Table ofContents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 
| **x** | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**FOR THEQUARTER ENDED MARCH 31, 2010**

 
| **o** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|-------|----------------------------------------------------------------------------------------------------------|

 

**COMMISSIONFILE NUMBER: 814-00237**

 

**GLADSTONECAPITAL CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

**1521WESTBRANCH DRIVE, SUITE 200**

**MCLEAN,VIRGINIA 22102**

(Address of principalexecutive office)

 

**(703)287-5800**

(Registrant’s telephonenumber, including area 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 xNo o.

 

Indicate by check mark whether theregistrant has submitted electronically and posted on its corporate Web site,if any, every Interactive Data File required to be submitted and postedpursuant to Rule 405 of Regulation S-T during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).  Yes o  No o

 

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

 

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

 

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

 

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 May 4, 2010 was21,039,242.

 

 

 

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Table ofContents

 

**GLADSTONECAPITAL CORPORATION**

**TABLEOF CONTENTS**

 
| PART I.  | FINANCIAL INFORMATION                                                                                               |   |
|---------------|---------------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                                |   |
| Item 1.       | Financial Statements (Unaudited)                                                                                    |   |
|          |                                                                                                                |   |
|          | Condensed  Consolidated Statements of Assets and Liabilities as of March 31, 2010  and September 30, 2009 | 2      |
|          | Condensed Consolidated Schedules of Investments as of  March 31, 2010 and September 30, 2009              | 3      |
|          | Condensed Consolidated Statements of Operations for  the three and six months ended March 31, 2010 and 2009    | 11     |
|          | Condensed Consolidated Statements of Changes in Net  Assets for the six months ended March 31, 2010 and 2009   | 12     |
|          | Condensed Consolidated Statements of Cash Flows for  the six months ended March 31, 2010 and 2009              | 13     |
|          | Financial Highlights for the three and six months  ended March 31, 2010 and 2009                               | 14     |
|          | Notes to Condensed Consolidated Financial Statements                                                                | 16     |
|          |                                                                                                                |   |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 32     |
|          | Overview                                                                                                            | 32     |
|          | Results of Operations                                                                                               | 35     |
|          | Liquidity and Capital Resources                                                                                     | 43     |
|          |                                                                                                                |   |
| Item 3.       | Quantitative  and Qualitative Disclosure About Market Risk                                                          | 53     |
|          |                                                                                                                |   |
| Item 4.       | Controls and  Procedures                                                                                            | 54     |
|          |                                                                                                                |   |
| PART II. | OTHER INFORMATION                                                                                                   |   |
|          |                                                                                                                |   |
| Item 1.       | Legal Proceedings                                                                                                   | 55     |
|          |                                                                                                                |   |
| Item  1A.     | Risk  Factors                                                                                                       | 55     |
|          |                                                                                                                |   |
| Item 2.       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                        | 57     |
|          |                                                                                                                |   |
| Item 3.       | Defaults  Upon Senior Securities                                                                                    | 57     |
|          |                                                                                                                |   |
| Item 4.       | Submission  of Matters to a Vote of Security Holders                                                                | 57     |
|          |                                                                                                                |   |
| Item 5.       | Other Information                                                                                                   | 58     |
|          |                                                                                                                |   |
| Item  6.      | Exhibits                                                                                                            | 58     |
|          |                                                                                                                |   |
| SIGNATURES    | 58                                                                                                                  |

 

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**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES**

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

**(UNAUDITED)**

 
| ** **                                                                                                                                                                                  | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **2010**           | ** ** | **2009**               | ** ** |
| ASSETS                                                                                                                                                                                      |       |               |       |                   |       |
| Non-Control/Non-Affiliate investments (Cost 3/31/10:  $274,627; 9/30/09: $312,043)                                                                                                          |       | $                  | 256,227    |                   | $          | 286,997 |   |
| Control investments (Cost 3/31/10: $55,467; 9/30/09:  $52,350)                                                                                                                              |       | 35,524             |       | 33,972                 |       |
| Total investments at fair value (Cost 3/31/10:  $330,094; 9/30/09: $364,393)                                                                                                                |       | 291,751            |       | 320,969                |       |
| Cash                                                                                                                                                                                        |       | 4,261              |       | 5,276                  |       |
| Interest receivable – investments in debt securities                                                                                                                                   |       | 2,387              |       | 3,048                  |       |
| Interest receivable – employees (Refer to Note 4)                                                                                                                                      |       | 91                 |       | 85                     |       |
| Due from custodian                                                                                                                                                                          |       | 10,571             |       | 3,059                  |       |
| Due from Adviser (Refer to Note 4)                                                                                                                                                          |       | —             |       | 69                     |       |
| Deferred financing fees                                                                                                                                                                     |       | 1,610              |       | 1,230                  |       |
| Prepaid assets                                                                                                                                                                              |       | 288                |       | 341                    |       |
| Receivable from portfolio companies, less allowance  for uncollectible receivables of $177 and $0 at March 31, 2010 and  September 30, 2009, respectively                         |       | 367                |       | 1,528                  |       |
| Other assets                                                                                                                                                                                |       | 312                |       | 305                    |       |
| TOTAL ASSETS                                                                                                                                                                                |       | $                  | 311,638    |                   | $          | 335,910 |   |
|                                                                                                                                                                                        |       |               |       |                   |       |
| LIABILITIES                                                                                                                                                                                 |       |               |       |                   |       |
| Accounts payable                                                                                                                                                                            |       | $                  | —     |                   | $          | 67 |   |
| Interest payable                                                                                                                                                                            |       | 244                |       | 378                    |       |
| Fee due to Administrator (Refer to Note 4)                                                                                                                                                  |       | 176                |       | 216                    |       |
| Due to Adviser (Refer to Note 4)                                                                                                                                                            |       | 2,365              |       | 834                    |       |
| Borrowings under line of credit at fair value (Cost  3/31/10: $53,000; 9/30/09: $83,000)                                                                                                    |       | 53,000             |       | 83,350                 |       |
| Accrued expenses and deferred liabilities                                                                                                                                                   |       | 1,203              |       | 1,800                  |       |
| Funds held in escrow                                                                                                                                                                        |       | 101                |       | 189                    |       |
| TOTAL LIABILITIES                                                                                                                                                                           |       | 57,089             |       | 86,834                 |       |
| NET ASSETS                                                                                                                                                                                  |       | $                  | 254,549    |                   | $          | 249,076 |   |
|                                                                                                                                                                                        |       |               |       |                   |       |
| ANALYSIS OF NET  ASSETS                                                                                                                                                                     |       |               |       |                   |       |
| Common stock, $0.001 par value, 50,000,000 shares  authorized and 21,039,242 and 21,087,574 shares issued and outstanding at  March 31, 2010 and September 30, 2009, respectively |       | $                  | 21         |                   | $          | 21 |   |
| Capital in excess of par value                                                                                                                                                              |       | 327,709            |       | 328,203                |       |
| Notes receivable — employees (Refer to Note 4)                                                                                                                                         |       | (8,503             | )          | (9,019                 | )          |
| Net unrealized depreciation on investments                                                                                                                                                  |       | (38,343            | )          | (43,425                | )          |
| Net unrealized appreciation on borrowings under line  of credit                                                                                                                             |       | —             |       | (350                   | )          |
| Accumulated Net Realized Losses                                                                                                                                                             |       | (26,335            | )          | (26,354                | )          |
| TOTAL NET ASSETS                                                                                                                                                                            |       | $                  | 254,549    |                   | $          | 249,076 |   |
| NET ASSETS PER SHARE                                                                                                                                                                        |       | $                  | 12.10      |                   | $          | 11.81 |   |

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS.*

 

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**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS**

**AS OF MARCH 31,2010**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

** **
| **Company  (1)**                                        | ** ** | **Industry**                                                   | ** **                                        | **Investment  (2)**                                                | ** ** | **Cost**   | ** ** | **Fair  Value** |
|---------------------------------------------------------|------------|----------------------------------------------------------------|---------------------------------------------------|--------------------------------------------------------------------|------------|------------|------------|-----------------|
| ** **                                              | ** ** | ** **                                                     | ** **                                        | ** **                                                         | ** ** | ** ** | ** ** | ** **      |
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS**              |       |                                                           |                                              |                                                               |       |       |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| ***Non-syndicated Loans:***                             |       |                                                           |                                              |                                                               |       |       |       |            |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Access Television  Network, Inc.                   |       | Service-cable  airtime (infomercials)                          |                                              | Senior Term Debt  (14.5%, Due 12/2009) (5) (11)               |       | $          | 963        |            | $ | 794 |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Allison  Publications, LLC                              |       | Service-publisher  of consumer oriented magazines              |                                              | Senior Term Debt  (10.5%, Due 9/2012) (5)                          |       | 9,399      |       | 8,779           |
|                                                    |       |                                                           |                                              | Senior Term Debt  (13.0%, Due 12/2010) (5)                         |       | 195        |       | 191             |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Anitox  Acquisition Company                             |       | Manufacturing-preservatives  for animal feed                   |                                              | Line of Credit,  $3,000 available (4.5%, Due 1/2011) (5)           |       | 1,950      |       | 1,950           |
|                                                    |       |                                                           |                                              | Senior Term Debt  (8.5%, Due 1/2012) (5)                           |       | 2,603      |       | 2,596           |
|                                                    |       |                                                           |                                              | Senior Term Debt  (10.5%, Due 1/2012) (3) (5)                 |       | 3,688      |       | 3,660           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| BAS Broadcasting                                        |       | Service-radio  station operator                                |                                              | Senior Term Debt  (11.5%, Due 7/2013) (5)                          |       | 7,435      |       | 6,766           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Chinese Yellow  Pages Company                      |       | Service-publisher  of Chinese language directories             |                                              | Line of Credit,  $700 available (7.3%, Due 9/2010) (5)             |       | 450        |       | 432             |
|                                                    |       |                                                           |                                              | Senior Term Debt  (7.3%, Due 9/2010) (5)                           |       | 425        |       | 407             |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| CMI Acquisition,  LLC                                   |       | Service-recycling                                              |                                              | Senior  Subordinated Term Debt (10.3%, Due 11/2012) (5)            |       | 6,240      |       | 6,061           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Doe &  Ingalls Management LLC                  |       | Distributor-specialty  chemicals                               |                                              | Senior Term Debt  (8.0%, Due 11/2010) (5)                          |       | 1,900      |       | 1,881           |
|                                                    |       |                                                           |                                              | Senior Term Debt  (9.0%, Due 11/2010) (3) (5)                 |       | 4,343      |       | 4,299           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Finn Corporation                                        |       | Manufacturing-landscape  equipment                             |                                              | Common Stock  Warrants (7) (8)                                |       | 37         |       | 651             |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| GFRC Holdings LLC                                       |       | Manufacturing-glass-fiber  reinforced concrete                 |                                              | Senior Term Debt  (9.0%, Due 12/2012) (5)                          |       | 6,405      |       | 6,333           |
|                                                    |       |                                                           |                                              | Senior  Subordinated Term Debt (11.5%, Due 12/2012) (3) (5)   |       | 6,649      |       | 6,516           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Global Materials  Technologies, Inc.               |       | Manufacturing-steel  wool products and metal fibers            |                                              | Senior Term Debt  (14.0%, Due 6/2010) (3) (5)                 |       | 4,310      |       | 3,232           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Heartland  Communications Group                         |       | Service-radio  station operator                                |                                              | Senior Term Debt  (10.0%, Due 5/2011) (5)                          |       | 4,559      |       | 2,272           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Interfilm  Holdings, Inc.                          |       | Service-slitter and  distributor of plastic films              |                                              | Senior Term Debt  (12.3%, Due 10/2012) (5)                         |       | 4,924      |       | 4,796           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| International  Junior Golf Training Acquisition Company |       | Service-golf  training                                         |                                              | Line of Credit,  $1,500 available (9.0%, Due 5/2010) (5) (13) |       | 1,500      |       | 1,487           |
|                                                    |       |                                                           |                                              | Senior Term Debt  (8.5%, Due 5/2012) (5)                           |       | 1,854      |       | 1,823           |
|                                                    |       |                                                           |                                              | Senior Term Debt  (10.5%, Due 5/2012) (3) (5)                 |       | 2,500      |       | 2,438           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| KMBQ Corporation                                        |       | Service-AM/FM  radio broadcaster                               |                                              | Line of Credit,  $200 available (11.0%, Due 7/2010) (5)            |       | 162        |       | 32              |
|                                                    |       |                                                           |                                              | Senior Term Debt  (11.0%, Due 7/2010) (5)                          |       | 1,921      |       | 384             |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Legend  Communications of Wyoming LLC                   |       | Service-operator  of radio stations                            |                                              | Line of Credit,  $500 available (12.0%, Due 6/2011) (5)            |       | 497        |       | 430             |
|                                                    |       |                                                           |                                              | Senior Term Debt  (12.0%, Due 6/2013) (5)                          |       | 9,373      |       | 8,107           |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Newhall  Holdings, Inc.                            |       | Service-distributor  of personal care products and supplements |                                              | Line of Credit,  $1,350 available (5.0%, Due 5/2010) (5)           |       | 1,000      |       | 934             |
|                                                    |       |                                                           | Senior Term Debt  (5) (5.0%, Due 5/2012) (5) |                                                               | 3,870      |       | 3,614      |
|                                                    |       |                                                           |                                              | Senior Term Debt  (5.0%, Due 5/2012) (3) (5)                  |       | 4,648      |       | 4,294           |
|                                                    |       |                                                           |                                              | Preferred Equity  (7) (8)                                     |       | —     |       | —          |
|                                                    |       |                                                           |                                              | Common Stock  (7) (8)                                         |       | —     |       | —          |
|                                                    |       |                                                           |                                              |                                                               |       |       |       |            |
| Northern  Contours, Inc.                           |       | Manufacturing-veneer  and laminate components                  |                                              | Senior  Subordinated Term Debt (13.0%, Due 9/2012) (5)             |       | 6,388      |       | 5,781           |
|                                                         |            |                                                                |                                                   |                                                                    |            |            |            |                 |  |  |

 

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** **

**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**AS OF MARCH 31,2010**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company  (1)**                                 | ** ** | **Industry**                                                    | ** **                                   | **Investment  (2)**                                                  | ** ** | **Cost**   | ** ** | **Fair  Value** |
|--------------------------------------------------|------------|-----------------------------------------------------------------|----------------------------------------------|----------------------------------------------------------------------|------------|------------|------------|-----------------|
| ** **                                       | ** ** | ** **                                                      | ** **                                   | ** **                                                           | ** ** | ** ** | ** ** | ** **      |
| Northstar  Broadband, LLC                        |       | Service-cable TV  franchise owner                               |                                         | Senior Term Debt  (0.7%, Due 12/2012) (5)                            |       | $          | 143        |            | $ | 120 |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Pinnacle Treatment  Centers, Inc.           |       | Service-Addiction  treatment centers                            |                                         | Senior Term Debt  (10.5%, Due 12/2011) (5)                           |       | 2,350      |       | 2,332           |
|                                             |       |                                                            |                                         | Senior Term Debt  (10.5%, Due 12/2011) (3) (5)                  |       | 7,500      |       | 7,359           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Precision  Acquisition Group Holdings, Inc. |       | Manufacturing-consumable  components for the aluminum industry  |                                         | Equipment Note  (13.0%, Due 10/2010) (5)                             |       | 1,000      |       | 975             |
|                                             |       |                                                            | Senior Term Debt  (13.0%, Due 10/2010) (5)   |                                                                 | 4,125      |       | 4,022      |
|                                             |       |                                                            |                                         | Senior Term Debt  (13.0%, Due 10/2010) (3) (5)                  |       | 4,053      |       | 3,952           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| PROFITSystems  Acquisition Co.                   |       | Service-design  and develop ERP software                        |                                         | Line of Credit,  $350 available (4.5%, Due 7/2010)                   |       | —     |       | —          |
|                                             |       |                                                            |                                         | Senior Term Debt  (8.5%, Due 7/2011) (5)                             |       | 1,300      |       | 1,216           |
|                                             |       |                                                            |                                         | Senior Term Debt  (10.5%, Due 7/2011) (3) (5)                   |       | 2,900      |       | 2,686           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| RCS Management  Holding Co.                      |       | Service-healthcare  supplies                                    |                                         | Senior Term Debt  (8.5%, Due 1/2011) (3) (5)                    |       | 2,187      |       | 2,179           |
|                                             |       |                                                            |                                         | Senior Term Debt  (10.5%, Due 1/2011) (4) (5)                   |       | 3,060      |       | 3,037           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Reliable  Biopharmaceutical Holdings, Inc.  |       | Manufacturing-pharmaceutical  and biochemical intermediates     |                                         | Line of Credit,  $5,000 available (9.0%, Due 10/2010) (5)            |       | 700        |       | 698             |
|                                             |       |                                                            | Mortgage Note  (9.5%, Due 10/2014) (5)  |                                                                 | 7,293      |       | 7,284      |
|                                             |       |                                                            |                                         | Senior Term Debt  (9.0%, Due 10/2012) (5)                       |       | 1,305      |       | 1,302           |
|                                             |       |                                                            |                                         | Senior Term Debt  (11.0%, Due 10/2012) (3) (5)             |       | 11,753     |       | 11,635          |
|                                             |       |                                                            |                                         | Senior  Subordinated Term Debt (12.0%, Due 10/2013) (5)         |       | 6,000      |       | 5,873           |
|                                             |       |                                                            |                                         | Common Stock  Warrants (7) (8)                             |       | 209        |       | —          |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Saunders &  Associates                  |       | Manufacturing-equipment  provider for frequency control devices |                                         | Senior Term Debt  (9.8%, Due 5/2013) (5)                             |       | 9,558      |       | 9,534           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| SCI  Cable, Inc.                            |       | Service-cable,  internet, voice provider                        |                                         | Senior Term Debt  (non-accrual, Due 10/2008) (5) (10) (13) |       | 3,031      |       | 379             |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Sunburst Media -  Louisiana, LLC                 |       | Service-radio  station operator                                 |                                         | Senior Term Debt  (10.5%, Due 6/2011) (5)                            |       | 6,401      |       | 5,961           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Sunshine Media  Holdings                         |       | Service-publisher  regional B2B trade magazines                 |                                         | Line of credit,  $2,000 available (9.0%, Due 2/2011) (5)             |       | 799        |       | 751             |
|                                             |       |                                                            |                                         | Senior Term Debt  (10.5%, Due 5/2012) (5)                            |       | 16,948     |       | 15,931          |
|                                             |       |                                                            |                                         | Senior Term Debt  (13.3%, Due 5/2012) (3) (5)                   |       | 10,700     |       | 9,898           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Thibaut  Acquisition Co.                         |       | Service-design  and disbribute wall covering                    |                                         | Line of Credit,  $1,000 available (9.0%, Due 1/2011) (5)             |       | 1,000      |       | 957             |
|                                             |       |                                                            |                                         | Senior Term Debt  (8.5%, Due 1/2011) (5)                             |       | 1,413      |       | 1,352           |
|                                             |       |                                                            |                                         | Senior Term Debt  (12.0%, Due 1/2011) (3) (5)                   |       | 3,000      |       | 2,839           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| VantaCore                                        |       | Service-acquisition  of aggregate quarries                      |                                         | Senior  Subordinated Term Debt (12.0%, Due 8/2013) (14)              |       | 13,590     |       | 13,590          |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Viapack, Inc.                               |       | Manufacturing-polyethylene  film                                |                                         | Senior Real  Estate Term Debt (10.0%, Due 3/2011) (5)                |       | 725        |       | 719             |
|                                             |       |                                                            |                                         | Senior Term Debt  (13.0%, Due 3/2011) (3) (5)                   |       | 4,058      |       | 4,022           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Westlake  Hardware, Inc.                    |       | Retail-hardware  and variety                                    |                                         | Senior  Subordinated Term Debt (10.3%, Due 1/2011) (5)               |       | 15,000     |       | 14,700          |
|                                             |       |                                                            |                                         | Senior  Subordinated Term Debt (11.5%, Due 1/2011) (5)               |       | 10,000     |       | 9,700           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| Winchester  Electronics                          |       | Manufacturing-high  bandwidth connectors and cables             |                                         | Senior Term Debt  (5.2%, Due 12/2010) (5)                            |       | 1,250      |       | 1,244           |
|                                             |       |                                                            |                                         | Senior Term Debt  (5.7%, Due 5/2013) (5)                             |       | 1,686      |       | 1,648           |
|                                             |       |                                                            |                                         | Senior  Subordinated Term Debt (14.0%, Due 6/2013) (5)               |       | 9,900      |       | 9,529           |
|                                             |       |                                                            |                                         |                                                                 |       |       |       |            |
| *Subtotal  — Non-syndicated loans*          |       |                                                            |                                         |                                                                 |       | 265,125    |       | 248,364         |
|                                                  |            |                                                                 |                                              |                                                                      |            |            |            |                 |  |  |

 

4

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Table ofContents

 

**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**AS OF MARCH 31,2010**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company  (1)**                                 | ** ** | **Industry**                                             | ** ** | **Investment  (2)**                                                              | ** ** | **Cost**   | ** **  | **Fair  Value** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|------------|-------------|-----------------|
| ** **                                       | ** ** | ** **                                               | ** ** | ** **                                                                       | ** ** | ** ** | ** **  | ** **      |
| ***Syndicated Loans:***                          |       |                                                     |       |                                                                             |       |       |        |            |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| Puerto Rico Cable Acquisition Company, Inc. |       | Service-telecommunications                               |       | Senior  Subordinated Term Debt (7.8%, Due 1/2012) (6)                            |       | $          | 7,167       |            | $ | 6,284 |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| WP Evenflo Group  Holdings Inc.                  |       | Manufacturing-infant  and juvenile products              |       | Senior Term Debt  (8.0%, Due 2/2013) (6)                                         |       | 1,891      |        | 1,579           |
|                                             |       |                                                     |       | Senior Preferred  Equity (7) (8)                                       |       | 333        |        | —          |
|                                             |       |                                                     |       | Junior Preferred  Equity (7) (8)                                       |       | 111        |        | —          |
|                                             |       |                                                     |       | Common Stock  (7) (8)                                                  |       | —     |        | —          |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| *Subtotal  - Syndicated loans*                   |       |                                                     |       |                                                                             |       | 9,502      |        | 7,863           |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| **Total  Non-Control/Non-Affiliate Investments** |       |                                                     |       | ** **                                                                       | ** ** | **$**      | **274,627** |            | **$** | **256,227** |
| * *                                         | * *   |                                                     |       |                                                                             |       |       |        |            |
| **CONTROL  INVESTMENTS**                         |       |                                                     |       |                                                                             |       |       |        |            |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| BERTL, Inc.                                 |       | Service-web-based  evaluator of digital imaging products |       | Line of Credit,  $1,023 available (non-accrual, Due 10/2010) (7)(10)(12)         |       | $          | 996         |            | $ | 232 |
|                                             |       |                                                     |       | Common Stock  (7) (8)                                                       |       | 423        |        | —          |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| Clinton Holdings,  LLC                           |       | Distribution-aluminum  sheets and stainless steel        |       | Senior  Subordinated Term Debt (12.0%, Due 1/2013) (5)                           |       | 17,140     |        | 12,855          |
|                                             |       |                                                     |       | Common Stock  Warrants (7) (8)                                              |       | 109        |        | —          |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| Defiance  Integrated Technologies, Inc.     |       | Manufacturing-trucking  parts                            |       | Senior Term Debt  (11.0%, Due 4/2013) (3) (5)                               |       | 8,324      |        | 8,325           |
|                                             |       |                                                     |       | Common Stock  (7) (8)                                                       |       | 1          |        | —          |
|                                             |       |                                                     |       | Guaranty ($250)                                                                  |       |       |        |            |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| Lindmark Acquisition,  LLC                       |       | Service-advertising                                      |       | Senior  Subordinated Term Debt (non-accrual, Due 10/2012) (5) (9) (10) |       | 10,000     |        | 8,825           |
|                                             |       |                                                     |       | Senior  Subordinated Term Debt (non-accrual, Due 12/2010) (5) (9) (10) |       | 2,000      |        | 1,765           |
|                                             |       |                                                     |       | Senior  Subordinated Term Debt (non-accrual, Due Upon Demand) (5)(9)(10)         |       | 1,788      |        | 1,274           |
|                                             |       |                                                     |       | Common Stock  (7) (8)                                                       |       | 1          |        | —          |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| LYP Holdings  Corp.                              |       | Service-yellow  pages publishing                    |       | Line of credit,  $1,850 available (10.0%, Due 12/2010) (7)                       |       | 1,698      |        | 1,698           |
|                                             |       |                                                     |       | Senior Term Debt  (12.5%, Due 2/2012) (7)                                        |       | 325        |        | 325             |
|                                             |       |                                                     |       | Line of Credit,  $3,000 available (non-accrual, Due 6/2010) (7) (10)        |       | 1,170      |        | 64              |
|                                             |       |                                                     |       | Senior Term Debt  (non-accrual, Due 6/2011) (7) (10)                        |       | 2,688      |        | —          |
|                                             |       |                                                     |       | Senior Term Debt  (non-accrual, Due 6/2011) (3) (7) (10)               |       | 2,750      |        | —          |
|                                             |       |                                                     |       | Common Stock Warrants  (7) (8)                                              |       | —     |        | —          |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| U.S. Healthcare  Communications, Inc.       |       | Service-magazine  publisher/operator                     |       | Line of credit,  $400 available (non-accrual, Due 12/2010) (7) (10)         |       | 269        |        | 161             |
|                                             |       |                                                     |       | Line of credit,  $450 available (non-accrual, Due 12/2010) (7) (10)         |       | 450        |        | —          |
|                                             |       |                                                     |       | Common Stock  (7) (8)                                                       |       | 2,470      |        | —          |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| Western  Directories, Inc.                  |       | Service-directory  publisher                             |       | Line of credit,  $1,280 available (non-accrual, Due 12/2010) (7) (10)       |       | 1,280      |        | —          |
|                                             |       |                                                     |       | Preferred Stock  (7) (8)                                                    |       | 1,584      |        | —          |
|                                             |       |                                                     |       | Common Stock  (7) (8)                                                       |       | 1          |        | —          |
|                                             |       |                                                     |       |                                                                             |       |       |        |            |
| **Total  Control Investments**                   | ** ** | ** **                                               | ** ** | ** **                                                                       | ** ** | **$**      | **55,467**  | ** **      | **$** | **35,524** |
| ** **                                       | ** ** | ** **                                               | ** ** | ** **                                                                       | ** ** | ** ** |        | ** **      |
| **Total  Investments**                           |       |                                                     |       |                                                                             |       | **$**      | **330,094** | ** **      | **$** | **291,751** |

 

5

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Table ofContents

 

**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**AS OF MARCH 31,2010**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 

----

| (1)  | Certain of the listed securities are issued by  affiliate(s) of the indicated portfolio company.                                                                                                                                                                                                                                                                                                                                                                 |
|------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  | Percentage represents interest rates in effect at  March 31, 2010 and due date represents the contractual maturity date.                                                                                                                                                                                                                                                                                                                                         |
| (3)  | Last Out Tranche of senior debt, meaning if the  portfolio company is liquidated, the holder of the Last Out Tranche is paid  after the senior debt.                                                                                                                                                                                                                                                                                                                  |
| (4)  | Last Out Tranche of senior debt, meaning if the  portfolio company is liquidated, the holder of the Last Out Tranche is paid  after the senior debt, however, the debt is also junior to another Last Out  Tranche.                                                                                                                                                                                                                                                   |
| (5)  | Fair value was based on opinions of value submitted  by Standard & Poor’s Securities Evaluations, Inc.                                                                                                                                                                                                                                                                                                                                             |
| (6)  | Security valued based on the indicative bid price on  or near March 31, 2010, offered by the respective syndication agent’s  trading desk or secondary desk.                                                                                                                                                                                                                                                                                                |
| (7)  | Fair value was  based on the total enterprise value of the portfolio company using a  liquidity waterfall approach. The Company also considered discounted cash  flow methodologies.                                                                                                                                                                                                                                                                                  |
| (8)  | Security is non-income producing.                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| (9)  | Lindmark’s loan agreement was amended in  March 2009 such that any unpaid current interest accrues at a success  fee rate.  The success fee is to be paid upon certain conditions being  met and is not recorded until paid. Please refer to Note 2, “Summary of  Significant Accounting Policies — Interest Income Recognition.” For the three  and six months ended March 31, 2010, the Company recorded $0 of interest  income. |
| (10) | BERTL, Lindmark,  SCI Cable, U.S. Healthcare, Western Directories and a portion of LYP Holdings  are currently past due on interest payments and are on non-accrual.                                                                                                                                                                                                                                                                                                  |
| (11) | Access TV’s loan  matured in December 2009. The Company is actively working to recover  amounts due under this loan, however, there is no assurance that there will  be any recovery of amounts past due.                                                                                                                                                                                                                                                   |
| (12) | ACE Expediters’  interest and BERTL’s interest include paid in kind interest. Please refer to  Note 2, “Summary of Significant Accounting Policies.”                                                                                                                                                                                                                                                                                              |
| (13) | Subsequent to  March 31, 2010, International Junior Golf’s line of credit was extended  to May 2011 and SCI Cable’s senior term debt was amended with a maturity  date of October 2012.                                                                                                                                                                                                                                                      |
| (14) | VantaCore’s fair  value was based on the full repayment subsequent to March 31, 2010.  Please refer to Note 10, “Subsequent Events.”                                                                                                                                                                                                                                                                                                              |

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS.*

 

6

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Table ofContents

 

**GLADSTONECAPITAL CORPORATION**

**CONSOLIDATEDSCHEDULE OF INVESTMENTS**

**AS OFSEPTEMBER 30, 2009**

**(DOLLARAMOUNTS IN THOUSANDS)**

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

 

7

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Table of Contents

 

**GLADSTONE CAPITAL CORPORATION**

**CONSOLIDATED SCHEDULE OF INVESTMENTS(Continued)**

**SEPTEMBER 30, 2009**

**(DOLLARAMOUNTS IN THOUSANDS)**

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

 

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Table of Contents

 

**GLADSTONE CAPITAL CORPORATION**

**CONSOLIDATED SCHEDULE OF INVESTMENTS(Continued)**

**SEPTEMBER 30, 2009**

**(DOLLARAMOUNTS IN THOUSANDS)**

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

 

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| (1)  | Certain of the  listed securities are issued by affiliate(s) of the indicated portfolio  company.                                                                                                                                                                                                                                                                                                                                                                         |
|------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  | Percentage  represents interest rates in effect at September 30, 2009 and due date  represents the contractual maturity date.                                                                                                                                                                                                                                                                                                                                             |
| (3)  | Last Out Tranche  of senior debt, meaning if the portfolio company is liquidated, the holder of  the Last Out Tranche is paid after the senior debt.                                                                                                                                                                                                                                                                                                                           |
| (4)  | Last Out Tranche  of senior debt, meaning if the portfolio company is liquidated, the holder of  the Last Out Tranche is paid after the senior debt, however, the debt is also  junior to another Last Out Tranche.                                                                                                                                                                                                                                                            |
| (5)  | Fair value was  based on opinions of value submitted by Standard & Poor’s Securities  Evaluations, Inc.                                                                                                                                                                                                                                                                                                                                                     |
| (6)  | Security valued  based on the indicative bid price on or near September 30, 2009, offered  by the respective syndication agent’s trading desk or secondary desk.                                                                                                                                                                                                                                                                                                     |
| (7)  | Security valued  based on the transaction sale price subsequent to September 30, 2009.                                                                                                                                                                                                                                                                                                                                                                                    |
| (8)  | Security is  non-income producing.                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (9)  | Access  Television includes a success fee with a fair value of $1.                                                                                                                                                                                                                                                                                                                                                                                                             |
| (10) | BERTL, CCS, U.S.  Healthcare, Western Directories and a portion of LYP Holdings are currently  past due on interest payments and are on non-accrual. BERTL’s loan matured in  October 2009 and the Company is actively working to recover amounts due  under this loan. However, there is no assurance that there will be any  recovery of amounts past due.                                                                                                         |
| (11) | Fair value of  security estimated to be equal to cost due to recent recapitalization.                                                                                                                                                                                                                                                                                                                                                                                          |
| (12) | BAS  Broadcasting’s loan matured in July 2009, CCS’ loan matured in August 2008  and SCI Cable’s loan matured in October 2008. The Company is actively  working to recover amounts due under these loans, however, there is no  assurance that there will be any recovery of amounts past due.                                                                                                                                                   |
| (13) | ACE Expediters’  interest and BERTL’s interest include paid in kind interest. Please refer to  Note 2, “Summary of Significant Accounting Policies.”                                                                                                                                                                                                                                                                                                       |
| (14) | Subsequent to  September 30, 2009, Clinton’s senior subordinated term debt and escrow  funding note were combined into one term note, with an interest rate of 12.0%  and maturity date of January 2013. In addition, a term loan was entered  into for $320, with an interest rate of 12.0% and maturity date of  January 2013.                                                                                                                           |
| (15) | Fair value was  based on the total enterprise value of the portfolio company using a  liquidity waterfall approach.  The  Company also considered discounted cash flow methodologies.                                                                                                                                                                                                                                                                                     |
| (16) | Lindmark’s loan  agreement was amended in March 2009 such that any unpaid current  interest accrues at a success fee rate.  The success fee is to be paid  upon certain conditions being met and is not recorded until paid. Please  refer to Note 2, “Summary of Significant Accounting Policies — Interest  Income Recognition.” For the period from April 2009 through  September 2009, the Company recorded $0 of interest income. |

 

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

 

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**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(UNAUDITED)**

 
| ** **                                                                      | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                      | ** ** | **2010**                               | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| INVESTMENT INCOME                                                               |       |                                   |       |                                |       |   |   |   |   |
| Interest income —  Non-Control/Non-Affiliate investments                   |       | $                                      | 8,523      |                                | $          | 10,329 |   | $ | 17,432 |   | $ | 21,990 |   |
| Interest income — Control investments                                      |       | 709                                    |       | 482                                 |       | 1,477 |   | 502 |   |
| Interest income — Cash                                                     |       | —                                 |       | 1                                   |       | — |   | 11 |   |
| Interest income — Notes receivable from employees (Refer to Note 4)        |       | 108                                    |       | 117                                 |       | 221 |   | 235 |   |
| Prepayment fees and other income                                                |       | 474                                    |       | —                              |       | 488 |   | — |   |
| Total investment income                                                         |       | 9,814                                  |       | 10,929                              |       | 19,618 |   | 22,738 |   |
|                                                                            |       |                                   |       |                                |       |   |   |   |   |
| EXPENSES                                                                        |       |                                   |       |                                |       |   |   |   |   |
| Interest expense                                                                |       | 1,136                                  |       | 2,016                               |       | 2,671 |   | 4,478 |   |
| Loan servicing fee (Refer to Note 4)                                            |       | 852                                    |       | 1,526                               |       | 1,781 |   | 3,149 |   |
| Base management fee (Refer to Note 4)                                           |       | 739                                    |       | 484                                 |       | 1,459 |   | 917 |   |
| Incentive fee (Refer to Note 4)                                                 |       | 1,072                                  |       | 1,089                               |       | 1,447 |   | 2,265 |   |
| Administration fee (Refer to Note 4)                                            |       | 176                                    |       | 211                                 |       | 354 |   | 438 |   |
| Professional fees                                                               |       | 219                                    |       | 205                                 |       | 1,131 |   | 518 |   |
| Amortization of deferred financing fees                                         |       | 449                                    |       | 726                                 |       | 943 |   | 1,446 |   |
| Stockholder related costs                                                       |       | 144                                    |       | 196                                 |       | 222 |   | 284 |   |
| Directors fees                                                                  |       | 48                                     |       | 48                                  |       | 97 |   | 97 |   |
| Insurance expense                                                               |       | 79                                     |       | 65                                  |       | 147 |   | 122 |   |
| Compensation expense (Refer to Note 4)                                          |       | 245                                    |       | —                              |       | 245 |   | — |   |
| Other expenses                                                                  |       | 187                                    |       | 74                                  |       | 254 |   | 140 |   |
| Expenses before credit from Adviser                                             |       | 5,346                                  |       | 6,640                               |       | 10,751 |   | 13,854 |   |
| Credit to base management and incentive feesfrom Adviser (Refer to Note  4)     |       | (6                                     | )          | (1,266                              | )          | (35 | ) | (2,553 | ) |
| Total expenses net of credit to base management and incentive fees              |       | 5,340                                  |       | 5,374                               |       | 10,716 |   | 11,301 |   |
|                                                                            |       |                                   |       |                                |       |   |   |   |   |
| NET INVESTMENT INCOME                                                           |       | 4,474                                  |       | 5,555                               |       | 8,902 |   | 11,437 |   |
|                                                                            |       |                                   |       |                                |       |   |   |   |   |
| REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS,                             |       |                                   |       |                                |       |   |   |   |   |
| DERIVATIVE AND BORROWINGS UNDER LINE OF CREDIT:                                 |       |                                   |       |                                |       |   |   |   |   |
| Net realized gain (loss) on investments                                         |       | 892                                    |       | (2,000                              | )          | (28 | ) | (3,731 | ) |
| Realized loss on settlement of derivative                                       |       | —                                 |       | (304                                | )          | — |   | (304 | ) |
| Unrealized appreciation on derivative                                           |       | —                                 |       | 304                                 |       | — |   | 304 |   |
| Net unrealized appreciation (depreciation) on investments                       |       | 2,483                                  |       | 6,725                               |       | 5,082 |   | (6,528 | ) |
| Net unrealized depreciation on borrowings under line of credit                  |       | 131                                    |       | —                              |       | 350 |   | — |   |
| Net gain (loss) on investments, derivative and borrowings under line  of credit |       | 3,506                                  |       | 4,725                               |       | 5,404 |   | (10,259 | ) |
|                                                                            |       |                                   |       |                                |       |   |   |   |   |
| NET INCREASE IN NET ASSETS RESULTING FROMOPERATIONS                             |       | $                                      | 7,980      |                                | $          | 10,280 |   | $ | 14,306 |   | $ | 1,178 |   |
|                                                                            |       |                                   |       |                                |       |   |   |   |   |
| NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE:          |       |                                   |       |                                |       |   |   |   |   |
| Basic and Diluted                                                               |       | $                                      | 0.38       |                                | $          | 0.48 |   | $ | 0.68 |   | $ | 0.05 |   |
|                                                                            |       |                                   |       |                                |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING:                            |       |                                   |       |                                |       |   |   |   |   |
| Basic and Diluted                                                               |       | 21,075,445                             |       | 21,087,574                          |       | 21,081,576 |   | 21,087,574 |   |

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS.*

 

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**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS**

**(DOLLAR AMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                                                      | ** ** | **Six Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                      | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| *Operations:*                                                                   |       |                                |       |   |   |
| Net investment  income                                                          |       | $                                   | 8,902      |   | $ | 11,437 |   |
| Net realized  loss on investments                                               |       | (28                                 | )          | (3,731 | ) |
| Realized loss on  settlement of derivative                                      |       | —                              |       | (304 | ) |
| Unrealized appreciation  on derivative                                          |       | —                              |       | 304 |   |
| Net unrealized  appreciation (depreciation) on investments                      |       | 5,082                               |       | (6,528 | ) |
| Net unrealized  depreciation on borrowings under line of credit                 |       | 350                                 |       | — |   |
| Net increase in  net assets from operations                                     |       | 14,306                              |       | 1,178 |   |
|                                                                            |       |                                |       |   |   |
| *Capital  transactions:*                                                        |       |                                |       |   |   |
| Shelf offering  costs                                                           |       | (74                                 | )          | (3 | ) |
| Distributions to  stockholders                                                  |       | (8,853                              | )          | (17,714 | ) |
| Repayment of  principal on employee notes                                       |       | —                              |       | 4 |   |
| Conversion of  former employee stock option loans from recourse to non-recourse |       | (420                                | )          | — |   |
| Reclassification  of principal on employee note                                 |       | 514                                 |       | — |   |
| Net decrease in  net assets from capital transactions                           |       | (8,833                              | )          | (17,713 | ) |
|                                                                            |       |                                |       |   |   |
| Total increase  (decrease) in net assets                                        |       | 5,473                               |       | (16,535 | ) |
| Net assets at  beginning of year                                                |       | 249,076                             |       | 271,748 |   |
| Net assets at  end of period                                                    |       | $                                   | 254,549    |   | $ | 255,213 |   |

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS.*

 

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**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(DOLLAR AMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                                                                                                    | ** ** | **Six Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                      |       |                                |       |   |   |
| Net increase in net assets resulting from operations                                                                          |       | $                                   | 14,306     |   | $ | 1,178 |   |
| Adjustments to reconcile  net increase in net assets resulting from operations to net cash provided by  operating activities: |       |                                |       |   |   |
| Purchase of investments                                                                                                       |       | (7,320                              | )          | (17,129 | ) |
| Principal repayments on investments                                                                                           |       | 38,418                              |       | 27,980 |   |
| Proceeds from sale of investments                                                                                             |       | 3,119                               |       | 2,212 |   |
| Net amortization of premiums and discounts                                                                                    |       | 63                                  |       | (109 | ) |
| Increase in investment balance due to paid in kind interest                                                                   |       | (60                                 | )          | (377 | ) |
| Repayment of paid in kind interest                                                                                            |       | 51                                  |       | — |   |
| Net realized loss on investments                                                                                              |       | 28                                  |       | 3,731 |   |
| Amortization of deferred financing fees                                                                                       |       | 943                                 |       | 1,445 |   |
| Realized loss on settlement of derivative                                                                                     |       | —                              |       | 304 |   |
| Unrealized appreciation on derivative                                                                                         |       | —                              |       | (304 | ) |
| Change in net unrealized (depreciation) appreciation on investments                                                           |       | (5,082                              | )          | 6,528 |   |
| Change in net unrealized appreciation on borrowings under line of  credit                                                     |       | (350                                | )          | — |   |
| Change in compensation expense from non-recourse notes                                                                        |       | 245                                 |       | — |   |
| Decrease in interest receivable                                                                                               |       | 655                                 |       | 89 |   |
| Increase in funds due from custodian                                                                                          |       | (7,512                              | )          | (5,588 | ) |
| Decrease in prepaid assets                                                                                                    |       | 53                                  |       | 57 |   |
| Decrease in due from affiliate                                                                                                |       | 69                                  |       | — |   |
| Decrease in receivables from portfolio companies                                                                              |       | 1,161                               |       | — |   |
| Increase in other assets                                                                                                      |       | (2                                  | )          | (317 | ) |
| Decrease in accounts payable                                                                                                  |       | (67                                 | )          | — |   |
| Decrease in interest payable                                                                                                  |       | (134                                | )          | (166 | ) |
| Decrease in accrued expenses and deferred liabilities                                                                         |       | (752                                | )          | (33 | ) |
| Increase in fees due to affiliate (Refer to Note 4)                                                                           |       | 1,531                               |       | 235 |   |
| Decrease in administration fee due to Gladstone Administration (Refer  to Note 4)                                             |       | (39                                 | )          | (37 | ) |
| Decrease in funds held in escrow                                                                                              |       | (89                                 | )          | (113 | ) |
| Net cash provided by operating activities                                                                                     |       | 39,235                              |       | 19,586 |   |
|                                                                                                                          |       |                                |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                                     |       |                                |       |   |   |
| Shelf offering costs                                                                                                          |       | (74                                 | )          | (3 | ) |
| Borrowings from the line of credit                                                                                            |       | 5,500                               |       | 39,300 |   |
| Repayments on the line of credit                                                                                              |       | (35,500                             | )          | (36,960 | ) |
| Distributions paid                                                                                                            |       | (8,853                              | )          | (17,714 | ) |
| Receipt of principal on notes receivable — employees (Refer to Note 4)                                                   |       | —                              |       | 4 |   |
| Deferred financing fees                                                                                                       |       | (1,323                              | )          | (177 | ) |
| Net cash used in financing activities                                                                                         |       | (40,250                             | )          | (15,550 | ) |
|                                                                                                                          |       |                                |       |   |   |
| **NET (DECREASE) INCREASE IN CASH**                                                                                           |       | (1,015                              | )          | 4,036 |   |
| **CASH, BEGINNING OF PERIOD**                                                                                                 |       | 5,276                               |       | 6,493 |   |
| **CASH, END OF PERIOD**                                                                                                       |       | $                                   | 4,261      |   | $ | 10,529 |   |
| ** **                                                                                                                    |       |                                |       |   |   |
| **NON-CASH FINANCING ACTIVITIES**                                                                                             |       |                                |       |   |   |
| Portfolio company payoff proceeds held in  escrow (included in other assets and other liabilities)                            |       | $                                   | 155        |   | $ | — |   |
| Reclassification of principal on employee  note (Refer to Note 4)                                                             |       | $                                   | 514        |   | $ | — |   |
| Conversion of former employee stock option  loans from recourse to non-recourse (Refer to Note 6)                             |       | $                                   | 420        |   | $ | — |   |

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS.*

 

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**GLADSTONECAPITAL CORPORATION**

**FINANCIAL HIGHLIGHTS**

**(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PER UNITDATA)**

**(UNAUDITED)**

** **
| ** **                                                                      | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                      | ** ** | **2010**                               | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Per Share Data (1)                                                              |       |                                   |       |                                |       |   |   |   |   |
| Net asset value at beginning of period                                          |       | $                                      | 11.92      |                                | $          | 12.04 |   | $ | 11.81 |   | $ | 12.89 |   |
| *Income from investment operations:*                                            |       |                                   |       |                                |       |   |   |   |   |
| Net investment income (2)                                                       |       | 0.21                                   |       | 0.26                                |       | 0.42 |   | 0.54 |   |
| Net realized gain (loss) on investments (2)                                     |       | 0.04                                   |       | (0.09                               | )          | — |   | (0.18 | ) |
| Realized loss on settlement of derivative (2)                                   |       | —                                 |       | (0.01                               | )          | — |   | (0.01 | ) |
| Unrealized appreciation on derivative (2)                                       |       | —                                 |       | 0.01                                |       | — |   | 0.01 |   |
| Net unrealized appreciation (depreciation) on investments (2)                   |       | 0.12                                   |       | 0.31                                |       | 0.24 |   | (0.31 | ) |
| Net unrealized depreciation on borrowings under line of credit (2)              |       | 0.01                                   |       | —                              |       | 0.02 |   | — |   |
| Total from investment operations                                                |       | 0.38                                   |       | 0.48                                |       | 0.68 |   | 0.05 |   |
|                                                                            |       |                                   |       |                                |       |   |   |   |   |
| Distributions to stockholders (3)                                               |       | (0.21                                  | )          | (0.42                               | )          | (0.42 | ) | (0.84 | ) |
| Conversion of former employee stock option loans from recourse to  non-recourse |       | (0.02                                  | )          | —                              |       | (0.02 | ) | — |   |
| Reclassification of principal on employee note                                  |       | —                                 |       | —                              |       | 0.02 |   | — |   |
| Anti-dilutive effect from retirement of employee loan shares                    |       | 0.03                                   |       | —                              |       | 0.03 |   | — |   |
| Net asset value at end of period                                                |       | $                                      | 12.10      |                                | $          | 12.10 |   | $ | 12.10 |   | $ | 12.10 |   |
|                                                                            |       |                                   |       |                                |       |   |   |   |   |
| Per share market value at beginning of period                                   |       | $                                      | 7.69       |                                | $          | 8.09 |   | $ | 8.93 |   | $ | 15.24 |   |
| Per share market value at end of period                                         |       | $                                      | 11.80      |                                | $          | 6.26 |   | $ | 11.80 |   | $ | 6.26 |   |
| Total return (4)(5)                                                             |       | 56.94                                  | %          | (17.93                              | )%         | 38.77 | % | (54.11 | )% |
| Shares outstanding at end of period                                             |       | 21,039,242                             |       | 21,087,574                          |       | 21,039,242 |   | 21,087,574 |   |
| Statement of Assets and Liabilities Data:                                       |       |                                   |       |                                |       |   |   |   |   |
| Net assets at end of period                                                     |       | $                                      | 254,549    |                                | $          | 255,213 |   | $ | 254,549 |   | $ | 255,213 |   |
| Average net assets (6)                                                          |       | $                                      | 251,111    |                                | $          | 249,526 |   | $ | 251,111 |   | $ | 255,763 |   |
| Senior Securities Data:                                                         |       |                                   |       |                                |       |   |   |   |   |
| Borrowings under line of credit                                                 |       | $                                      | 53,000     |                                | $          | 153,370 |   | $ | 53,000 |   | $ | 153,370 |   |
| Asset coverage ratio (7)(8)                                                     |       | 575                                    | %          | 266                                 | %          | 575 | % | 266 | % |
| Asset coverage per unit (8)                                                     |       | $                                      | 5,754      |                                | $          | 2,659 |   | $ | 5,754 |   | $ | 2,659 |   |
| Ratios/Supplemental Data:                                                       |       |                                   |       |                                |       |   |   |   |   |
| Ratio of expenses to average net assets-annualized (9)                          |       | 8.52                                   | %          | 10.64                               | %          | 8.60 | % | 10.83 | % |
| Ratio of net expenses to average net assets-annualized (10)                |       | 8.51                                   | %          | 8.61                                | %          | 8.57 | % | 8.84 | % |
| Ratio of net investment income to average net assets-annualized                 |       | 7.13                                   | %          | 8.91                                | %          | 7.12 | % | 8.94 | % |

 

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

 

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| (9)  | Ratio of expenses to  average net assets is computed using expenses before credits from Adviser to  the base management and incentive fees and including income tax expense.           |
|------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (10) | Ratio of net expenses to average net  assets is computed using total expenses net of credits from Adviser to the base  management and incentive fees and including income tax expense. |

 

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

 

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**GLADSTONECAPITAL CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**MARCH 31,2010**

**(DOLLARAMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA AND AS OTHERWISE INDICATED)**

**(UNAUDITED)**

 

**NOTE 1.  ORGANIZATION**

 

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

 

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

 

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

 

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

 

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

 

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

 

**NOTE 2.  SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

*Unaudited Interim Financial Statements*

 

Interimfinancial statements of the Company are prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) forinterim financial information and pursuant to the requirements for reporting onForm 10-Q and Article 10 of Regulation S-X.  Accordingly, certain disclosures accompanyingannual financial statements prepared in accordance with GAAP are omitted.  In the opinion of the Company’s management,all adjustments, consisting solely of normal recurring accruals, necessary forthe fair statement of financial statements for the interim periods have beenincluded.  The current period’s resultsof operations are not necessarily indicative of results that ultimately may beachieved for the year.  The interimfinancial statements and notes thereto should be read in conjunction with thefinancial statements and notes thereto included in the Company’s Form 10-Kfor the fiscal year ended September 30, 2009, as filed with the Securitiesand Exchange Commission (the “SEC”) on November 23, 2009.

 

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

 

*Reclassifications*

 

Certain amounts inthe prior year’s financial statements have been reclassified to conform to thecurrent year presentation with no effect to net increase in net assetsresulting from operations.  The Company’sasset coverage ratio calculation was revised so the indebtedness includesinterest payable and guarantees.

 

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*Out-of-Period Adjustment*

 

During the three and six months ended March 31, 2010, the Companyrecorded adjustments to interest income, operating expenses and certain balancesheet accounts to reverse interest income and record additional expensesprimarily related to professional fees that were not correctly recorded inprior periods. The net adjustments resulted in reductions of $408 and $551 innet investment income for the three and six months ended March 31, 2010,respectively. These adjustments reduced net investment income per share by$0.02 and $0.03 for the three and six months ended March 31, 2010,respectively. These adjustments both individually and in the aggregate were notmaterial to any of the fiscal 2009 interim or full year consolidated financialstatements nor are they expected to be material to full year fiscal 2010results.

 

*Investment Valuation Policy*

 

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

 

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

 

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

 

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

 

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

 

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

 

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As of March 31,2010, the Company assessed trading activity in its syndicated loan assets anddetermined that there continued to be market liquidity and a functioningsecondary market for these assets.  Thus,firm bid prices or indicative bids were used to fair value the Company’sremaining syndicated loans as of March 31, 2010.

 

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

 

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

 

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

 

·                  the issuer’s ability to make payments;

·                  the earnings of the issuer;

·                  recent sales to third parties of similar securities;

·                  the comparison to publicly traded securities; and

·                  DCF or other pertinent factors.

 

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

 

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

 

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

 

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

 

*InterestIncome Recognition*

 

Interest income, adjusted for amortization of premiums and acquisitioncosts and for the accretion of discounts, is recorded on the accrual basis tothe extent that such amounts are expected to be collected. Generally, when a loan becomes 90 days ormore past due or if the Company’s qualitative assessment indicates that thedebtor is unable to service its debt or other obligations, the Company willplace the loan on non-accrual status and cease recognizing interest income onthat loan until the borrower has demonstrated the ability and intent to paycontractual amounts due.  However, theCompany remains contractually entitled to this interest.  Interest payments received on loans on non-accrualmay be recognized as income or applied to principal depending upon management’sjudgment.  Loans on non-accrual arerestored to accrual status when past due principal and interest is paid or dueto a restructuring such that the interest income is deemed to be collectible, andin management’s judgment, are likely to remain current.  At March 31,2010, one Non-Control/Non-Affiliate investment and five Control investmentswere on non-accrual with an aggregate cost basis of approximately $26,422, or8.0% of the cost basis of all loans in the Company’s portfolio.  At September 30, 2009, oneNon-Control/Non-Affiliate investment and four Control investments were onnon-accrual with an aggregate cost basis of approximately $10,022, or 2.8% ofthe cost basis of all loans in the Company’s portfolio.  Success fees are recorded upon receipt andare contractually due upon a change of control in a portfolio company.

 

*Paid in Kind Interest*

 

TheCompany has two loans in its portfolio which contain PIK provisions. The PIKinterest, computed at the contractual rate specified in each loan agreement, isadded to the principal balance of the loan and recorded as income. To maintainthe Company’s status as a RIC, this non-cash source of income must be paid outto stockholders in the form of distributions, even though the Company has notyet collected the cash.  The Companyrecorded PIK income of $49 and $100 for the three and six months ended March 31,2010, respectively, as compared to $13 and $31 for the three and six monthsended March, 31 2009, respectively.

 

*Services Provided to Portfolio Companies*

 

Asof March 31, 2010 and September 30, 2009, the Company had grossreceivables from portfolio companies of $544 and $1,528, respectively, ofreimbursements for non-recurring costs incurred on behalf of the portfoliocompanies.  The allowance for uncollectiblereceivables was $177 and $0 as of March 31, 2010 and September 30,2009, respectively.

 

*Recent Accounting Pronouncements*

 

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

 

In September 2009, theFASB issued ASU No. 2009-12, “Measuring Fair Value Measurements andDisclosures: Investments in Certain Entities That Calculate Net Asset Value perShare (or Its Equivalent),” that provides additional guidance on how companiesshould estimate the fair value of certain alternative investments, such ashedge funds, private equity funds and venture capital funds. The fair value of suchinvestments can now be determined using net asset value (“NAV”) as a practicalexpedient, unless it is probable that the investment will not be sold at aprice equal to NAV. In those situations, the practical expedient cannot be usedand disclosure of the remaining actions necessary to complete the sale will berequired.  New disclosures of theattributes of all investments within the scope of the new guidance is required,regardless of whether an entity used the practical expedient to measure thefair value of any of its investments. ASU No. 2009-12 is effective for the first annual or interimreporting period ending after December 15, 2009, with early applicationpermitted. The Company determined that the adoption of this standard did nothave a material effect on its financial position and results of operations asof and for the six months ended March 31, 2010.

 

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In December 2009,the FASB issued ASU No. 2009-17, “Consolidations: Improvements toFinancial Reporting by Enterprises Involved with Variable Interest Entities,”that amends the FASB ASC for the issuance of FASB Statement No. 167, “Amendments to FASB Interpretation No. 46(R).”  The amendments in this ASU replace thequantitative-based risks and rewards calculation for determining whichreporting entity, if any, has a controlling financial interest in a variableinterest entity with an approach focused on identifying which reporting entityhas the power to direct the activities of a variable interest entity that mostsignificantly impact such entity’s economic performance and (1) theobligation to absorb losses of such entity or (2) the right to receive benefitsfrom such entity. An approach that is expected to be primarily qualitative willbe more effective for identifying which reporting entity has a controllingfinancial interest in a variable interest entity. The amendments in ASU No. 2009-17also require additional disclosures about a reporting entity’s involvement invariable interest entities, which will enhance the information provided tousers of financial statements.  ASU No. 2009-17is effective for annual periods beginning after November 15, 2009.  The Company does not believe the adoption ofthis standard will have a material effect on its financial position and resultsof operations.

 

In January 2010, the FASB issued ASU No. 2010-06, “Fair ValueMeasurements and Disclosures,” that requires reporting entities to make newdisclosures about recurring or nonrecurring fair-value measurements includingsignificant transfers into and out of Level 1 and Level 2 fair-valuemeasurements and information on purchases, sales, issuances, and settlements ona gross basis in the reconciliation of Level 3 fair-value measurements.  The FASB also clarified existing fair-valuemeasurement disclosure guidance about the level of disaggregation, inputs, andvaluation techniques. The new and revised disclosures are required to beimplemented in interim or annual periods beginning after December 15,2009, except for the gross presentation of the Level 3 rollforward, which isrequired for annual reporting periods beginning after December 15,2010.  The Company adopted ASU No. 2010-06beginning with the quarter ended March 31, 2010.  The adoption of this standard did not have amaterial effect on the Company’s financial position and results of operations.

 

In February 2010,the FASB issued ASU No. 2010-09, “Subsequent Events,” that amended itsguidance on subsequent events.  SECfilers are not required to disclose the date through which an entity hasevaluated subsequent events.  The amendedguidance was effective upon issuance for all entities.

 

InFebruary 2010, the FASB issued ASU 2010-10, “Consolidations” to defer FAS167, Amendments to FASB Interpretation No. 46(R), for certain investmententities that have the attributes of entities subject to ASC 946 (the “investmentcompany guide”). In addition, the ASU (1) amends the requirements forevaluating whether a decision maker or service contract is a variable interestto clarify that a quantitative approach should not be the sole consideration inassessing the criteria and (2) clarifies that related parties should beconsidered in applying all of the decision maker and service contract criteria.The Company’s adoption of this standard did not have a material effect on itsfinancial position and results of operations.

 

**NOTE 3. INVESTMENTS**

 

The Company adopted guidance for fair value measurements on October 1,2008.  In part, this guidance definesfair value, establishes a framework for measuring fair value and expandsdisclosures about assets and liabilities measured at fair value. The guidanceprovides a consistent definition of fair value that focuses on exit price inthe principal, or most advantageous, market and prioritizes, within ameasurement of fair value, the use of market-based inputs over entity-specificinputs. The guidance also establishes the following three-level hierarchy forfair value measurements based upon the transparency of inputs to the valuationof an asset or liability as of the measurement date.

 

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

 

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

 

·                  *Level 3*— inputs to the valuation methodology areunobservable and significant to the fair value measurement. Unobservable inputsare those inputs that reflect the Company’s own assumptions that marketparticipants would use to price the asset or liability based upon the bestavailable information.

 

As of March 31, 2010, all of the Company’s assets were valuedusing Level 3 inputs.

 

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The following table presents the financial instruments carried at fairvalue as of March 31, 2010 and September 30, 2009, by caption on theaccompanying condensed consolidated statements of assets and liabilities foreach of the three levels of hierarchy established by the guidance:

 
| ** **                       | ** ** | **As of  March 31, 2010** | ** ** |
|----------------------------------|------------|--------------------------------|------------|
| ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statements of** | ** ** |
| ** **                       | ** ** | **Level 1**               | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Senior Term Debt                 |       | $                              | —     |   | $ | — |   | $ | 188,348 |   | $ | 188,348 |   |
| Senior Subordinated Term Debt    |       | —                         |       | — |   | 102,752 |   | 102,752 |   |
| Preferred Equity Securities      |       | —                         |       | — |   | — |   | — |   |
| Common Equity Securities         |       | —                         |       | — |   | 651 |   | 651 |   |
| Total  investments at fair value |       | $                              | —     |   | $ | — |   | $ | 291,751 |   | $ | 291,751 |   |

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

 

*Changes in Level 3 Fair ValueMeasurements*

 

The following table provides a roll-forward in the changes in fairvalue during the three-month period from December 31, 2009 to March 31,2010, and for the six-month period from September 30, 2009 to March 31,2010, for all investments for which the Company determines fair value usingunobservable (Level 3) factors. When a determination is made to classify afinancial instrument within Level 3 of the valuation hierarchy, thedetermination is based upon the significance of the unobservable factors to theoverall fair value measurement. However, Level 3 financial instrumentstypically include, in addition to the unobservable or Level 3 components,observable components (that is, components that are actively quoted and can bevalidated by external sources). Accordingly, the losses in the table belowinclude changes in fair value due in part to observable factors that are partof the valuation methodology.

 

**Fair value measurements usingunobservable data inputs (Level 3)**

 
| ** **                                                | ** ** | **Non-Control/  Non-Affiliate  Investments** | ** ** | **Control  Investments** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------|------------|-----------|------------|
| **Three  months ended March 31, 2010:**              |       |                                         |       |                     |       |      |       |
| Fair value at  December 31, 2009                     |       | $                                            | 272,380    |                     | $          | 34,258    |       | $ | 306,638 |   |
| Total gains or  losses                                    |       |                                         |       |                     |       |      |       |
| Realized losses  (a)                                      |       | 892                                          |       | —                   |       | 892       |       |
| Reversal of  prior period depreciation on realization (b) |       | 2,031                                        |       | —                   |       | 2,031     |       |
| Unrealized  appreciation (depreciation) (b)               |       | 1,018                                        |       | (566                     | )          | 452       |       |
| New investments,  repayments and settlements (c)          |       |                                         |       |                     |       |      |       |
| Issuances/New  investments                                |       | 3,308                                        |       | 1,832                    |       | 5,140     |       |
| Settlements/Repayments                                    |       | (23,065                                      | )          | —                   |       | (23,065   | )          |
| Sales                                                     |       | (337                                         | )          | —                   |       | (337      | )          |
| Transfers  into/out of Level 3                            |       | —                                       |       | —                   |       | —    |       |
| Fair value as of  March 31, 2010                     |       | $                                            | 256,227    |                     | $          | 35,524    |       | $ | 291,751 |   |
| ** **                                                |       |                                         |       |                     |       |      |       |
| **Six  months ended March 31, 2010:**                |       |                                         |       |                     |       |      |       |
| Fair value at  September 30, 2009                    |       | $                                            | 286,997    |                     | $          | 33,972    |       | $ | 320,969 |   |
| Total gains or  losses                                    |       |                                         |       |                     |       |      |       |
| Realized losses  (a)                                      |       | (28                                          | )          | —                   |       | (28       | )          |
| Reversal of  prior period depreciation on realization (b) |       | 3,437                                        |       | —                   |       | 3,437     |       |
| Unrealized  depreciation (b)                              |       | 3,211                                        |       | (1,566                   | )          | 1,645     |       |
| New investments,  repayments and settlements, net (c)     |       |                                         |       |                     |       |      |       |
| Issuances/New  investments                                |       | 4,202                                        |       | 3,118                    |       | 7,320     |       |
| Settlements/Repayments                                    |       | (38,473                                      | )          | —                   |       | (38,473   | )          |
| Sales                                                     |       | (3,119                                       | )          | —                   |       | (3,119    | )          |
| Transfers  into/out of Level 3                            |       | —                                       |       | —                   |       | —    |       |
| Fair value as of  March 31, 2010                     |       | $                                            | 256,227    |                     | $          | 35,524    |       | $ | 291,751 |   |

 

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| ** **                                                 | ** ** | **Senior  Term  Debt** | ** ** | **Senior  Subordinated  Term Debt** | ** ** | **Preferred  Equity  Securities** | ** ** | **Common****Equity  Securities** | ** ** | **Total** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|-----------|------------|
| **Three months ended March 31, 2010:**                |       |                   |       |                                |       |                              |       |                             |       |      |       |
| Fair value at December 31, 2009                       |       | $                      | 198,577    |                                | $          | 106,609                           |       | $                                | —     |      | $          | 1,452 |   | $ | 306,638 |   |
| Total gains or losses                                      |       |                   |       |                                |       |                              |       |                             |       |      |       |
| Realized losses (a)                                        |       | (312                   | )          | (163                                | )          | —                            |       | 1,367                            |       | 892       |       |
| Reversal of prior period depreciation on realization (b)   |       | 1,066                  |       | 1,212                               |       | —                            |       | (247                             | )          | 2,031     |       |
| Unrealized appreciation (depreciation) (b)                 |       | 414                    |       | 392                                 |       | —                            |       | (354                             | )          | 452       |       |
| New investments, repayments, and settlements, net (c) |       |                   |       |                                |       |                              |       |                             |       |      |       |
| Issuances/New investments                                  |       | 4,901                  |       | 239                                 |       | —                            |       | —                           |       | 5,140     |       |
| Settlements/Repayments                                     |       | (16,298                | )          | (5,200                              | )          | —                            |       | (1567                            | )          | (23,065   | )          |
| Sales                                                      |       | —                 |       | (337                                | )          | —                            |       | —                           |       | (337      | )          |
| Transfers into/out of Level 3                              |       | —                 |       | —                              |       | —                            |       | —                           |       | —    |       |
| Fair value as of March 31, 2010                       |       | $                      | 188,348    |                                | $          | 102,752                           |       | $                                | —     |      | $          | 651 |   | $ | 291,751 |   |
| ** **                                                 |       |                   |       |                                |       |                              |       |                             |       |      |       |
| **Six months ended March 31, 2010:**                  |       |                   |       |                                |       |                              |       |                             |       |      |       |
| Fair value at September 30, 2009                      |       | $                      | 212,290    |                                | $          | 105,794                           |       | $                                | —     |      | $          | 2,885 |   | $ | 320,969 |   |
| Total gains or losses                                      |       |                   |       |                                |       |                              |       |                             |       |      |       |
| Realized losses (a)                                        |       | (825                   | )          | (570                                | )          | —                            |       | 1,367                            |       | (28       | )          |
| Reversal of prior period depreciation on realization (b)   |       | 2,065                  |       | 1,619                               |       | —                            |       | (247                             | )          | 3,437     |       |
| Unrealized depreciation (b)                                |       | 1,210                  |       | 2,222                               |       | —                            |       | (1,787                           | )          | 1,645     |       |
| New investments, repayments and settlements, net (c)  |       |                   |       |                                |       |                              |       |                             |       |      |       |
| Issuances/New investments                                  |       | 6,078                  |       | 1,242                               |       | —                            |       | —                           |       | 7,320     |       |
| Settlements/Repayments                                     |       | (31,545                | )          | (5,361                              | )          | —                            |       | (1,567                           | )          | (38,473   | )          |
| Sales                                                      |       | (925                   | )          | (2,194                              | )          | —                            |       | —                           |       | (3,119    | )          |
| Transfers into/out of Level 3                              |       | —                 |       | —                              |       | —                            |       | —                           |       | —    |       |
| Fair value as of March 31, 2010                       |       | $                      | 188,348    |                                | $          | 102,752                           |       | $                                | —     |      | $          | 651 |   | $ | 291,751 |   |

 
| ** **                                                | ** ** | **Non-Control/  Non-Affiliate  Investments** | ** ** | **Control  Investments** | ** ** | **Derivative** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------|------------|----------------|------------|-----------|------------|
| **Three  months ended March 31, 2009:**              |       |                                         |       |                     |       |           |       |      |       |
| Fair value at  December 31, 2008                     |       | $                                            | 384,012    |                     | $          | 566            |       | $         | —     |   | $ | 384,578 |   |
| Realized losses  (a)                                      |       | (2,000                                       | )          | —                   |       | (304           | )          | (2,304    | )          |
| Reversal of  prior period depreciation on realization (b) |       | 1,960                                        |       | —                   |       | 304            |       | 2,264     |       |
| Unrealized  appreciation (b)                              |       | 1,239                                        |       | 3,526                    |       | —         |       | 4,765     |       |
| New investments,  repayments, and settlements, net (c)    |       | (15,616                                      | )          | 11,410                   |       | —         |       | (4,206    | )          |
| Transfers in  (out) of Level 3                            |       | —                                       |       | —                   |       | —         |       | —    |       |
| Fair value as of  March 31, 2009                     |       | $                                            | 369,595    |                     | $          | 15,502         |       | $         | —     |   | $ | 385,097 |   |
| ** **                                                |       |                                         |       |                     |       |           |       |      |       |
| **Six  months ended March 31, 2009:**                |       |                                         |       |                     |       |           |       |      |       |   |   |   |   |
| Fair value at  September 30, 2008                    |       | $                                            | 407,153    |                     | $          | 780            |       | $         | —     |   | $ | 407,933 |   |
| Realized losses  (a)                                      |       | (3,731                                       | )          | —                   |       | (304           | )          | (4,035    | )          |
| Reversal of  prior period depreciation on realization (b) |       | 3,145                                        |       | —                   |       | 304            |       | 3,449     |       |
| Unrealized  appreciation (depreciation) (b)               |       | (12,387                                      | )          | 2,714                    |       | —         |       | (9,673    | )          |
| New investments,  repayments, and settlements, net (c)    |       | (24,585                                      | )          | 12,008                   |       | —         |       | (12,577   | )          |
| Transfers in  (out) of Level 3                            |       | —                                       |       | —                   |       | —         |       | —    |       |
| Fair value as of  March 31, 2009                     |       | $                                            | 369,595    |                     | $          | 15,502         |       | $         | —     |   | $ | 385,097 |   |

 

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(a)          Included in net realized loss on investments on theaccompanying condensed consolidated statements of operations for the three andsix months ended March 31, 2010 and 2009.

(b)         Included in unrealized appreciation (depreciation) oninvestments on the accompanying condensed consolidated statements of operationsfor the three and six months ended March 31, 2010 and 2009.

(c)          Includes increases in the cost basis of investmentsresulting from new portfolio investments, the amortization of discounts,premiums and closing fees as well as decreases in the cost basis of investmentsresulting from principal repayments or sales.

 

*Non-Control/Non-AffiliateInvestments*

 

As of March 31, 2010 and September 30, 2009, the Company heldNon-Control/Non-Affiliate investments in the aggregate of approximately$256,227and $286,997, at fair value, respectively.

 

*Control Investments*

 

As of March 31, 2010 and September 30, 2009, the Company heldControl investments in the aggregate of approximately $35,524 and $33,972, atfair value, respectively.  As of March 31,2010, the Control investments were comprised of BERTL, Inc. (“BERTL”),Clinton Holdings, LLC (“Clinton”), Defiance Integrated Technologies, Inc.(“Defiance”), Lindmark Acquisition, LLC (“Lindmark”), LYP Holdings Corp. (“LYPHoldings”), U.S. Healthcare Communications, Inc. (“U.S. Healthcare”) andWestern Directories, Inc. (“Western Directories”).

 

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

 

·                  *Clinton:* In September 2009, the Company took control of certain Clintonentities by exercising contractual rights under the investment documents. Clinton is a distributor of aluminum sheets and stainless steel.

 

·                  *Defiance:* In July 2009, the Company acquiredfrom the previous owner certain assets of Defiance Acquisition Corp.,consisting of tangible and intangible personal property.  The Companyacquired these assets through a newly formed subsidiary, Defiance, and intendsto continue the business under its control.  Defiance is a manufacturer oftrucking parts.

 

·                  *Lindmark:* In March 2009, the Company acquiredfrom the previous owner certain assets of Lindmark Outdoor Advertising, LLC,consisting of all tangible and intangible personal property.  The Company acquired these assets through anewly formed subsidiary, Lindmark, and intends to continue the business underits control.  Lindmark is a billboardadvertising company.

 

·                  *LYP Holdings:*In July 2008, the Company acquiredfrom the previous owner certain assets of LocalTel, Inc., consisting ofall tangible and intangible personal property. The Company acquired these assets through a newly formed subsidiary, LYPHoldings, and intends to continue the business under its control.  LYP Holdings is a publisher of communityyellow page directories.

 

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

 

·                  *Western Directories:* In August 2008, the Companyacquired from the previous owner certain assets of West Coast Yellow Pages, Inc.,consisting of all tangible and intangible personal property.  The Company acquired these assets through anewly

 

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formed subsidiary,Western Directories, and intends to continue the business under itscontrol.  Western Directories is apublisher of community yellow page directories.

 

*Investment Concentrations*

 

As of March 31, 2010, the Company had aggregateinvestments in 41 portfolio companies and approximately 64.6% of the aggregatefair value of such investments was senior term debt, approximately 35.2% wassenior subordinated term debt, no investments were in junior subordinated debtand approximately 0.2% was in equity securities.  The following table outlines the Company’sinvestments by type at March 31, 2010 and September 30, 2009:

 
| ** **                    | ** ** | **March 31,  2010** | ** ** | **September 30,  2009** | ** ** |
|-------------------------------|------------|--------------------------|------------|------------------------------|------------|
| ** **                    | ** ** | **Cost**                 | ** ** | **Fair Value**               | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Senior Term Debt              |       | $                        | 212,955    |                         | $          | 188,348 |   | $ | 240,172 |   | $ | 212,290 |   |
| Senior Subordinated Term Debt |       | 111,861                  |       | 102,752                      |       | 118,743 |   | 105,794 |   |
| Preferred Equity Securities   |       | 2,028                    |       | —                       |       | 2,028 |   | — |   |
| Common Equity Securities      |       | 3,250                    |       | 651                          |       | 3,450 |   | 2,885 |   |
|                          |       |                     |       |                         |       |   |   |   |   |
| Total Investments             |       | $                        | 330,094    |                         | $          | 291,751 |   | $ | 364,393 |   | $ | 320,969 |   |

 

Investmentsat fair value consisted of the following industry classifications as of March 31,2010 and September 30, 2009:

 
| ** **                                                          | ** ** | **March 31,  2010** | ** ** | **September 30,  2009** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------|------------|------------------------------|------------|
| ** **                                                          | ** ** | ** **               | ** ** | **Percentage**               | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Industry Classification**                                    | ** ** | **Fair Value**      | ** ** | **Total  Investments**       | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Aerospace &  Defense                                       |       | $                        | —     |                         | —     |   | — |   | $ | 1,857 |   | 0.6 | % | 0.7 | % |
| Automobile                                                          |       | 8,325                    |       | 2.9                          | %          | 3.3 | % | 7,999 |   | 2.5 | % | 3.2 | % |
| Broadcast  (TV & Radio)                                    |       | 43,394                   |       | 14.9                         | %          | 17.0 | % | 43,403 |   | 13.5 | % | 17.4 | % |
| Buildings &  Real Estate                                   |       | 12,848                   |       | 4.4                          | %          | 5.0 | % | 12,882 |   | 4.0 | % | 5.2 | % |
| Cargo Transport                                                     |       | —                   |       | —                       |       | — |   | 5,427 |   | 1.7 | % | 2.2 | % |
| Chemicals,  Plastics & Rubber                              |       | 15,717                   |       | 5.4                          | %          | 6.2 | % | 15,884 |   | 4.9 | % | 6.4 | % |
| Diversified/Conglomerate  Manufacturing                             |       | 1,579                    |       | 0.5                          | %          | 0.6 | % | 1,236 |   | 0.4 | % | 0.5 | % |
| Diversified  Natural Resources, Precious Metals & Minerals |       | 13,590                   |       | 4.7                          | %          | 5.3 | % | 13,589 |   | 4.2 | % | 5.5 | % |
| Electronics                                                         |       | 25,856                   |       | 8.9                          | %          | 10.2 | % | 27,899 |   | 8.7 | % | 11.2 | % |
| Farming &  Agriculture                                     |       | 8,857                    |       | 3.0                          | %          | 3.5 | % | 9,309 |   | 2.9 | % | 3.7 | % |
| Healthcare,  Education & Childcare                         |       | 41,700                   |       | 14.3                         | %          | 16.4 | % | 58,054 |   | 18.1 | % | 23.3 | % |
| Home &  Office Furnishings                                 |       | 10,929                   |       | 3.7                          | %          | 4.3 | % | 16,744 |   | 5.2 | % | 6.7 | % |
| Leisure,  Amusement, Movies & Entertainment                |       | 5,747                    |       | 2.0                          | %          | 2.3 | % | 5,091 |   | 1.6 | % | 2.0 | % |
| Machinery                                                           |       | 8,949                    |       | 3.1                          | %          | 3.5 | % | 9,202 |   | 2.9 | % | 3.7 | % |
| Mining, Steel,  Iron & Non-Precious Metals                 |       | 22,149                   |       | 7.5                          | %          | 8.7 | % | 21,926 |   | 6.8 | % | 8.8 | % |
| Personal &  Non-durable Consumer Products                  |       | 8,841                    |       | 3.0                          | %          | 3.5 | % | 8,714 |   | 2.7 | % | 3.5 | % |
| Printing &  Publishing                                     |       | 38,870                   |       | 13.3                         | %          | 15.3 | % | 37,864 |   | 11.8 | % | 15.2 | % |
| Retail Stores                                                       |       | 24,400                   |       | 8.4                          | %          | 9.6 | % | 23,669 |   | 7.4 | % | 9.5 | % |
| Textiles &  Leather                                        |       | —                   |       | —                       |       | — |   | 220 |   | 0.1 | % | 0.1 | % |
| **Total**                                                           |       | $                        | 291,751    |                         | 100.0      | % |   |   | $ | 320,969 |   | 100.0 | % |   |   |

 

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Theinvestments at fair value were included in the following geographic regions ofthe United States at March 31, 2010 and September 30, 2009:

 
| ** **             | ** ** | **March 31,  2010** | ** ** | **September 30,  2009** | ** ** |
|------------------------|------------|--------------------------|------------|------------------------------|------------|
| ** **             | ** ** | ** **               | ** ** | **Percentage**               | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Geographic  Region** | ** ** | **Fair Value**           | ** ** | **Total********Investments** | ** ** | **Net********Assets** | ** ** | **Fair Value** | ** ** | **Total********Investments** | ** ** | **Net********Assets** | ** ** |
| Midwest                |       | $                        | 150,628    |                         | 51.6       | % | 59.2 | % | $ | 172,263 |   | 53.7 | % | 69.2 | % |
| West                   |       | 61,837                   |       | 21.2                         | %          | 24.3 | % | 65,678 |   | 20.5 | % | 26.4 | % |
| Southeast              |       | 29,670                   |       | 10.2                         | %          | 11.7 | % | 34,708 |   | 10.8 | % | 13.9 | % |
| Mid-Atlantic           |       | 28,824                   |       | 9.9                          | %          | 11.3 | % | 28,437 |   | 8.8 | % | 11.4 | % |
| Northeast              |       | 14,508                   |       | 5.0                          | %          | 5.7 | % | 14,170 |   | 4.4 | % | 5.7 | % |
| U.S. Territory         |       | 6,284                    |       | 2.1                          | %          | 2.5 | % | 5,713 |   | 1.8 | % | 2.3 | % |
|                   |       | $                        | 291,751    |                         | 100.0      | % |   |   | $ | 320,969 |   | 100.0 | % |   |   |

 

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

 

*Investment Principal Repayments*

 

The following table summarizes the contractual principal repayment andmaturity of the Company’s investment portfolio by fiscal year, assuming novoluntary prepayments:

 
| ** **                                              | ** ** | ** **                                                                           | ** ** | **Amount** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|------------|------------|
| For the  remaining six months ending September 30: |       | 2010                                                                                 |       | $          | 20,904     |   |
| For the fiscal year ending September 30:           |       | 2011                                                                                 |       | 92,686     |       |
|                                                    |       | 2012                                                                                 |       | 78,069     |       |
|                                                    |       | 2013                                                                                 |       | 119,763    |       |
|                                                    |       | 2014                                                                                 |       | 6,116      |       |
|                                                    |       | 2015                                                                                 |       | 6,851      |       |
| ** **                                              | ** ** | **Total  Contractual Repayments**                                                    |       | 324,389    |       |
|                                                    |       | Investments in equity securities                                                     |       | 5,278      |       |
| ** **                                              |       | Unamortized premiums, discounts and investment acquisition  costs on debt securities |       | 427        |       |
| ** **                                              | ** ** | **Total**                                                                            |       | $          | 330,094    |   |

 

**NOTE 4. RELATED PARTY TRANSACTIONS**

 

*Loans to Employees*

 

TheCompany provided loans to employees of the Adviser, who at the time of theloans were joint employees of the Company and either the Adviser or the Company’sprevious investment adviser, Gladstone Capital Advisers, Inc., for theexercise of options under the Amended and Restated 2001 Equity Incentive Plan,which has since been terminated and is no longer in operation.  The loans require the quarterly payment ofinterest at the market rate in effect at the date of issue, have varying termsnot exceeding ten years and have been recorded as a reduction of netassets.  The loans are evidenced by full recoursenotes that are due upon maturity or 60 days following termination ofemployment, and the shares of common stock purchased with the proceeds of theloan are posted as collateral.  No newloans were issued during the six months ended March 31, 2010 or March 31,2009.  The Company received $0 and $4 ofprincipal repayments during the six months ended March 31, 2010 and March 31,2009, respectively.  The Companyrecognized interest income from all employee stock option loans of $108 and$221 for the three and six months ended March 31, 2010, respectively, and$117 and $235 for the three and six months ended March 31, 2009,respectively.

 

Duringthe six months ended March 31, 2010, $514 of an employee stock option loanto a former employee of the Adviser was transferred from notes receivable —employees to other assets in connection with the termination of her employmentwith the Adviser and the later amendment of the loan.  The intereston the loan from the time the employee stopped working for the Adviser isincluded in other income on the condensed consolidated statement of operations.

 

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*CompensationExpense*

 

Duringthe three months ended March 31, 2010, the employee stock option loans oftwo former employees were converted from recourse to non-recourse loans.  The conversions were non-cash transactions and were accounted for as repurchases of theshares previously received by the employees upon exercise of the stock optionin exchange for the non-recourse notes. The repurchases were accounted for astreasury stock transactions at the fair value of the shares, totaling$420.  Since the value of the stock optionloans totaled $665, the Company recorded compensation expense of $245.

 

*Investment Advisory and Management Agreement*

 

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

 

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

 
| ** **                                                                                                        | ** ** | **Three  months ended**        | ** ** | **Six months  ended**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------|------------|
| ** **                                                                                                        | ** ** | **March 31,********2010** | ** ** | **March 31,  2009** | ** ** | **March 31,********2010** | ** ** | **March 31,  2009** | ** ** |
| Base management fee (1)                                                                                           |       | $                              | 739        |                     | $          | 484 |   | $ | 1,459 |   | $ | 917 |   |
| Credit for fees received by Adviser from the portfolio companies                                                  |       | —                         |       | (80                      | )          | — |   | (85 | ) |
| Fee reduction for the voluntary, irrevocable waiver of 2.0% fee on  senior syndicated loans to 0.5% per annum (2) |       | (6                             | )          | (97                      | )          | (13 | ) | (203 | ) |
| Net base management fee                                                                                           |       | $                              | 733        |                     | $          | 307 |   | $ | 1,446 |   | $ | 629 |   |
|                                                                                                              |       |                           |       |                     |       |   |   |   |   |
| Incentive fee                                                                                                     |       | $                              | 1,072      |                     | $          | 1,089 |   | $ | 1,447 |   | $ | 2,265 |   |
| Credit from voluntary, irrevocable waiver issued by Adviser’s board of  directors                            |       | —                         |       | (1,089                   | )          | (22 | ) | (2,265 | ) |
| Net incentive fee                                                                                                 |       | $                              | 1,072      |                     | $          | — |   | $ | 1,425 |   | $ | — |   |
|                                                                                                              |       |                           |       |                     |       |   |   |   |   |
| Credit for fees received by Adviser from the portfolio companies                                                  |       | $                              | —     |                     | $          | (80 | ) | $ | — |   | $ | (85 | ) |
| Fee reduction for the voluntary, irrevocable waiver of 2% fee on  senior syndicated loans to 0.5% per annum       |       | (6                             | )          | (97                      | )          | (13 | ) | (203 | ) |
| Incentive fee credit                                                                                              |       | —                         |       | (1,089                   | )          | (22 | ) | (2,265 | ) |
| Credit to base management and incentive fees from Adviser                                                         |       | $                              | (6         | )                        | $          | (1,266 | ) | $ | (35 | ) | $ | (2,553 | ) |

 

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

(2)          The board of our Adviser voluntarily,irrevocably and unconditionally waived, for the three and six months ended March 31,2010 and 2009, the annual 2.0% base management fee to 0.5% for seniorsyndicated loan participations.  Feeswaived cannot be recouped by the Adviser in the future.

 

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

 
| ** **                             | ** ** | **March 31,********2010** | ** ** | **September 30,  2009** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| Unpaid base management fee  to Adviser |       | $                              | 733        |                         | $          | 617 |   |
| Unpaid incentive fee to  Adviser       |       | 1,425                          |       | —                       |       |
| Unpaid loan servicing fees  to Adviser |       | 207                            |       | 217                          |       |
| Total Due to Adviser                   |       | $                              | 2,365      |                         | $          | 834 |   |

 

Asof March 31, 2010 and September 30, 2009, Due from Adviser totaled $0and $69, respectively, which included reimbursements for non-recurring costsincurred on behalf of the portfolio companies.

 

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*Loan Servicing and Portfolio Company Fees*

 

TheAdviser also services the loans held by Business Loan, in return for which itreceives a 1.5% annual fee based on the monthly aggregate outstanding balanceof the loans pledged under the Company’s line of credit.  Since the Company owns these loans, all loanservicing fees paid to the Adviser have been and continue to be treated asreductions directly against the 2% base management fee under the AdvisoryAgreement.  For the three and six monthsended March 31, 2010 and 2009, these loan servicing fees totaled $852 and$1,781, and $1,526 and $3,149, respectively, all of which were deducted againstthe 2% base management fee in order to derive the base management fee, which ispresented as the line item Base management fee in the accompanying condensedconsolidated statements of operations. As of March 31, 2010 and September 30, 2009, the Company owed$207 and $217, respectively, of unpaid loan servicing fees to the Adviser,which are recorded in Fees due to Adviser in the accompanying condensedconsolidated statements of assets and liabilities.

 

*Administration Agreement*

 

OnOctober 1, 2006, the Company entered into an administration agreement (the“Administration Agreement”) with Gladstone Administration, LLC (the “Administrator”),an affiliate of the Adviser.  Under the Administration Agreement, theCompany pays separately for administrative services.  The Administration Agreement provides forpayments equal to the Company’s allocable portion of the Administrator’soverhead expenses in performing its obligations under the AdministrationAgreement, including, but not limited to, rent for employees of theAdministrator, and the allocable portion of salaries and benefits expenses ofthe Company’s chief financial officer, chief compliance officer, internalcounsel, treasurer and their respective staffs. For the three and six months ended March 31, 2010 and 2009, theCompany recorded administration fees of $176 and $354, and $211 and $438,respectively.  As of March 31, 2010and September 30, 2009, the Company owed $176 and $216, respectively, ofunpaid administration fees to the Adviser, which is recorded in the Fee due toAdministrator in the accompanying condensed consolidated statements of assetsand liabilities.

 

**NOTE 5. LINE OF CREDIT**

 

On March 15, 2010, the Company, through Business Loan, enteredinto a fourth amended and restated credit agreement which currently providesfor a $127,000 revolving line of credit arranged by Key Equipment Finance Inc.as administrative agent (the “Credit Facility”).  Branch Banking and Trust Company (“BB&T”)and ING Capital LLC (“ING”) also joined the Credit Facility as committedlenders.  Subject to certain terms andconditions, the Credit Facility may be expanded up to $202,000 through theaddition of other committed lenders to the facility.  Advances underthe Credit Facility will generally bear interest at the 30-day LIBOR (subjectto a minimum rate of 2%), plus 4.5% per annum, with a commitment fee of 0.5%per annum on undrawn amounts.  As of March 31,2010, there was a cost basis of approximately $53,000 of borrowings outstandingunder the Credit Facility at an average interest rate of 6.5%.  Available borrowings are subject to variousconstraints imposed under the Credit Facility, based on the aggregate loanbalance pledged by Business Loan. Interest is payable monthly during the termof the Credit Facility.  The CreditFacility matures on March 15, 2012, and, if the facility is not renewed orextended by this date, all principal and interest will be due and payable on March 15,2013.  In addition, if the CreditFacility is not renewed on or before March 15, 2012, the Company will berequired to use all principal collections from its loans to pay outstandingprincipal on the Credit Facility.

 

The Credit 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 facility requires a minimum of 20obligors in the borrowing base and also limits payments of distributions.  As of March 31, 2010, Business Loan had23 obligors and the Company was in compliance with all of the facilitycovenants.

 

The Companyapplied ASC 825, “FinancialInstruments,” specifically for the Credit Facility, which was consistentwith its application of ASC 820 to its investments.  ASC825 requires that the Company apply a fair value methodology to theCredit Facility. The Company estimated the fair value of the Credit Facilityusing estimates of value provided by an independent third party and its ownassumptions in the absence of observable market data, including estimatedremaining life, current market yield and interest rate spreads of similarsecurities as of the measurement date. The Company also considered its own credit risk.  Since the Credit Facility was entered intoduring the three months ended March 31, 2010, the cost basis of the CreditFacility of $53,000 was determined to be the best approximation of fair valueas of March 31, 2010.  The followingtable presents the Credit Facility carried at fair value as of March 31,2010 and September 30, 2009, by caption on the accompanying consolidatedstatements of assets and liabilities for each of the three levels of hierarchyestablished by ASC 820-10:

 

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| ** **                      | ** ** | **As of March 31, 2010** | ** ** |
|---------------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statement of** | ** ** |
| ** **                      | ** ** | **Level 1**                   | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Borrowings under Line of Credit |       | $                             | —     |   | $ | — |   | $ | 53,000 |   | $ | 53,000 |   |
| Total                           |       | $                             | —     |   | $ | — |   | $ | 53,000 |   | $ | 53,000 |   |

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

 

*Changes in Level 3 Fair ValueMeasurements*

 

The following table provides a roll-forward in the changes in fairvalue during the three-month period from December 31, 2009 to March 31,2010 and the six month period from September 30, 2009 to March 31,2010, for the Credit Facility for which the Company determines fair value usingunobservable (Level 3) factors. When a determination is made to classify afinancial instrument within Level 3 of the valuation hierarchy, thedetermination is based upon the significance of the unobservable factors to theoverall fair value measurement. However, Level 3 financial instrumentstypically include, in addition to the unobservable or Level 3 components,observable components (that is, components that are actively quoted and can bevalidated by external sources). Accordingly, the losses in the table belowinclude changes in fair value due in part to observable factors that are partof the valuation methodology.

 

**Fair value measurements usingunobservable data inputs (Level 3)**

 
| ** **                                   | ** ** | **Borrowings  under line  of credit** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| **Three  months ended March 31, 2010:** |       |                                  |       |
| Fair value at  December 31, 2009        |       | $                                     | 73,531     |   |
| Unrealized  depreciation (a)                 |       | (131                                  | )          |
| Borrowings                                   |       | 2,600                                 |       |
| Repayments                                   |       | (23,000                               | )          |
| Transfers  into/out of Level 3               |       | —                                |       |
| Fair value as of  March 31, 2010        |       | $                                     | 53,000     |   |
|                                         |       |                                  |       |
| **Six  months ended March 31, 2010:**   |       |                                  |       |
| Fair value at  September 30, 2009       |       | $                                     | 83,350     |   |
| Unrealized  depreciation (a)                 |       | (350                                  | )          |
| Borrowings                                   |       | 5,500                                 |       |
| Repayments                                   |       | (35,500                               | )          |
| Transfers  into/out of Level 3               |       | —                                |       |
| Fair value as of  March 31, 2010        |       | $                                     | 53,000     |   |

 

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(a)          Included in unrealized depreciation on borrowingsunder line of credit on the accompanying condensed consolidated statements ofoperations for the three and six months ended March 31, 2010.

 

**NOTE 6. COMMON STOCK TRANSACTIONS**

 

On October 20, 2009, the Company filed a registration statement onForm N-2 with the SEC that was amended on December 9, 2009.  The SEC declared the registration statementeffective on January 28, 2010 and such registration statement will permitthe Company to issue, through one or more transactions, up to an aggregate of$300,000 in securities, consisting of common stock, senior common 

 

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stock, preferred stock, subscription rights, debt securities andwarrants to purchase common stock, or a combination of these securities.

 

Transactionsin common stock were as follows:

 
| ** **                                        | ** ** | **Shares** | ** ** | **Total Value** | ** ** |
|---------------------------------------------------|------------|------------|------------|-----------------|------------|
| Balance at  September 30, 2009               |       | 21,087,574 |       | $               | 328,224    |   |
| Conversion of  recourse to non-recourse loans (1) |       | —     |       | (420            | )          |
| Retirement of  employee loan shares (2)           |       | (48,332    | )          | —          |       |
| Shelf offering  costs                             |       | —     |       | (74             | )          |
| Balance at  March 31, 2010                   |       | 21,039,242 |       | $               | 327,730    |   |

 

----

(1)          During the three months ended March 31, 2010, theemployee stock option loans of two former employees of the Adviser wereconverted from recourse to non-recourse loans. The conversions were non-cashtransactions and were accounted for as repurchases of the sharespreviously received by the employees of the Adviser upon exercise of the stockoptions in exchange for the non-recourse notes. The repurchases were accountedfor as treasury stock transactions at the fair value of the shares, whichtotaled $420.

 

(2)          During the three months ended March 31, 2010,subsequent to the conversion of the stock option loans of two former employeesof the Adviser from recourse to non-recourse, the loans came due when theunderlying market value for the collateral reached the outstanding loanamount.  As such, and consistent with the loan agreements, the sharespledged as collateral were retired in March 2010.  Since these shareswere already accounted for during the conversion to non-recourse above, thesebecame non-cash events that didnot require journal entries to the financial statements.  However, theyresulted in a reduction of the number of shares of common stock outstanding.

 

The following table is a summary of all outstanding notes issued toemployees of the Adviser for the exercise of stock options:

 
| ** ** | ** ** | ** **    | ** ** | ** **          | ** ** | ** **              | ** ** | **Outstanding**    | ** ** | ** **   | ** ** | ** **   | ** ** |
|------------|------------|---------------|------------|---------------------|------------|-------------------------|------------|--------------------|------------|--------------|------------|--------------|------------|
| ** ** | ** ** | **Number of** | ** ** | **Strike Price of** | ** ** | **Amount of**           | ** ** | **Balance of**     | ** ** | ** **   | ** ** | **Interest** | ** ** |
| **Issue**  | ** ** | **Options**   | ** ** | **Options**         | ** ** | **Promissory Note**     | ** ** | **Employee Loans** | ** ** | **Maturity** | ** ** | **Rate**     | ** ** |
| **Date**   | ** ** | **Exercised** | ** ** | **Exercised**       | ** ** | **Issued to Employees** | ** ** | **at 3/31/10**     | ** ** | **Date**     | ** ** | **on Note**  | ** ** |
| Aug-01     |       | 93,334        |       | $                   | 15.00      |                    | $          | 1,400              |       | $            | 1,400      |         | Aug-10     |   | 4.90 | % |
| Aug-01     |       | 18,334        |       | 15.00               |       | 275                     |       | 255                |       | Aug-10       |       | 4.90         | %          |
| Sep-04     |       | 13,332        |       | 15.00               |       | 200                     |       | 198                |       | Sep-13       |       | 5.00         | %          |
| Aug-01     |       | 393,334       |       | 15.00               |       | 5,900                   |       | 5,900              |       | Aug-10       |       | 4.90         | %          |
| Aug-01     |       | 18,334        |       | 15.00               |       | 275                     |       | 275                |       | Aug-10       |       | 4.90         | %          |
| Jul-06     |       | 13,332        |       | 15.00               |       | 200                     |       | 200                |       | Jul-15       |       | 8.26         | %          |
| Jul-06     |       | 18,334        |       | 15.00               |       | 275                     |       | 275                |       | Jul-15       |       | 8.26         | %          |
|       |       | 568,334       |       |                |       | $                       | 8,525      |               | $          | 8,503        |       |         |       |   |   |
|            |            |               |            |                     |            |                         |            |                    |            |              |            |              |            |  |  |  |

 

In accordance withASC 505-10-45-2, “Equity,” receivables from employees for the issuance ofcapital stock to employees prior to the receipt of cash payment should bereflected in the balance sheet as a reduction to stockholders’ equity.Therefore, these recourse notes were recorded as loans to employees and areincluded in the equity section of the accompanying condensed consolidatedstatements of assets and liabilities.  Asof March 31, 2010, the Company determined that these notes were stillrecourse.

 

**NOTE 7. NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONSPER COMMON SHARE**

 

Thefollowing table sets forth the computation of basic and diluted net increase innet assets resulting from operations per common share for the three and sixmonths ended March 31, 2010 and 2009:

 
| ** **                                                                                       | ** ** | **Three months ended  March 31,** | ** ** | **Six months ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                       | ** ** | **2010**                               | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Numerator for  basic and diluted net increase in net assets resulting from operations per  share |       | $                                      | 7,980      |                                | $          | 10,280 |   | $ | 14,306 |   | $ | 1,178 |   |
| Denominator for  basic and diluted shares                                                        |       | 21,075,445                             |       | 21,087,574                          |       | 21,081,576 |   | 21,087,574 |   |
| Basic and  diluted net increase in net assets resulting from operations per common share         |       | $                                      | 0.38       |                                | $          | 0.48 |   | $ | 0.68 |   | $ | 0.05 |   |

 

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**NOTE 8. DISTRIBUTIONS**

 

Thefollowing table lists the per share distributions paid for the six months endedMarch 31, 2010 and 2009:

 
| **Fiscal  Year** | ** ** | **Record  Date**       | ** ** | **Payment  Date**      | ** ** | **Distribution  per Share** | ** ** |
|------------------|------------|------------------------|------------|------------------------|------------|-----------------------------|------------|
| 2010             |       | October 22, 2009  |       | October 30, 2009  |       | $                           | 0.07       |   |
|             |       | November 19, 2009 |       | November 30, 2009 |       | $                           | 0.07       |   |
|             |       | December 22, 2009 |       | December 31, 2009 |       | $                           | 0.07       |   |
|             |       | January 21, 2010  |       | January 29, 2010  |       | $                           | 0.07       |   |
|             |       | February 18, 2010 |       | February 26, 2010 |       | $                           | 0.07       |   |
|             |       | March 23, 2010    |       | March 31, 2010    |       | $                           | 0.07       |   |
|             |       |                   |       | Total                  |       | $                           | 0.42       |   |
|             |       |                   |       |                   |       |                        |       |
| 2009             |       | October 23, 2008  |       | October 31, 2008  |       | $                           | 0.14       |   |
|             |       | November 19, 2008 |       | November 28, 2008 |       | $                           | 0.14       |   |
|             |       | December 22, 2008 |       | December 31, 2008 |       | $                           | 0.14       |   |
|             |       | January 22, 2009  |       | January 31, 2009  |       | $                           | 0.14       |   |
|             |       | February 19, 2009 |       | February 27, 2009 |       | $                           | 0.14       |   |
|             |       | March 23, 2009    |       | March 30, 2009    |       | $                           | 0.14       |   |
|             |       |                   |       | Total                  |       | $                           | 0.84       |   |

 

Aggregate distributions declared and paid for the sixmonths ended March 31, 2010 and 2009 were approximately $8,853 and$17,714, respectively.  All distributionswere declared based on estimates of net investment income for the respectivefiscal years, and some of the distributions include a return of capital.

 

Thetiming and characterization of certain income and capital gains distributionsare determined annually in accordance with federal tax regulations which maydiffer from GAAP. These differences primarily relate to items recognized asincome for financial statement purposes and realized gains for tax purposes. Asa result, net investment income and net realized gain (loss) on 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.

 

**NOTE 9. COMMITMENTS AND CONTINGENCIES**

 

Asof March 31, 2010, the Company was not party to any signed term sheets forpotential investments.

 

InJuly 2009, the Company executed a guaranty of a line of credit agreementbetween Comerica Bank and Defiance Integrated Technologies, Inc., one ofits Control investments.  If Defiance has a payment default, the guarantyis callable once the bank has reduced its claim by using commercial reasonableefforts to collect through disposition of the Defiance collateral.  Theguaranty is limited to $250 plus interest on that amount accrued from the datedemand payment is made under the guaranty, and all costs incurred by the bank inits collection efforts.  As of March 31, 2010, the Company has notbeen required to make any payments on the guaranty of the line of creditagreement and the Company considers the credit risk to be remote.  The Company reports off-balance sheetguarantees on its condensed consolidated schedule of investments, as requiredby the 1940 Act.

 

**NOTE 10. SUBSEQUENT EVENTS**

 

*Distributions*

 

In April 2010, the Company’s Board of Directors declared thefollowing monthly cash distributions:

 
| **Record  Date**     | ** ** | **Payment  Date**   | ** ** | **Distribution  per Share** | ** ** |
|----------------------|------------|---------------------|------------|-----------------------------|------------|
| April 22,  2010 |       | April 30, 2010 |       | $                           | 0.07       |   |
| May 20,  2010   |       | May 28, 2010   |       | $                           | 0.07       |   |
| June 22,  2010  |       | June 30, 2010  |       | $                           | 0.07       |   |

 

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*Investment Activity*

 

Subsequent to March 31, 2010, the Company extended approximately$1,200 of revolver draws and additional investments to existing portfoliocompanies.  In addition, the Companyextended $400 in a new investment, FedCap Partners, LLC, which is a fund thatinvests in government contractors.  TheCompany’s investment commitment in FedCap Partners is the lesser of $2,000 or10% of the fund’s aggregate investor commitments.  The Company also received approximately $14,994from scheduled and unscheduled loan repayments and a loan payoff.  This included a $13,590 payoff fromVantaCore.

 

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**ITEM 2.MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (dollar amounts inthousands, except per share data or unless otherwise indicated)**

 

**All statements contained herein, other than historical facts,may constitute “forward-looking statements.” These statements may relate to,among other things, future events or our future performance or financialcondition. In some cases, you can identify forward-looking statements byterminology such as “estimate,” “may,” “might,” “believe,” “will,” “provided,” “anticipate,”“future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,”“seek,” “possible,” “potential,” “likely” or the negative of such terms orcomparable terminology. These forward-looking statements involve known andunknown risks, uncertainties and other factors that may cause our actualresults, levels of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance or achievementsexpressed or implied by such forward-looking statements. We caution readers notto place undue reliance on any such forward-looking statements. We undertake noobligation to publicly update or revise any forward-looking statements, whetheras a result of new information, future events or otherwise, after the date ofthis Form 10-Q**.

 

**The following analysis of ourfinancial condition and results of operations should be read in conjunctionwith our condensed consolidated financial statements and the notes theretocontained elsewhere in this report and our annual report on Form 10-K forthe fiscal year ended September 30, 2009.**

 

**OVERVIEW**

 

**General**

 

We were incorporated under the General CorporationLaws of the State of Maryland on May 30, 2001. Our investment objective isto achieve a high level of current income by investing in debt securities,consisting primarily of senior notes, senior subordinated notes and juniorsubordinated notes, of established private businesses that are substantiallyowned by leveraged buyout funds, individual investors or are family-ownedbusinesses, with a particular focus on senior notes. In addition, we mayacquire from others existing loans that meet this profile. We also seek toprovide our stockholders with long-term capital growth through the appreciationin the value of warrants or other equity instruments that we may receive whenwe make loans. We operate as a closed-end, non-diversified managementinvestment company, and have elected to be treated as a business developmentcompany under the Investment Company Act of 1940, as amended (the “1940 Act”).  In addition, for tax purposes we have electedto be treated as a regulated investment company (“RIC”) under the InternalRevenue Code of 1986, as amended (the “Code”).

 

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

 

**Business Environment**

 

While economic conditions generally appear to be improving somewhat, weremain cautious about a long-term economic recovery.  The recent recession generally, and thedisruptions in the capital markets in particular, have decreased liquidity andincreased our cost of debt and equity capital, where available. The longerthese conditions persist, the greater the probability that these factors couldcontinue to increase our costs of, and significantly limit our access to, debtand equity capital and, thus, have an adverse effect on our operations andfinancial results. Many of the companies in which we have made or will makeinvestments are still susceptible to the economic conditions, which may affectthe ability of one or more of our portfolio companies to repay our loans or engagein a liquidity event, such as a sale, recapitalization or initial publicoffering. The economic conditions could also disproportionately impact some ofthe industries in which we invest, causing us to be more vulnerable to lossesin our portfolio, which could cause the number of our non-performing assets toincrease and the fair market value of our portfolio to decrease.  We do not know when market conditions willstabilize, if adverse conditions will intensify or the full extent to which thedisruptions will affect us.  If marketinstability persists or intensifies, we may experience difficulty in raisingcapital.

 

Challenges in the current market are intensified for us by certainregulatory limitations under the Code and the 1940 Act, as well as contractualrestrictions under the agreement governing our credit facility that furtherconstrain our ability to access the capital markets.  To maintain our qualification as a RIC, wemust satisfy, among other requirements, an annual distribution requirement topay out at least 90% of our ordinary income and short-term capital gains to ourstockholders on an annual basis.  Becausewe are required to

 

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distribute our income in this manner, and because the illiquidity ofmany of our investments makes it difficult for us to finance new investmentsthrough the sale of current investments, our ability to make new investments ishighly dependent upon external financing. Our external financing sources include the issuance of equitysecurities, debt securities or other leverage such as borrowings under our lineof credit.  Our ability to seek externaldebt financing, to the extent that it is available under current marketconditions, is further subject to the asset coverage limitations of the 1940Act, which require us to have at least a 200% asset coverage ratio, meaninggenerally that for every dollar of debt, we must have two dollars of assets.

 

Market conditions have also affected the trading price of our commonstock and thus our ability to finance new investments through the issuance ofequity.  When our stock is trading belownet asset value (“NAV”), as it has consistently traded for most of the last 18months, our ability to issue equity is constrained by provisions of the 1940Act which generally prohibit the issuance and sale of our common stock belowNAV per share without stockholder approval other than through sales to ourthen-existing stockholders pursuant to a rights offering.  At our annual meeting of stockholders held onFebruary 18, 2010, stockholders approved a proposal which authorizes us tosell shares of our common stock at a price below our then current NAV per sharefor a period of one year from the date of approval, provided that our Board ofDirectors makes certain determinations prior to any such sale. On May 3,2010, the closing market price of our common stock was $13.87, which pricerepresented a 15% premium to our March 31, 2010 NAV per share.

 

Current economic conditions may also decrease the value of collateralsecuring some of our loans, as well as the value of our equity investments,which has impacted and may continue to impact our ability to borrow under ourcredit facility.  For the six monthsended March 31, 2010, we recorded net unrealized appreciation on ourportfolio of investments of $5,082.  Wemay see decreases in the value of our portfolio, which will further limit ourability to borrow under our current credit facility.  Additionally, our credit facility containscovenants regarding the maintenance of certain minimum net worth requirementswhich are affected by the decrease in value of our portfolio.  Failure to meet these requirements wouldresult in a default which, if we are unable to obtain a waiver from ourlenders, would result in the acceleration of our repayment obligations underour credit facility.  As of March 31,2010, we were in compliance with all of the facility covenants.

 

We expect that, given these regulatory and contractual constraints incombination with current market conditions, debt and equity capital may becostly or difficult for us to access. However, we believe that our entry into a new $127,000 credit facilitywith a two-year term (discussed in detail further below) increases our abilityto make new investments consistent with our strategy of making conservativeinvestments in businesses that we believe will weather the current economy andthat are likely to produce attractive long-term returns for our stockholders.

 

**Syndicated Loan Valuations**

 

In monitoring the market activity during thequarter ended March 31, 2010, we noted markets conditions indicatingcontinued liquidity and a better functioning secondary market for syndicatedloans.  Therefore, in accordance withAccounting Standards Codification (“ASC”) 820, and following our valuationprocedures which specify the use of third-party indicative bid quotes forvaluing syndicated loans where there is a liquid public market for those loansand market pricing quotes are readily available, third-party bid quotes wereused to value the remaining syndicated loans not sold during the quarter ended March 31,2010.  As we noted some illiquidity inthe public market, we don’t believe that the third-party bid quotes arerepresentative of Level 2 inputs.

 

**Investment Highlights**

 

*Purchases:* During the six months ended March 31,2010, we extended $180 of investments to a new portfolio company and $7,140 ofinvestments to existing portfolio companies through revolver draws or theadditions of new term notes, for total investments of $7,320.

 

*Repayments:* During the six months ended March 31,2010, five borrowers made unscheduled full payoffs of $31,006, one borrowermade an unscheduled partial payoff of $950 and we experienced contractualamortization, revolver repayments and some principal payments received ahead ofschedule for an aggregate of $6,513, for total principal repayments of $38,469.

 

*Sales:* During the six months ended March 31,2010, we sold three syndicated loans (which resulted in our exit from threeportfolio companies) for an aggregate of $3,119 in net proceeds.

 

Since our initial public offering in August 2001, we have made 263different loans to, or investments in, 127 companies for a total ofapproximately $958,933, before giving effect to principal repayments oninvestments and divestitures.

 

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**Financing Highlights**

 

On March 15, 2010, through our wholly-owned subsidiary, GladstoneBusiness Loan, LLC (“Business Loan”), we entered into a fourth amended andrestated credit agreement which provides for a $127,000 revolving line ofcredit arranged by Key Equipment Finance Inc. as administrative agent (the “CreditFacility”).  Branch Banking and TrustCompany (“BB&T”) and ING Capital LLC (“ING”) also joined the CreditFacility as committed lenders.  Subjectto certain terms and conditions, the Credit Facility may be expanded up to $202million through the addition of other committed lenders to thefacility.  The Credit Facility matures in two years on March 15,2012, and, if the facility is not renewed or extended by this date, all principaland interest will be due and payable on March 15, 2013.  Advancesunder the Credit Facility will generally bear interest at the 30-day LIBOR(subject to a minimum rate of 2%), plus 4.5% per annum, with a commitment feeof 0.5% per annum on undrawn amounts.

 

During the six months ended March 31, 2010, we applied FinancialAccounting Standards Board (“FASB”) ASC 825, “Financial Instruments,”specifically to our Credit Facility, which requires us to apply a fair valuemethodology to the Credit Facility as of March 31, 2010.  Since the Credit Facility was entered intoduring the three months ended March 31, 2010, the cost basis of the CreditFacility of $53,000 was determined to be the best approximation of fair valueas of March 31, 2010.

 

**Registration Statement**

 

On October 20, 2009, we filed a registration statement on Form N-2with the Securities and Exchange Commission (the “SEC”) that was amended on December 9,2009.  The SEC declared the registrationstatement effective on January 28, 2010 and such registration statementwill permit us to issue, through one or more transactions, up to an aggregateof $300,000 in securities, consisting of common stock, senior common stock,preferred stock, subscription rights, debt securities and warrants to purchasecommon stock, or a combination of these securities.

 

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**RESULTSOF OPERATIONS**

 

***Comparison of the Three Months Ended March 31,2010 to the Three Months Ended March 31, 2009***

 

*A comparison of our operatingresults for the three months ended March 31, 2010 and March 31, 2009is shown below:*

** **
| ** **                                                                                           | ** ** | **For the  three months ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2010**                                       | ** ** | **2009** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| INVESTMENT INCOME                                                                                    |       |                                           |       |   |   |   |   |   |   |
| Interest income — non  control/non affiliate investments                                        |       | $                                              | 8,523      |   | $ | 10,329 |   | $ | (1,806 | ) | (17.5 | )% |
| Interest income — control  investments                                                          |       | 709                                            |       | 482 |   | 227 |   | 47.1 | % |
| Interest income — cash                                                                          |       | —                                         |       | 1 |   | (1 | ) | (100.0 | )% |
| Interest income — notes receivable  from employees                                              |       | 108                                            |       | 117 |   | (9 | ) | (7.7 | )% |
| Prepayment fees and other  income                                                                    |       | 474                                            |       | — |   | 474 |   | — |   |
| Total investment income                                                                              |       | 9,814                                          |       | 10,929 |   | (1,115 | ) | (10.2 | )% |
|                                                                                                 |       |                                           |       |   |   |   |   |   |   |
| EXPENSES                                                                                             |       |                                           |       |   |   |   |   |   |   |
| Interest expense                                                                                     |       | 1,136                                          |       | 2,016 |   | (880 | ) | (43.7 | )% |
| Loan servicing fee                                                                                   |       | 852                                            |       | 1,526 |   | (674 | ) | (44.2 | )% |
| Base management fee                                                                                  |       | 739                                            |       | 484 |   | 255 |   | 52.7 | % |
| Incentive fee                                                                                        |       | 1,072                                          |       | 1,089 |   | (17 | ) | (1.6 | )% |
| Administration fee                                                                                   |       | 176                                            |       | 211 |   | (35 | ) | (16.6 | )% |
| Professional fees                                                                                    |       | 219                                            |       | 205 |   | 14 |   | 6.8 | % |
| Amortization of deferred  financing fees                                                             |       | 449                                            |       | 726 |   | (277 | ) | (38.2 | )% |
| Stockholder related costs                                                                            |       | 144                                            |       | 196 |   | (52 | ) | (26.5 | )% |
| Directors’ fees                                                                                 |       | 48                                             |       | 48 |   | — |   | 0.0 | % |
| Insurance expense                                                                                    |       | 79                                             |       | 65 |   | 14 |   | 21.5 | % |
| Compensation expense                                                                                 |       | 245                                            |       | — |   | 245 |   | — |   |
| Other expenses                                                                                       |       | 187                                            |       | 74 |   | 113 |   | 152.7 | % |
| Expenses before credit from  Adviser                                                                 |       | 5,346                                          |       | 6,640 |   | (1,294 | ) | (19.5 | )% |
| Credit to base management  and incentive fees from Adviser                                           |       | (6                                             | )          | (1,266 | ) | 1,260 |   | (99.5 | )% |
| Total expenses net of  credit to base management and incentive fees                                  |       | 5,340                                          |       | 5,374 |   | (34 | ) | (0.6 | )% |
|                                                                                                 |       |                                           |       |   |   |   |   |   |   |
| NET INVESTMENT INCOME                                                                                |       | 4,474                                          |       | 5,555 |   | (1,081 | ) | (19.5 | )% |
|                                                                                                 |       |                                           |       |   |   |   |   |   |   |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS, DERIVATIVE AND BORROWINGS UNDER LINE OF CREDIT: |       |                                           |       |   |   |   |   |   |   |
| Net realized gain (loss) on  investments                                                             |       | 892                                            |       | (2,000 | ) | 2,892 |   | (144.6 | )% |
| Realized loss on settlement  of derivative                                                           |       | —                                         |       | (304 | ) | 304 |   | (100.0 | )% |
| Net unrealized appreciation  on derivative                                                           |       | —                                         |       | 304 |   | (304 | ) | (100.0 | )% |
| Net unrealized appreciation  on investments                                                          |       | 2,483                                          |       | 6,725 |   | (4,242 | ) | (63.1 | )% |
| Net unrealized depreciation  on borrowings under line of credit                                      |       | 131                                            |       | — |   | 131 |   | — |   |
| Net gain on investments,  derivative and borrowingsunder line of credit                              |       | 3,506                                          |       | 4,725 |   | (1,219 | ) | (25.8 | )% |
|                                                                                                 |       |                                           |       |   |   |   |   |   |   |
| NET INCREASE IN NET ASSETS  RESULTING FROM OPERATIONS                                                |       | $                                              | 7,980      |   | $ | 10,280 |   | $ | (2,300 | ) | (22.4 | )% |

 

**Investment Income**

 

Investment income for the three months ended March 31, 2010 was$9,814, as compared to $10,929 for the three months ended March 31,2009.  Interest income from our aggregateinvestment portfolio decreased for the three months ended March 31, 2010,as compared to the prior year period. The level of interest income from investments is directly related to thebalance, at cost, of the interest-bearing investment portfolio outstandingduring the period 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 decreasedprimarily due to the overall reduction in the cost basis of our investments,resulting from the exit of loans subsequent to March 31, 2009, partiallyoffset by an increase in the weighted average yield on our portfolio.  The annualized weighted average yield on ourportfolio, excluding cash and cash equivalents, was 10.9% for the three monthsended March 31, 2010 as compared to 9.7% for the prior year period.  During the three months ended March 31,2010, six investments were on non-accrual, for an aggregate of approximately$26,422 at cost, or 8.0% of the aggregate 

 

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cost of our investment portfolio, and during the prior year period,three investments were on non-accrual, for an aggregate of approximately$10,659 at cost, or 2.4% of the aggregate cost of our investmentportfolio.  The increase in investmentson non-accrual was due primarily to the addition of one portfolio company(Lindmark).  Although we did nothistorically report Lindmark as non-accrual, we have not recognized interestincome on this investment since April 2009.

 

Interest income from Non-Control/Non-Affiliate investments decreasedfor the three months ended March 31, 2010, as compared to the prior yearperiod. The decrease was primarily attributable to an overall decrease in theaggregate Non-Control/Non-Affiliate investments held at March 31, 2010compared to the prior year period.  Thedecrease was also attributable to the conversion of twoNon-Control/Non-Affiliate investments held during the prior year period(Clinton and Defiance) to Control investments. In addition, we reversedpreviously recorded interest income of approximately $90 during the threemonths ended March 31, 2010.  Thesuccess fees earned during the three months ended March 31, 2010 and March 31,2009 included in interest income were $848 and $21, respectively.   Success fees earned during the three monthsended March 31, 2010 resulted from payoffs from ActivStyle, Saunders andVisual Edge.  Success fees earned duringthe three months ended March 31, 2009 resulted from a refinancing by It’sJust Lunch.

 

Interest income from Control investments increased for the three monthsended March 31, 2010, as compared to the prior year period.  The increase was attributable to twoadditional Control investments held during the quarter ended March 31,2010 (Clinton and Defiance), which were converted fromNon-Control/Non-Affiliate investments, as compared to the prior year period.

 

The following table lists the interest income from investments for thefive largest portfolio company investments during the respective periods:

 

 
| **Three months ended March 31,  2010** |
|---------------------------------------------|
| ** **                                  |
| **Company**                                 | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
| Visual Edge                                 |   | $ | 967 |   | 10.5 | % |
| Reliable  Biopharma                         |   | 738 |   | 8.0 | % |
| Sunshine Media                              |   | 693 |   | 7.5 | % |
| Westlake  Hardware                          |   | 672 |   | 7.3 | % |
| Clinton                                     |   | 514 |   | 5.5 | % |
| **Subtotal**                                | ** ** | **$** | **3,584** | ** ** | **38.8** | **%** |
| Other companies                             |   | 5,648 |   | 61.2 | % |
| **Total  interest income**                  | ** ** | **$** | **9,232** | ** ** | **100.0** | **%** |

 
| **Three months ended March 31,  2009** |
|---------------------------------------------|
| ** **                                  |
| **Company**                                 | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
| Sunshine Media                              |   | $ | 824 |   | 7.6 | % |
| Reliable  Biopharma                         |   | 757 |   | 7.0 | % |
| Westlake  Hardware                          |   | 597 |   | 5.5 | % |
| Clinton                                     |   | 465 |   | 4.3 | % |
| VantaCore                                   |   | 416 |   | 3.9 | % |
| **Subtotal**                                | ** ** | **$** | **3,059** | ** ** | **28.3** | **%** |
| Other companies                             |   | 7,752 |   | 71.7 | % |
| **Total  interest income**                  | ** ** | **$** | **10,811** | ** ** | **100.0** | **%** |

 

Interest income from invested cash for the three months ended March 31,2010 and 2009 was nominal.  Interestincome is based on the amount of cash held in interest bearing accounts and theinterest earned on our custodial account prior to disbursement.

 

Interest income from loans to our employees, in connection with theexercise of employee stock options, decreased slightly for the three monthsended March 31, 2010 as compared to the prior year period due to thereduction of employee loans during the previous quarter ended December 31,2009.

 

Prepayment fees and other income increased for the three months ended March 31,2010 as compared to the prior year period. The income for the current period consisted of prepayment penalty feesreceived upon unscheduled principal repayments as well as interest from stockoption loans of former employees.

 

**Operating Expenses**

 

Operating expenses, net of credits from the Adviser for fees earned andvoluntary and irrevocable waivers applied to the base management and incentivefees, decreased for the three months ended March 31, 2010, as compared tothe prior year period.  This reductionwas primarily due to a decrease in interest expense and the amortization ofdeferred financing fees incurred in connection with the Credit Facility, aswell as a decrease in incentive fees, which were offset by a reduction in theAdviser’s voluntary credit to the incentive fee and compensation expense.

 

Interest expense decreased for the three months ended March 31,2010 as compared to the prior year period due primarily to decreased borrowingsunder our line of credit during the three months ended March 31, 2010 aswell as a lower weighted average annual interest cost, which is determined byusing the annual stated interest rate plus commitment and other fees, plus theamortization of deferred financing fees divided by the weighted average debtoutstanding.

 

Loan servicing fees decreased for the three months ended March 31,2010 as compared to the prior year period. These fees are incurred in connection with a loan servicing agreementbetween Business Loan and our Adviser, which is based on the size of our 

 

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investment portfolio.  Thedecrease was primarily due to the reduction in the size of our investmentportfolio, in particular the loans in our borrowing base. Due to voluntary,irrevocable and unconditional waivers applied during these periods, seniorsyndicated loans incurred a 0.5% annual fee, whereas proprietary loans incurreda 1.5% annual fee.  All of these feeswere offset against the amount of the base management fee due to our Adviser.

 

Base management fee (which is net of loan servicing fees) increased forthe three months ended March 31, 2010 as compared to the prior yearperiod.  However, the gross managementfee (consisting of the loan servicing fees plus the base management fee)decreased from the prior year period as shown below:

 

| ** **            | ** ** | **Three  months ended**  | ** ** |
|-----------------------|------------|--------------------------|------------|
| ** **            | ** ** | **March 31,  2010** | ** ** | **March 31,  2009** | ** ** |
| Loan servicing  fee   |       | $                        | 852        |   | $ | 1,526 |   |
| Base management  fee  |       | 739                      |       | 484 |   |
| Gross management  fee |       | $                        | 1,591      |   | $ | 2,010 |   |

 

Gross management fee decreased due to fewer total assets held duringthe three months ended March 31, 2010. The base management fee is computed quarterly as described under *“Investment Advisory and Management Agreement”*in Note 4 of the notes to the consolidated financial statements in our AnnualReport on Form 10-K as filed with the SEC on November 23, 2009, andis summarized in the table below:

 

| ** **                                                                                                         | ** ** | **Three  months ended**  | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                         | ** ** | **March 31,  2010** | ** ** | **March 31,  2009** | ** ** |
| Base management  fee (1)                                                                                           |       | $                        | 739        |   | $ | 484 |   |
| Credit for fees  received by Adviser from the portfolio companies                                                  |       | —                   |       | (80 | ) |
| Fee reduction for  the voluntary, irrevocable waiver of 2.0% fee on senior syndicated loans to  0.5% per annum (2) |       | (6                       | )          | (97 | ) |
| Net base  management fee                                                                                           |       | $                        | 733        |   | $ | 307 |   |

 

----

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

(2)   The board of our Adviser voluntarily andirrevocably waived, for the three months ended March 31, 2010 and 2009,the annual 2.0% base management fee to 0.5% for senior syndicated loanparticipations.  Fees waived cannot berecouped by the Adviser in the future.

 

Incentive fee decreased slightly for the three months ended March 31,2010 as compared to the prior year period. The board of directors of our Adviser voluntarily, irrevocably andunconditionally waived the entire incentive fee for the three months ended March 31,2009.  No portion of the incentive feewas waived during the three months ended March 31, 2010.  The incentive fee and associated credits aresummarized in the table below:

 

| ** **                                                                             | ** ** | **Three  months ended**  | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                             | ** ** | **March 31,  2010** | ** ** | **March 31,  2009** | ** ** |
| Incentive fee                                                                          |       | $                        | 1,072      |   | $ | 1,089 |   |
| Credit from  voluntary, irrevocable waiver issued by Adviser’s board of directors |       | —                   |       | (1,089 | ) |
| Net incentive  fee                                                                     |       | $                        | 1,072      |   | $ | — |   |

 

Administration fee decreased for the three months ended March 31,2010 as compared to the prior year period, due to a decrease of administrationstaff and related expenses, as well as a decrease in our total assets incomparison to the total assets of all companies managed by our Adviser undersimilar agreements.  The calculation ofthe administration fee is described in detail above under *“Investment Advisory and Management Agreement”*in Note 4 of the notes to the consolidated financial statements in our AnnualReport on Form 10-K as filed with the SEC on November 23, 2009.

 

Compensation expense increased for the three months ended March 31,2010 as compared to the prior year period due to the conversion of stock optionloans of two former employees of the Adviser from recourse to non-recourseloans.  The conversions were non-cash transactions and were accountedfor as repurchases of the shares previously received by the employees of theAdviser upon exercise of the stock options in exchange for the non-recoursenotes. The repurchases were accounted for as treasury stock transactions at thefair value of the shares, totaling $420. Since the value of the stock option loans totaled $665, we recordedcompensation expense of $245.

 

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Other operating expenses (including professional fees, deferredfinancing fees, stockholder related costs, director’s fees, insurance and otherdirect expenses) increased for the three months ended March 31, 2010 ascompared to the prior year period, due primarily to legal fees incurred inconnection with troubled loans during the three months ended March 31,2010 and the provision for uncollectible receivables from portfolio companies.

 

**Net Realized Gain (Loss) onInvestments**

 

Net realized gain on investments for the three months ended March 31,2010 was $892, which consisted of a gain from ACE Expediters of $1,366,partially offset by an aggregate of $474 of losses from the CCS payoff andGoldToe syndicated loan sale.  Netrealized loss on investments for the three months ended March 31, 2009 was$2,000, which resulted from writing off the remaining balance of the Greatwidesenior subordinated term loan.

 

**Realized Loss on Settlement ofDerivative**

 

During the three months ended March 31, 2009, we realized a lossof $304 due to the expiration of the interest rate cap in February 2009.

 

**Net Unrealized Appreciation onDerivative**

 

Net unrealized appreciation (depreciation) on derivative is the netchange in the fair value of our interest rate cap during the reporting period,including the reversal of previously recorded unrealized appreciation ordepreciation when gains and losses are realized.  For the three months ended March 31,2009, we recorded unrealized appreciation on derivative of $304, which resultedfrom the reversal of previously recorded unrealized depreciation when the losswas realized during the March 2009 quarter (see discussion above).

 

**Net Unrealized Appreciation onInvestments**

 

Net unrealized appreciation (depreciation) on investments is the netchange in the fair value of our investment portfolio during the reportingperiod, including the reversal of previously recorded unrealized appreciationor depreciation when gains and losses are realized.  The net unrealized appreciation on investmentsfor the three months ended March 31, 2010 consisted of the following:

 
| ·    Control investments                                                                 |   | $     | (566   | )      |
|--------------------------------------------------------------------------------------------------------------|--------|-------|--------|--------|
| ·    Non-Control/Non-Affiliate  investments                                              |   | 1,018 |   |
| ·    Reversal of previously recorded unrealized  depreciation upon realization of losses |   | 2,031 |   |
| Total                                                                                                        |   | $     | 2,483  |   |

 

Although ourinvestment portfolio appreciated during the three months ended March 31,2010, our entire portfolio was fair valued at 88% of cost as of March 31,2010.  The cumulative unrealizeddepreciation of our investments does not have an impact on our current abilityto pay distributions to stockholders; however, it may be an indication offuture realized losses, which could ultimately reduce our income available fordistribution.

 

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

 

Netunrealized depreciation on borrowings under line of credit is the net change inthe fair value of our line of credit borrowings during the reporting period,including the reversal of previously recorded unrealized appreciation ordepreciation when gains and losses are realized.  We elected to apply ASC 825, “Financial Instruments,”which requires that we apply a fair value methodology to the CreditFacility.  We estimated the fair value ofthe Credit Facility using estimates of value provided by an independent thirdparty and our own assumptions in the absence of observable market data,including estimated remaining life, current market yield and interest ratespreads of similar securities as of the measurement date.  Since the Credit Facility was entered intoduring the three months ended March 31, 2010, the cost basis of the CreditFacility of $53,000 was determined to be the best approximation of the fairvalue as of March 31, 2010.

 

**Net Increase in Net Assets Resulting from Operations**

 

For the three months ended March 31, 2010, we realized a netincrease in net assets resulting from operations of $7,980 as a result of thefactors discussed above.  For the threemonths ended March 31, 2009, we realized a net increase in net assetsresulting from operations of $10,280.  Our net increase in net assets resultingfrom operations per basic and diluted weighted average common share for thethree months ended March 31, 2010 and March 31, 2009 were $0.38 and$0.48, respectively.

 

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***Comparison of the Six Months Ended March 31,2010 to the Six Months Ended March 31, 2009***

 

*A comparison of our operatingresults for the six months ended March 31, 2010 and March 31, 2009 isshown below:*

** **
| ** **                                                                                           | ** ** | **For the  six months ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2010**                                     | ** ** | **2009** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| INVESTMENT INCOME                                                                                    |       |                                         |       |   |   |   |   |   |   |
| Interest income — non  control/non affiliate investments                                        |       | $                                            | 17,432     |   | $ | 21,990 |   | $ | (4,558 | ) | (20.7 | )% |
| Interest income — control  investments                                                          |       | 1,477                                        |       | 502 |   | 975 |   | 194.2 | % |
| Interest income — cash                                                                          |       | —                                       |       | 11 |   | (11 | ) | (100.0 | )% |
| Interest income — notes  receivable from employees                                              |       | 221                                          |       | 235 |   | (14 | ) | (6.0 | )% |
| Prepayment fees and other  income                                                                    |       | 488                                          |       | — |   | 488 |   | — |   |
| Total investment income                                                                              |       | 19,618                                       |       | 22,738 |   | (3,120 | ) | (13.7 | )% |
|                                                                                                 |       |                                         |       |   |   |   |   |   |   |
| EXPENSES                                                                                             |       |                                         |       |   |   |   |   |   |   |
| Interest expense                                                                                     |       | 2,671                                        |       | 4,478 |   | (1,807 | ) | (40.4 | )% |
| Loan servicing fee                                                                                   |       | 1,781                                        |       | 3,149 |   | (1,368 | ) | (43.4 | )% |
| Base management fee                                                                                  |       | 1,459                                        |       | 917 |   | 542 |   | 59.1 | % |
| Incentive fee                                                                                        |       | 1,447                                        |       | 2,265 |   | (818 | ) | (36.1 | )% |
| Administration fee                                                                                   |       | 354                                          |       | 438 |   | (84 | ) | (19.2 | )% |
| Professional fees                                                                                    |       | 1,131                                        |       | 518 |   | 613 |   | 118.3 | % |
| Amortization of deferred  financing fees                                                             |       | 943                                          |       | 1,446 |   | (503 | ) | (34.8 | )% |
| Stockholder related costs                                                                            |       | 222                                          |       | 284 |   | (62 | ) | (21.8 | )% |
| Directors’ fees                                                                                 |       | 97                                           |       | 97 |   | — |   | 0.0 | % |
| Insurance expense                                                                                    |       | 147                                          |       | 122 |   | 25 |   | 20.5 | % |
| Compensation expense                                                                                 |       | 245                                          |       | — |   | 245 |   | — |   |
| Other expenses                                                                                       |       | 254                                          |       | 140 |   | 114 |   | 81.4 | % |
| Expenses before credit from  Adviser                                                                 |       | 10,751                                       |       | 13,854 |   | (3,103 | ) | (22.4 | )% |
| Credit to base management  and incentive fees from Adviser                                           |       | (35                                          | )          | (2,553 | ) | 2,518 |   | (98.6 | )% |
| Total expenses net of  credit to base management and incentive fees                                  |       | 10,716                                       |       | 11,301 |   | (585 | ) | (5.2 | )% |
|                                                                                                 |       |                                         |       |   |   |   |   |   |   |
| NET INVESTMENT INCOME                                                                                |       | 8,902                                        |       | 11,437 |   | (2,535 | ) | (22.2 | )% |
|                                                                                                 |       |                                         |       |   |   |   |   |   |   |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS, DERIVATIVE AND BORROWINGS UNDER LINE OF CREDIT: |       |                                         |       |   |   |   |   |   |   |
| Net realized loss on  investments                                                                    |       | (28                                          | )          | (3,731 | ) | 3,703 |   | (99.2 | )% |
| Realized loss on settlement  of derivative                                                           |       | —                                       |       | (304 | ) | 304 |   | (100.0 | )% |
| Net unrealized appreciation  on derivative                                                           |       | —                                       |       | 304 |   | (304 | ) | (100.0 | )% |
| Net unrealized appreciation  (depreciation) on investments                                           |       | 5,082                                        |       | (6,528 | ) | 11,610 |   | (177.8 | )% |
| Net unrealized appreciation  on borrowings under line of credit                                      |       | 350                                          |       | — |   | 350 |   | — |   |
| Net gain (loss) on  investments, derivative and borrowingsunder line of credit                       |       | 5,404                                        |       | (10,259 | ) | 15,663 |   | (152.7 | )% |
|                                                                                                 |       |                                         |       |   |   |   |   |   |   |
| NET INCREASE IN NET ASSETS  RESULTING FROM OPERATIONS                                                |       | $                                            | 14,306     |   | $ | 1,178 |   | $ | 13,128 |   | 1,114.4 | % |

 

**Investment Income**

 

Investment income for the six months ended March 31, 2010 was$19,618, as compared to $22,738 for the six months ended March 31,2009.  Interest income from our aggregateinvestment portfolio decreased for the six months ended March 31, 2010, ascompared to the prior year period.  Thelevel of interest income from investments is directly related to the balance,at cost, of the interest-bearing investment portfolio outstanding during theperiod multiplied by the weighted average yield.  The weighted average yield varies from periodto period based on the current stated interest rate on interest-bearing investmentsand the amounts of loans for which interest is not accruing.  Interest income from our investmentsdecreased primarily due to the overall reduction in the cost basis of ourinvestments, resulting from the exit of loans subsequent to March 31,2009, partially offset by an increase in the weighted average yield on ourportfolio.  The annualized weightedaverage yield on our portfolio, excluding cash and cash equivalents, was 10.7%for the six months ended March 31, 2010 as compared to 10.0% for the prioryear period.  During the six months endedMarch 31, 2010, six investments were on non-accrual, for an aggregate ofapproximately $26,422 at cost, or 8.0% of the aggregate cost of our investmentportfolio, and during the prior year period, three investments were onnon-accrual, for an aggregate of approximately $10,659 at cost, or 2.4% of theaggregate cost of our investment portfolio. The increase in investments on non-accrual was due

 

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primarily to the addition of one portfolio company (Lindmark).  Although we did not historically reportLindmark as non-accrual, we have not recognized interest income on thisinvestment since April 2009.

 

Interest income from Non-Control/Non-Affiliate investments decreasedfor the six months ended March 31, 2010, as compared to the prior year period.The decrease was primarily attributable to an overall decrease in the aggregateNon-Control/Non-Affiliate investments held at March 31, 2010 compared to theprior year period.  The decrease was alsoattributable to the conversion of two Non-Control/Non-Affiliate investmentsheld during the prior year period (Clinton and Defiance) to Controlinvestments. In addition, we reversed previously recorded interest ofapproximately $598 during the six months ended March 31, 2010.  The success fees earned during the six monthsended March 31, 2010 and March 31, 2009, included in interest income, were$1,387 and $21, respectively.  Successfees earned during the six months ended March 31, 2010 resulted from payoffs byActivStyle, Saunders and Visual Edge, an amendment to senior term debt issuedto Doe & Ingalls and a refinancing by Tulsa Welding.  Success fees earned during the six monthsended March 31, 2009 resulted from a refinancing by It’s Just Lunch.

 

Interest income from Control investments increased for the six monthsended March 31, 2010, as compared to the prior year period.  The increase was attributable to twoadditional Control investments held during the six months ended March 31, 2010(Clinton and Defiance), which were converted from Non-Control/Non-Affiliateinvestments, as compared to the prior year period.  In addition, we reversed previously recordedinterest of approximately $75 during the six months ended March 31, 2010.

 

The following table lists the interest income from investments for thefive largest portfolio company investments during the respective periods:

 
| **Six months ended March 31, 2010** |
|-------------------------------------|
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Company**                         | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
| Westlake  Hardware                  |   | $ | 1,596 |   | 8.5 | % |
| Sunshine Media                      |   | 1,539 |   | 8.1 | % |
| Reliable  Biopharma                 |   | 1,497 |   | 7.9 | % |
| Visual Edge                         |   | 1,246 |   | 6.6 | % |
| Clinton                             |   | 1,036 |   | 5.5 | % |
| **Subtotal**                        | ** ** | **6,914** | ** ** | **36.6** | **%** |
| Other companies                     |   | 11,995 |   | 63.4 | % |
| **Total  interest income**          | ** ** | **$** | **18,909** | ** ** | **100.0** | **%** |

 
| **Six months ended March 31, 2009** |
|-------------------------------------|
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Company**                         | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
| Sunshine Media                      |   | $ | 1,667 |   | 7.4 | % |
| Reliable Biopharma                  |   | 1,530 |   | 6.8 | % |
| Westlake Hardware                   |   | 1,213 |   | 5.4 | % |
| Clinton                             |   | 940 |   | 4.2 | % |
| VantaCore                           |   | 857 |   | 3.8 | % |
| **Subtotal**                        | ** ** | **6,207** | ** ** | **27.6** | **%** |
| Other companies                     |   | 16,285 |   | 72.4 | % |
| **Total interest income**           | ** ** | **22,492** | ** ** | **100.0** | **%** |
|                                     |  |  |  |  |  |  |

 

Interest income from invested cash for the six months ended March 31,2010 and 2009 was nominal.  Interestincome is based on the amount of cash held in interest bearing accounts and theinterest earned on our custodial account prior to disbursement.

 

Interest income from loans to our employees, in connection with theexercise of employee stock options, decreased slightly for the six months endedMarch 31, 2010 as compared to the prior year period due to the reduction ofemployee loans during the prior quarter ended December 31, 2009.

 

Prepayment fees and other income increased for the six months ended March31, 2010 as compared to the prior year period. The income for the current period consisted of prepayment penalty feesreceived upon unscheduled principal repayments as well as interest from stockoption loans of former employees.

 

**Operating Expenses**

 

Operating expenses, net of credits from the Adviser for fees earned andvoluntary and irrevocable waivers applied to the base management and incentivefees, decreased for the six months ended March 31, 2010, as compared to theprior year period.  This reduction wasprimarily due to a decrease in interest expense and the amortization ofdeferred financing fees incurred in connection with the Credit Facility, aswell as a decrease in incentive fees, which were offset by a reduction in theAdviser’s voluntary credit to the incentive fee, compensation expense and anincrease in professional fees.

 

Interest expense decreased for the six months ended March 31, 2010 ascompared to the prior year period due primarily to decreased borrowings underour line of credit during the six months ended March 31, 2010 as well as alower weighted average annual interest cost, which is determined by using theannual stated interest rate plus commitment and other fees, plus theamortization of deferred financing fees divided by the weighted average debtoutstanding. 

 

Loan servicing fees decreased for the six months ended March 31, 2010as compared to the prior year period. These fees are incurred in connection with a loan servicing agreementbetween Business Loan and our Adviser, which is based on the size of ourinvestment 

 

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portfolio.  The decrease wasprimarily due to the reduction in the size of our investment portfolio, inparticular the loans in our borrowing base. Due to voluntary, irrevocable andunconditional waivers applied during these periods, senior syndicated loansincurred a 0.5% annual fee, whereas proprietary loans incurred a 1.5% annualfee.  All of these fees were offsetagainst the amount of the base management fee due to our Adviser.

 

Base management fee (which is net of loan servicing fees) increased forthe six months ended March 31, 2010 as compared to the prior year period.  However, the gross management fee (consistingof the loan servicing fees plus the base management fee) decreased from theprior year period as shown below:

 

| ** **            | ** ** | **Six months  ended** | ** ** |
|-----------------------|------------|-----------------------|------------|
| ** **            | ** ** | **March 31,  2010**   | ** ** | **March 31,  2009** | ** ** |
| Loan servicing  fee   |       | $                     | 1,781      |   | $ | 3,149 |   |
| Base management  fee  |       | 1,459                 |       | 917 |   |
| Gross management  fee |       | $                     | 3,240      |   | $ | 4,066 |   |

 

Gross management fee decreased due to fewer total assets held duringthe six months ended March 31, 2010.  Thebase management fee is computed quarterly as described under “Investment Advisory and ManagementAgreement” in Note 4 of the notes to the consolidated financialstatements in our Annual Report on Form 10-K as filed with the SEC on November 23,2009, and is summarized in the table below:

 

| ** **                                                                                                         | ** ** | **Six months  ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                         | ** ** | **March 31,  2010**   | ** ** | **March 31,  2009** | ** ** |
| Base management  fee (1)                                                                                           |       | $                     | 1,459      |   | $ | 917 |   |
| Credit for fees  received by Adviser from the portfolio companies                                                  |       | —                |       | (85 | ) |
| Fee reduction  for the voluntary, irrevocable waiver of 2.0% fee on senior syndicated loans  to 0.5% per annum (2) |       | (13                   | )          | (203 | ) |
| Net base  management fee                                                                                           |       | $                     | 1,446      |   | $ | 629 |   |

 

----

| (1) |   | Base management fee is net of loan servicing fees  per the terms of the Advisory Agreement.                                                                                                                                                                           |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | The board of our Adviser voluntarily and irrevocably  waived, for the six months ended March 31, 2010 and 2009, the annual 2.0%  base management fee to 0.5% for senior syndicated loan participations. Fees  waived cannot be recouped by the Adviser in the future. |

 

Incentive fee decreased for the six months ended March 31, 2010 ascompared to the prior year period.  Theboard of directors of our Adviser voluntarily, irrevocably and unconditionallywaived a portion of the incentive fee for the six months ended March 31, 2010and the entire incentive fee for the six months ended March 31, 2009.  The incentive fee and associated credits aresummarized in the table below:

 

| ** **                                                                             | ** ** | **Six months  ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                             | ** ** | **March 31,  2010**   | ** ** | **March 31,  2009** | ** ** |
| Incentive fee                                                                          |       | $                     | 1,447      |   | $ | 2,265 |   |
| Credit from  voluntary, irrevocable waiver issued by Adviser’s board of directors |       | (22                   | )          | (2,265 | ) |
| Net incentive  fee                                                                     |       | $                     | 1,425      |   | $ | — |   |

 

Administration fee decreased for the six months ended March 31, 2010 ascompared to the prior year period, due to a decrease of administration staffand related expenses, as well as a decrease in our total assets in comparisonto the total assets of all companies managed by our Adviser under similaragreements.  The calculation of theadministration fee is described in detail above under “Investment Advisory and Management Agreement” in Note 4 of thenotes to the consolidated financial statements in our Annual Report on Form 10-Kas filed with the SEC on November 23, 2009.

 

Compensation expense increased for the six months ended March 31, 2010as compared to the prior year period due to the conversion of stock optionloans of two former employees from recourse to non-recourse loans.  The conversions were non-cash transactions and were accounted for as repurchases of theshares previously received by the employees upon exercise of the stock optionin exchange for the non-recourse notes. The repurchases were accounted for astreasury stock transactions at the fair value of the shares, totaling$420.  Since the value of the stockoption loans totaled $665, we recorded compensation expense of $245.

 

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Other operating expenses (including professional fees, deferredfinancing fees, stockholder related costs, director’s fees, insurance and otherdirect expenses) increased for the six months ended March 31, 2010 as comparedto the prior year period, due primarily to legal fees incurred in connectionwith troubled loans during the six months ended March 31, 2010 and theprovision for uncollectible receivables from portfolio companies.

 

**Net Realized Loss on Investments**

 

Net realized loss on investments for the six months ended March 31,2010 was $28, which consisted of $1,394 of losses from the Gold Toe, Kinetekand Wesco syndicated loan sales and CCS payoff, offset by a $1,366 gain fromACE Expediters payoff.  Net realized losson investments for the six months ended March 31, 2009 was $3,731, whichconsisted of $2,000 from writing off the remaining balance of the Greatwidesenior subordinated term loan and a $1,758 loss from the sale of the Greatwidesenior subordinated term loan, offset by a $27 gain from the Country Roadpayoff.

 

**Realized Loss on Settlement ofDerivative**

 

During the six months ended March 31, 2009, we realized a loss of $304due to the expiration of the interest rate cap in February 2009.

 

**Net Unrealized Appreciation onDerivative**

 

Net unrealized appreciation (depreciation) on derivative is the netchange in the fair value of our interest rate cap during the reporting period,including the reversal of previously recorded unrealized appreciation ordepreciation when gains and losses are realized.  For the six months ended March 31, 2009, werecorded unrealized appreciation on derivative of $304, which resulted from thereversal of previously recorded unrealized depreciation when the loss wasrealized during the quarter ended March 31, 2009 (see discussion above).

 

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

 

Net unrealized appreciation (depreciation) on investments is the netchange in the fair value of our investment portfolio during the reportingperiod, including the reversal of previously recorded unrealized appreciationor depreciation when gains and losses are realized.  The net unrealized appreciation oninvestments for the six months ended March 31, 2010 consisted of the following:

 
| · | Control investments                                                                 |   | $     | (1,566 | )      |
|--------|-------------------------------------------------------------------------------------|--------|-------|--------|--------|
| · | Non-Control/Non-Affiliate  investments                                              |   | 3,437 |   |
| · | Reversal of previously recorded unrealized  depreciation upon realization of losses |   | 3,211 |   |
|   | Total                                                                               |   | $     | 5,082  |   |

 

Although ourinvestment portfolio appreciated during the six months ended March 31, 2010,our entire portfolio was fair valued at 88% of cost as of March 31, 2010.  The cumulative unrealized depreciation of ourinvestments does not have an impact on our current ability to pay distributionsto stockholders; however, it may be an indication of future realized losses,which could ultimately reduce our income available for distribution.

 

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

 

Netunrealized depreciation on borrowings under line of credit is the net change inthe fair value of our line of credit borrowings during the reporting period,including the reversal of previously recorded unrealized appreciation ordepreciation when gains and losses are realized.  We elected to apply ASC 825, “FinancialInstruments,” which requires that we apply a fair value methodology to theCredit Facility.  We estimated the fairvalue of the Credit Facility using estimates of value provided by anindependent third party and our own assumptions in the absence of observablemarket data, including estimated remaining life, current market yield andinterest rate spreads of similar securities as of the measurement date.  Since the Credit Facility was entered into duringthe six months ended March 31, 2010, the cost basis of the Credit Facility of$53,000 was determined to be the best approximation of fair value as of March 31,2010.

 

**Net Increase in Net Assets Resulting from Operations**

 

For the six months ended March 31, 2010, we realized a netincrease in net assets resulting from operations of $14,306 as a result of thefactors discussed above.  For the sixmonths ended March 31, 2009, we realized a net increase in net assets resultingfrom operations of $1,178.  Our net increase in net assets resultingfrom operations per basic and diluted weighted average common share for the sixmonths ended March 31, 2010 and March 31, 2009 were $0.68 and $0.05,respectively.

 

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

 

**Operating Activities**

 

At March 31, 2010, we had investments in debt securities of, or loansto, 41 private companies with a cost basis totaling approximately$330,094.  During the six months ended March31, 2010 and March 31, 2009, the following investment activity occurred:

 

| **Quarter********Ended** | ** ** | **New********Investments (1)** | ** ** | **Principal  Repayments (2)** | ** ** | **Proceeds  from  Sales/Exits (3)** | ** ** | **Net Gain  (Loss)  on Sale/Exit** | ** ** |
|--------------------------|------------|--------------------------------|------------|-------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| March 31, 2010           |       | $                              | 5,153      |                          | $          | 23,065                              |       | $                                  | 337        |   | $ | 892 |   |
| December 31,  2009       |       | 2,167                          |       | 15,404                        |       | 2,782                               |       | (920                               | )          |
|                     |       | $                              | 7,320      |                          | $          | 38,469                              |       | $                                  | 3,119      |   | $ | (28 | ) |
|                     |       |                           |       |                          |       |                                |       |                               |       |
| March 31, 2009           |       | $                              | 8,427      |                          | $          | 13,053                              |       | $                                  | —     |   | $ | (2,000 | ) |
| December 31,  2008       |       | 8,702                          |       | 14,927                        |       | 2,212                               |       | (1,731                             | )          |
|                     |       | $                              | 17,129     |                          | $          | 27,980                              |       | $                                  | 2,212      |   | $ | (3,731 | ) |

 

----

**(1) NewInvestments:**

** **

| ** **        | ** ** | ** **          | ** ** | ** **             | ** ** | **Disbursements to** | ** ** | ** **        | ** ** |
|-------------------|------------|---------------------|------------|------------------------|------------|----------------------|------------|-------------------|------------|
| ** **        | ** ** | **New Investments** | ** ** | **Existing Portfolio** | ** ** | **Total**            | ** ** |
| **Quarter Ended** | ** ** | **Companies**       | ** ** | **Investments**        | ** ** | **Companies**        | ** ** | **Disbursements** | ** ** |
| March 31, 2010    |       | —              |       | $                      | —     |                 | $          | 5,153             |       | $ | 5,153 |   |
| December 31, 2009 |       | 1                   | (a)        | 180                    |       | 1,987                |       | 2,167             |       |
|              |       | 1                   |       | $                      | 180        |                 | $          | 7,140             |       | $ | 7,320 |   |
|              |       |                |       |                   |       |                 |       |              |       |
| March 31, 2009    |       | —              |       | $                      | —     |                 | $          | 8,427             |       | $ | 8,427 |   |
| December 31, 2008 |       | —              |       | —                 |       | 8,702                |       | 8,702             |       |
|              |       | —              |       | $                      | —     |                 | $          | 17,129            |       | $ | 17,129 |   |

 

----

(a)          Northstar Broadband

 

**(2)****        ****Principal Repayments (includingrepayment of paid in kind interest previously applied to principal balance):**

** **

| **Quarter Ended** | ** ** | **Number of  Companies  Fully Exited** | ** ** | **Unscheduled  Principal  Repayments (*)** | ** ** | **Scheduled  Principal  Repayments** | ** ** | **Total  Principal  Repayments** | ** ** | **Net Gain on  Sale/Exit (#)** | ** ** |
|-------------------|------------|----------------------------------------|------------|--------------------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| March 31, 2010    |       | 4                                      | (a)        | $                                          | 18,902     |                                 | $          | 4,163                            |       | $                              | 23,065     |   | $ | 1,055 |   |
| December 31, 2009 |       | 1                                      | (b)        | 13,054                                     |       | 2,350                                |       | 15,404                           |       | —                         |       |
|              |       | 5                                      |       | $                                          | 31,956     |                                 | $          | 6,513                            |       | $                              | 38,469     |   | $ | 1,055 |   |
|              |       |                                   |       |                                       |       |                                 |       |                             |       |                           |       |
| March 31, 2009    |       | —                                 | (c)        | $                                          | 7,813      |                                 | $          | 5,240                            |       | $                              | 13,053     |   | $ | — |   |
| December 31, 2008 |       | 2                                      | (d)        | 6,966                                      |       | 7,961                                |       | 14,927                           |       | —                         |       |
|              |       | 2                                      |       | $                                          | 14,779     |                                 | $          | 13,201                           |       | $                              | 27,980     |   | $ | — |   |

 

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

(#)         Net gainon principal repayments of $1,055 plus the net loss on sales/exits of $1,083(per footnote 3 below) equals net loss of $28, which is included on thecondensed consolidated statement of operations for the six months ended March 31,2010.

(a)          Fullpayoff from ACE Expediters (which resulted in a gain on the warrants),ActivStyle, CCS and Visual Edge.

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

(c)          Refinancingfrom ACE Expediters and Sunburst Media.

(d)         Fullpayoff from CommunityMedia and Country Road.

 

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

** **

| **Quarter Ended** | ** ** | **Number of  Companies  Fully Exited** | ** ** | **Proceeds  Received** | ** ** | **Position  (Principal)  Exited** | ** ** | **Unamortized  Loan Costs (*)** | ** ** | **Net Loss on  Exit (#)** | ** ** |
|-------------------|------------|----------------------------------------|------------|------------------------|------------|-----------------------------------|------------|---------------------------------|------------|---------------------------|------------|
| March 31, 2010    |       | 1                                      | (a)        | $                      | 337        |                              | $          | (500                            | )          | $                         | —     |   | $ | (163 | ) |
| December 31, 2009 |       | 2                                      | (b)        | 2,782                  |       | (3,685                            | )          | (17                             | )          | (920                      | )          |
|              |       | 3                                      |       | $                      | 3,119      |                              | $          | (4,185                          | )          | $                         | (17        | ) | $ | (1,083 | ) |
|              |       |                                   |       |                   |       |                              |       |                            |       |                      |       |
| March 31, 2009    |       | 1                                      | (c)        | $                      | —     |                              | $          | (2,000                          | )          | $                         | —     |   | $ | (2,000 | ) |
| December 31, 2008 |       | —                                 | (d)        | 2,212                  |       | (3,950                            | )          | 7                               |       | (1,731                    | )          |
|              |       | 1                                      |       | $                      | 2,212      |                              | $          | (5,950                          | )          | $                         | 7          |   | $ | (3,731 | ) |

 

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

(#)         Netgain on principal repayments of $1,055 (per footnote 2 above) plus the net losson sales/exits of $1,083 equals net loss of $28, which is included on thecondensed consolidated statement of operations for the six months ended March 31,2010.

(a)          Completesale of Gold Toe senior subordinated syndicated loan.

(b)         Completesale of Kinetek senior term syndicated loan and Wesco Holdings seniorsubordinated syndicated loan.

(c)          Write-offof Greatwide Logistics senior subordinated syndicated loan.

(d)         Partial sale of Greatwide Logisticssenior term syndicated loan.

 

The following table summarizes the contractual principal repayments andmaturity of our investment portfolio by fiscal year, assuming no voluntaryprepayments:

 
| ** **                                        | ** ** | ** **                                                                           | ** ** | **Amount** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|------------|------------|
| For the remaining six months ending September 30: |       | 2010                                                                                 |       | $          | 20,904     |   |
| For the fiscal  year ending September 30:         |       | 2011                                                                                 |       | 92,686     |       |
|                                              |       | 2012                                                                                 |       | 78,069     |       |
|                                              |       | 2013                                                                                 |       | 119,763    |       |
|                                              |       | 2014                                                                                 |       | 6,116      |       |
|                                              |       | 2015                                                                                 |       | 6,851      |       |
| ** **                                        | ** ** | **Total  Contractual Repayments**                                                    |       | 324,389    |       |
|                                              |       | Investments in equity securities                                                     |       | 5,278      |       |
| ** **                                        |       | Unamortized premiums, discounts and investment  acquisition costs on debt securities |       | 427        |       |
| ** **                                        | ** ** | **Total**                                                                            |       | $          | 330,094    |   |

 

Net cash provided by operating activities for the six months ended March31, 2010, consisting primarily of the items described in “—Results of Operations” and the investment activity describedabove, was $39,235 as compared to net cash provided by operating activities of$19,586 for the six months ended March 31, 2009.

 

**Financing Activities**

 

Net cash used in financing activities for the six months ended March 31,2010 was $40,250 and mainly consisted of net payments on the Credit Facility of$30,000, distributions to stockholders of $8,853 and $1,323 in financing feesfor the Credit Facility.  On March 15,2010, we entered into the Credit Facility. BB&T and ING also joined the Credit Facility as committedlenders.  Net cash used in financingactivities for the six months ended March 31, 2009 was $15,550 and primarilyconsisted of distributions to stockholders of $17,714, offset by net borrowingsunder our line of credit of $2,340.

 

**Distributions**

 

In order toqualify as a RIC and to avoid corporate level tax on the income we distributeto our stockholders, we are required, under Subchapter M of the Code, todistribute at least 90% of our ordinary income and short-term capital gains toour stockholders on an annual basis. Further, our Credit Facility requires usto pay distributions only from estimated net investment income.  In accordance with these requirements, wedeclared and paid monthly cash distributions of $0.07 per common share forJanuary, February and March 2010.  In April2010, our Board of Directors declared a monthly distribution of $0.07 percommon share for each of April, May and June 2010.

 

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*Section 19(a) Disclosure*

 

OurBoard of Directors estimates the source of the distributions at the time oftheir declaration as required by Section 19(a) of the 1940 Act.  On a monthly basis, if required under Section19(a), we post a Section 19(a) notice through the Depository Trust Company’sLegal Notice System (“LENS”) and also send to our registered stockholders awritten Section 19(a) notice along with the payment of distributions for anypayment which includes a distribution estimated to be paid from any othersource other than net investment income. The estimates of the source of the distribution are interim estimates basedon GAAP that are subject to revision, and the exact character of thedistributions for tax purposes cannot be determined until our books and recordsare finalized for the calendar year. Following the calendar year end, after we have determined definitiveinformation, if we have made distributions of taxable income (or return ofcapital), we will deliver a Form 1099-DIV to our stockholders specifying suchamount and the tax characterization of such amount.  Therefore, these estimates are made solely inorder to comply with the requirements of Section 19(a) of the 1940 Act andshould not be relied upon for tax reporting or any other purposes and coulddiffer significantly from the actual character of distributions for taxpurposes.

 

Thefollowing GAAP estimates were made by our Board of Directors during the quarterended March 31, 2010:

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

 

Becauseour Board of Directors declares distributions at the beginning of a quarter, itis difficult to estimate how much of our monthly distributions, based on GAAP,will come from ordinary income, capital gains and returns of capital.  Subsequent to the quarter ended March 31,2010, the following corrections were made to the above listed estimates forthat quarter:

 
| **Month  Ended**   | ** ** | **Ordinary  Income** | ** ** | **Return of  Capital *** | ** ** | **Total  Distribution** | ** ** |
|--------------------|------------|----------------------|------------|--------------------------|------------|-------------------------|------------|
| January 31, 2010   |       | $                    | 0.098      |                     | $          | (0.028                  | )          | $ | 0.070 |   |
| February 28,  2010 |       | 0.047                |       | 0.023                    |       | 0.070                   |       |
| March 31, 2010     |       | 0.065                |       | 0.005                    |       | 0.070                   |       |
|                    |            |                      |            |                          |            |                         |            |  |  |  |

 

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

 
| **Month  Ended** | ** ** | **Ordinary  Income** | ** ** | **Return of  Capital *** | ** ** | **Total  Distribution** | ** ** |
|------------------|------------|----------------------|------------|--------------------------|------------|-------------------------|------------|
| April 30, 2010   |       | $                    | 0.119      |                     | $          | (0.049                  | )          | $ | 0.070 |   |
| May 31, 2010     |       | 0.086                |       | (0.016                   | )          | 0.070                   |       |
| June 30, 2010    |       | 0.028                |       | 0.042                    |       | 0.070                   |       |
|                  |            |                      |            |                          |            |                         |            |  |  |  |

 

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*A positive number under Return of Capital indicates a return of capital wasestimated whereas a negative number indicates that a surplus of income abovethe distribution was estimated.

 

**Issuance of Equity**

 

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

 

We anticipate issuing equity securities to obtain additional capital inthe future.  However, we cannot determinethe terms of any future equity issuances or whether we will be able to issueequity on terms favorable to us, or at all. Additionally, when our common stock is trading below NAV, as it hasconsistently traded for most of the last 18 months, we will have regulatoryconstraints under the 1940 Act on our ability to obtain additional capital inthis manner.  Generally, the 1940 Actprovides that we may not issue and sell our common stock at a price below ourNAV per share, other than to our then existing stockholders pursuant to arights offering, without first obtaining approval from our stockholders and ourindependent directors.  As of March 31,2010, our NAV per share was $12.10 and as of May 3 our closing market price was$13.87 per share.  To the extent that ourcommon stock trades at a market price below our NAV per share, we willgenerally be precluded from raising equity capital through public offerings ofour common stock, other than pursuant to stockholder approval or a rightsoffering.  The asset coverage requirementof a business development company under the 1940 Act effectively limits ourratio of debt to equity to 1:1.  To theextent that we are unable to raise capital

 

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through the issuance of equity, our ability to raise capital throughthe issuance of debt may also be inhibited to the extent of our regulatory debtto equity ratio limits.

 

At our Annual Meeting of Stockholders held on February 18, 2010, ourstockholders approved a proposal that authorizes us to sell shares of ourcommon stock at a price below our then current NAV per share for a period ofone year, provided that our Board of Directors makes certain determinationsprior to any such sale.

 

**Revolving Credit Facility**

 

On March 15, 2010, we entered into a fourth amended and restated creditagreement which currently provides for a $127,000 revolving line ofcredit.  Advances under the CreditFacility will generally bear interest at the 30-day LIBOR (subject to a minimumrate of 2%), plus 4.5% per annum, with a commitment fee of 0.5% per annum onundrawn amounts.  Subject to certainterms and conditions, the Credit Facility may be expanded up to $202 millionthrough the addition of other committed lenders to the facility. As of March 31,2010, there was a cost basis of approximately $53,000 of borrowings outstandingunder the Credit Facility at an average interest rate of 6.5%.  As of May 4, 2010, there was a cost basis ofapproximately $28,400 of borrowings outstanding.  We expect that the Credit Facility will allowus to increase the rate of our investment activity and grow the size of ourinvestment portfolio.  Availableborrowings are subject to various constraints imposed under the CreditFacility, based on the aggregate loan balance pledged by us. Interest ispayable monthly during the term of the Credit Facility.  The Credit Facility matures on March 15,2012, and, if the facility is not renewed or extended by this date, allprincipal and interest will be due and payable on March 15, 2013.  In addition, if the Credit Facility is notrenewed on or before March 15, 2012, we will be required to use all principalcollections from our loans to pay outstanding principal on the Credit Facility.

 

The Credit 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 requires a minimum of 20 obligors in the borrowing base andalso limits payments of distributions. As of March 31, 2010, we had 23 obligors and we were in compliance withall of the facility covenants.

 

We applied ASC 825, “Financial Instruments,” specificallyfor the Credit Facility, which was consistent with our application of ASC 820to our investments.  ASC 825 requires that we apply a fairvalue methodology to the Credit Facility. We estimated the fair value of theCredit Facility using estimates of value provided by an independent third partyand our own assumptions in the absence of observable market data, includingestimated remaining life, current market yield and interest rate spreads ofsimilar securities as of the measurement date. We also considered our own credit risk. Since the Credit Facility was entered into during the three months endedMarch 31, 2010, the cost basis of the Credit Facility of $53,000 was determinedto be the best approximation of the fair value as of March 31, 2010. Thefollowing table presents the Credit Facility carried at fair value as of March 31,2010 and September 30, 2009, by caption on the accompanying consolidatedstatements of assets and liabilities for each of the three levels of hierarchyestablished by ASC 820-10:

** **
| ** **                      | ** ** | **As of March 31, 2010** | ** ** |
|---------------------------------|------------|--------------------------|------------|
| ** **                      | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                      | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                      | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statement of** | ** ** |
| ** **                      | ** ** | **Level 1**              | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Borrowings under Line of Credit |       | $                        | —     |   | $ | — |   | $ | 53,000 |   | $ | 53,000 |   |
| Total                           |       | $                        | —     |   | $ | — |   | $ | 53,000 |   | $ | 53,000 |   |

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

 

*Changes in Level 3 Fair ValueMeasurements*

 

The following table provides a roll-forward in the changes in fairvalue during the three-month period from December 31, 2009 to March 31, 2010and the six month period from September 30, 2009 to March 31, 2010, for theCredit Facility for which we determine fair value using unobservable (Level 3)factors. When a determination is made to classify a financial instrument withinLevel 3 of the

 

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valuation hierarchy, the determination is based upon the significanceof the unobservable factors to the overall fair value measurement. However,Level 3 financial instruments typically include, in addition to theunobservable or Level 3 components, observable components (that is, componentsthat are actively quoted and can be validated by external sources). Accordingly,the losses in the table below include changes in fair value due in part toobservable factors that are part of the valuation methodology.

 

**Fair value measurements usingunobservable data inputs (Level 3)**

 
| ** **                              | ** ** | **Borrowings  under line  of credit** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|
| **Three  months ended March 31, 2010:** |       |                                  |       |
| Fair value at  December 31, 2009        |       | $                                     | 73,531     |   |
| Unrealized  depreciation (a)            |       | (131                                  | )          |
| Borrowings                              |       | 2,600                                 |       |
| Repayments                              |       | (23,000                               | )          |
| Transfers  into/out of Level 3          |       | —                                |       |
| Fair value as of  March 31, 2010        |       | $                                     | 53,000     |   |
|                                    |       |                                  |       |
| **Six  months ended March 31, 2010:**   |       |                                  |       |
| Fair value at  September 30, 2009       |       | $                                     | 83,350     |   |
| Unrealized  depreciation (a)            |       | (350                                  | )          |
| Borrowings                              |       | 5,500                                 |       |
| Repayments                              |       | (35,500                               | )          |
| Transfers  into/out of Level 3          |       | —                                |       |
| Fair value as of  March 31, 2010        |       | $                                     | 53,000     |   |

 

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(a)      Included in unrealized depreciation on borrowingsunder line of credit on the accompanying condensed consolidated statements ofoperations for the three and six months ended March 31, 2010.

 

**Contractual Obligations andOff-Balance Sheet Arrangements**

 

As of March 31, 2010, we were not party to any signed term sheets forpotential investments.

 

In July 2009, we executed a guaranty of a line of credit agreementbetween Comerica Bank and Defiance Integrated Technologies, Inc., one of ourControl investments.  If Defiance has apayment default, the guaranty is callable once the bank has reduced its claimby using commercial reasonable efforts to collect through disposition of theDefiance collateral.  The guaranty islimited to $250 plus interest on that amount accrued from the date demandpayment is made under the guaranty, and all costs incurred by the bank in itscollection efforts.  As of March 31,2010, we have not been required to make any payments on the guaranty of theline of credit agreement and we consider the credit risk to be remote.

 

**Critical Accounting Policies**

 

The preparation of financial statements and related disclosures inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the reportedconsolidated amounts of assets and liabilities, and disclosure of contingentassets and liabilities at the date of the financial statements, and revenuesand expenses during the period reported. Actual results could differ materiallyfrom those estimates.  We have identifiedour investment valuation process as our most critical account policy.

 

***InvestmentValuation***

 

The most significant estimate inherent in the preparation of ourcondensed consolidated financial statements is the valuation of investments andthe related amounts of unrealized appreciation and depreciation of investmentsrecorded.

 

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

 

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We adoptedguidance for fair value measurements on October 1, 2008. In part, this guidancedefines fair value, establishes a framework for measuring fair value, andexpands disclosures about assets and liabilities measured at fair value. Theguidance provides a consistent definition of fair value that focuses on exitprice in the principal, or most advantageous, market and prioritizes, within ameasurement of fair value, the use of market-based inputs over entity-specificinputs. The guidance also establishes the following three-level hierarchy forfair value measurements based upon the transparency of inputs to the valuationof an asset or liability as of the measurement date.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·                  Publicly-traded securities;

·                  Securities for which a limited market exists; and

·                  Securities for which no market exists.

 

*ValuationMethods:*

 

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

 

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

 

In the event theselimited markets become illiquid such that market prices are no longer readilyavailable, we will value our syndicated loans using estimated net presentvalues of the future cash flows or discounted cash flows. The use of a DCFmethodology follows that prescribed by ASC 820, which provides guidance on theuse of a reporting entity’s own assumptions about future cash flows andrisk-adjusted discount rates when relevant observable inputs, such as quotes inactive markets, are not available. When relevant

 

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observable market datadoes not exist, the alternative outlined in ASC 820 is the use of valuinginvestments based on DCF.  For thepurposes of using DCF to provide fair value estimates, we consider multipleinputs such as a risk-adjusted discount rate that incorporates adjustments thatmarket participants would make both for nonperformance and liquidityrisks.  As such, we develop a modifieddiscount rate approach that incorporates risk premiums including, among others,increased probability of default, or higher loss given default, or increasedliquidity risk.  The DCF valuationsapplied to the syndicated loans provide an estimate of what we believe a marketparticipant would pay to purchase a syndicated loan in an active market,thereby establishing a fair value.  Wewill continue to apply the DCF methodology in illiquid markets until quotedprices are available or are deemed reliable based on trading activity.

 

As of March 31, 2010, weassessed trading activity in syndicated loan assets and determined that therecontinued to be market liquidity and a functioning secondary market for theseassets.  Thus, firm bid prices orindicative bids were used to fair value our remaining syndicated loans at March31, 2010.

 

**Securitiesfor which no market exists:** The valuation methodology for securities for which nomarket exists falls into three categories: (1) portfolio investments comprisedsolely of debt securities; (2) portfolio investments in controlled companiescomprised of a bundle of securities, which can include debt and equitysecurities; and (3) portfolio investments in non-controlled companies comprisedof a bundle of investments, which can include debt and equity securities.

 

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

 

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

 

SPSE provides evaluated price opinions which are reflective of whatSPSE believes the bid side of the market would be for each loan after carefulreview and analysis of descriptive, market and credit information. Each pricereflects SPSE’s best judgment based upon careful examination of a variety ofmarket factors. Because of fluctuation in the market and in other factorsbeyond its control, SPSE cannot guarantee these evaluations. The evaluationsreflect the market prices, or estimates thereof, on the date specified. Theprices are based on comparable market prices for similar securities. Marketinformation has been obtained from reputable secondary market sources. Althoughthese sources are considered reliable, SPSE cannot guarantee their accuracy.

 

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

 

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

 

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(2)         **Portfolio investments in controlledcompanies comprised of a bundle of investments, which can include debt andequity securities:**The fair value of these investments is determined based on the total enterprisevalue of the portfolio company, or issuer, utilizing a liquidity waterfallapproach.  For Non-Public Debt Securitiesand equity or equity-like securities (e.g. preferred equity, equity, or otherequity-like securities) that are purchased together as part of a package, wherewe have control or could gain control through an option or warrant security;both the debt and equity securities of the portfolio investment would exit inthe mergers and acquisitions market as the principal market, generally througha sale or recapitalization of the portfolio company. In accordance with ASC820-10, we apply the in-use premise of value which assumes the debt and equitysecurities are sold together. Under this liquidity waterfall approach, wecontinue to use the enterprise value methodology utilizing a liquidity waterfallapproach to determine the fair value of these investments under ASC 820-10 ifwe have the ability to initiate a sale of a portfolio company as of themeasurement date. Under this approach, we first calculate the total enterprisevalue of the issuer by incorporating some or all of the following factors:

 

·                  the issuer’s ability to make payments;

·                  the earnings of the issuer;

·                  recent sales to third parties of similar securities;

·                  the comparison to publicly traded securities; and

·                  discounted cash flow or other pertinent factors.

 

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

 

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

 

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

 

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

 

·                  the nature andrealizable value of the collateral;

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

·                  the markets in whichthe portfolio company does business;

·                  the comparison topublicly traded companies; and

·                  DCF and other relevantfactors.

 

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

 

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

 

*LoanGrading and Risk Rating:*  As part of our valuationprocedures above, we risk rate all of our investments in debt securities. Forsyndicated loans that have been rated by an NRSRO (as defined in Rule 2a-7under the 1940 Act), we use the NRSRO’s risk rating for such security. For allother debt securities, we use a proprietary risk rating system. Our risk ratingsystem uses a scale of 0 to 10, with 10 being the lowest probability ofdefault. This system is used to estimate the probability of default on debtsecurities and the probability of loss if there is a default. These types ofsystems are referred to as risk rating systems and are used by banks and ratingagencies. The risk rating system covers both qualitative and quantitativeaspects of the business and the securities we hold.  During the three months ended March 31, 2010,we modified our risk rating model to incorporate additional factors in ourqualitative and quantitative analysis. While the overall process did not change, we believe the additionalfactors enhance the quality of the risk ratings of our investments.  No adjustments were made to prior periods asa result of this modification.

 

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

 
| **Company’s  System** | ** ** | **First  NRSRO** | ** ** | **Second  NRSRO** | ** ** | **Gladstone Capital’s Description(a)**                                                           |
|----------------------------|------------|------------------|------------|-------------------|------------|-------------------------------------------------------------------------------------------------------|
| **>10**                 |       | Baa2             |       | BBB               |       | Probability of Default (PD) during the next ten  years is 4% and the Expected Loss (EL) is 1% or less |
| **10**                     |       | Baa3             |       | BBB-              |       | PD is 5% and the EL is 1% to 2%                                                                       |
| **9**                      |       | Ba1              |       | BB+               |       | PD is 10% and the EL is 2% to 3%                                                                      |
| **8**                      |       | Ba2              |       | BB                |       | PD is 16% and the EL is 3% to 4%                                                                      |
| **7**                      |       | Ba3              |       | BB-               |       | PD is 17.8% and the EL is 4% to 5%                                                                    |
| **6**                      |       | B1               |       | B+                |       | PD is 22% and the EL is 5% to 6.5%                                                                    |
| **5**                      |       | B2               |       | B                 |       | PD is 25% and the EL is 6.5% to 8%                                                                    |
| **4**                      |       | B3               |       | B-                |       | PD is 27% and the EL is 8% to 10%                                                                     |
| **3**                      |       | Caa1             |       | CCC+              |       | PD is 30% and the EL is 10% to 13.3%                                                                  |
| **2**                      |       | Caa2             |       | CCC               |       | PD is 35% and the EL is 13.3% to 16.7%                                                                |
| **1**                      |       | Caa3             |       | CC                |       | PD is 65% and the EL is 16.7% to 20%                                                                  |
| **0**                      |       | N/a              |       | D                 |       | PD is 85% or there is a payment default and the EL  is greater than 20%                               |

 

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(a)*                                **The default rates setforth are for a ten year term debt security. If a debt security is less thanten years, then the probability of default is adjusted to a lower percentagefor the shorter period, which may move the security higher on our risk ratingscale.*

 

The above scale gives an indication of the probability of default andthe magnitude of the loss if there is a default. Our policy is to stop accruinginterest on an investment if we determine that interest is no longercollectible. As of March 31, 2010 one Non-Control/Non-Affiliate investment andfive Control investments were on non-accrual. As of September 30, 2009, one Non-Control/Non-Affiliate investment andfour Control investments were on non-accrual. Additionally, we do not risk rate our equity securities.

 

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The following table lists the risk ratings for all non-syndicated loansin our portfolio at March 31, 2010 and September 30, 2009, representingapproximately 97% and 96%, respectively, of all loans in our portfolio at theend of each period:

 
| **Rating**       | ** ** | **Mar. 31,  2010** | ** ** | **Sept. 30,  2009** | ** ** |
|------------------|------------|--------------------|------------|---------------------|------------|
| Average          | ** ** | **6.3**            | ** ** | **7.1**             | ** ** |
| Weighted Average | ** ** | **5.9**            | ** ** | **7.2**             | ** ** |
| Highest          | ** ** | **10.0**           | ** ** | **9.0**             | ** ** |
| Lowest           | ** ** | **2.0**            | ** ** | **3.0**             | ** ** |

 

The following table lists the risk ratings for all syndicated loans inour portfolio that were not rated by an NRSRO at March 31, 2010 and September 30,2009, representing approximately 2% of all loans in our portfolio at the end ofeach period:

 
| **Rating**       | ** ** | **Mar. 31,  2010** | ** ** | **Sept. 30,  2009** | ** ** |
|------------------|------------|--------------------|------------|---------------------|------------|
| Average          | ** ** | **7.0**            | ** ** | **7.0**             | ** ** |
| Weighted Average | ** ** | **7.0**            | ** ** | **7.0**             | ** ** |
| Highest          | ** ** | **7.0**            | ** ** | **7.0**             | ** ** |
| Lowest           | ** ** | **7.0**            | ** ** | **7.0**             | ** ** |

 

For syndicated loans that are currently rated by an NRSRO, we risk ratesuch loans in accordance with the risk rating systems of major risk ratingorganizations, such as those provided by an NRSRO. The following table liststhe risk ratings for all syndicated loans in our portfolio that were rated byan NRSRO at March 31, 2010 and September 30, 2009, representing approximately1% and 2%, respectively, of all loans in our portfolio at the end of eachperiod:

 
| **Rating**       | ** ** | **Mar. 31, 2010** | ** ** | **Sept. 30, 2009** | ** ** |
|------------------|------------|-------------------|------------|--------------------|------------|
| Average          |       | B2                |       | CCC+/Caa1          |       |
| Weighted Average |       | B2                |       | CCC+/Caa1          |       |
| Highest          |       | B2                |       | B-/B3              |       |
| Lowest           |       | B2                |       | D/C                |       |

 

***Tax Status***

 

We intend to continue to qualify for treatment as a RIC under SubtitleA, Chapter 1 of Subchapter M of the Code. As a RIC, we are not subject tofederal income tax on the portion of our taxable income and gains distributedto stockholders. To qualify as a RIC, we must meet certain source-of-income,asset diversification, and annual distribution requirements.  Under the annual distribution requirement, weare required to distribute to stockholders at least 90% of our investmentcompany taxable income, as defined by the Code. We have a policy to pay out as a distribution up to 100% of that amount.

 

In an effort to avoid certain excise taxes imposed on RICs, we currentlyintend to distribute during each calendar year, an amount at least equal to thesum of (1) 98% of our ordinary income for the calendar year, (2) 98% of ourcapital gains in excess of capital losses for the one-year period ending on October31 of the calendar year and (3) any ordinary income and net capital gains forpreceding years that were not distributed during such years.

 

***Revenue Recognition***

 

*Interest Income Recognition*

 

Interest income, adjusted for amortization of premiums and acquisitioncosts and for the accretion of discounts, is recorded on the accrual basis tothe extent that such amounts are expected to be collected.  Generally, when a loan becomes 90 days ormore past due or if our qualitative assessment indicates that the debtor is unableto service its debt or other obligations, we will place the loan on non-accrualstatus and cease recognizing interest income on that loan until the borrowerhas demonstrated the ability and intent to pay contractual amounts due.  However, we remain contractually entitled tothis interest.  Interest paymentsreceived on non-accrual loans are restored to accrual status when past dueprincipal and interest is paid or due to a restructuring such that the interestincome is deemed to be collectible, and in management’s judgment, are likely toremain current.  At March 31, 2010, oneNon-Control/Non-Affiliate investment and five Control investments were onnon-accrual with an aggregate cost basis of approximately $26,422 or 8.0% ofthe cost basis of all investments in our portfolio.  At September 30, 2009, oneNon-Control/Non-Affiliate investment and four Control investments were onnon-accrual with an aggregate cost basis of approximately $10,022 or 2.8% ofthe cost basis of all investments in our portfolio.  Success fees are recorded upon receipt andare contractually due upon a change of control in a portfolio company.

 

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*Paid in Kind Interest*

 

Two loans in ourportfolio contain PIK provisions. The PIK interest, computed at the contractualrate specified in each loan agreement, is added to the principal balance of theloan and recorded as interest income. To maintain our status as a RIC, thisnon-cash source of income must be paid out to stockholders in the form ofdistributions, even though we have not yet collected the cash.   For the three and six months ended March 31,2010 we recorded PIK income of $49 and $100, respectively.  For the three and six months ended March 31,2009, we recorded PIK income of $13 and $31, respectively.

 

*Services Provided to PortfolioCompanies*

 

As a business development company under the 1940 Act,we are required to make available significant managerial assistance to ourportfolio companies. We provide these services through our Adviser, whoprovides these services on our behalf through its officers who are also ourofficers.  Currently, neither we nor ourAdviser charges a fee for managerial assistance; however, if our Adviser doesreceive fees for such managerial assistance, our Adviser will credit themanagerial assistance fees to the base management fee due from us to ourAdviser.

 

Our Adviser receives fees for the other services itprovides to our portfolio companies. These other fees are typically non-recurring, are recognized as revenuewhen earned and are generally paid directly to our Adviser by the borrower orpotential borrower upon the closing of the investment. The services our Adviserprovides to our portfolio companies vary by investment, but generally include abroad array of services such as investment banking services, arranging bank andequity financing, structuring financing from multiple lenders and investors,reviewing existing credit facilities, restructuring existing investments,raising equity and debt capital, turnaround management, merger and acquisitionservices and recruiting new management personnel.  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 andreviewing portfolio company investments. These fees are recurring and are generally paid annually or quarterly inadvance to our Adviser throughout the life of the investment.  Fees of this nature are recorded as revenueby our Adviser when earned and are not credited against the base managementfee.

 

We may receive fees for the origination and closingservices we provide to portfolio companies through our Adviser.  These fees are paid directly to us and arerecognized as revenue upon closing of the originated investment and arereported as fee income in the accompanying condensed consolidated statements ofoperations.

 

**Recent Accounting Pronouncements**

 

Refer to Note 2 in the accompanying condensed consolidated financialstatements for a summary of recently issued accounting pronouncements.

 

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

 

We are subject to financial market risks, including changes in interestrates.  We estimate that ultimatelyapproximately 20% of the loans in our portfolio will be made at fixed rates andapproximately 80% will be made at variable rates.  As of March 31, 2010, our portfolio consistedof the following:

 
| 85  | % | variable rates with a floor               |   |
|-----|---|-------------------------------------------|--------|
| 2   | % | variable rates with a floor and ceiling   |   |
| 9   | % | variable rates without a floor or ceiling |   |
| 4   | % | fixed rate                                |   |
| 100 | % | total                                     |   |

 

There have been no material changes in the quantitative and qualitativemarket risk disclosures for the six months ended March 31, 2010 from thatdisclosed in our Annual Report on Form 10-K for the fiscal year ended September30, 2009, as filed with the SEC on November 23, 2009.

 

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**ITEM 4.CONTROLS AND PROCEDURES.**

 

a) Evaluation of Disclosure Controls and Procedures

 

As of March 31, 2010, we, including our Chief Executive Officer andChief Financial Officer, evaluated the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Exchange ActRules 13a-15(e) and 15d-15(e)).  Based onthat evaluation, our management, including the Chief Executive Officer andChief Financial Officer, concluded that our disclosure controls and procedureswere effective in timely alerting management, including the Chief ExecutiveOfficer and Chief Financial Officer, of material information about us requiredto be included in periodic Securities and Exchange Commission filings.  However, in evaluating the disclosurecontrols and procedures, management recognized that any controls andprocedures, no matter how well designed and operated can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

b) Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financialreporting that occurred during the quarter ended March 31, 2010 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II—OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS.**

 

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

 

**ITEM1A. RISK FACTORS.**

 

Our business is subject to certain risks and events that, if theyoccur, could adversely affect our financial condition and results of operationsand the trading price of our common stock. For a discussion of these risks, please refer to the “Risk Factors”section of our Annual Report on Form 10-K for the fiscal year ended September 30,2009, filed by us with the SEC on November 23, 2009.  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.

 

**RiskRelated to Our External Management**

 

***There are significant potential conflicts of interest whichcould impact our investment returns.***

 

Our executiveofficers and directors, and the officers and directors of our Adviser, serve ormay serve as officers, directors or principals of entities that operate in thesame or a related line of business as we do or of investment funds managed byour affiliates. Accordingly, they may have obligations to investors in thoseentities, the fulfillment of which might not be in the best interests of us orour stockholders. For example, Mr. Gladstone, our chairman and chiefexecutive officer, is the chairman of the board and chief executive officer ofour Adviser; Gladstone Investment Corporation, or Gladstone Investment, apublicly-traded business development company; and Gladstone CommercialCorporation, or Gladstone Commercial, a publicly-traded real estate investmenttrust.  Mr. Gladstone is also the solestockholder of Gladstone Land Corporation, or Gladstone Land, a privately heldagricultural real estate company managed by the Adviser. In addition, Mr. Brubaker,our vice chairman, chief operating officer and secretary is the vice chairman,chief operating officer and secretary of our Adviser, Gladstone Investment andGladstone Commercial. Mr. Stelljes, our president and chief investmentofficer, is also the president and chief investment officer of our Adviser andGladstone Commercial and vice chairman and chief investment officer ofGladstone Investment. Moreover, our Adviser may establish or sponsor otherinvestment vehicles which from time to time may have potentially overlappinginvestment objectives with those of ours and accordingly may invest in, whetherprincipally or secondarily, asset classes similar to those we target. Forexample, our Adviser recently filed a registration statement with theSecurities and Exchange Commission for a proposed initial public offering ofcommon stock of Gladstone Lending Corporation, a proposed fund that wouldprimarily invest in first and second lien term loans.  While our Advisergenerally has broad authority to make investments on behalf of the investmentvehicles that it advises, our Adviser has adopted investment allocationprocedures to address these potential conflicts and intends to directinvestment opportunities to the Gladstone affiliate with the investmentstrategy that most closely fits the investment opportunity. Nevertheless, themanagement of our Adviser may face conflicts in the allocation of investmentopportunities to other entities managed by our Adviser. As a result, it ispossible that we may not be given the opportunity to participate in certaininvestments made by other members of our Adviser and its affiliated companiesor investment funds managed by investment managers affiliated with our Adviser.

 

In certaincircumstances, we may make investments in a portfolio company in which one ofour affiliates has or will have an investment, subject to satisfaction of anyregulatory restrictions and, where required, to the prior approval of our Boardof Directors. As of 

 

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March 31,2010, our Board of Directors has approved the following types of co-investmenttransactions:

 

·                  Our affiliate, Gladstone Commercial, maylease property to portfolio companies that we do not control under certaincircumstances. We may pursue such transactions only if (i) the portfoliocompany is not controlled by us or any of our affiliates, (ii) theportfolio company satisfies the tenant underwriting criteria of GladstoneCommercial, and (iii) the transaction is approved by a majority of ourindependent directors and a majority of the independent directors of GladstoneCommercial. We expect that any such negotiations between Gladstone Commercialand our portfolio companies would result in lease terms consistent with theterms that the portfolio companies would be likely to receive were they notportfolio companies of ours.

 

·                  We may invest simultaneously with ouraffiliate Gladstone Investment in senior syndicated loans whereby neither wenor any affiliate has the ability to dictate the terms of the loans.

 

·                  Additionally, pursuant to an exemptiveorder granted by the Securities and Exchange Commission, our Adviser maysponsor a private investment fund to co-invest with us and Gladstone Investmentin accordance with the terms and conditions of the order.

 

Certain of ourofficers, who are also officers of our Adviser, may from time to time serve asdirectors of certain of our portfolio companies. If an officer serves in suchcapacity with one of our portfolio companies, such officer will owe fiduciaryduties to all stockholders of the portfolio company, which duties may from timeto time conflict with the interests of our stockholders.

 

In the course ofour investing activities, we will pay management and incentive fees to ourAdviser and will reimburse our Administrator for certain expenses it incurs. Asa result, investors in our common stock will invest on a “gross” basis andreceive distributions on a “net” basis after expenses, resulting in, amongother things, a lower rate of return than one might achieve through ourinvestors themselves making direct investments. As a result of thisarrangement, there may be times when the management team of our Adviser hasinterests that differ from those of our stockholders, giving rise to aconflict.

 

**Riskrelated to our External Financing**

 

***In recent years, creditors have significantly curtailedtheir lending to business development companies, including us. Because of thelimited amount of committed funding under our credit facility, we will havelimited ability fund new investments if we are unable to expand the facility.***

 

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In recent years,creditors have significantly curtailed their lending to many businessdevelopment companies, including us.  In March 2010 we entered into afourth amended and restated credit agreement providing for a revolving line ofcredit, which we refer to as the Credit Facility. Committed funding under theCredit Facility is $127.0 million.  The Credit Facility may be expanded upto $202.0 million through the addition of other committed lenders to thefacility. However, if additional lenders are unwilling to join the facility onits terms, we will be unable to expand the facility and thus will continue tohave limited availability to finance new investments under our line of credit.The Credit Facility matures on March 15, 2012, and, if the facility is notrenewed or extended by this date, all principal and interest will be due andpayable on March 15, 2013.  As of May 4, 2010, we had $28.4million drawn and outstanding under the Credit Facility.

 

There can be noguarantee that we will be able to renew, extend or replace the Credit Facilityupon its maturity on terms that are favorable to us, if at all. Our ability toexpand the Credit Facility, and to obtain replacement financing at the time ofmaturity, will be constrained by then-current economic conditions affecting thecredit markets. In the event that we are not able to expand the CreditFacility, or to renew, extend or refinance the Credit Facility at the time ofits maturity, this could have a material adverse effect on our liquidity andability to fund new investments, our ability to make distributions to ourstockholders and our ability to qualify as a RIC under the Code.

 

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

 

Notapplicable.

 

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

 

Notapplicable.

 

**ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.**

 

The 2010 Annual Meeting of Stockholders was held on February 18, 2010.The stockholders voted and approved the following matters:

 

·                  The election of three directors to hold office untilthe 2013 Annual Meeting of Stockholders.

 
| **Nominee**     | ** ** | **Shares Voted  For** | ** ** | **Shares Voted********Against** | ** ** | **Shares********Abstained** | ** ** |
|-----------------|------------|-----------------------|------------|---------------------------------|------------|-----------------------------|------------|
| Paul Adelgren   |       | 13,213,201            |       | 499,067                         |       | 240,316                     |       |
| David Gladstone |       | 13,204,448            |       | 516,099                         |       | 232,037                     |       |
| John H. Outland |       | 13,242,744            |       | 475,684                         |       | 234,156                     |       |

 

The other incumbentdirectors whose terms of office continued after the meeting are listed below:

 
| **Director**          | ** ** | **End of term** | ** ** |
|-----------------------|------------|-----------------|------------|
| Michela English       |       | 2011            |       |
| Anthony W.  Parker    |       | 2011            |       |
| George Stelljes,  III |       | 2011            |       |
| Terry Lee  Brubaker   |       | 2012            |       |
| Maurice W.  Coulon    |       | 2012            |       |
| David A. R.  Dullum   |       | 2012            |       |
| Gerard Mead           |       | 2012            |       |

 

·                  The authorization, for a period of one year, to issueand sell shares of our common stock at a price below our then current net assetvalue per share.

** **
| **Number of Shares** | ** ** | ** **         | ** ** |
|----------------------|------------|--------------------|------------|
| **Voted For**        | ** ** | **Voted  Against** | ** ** | **Abstained** | ** ** | **Broker  Non-Votes** | ** ** |
| 11,443,907           |       | 2,208,563          |       | 300,114 |   | 5,414,736 |   |

 

·                  Theratification of the selection by the Audit Committee of the Board of Directorsof PricewaterhouseCoopers LLP as our independent registered public accountingfirm for our fiscal year ending September 30, 2010.

** **
| **Number of Shares** | ** ** | ** **         | ** ** |
|----------------------|------------|--------------------|------------|
| **Voted For**        | ** ** | **Voted  Against** | ** ** | **Abstained** | ** ** | ** ** | ** ** |
| 19,009,665           |       | 186,829            |       | 170,826 |   |   |   |   |
|                      |            |                    |            |  |  |  |  |  |

 

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**ITEM 5.OTHER INFORMATION.**

 

Notapplicable

 

**ITEM6.  EXHIBITS**

 

Seethe exhibit index.

 

**SIGNATURE**

 

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

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

 

Date:May 4, 2010

 

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**EXHIBITINDEX**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.1         |       | Articles of Amendment and Restatement of the  Articles of Incorporation, incorporated by reference to Exhibit a.2 to  Pre-Effective Amendment No. 1 to the Registration Statement on Form N-2 (File  No. 333-63700), filed July 27, 2001.                                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.2         |       | By-laws, incorporated by reference to Exhibit b to  Pre-Effective Amendment No. 1 to the Registration Statement on Form N-2 (File  No. 333-63700), filed July 27, 2001.                                                                                                                                                                                                                                                                                   |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 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        |       | Fourth Amended and Restated Credit Agreement dated  as of March 15, 2010 by and among Gladstone Business Loan, LLC as Borrower,  Gladstone Management Corporation as Servicer, the Committed Lenders named  therein, the Managing Agents named therein, and Key Equipment Finance Inc. as  Administrative Agent, incorporated by reference to Exhibit 10.1 to the  Company’s Current Report on Form 8-K (File No. 814-00237), filed March 16,  2010. |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 11          |       | Computation of Per Share Earnings (included in the  notes to the unaudited condensed consolidated financial statements contained  in this report).                                                                                                                                                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.1        |       | Certification of Chief Executive Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.2        |       | Certification of Chief Financial Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 32.1        |       | Certification of Chief Executive Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 32.2        |       | Certification of Chief Financial Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                      |

 

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

 

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