as a tabular format ofthe fair values of the derivative instruments and their gains and losses.  SFAS No. 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008.  We are evaluating the impact ofthis pronouncement on the reporting of our derivatives.

 

**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.  We have identified ourinvestment valuation process as our most critical accounting policy.

 

***Investment Valuation***

 

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

 

*GeneralValuation Policy:*  Wevalue our investments in accordance with the requirements of the 1940 Act.  As discussed more fully below, we valuesecurities for which market quotations are readily available at their market value.  We value all other securities and assets atfair value as determined in good faith by our Board of Directors.

 

We use generallyaccepted valuation techniques to value our portfolio unless we have specificinformation about the value of an investment to determine otherwise. From timeto time we may accept an appraisal of a business in which we hold securities.These appraisals are expensive and occur infrequently but provide a third-partyvaluation opinion that may differ in results, techniques and scopes used tovalue our investments.  When thesespecific third-party appraisals are engaged or accepted, we would use suchappraisals to value the investment we have in that business if we determinedthat the appraisals were the best estimate of fair value.

 

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

 

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

 

·                  Publicly-tradedsecurities;

·                  Securities forwhich a limited market exists; and

·                  Securities forwhich no market exists.

 

*ValuationMethods:*

 

**Publicly-tradedsecurities:** We determine the value of publicly-tradedsecurities based on the closing price for the security on the exchange orsecurities market on which it is listed and primarily traded on the valuationdate. To the extent that we own restricted securities that are not freelytradable, but for which a public market otherwise exists, we will use themarket value of that security adjusted for any decrease in value resulting fromthe restrictive feature.

 

**Securitiesfor which a limited market exists:**We value securities thatare not traded on an established secondary securities market, but for which alimited market for the security exists, such as certain participations in, orassignments of, syndicated loans, at the quoted bid price.  Firm bid prices are requested; however, if afirm bid price is unavailable, we base the value of the security upon theindicative bid price offered by the respective originating syndication agent’strading desk, or secondary desk, on or near the valuation 

 

31

----

Table of Contents

 

date.  To the extent that we use the indicative bidprice as a basis for valuing the security, our Adviser may take further stepsto consider additional information to validate that price in accordance with thepolicy.

 

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

 

(1)          **Portfolioinvestments comprised solely of debt securities:** Debt securitiesthat are not publicly traded on an established securities market, or for whicha limited market does not exist (“Non-Public Debt Securities”), and that areissued by portfolio companies where we have no equity, or equity-likesecurities, are fair valued in accordance with the terms of the policy, whichutilizes opinions of value submitted to us by Standard & Poor’sSecurities Evaluations, Inc. (“SPSE”). We may also submit paid in kind (“PIK”)interest to SPSE for their evaluation when it is determined the PIK interest islikely to be received.

 

In the case of Non-Public Debt Securities, we haveengaged SPSE to submit opinions of value for our debt securities that areissued by portfolio companies in which we own no equity, or equity-likesecurities.  SPSE’s opinions of value arebased on the valuations prepared by our portfolio management team as describedbelow.  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. SPSEwill only evaluate the debt portion of our investments for which wespecifically request evaluation, and may decline to make requested evaluationsfor any reason at its sole discretion. Upon completing our collection of datawith respect to the investments (which may include the information describedbelow under “Credit Information,” the risk ratings of the loans described belowunder “Loan Grading and Risk Rating” and the factors described hereunder), thisvaluation data is forwarded to SPSE for review and analysis. SPSE makes itsindependent assessment of the data that we have assembled and assesses itsindependent data to form an opinion as to what they consider to be the marketvalues for the securities. With regard to its work, SPSE has issued thefollowing paragraph:

 

SPSE provides evaluated price opinions which arereflective of what SPSE believes the bid side of the market would be for eachloan after careful review and analysis of descriptive, market and creditinformation. Each price reflects SPSE’s best judgment based upon carefulexamination of a variety of market factors. Because of fluctuation in themarket and in other factors beyond its control, SPSE cannot guarantee theseevaluations. The evaluations reflect the market prices, or estimates thereof,on the date specified. The prices are based on comparable market prices forsimilar securities. Market information has been obtained from reputablesecondary market sources. Although these sources are considered reliable, SPSEcannot guarantee their accuracy.

 

SPSE opinions of value of our debt securities that areissued by portfolio companies where we have no equity, or equity-likesecurities are submitted to our Board of Directors along with our Adviser’ssupplemental assessment and recommendation regarding valuation of each of theseinvestments. Our Adviser generally accepts the opinion of value given by SPSE,however, in certain limited circumstances, such as when our Adviser may learnnew information regarding an investment between the time of submission to SPSEand the 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 to accept or reject the recommendedvaluation of our investment portfolio. Our Adviser and our managementrecommended, and the Board of Directors voted to accept, the opinions of valuedelivered by SPSE on the loans in our portfolio as denoted on the Schedule ofInvestments as of June 30, 2008 included in our accompanying consolidatedfinancial statements.

 

Because there is a delay between when we close aninvestment and when the investment can be evaluated by SPSE, new loans are notvalued immediately by SPSE; rather, management makes its own determinationabout the value of these investments in accordance with our valuation policyusing the methods described herein.

 

(2)          **Portfolioinvestments in controlled companies comprised of a bundle of investments, whichcan include debt and equity securities:** We value Non-Public DebtSecurities and equity or equity-like securities (e.g. preferred equity, equity,or other equity-like securities) that are purchased together from the same “controlled”portfolio company, or issuer, as part of a package based on the totalenterprise value of the issuer, which is calculated using a liquidity waterfallapproach.  Under this approach, we firstcalculate the total enterprise value of the issuer by incorporating some or allof the following factors:

 

·                  the issuer’sability to make payments;

·                  the earnings ofthe issuer;

·                  recent sales tothird parties of similar securities;

·                  the comparisonto publicly traded securities; and

·                  discounted cashflow or other pertinent factors.

 

32

----

Table of Contents

 

In gathering the sales to third parties of similarsecurities, we may reference industry statistics and use outside experts. Oncewe have estimated the total enterprise value of the issuer, we subtract thevalue of all the debt securities of the issuer; which are valued at thecontractual principal balance. Fair values of these debt securities arediscounted for any shortfall of total enterprise value over the total debtoutstanding for the issuer. Once the values for all outstanding seniorsecurities (which include the debt securities) have been subtracted from thetotal enterprise value of the issuer, the remaining amount, if any, is used todetermine the value of the issuer’s equity or equity like securities.

 

(3)          **Portfolioinvestments in non-controlled companies comprised of a bundle of investments,which can include debt and equity securities:**We value Non-PublicDebt Securities and equity or equity-like securities that are purchasedtogether from the same “non-controlled” portfolio company, or issuer, byvaluing the debt portion with SPSE (as described above) and valuing the equityportion based on the total enterprise value of the issuer, which is calculatedusing a liquidity waterfall approach as described above.

 

Due to the uncertainty inherent in the valuationprocess, such estimates of fair value may differ significantly from the valuesthat would have been obtained had a ready market for the securities existed,and the differences could be material. Additionally, changes in the marketenvironment and other events that may occur over the life of the investmentsmay cause the gains or losses ultimately realized on these investments to bedifferent than the valuations currently assigned. There is no single standardfor determining fair value in good faith, as fair value depends uponcircumstances of each individual case. In general, fair value is the amountthat we might reasonably expect to receive upon the current sale of thesecurity in an arms-length transaction in the security’s principal market.

 

*ValuationConsiderations: *Fromtime to time, depending on certain circumstances, the Adviser may use thefollowing valuation considerations, including but not limited to:

 

·                  the risk rating of thesecurity (see “Loan Grading and Risk Rating”);

·                  the principal balance orcost basis and the type of the security;

·                  the nature and realizablevalue of the collateral;

·                  the portfolio company’sability to make payments and discounted cash flow;

·                  reports from portfoliocompany senior management and board meetings;

·                  reported values of similar securities of theportfolio company or comparable companies;

·                  changes in the economy affecting the portfoliocompany; and

·                  other third-party appraisals of the portfoliocompanies.

 

*CreditInformation:*  OurAdviser monitors a wide variety of key credit statistics that provideinformation regarding our portfolio companies to help us assess credit qualityand portfolio performance. We and our Adviser participate in the periodic boardmeetings of our portfolio companies in which we hold control and affiliateinvestments and also require them to provide annual audited and monthlyunaudited financial statements. Using these statements or comparable informationand board discussions, our Adviser calculates and evaluates the creditstatistics.

 

*LoanGrading and Risk Rating:* As part of our valuation procedures above, we risk rate all of ourinvestments in debt securities. For syndicated loans that have been rated by aNRSRO (as defined in Rule 2a-7 under the 1940 Act), we use the NRSRO’srisk rating for such security. For all other debt securities, we use aproprietary risk rating system. Our risk rating system uses a scale of 0 to 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 debtsecurities for which we do not use a third-party NRSRO risk rating, we seek tohave our risk rating system mirror the risk rating systems of major risk ratingorganizations, such as those provided by 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 theNRSRO set out below is accurate. We believe our risk rating would besignificantly higher than a typical NRSRO risk rating because the risk ratingof the typical NRSRO is designed for larger businesses. However, our riskrating has been designed to risk rate the securities of smaller businesses thatare not rated by a typical NRSRO. Therefore, when we use our risk rating onlarger business securities, the risk rating is higher than a typical NRSROrating. The primary difference between our risk rating and the rating of atypical NRSRO is that our risk rating uses more quantitative determinants andincludes qualitative determinants that we believe are not used in the NRSROrating. It is our understanding that most debt securities of medium-sizedcompanies do not exceed the grade of BBB on a NRSRO scale, so there would be nodebt securities in the middle market that would 

 

33

----

Table of Contents

 

meet thedefinition of AAA, AA or A. Therefore, our scale begins with the designation 10as the best risk rating which may be equivalent to a BBB from a NRSRO, however,no assurance can be given that a 10 on our scale is equal to a BBB on a NRSROscale.

 
| **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%                                |       |

 

----

(a)*                                  Thedefault rates set forth are for a ten year term debt security. If a debtsecurity is less than ten years, then the probability of default is adjusted toa lower percentage for the shorter period, which may move the security higheron our risk rating scale.*

 

The above scalegives an indication of the probability of default and the magnitude of the lossif there is a default. Our policy is to stop accruing interest on an investmentif we determine that interest is no longer collectible. At June 30, 2008three investments were on non-accrual and at September 30, 2007, oneinvestment was on non-accrual. Additionally, we do not risk rate our equity securities.

 

The followingtable lists the risk ratings for all non-syndicated loans in our portfolio at June 30,2008 and September 30, 2007, representing approximately 82% and 79%,respectively, of all loans in our portfolio at the end of each period:

 
| **Rating**       | ** ** | **June 30, 2008** | ** ** | **Sept. 30, 2007** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **7.3**                     | ** ** | **7.3**                      | ** ** |
| Weighted Average | ** ** | **7.1**                     | ** ** | **7.1**                      | ** ** |
| Highest          | ** ** | **10.0**                    | ** ** | **9.0**                      | ** ** |
| Lowest           | ** ** | **5.0**                     | ** ** | **4.0**                      | ** ** |

 

The followingtable lists the risk ratings for syndicated loans in our portfolio that werenot rated by an NRSRO at June 30, 2008 and September 30, 2007,representing approximately 4% of all loans in our portfolio at the end of eachperiod:

 
| **Rating**       | ** ** | **June 30, 2008** | ** ** | **Sept. 30, 2007** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **6.5**                     | ** ** | **6.0**                      | ** ** |
| Weighted Average | ** ** | **6.4**                     | ** ** | **6.0**                      | ** ** |
| Highest          | ** ** | **7.0**                     | ** ** | **6.0**                      | ** ** |
| Lowest           | ** ** | **6.0**                     | ** ** | **6.0**                      | ** ** |

 

For syndicatedloans that are currently rated by a NRSRO, we risk rate such loans inaccordance with the risk rating systems of major risk rating organizations,such as those provided by a NRSRO. The following table lists the risk ratingsfor all syndicated loans in our portfolio that were rated by an NRSRO at June 30,2008 and September 30, 2007, representing approximately 13% and 17%,respectively, of all loans in our portfolio at the end of each period:

 
| **Rating**       | ** ** | **June 30, 2008** | ** ** | **Sept.30, 2007** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------|------------|
| Average          |       | CCC+/Caa1                   |       | CCC+/Caa1              |       |
| Weighted Average |       | CCC+/Caa1                   |       | CCC+/Caa1              |       |
| Highest          |       | BB/Ba3                      |       | B/B3                   |       |
| Lowest           |       | CCC/Caa2                    |       | CCC/Caa2               |       |

 

34

----

Table of Contents

 

***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% ofour investment 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 to the sum of (1) 98%of our ordinary income for the calendar year, (2) 98% of our capital gainsin excess of capital losses for the one-year period ending on October 31of the calendar year and (3) any ordinary income and net capital gains forpreceding years that were not distributed during such years.

 

***Revenue Recognition***

 

*Interest Income Recognition*

 

Interest income 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*

 

We may hold loansin our portfolio which contain a PIK interest provision. The PIK interest,computed at the contractual rate specified in each loan agreement, is added tothe principal balance of the loan and recorded as interest income. To maintainour status as a RIC, this non-cash source of income must be paid out tostockholders in the form of dividends, even though we have not yet collectedthe cash.

 

*Services Provided to Portfolio Companies*

 

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

 

Our Adviser receives fees for the other services it provides to ourportfolio companies.  These other feesare typically non-recurring, are recognized as revenue when earned and aregenerally paid directly to our Adviser by the borrower or potential borrowerupon the closing of the investment. The services our Adviser provides to ourportfolio companies vary by investment, but generally include a broad array ofservices such as investment banking services, arranging bank and equityfinancing, structuring financing from multiple lenders and investors, reviewingexisting credit facilities, restructuring existing investments, raising equityand debt capital, turnaround management, merger and acquisition services andrecruiting new management personnel. Effective April 1, 2007, when our Adviser receives fees for theseservices, 50% of certain of those fees are voluntarily and irrevocably creditedagainst the base management fee that we pay to our Adviser, whereas prior tosuch date fees were 100% credited.  Anyservices of this nature subsequent to the closing would typically generate aseparate fee at the time of completion.

 

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

 

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

 

35

----

Table of Contents

 

**RESULTS OF OPERATIONS(dollar amounts in thousands, unless otherwise indicated)**

 

***Comparisonof the Three Months Ended June 30, 2008 to the Three Months Ended June 30,2007***

 

**Investment Income**

 

Investment incomefor the three months ended June 30, 2008 was $11,420, as compared to$9,201 for the three months ended June 30, 2007.

 

Interest incomefrom our investments in debt securities of private companies was $11,236 forthe three months ended June 30, 2008, as compared to $8,912 for the threemonths ended June 30, 2007.  Thelevel of interest income from investments is directly related to the balance,at cost, of the interest-bearing investment portfolio outstanding during theperiod multiplied by the weighted average yield.  The weighted average yield varies from periodto period based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.  Interest income from our investments increased$2.3 million, or 26%, during the three months ended June 30, 2008 comparedto the prior year period based on the overall growth in the cost basis of ourinvestments.  The success fees during thethree months ended June 30, 2008 and 2007 were $500 and $515,respectively.  The success fee for thethree months ended June 30, 2008 resulted from a refinancing by DefianceAcquisition Corp, while the success fee for the three months ended June 30,2007 resulted from a full repayment by Allied Extruders LLC and SCPH Holdings.

 

·                  Theinterest-bearing investment portfolio had an average cost basis ofapproximately $440.2 million for the three months ended June 30, 2008, ascompared to an average cost basis of $325.7 million for the three months ended June 30,2007.  The following table lists theinterest income from investments for the five largest portfolio companiesduring the respective periods:

 
| **Three months ended June 30, 2008** | ** ** | **Three months ended June 30, 2007** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **Company**                                                   | ** ** | **Interest   Income**                                    | ** ** | **% of   Total** | ** ** | **Company** | ** ** | **Interest   Income** | ** ** | **% of   Total** | ** ** |
| Reliable Biopharma                                            |       | $                                                             | 758        |   | 6.7 | % | Allied Extruders |   | $ | 566 |   | 6.4 | % |
| Sunshine Media                                                |       | 693                                                           |       | 6.2 | % | Clinton Aluminum |   | 493 |   | 5.5 | % |
| Defiance Acquisition                                          |       | 674                                                           |       | 6.0 | % | Westlake Hardware |   | 477 |   | 5.4 | % |
| Westlake Hardware                                             |       | 521                                                           |       | 4.6 | % | Sunshine Media |   | 377 |   | 4.2 | % |
| Clinton Aluminum                                              |       | 470                                                           |       | 4.2 | % | Specialty Coatings |   | 315 |   | 3.5 | % |
| **Subtotal**                                                  | ** ** | **$**                                                         | **3,116**  | ** ** | **27.7** | **%** | **Subtotal** | ** ** | **$** | **2,228** | ** ** | **25.0** | **%** |
| Other companies                                               |       | 8,120                                                         |       | 72.3 | % | Other companies |   | 6,684 |   | 75.0 | % |
| **Total interest income**                                     | ** ** | **$**                                                         | **11,236** | ** ** | **100.0** | **%** | **Total interest income** | ** ** | **$** | **8,912** | ** ** | **100.0** | **%** |

 

·                  The annualizedweighted average yield on our portfolio, excluding cash and cash equivalents,for the three months ended June 30, 2008 was 10.1%, compared to 11.8% forthe three months ended June 30, 2007. The weighted average yields were not materially impacted by the PIKinterest, which were $16 and $0 for the three months ended June 30, 2008and 2007, respectively.  The decrease inthe annualized weighted average yield primarily resulted from a reduction inthe average LIBOR, which was 2.7% for the three months ended June 30,2008, compared to 5.3% in the prior year period, as well as three investmentsbeing on non-accrual during the three months ended June 30, 2008(LocalTel, West Cost Yellow Pages, and U.S. Healthcare) and none in the prioryear period.

 

Interest incomefrom invested cash and cash equivalents for the three months ended June 30,2008 was $38, as compared to $109 for the three months ended June 30,2007. Interest income decreased from the prior year due to the amount of cashthat was held in interest bearing accounts and the interest earned on ourcustodial account prior to disbursement.

 

Interest incomefrom loans to our employees, in connection with the exercise of employee stockoptions, for the three months ended June 30, 2008 and June 30, 2007,was $118 and $133, respectively.  Thedecrease is due to the cancellation of one employee loan during the fourthquarter of the prior fiscal year, and repayment of another employee loan in thesecond quarter of this fiscal year.

 

Prepayment feesand other income for the three months ended June 30, 2008 was $28, ascompared to $47 for the three months ended June 30, 2007.  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 was based on a percentage of theoutstanding principal amount of the loan at the date of prepayment.

 

**OperatingExpenses**

 

Operatingexpenses, net of credits from the Adviser for fees earned and voluntary andirrevocable waivers to the base management and incentive fees, were $4,723 forthe three months ended June 30, 2008, as compared to $3,496 for the threemonths ended June 30, 

 

36

----

Table of Contents

 

2007. Operatingexpenses for the three months ended June 30, 2008 reflected a significantincrease in loan servicing fees and amortization of deferred financing feesincurred in connection with certain amendments to our credit facility withDeutsche Bank AG.

 

Interest expensefor the three months ended June 30, 2008 was $1,771, as compared to $1,762for the three months ended June 30, 2007. This increase is primarily a result of increased borrowings under ourline of credit during the three months ended June 30, 2008, whichborrowings were partially used to finance our increased investments.

 

Loan servicing feesfor the three months ended June 30, 2008 were $1,598, as compared to $898for the three months ended June 30, 2007. These fees were incurred in connection with a loan servicing agreementbetween Business Loan and our Adviser, which is based on the size and mix ofthe portfolio.  The average size of ourinvestment portfolio, excluding equity investments and control investments, wasapproximately $408.1 million for the three months ended June 30, 2008 ascompared to approximately $322.6 million for the three months ended June 30,2007.  In terms of portfolio mix, seniorsyndicated loans comprised 6.4% and 11.1% of the portfolio during the threemonths ended June 30, 2008 and 2007, respectively.  Due to voluntary, irrevocable waivers inplace during these periods, senior syndicated loans incurred a 0.5% annual feewhereas proprietary loans incurred a 1.5% annual fee.  These fees were reduced against the amount ofthe base management fee due to our Adviser.

 

Base managementfee for the three months ended June 30, 2008 was $529, as compared to $847for the three months ended June 30, 2007. The base management fee is computed quarterly as described under *“Investment Advisory and Management Agreement”* in footnote4, and is summarized in the table below:

 
| ** **                                                                                            | ** ** | **Three months ended** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                            | ** ** | **June 30, 2008**      | ** ** | **June 30, 2007** | ** ** |
| Base management fee                                                                                   |       | $                                | 529        |   | $ | 847 |   |
| Credit for investment advisory fees received by  Adviser (1)                                          |       | (348                             | )          | (531 | ) |
| Fee reduction for the voluntary, irrevocable waiver  of 2% fee on senior syndicated loans to 0.5% (2) |       | (97                              | )          | (259 | ) |
| Net base management fee                                                                               |       | $                                | 84         |   | $ | 57 |   |

 

----

(1)   EffectiveApril 1, 2007, the board of our Adviser reduced the amount of voluntaryirrevocable credit for investment advisory fees received by our Adviser from100% of the fees received to 50% of the fees received.  Therefore, the three months ended June 30,2008 and 2007 reflect the reduced credit for fees received by our Adviser.

 

(2)   Theboard of our Adviser voluntarily and irrevocably waived, for the three monthsended June 30, 2008 and 2007, the annual 2.0% base management fee to 0.5%for senior syndicated loan participations.

 

Incentive fee forthe three months ended June 30, 2008 was $1,340, as compared to $1,167 forthe three months ended June 30, 2007. The board of our Adviser waived the entire incentive fee for the threemonths ended June 30, 2008 and a portion of the incentive fee due for thethree months ended June 30, 2007. The incentive fees and associated credits are summarized in the tablebelow:

 
| ** **                                                                             | ** ** | **Three months ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                             | ** ** | **June 30, 2008**      | ** ** | **June 30, 2007** | ** ** |
| Incentive fee                                                                          |       | $                                | 1,340      |   | $ | 1,167 |   |
| Credit from voluntary, irrevocable waiver issued by  Adviser’s board of directors |       | (1,340                           | )          | (1,039 | ) |
| Net incentive fee                                                                      |       | $                                | —     |   | $ | 128 |   |

 

Administrationfee for the three months ended June 30, 2008 was $285 as compared to $187for the three months ended June 30, 2007. The increase is due to theaddition of administration staff and related expenses.

 

Professional fees,consisting primarily of legal and audit fees, for the three months ended June 30,2008 were $167, as compared to $149 for the three months ended June 30,2007.  The increase is due to therecording of audit accruals and non reimbursable legal fees.

 

Amortization ofdeferred financing fees, in connection with our line of credit, was $572 forthe three months ended June 30, 2008, as compared to $72 for the threemonths ended June 30, 2007.  Theincrease is due to the amortization of additional fees incurred with our lineof credit.  In February 2008, weincreased the DB Facility from $220 million to $250 million, and in April 2008,increased the DB Facility to $300 million and added Branch Banking and TrustCompany (“BB&T”) as a committed lender. In June 2008, we renewed the DB Facility.  The fees incurred for the above amendmentsare recorded in deferred financing fees on our consolidated statement of assetsand liabilities, and amortized over the life of the DB Facility.

 

37

----

Table of Contents

 

Stockholderrelated costs for the three months ended June 30, 2008 were $34, ascompared to $39 for the three months ended June 30, 2007.  Stockholder related costs include suchrecurring items as transfer agent fees, NASDAQ listing fees, costs associatedwith SEC filings, and the annual report printing and distribution costs.

 

Directors’ feesfor the three months ended June 30, 2008 and 2007 were $52 and $56respectively, and consisted of amortization of their annual stipend and meetingstipends.

 

Insurance expensefor the three months ended June 30, 2008 was $57, as compared to $66 forthe three months ended June 30, 2007. The decrease was primarily theresult of a decrease of our directors and officers insurance policy premiums.

 

Other expenses forthe three months ended June 30, 2008 were $103, as compared to $82 for thethree months ended June 30, 2007. 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.  The increase is primarily due to the increasein direct expenses as the overall size of our investment portfolio continued togrow from the prior year period.

 

**NetRealized Loss on Sale of Investments**

 

During the threemonths ended June 30, 2008, we realized a net loss of $86 from the payoffof two loans (in particular the unamortized investment acquisition costsrelated to the Anitox and Macfadden loans), as compared to a realized net lossof $5 from the sale or repayment of eleven syndicated loan investments in thethree months ended June 30, 2007.

 

**RealizedGain on Settlement of Derivative**

 

During the threemonths ended June 30, 2008, we did not receive any interest rate capagreement payments.  During the threemonths ended June 30, 2007, we received interest rate cap agreementpayments of $8 as a result of the one month LIBOR having an increasingtrend.  We receive payments when the onemonth LIBOR is over 5%.

 

**NetUnrealized Depreciation on Derivative**

 

During the threemonth periods ended June 30, 2008 and June 30, 2007, we recordednominal amounts of net unrealized depreciation due to a decrease in the fairmarket value of our interest rate cap agreement.

 

**NetUnrealized (Depreciation) Appreciation on Investments**

 

For the threemonths ended June 30, 2008, we recorded net unrealized depreciation oninvestments of $3,802, as compared to net unrealized appreciation of $257, forthe three months ended June 30, 2007. The unrealized depreciation is mainly attributable to the decrease infair value on our portfolio, most notably in the following investments:  Reliable Biopharmaceutical, WestlakeHardware, SCI Cable, Sunshine Media, and Greatwide Logistics Services.  We believe that our investment portfolio wasvalued at a depreciated value due primarily to the general instability of theloan markets and, to a lesser extent, the use of a modified valuation procedurefor our non-control/non-affiliate investments, which was implemented during thequarter ended June 30, 2008. Previously, we valued the debt portion of bundled debt and equityinvestments in non-controlled companies in accordance with board approvedvaluation procedures, which valued the debt securities at the contractualprincipal balance.  Consistent with theBoard’s ongoing review and analysis of appropriate valuation procedures, and inconsideration of the fair value measurements of SFAS No. 157 (which wewill be required to adopt on October 1, 2008), the Board of Directorsmodified our valuation procedure so that the debt portion of bundledinvestments in non-controlled companies is based on opinions of value providedby SPSE.  This change in valuation procedureaccounted for $1,037, or 27%, of the net unrealized depreciation for thequarter.  Although our investmentportfolio has depreciated, our entire portfolio was fair valued at 92% of costas of June 30, 2008.  The unrealizeddepreciation of our investments does not have an impact on our current abilityto pay distributions to stockholders.

 

**Net Increase in Net Assets from Operations**

 

Overall, we realized a net increase in net assets resulting fromoperations of $2,809 for the three months ended June 30, 2008.  Based on a weighted-average of 21,087,574basic and diluted shares outstanding, our net increase in net assets fromoperations per weighted-average common share for the three months ended June 30,2008 was $0.13, basic and diluted.

 

For the three months ended June 30,2007, we realizeda net increase in net assets resulting from operations of $5,965.  Based on a weighted-average of 13,561,511basic and diluted shares outstanding, our net increase in net assets fromoperations per weighted-average common share for the three months ended June 30,2007 was $0.44 basic and diluted.

 

38

----

Table of Contents

 

***Comparisonof the Nine Months Ended June 30, 2008 to the Nine Months Ended June 30,2007***

 

**Investment Income**

 

Investment incomefor the nine months ended June 30, 2008 was $34,172, as compared to$26,079 for the nine months ended June 30, 2007.

 

Interest incomefrom our investments in debt securities of private companies was $33,499 forthe nine months ended June 30, 2008, as compared to $25,065 for the ninemonths ended June 30, 2007.  Thelevel of interest income from investments is directly related to the balance,at cost, of the interest-bearing investment portfolio outstanding during theperiod multiplied by the weighted average yield.  The weighted average yield varies from periodto period based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.  Interest income from our investmentsincreased $8.4 million, or 33.6%, during the nine months ended June 30,2008 compared to the prior year period based on the overall growth in the costbasis of our investments, offset by the decrease in the weighted averageyield.  The success fees during the ninemonths ended June 30, 2008 and 2007 were $846 and $2,249,respectively.  The success fee for thenine months ending June 30, 2008 resulted from a refinancing by WestlakeHardware, Inc. and Defiance Acquisition Corp., while the success fee forthe nine months ended June 30, 2007 resulted from a refinancing by BadancoAcquisition Corp. and a full repayment by Mistras Holdings Corp., SCPH Holdingsand Allied Extruders LLC.

 

·      The interest-bearing investment portfoliohad an average cost basis of approximately $398.1 million for the nine monthsended June 30, 2008, as compared to an average cost basis of $293.0million for the nine months ended June 30, 2007.  The following table lists the interest incomefrom investments for the five largest portfolio companies during the respectiveperiods:

 
| **Nine months ended June 30, 2008** | ** ** | **Nine months ended June 30, 2007** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **Company**                                                  | ** ** | **Interest   Income**                                   | ** ** | **% of  Total** | ** ** | **Company** | ** ** | **Interest   Income** | ** ** | **% of  Total** | ** ** |
| Westlake Hardware                                            |       | $                                                            | 2,245      |   | 6.7 | % | Badanco |   | $ | 1,604 |   | 6.4 | % |
| Sunshine Media                                               |       | 2,096                                                        |       | 6.3 | % | Westlake Hardware |   | 1,430 |   | 5.7 | % |
| Reliable Biopharma                                           |       | 2,090                                                        |       | 6.2 | % | Mistras Holdings |   | 1,356 |   | 5.4 | % |
| Clinton Aluminum                                             |       | 1,427                                                        |       | 4.3 | % | Allied Extruders |   | 1,074 |   | 4.3 | % |
| Defiance Acquisition                                         |       | 1,071                                                        |       | 3.2 | % | Specialty Coatings |   | 967 |   | 3.9 | % |
| **Subtotal**                                                 | ** ** | **$**                                                        | **8,929**  | ** ** | **26.7** | **%** | **Subtotal** | ** ** | **$** | **6,431** | ** ** | **25.7** | **%** |
| Other companies                                              |       | 24,570                                                       |       | 73.3 | % | Other companies |   | 18,634 |   | 74.3 | % |
| **Total interest income**                                    | ** ** | **$**                                                        | **33,499** | ** ** | **100.0** | **%** | **Total interest income** | ** ** | **$** | **25,065** | ** ** | **100.0** | **%** |

 

·      The annualized weighted average yield onour portfolio, excluding cash and cash equivalents, for the nine months ended June 30,2008 was 10.5% compared to 12.3% for the nine months ended June 30,2007.  The weighted average yields werenot materially impacted by the PIK interest, which were $46 and $0 for the ninemonths ended June 30, 2008 and 2007, respectively.  The decrease in the annualized weightedaverage yield primarily resulted from a reduction in the average LIBOR, whichwas 3.8% for the nine months ended June 30, 2008, compared to 5.3% in theprior year period, as well as three investments being on non-accrual during thenine months ended June 30, 2008 (LocalTel, West Cost Yellow Pages, andU.S. Healthcare) and none in the prior year period.

 

Interest incomefrom invested cash and cash equivalents for the nine months ended June 30,2008 was $285, as compared to $178 for the nine months ended June 30, 2007due to the amount of cash that was held in interest bearing accounts and theinterest earned on our custodial account prior to disbursement.

 

Interest incomefrom loans to our employees, in connection with the exercise of employee stockoptions, for the nine months ended June 30, 2008 and June 30, 2007,was $354 and $404 respectively.  Thedecrease is due to the cancellation in full of one employee loan during thefourth quarter of the prior fiscal year, and repayment of another employee loanin the second quarter of this fiscal year.

 

Prepayment feesand other income for the nine months ended June 30, 2008 was $34, ascompared to $432 for the nine months ended June 30, 2007.  The income for the prior period 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 was based on a percentage of theoutstanding principal amount of the loan at the date of prepayment.

 

39

----

Table of Contents

 

**Operating Expenses**

 

Operatingexpenses, net of credits from the Adviser for fees earned and voluntary waiversto the base management and incentive fees, were $13,729 for the nine monthsended June 30, 2008, as compared to $9,487 for the nine months ended June 30,2007. Operating expenses for the nine months ended June 30, 2007 reflecteda significant increase in interest expense, loan servicing fees andamortization of deferred financing fees incurred in connection with certainamendments to our credit facility.

 

Interest expensefor the nine months ended June 30, 2008 was $5,982, as compared to $4,694for the nine months ended June 30, 2007.  This increase is primarily a result of increased borrowings under ourline of credit during the nine months ended June 30, 2008, whichborrowings were partially used to finance our increased investments, borrowingsremaining outstanding for longer periods of time and an increase in theinterest rates on our borrowings.

 

Loan servicingfees for the nine months ended June 30, 2008 were $4,541, as compared to$2,377 for the nine months ended June 30, 2007.  These fees were incurred in connection with aloan servicing agreement between Business Loan and our Adviser, which is basedon the size and mix of the portfolio. The average size of our investment portfolio, excluding equityinvestments and control investments, was approximately $376.7 million for thenine months ended June 30, 2008 as compared to approximately $291.4million for the nine months ended June 30, 2007.  In terms of portfolio mix, senior syndicatedloans comprised 6.9% and 12.3% of the portfolio during the three months ended June 30,2008 and 2007, respectively.  Due tovoluntary, irrevocable waivers in place during these periods, senior syndicatedloans incurred a 0.5% annual fee whereas proprietary loans incurred a 1.5%annual fee.  These fees were reducedagainst the amount of the base management fee due to our Adviser.

 

Base managementfee for the nine months ended June 30, 2008 was $1,664, as compared to$1,997 for the nine months ended June 30, 2007.  The base management fee is computed quarterlyas described under *“Investment Advisory andManagement Agreement”* in footnote 4, and is summarized in the tablebelow:

 
| ** **                                                                                            | ** ** | **Nine months ended** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                            | ** ** | **June 30, 2008**     | ** ** | **June 30, 2007** | ** ** |
| Base management fee                                                                                   |       | $                               | 1,664      |   | $ | 1,997 |   |
| Credit for investment advisory fees received by  Adviser (1)                                          |       | (1,320                          | )          | (1,617 | ) |
| Fee reduction for the voluntary, irrevocable waiver  of 2% fee on senior syndicated loans to 0.5% (2) |       | (299                            | )          | (560 | ) |
| Net base management fee                                                                               |       | $                               | 45         |   | $ | (180 | ) |

 

----

(1)   Effective April 1, 2007,the board of our Adviser reduced the amount of voluntary irrevocable credit forinvestment advisory fees received by our Adviser from 100% of the fees receivedto 50% of the fees received.  Therefore,the nine months ended June 30, 2008 and third quarter ended June 30,2007 reflect the reduced credit for fees received by our Adviser.

 

(2)   The board of our Adviservoluntarily and irrevocably waived, for the nine months ended June 30,2008 and 2007, the annual 2.0% base management fee to 0.5% for seniorsyndicated loan participations.

 

Incentive fee forthe nine months ended June 30, 2008 was $4,089, as compared to $3,474 forthe nine months ended June 30, 2007. The board of our Adviser waived the entire incentive fee for the ninemonths ended June 30, 2008 and a portion of the incentive fee due for thenine months ended June 30, 2007. The incentive fees and associated credits are summarized in the tablebelow:

 
| ** **                                                                             | ** ** | **Nine months ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                             | ** ** | **June 30, 2008**     | ** ** | **June 30, 2007** | ** ** |
| Incentive fee                                                                          |       | $                               | 4,089      |   | $ | 3,474 |   |
| Credit from voluntary, irrevocable waiver issued by  Adviser’s board of directors |       | (4,089                          | )          | (2,696 | ) |
| Net incentive fee                                                                      |       | $                               | —     |   | $ | 778 |   |

 

Administration feefor the nine months ended June 30, 2008 was $737, compared to $482 for thenine months ended June 30, 2007. The increase is due to the addition of administration staff and relatedexpenses.

 

Professional fees,consisting primarily of legal and audit fees, for the nine months ended June 30,2008 were $706, as compared to $369 for the nine months ended June 30,2007.  The increase is due to legal feesincurred for converting troubled loans to control investments.

 

Amortization ofdeferred financing costs, in connection with our line of credit, was $830 forthe nine months ended June 30, 2008, as compared to $199 for the ninemonths ended June 30, 2007.  Theincrease is due to the amortization of additional fees incurred with 

 

40

----

Table of Contents

 

our line ofcredit.  In February 2008, we increasedthe DB Facility from $220 million to $250 million, and in April 2008,increased the DB Facility to $300 million and added BB&T as a committedlender.  In June 2008, the Companyrenewed the DB Facility.  The feesincurred for the above amendments are recorded in deferred financing fees onour consolidated statement of assets and liabilities, and amortized over thelife of the DB Facility.

 

Stockholderrelated costs for the nine months ended June 30, 2008 were $292, ascompared to $190 for the nine months ended June 30, 2007.  Stockholder related costs include suchrecurring items as transfer agent fees, NASDAQ listing fees, costs associatedwith SEC filings, and annual report printing and distribution costs.  These fees increased during the nine months endedJune 30, 2008 due to the size and quantity of our annual report andadditional filing fees as compared to the prior year.

 

Directors’ feesfor the nine months ended June 30, 2008 and 2007 were $163 and $167respectively, and consisted of amortization of their annual stipend and meetingstipends.

 

Insurance expensefor the nine months ended June 30, 2008 was $170, as compared to $191 forthe nine months June 30, 2007. The increase is primarily the result of adecrease in the amortization of our directors and officers insurance policypremiums.

 

Other expenses forthe nine months ended June 30, 2008 was $263, as compared to $220 for thenine months ended June 30, 2007. 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.  The increase is primarily due to the increasein direct expenses as the overall size of our investment portfolio continued togrow from the prior year period.

 

**NetRealized Gain (Loss) on Sale of Investments**

 

During the ninemonths ended June 30, 2008, we realized a net loss of $86 from the payoffof two loans (in particular the unamortized investment acquisition costsrelated to the Anitox and Macfadden loans), as compared to a realized net gainof $82 from the sale or repayment of 21 syndicated loan investments in the ninemonths ended June 30, 2007.

 

**RealizedGain on Settlement of Derivative**

 

During the ninemonths ended June 30, 2008 and June 30, 2007, we received interestrate cap agreement payments of  $6 and$31, respectively, as a result of the one month LIBOR exceeding 5%.

 

**NetUnrealized Depreciation on Derivative**

 

During the ninemonths ended June 30, 2008, we recorded net unrealized depreciation of $12due to a decrease in the fair market value of our interest rate cap agreement,as compared to unrealized depreciation of $26 during the nine months ended June 30,2007.

 

**NetUnrealized Depreciation on Investments**

 

For the ninemonths ended June 30, 2008, we recorded net unrealized depreciation oninvestments of $27,545, as compared to net unrealized depreciation of $2,466,for the nine months ended June 30, 2007. The unrealized depreciation is mainly attributable to the decrease infair value on our portfolio, most notably in the following investments:  LocalTel, Greatwide Logistics Services, U.S.Healthcare, and Visual Edge Technology. We believe that our investment portfolio was valued at a depreciatedvalue due primarily to the general instability of the loan markets and, to alesser extent, the use of a modified valuation procedure for ournon-control/non-affiliate investments. Previously, we valued the debt portion of bundled debt and equityinvestments in non-controlled companies in accordance with board approvedvaluation procedures, which valued the debt securities at the contractualprincipal balance.  Consistent with theBoard’s ongoing review and analysis of appropriate valuation procedures, and inconsideration of the fair value measurements of SFAS No. 157 (which wewill be required to adopt on October 1, 2008), the Board of Directorsmodified our valuation procedure so that the debt portion of bundledinvestments in non-controlled companies is based on opinions of value providedby SPSE.  This change in valuationestimate accounted for $1,037, or 4%, of the net unrealized depreciation forthe nine month period.  Although ourinvestment portfolio has depreciated, our entire portfolio was fair valued at92% of cost as of June 30, 2008. The unrealized depreciation of our investments does not have an impacton our current ability to pay distributions to stockholders.

 

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

 

Overall, we realized a net decrease in net assets resulting fromoperations of $7,194 for the nine months ended June 30, 2008.  Based on a weighted-average of 19,237,203basic and diluted shares outstanding, our net decrease in net assets fromoperations per weighted-average common share for the nine months ended June 30,2007 was $0.37, basic and diluted.

 

41

----

Table of Contents

 

For the nine months ended June 30,2007, werealized a net increase in net assets resulting from operations of$14,213.  Based on a weighted-average of12,701,845 basic and diluted shares outstanding, our net increase in net assetsfrom operations per weighted-average common share for the nine months endedJune, 2007 was $1.12, basic and diluted.

 

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

 

**OperatingActivities**

 

At June 30,2008, we had investments in debt securities of, or loans to, 62 private companies,totaling approximately $441.8 million (cost basis) of total assets.  During the nine months ended June 30,2008 and June 30, 2007, the following investment activity occurred:

 
| **Quarter   Ended** | ** ** | **New   Investments (1)** | ** ** | **Principal   Repayments (2)** | ** ** | **Net Gain (Loss)   on Disposal** | ** ** |
|--------------------------|------------|-------------------------------------|------------|------------------------------------------|------------|-------------------------------------------------------|------------|
| June 30, 2008       |       | $                                   | 43,678     |                                     | $          | 40,755                                                |       | $ | (86 | ) |
| March 31, 2008      |       | 20,483                              |       | 3,000                                    |       | —                                                |       |
| December 31, 2007   |       | 73,341                              |       | 4,047                                    |       | —                                                |       |
|                     |       | $                                   | 137,502    |                                     | $          | 47,802                                                |       | $ | (86 | ) |
|                     |       |                                |       |                                     |       |                                                  |       |
| June 30, 2007       |       | $                                   | 126,087    |                                     | $          | 37,573                                                |       | $ | (5 | ) |
| March 31, 2007      |       | 75,330                              |       | 38,263                                   |       | 85                                                    |       |
| December 31, 2006   |       | 52,311                              |       | 23,967                                   |       | 2                                                     |       |
|                     |       | $                                   | 253,728    |                                     | $          | 99,803                                                |       | $ | 82 |   |

 

**(1)****  ****New Investments**

 

During the ninemonths ended June 30, 2008, we extended, directly or throughparticipations, $107.4 million of loan originations to 9 new portfoliocompanies, in one instance receiving a common equity warrant, and $30.1 millionof investments to existing portfolio companies through revolver draws oradditions of new notes, for total new investments of $137.5 million. The originations of loans to new portfolio companies by quarter were asfollows:

 
| **Quarter ended** | ** ** | **Originations** | ** **    | **Companies** | ** ** | **Description**                                     | ** **                             |
|------------------------|------------|------------------|---------------|---------------|------------|-----------------------------------------------------|----------------------------------------|
| June 30, 2008     |       | $                | 35.7 million  |          | 3          |                                                | Saunders, Legend  and BAS Broadcasting |   |
| March 31, 2008    |       | 13.7 million     |          | 1             |       | ACE Expediters                                      |                                   |
| December 31, 2007 |       | 58.0 million     |          | 5             |       | Interfilm, Reliable, Lindmark, GS Maritime and GFRC |                                   |
| Total                  |       | $                | 107.4 million |          | 9          |                                                |                                   |   |

 

During the ninemonths ended June 30, 2007, we extended, directly or throughparticipations, $214.6 million of loan originations to 52 new portfoliocompanies, in one instance receiving a common equity warrant, and $39.1 millionof investments to existing portfolio companies through revolver draws oradditions of new notes, for total new investments of $253.7 million. The new loan originations by quarter were as follows:

 
| **Quarter ended** | ** ** | **Originations** | ** **    | **Companies** | ** ** | **Description**                                        | ** **                                                                                          |
|------------------------|------------|------------------|---------------|---------------|------------|--------------------------------------------------------|-----------------------------------------------------------------------------------------------------|
| June 30, 2007     |       | $                | 112.7 million |          | 20         |                                                   | Includes acquisition of $63.3 million in senior debt with 16  different borrowers in June 2007 |   |
| March 31, 2007    |       | 53.1 million     |          | 12            |       | Most notably  Clinton Holdings and Greatwide Logistics |                                                                                                |
| December 31, 2006 |       | 48.8 million     |          | 20            |       | Most notably  Precision and Pinnacle Treatment Centers |                                                                                                |
| Total                  |       | $                | 214.6 million |          | 52         |                                                   |                                                                                                |   |

 

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

 

During the ninemonths ended June 30, 2008, 3 borrowers made payments in full ahead ofcontractual maturity of $25.0 million, 2 borrowers made unscheduled partialpayoffs of $3.6 million, and we experienced contractual amortization, revolverrepayments and some principal payments received ahead of schedule of $19.2million, for total principal repayments of $47.8 million.  The total and partial payoffs by quarter wereas follows:

 
| **Quarter ended** | ** ** | **Repayments**                    | ** ** | **Companies** | ** ** | **Description**                                                            | ** ** |
|------------------------|------------|-----------------------------------|------------|---------------|------------|----------------------------------------------------------------------------|------------|
| June 30, 2008     |       | Repaid in full  ahead of maturity |       | 3             |       | Reading  Broadcasting, Macfadden Performing Arts and SCS Acquisition Corp. |       |
|                   |       | Partial payoff                    |       | 1             |       | Anitox – Senior  Real Estate Term Debt                                |       |
| March 31, 2008    |       | Partial payoff                    |       | 1             |       | Risk Metrics –  Senior Subordinated Term Debt                         |       |
| December 31, 2007 |       | None                              |       | —        |       |                                                                       |       |

 

42

----

Table of Contents

 

During the ninemonths ended June 30, 2007, 4 borrowers made payments in full ahead ofcontractual maturity, 1 borrower refinanced its investment and we soldor were repaid in full on 21 syndicated loans of $87.6 million, and we experienced contractual amortization,revolver repayments and some principal payments received ahead of schedule of$12.2 million, for total principal repayments of $99.8 million.  The total payoffs and refinancing by quarterwere as follows:

 
| **Quarter ended** | ** ** | **Repayments**                    | ** ** | **Companies** | ** ** | **Description**                               | ** ** |
|------------------------|------------|-----------------------------------|------------|---------------|------------|-----------------------------------------------|------------|
| June 30, 2007     |       | Repaid in full  ahead of maturity |       | 3             |       | SCPH Holdings,  Benetech and Allied Extruders |       |
|                   |       | Syndicated loans                  |       | 11            |       |                                          |       |
| March 31, 2007    |       | Refinanced                        |       | 1             |       | Badanco  Acquisition Corp.                    |       |
|                   |       | Syndicated loans                  |       | 8             |       |                                          |       |
| December 31, 2006 |       | Repaid in full  ahead of maturity |       | 1             |       | Mistras Holdings                              |       |
|                   |       | Syndicated loans                  |       | 2             |       |                                          |       |

 

The following table summarizes the contractual principalrepayments and maturity of our investment portfolio by fiscal year, assuming novoluntary prepayments:

 
| ** **                                                | ** ** | ** **                        | ** ** | **Amount** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------|------------|------------|------------|
| For the remaining three months ending  September 30: |       | 2008                              |       | $          | 6,641      |   |
| For the year ending September 30:                    |       | 2009                              |       | 25,573     |       |
|                                                      |       | 2010                              |       | 48,070     |       |
|                                                      |       | 2011                              |       | 109,311    |       |
|                                                      |       | 2012                              |       | 91,878     |       |
|                                                      |       | 2013                              |       | 111,810    |       |
|                                                      |       | Thereafter                        |       | 48,469     |       |
| ** **                                                | ** ** | **Total  Contractual Repayments** |       | $          | 441,752    |   |
|                                                      |       | Investments in  Equity Securities |       | 3,448      |       |
| ** **                                                | ** ** | **Total**                         |       | $          | 445,200    |   |

 

Net cash used in operating activities for the nine months ended June 30,2008, consisting primarily of the items described in *“Results ofOperations”* and the investment activity described above, was $72,430as compared to net cash used in operating activities of $136,605 for the nine monthsended June 30, 2007.

 

**Investing Activities**

 

Net cash provided by investing activities for the nine monthsended June 30, 2008 was $2,484, which resulted from the redemption of theU.S. Treasury bill held by Gladstone Financial.

 

**Financing Activities**

 

Net cash provided by financing activities for the nine monthsended June 30, 2008 was $66,533 and mainly consisted of two offerings ofcommon stock for aggregate net proceeds of $106,226, offset by net repaymentson our line of credit of $11,350, dividend payments of $24,523, and payments toamend our DB Facility totaling $3,026.  Netcash provided by financing activities was $139,365 for the nine months ended June 30,2007 and consisted primarily of one offering of common stock for net proceedsof $45,669, net borrowings on our line of credit of approximately $111,195,offset by dividend payments of $16,013.

 

**Dividends**

 

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 April, May andJune 2008 and also January, February and March 2007.  In July 2008, our Board of Directorsdeclared a monthly dividend of $0.14 per common share for each of July, August,and September 2008.

 

43

----

Table of Contents

 

**Issuanceof Equity**

 

We anticipateborrowing funds and issuing additional equity securities to obtain additionalcapital in the future.  However, wecannot determine the terms of any future equity issuances or whether we will beable to issue equity on terms favorable to us, or if at all.  During fiscal year 2007, we filed aregistration statement on Form N-2 (File No. 333-143027) (the “Registration Statement”) with theSEC that permits us to issue, through one or more transactions, up to anaggregate of $300 million in securities, consisting of common stock, ordebt securities, of which to date we have issued $123.8 million in commonstock, which leaves a remaining capacity of $176.2 million.

 

On October 19,2007, we completed an offering of 2,500,000 shares of our common stock at aprice of $18.70 per share, less an underwriting discount of $1.03 per share,under the Registration Statement and as supplemented by a final prospectussupplement dated October 15, 2007. On November 19, 2007, the underwriter exercised its over-allotmentoption and we closed on an additional 375,000 shares of common stock, at thesame price.  Net proceeds of theoffering, after deducting underwriting discounts and offering expenses borne byus, were approximately $50.5 million and were used to repay a portion ofoutstanding borrowings under our line of credit.

 

On February 5,2008, we completed an offering of 3,000,000 shares of our common stock at aprice of $17.00 per share, less an underwriting discount of $0.935 per share,under the Registration Statement and as supplemented by a final prospectussupplement dated January 30, 2008. On February 26, 2008, theunderwriter exercised its over-allotment option and we closed on an additional450,000 shares of common stock, at the same price.  Net proceeds of the offering, after deductingunderwriting discounts and offering expenses borne by us, were approximately$55.0 million and were used to repay a portion of outstanding borrowings underour line of credit.

 

On February 21,2008, our stockholders approved a proposal to authorize us to offer and issuelong-term rights, including warrants, to purchase shares of our common stock atan exercise price that, at the time such rights are issued, will not be lessthan the greater of the market value of our common stock or the net asset value(“NAV”) of our common stock.  Such rightsmay be part of or accompanied by other securities of ours such as convertibledebt.  We have determined that it wouldbe advantageous to have the ability to sell, either alone or as part of anothersecurity, warrants, options or rights to purchase common stock in connectionwith our financing and capital raising activities.  This ability may give us a cost-effective wayto raise capital.  We believe that therights to purchase shares of our common stock give us additional flexibility overand above the limited amount that can be raised without stockholder approvalthrough short-term transferable rights offering to take advantage of investmentopportunities that may arise in the future.

 

Generally, the1940 Act provides that we may not issue and sell our common stock at a pricebelow our NAV per share, other than to our then existing stockholders pursuantto a rights offering, without first obtaining approval from our stockholdersand our independent directors.  As of June 30,2008, our NAV per share was $13.97 per share on that date and our closingmarket price was $15.24 per share.  Tothe extent that our common stock trades at a market price below our NAV pershare, we will generally be precluded from raising equity capital throughpublic offerings of our common stock, other than pursuant to a rightsoffering.  The asset coverage requirementof a BDC under the 1940 Act effectively limits our ratio of debt to equity to1:1.  To the extent that we are unable toraise capital through the issuance of equity, our ability to raise capitalthrough the issuance of debt may also be inhibited to the extent of ourregulatory debt to equity ratio limits.

 

**RevolvingCredit Facility**

 

Through ourwholly-owned subsidiary, Business Loan, we have a $300 million revolving creditfacility (the “DB Facility”) with Deutsche Bank AG, as administrative agent,which is scheduled to mature on May 21, 2009.  Pursuant to the DB Facility, Business Loanhas pledged the loans it holds to secure future advances by certaininstitutional lenders.  The interest ratecharged on the advances under the DB Facility is based on the Commercial Paper(“CP”) rate, which is equivalent to the weighted average per annum rates paidby the DB Facility’s CP lenders in respect of CP notes issued by the CP lenderduring such period.  Business Loan alsohas the ability to borrow at an alternative rate from the committed lenders ifCP lenders are unable to fund advances. The alternative rate is the London Interbank Offered Rate (“LIBOR”), orif LIBOR is unavailable, the Prime Rate or the Federal Funds Rate plus 1.0%.  In February 2008, we increased the DBFacility from $220 million to $250 million, and in April 2008, increasedthe DB Facility to $300 million and added Branch Banking and Trust Company (“BB&T”)as a committed lender.  In June 2008,we renewed the DB Facility, which matures on May 21, 2009.

 

As of June 30,2008, the outstanding principal balance under this credit facility wasapproximately $133.1 million at an interest rate of approximately 2.71% plus a2.50% program fee.  We are also chargedan unused commitment fee of 0.75% per annum. 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 such repaymentsare early prepayment or are made as contractually required.  At June 30, 2008, the remainingborrowing capacity available under the DB Facility was approximately $166.9million.

 

44

----

Table of Contents

 

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 our credit and collection policies. The facility also restricts some of the terms and provisions (includinginterest rates, terms to maturity and payments schedules) and limits theborrower and industry concentrations of loans that are eligible to secureadvances.  As of June 30, 2008,Business Loan was in compliance with all of the facility covenants.  We currently intend to securitize the loansheld by Business Loan and if we are able to do so, we will use the proceedsfrom the securitization to pay down any amounts then outstanding under therevolving credit facility.

 

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 Mellon as custodian.  Deutsche BankAG is also the trustee of the account and once a month remits the collectedfunds to us. At June 30, 2008 and September 30, 2007, the amount duefrom custodian was $6,637 and $3,230, respectively.

 

Our Adviser alsoservices 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 our Adviserwould comply fully with all of its obligations under the facility. Theperformance guaranty requires us to maintain a minimum net worth of $100million plus 75% of equity issued after May 2003 and to maintain “assetcoverage” with respect to “senior securities representing indebtedness” of atleast 200%, in accordance with Section 18 of the 1940 Act.  As of June 30, 2008, we were incompliance with our covenants under the performance guaranty.

 

**ContractualObligations and Off-Balance Sheet Arrangements**

 

As of June 30,2008, we were a party to signed and non-binding term sheets for two loanoriginations for an aggregate of $26 million and, as of August 4, 2008,funded one of those originations (see further discussion in footnote 11.Subsequent Events).  We expect to fundthe other potential investment within the next 12 months.

 

All prospectiveinvestments are subject to, among other things, the satisfactory completion ofthe Company’s due diligence investigation of each borrower, acceptance of termsand structure and receipt of necessary consents. With respect to eachprospective investment, the Company will only agree to provide the investmentif, among other things, the results of its due diligence investigations aresatisfactory, the terms and conditions of the investment are acceptable and allnecessary consents are received. The Company has initiated its due diligenceinvestigations of the potential borrowers, however there can be no guaranteethat facts will not be discovered in the course of completing the due diligencethat would render a particular investment imprudent or that any of theseinvestments will actually be made.

 

We do not have anyoff-balance sheet arrangements as defined in Item 303(a)(4)(ii) ofRegulation S-K as of June 30, 2008.

 

**ITEM 3. QUANTITATIVEAND 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 consists of thefollowing:

 
| 63  | % | variable rates with a  floor               |   |
|-----|---|--------------------------------------------|--------|
| 2   | % | variable rates with a  floor and ceiling   |   |
| 32  | % | variable rates without  a floor or ceiling |   |
| 3   | % | fixed rate                                 |   |
| 100 | % | total                                      |   |

 

There have been nomaterial changes in the quantitative and qualitative market risk disclosuresfor the nine months ended June 30, 2008 from that disclosed in our AnnualReport on Form 10-K for the fiscal year ended September 30, 2007, asfiled with the Securities and Exchange Commission on December 3, 2007.

 

**ITEM 4. CONTROLS ANDPROCEDURES.**

 

As of June 30, 2008, we, including our Chief ExecutiveOfficer and Chief Financial Officer, evaluated the effectiveness of the designand operation of our disclosure controls and procedures.  Based on that evaluation, our management,including the Chief Executive Officer and Chief Financial Officer, concludedthat our disclosure controls and procedures were effective in timely alertingmanagement, including the Chief Executive Officer and Chief Financial Officer,of material information about us required to be included in periodic Securitiesand Exchange Commission filings. However, in evaluating the disclosure controls and procedures,management recognized that any controls and procedures, no matter how welldesigned and operated can provide only reasonable 

 

45

----

Table of Contents

 

assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

There have been no changes in our internal control over financialreporting that occurred during the quarter ended June 30, 2008, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

46

----

Table of Contents

 

**PART II–OTHERINFORMATION**

 

**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 issubject to certain risks and events that, if they occur, could adversely affectour financial condition and results of operations and the trading price of ourcommon stock.  For a discussion of theserisks, please refer to the “Risk Factors” section of our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2007, filed by us with theSecurities and Exchange Commission on December 3, 2007.  In connection with our preparation of thisquarterly report, management has reviewed and considered these risk factors andhas determined that the following risk factors should be read in connectionwith the existing risk factors disclosed in the Form 10-K.

 

*Anyunrealized depreciation we experience on our investment portfolio may be anindication of future realized losses, which could reduce our income availablefor distribution.*

 

As a business developmentcompany we are required to carry our investments at market value or, if nomarket value is ascertainable, at fair value as determined in good faith by orunder the direction of our Board of Directors. Decreases in the market valuesor fair values of our investments will be recorded as unrealized depreciation.Since our inception, we have, at times, incurred a cumulative net unrealizeddepreciation of our portfolio. Any unrealized depreciation in our investmentportfolio could result in realized losses in the future and ultimately inreductions of our income available for distribution to stockholders in futureperiods.

 

*Shares ofclosed-end investment companies frequently trade at a discount from net assetvalue.*

 

Shares ofclosed-end investment companies frequently trade at a discount from net assetvalue.  Since our inception, our commonstock has traded above net asset value. However, subsequent to June 30, 2008, our common stock at timestraded below the June 30, 2008 net asset value of $13.97 per share.  This characteristic of shares of closed-endinvestment companies is separate and distinct from the risk that our net assetvalue per share will decline.  As withany stock, the price of our shares will fluctuate with market conditions andother factors.  If shares are sold, theprice received may be more or less than the original investment.  Whether investors will realize gains orlosses upon the sale of our shares will not depend directly upon our net assetvalue, but will depend upon the market price of the shares at the time ofsale.  Since the market price of ourshares will be affected by such factors as the relative demand for and supplyof the shares in the market, general market and economic conditions and otherfactors beyond our control, we cannot predict whether the shares will trade at,below or above our net asset value.

 

**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.**

 

Not applicable.

 

**ITEM 5. OTHERINFORMATION.**

 

Not applicable

 

**ITEM 6.  EXHIBITS**

 

See the exhibit index.

 

47

----

Table of Contents

 

**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/ GRESFORD GRAY |
|       | Gresford Gray                     |
|       | Chief Financial Officer           |

 

Date: August 4, 2008

 

48

----

Table of Contents

 

**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                          |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                                                     |
| 3.1         |       | Articles of Amendment and Restatement of  the Articles of Incorporation, incorporated by reference to Exhibit a.2  to Pre-Effective Amendment No. 1 to the Registration Statement on  Form N-2 (File No. 333-63700), filed July 27, 2001.                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                     |
| 3.2         |       | By-laws, incorporated by reference to  Exhibit b to Pre-Effective Amendment No. 1 to the Registration  Statement on Form N-2 (File No. 333-63700), filed July 27,  2001.                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                     |
| 3.3         |       | Amendment to by-laws, incorporated by  reference to Exhibit 3.3 to the Company’s Quarterly Report on  Form 10-Q for the quarter ended December 31, 2003 (File  No. 814-00237), filed February 17, 2004.                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                                                                     |
| 3.4         |       | Second amendment to by-laws,  incorporated by reference to Exhibit 99.1 to the Company’s Current  Report on Form 8-K (File No. 814-00237), filed July 10, 2007.                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                     |
| 10.1        |       | Amendment No. 6 to the Amended and  Restated Credit Agreement by and among Gladstone Business Loan LLC, Deutsche  Bank AG, and certain other parties, dated as of April 24, 2008,  incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K (File No. 814-00237), filed April 25, 2008. |
|        |       |                                                                                                                                                                                                                                                                                                                                                     |
| 10.2        |       | Amendment No. 7 to the Amended and  Restated Credit Agreement by and among Gladstone Business Loan LLC, Deutsche  Bank AG, and certain other parties, dated as of May 23, 2008,  incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K (File No. 814-00237), filed May 23, 2008.     |
|        |       |                                                                                                                                                                                                                                                                                                                                                     |
| 10.3        |       | Second Amended and Restated Credit  Agreement by and among Gladstone Business Loan LLC, Deutsche Bank AG, and  certain other parties, dated as of June 6, 2008, incorporated by  reference to Exhibit 10.1 to the Company’s Current Report on  Form 8-K (File No. 814-00237), filed June 9, 2008.                          |
|        |       |                                                                                                                                                                                                                                                                                                                                                     |
| 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 and thereforehave been omitted.

 

49

----