Table of Contents

 

 

 

**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 THE QUARTER ENDED JUNE 30, 2009** |
|                                    |                                                                                                     |
| **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 August 3, 2009 was 21,087,574.

 

 

 

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Table of Contents

 

**GLADSTONECAPITAL CORPORATION**

**TABLEOF CONTENTS**

 
| PART I.  | FINANCIAL INFORMATION                                                                                              |   |
|---------------|--------------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                               |   |
| Item 1.       | Financial Statements (Unaudited)                                                                                   |   |
|          |                                                                                                               |   |
|          | Condensed  Consolidated Statements of Assets and Liabilities as of June 30, 2009  and September 30, 2008 | 2      |
|          | Condensed Consolidated Schedules of Investments as of  June 30, 2009 and September 30, 2008              | 3      |
|          | Condensed Consolidated Statements of Operations for  the three and nine months ended June 30, 2009 and 2008   | 11     |
|          | Condensed Consolidated Statements of Changes in Net  Assets for the nine months ended June 30, 2009 and 2008  | 12     |
|          | Condensed Consolidated Statements of Cash Flows for  the nine months ended June 30, 2009 and 2008             | 13     |
|          | Financial  Highlights for the three and nine months ended June 30, 2009 and 2008                              | 14     |
|          | Notes to Condensed Consolidated Financial Statements                                                               | 15     |
|          |                                                                                                               |   |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                        | 29     |
|          | Overview                                                                                                           | 29     |
|          | Results  of Operations                                                                                             | 31     |
|          | Liquidity and Capital Resources                                                                                    | 37     |
|          |                                                                                                               |   |
| Item 3.       | Quantitative  and Qualitative Disclosure About Market Risk                                                         | 47     |
|          |                                                                                                               |   |
| Item 4.       | Controls and  Procedures                                                                                           | 48     |
|          |                                                                                                               |   |
| PART II. | OTHER INFORMATION                                                                                                  |   |
|          |                                                                                                               |   |
| Item 1.       | Legal Proceedings                                                                                                  | 49     |
|          |                                                                                                               |   |
| Item 1A.      | Risk Factors                                                                                                       | 49     |
|          |                                                                                                               |   |
| Item 2.       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                       | 49     |
|          |                                                                                                               |   |
| Item 3.       | Defaults  Upon Senior Securities                                                                                   | 49     |
|          |                                                                                                               |   |
| Item 4.       | Submission  of Matters to a Vote of Security Holders                                                               | 49     |
|          |                                                                                                               |   |
| Item 5.       | Other Information                                                                                                  | 49     |
|          |                                                                                                               |   |
| Item  6.      | Exhibits                                                                                                           | 49     |
|          |                                                                                                               |   |
| SIGNATURES    | 49                                                                                                                 |

 

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Table of Contents

 

**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES**

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

**(UNAUDITED)**

 
| ** **                                                                                                                                                    | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2009**          | ** ** | **2008**               | ** ** |
| ASSETS                                                                                                                                                        |       |              |       |                   |       |
| Non-Control/Non-Affiliate  investments (Cost 6/30/09: $357,896; 9/30/08: $448,356)                                                                            |       | $                 | 317,501    |                   | $          | 407,153 |   |
| Control  investments (Cost 6/30/09: $28,232; 9/30/08: $12,514)                                                                                                |       | 13,532            |       | 780                    |       |
| Total  investments at fair value (Cost 6/30/09: $386,128; 9/30/08: $460,870)                                                                                  |       | 331,033           |       | 407,933                |       |
| Cash                                                                                                                                                          |       | 4,566             |       | 6,493                  |       |
| Interest  receivable – investments in debt securities                                                                                                    |       | 3,669             |       | 3,588                  |       |
| Interest  receivable – employees (Refer to Note 4)                                                                                                       |       | 117               |       | 91                     |       |
| Due from  custodian                                                                                                                                           |       | 1,631             |       | 4,544                  |       |
| Deferred  financing fees                                                                                                                                      |       | 1,761             |       | 1,905                  |       |
| Prepaid assets                                                                                                                                                |       | 216               |       | 306                    |       |
| Other assets                                                                                                                                                  |       | 1,340             |       | 838                    |       |
| TOTAL ASSETS                                                                                                                                                  |       | $                 | 344,333    |                   | $          | 425,698 |   |
|                                                                                                                                                          |       |              |       |                   |       |
| LIABILITIES                                                                                                                                                   |       |              |       |                   |       |
| Accounts payable                                                                                                                                              |       | $                 | 6          |                   | $          | 8 |   |
| Interest payable                                                                                                                                              |       | 429               |       | 646                    |       |
| Fee due to  Administrator (Refer to Note 4)                                                                                                                   |       | 218               |       | 247                    |       |
| Due to Adviser  (Refer to Note 4)                                                                                                                             |       | 700               |       | 457                    |       |
| Borrowings under  line of credit                                                                                                                              |       | 91,700            |       | 151,030                |       |
| Accrued expenses  and deferred liabilities                                                                                                                    |       | 1,119             |       | 1,328                  |       |
| Funds held in  escrow                                                                                                                                         |       | 165               |       | 234                    |       |
| TOTAL  LIABILITIES                                                                                                                                            |       | 94,337            |       | 153,950                |       |
| NET ASSETS                                                                                                                                                    |       | $                 | 249,996    |                   | $          | 271,748 |   |
|                                                                                                                                                          |       |              |       |                   |       |
| ANALYSIS OF NET  ASSETS                                                                                                                                       |       |              |       |                   |       |
| Common stock,  $0.001 par value, 50,000,000 shares authorized and 21,087,574 shares issued  and outstanding at June 30, 2009 and September 30, 2008 |       | $                 | 21         |                   | $          | 21 |   |
| Capital in  excess of par value                                                                                                                               |       | 334,140           |       | 334,143                |       |
| Notes receivable  – employees (Refer to Note 4)                                                                                                          |       | (9,170            | )          | (9,175                 | )          |
| Net unrealized  depreciation on investments                                                                                                                   |       | (55,096           | )          | (52,937                | )          |
| Unrealized depreciation  on derivative                                                                                                                        |       | —            |       | (304                   | )          |
| Distributions in  excess of net investment income                                                                                                             |       | (19,899           | )          | —                 |       |
| TOTAL NET ASSETS                                                                                                                                              |       | $                 | 249,996    |                   | $          | 271,748 |   |
| NET ASSETS PER  SHARE                                                                                                                                         |       | $                 | 11.86      |                   | $          | 12.89 |   |

 

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

 

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Table ofContents

 

**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS**

**AS OFJUNE 30, 2009**

**(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 (10.5%, Due 6/2009) (5) (9)                       |       | $          | 1,013      |            | $          | 967 |   |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| ACE Expediters, Inc                                     |       | Service-over-the-ground logistics                   |       | Senior Term Debt (13.5%, Due 1/2012) (5)                                |       | 5,000      |       | 4,706           |       |
|                                                    |       |                                                |       | Common Stock Warrants (8) (14)                                          |       | 200        |       | 600             |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| ActivStyle Acquisition Co.                              |       | Service-medical products  distribution              |       | Senior Term Debt (13.0%, Due 9/2012) (3) (5)                       |       | 4,000      |       | 3,850           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Allison Publications, LLC                               |       | Service-publisher of  consumer oriented magazines   |       | Senior Term Debt (10.0%, Due 9/2012) (5)                                |       | 9,864      |       | 8,833           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Anitox Acquisition Company                              |       | Manufacturing-preservatives  for animal feed        |       | Line of Credit, $3,000  available (4.6%, Due 1/2010) (5)                |       | 2,000      |       | 1,935           |       |
|                                                    |       |                                                |       | Senior Term Debt (8.5%, Due 1/2012) (5)                                 |       | 3,014      |       | 2,916           |       |
|                                                    |       |                                                |       | Senior Term Debt (10.5%, Due 1/2012) (3) (5)                       |       | 3,688      |       | 3,513           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Badanco Acquisition Corp.                               |       | Service-luggage design  and distribution            |       | Senior Subordinated Term  Debt (non-accrual, Due 7/2012) (10) (15) |       | 9,409      |       | —          |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| BAS Broadcasting                                        |       | Service-radio station operator                      |       | Senior Term Debt (11.5%, Due 7/2013) (5)                                |       | 7,300      |       | 6,880           |       |
|                                                    |       |                                                |       | Senior Term Debt (12.0%, Due 7/2009) (3) (5)                       |       | 950        |       | 931             |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| CCS, LLC                                                |       | Service-cable TV  franchise owner                   |       | Senior Term Debt  (non-accrual, Due 8/2008) (5) (10)               |       | 631        |       | 158             |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Chinese Yellow Pages Company                            |       | Service-publisher of  Chinese language directories  |       | Line of Credit, $700  available (7.3%, Due 9/2010) (5)                  |       | 675        |       | 626             |       |
|                                                    |       |                                                |       | Senior Term Debt (7.3%, Due 9/2010) (5)                                 |       | 564        |       | 518             |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Clinton Holdings, LLC                                   |       | Distribution-aluminum  sheets and stainless steel   |       | Senior Subordinated Term  Debt (12.0%, Due 1/2013) (5)                  |       | 15,500     |       | 13,175          |       |
|                                                    |       |                                                |       | Escrow Funding Note (1.4%, Due 1/2010) (11)                             |       | 640        |       | 640             |       |
|                                                    |       |                                                |       | Common Stock Warrants (8) (14)                                          |       | 109        |       | —          |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| CMI Acquisition, LLC                                    |       | Service-recycling                                   |       | Senior Subordinated Term  Debt (11.0%, Due 11/2012) (5)                 |       | 6,276      |       | 5,883           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Defiance Acquisition Corp.                              |       | Manufacturing-trucking parts                        |       | Senior Term Debt (11.0%, Due 4/2010) (3) (5)                       |       | 6,005      |       | 3,603           |       |
|                                                    |       |                                                |       | Senior Term Debt (11.0%, Due 4/2010) (3) (5)                       |       | 987        |       | 592             |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Doe & Ingalls Management LLC                        |       | Distributor-specialty chemicals                     |       | Senior Term Debt (6.8%, Due 11/2010) (5)                                |       | 2,500      |       | 2,456           |       |
|                                                    |       |                                                |       | Senior Term Debt (7.8%, Due 11/2010) (3) (5)                       |       | 4,376      |       | 4,267           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Finn Corporation                                        |       | Manufacturing-landscape  equipment                  |       | Common Stock Warrants (8) (14)                                          |       | 37         |       | 1,427           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| GFRC Holdings LLC                                       |       | Manufacturing-glass-fiber  reinforced concrete      |       | Line of Credit, $1,000  available (4.6%, Due 12/2010) (5)               |       | —     |       | —          |       |
|                                                    |       |                                                |       | Senior Term Debt (9.0%, Due 12/2012) (5)                                |       | 6,599      |       | 6,417           |       |
|                                                    |       |                                                |       | Senior Subordinated Term  Debt (11.5%, Due 12/2012) (3) (5)        |       | 6,665      |       | 6,399           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Global Materials Technologies, Inc.                     |       | Manufacturing-steel wool  products and metal fibers |       | Senior Term Debt (13.0%, Due 11/2009) (3) (5)                      |       | 4,460      |       | 3,947           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Heartland Communications Group                          |       | Service-radio station operator                      |       | Senior Term Debt (10.0%, Due 5/2011) (5)                                |       | 4,570      |       | 2,726           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Interfilm Holdings, Inc.                                |       | Service-slitter and  distributor of plastic films   |       | Senior Term Debt (10.5%, Due 10/2012) (5)                               |       | 4,962      |       | 4,609           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| International Junior Golf Training Acquisition  Company |       | Service-golf training                               |       | Line of Credit, $1,500  available (9.0%, Due 5/2010) (5)                |       | 1,400      |       | 1,375           |       |
|                                                    |       |                                                |       | Senior Term Debt (4.6%, Due 5/2012) (5)                                 |       | 2,252      |       | 2,151           |       |
|                                                    |       |                                                |       | Senior Term Debt (10.5%, Due 5/2012) (3) (5)                       |       | 2,500      |       | 2,359           |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| 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)                                |       | 1,787      |       | 801             |       |
|                                                    |       |                                                |       |                                                                         |       |       |       |            |       |
| Legend Communications of Wyoming LLC                    |       | Service-operator of radio stations                  |       | Line of Credit, $500  available (11.0%, Due 6/2011) (5)                 |       | 497        |       | 448             |       |
|                                                    |       |                                                |       | Senior Term Debt (11.0%, Due 6/2013) (5)                                |       | 9,250      |       | 8,325           |       |
|                                                         |            |                                                     |            |                                                                              |            |            |            |                 |            |  |  |

 

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**GLADSTONECAPITAL CORPORATION**

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

**AS OFJUNE 30, 2009**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company  (1)**                           | ** ** | **Industry**                                                    | ** ** | **Investment  (2)**                                                                                           | ** ** | **Cost**       | ** ** | **Fair  Value** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|----------------|------------|-----------------|------------|
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| 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      |            | $          | 950 |   |
|                                       |       |                                                            |       | Senior Term Debt (5) (11.3%,  Due 5/2012) (5)                                                       |       | 3,960          |       | 3,762           |       |
|                                       |       |                                                            |       | Senior Term Debt (14.3%,  Due 5/2012) (3) (5)                                                       |       | 4,432          |       | 4,144           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Northern Contours, Inc.                    |       | Manufacturing-veneer and  laminate components                   |       | Senior Subordinated Term  Debt (10.0%, Due 5/2010) (5)                                                   |       | 6,650          |       | 5,686           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Pinnacle Treatment Centers, Inc.           |       | Service-Addiction  treatment centers                            |       | Line of Credit, $500  available (4.6%, Due  12/2009)                                                          |       | —         |       | —          |       |
|                                       |       |                                                            |       | Senior Term Debt (8.5%,  Due 12/2011) (5)                                                                |       | 2,950          |       | 2,803           |       |
|                                       |       |                                                            |       | Senior Term Debt (10.5%,  Due 12/2011) (3) (5)                                                      |       | 7,500          |       | 7,087           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Precision Acquisition Group Holdings, Inc. |       | Manufacturing-consumable  components for the aluminum industry  |       | Equipment Note, $1,500  available (8.5%, Due 10/2011) (5)

Senior Term Debt (8.5%, Due 10/2010) (5) |       | 1,000  4,375   |       | 986  4,309      |       |
|                                       |       |                                                            |       | Senior Term Debt (11.5%,  Due 10/2010) (3) (5)                                                      |       | 4,095          |       | 4,039           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| PROFITSystems Acquisition Co.              |       | Service-design and  develop ERP software                        |       | Line of Credit, $350  available (4.6%, Due 7/2009)  Senior Term Debt (8.5%, Due 7/2011) (5)              |       | —  1,750  |       | —  1,610   |       |
|                                       |       |                                                            |       | Senior Term Debt (10.5%,  Due 7/2011) (3) (5)                                                       |       | 2,900          |       | 2,639           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| RCS Management Holding Co.                 |       | Service-healthcare supplies                                     |       | Senior Term Debt (8.5%,  Due 1/2011) (3) (5)                                                        |       | 2,562          |       | 2,460           |       |
|                                       |       |                                                            |       | Senior Term Debt (10.5%,  Due 1/2011) (4) (5)                                                       |       | 3,060          |       | 2,903           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Reliable Biopharmaceutical Holdings, Inc.  |       | Manufacturing-pharmaceutical  and biochemical intermediates     |       | Line of Credit, $5,000  available (9.0%, Due 10/2010) (5)                                                |       | 1,700          |       | 1,649           |       |
|                                       |       |                                                            |       | Mortgage Note (9.5%, Due  10/2014) (5)                                                                   |       | 7,352          |       | 7,187           |       |
|                                       |       |                                                            |       | Senior Term Debt (9.0%,  Due 10/2012) (5)                                                                |       | 1,597          |       | 1,550           |       |
|                                       |       |                                                            |       | Senior Term Debt (11.0%,  Due 10/2012) (3) (5)                                                      |       | 11,843         |       | 11,355          |       |
|                                       |       |                                                            |       | Senior Subordinated Term  Debt (12.0%, Due 10/2013) (5)                                                  |       | 6,000          |       | 5,490           |       |
|                                       |       |                                                            |       | Common Stock Warrants (8) (14)                                                                           |       | 209            |       | 206             |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Saunders & Associates                  |       | Manufacturing-equipment  provider for frequency control devices |       | Senior Term Debt (9.8%,  Due 5/2013) (5)                                                                 |       | 10,780         |       | 10,484          |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| SCI Cable, Inc.                            |       | Service-cable, internet,  voice provider                        |       | Senior Term Debt (9.3%,  Due 10/2008) (5) (12)                                                      |       | 2,781          |       | 556             |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Sunburst Media - Louisiana, LLC            |       | Service-radio station operator                                  |       | Senior Term Debt (10.5%,  Due 6/2011) (5)                                                                |       | 6,417          |       | 5,849           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Sunshine Media Holdings                    |       | Service-publisher  regional B2B trade magazines                 |       | Senior Term Debt (11.0%,  Due 5/2012) (5)  Senior Term Debt (13.5%, Due 5/2012) (3) (5)        |       | 16,948  10,700 |       | 16,058  9,991   |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Thibaut Acquisition Co.                    |       | Service-design and  disbribute wall covering                    |       | Line of Credit, $1,000  available (9.0%, Due 1/2011) (5)                                                 |       | 1,000          |       | 940             |       |
|                                       |       |                                                            |       | Senior Term Debt (8.5%,  Due 1/2011) (5)                                                                 |       | 1,487          |       | 1,398           |       |
|                                       |       |                                                            |       | Senior Term Debt (12.0%,  Due 1/2011) (3) (5)                                                       |       | 3,000          |       | 2,760           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Tulsa Welding School                       |       | Service-private welding school                                  |       | Line of credit, $750  available (9.5%, Due 9/2011) (5)                                                   |       | —         |       | —          |       |
|                                       |       |                                                            |       | Senior Term Debt (9.5%,  Due 9/2013) (5)                                                                 |       | 4,144          |       | 4,139           |       |
|                                       |       |                                                            |       | Senior Term Debt (12.8%,  Due 9/2013) (5)                                                                |       | 8,000          |       | 7,980           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| VantaCore                                  |       | Service-acquisition of  aggregate quarries                      |       | Senior Subordinated Term  Debt (12.0%, Due 8/2013) (5)                                                   |       | 13,795         |       | 13,588          |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Viapack, Inc.                              |       | Manufacturing-polyethylene film                                 |       | Senior Real Estate Term  Debt (10.0%, Due 3/2011) (5)                                                    |       | 800            |       | 740             |       |
|                                       |       |                                                            |       | Senior Term Debt (13.0%,  Due 3/2011) (3) (5)                                                       |       | 4,062          |       | 3,738           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Visual Edge Technology, Inc.               |       | Service-office equipment  distribution                          |       | Line of credit, $3,000  available (7.8%, Due 9/2011) (5)                                                 |       | 3,000          |       | 2,355           |       |
|                                       |       |                                                            |       | 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         |       | 14,100          |       |
|                                       |       |                                                            |       | Senior Subordinated Term  Debt (10.3%, Due 1/2011) (5)                                                   |       | 10,000         |       | 9,250           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| Winchester Electronics                     |       | Manufacturing-high  bandwidth connectors and cables             |       | Senior Term Debt (5.3%,  Due 5/2013) (5)  Senior Term Debt (5.8%, Due 5/2013) (5)                   |       | 860  1,690     |       | 847  1,614      |       |
|                                       |       |                                                            |       | Senior Subordinated Term  Debt (14.0%, Due 6/2013) (5)                                                   |       | 9,925          |       | 9,255           |       |
|                                       |       |                                                            |       |                                                                                                          |       |           |       |            |       |
| *Subtotal - Non-syndicated loans*          |       |                                                            |       |                                                                                                          |       | 334,157        |       | 298,484         |       |
|                                            |            |                                                                 |            |                                                                                                               |            |                |            |                 |            |  |  |

 

4

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Table of Contents

 

**GLADSTONECAPITAL CORPORATION**

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

**AS OFJUNE 30, 2009**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| **Company  (1)**                                 | ** ** | **Industry**                                             | ** ** | **Investment  (2)**                                                                                       | ** ** | **Cost**     | ** **  | **Fair  Value** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|--------------|-------------|-----------------|------------|
| *** ***                                     |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| ***Syndicated Loans:***                          |       |                                                     |       |                                                                                                      |       |         |        |            |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| CHG Companies, Inc.                              |       | Service-healthcare staffing                              |       | Senior Subordinated Term  Debt (6.3%, Due 12/2013) (6)                                               |       | $            | 500         |            | $          | 471 |   |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| GTM Holdings, Inc.                               |       | Manufacturing-socks                                      |       | Senior Subordinated Term  Debt (11.8%, Due 4/2014) (6)                                               |       | 500          |        | 462             |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| John Henry Holdings, Inc.                        |       | Manufacturing-packaging  products                        |       | Senior Subordinated Term  Debt (7.3%, Due 6/2011) (7)                                                |       | 8,000        |        | 6,400           |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| Kinetek Acquisition Corp.                        |       | Manufacturing-custom  engineered motors & controls   |       | Senior Term Debt (3.6%,  Due 11/2013) (6)  Senior Subordinated Term Debt (6.6%, Due 5/2014) (6) |       | 1,439  1,507 |        | 718  300        |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| Puerto Rico Cable Acquisition Company, Inc.      |       | Service-telecommunications                               |       | Senior Subordinated Term  Debt (7.9%, Due 1/2012) (6)                                                |       | 7,178        |        | 6,853           |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| Wesco Holdings, Inc.                             |       | Service-aerospace parts  and distribution                |       | Senior Subordinated Term  Debt (6.1%, Due 3/2014) (6)                                                |       | 2,265        |        | 1,927           |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| WP Evenflo Group Holdings Inc.                   |       | Manufacturing-infant and  juvenile products              |       | Senior Term Debt (7.3%,  Due 2/2013) (6)  Senior Preferred Equity (8) (11)                      |       | 1,906  333   |        | 1,442  333      |       |
|                                             |       |                                                     |       | Junior Preferred Equity  (8) (11)                                                                    |       | 111          |        | 111             |       |
|                                             |       |                                                     |       | Common Stock (8) (11)                                                                                |       | —       |        | —          |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| *Subtotal - Syndicated loans*                    |       |                                                     |       |                                                                                                      |       | 23,739       |        | 19,017          |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| **Total Non-Control/Non-Affiliate  Investments** | ** ** | ** **                                               | ** ** | ** **                                                                                                | ** ** | **$**        | **357,896** | ** **      | **$**      | **317,501** | ** ** |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| **CONTROL INVESTMENTS**                          |       |                                                     |       |                                                                                                      |       |         |        |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| BERTL, Inc.                                      |       | Service-web-based  evaluator of digital imaging products |       | Line of Credit, $842  available (6.6%, Due 10/2009) (13) (14)                                   |       | $            | 908         |            | $          | — |   |
|                                             |       |                                                     |       | Common Stock (8) (14)                                                                                |       | 424          |        | —          |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| Lindmark Acquisition, LLC                        |       | Service-advertising                                      |       | Senior Subordinated Term  Debt (11.3%, Due 10/2012) (14)                                             |       | 12,000       |        | 10,260          |       |
|                                             |       |                                                     |       | Senior Subordinated Term  Debt (13.0%, Due 10/2012) (14)                                             |       | 1,469        |        | 962             |       |
|                                             |       |                                                     |       | Common Stock (8) (14)                                                                                |       | 1            |        | —          |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| LYP Holdings Corp.                               |       | Service-yellow pages publishing                          |       | Line of credit, $1,250  available (10.0%, Due 7/2010) (14)                                           |       | 773          |        | 773             |       |
|                                             |       |                                                     |       | Senior Term Debt (12.5%,  Due 2/2012) (14)                                                           |       | 250          |        | 250             |       |
|                                             |       |                                                     |       | Line of Credit, $3,000  available (4.8%, Due 6/2010) (14)                                            |       | 1,170        |        | 717             |       |
|                                             |       |                                                     |       | Senior Term Debt (8.5%,  Due 6/2011) (14)                                                            |       | 2,688        |        | —          |       |
|                                             |       |                                                     |       | Senior Term Debt (10.5%,  Due 6/2011) (3) (14)                                                  |       | 2,750        |        | —          |       |
|                                             |       |                                                     |       | Common Stock Warrants (8) (14)                                                                       |       | —       |        | —          |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| U.S. Healthcare Communications, Inc.             |       | Service-magazine  publisher/operator                     |       | Line of credit, $200  available (non-accrual, Due 3/2010) (10) (14)                             |       | 169          |        | 169             |       |
|                                             |       |                                                     |       | Line of credit, $450  available (non-accrual, Due 3/2010) (10) (14)                             |       | 450          |        | 401             |       |
|                                             |       |                                                     |       | Common Stock (8) (14)                                                                                |       | 2,470        |        | —          |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| Western Directories, Inc.                        |       | Service-directory publisher                              |       | Line of credit, $1,250  available (10%, Due 12/2009) (14)                                            |       | 1,125        |        | —          |       |
|                                             |       |                                                     |       | Preferred Stock (8) (14)                                                                             |       | 1,584        |        | —          |       |
|                                             |       |                                                     |       | Common Stock (8) (14)                                                                                |       | 1            |        | —          |       |
|                                             |       |                                                     |       |                                                                                                      |       |         |        |            |       |
| **Total Control Investments**                    | ** ** | ** **                                               | ** ** | ** **                                                                                                | ** ** | **$**        | **28,232**  | ** **      | **$**      | **13,532** | ** ** |
| ** **                                       | ** ** | ** **                                               | ** ** | ** **                                                                                                | ** ** | ** **   | ** **  | ** **      | ** ** |
| **Total Investments**                            | ** ** | ** **                                               | ** ** | ** **                                                                                                | ** ** | **$**        | **386,128** | ** **      | **$**      | **331,033** | ** ** |

 

5

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Table of Contents

 

**GLADSTONECAPITAL CORPORATION**

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

**AS OFJUNE 30, 2009**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 

----

(1)    Certain of the listed securities are issued byaffiliate(s) of the indicated portfolio company.

(2)    Percentage represents interest rates in effect at June 30,2009 and due date represents the contractual maturity date.

(3)    Last Out Tranche of senior debt, meaning if theportfolio company is liquidated, the holder of the Last Out Tranche is paidafter the senior debt.

(4)    Last Out Tranche of senior debt, meaning if theportfolio company is liquidated, the holder of the Last Out Tranche is paidafter the senior debt, however, the debt is also junior to another Last OutTranche.

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

(6)    Security valued using internally-developed,risk-adjusted discounted cash flow methodologies as of June 30, 2009.

(7)    Security valued based on the transaction sale pricesubsequent to June 30, 2009 (see Note 11).

(8)    Security is non-income producing.

(9)    Access Television includes a success fee with a fairvalue of $4.  The loan matured in June 2009,and the Company is actively working to recover amounts due under this loan.

(10)  Badanco, CCS and U.S. Healthcare are currently pastdue on interest payments and are on non-accrual.

(11)  Fair value of security estimated to be equal to costdue to recent acquisition.

(12)SCI Cable’s loan matured in October 2008.  The Company is actively working to recoveramounts due under this loan, however, there is no assurance that there will bea full recovery of amounts past due.

(13)  BERTL’s interest is currently being capitalized asPaid in Kind (“PIK”) interest.

(14)  Fair value was based on the total enterprise value ofthe portfolio company using a liquidity waterfall approach.

(15)  Badanco is in bankruptcy proceedings and is assigned afair value of $0 at June 30, 2009 as recovery of our unsecured loanoutstanding is uncertain and doubtful.

 

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

 

6

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Table ofContents

 

**GLADSTONECAPITAL CORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS**

**AS OFSEPTEMBER 30, 2008**

**(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  (10.5%, Due 3/2009) (6)                   |       | $          | 1,923      |            | $          | 1,774 | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| ACE Expediters, Inc                                     |                                                                  | Service-over-the-ground  logistics                  |       | Line of Credit,  $850 available (6.0%, Due 1/2011)               |       | —     |       | —          | ** ** |
|                                                    | Senior Term Debt  (9.8%, Due 1/2012) (6)                         |                                                | 11,966     |                                                             | 11,248     | ** ** |
|                                                    |                                                                  |                                                |       | Common Stock  Warrants (8)                                       |       | 200        |       | 142             | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| ActivStyle Acquisition Co.                              |                                                                  | Service-medical  products distribution              |       | Line of Credit,  $1,500 available (6.7%, Due 7/2009) (6)    |       | 1,100      |       | 1,059           | ** ** |
|                                                    | Senior Term Debt  (8.5%, Due 9/2012) (6)                         |                                                | 4,721      |                                                             | 4,543      | ** ** |
|                                                    |                                                                  |                                                |       | Senior Term Debt  (10.5%, Due 9/2012) (3) (6)          |       | 4,435      |       | 4,213           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Allison Publications, LLC                               |                                                                  | Service-publisher  of consumer oriented magazines   |       | Line of Credit,  $4,000 available (9.0%, Due 9/2010)             |       | —     |       | —          | ** ** |
|                                                    | Senior Term Debt  (9.0%, Due 9/2012) (6)                         |                                                | 10,465     |                                                             | 9,568      | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Anitox Acquisition Company                              |                                                                  | Manufacturing-preservatives  for animal feed        |       | Line of Credit,  $3,000 available (6.7%, Due 1/2010) (6)    |       | 2,000      |       | 1,880           | ** ** |
|                                                    | Senior Term Debt  (8.5%, Due 1/2012) (6)                         |                                                | 3,388      |                                                             | 3,185      | ** ** |
|                                                    |                                                                  |                                                |       | Senior Term Debt  (10.5%, Due 1/2012) (3) (6)          |       | 3,688      |       | 3,388           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Badanco Acquisition Corp.                               |                                                                  | Service-luggage  design and distribution            |       | Senior  Subordinated Term Debt (11.5%, Due 7/2012) (6)      |       | 9,458      |       | 8,795           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| BAS Broadcasting                                        |                                                                  | Service-radio  station operator                     |       | Senior Term Debt  (11.5%, Due 7/2013) (5)                   |       | 7,300      |       | 7,209           | ** ** |
|                                                    |                                                                  |                                                |       | Senior Term Debt  (12.0%, Due 7/2009) (3) (5)          |       | 1,000      |       | 988             | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| CCS, LLC                                                |                                                                  | Service-cable TV  franchise owner                   |       | Senior Term Debt  (9.0%, Due 8/2008) (6)                    |       | 728        |       | 364             | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Chinese Yellow Pages Company                       |                                                                  | Service-publisher  of Chinese language directories  |       | Line of Credit,  $700 available (9.0%, Due 9/2010) (6)      |       | 575        |       | 529             | ** ** |
|                                                    | Senior Term Debt  (9.0%, Due 9/2010) (6)                         |                                                | 702        |                                                             | 638        | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Clinton Holdings, LLC                                   |                                                                  | Distribution-aluminum  sheets and stainless steel   |       | Senior  Subordinated Term Debt (12.0%, Due 1/2013) (6)      |       | 15,500     |       | 14,880          | ** ** |
|                                                    | Common Stock  Warrants (8)                                            |                                                | 109        |                                                             | —     |       |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| CMI Acquisition, LLC                                    |                                                                  | Service-recycling                                   |       | Senior  Subordinated Term Debt (10.2%, Due 11/2012) (6)     |       | 6,414      |       | 6,061           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Community Media Corporation                             |                                                                  | Service-publisher  of free weekly newspapers        |       | Senior Term Debt  (7.0%, Due 8/2012) (6)                    |       | 987        |       | 936             | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Defiance Acquisition Corporation                        |                                                                  | Manufacturing-trucking  parts                       |       | Senior Term Debt  (11.0%, Due 4/2010) (3) (6)          |       | 6,165      |       | 5,055           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Doe & Ingalls Management LLC                   |                                                                  | Distributor-specialty  chemicals                    |       | Senior Term Debt  (6.8%, Due 11/2010) (6)                   |       | 3,100      |       | 2,945           | ** ** |
|                                                    |                                                                  |                                                |       | Senior Term Debt  (7.8%, Due 11/2010) (3) (6)          |       | 4,410      |       | 4,167           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Finn Corporation                                        |                                                                  | Manufacturing-landscape  equipment                  |       | Common Stock  Warrants (8)                                       |       | 37         |       | 1,578           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| GFRC Holdings LLC                                  |                                                                  | Manufacturing-glass-fiber  reinforced concrete      |       | Line of Credit,  $3,000 available (6.7%, Due 12/2010)            |       | —     |       | —          | ** ** |
|                                                    | Senior Term Debt  (9.3%, Due 12/2012) (6)                        |                                                | 7,362      |                                                             | 7,105      | ** ** |
|                                                    | Senior  Subordinated Term Debt (11.8%, Due 12/2012) (3) (6) |                                                | 6,716      |                                                             | 6,414      | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Global Materials  Technologies, Inc.          |                                                                  | Manufacturing-steel  wool products and metal fibers |       | Senior Term Debt  (13.0%, Due 11/2009) (3) (6)         |       | 4,640      |       | 4,153           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Heartland Communications Group, LLC                     |                                                                  | Service-radio  station operator                     |       | Line of Credit,  $500 available (10.0%, Due 12/2008) (6)    |       | 105        |       | 79              | ** ** |
|                                                    |                                                                  |                                                |       | Senior Term Debt  (10.0%, Due 5/2011) (6)                   |       | 4,523      |       | 3,386           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| Interfilm Holdings, Inc.                           |                                                                  | Service-slitter  and distributor of plastic films   |       | Senior Term Debt  (10.5%, Due 10/2012) (6)                  |       | 5,000      |       | 4,750           | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| International Junior Golf Training Acquisition  Company |                                                                  | Service-golf  training                              |       | Line of Credit,  $1,500 available (9.2%, Due 5/2010) (6)    |       | 1,400      |       | 1,288           | ** ** |
|                                                    | Senior Term Debt  (6.7%, Due 5/2012) (6)                         |                                                | 2,551      |                                                             | 2,347      | ** ** |
|                                                    | Senior Term Debt  (10.5%, Due 5/2012) (3) (6)               |                                                | 2,500      |                                                             | 2,288      | ** ** |
|                                                    |                                                                  |                                                |       |                                                             |       |       |       |            | ** ** |
| It’s Just Lunch International, LLC                 |                                                                  | Service-dating  service                             |       | Line of Credit,  $750 available (6.5%, Due 6/2009) (6)      |       | 550        |       | 275             | ** ** |
|                                                    |                                                                  |                                                |       | Senior Term Debt  (6.7%, Due 6/2011) (6)                    |       | 3,300      |       | 1,650           | ** ** |
|                                                    |                                                                  |                                                |       | Senior Term Debt  (10.5%, Due 6/2011) (3) (6) (9) |       | 500        |       | 250             | ** ** |
|                                                         |                                                                       |                                                     |            |                                                                  |            |            |            |                 |            |  |  |

 

7

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Table of Contents

 

**GLADSTONE CAPITAL CORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**SEPTEMBER 30, 2008**

**(DOLLARAMOUNTS IN THOUSANDS)**

 
| **Company (1)**                                 | ** **                                                   | **Industry**                                                    | ** ** | **Investment  (2)**                                            | ** ** | **Cost**   | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------------|--------------------------------------------------------------|-----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------|------------|-----------------|------------|
| KMBQ Corporation                                |                                                         | Service-AM/FM  radio broadcaster                                |       | Line of Credit,  $200 available (11.0%, Due 3/2010) (6)   |       | $          | 153        |            | $          | 137 | ** ** |
|                                            | Senior Term Debt  (11.0%, Due 3/2010) (6)               |                                                            | 1,792      |                                                           | 1,594      | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Legend Communications of Wyoming LLC            |                                                         | Service-operator  of radio stations                             |       | Line of Credit,  $500 available (11.0%, Due 6/2011) (5)   |       | 397        |       | 392             | ** ** |
|                                            | Senior Term Debt  (11.0%, Due 6/2013) (5)               |                                                            | 9,250      |                                                           | 9,134      | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Lindmark Outdoor Advertising LLC                |                                                         | Service-advertising                                             |       | Senior  Subordinated Term Debt (11.0%, Due 10/2012) (6)   |       | 11,421     |       | 9,651           | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Multi-Ag Media LLC                              |                                                         | Service-dairy  magazine publisher/information database          |       | Senior Term Debt  (9.0%, Due 12/2009) (6)                 |       | 2,072      |       | 1,853           | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Newhall Holdings, Inc.                |                                                         | Service-distributor  of personal care products and supplements  |       | Line of Credit,  $4,000 available (6.0%, Due 5/2010) (6)  |       | 2,100      |       | 1,880           | ** ** |
|                                            | Senior Term Debt  (8.3%, Due 5/2012) (6)                |                                                            | 4,230      |                                                           | 3,807      | ** ** |
|                                            | Senior Term Debt  (11.3%, Due 5/2012) (3) (6)      |                                                            | 4,500      |                                                           | 4,016      | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Northern Contours, Inc.                    |                                                         | Manufacturing-veneer  and laminate components                   |       | Senior  Subordinated Term Debt (10.0%, Due 5/2010) (6)    |       | 6,912      |       | 6,082           | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Pinnacle Treatment Centers, Inc.           |                                                         | Service-Addiction  treatment centers                            |       | Line of Credit,  $500 available (6.7%, Due 12/2009)            |       | —     |       | —          | ** ** |
|                                            | Senior Term Debt  (8.5%, Due 12/2011) (6)               |                                                            | 3,550      |                                                           | 3,319      | ** ** |
|                                            | Senior Term Debt  (10.5%, Due 12/2011) (3) (6)     |                                                            | 7,500      |                                                           | 6,938      | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Precision Acquisition Group Holdings, Inc. |                                                         | Manufacturing-consumable  components for the aluminum industry  |       | Equipment Note,  $1,500 available (8.5%, Due 10/2011) (6) |       | 1,000      |       | 993             | ** ** |
|                                            | Senior Term Debt  (8.5%, Due 10/2010) (6)               |                                                            | 4,750      |                                                           | 4,714      | ** ** |
|                                            | Senior Term Debt  (11.5%, Due 10/2010) (3) (6)     |                                                            | 4,158      |                                                           | 4,127      | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| PROFITSystems Acquisition Co.                   |                                                         | Service-design  and develop ERP software                        |       | Line of Credit,  $1,250 available (6.7%, Due 7/2009)           |       | —     |       | —          | ** ** |
|                                            | Senior Term Debt  (8.5%, Due 7/2011) (6)                |                                                            | 2,200      |                                                           | 2,027      | ** ** |
|                                            | Senior Term Debt  (10.5%, Due 7/2011) (3) (6)      |                                                            | 2,900      |                                                           | 2,657      | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| RCS Management Holding Co.                      |                                                         | Service-healthcare  supplies                                    |       | Senior Term Debt  (8.5%, Due 1/2011) (3) (6)         |       | 2,875      |       | 2,695           | ** ** |
|                                            |                                                         |                                                            |       | Senior Term Debt  (10.5%, Due 1/2011) (4) (6)        |       | 3,060      |       | 2,815           | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Reliable Biopharmaceutical Holdings, Inc.  |                                                         | Manufacturing-pharmaceutical  and biochemical intermediates     |       | Line of Credit,  $5,000 available (9.0%, Due 10/2010) (6) |       | 1,600      |       | 1,528           | ** ** |
|                                            | Mortgage Note  (9.5%, Due 10/2014) (6)                  |                                                            | 7,407      |                                                           | 7,147      | ** ** |
|                                            | Senior Term Debt  (9.0%, Due 10/2012) (6)               |                                                            | 1,800      |                                                           | 1,719      | ** ** |
|                                            | Senior Term Debt  (11.0%, Due 10/2012) (3) (6)     |                                                            | 11,933     |                                                           | 11,352     | ** ** |
|                                            | Senior  Subordinated Term Debt (12.0%, Due 10/2013) (6) |                                                            | 6,000      |                                                           | 5,445      | ** ** |
|                                            | Common Stock Warrants  (8)                                   |                                                            | 209        |                                                           | —     | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Saunders & Associates                  |                                                         | Manufacturing-equipment  provider for frequency control devices |       | Line of Credit,  $2,500 available (6.9%, Due 5/2009)           |       | —     |       | —          | ** ** |
|                                            | Senior Term Debt  (9.8%, Due 5/2013) (6)                |                                                            | 10,945     |                                                           | 10,740     | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| SCI Cable, Inc.                            |                                                         | Service-cable,  internet, voice provider                        |       | Senior Term Debt  (11.0%, Due 10/2008) (6)                |       | 2,712      |       | 1,355           | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Sunburst Media - Louisiana, LLC                 |                                                         | Service-radio  station operator                                 |       | Senior Term Debt  (9.5%, Due 6/2011) (6)                  |       | 7,857      |       | 6,728           | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Sunshine Media Holdings                         |                                                         | Service-publisher  regional B2B trade magazines                 |       | Line of Credit,  $3,000 available (11.0%, Due 5/2010) (6) |       | 700        |       | 627             | ** ** |
|                                            | Senior Term Debt  (11.0%, Due 5/2012) (6)               |                                                            | 17,000     |                                                           | 15,300     | ** ** |
|                                            | Senior Term Debt  (13.5%, Due 5/2012) (3) (6)      |                                                            | 10,000     |                                                           | 8,750      | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Thibaut Acquisition Co.                         |                                                         | Service-design  and disbribute wall covering                    |       | Line of Credit,  $2,000 available (7.0%, Due 1/2011) (6)  |       | 2,000      |       | 1,838           | ** ** |
|                                            | Senior Term Debt  (7.0%, Due 1/2011) (6)                |                                                            | 2,013      |                                                           | 1,849      | ** ** |
|                                            | Senior Term Debt (10.5%,  Due 1/2011) (3) (6)      |                                                            | 3,000      |                                                           | 2,685      | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Tulsa Welding School                            |                                                         | Service-private  welding school                                 |       | Line of credit,  $2,000 available (9.5%, 9/2011)               |       | —     |       | —          | ** ** |
|                                            |                                                         |                                                            |       | Senior Term Debt  (9.5%, 9/2013) (5)                      |       | 4,000      |       | 4,000           | ** ** |
|                                            |                                                         |                                                            |       | Senior Term Debt  (12.8%, 9/2013) (5)                     |       | 8,000      |       | 8,000           | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| VantaCore                                       |                                                         | Service-acquisition  of aggregate quarries                      |       | Senior  Subordinated Term Debt (12.0%, 8/2013) (6)        |       | 13,100     |       | 12,936          | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Viapack, Inc.                              |                                                         | Manufacturing-polyethylene  film                                |       | Senior Real  Estate Term Debt (7.0%, Due 3/2011) (6)      |       | 850        |       | 780             | ** ** |
|                                            | Senior Term Debt  (11.3%, Due 3/2011) (3) (6)      |                                                            | 4,091      |                                                           | 3,733      | ** ** |
|                                            |                                                         |                                                            |       |                                                           |       |       |       |            | ** ** |
| Visual Edge Technology, Inc.               |                                                         | Service-office  equipment distribution                          |       | Senior  Subordinated Term Debt (11.5%, Due 8/2011) (6)    |       | 5,000      |       | 2,925           | ** ** |
|                                                 |                                                              |                                                                 |            |                                                                |            |            |            |                 |            |  |  |

 

8

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Table of Contents

 

**GLADSTONE CAPITAL CORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**SEPTEMBER 30, 2008**

**(DOLLARAMOUNTS IN THOUSANDS)**

 
| **Company (1)**                                  | ** **                                                             | **Industry**                                                | ** ** | **Investment  (2)**                                            | ** ** | **Cost**   | ** **  | **Fair  Value** | ** ** |
|--------------------------------------------------|------------------------------------------------------------------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------|-------------|-----------------|------------|
| Westlake Hardware, Inc.                     |                                                                   | Retail-hardware  and variety                                |       | Senior  Subordinated Term Debt (9.0%, Due 1/2011) (6)     |       | $          | 15,000      |            | $          | 13,800 | ** ** |
|                                             |                                                                   |                                                        |       | Senior  Subordinated Term Debt (10.3%, Due 1/2011) (6)    |       | 10,000     |        | 9,000           | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| Winchester Electronics                           |                                                                   | Manufacturing-high  bandwidth connectors and cables         |       | Senior Term Debt  (8.0%, Due 5/2013) (6)                  |       | 1,699      |        | 1,563           | ** ** |
|                                             | Senior  Subordinated Term Debt (13.0%, Due 6/2013) (6)            |                                                        | 9,950      |                                                           | 9,055      | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| *Subtotal - Non-syndicated loans*                |                                                                   |                                                        |       |                                                           |       | 371,204    |        | 340,816         | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| ***Syndicated Loans:***                          |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| AKQA Holdings                                    |                                                                   | Service-market  and advertising                             |       | Senior Term Debt  (7.7%, Due 3/2013) (7)                  |       | $          | 8,273       |            | $          | 7,980 | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| Bresnan Communications, LLC                      |                                                                   | Service-telecommunications                                  |       | Senior Term Debt  (4.8%, Due 9/2013) (7)                  |       | 3,001      |        | 2,670           | ** ** |
|                                             |                                                                   |                                                        |       | Senior  Subordinated Term Debt (7.6%, Due 3/2014) (7)     |       | 1,508      |        | 1,305           | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| CHG Companies, Inc.                         |                                                                   | Service-healthcare  staffing                                |       | Letter of Credit,  $400 available (6.0%, Due 12/2012) (7) |       | 400        |        | 356             | ** ** |
|                                             |                                                                   |                                                        |       | Senior Term Debt  (5.3%, Due 12/2012) (7)                 |       | 1,572      |        | 1,399           | ** ** |
|                                             |                                                                   |                                                        |       | Senior  Subordinated Term Debt (8.5%, Due 12/2013) (7)    |       | 500        |        | 425             | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| Country Road Communications LLC                  |                                                                   | Service-telecommunications                                  |       | Senior  Subordinated Term Debt (11.5%, Due 7/2013) (7)    |       | 5,973      |        | 5,880           | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| Emdeon Business Services, Inc.              |                                                                   | Service-healthcare  technology solutions                    |       | Senior Term Debt  (5.8%, Due 11/2013) (7)                 |       | 2,359      |        | 2,027           | ** ** |
|                                             | Senior  Subordinated Term Debt (8.8%, Due 5/2014) (7)             |                                                        | 2,011      |                                                           | 1,720      | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| GTM Holdings, Inc.                          |                                                                   | Manufacturing-socks                                         |       | Senior Term Debt  (8.5%, Due 10/2013) (7)                 |       | 491        |        | 359             | ** ** |
|                                             |                                                                   |                                                        |       | Senior  Subordinated Term Debt (11.8%, Due 4/2014) (7)    |       | 500        |        | 325             | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| Greatwide Logistics Services, Inc.          |                                                                   | Service-logistics  and transportation                       |       | Senior Term Debt  (non-accrual, Due 12/2013)(7) (10)      |       | 3,950      |        | 2,765           | ** ** |
|                                             | Senior  Subordinated Term Debt (non-accrual, Due 6/2014) (7) (10) |                                                        | 2,000      |                                                           | 700        | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| Harrington Holdings, Inc.                   |                                                                   | Service-healthcare  products distribution                   |       | Senior Term Debt  (6.0%, Due 1/2014) (7)                  |       | 2,463      |        | 2,192           | ** ** |
|                                             | Senior  Subordinated Term Debt (9.7%, Due 1/2014) (7)             |                                                        | 5,000      |                                                           | 3,750      | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| John Henry Holdings, Inc.                   |                                                                   | Manufacturing-packaging  products                           |       | Senior  Subordinated Term Debt (11.6%, Due 6/2011) (7)    |       | 8,000      |        | 7,600           | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| Kinetek Acquisition Corp.                        |                                                                   | Manufacturing-custom  engineered motors & controls |       | Senior Term Debt  (6.2%, Due 11/2013) (7)                 |       | 1,478      |        | 1,326           | ** ** |
|                                             | Senior  Subordinated Term Debt (9.2%, Due 5/2014) (7)             |                                                        | 1,508      |                                                           | 1,275      | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| Puerto Rico Cable Acquisition Company, Inc. |                                                                   | Service-telecommunications                                  |       | Senior  Subordinated Term Debt (11.3%, Due 1/2012) (7)    |       | 7,189      |        | 5,570           | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| RedPrairie Holding, Inc.                    |                                                                   | Service-design  and develop supply chain software           |       | Senior Term Debt  (6.1%, Due 7/2012) (7)                  |       | 4,412      |        | 4,014           | ** ** |
|                                             | Senior  Subordinated Term Debt (9.3%, Due 1/2013) (7)             |                                                        | 3,000      |                                                           | 2,550      | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| RiskMetrics Group Holdings, LLC                  |                                                                   | Service-develop  risk and wealth management solutions       |       | Senior Term Debt  (5.8%, Due 1/2014) (7)                  |       | 1,936      |        | 1,812           | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| United Maritime Group, LLC                       |                                                                   | Service-cargo  transport                                    |       | Senior  Subordinated Term Debt (11.2%, Due 12/2013) (7)   |       | 1,000      |        | 950             | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| Wesco Holdings, Inc.                        |                                                                   | Service-aerospace  parts and distribution                   |       | Senior Term Debt  (6.0%, Due 9/2013) (7)                  |       | 2,451      |        | 2,212           | ** ** |
|                                             | Senior  Subordinated Term Debt (9.5%, Due 3/2014) (7)             |                                                        | 2,267      |                                                           | 1,980      | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| WP Evenflo Group Holdings Inc.                   |                                                                   | Manufacturing-infant  and juvenile products                 |       | Senior Term Debt  (5.3%, Due 2/2013) (7)                  |       | 1,910      |        | 1,595           | ** ** |
|                                             | Senior  Subordinated Term Debt (8.8%, Due 2/2014) (7)             |                                                        | 2,000      |                                                           | 1,600      | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| *Subtotal - Syndicated loans*                    |                                                                   |                                                        |       |                                                           |       | 77,152     |        | 66,337          | ** ** |
|                                             |                                                                   |                                                        |       |                                                           |       |       |        |            | ** ** |
| **Total Non-Control/Non-Affiliate  Investments** | ** **                                                             | ** **                                                  | ** ** | ** **                                                     | ** ** | **$**      | **448,356** | ** **      | **$**      | **407,153** | ** ** |

 

9

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Table ofContents

 

**GLADSTONE CAPITAL CORPORATION**

**CONDENSED CONSOLIDATED SCHEDULE OFINVESTMENTS (Continued)**

**SEPTEMBER 30, 2008**

**(DOLLAR AMOUNTS IN THOUSANDS)**

 
| **Company (1)**                      | ** ** | **Industry**                                             | ** ** | **Investment  (2)**                                                        | ** ** | **Cost**   | ** **  | **Fair  Value** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|------------|-------------|-----------------|------------|
| **CONTROL INVESTMENTS**              |       |                                                     |       |                                                                       |       |       |        |            | ** ** |
|                                 |       |                                                     |       |                                                                       |       |       |        |            | ** ** |
| BERTL, Inc.                          |       | Service-web-based  evaluator of digital imaging products |       | Line of Credit, $700  available (8.7%, Due 10/2009) (11) (12)    |       | $          | 742         |            | $          | — | ** ** |
|                                 |       |                                                     |       | Common Stock (8)                                                           |       | 424        |        | —          | ** ** |
|                                 |       |                                                     |       |                                                                       |       |       |        |            | ** ** |
| LYP Holdings Corp.                   |       | Service-yellow pages publishing                          |       | Line of credit, $500  available (10.0%, 5/2009) (12)                       |       | 75         |        | —          | ** ** |
|                                 |       |                                                     |       | Line of Credit, $3,000  available (non-accrual, Due 6/2009) (10) (12) |       | 1,170      |        | —          |       |
|                                 |       |                                                     |       | Senior Term Debt  (non-accrual, Due 6/2011) (10) (12)                      |       | 2,688      |        | —          | ** ** |
|                                 |       |                                                     |       | Senior Term Debt  (non-accrual, Due 6/2011) (3) (10) (12)                  |       | 2,750      |        | —          | ** ** |
|                                 |       |                                                     |       | Common Stock Warrants  (8)                                                 |       | 1          |        | —          | ** ** |
|                                 |       |                                                     |       |                                                                       |       |       |        |            | ** ** |
| U.S. Healthcare Communications, Inc. |       | Service-magazine  publisher/ operator                    |       | Line of credit, $200  available (non-accrual, Due 3/2010) (10)        |       | 90         |        | 90              | ** ** |
|                                 |       |                                                     |       | Line of credit, $450  available (non-accrual, Due 3/2010) (10)        |       | 450        |        | 450             | ** ** |
|                                 |       |                                                     |       | Common Stock (8)                                                           |       | 2,470      |        | 240             | ** ** |
|                                 |       |                                                     |       |                                                                       |       |       |        |            | ** ** |
| Western Directories, Inc.            |       | Service-directory  publisher                             |       | Line of credit, $1,000  available (10%, Due 8/2009) (12)              |       | 69         |        | —          | ** ** |
|                                 |       |                                                     |       | Preferred Stock (8)                                                        |       | 1,584      |        | —          | ** ** |
|                                 |       |                                                     |       | Common Stock (8)                                                           |       | 1          |        | —          | ** ** |
| ** **                           | ** ** | ** **                                               | ** ** | ** **                                                                 | ** ** | ** ** | ** **  | ** **      | ** ** |
| **Total Control Investments**        | ** ** | ** **                                               | ** ** | ** **                                                                 | ** ** | **$**      | **12,514**  | ** **      | **$**      | **780** | ** ** |
| ** **                           | ** ** | ** **                                               | ** ** | ** **                                                                 | ** ** | ** ** | ** **  | ** **      | ** ** |
| **Total Investments**                | ** ** | ** **                                               | ** ** | ** **                                                                 | ** ** | **$**      | **460,870** | ** **      | **$**      | **407,933** | ** ** |

 

----

(1)             Certain of the listed securities are issued byaffiliate(s) of the indicated portfolio company.

(2)             Percentage represents interest rates ineffect at September 30, 2008 and due date represents the contractualmaturity date.

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

(4)             Last Out Tranche of senior debt, meaning if thecompany is liquidated, the holder of the Last Out Tranche is paid after thesenior debt, however the debt is junior to another Last Out Tranche.

(5)             Investment estimated to be equal to cost due to recentacquisition.

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

(7)             Marketable securities, such as syndicated loans, arevalued based on the indicative bid price, as of September 30, 2008, fromthe respective originating syndication agent’s trading desk.

(8)             Security is non-income producing.

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

(10)       Greatwide, LYP Holdings and U.S. Healthcare arecurrently past due on interest payments and are on non-accrual.

(11)       BERTL line of credit was overdrawn by $42 as of September 30,2008.  The Company is currentlyrestructuring the line of credit.  BERTLinterest is currently being capitalized as Paid in Kind (“PIK”) interest.   Please refer to Note 2 “Summary ofSignificant Accounting Policies.”

(12)       Fair value was based on the total enterprise value ofthe issuer using a liquidity waterfall approach.

 

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

 

10

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Table ofContents

 

**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(UNAUDITED)**

 
| ** **                                                                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| INVESTMENT INCOME                                                                  |       |                                  |       |                                |       |   |   |   |   |
| Interest income –  Non-Control/Non-Affiliate investments                      |       | $                                     | 9,726      |                                | $          | 11,220 |   | $ | 31,716 |   | $ | 33,454 |   |
| Interest income – Control investments                                         |       | 754                                   |       | 16                                  |       | 1,256 |   | 45 |   |
| Interest income – Cash                                                        |       | —                                |       | 38                                  |       | 11 |   | 285 |   |
| Interest income – Notes receivable from employees (Refer to Note 4)           |       | 118                                   |       | 118                                 |       | 352 |   | 354 |   |
| Prepayment fees and other income                                                   |       | —                                |       | 28                                  |       | — |   | 34 |   |
| Total investment income                                                            |       | 10,598                                |       | 11,420                              |       | 33,335 |   | 34,172 |   |
|                                                                               |       |                                  |       |                                |       |   |   |   |   |
| EXPENSES                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Interest expense                                                                   |       | 1,811                                 |       | 1,771                               |       | 6,288 |   | 5,982 |   |
| Loan servicing fee (Refer to Note 4)                                               |       | 1,410                                 |       | 1,598                               |       | 4,559 |   | 4,541 |   |
| Base management fee (Refer to Note 4)                                              |       | 457                                   |       | 529                                 |       | 1,374 |   | 1,664 |   |
| Incentive fee (Refer to Note 4)                                                    |       | 1,060                                 |       | 1,340                               |       | 3,326 |   | 4,089 |   |
| Administration fee (Refer to Note 4)                                               |       | 218                                   |       | 285                                 |       | 656 |   | 737 |   |
| Professional fees                                                                  |       | 266                                   |       | 167                                 |       | 784 |   | 706 |   |
| Amortization of deferred financing fees                                            |       | 808                                   |       | 572                                 |       | 2,253 |   | 830 |   |
| Stockholder related costs                                                          |       | 33                                    |       | 34                                  |       | 317 |   | 292 |   |
| Directors fees                                                                     |       | 55                                    |       | 52                                  |       | 151 |   | 163 |   |
| Insurance expense                                                                  |       | 69                                    |       | 57                                  |       | 192 |   | 170 |   |
| Other expenses                                                                     |       | 89                                    |       | 103                                 |       | 230 |   | 263 |   |
| Expenses before credit from Adviser                                                |       | 6,276                                 |       | 6,508                               |       | 20,130 |   | 19,437 |   |
| Credit to base management and incentive feesfrom Adviser (Refer to Note  4)        |       | (1,113                                | )          | (1,785                              | )          | (3,667 | ) | (5,708 | ) |
| Total expenses net of credit to base management and incentive fees                 |       | 5,163                                 |       | 4,723                               |       | 16,463 |   | 13,729 |   |
|                                                                               |       |                                  |       |                                |       |   |   |   |   |
| NET INVESTMENT INCOME                                                              |       | 5,435                                 |       | 6,697                               |       | 16,872 |   | 20,443 |   |
|                                                                               |       |                                  |       |                                |       |   |   |   |   |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS AND DERIVATIVE:                |       |                                  |       |                                |       |   |   |   |   |
| Net realized loss on investments                                                   |       | (10,594                               | )          | (86                                 | )          | (14,325 | ) | (86 | ) |
| Realized (loss) gain on settlement of derivative                                   |       | —                                |       | —                              |       | (304 | ) | 6 |   |
| Unrealized appreciation (depreciation) on derivative                               |       | —                                |       | —                              |       | 304 |   | (12 | ) |
| Net unrealized appreciation (depreciation) on investments                          |       | 4,371                                 |       | (3,802                              | )          | (2,158 | ) | (27,545 | ) |
| Net loss on investments                                                            |       | (6,223                                | )          | (3,888                              | )          | (16,483 | ) | (27,637 | ) |
|                                                                               |       |                                  |       |                                |       |   |   |   |   |
| NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS                    |       | $                                     | (788       | )                                   | $          | 2,809 |   | $ | 389 |   | $ | (7,194 | ) |
|                                                                               |       |                                  |       |                                |       |   |   |   |   |
| NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS PER  COMMON SHARE: |       |                                  |       |                                |       |   |   |   |   |
| Basic and Diluted                                                                  |       | $                                     | (0.04      | )                                   | $          | 0.13 |   | $ | 0.02 |   | $ | (0.37 | ) |
|                                                                               |       |                                  |       |                                |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING:                               |       |                                  |       |                                |       |   |   |   |   |
| Basic and Diluted                                                                  |       | 21,087,574                            |       | 21,087,574                          |       | 21,087,574 |   | 19,237,203 |   |

 

*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)**

 
| ** **                                                       | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                       | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| *Operations:*                                                    |       |                                |       |   |   |
| Net investment  income                                           |       | $                                   | 16,872     |   | $ | 20,443 |   |
| Net realized  loss on investments                                |       | (14,325                             | )          | (86 | ) |
| Realized (loss)  gain on settlement of derivative                |       | (304                                | )          | 6 |   |
| Unrealized  appreciation (depreciation) on derivative            |       | 304                                 |       | (12 | ) |
| Net unrealized  appreciation (depreciation) on investments       |       | (2,158                              | )          | (27,545 | ) |
| Net increase  (decrease) in net assets from operations           |       | 389                                 |       | (7,194 | ) |
|                                                             |       |                                |       |   |   |
| *Capital  transactions:*                                         |       |                                |       |   |   |
| Issuance of  common stock under shelf offering                   |       | —                              |       | 106,226 |   |
| Shelf offering  costs                                            |       | (3                                  | )          | (845 | ) |
| Distributions to  stockholders                                   |       | (22,142                             | )          | (24,523 | ) |
| Repayment of  principal on employee notes                        |       | 4                                   |       | 51 |   |
| Net (decrease)  increase in net assets from capital transactions |       | (22,141                             | )          | 80,909 |   |
|                                                             |       |                                |       |   |   |
| Total (decrease)  increase in net assets                         |       | (21,752                             | )          | 73,715 |   |
| Net assets at  beginning of year                                 |       | 271,748                             |       | 220,959 |   |
| Net assets at  end of period                                     |       | $                                   | 249,996    |   | $ | 294,674 |   |

 

*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)**

 
| ** **                                                                                                                                         | ** ** | **Nine Months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **2009**                            | ** ** | **2008** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                                           |       |                                |       |   |   |
| Net increase (decrease) in net assets resulting from operations                                                                                    |       | $                                   | 389        |   | $ | (7,194 | ) |
| Adjustments to reconcile  net (decrease) increase in net assets resulting from operations to net cash  provided by (used in) operating activities: |       |                                |       |   |   |
| Purchase of investments                                                                                                                            |       | (24,711                             | )          | (137,502 | ) |
| Principal repayments on investments                                                                                                                |       | 43,419                              |       | 47,802 |   |
| Proceeds from sale of investments                                                                                                                  |       | 41,962                              |       | — |   |
| Net amortization of premiums and discounts                                                                                                         |       | (205                                | )          | 215 |   |
| Increase in investment balance due to payment in kind interest                                                                                     |       | (48                                 | )          | (42 | ) |
| Net realized loss on investments                                                                                                                   |       | 14,325                              |       | 86 |   |
| Amortization of deferred financing fees                                                                                                            |       | 2,253                               |       | 830 |   |
| Realized loss on settlement of derivative                                                                                                          |       | 304                                 |       | — |   |
| Unrealized (appreciation) depreciation on derivative                                                                                               |       | (304                                | )          | 12 |   |
| Change in net unrealized depreciation on investments                                                                                               |       | 2,158                               |       | 27,545 |   |
| Increase in interest receivable                                                                                                                    |       | (107                                | )          | (945 | ) |
| Decrease (increase) in funds due from custodian                                                                                                    |       | 2,913                               |       | (3,406 | ) |
| Decrease in prepaid assets                                                                                                                         |       | 90                                  |       | 135 |   |
| Increase in other assets                                                                                                                           |       | (501                                | )          | (113 | ) |
| (Decrease) increase in accounts payable                                                                                                            |       | (2                                  | )          | 2 |   |
| Decrease in interest payable                                                                                                                       |       | (218                                | )          | (65 | ) |
| (Decrease) increase in accrued expenses and deferred liabilities                                                                                   |       | (226                                | )          | 114 |   |
| Increase (decrease) in fees due to affiliate (Refer to Note 4)                                                                                     |       | 260                                 |       | (241 | ) |
| (Decrease) increase in administration fee due to Gladstone Administration  (Refer to Note 4)                                                       |       | (29                                 | )          | 47 |   |
| (Decrease) increase in funds held in escrow                                                                                                        |       | (69                                 | )          | 290 |   |
| Net cash provided by (used in) operating activities                                                                                                |       | 81,653                              |       | (72,430 | ) |
|                                                                                                                                               |       |                                |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                                                                          |       |                                |       |   |   |
| Redemption of U.S. Treasury Bill                                                                                                                   |       | —                              |       | 2,484 |   |
| Net cash provided by investing activities                                                                                                          |       | —                              |       | 2,484 |   |
|                                                                                                                                               |       |                                |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                                                          |       |                                |       |   |   |
| Net proceeds from the issuance of common stock                                                                                                     |       | —                              |       | 106,226 |   |
| Shelf offering costs                                                                                                                               |       | (3                                  | )          | (845 | ) |
| Borrowings from the line of credit                                                                                                                 |       | 46,800                              |       | 151,418 |   |
| Repayments on the line of credit                                                                                                                   |       | (106,130                            | )          | (162,768 | ) |
| Distributions paid                                                                                                                                 |       | (22,142                             | )          | (24,523 | ) |
| Receipt of principal on notes receivable – employees (Refer to Note 4)                                                                        |       | 4                                   |       | 51 |   |
| Deferred financing fees                                                                                                                            |       | (2,109                              | )          | (3,026 | ) |
| Net cash (used in) provided by financing activities                                                                                                |       | (83,580                             | )          | 66,533 |   |
|                                                                                                                                               |       |                                |       |   |   |
| **NET DECREASE IN CASH**                                                                                                                           |       | (1,927                              | )          | (3,413 | ) |
| **CASH, BEGINNING OF PERIOD**                                                                                                                      |       | 6,493                               |       | 8,839 |   |
| **CASH, END OF PERIOD**                                                                                                                            |       | $                                   | 4,566      |   | $ | 5,426 |   |

 

*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  June 30,** | ** ** | **Nine months ended June 30,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                      | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Per Share Data (1)                                              |       |                                  |       |                                |       |   |   |   |   |
| Net asset value at beginning of period                          |       | $                                     | 12.10      |                                | $          | 14.27 |   | $ | 12.89 |   | $ | 14.97 |   |
| *Income from investment operations:*                            |       |                                  |       |                                |       |   |   |   |   |
| Net investment income (2)                                       |       | 0.26                                  |       | 0.32                                |       | 0.80 |   | 1.06 |   |
| Net realized loss on investments (2)                            |       | (0.50                                 | )          | —                              |       | (0.68 | ) | — |   |
| Realized loss on settlement of derivative (2)                   |       | —                                |       | —                              |       | (0.01 | ) | — |   |
| Unrealized appreciation on derivative (2)                       |       | —                                |       | —                              |       | 0.01 |   | — |   |
| Net unrealized appreciation (depreciation) on investments (2)   |       | 0.21                                  |       | (0.19                               | )          | (0.10 | ) | (1.43 | ) |
| Total from investment operations                                |       | (0.03                                 | )          | (0.13                               | )          | 0.02 |   | (0.37 | ) |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Distributions to stockholders (3)                               |       | (0.21                                 | )          | (0.42                               | )          | (1.05 | ) | (1.26 | ) |
| Issuance of common stock under shelf offering                   |       | —                                |       | —                              |       | — |   | 0.68 |   |
| Offering costs                                                  |       | —                                |       | (0.01                               | )          | — |   | (0.05 | ) |
| Net asset value at end of period                                |       | $                                     | 11.86      |                                | $          | 13.97 |   | $ | 11.86 |   | $ | 13.97 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Per share market value at beginning of period                   |       | $                                     | 6.26       |                                | $          | 18.71 |   | $ | 15.24 |   | $ | 19.52 |   |
| Per share market value at end of period                         |       | $                                     | 7.53       |                                | $          | 15.24 |   | $ | 7.53 |   | $ | 15.24 |   |
| Total return (4)(5)                                             |       | 23.88                                 | %          | -16.53                              | %          | -43.15 | % | -16.15 | % |
| Shares outstanding at end of period                             |       | 21,087,574                            |       | 21,087,574                          |       | 21,087,574 |   | 21,087,574 |   |
|                                                            |       |                                  |       |                                |       |   |   |   |   |
| Statement of Assets and Liabilities Data:                       |       |                                  |       |                                |       |   |   |   |   |
| Net assets at end of period                                     |       | $                                     | 249,996    |                                | $          | 294,674 |   | $ | 249,996 |   | $ | 294,674 |   |
| Average net assets (6)                                          |       | $                                     | 253,130    |                                | $          | 295,405 |   | $ | 254,886 |   | $ | 284,641 |   |
| Senior Securities Data:                                         |       |                                  |       |                                |       |   |   |   |   |
| Borrowings under line of credit                                 |       | $                                     | 91,700     |                                | $          | 133,090 |   | $ | 91,700 |   | $ | 133,090 |   |
| Asset coverage ratio (7)(8)                                     |       | 373                                   | %          | 321                                 | %          | 373 | % | 321 | % |
| Asset coverage per unit (8)                                     |       | $                                     | 3,726      |                                | $          | 3,214 |   | $ | 3,726 |   | $ | 3,214 |   |
| Ratios/Supplemental Data:                                       |       |                                  |       |                                |       |   |   |   |   |
| Ratio of expenses to average net assets-annualized (9)          |       | 9.92                                  | %          | 8.81                                | %          | 10.53 | % | 9.10 | % |
| Ratio of net expenses to average net assets-annualized (10)     |       | 8.16                                  | %          | 6.40                                | %          | 8.61 | % | 6.43 | % |
| Ratio of net investment income to average net assets-annualized |       | 8.59                                  | %          | 9.07                                | %          | 8.83 | % | 9.58 | % |

 

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

(2)          Based on weighted average basic per sharedata.

(3)          Distributions are determined based ontaxable income calculated in accordance with income tax regulations which maydiffer from amounts determined under accounting principles generally acceptedin the United States of America.

(4)          Total return equals the change in theending market value of the Company’s common stock from the beginning of theperiod taking into account distributions reinvested in accordance with theterms of the Company’s dividend reinvestment plan. Total return does not takeinto account distributions that may be characterized as a return of capital.For further information on estimated character of the Company’s distributionsplease refer to Note 9.

(5)          Amounts were not annualized.

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

(7)          As a business development company, theCompany is generally required to maintain a ratio of at least 200% of totalassets, less all liabilities and indebtedness not represented by seniorsecurities, to total borrowings.

(8)          Asset coverage ratio is the ratio of thecarrying value of the Company’s total consolidated assets, less all liabilitiesand indebtedness not represented by senior securities, to the aggregate amountof senior securities representing indebtedness. Asset coverage per unit is theasset coverage ratio expressed in terms of dollar amounts per $1,000 ofindebtedness.

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

(10)    Ratio of net expenses to average netassets is computed using total expenses net of credits from Adviser to the basemanagement 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**

**JUNE30, 2009**

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

**(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 investmentobjectives are 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, 2008, as filed with the Securitiesand Exchange Commission (the “SEC”) on December 2, 2008.

 

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

 

*Investment Valuation Policy*

 

The Company carries its investments at market value to the extent thatmarket quotations are readily available and reliable, and otherwise at fairvalue, as determined in good faith by its Board of Directors.  In determining the fair value of the Company’sinvestments, the Adviser has established an investment valuation policy (the “Policy”).  The Policy is approved by the Company’s 

 

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Board of Directors and each quarter the Board of Directors reviewswhether the Adviser has applied the Policy consistently and votes whether ornot to accept the recommended valuation of the Company’s investment portfolio.

 

The Company uses generally accepted valuationtechniques to value its portfolio unless the Company has specific informationabout the value of an investment to determine otherwise. From time to time theCompany may accept an appraisal of a business in which the Company holdssecurities. These appraisals are expensive and occur infrequently but provide athird-party valuation opinion that may differ in results, techniques and scopesused to value the Company’s investments. When these specific third-party appraisals are engaged or accepted, theCompany uses such appraisals to value the investment the Company has in thatbusiness if it was determined that the appraisals were the best estimate offair value.

 

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

 

**Publicly-traded securities:** The Company determines the value of publicly-tradedsecurities based on the closing price for the security on the exchange orsecurities market on which it is listed and primarily traded on the valuationdate.  To the extent that the Companyowns restricted 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.

 

**Securities for which a limited marketexists:** TheCompany values securities that are not traded on an established secondarysecurities market, but for which a limited market for the security exists, suchas certain participations in, or assignments of, syndicated loans, at thequoted price.  In valuing these assets,the Company assesses trading activity in an asset class and evaluates variancesin prices and other market insights to determine if any available quote pricesare reliable.  If the Company concludesthat quotes based on active markets or trading activity may be relied upon,firm bid prices are requested; however, if a firm bid price is unavailable, theCompany bases the value of the security upon the indicative bid price offeredby the respective originating syndication agent’s trading desk, or secondarydesk, on or near the valuation date. To the extent that the Company uses theindicative bid price as a basis for valuing the security, the Adviser may takefurther steps to consider additional information to validate that price inaccordance with the Policy.

 

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”) Staff Position No. 157-3, *Determining the Fair Value of a Financial Asset Whenthe Market for That Asset Is Not Active* (“FSP No. 157-3”),which provides guidance on the use of a reporting entity’s own assumptionsabout future cash flows and risk-adjusted discount rates when relevantobservable inputs, such as quotes in active markets, are not available. Whenrelevant observable market data does not exist, the alternative outlined in theFSP No. 157-3 is the use of valuing investments based on DCF.  For the purposes of using DCF to provide fairvalue estimates, the Company considered 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 developed a modified discount rate approach thatincorporates risk premiums including, among others, increased probability ofdefault, or higher loss given default, or increased liquidity risk.  The DCF valuations applied to the syndicatedloans provide an estimate of what the Company believes a market participantwould pay to purchase a syndicated loan in an active market, therebyestablishing a fair value.  The Companywill continue to apply the DCF methodology in illiquid markets until quotedprices are available or are deemed reliable based on trading activity.  As of June 30, 2009, the portion of theCompany’s investment portfolio that was valued using DCF was approximately$12,617, or 3.8% of the fair value of its total portfolio of investments.

 

**Securities for which no marketexists:** Thevaluation methodology for securities for which no market exists falls intothree categories: (1) portfolio investments comprised solely of debtsecurities; (2) portfolio investments in controlled companies comprised ofa bundle of securities, which can include debt or equity securities, or both;and (3) portfolio investments in non-controlled companies comprised of abundle of investments, which can include debt or equity securities, or both.

 

**(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 withthe terms of the Policy, which utilizes opinions of value submitted to theCompany by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”).The Company 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 orequity securities, or both:** The fair value of these investments is determinedbased on the total enterprise value of the portfolio company, or issuer,utilizing a liquidity waterfall approach under Statement of FinancialAccounting Standards (“SFAS”) No. 

 

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157, *Fair Value Measurements* (“SFAS No. 157”).Forthe Company’s Non-Public Debt Securities and equity or equity-like securities(e.g. preferred equity, equity or other equity-like securities) that arepurchased together as part of a package, where the Company has control or couldgain control through an option or warrant security, both the debt and equitysecurities of the portfolio investment would exit in the mergers andacquisition market as the principal market, generally through a sale orrecapitalization of the portfolio company. In accordance with SFAS No. 157,the Company applies the in-use premise of value which assumes the debt andequity securities are sold together. Under this liquidity waterfall approach,the Company first calculates the total enterprise value of the issuer by incorporatingsome or all of the following factors to determine the total enterprise value ofthe issuer:

 

·  the issuer’s ability to makepayments;

·  the earnings of the issuer;

·  recent sales to third partiesof similar securities;

·  the comparison to publiclytraded securities; and

·  DCF or other pertinentfactors.

 

In gathering the sales tothird parties of similar securities, the Company may reference industrystatistics and use outside experts. Once the Company has estimated the totalenterprise value of the issuer, the Company will subtract the value of all thedebt securities 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 debtsecurities) have been subtracted from the total enterprise value of the issuer,the remaining amount, if any, is used to determine the value of the issuer’sequity or equity -like securities.  If,in the Adviser’s judgment, the liquidity waterfall approach does not accuratelyreflect the value of the debt component, the Adviser may recommend that theCompany use a valuation by SPSE, or if that is unavailable, a DCF valuationtechnique.

 

**(3)****        ****Portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt or equity securities, or both:**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 SFAS No. 157, theCompany determines its fair value of these debt securities of non-controlinvestments assuming the sale of an individual debt security using thein-exchange premise of value (as defined in SFAS No. 157). As such, theCompany estimates the fair value of the debt component using estimates of valueprovided by SPSE and its own assumptions in the absence of observable marketdata, including synthetic credit ratings, estimated remaining life, currentmarket yield and interest rate spreads of similar securities as of themeasurement date. For equity and equity-like securities of investments forwhich the Company does not control or cannot gain control as of the measurementdate, the Company values the equity portion based principally on the totalenterprise value of the issuer, which is calculated using a liquidity waterfallapproach.

 

Due to the uncertaintyinherent in the valuation process, such estimates of fair value may differsignificantly from the values that would have been obtained had a ready marketfor the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains or losses ultimately realizedon these investments to be different than the valuations currently assigned.There is no single standard for determining fair value in good faith, as fairvalue depends upon circumstances of each individual case. In general, fairvalue is the amount that the Company might reasonably expect to receive uponthe current sale of the security in an arms-length transaction in the security’sprincipal market.

 

Refer to Note 3 for additional information regarding fair valuemeasurements and the Company’s adoption of SFAS No. 157.

 

*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 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.  At June 30, 2009, twoNon-Control/Non-Affiliate investments and one Control investment were onnon-accrual with an aggregate cost basis of approximately $10,659 or 2.8% ofthe cost basis of all investments in the Company’s portfolio.  At September 30, 2008, oneNon-Control/Non-Affiliate investment and two Control investments were onnon-accrual with a cost basis of approximately $13,098 at September 30,2008, or 2.8% of the cost basis of all loans in the Company’s portfolio.  Conditional interest, or a success fee, isrecorded upon full repayment of a loan investment.

 

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*Paid in Kind Interest*

 

TheCompany has one loan in its portfolio which contains a PIK provision. 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 Company recorded PIK interest income of $15 and $48for the three and nine months ended June 30, 2009, respectively, ascompared to $16 and $30 for the three and nine months ended June 30, 2008,respectively, from investments on the accompanying condensed consolidatedstatements of operations.

 

*Recent Accounting Pronouncements*

 

In June 2009, the FASB approved the *FASB Accounting Standards Codification* (*Codification*) as the single source ofauthoritative nongovernmental U.S. Generally Accepted Accounting Principles (*U.S. GAAP*) which was launched on July 1,2009.  The Codification does not change current U.S. GAAP but isintended to simplify user access to all authoritative U.S. GAAP by providingall the authoritative literature related to a particular topic in oneplace.  All existing accounting standard documents will be supersededand all other accounting literature not included in the Codification will beconsidered nonauthoritative.  The Codification is effective forinterim and annual periods ending after September 15, 2009.  TheCodification is effective for the Company during its interim period endingSeptember 30, 2009 and is not expected to have an impact on itsfinancial condition or results of operations.  The Company iscurrently evaluating the impact to its financial reporting process ofproviding Codification references in its public filings.

 

InJune 2009, the FASB issued SFAS No. 166, *Accounting for Transfers of Financial Assets*(“SFAS No. 166”).SFAS No. 166 removes the concept of a qualifying special-purpose entityfrom SFAS No. 140, *Accounting forTransfers and Servicing of Financial Assets and Extinguishment of Liabilities*(“SFASNo. 140”) and removes the exception from applying FASB Interpretation No. 46R.This statement also clarifies the requirements for isolation and limitations onportions of financial assets that are eligible for sale accounting. Thisstatement is effective for fiscal years beginning after November 15, 2009.SFAS No. 166 is effective for the Company’s fiscal year beginning October 1,2010. The Company is currently evaluating the impact of adopting this standardon the condensed consolidated financial statements.

 

InMay 2009, the FASB issued SFAS No. 165, *Subsequent Events* (“SFAS No. 165”).  The subsequent events project was initiatedin an effort to incorporate accounting guidance that originated as auditingstandards into the body of authoritative literature issued by the FASB.  Moving the accounting requirements out of theauditing literature and into the accounting literature is consistent with theFASB’s objective to codify all authoritative U.S. accounting guidance relatedto a particular topic in one place.  Italso provided an opportunity to consider international convergence issues.  The FASB has established general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before financial statements are issued or are available to be issued.  Although there is new terminology, thestandard is based on the same principles as those that previously existed inthe auditing standards.  The newstandard, which includes a required disclosure of the date through which anentity has evaluated subsequent events, is effective for interim or annualperiods ending after June 15, 2009. The Company’s adoption of this pronouncement did not have a materialimpact on the reporting of its subsequent events.

 

InApril 2009, the FASB issued FSP No. 115-2, *Recognition and Presentation of Other-Than-Temporary Impairments*(“FSP No. 115-2”), which was issued to make the guidance onother-than-temporary impairment more operational and to improve thepresentation and disclosure of other-than-temporary impairments on debt and equitysecurities in the financial statements. FSP No. 115-2 requires significant additional disclosures for bothannual and interim periods, including the amortized cost basis ofavailable-for-sale and held-to-maturity debt, the methodology and key importsused to measure the credit portion of other-than-temporary impairment, and aroll forward of amounts recognized in earnings for securities by major securitytype.  FSP No. 115-2 amends SFAS No. 115,*Accounting for Certain Investments in Debtand Equity Securities* (“SFAS No. 115”) and FSP No. 115-1, *The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments*, to require that entitiesidentify major security classes consistent with how the securities are managedbased on the nature and risks of the security, and also expands, for disclosurepurposes, the list of major security types identified in SFAS No. 115. FSPNo. 115-2 is effective for interim and annual reporting periods endingafter June 15, 2009.  The Company’sadoption of this pronouncement did not have a material impact on its financialstatements.

 

InApril 2009, the FASB issued FSP No. 157-4, *Determining Fair Value When the Volume and Level of Activity for theAsset or Liability Have Significantly Decreased and Identifying TransactionsThat Are Not Orderly* (“FSP No. 157-4”), which providesadditional guidance for estimating fair value in accordance with SFAS No. 157when the volume and level of activity for an asset or liability hassignificantly decreased and also provides guidance on identifying circumstancesthat indicate a transaction is not orderly. FSP No. 157-4 amends SFAS No. 157 to require entities todisclose in interim and annual periods the inputs and valuation techniques usedto measure fair value together with any changes in valuation techniques andrelated inputs during the period.  FSP No. 157-4also requires reporting entities to define major categories**for both debt and equity securities to bemajor security types as described in paragraph 19 of SFAS No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*.  This requiresentities to provide 

 

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disclosureson a more disaggregated basis than previously had been required under SFAS No. 157.  FSP No. 157-4 is effective for interimand annual reporting periods ending after June 15, 2009, and shall beapplied prospectively.  The Company’sadoption of this pronouncement did not have a material impact on its financialstatements.

 

In October 2008, the FASB issued FSP No. 157-3,which clarifies the application of SFAS No. 157 in a market that is notactive. More specifically, FSP No. 157-3 states that significant judgmentshould be applied to determine if observable data in a dislocated marketrepresents forced liquidations or distressed sales and is not representative offair value in an orderly transaction. FSP No. 157-3 also provides further guidance that the use of areporting entity’s own assumptions about future cash flows and appropriatelyrisk-adjusted discount rates is acceptable when relevant observable inputs arenot available.  In addition, FSP No. 157-3provides guidance on the level of reliability of broker quotes or pricingservices when measuring fair value in a non- active market stating that lessreliance should be placed on a quote that does not reflect actual markettransactions and a quote that is not a binding offer.  The guidance in FSP No. 157-3 iseffective upon issuance for all financial statements that have not been issuedand any changes in valuation techniques as a result of applying FSP No. 157-3are accounted for as a change in accounting estimate. The Company’s adoption ofthis pronouncement did not have a material impact on its financial statements.

 

In March 2008, the FASB issued SFAS No. 161,*Disclosures about Derivative Instruments andHedging Activities* (“SFAS No. 161”), which is intended to helpinvestors better understand how derivative instruments and hedging activitiesaffect an entity’s financial position, financial performance and cash flowsthrough enhanced disclosure requirements. The enhanced disclosures primarily surround disclosing the objectivesand strategies for using derivative instruments by their underlying risk aswell as a tabular format of the fair values of the derivative instruments andtheir gains and losses.  SFAS No. 161is effective for financial statements issued for fiscal years and interimperiods beginning after November 15, 2008. The adoption of this pronouncement did not have a material impact on thereporting of its derivatives.

 

In December 2007, the FASB issued SFAS No. 141(R), *Business Combinations* (“SFAS No. 141(R)”).SFAS No. 141(R) establishes principles and requirements for how anacquirer recognizes and measures in its financial statements the identifiableassets acquired, the liabilities assumed, any non-controlling interest in theacquiree and the goodwill acquired. SFAS No. 141(R) also establishesdisclosure requirements to enable the evaluation of the nature and financialeffects of the business combination. SFAS No. 141(R) is effective asof the beginning of an entity’s fiscal year that begins after December 15,2008.  The Company is required to adoptSFAS No. 141 (R) on October 1, 2009 and is currently evaluatingthe impact of this pronouncement on its condensed consolidated financialstatements.

 

In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assets andFinancial Liabilities* (“SFAS No. 159”).  Among other requirements, SFAS No. 159permits entities to choose to measure many financial instruments and certainother items at fair value.  SFAS No. 159is effective for the first fiscal year that begins after November 15,2007.  The Company adopted SFAS No. 159on October 1, 2008, and elected to apply SFAS No. 159 to its creditfacility entered into on May 15, 2009. The Company’s adoption of SFAS No. 159had no material impact on its condensed consolidated financial statements as ofJune 30, 2009.  See furtherdiscussion in Note 5 “Line of Credit.”

 

**NOTE 3. INVESTMENTS**

 

In September 2006, the FASB issued SFAS No. 157, which, forfinancial assets, is effective for fiscal years beginning after November 15,2007, with early adoption permitted. The Company adopted SFAS No. 157 on October 1,2008.  The adoption of SFAS No. 157did not have a material impact on the condensed consolidated financialstatements as of and for the nine months ended June 30, 2009.  In part, SFAS No. 157 defines fairvalue, establishes a framework for measuring fair value and expands disclosuresabout assets and liabilities measured at fair value. The new standard providesa consistent definition of fair value that focuses on exit price in theprincipal, or most advantageous, market and prioritizes, within a measurementof fair value, the use of market-based inputs over entity-specific inputs. Thestandard also establishes the following three-level hierarchy for fair valuemeasurements based upon the transparency of inputs to the valuation of an assetor liability as of the measurement date.

 

·                  *Level 1* — inputs to the valuation 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.

 

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At June 30, 2009, all of the Company’s assets were valued using Level3 inputs.

 

The following table presents the financial instruments carried at fairvalue as of June 30, 2009, by caption on the accompanying condensedconsolidated statements of assets and liabilities for each of the three levelsof hierarchy established by SFAS No. 157:

 
| ** **                            | ** ** | **As of  June 30, 2009** | ** ** |
|---------------------------------------|------------|-------------------------------|------------|
| ** **                            | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair  Value** | ** ** |
| ** **                            | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported  in Condensed** | ** ** |
| ** **                            | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated  Statements of** | ** ** |
| ** **                            | ** ** | **Level 1**                   | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and  Liabilities** | ** ** |
| Non-Control/Non-Affiliate investments |       | $                             | —     |   | $ | — |   | $ | 317,501 |   | $ | 317,501 |   |
| Control  investments                  |       | —                        |       | — |   | 13,532 |   | 13,532 |   |
| Total  investments at fair value      |       | $                             | —     |   | $ | — |   | $ | 331,033 |   | $ | 331,033 |   |

 

*Changes in Level 3 Fair ValueMeasurements*

 

The following table provides a roll-forward in the changes in fairvalue during the nine-month period from September 30, 2008 to June 30,2009, and for the three-month period from March 31, 2009 to June 30,2009, 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** | ** ** | **Control**     | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                                                     | ** ** | **Investments**   | ** ** | **Investments** | ** ** | **Derivative** | ** ** | **Total**  | ** ** |
| **Nine  months ended June 30, 2009:**                     |       |              |       |            |       |           |       |       |       |
| Fair value at  September 30, 2008                         |       | $                 | 407,153    |            | $          | 780            |       | $          | —     |   | $ | 407,933 |   |
| Realized losses  (a)                                           |       | (14,325           | )          | —          |       | (304           | )          | (14,629    | )          |
| Reversal of  prior period depreciation on realization (b) |       | 12,286            |       | —          |       | 304            |       | 12,590     |       |
| Unrealized  appreciation (depreciation) (b)               |       | (14,454           | )          | 10              |       | —         |       | (14,444    | )          |
| New investments,  repayments, and settlements, net (c)    |       | (73,159           | )          | 12,742          |       | —         |       | (60,417    | )          |
| Transfers in  (out) of Level 3                                 |       | —            |       | —          |       | —         |       | —     |       |
| Fair value as of  June 30, 2009                           |       | $                 | 317,501    |            | $          | 13,532         |       | $          | —     |   | $ | 331,033 |   |
|                                                           |       |              |       |            |       |           |       |       |       |
| **Three  months ended June 30, 2009:**                    |       |              |       |            |       |           |       |       |       |
| Fair value at  March 31, 2009                             |       | $                 | 369,595    |            | $          | 15,502         |       | $          | —     |   | $ | 385,097 |   |
| Realized losses (a)                                       |       | (10,594           | )          | —          |       | —         |       | (10,594    | )          |
| Reversal of  prior period depreciation on realization (b) |       | 9,141             |       | —          |       | —         |       | 9,141      |       |
| Unrealized  depreciation (b)                              |       | (2,067            | )          | (2,703          | )          | —         |       | (4,770     | )          |
| New investments,  repayments and settlements, net (c)     |       | (48,574           | )          | 733             |       | —         |       | (47,841    | )          |
| Transfers in  (out) of Level 3                                 |       | —            |       | —          |       | —         |       | —     |       |
| Fair value as of  June 30, 2009                           |       | $                 | 317,501    |            | $          | 13,532         |       | $          | —     |   | $ | 331,033 |   |

 

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(a)          Included in net realized loss on investments andrealized gain on settlement of derivative on the accompanying condensedconsolidated statements of operations for the three and nine months ended June 30,2009.

(b)         Included in unrealized appreciation (depreciation) oninvestments on the accompanying condensed consolidated statements of operationsfor the three and nine months ended June 30, 2009.

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

 

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*Non-Control/Non-AffiliateInvestments*

 

At June 30, 2009 and September 30, 2008, the Company heldNon-Control/Non-Affiliate investments in the aggregate of approximately$317,501 and $407,153, at fair value, respectively.

 

*Control Investments*

 

At June 30, 2009 and September 30, 2008, the Company heldControl investments in the aggregate of approximately $13,532 and $780, at fairvalue, respectively.  At June 30,2009, the Control investments were comprised of BERTL, Inc. (“BERTL”),Lindmark Acquisition, LLC (“Lindmark”), LYP Holdings Corp. (“LYP Holdings”),U.S. Healthcare Communications, Inc. (“U.S. Healthcare”) and WesternDirectories, Inc. (“Western Directories”).

 

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

 

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

 

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

 

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

 

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

 

*Investment Concentrations*

 

At June 30, 2009, the Company had aggregateinvestments in 51 portfolio companies and approximately 64.4% of the aggregatefair value of such investments was senior term debt, approximately 34.8% wassenior subordinated term debt, no investments were in junior subordinated debtand approximately 0.8% was in equity securities.  The following table outlines the Company’sinvestments by type at June 30, 2009 and September 30, 2008:

 
| ** **                     | ** ** | **June 30,  2009** | ** ** | **September 30,  2008** | ** ** |
|--------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                     | ** ** | **Cost**                | ** ** | **Fair Value**               | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Senior Term Debt               |       | $                       | 242,373    |                         | $          | 213,330 |   | $ | 297,910 |   | $ | 265,297 |   |
| Senior  Subordinated Term Debt |       | 138,277                 |       | 115,026                      |       | 157,927 |   | 140,676 |   |
| Preferred Equity  Securities   |       | 2,029                   |       | 444                          |       | 1,584 |   | — |   |
| Common Equity  Securities      |       | 3,449                   |       | 2,233                        |       | 3,449 |   | 1,960 |   |
| Total  Investments             |       | $                       | 386,128    |                         | $          | 331,033 |   | $ | 460,870 |   | $ | 407,933 |   |

 

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Investmentsat fair value consisted of the following industry classifications as of June 30,2009 and September 30, 2008:

 
| ** **                                                          | ** ** | **June 30,  2009** | ** ** | **September 30,  2008** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                                          | ** ** | ** **              | ** ** | **Percentage**               | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Industry Classification**                                         | ** ** | **Fair Value**          | ** ** | **Total  Investments**       | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Aerospace &  Defense                                       |       | $                       | 1,927      |                         | 0.6        | % | 0.8 | % | $ | 4,192 |   | 1.0 | % | 1.6 | % |
| Automobile                                                          |       | 4,195                   |       | 1.3                          | %          | 1.7 | % | 5,055 |   | 1.2 | % | 1.9 | % |
| Broadcast  (TV & Radio)                                    |       | 45,785                  |       | 13.8                         | %          | 18.3 | % | 52,336 |   | 12.8 | % | 19.2 | % |
| Buildings &  Real Estate                                   |       | 12,816                  |       | 3.9                          | %          | 5.1 | % | 13,519 |   | 3.3 | % | 5.0 | % |
| Cargo Transport                                                     |       | 5,306                   |       | 1.6                          | %          | 2.1 | % | 15,805 |   | 3.9 | % | 5.8 | % |
| Chemicals,  Plastics & Rubber                              |       | 15,809                  |       | 4.8                          | %          | 6.3 | % | 16,375 |   | 4.0 | % | 6.0 | % |
| Diversified/Conglomerate  Manufacturing                             |       | 1,886                   |       | 0.6                          | %          | 0.8 | % | 3,195 |   | 0.8 | % | 1.2 | % |
| Diversified  Natural Resources, Precious Metals & Minerals |       | 13,588                  |       | 4.1                          | %          | 5.4 | % | 12,936 |   | 3.2 | % | 4.8 | % |
| Electronics                                                         |       | 27,466                  |       | 8.3                          | %          | 11.0 | % | 35,208 |   | 8.6 | % | 13.0 | % |
| Farming &  Agriculture                                     |       | 9,791                   |       | 3.0                          | %          | 3.9 | % | 10,031 |   | 2.5 | % | 3.7 | % |
| Finance                                                             |       | —                  |       | —                       |       | — |   | 1,812 |   | 0.4 | % | 0.7 | % |
| Healthcare,  Education & Childcare                         |       | 59,129                  |       | 17.9                         | %          | 23.7 | % | 76,642 |   | 18.8 | % | 28.2 | % |
| Home &  Office Furnishings                                 |       | 17,064                  |       | 5.2                          | %          | 6.8 | % | 15,379 |   | 3.8 | % | 5.7 | % |
| Leisure,  Amusement, Movies & Entertainment           |       | 5,886                   |       | 1.8                          | %          | 2.4 | % | 8,097 |   | 2.0 | % | 3.0 | % |
| Machinery                                                           |       | 9,334                   |       | 2.8                          | %          | 3.7 | % | 9,834 |   | 2.4 | % | 3.6 | % |
| Mining, Steel,  Iron & Non-Precious Metals                 |       | 23,646                  |       | 7.1                          | %          | 9.5 | % | 25,095 |   | 6.2 | % | 9.2 | % |
| Personal &  Non-durable Consumer Products                  |       | 8,856                   |       | 2.7                          | %          | 3.5 | % | 9,703 |   | 2.4 | % | 3.6 | % |
| Printing &  Publishing                                     |       | 44,736                  |       | 13.4                         | %          | 17.9 | % | 60,440 |   | 14.8 | % | 22.2 | % |
| Retail Stores                                                       |       | 23,350                  |       | 7.0                          | %          | 9.3 | % | 22,800 |   | 5.6 | % | 8.4 | % |
| Textiles &  Leather                                        |       | 463                     |       | 0.1                          | %          | 0.2 | % | 9,479 |   | 2.3 | % | 3.5 | % |
| **Total**                                                           |       | $                       | 331,033    |                         | 100.0      | % |   |   | $ | 407,933 |   | 100.0 | % |   |   |

 

Theinvestments at fair value were included in the following geographic regions ofthe United States at June 30, 2009 and September 30, 2008:

 
| ** **               | ** ** | **June 30,  2009** | ** ** | **September 30,  2008** | ** ** |
|--------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **               | ** ** | ** **              | ** ** | **Percentage**               | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Geographic    Region** | ** ** | **Fair Value**          | ** ** | **Total********Investments** | ** ** | **Net********Assets** | ** ** | **Fair Value** | ** ** | **Total********Investments** | ** ** | **Net********Assets** | ** ** |
| Midwest                  |       | $                       | 179,076    |                         | 54.1       | % | 71.6 | % | $ | 206,271 |   | 50.6 | % | 69.4 | % |
| West                     |       | 66,673                  |       | 20.1                         | %          | 26.7 | % | 85,294 |   | 20.9 | % | 29.0 | % |
| Southeast                |       | 35,828                  |       | 10.8                         | %          | 14.3 | % | 49,374 |   | 12.1 | % | 20.4 | % |
| Mid-Atlantic             |       | 29,147                  |       | 8.8                          | %          | 11.7 | % | 50,807 |   | 12.4 | % | 14.7 | % |
| Northeast                |       | 13,456                  |       | 4.1                          | %          | 5.4 | % | 10,617 |   | 2.6 | % | 4.3 | % |
| U.S. Territory           |       | 6,853                   |       | 2.1                          | %          | 2.7 | % | 5,570 |   | 1.4 | % | 1.9 | % |
|                     |       | $                       | 331,033    |                         | 100.0      | % |   |   | $ | 407,933 |   | 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.

 

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*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 three months ending September 30: |       | 2009                                                                                 |       | $          | 11,465     |   |
| For the fiscal  year ending September 30:            |       | 2010                                                                                 |       | 42,873     |       |
|                                                      |       | 2011                                                                                 |       | 94,731     |       |
|                                                      |       | 2012                                                                                 |       | 90,650     |       |
|                                                      |       | 2013                                                                                 |       | 121,808    |       |
|                                                      |       | 2014                                                                                 |       | 11,738     |       |
|                                                      |       | Thereafter                                                                           |       | 6,851      |       |
| ** **                                                | ** ** | **Total  Contractual Repayments**                                                    |       | $          | 380,116    |   |
|                                                      |       | Investments in  equity securities                                                    |       | 5,477      |       |
| ** **                                                |       | Unamortized  premiums, discounts and investment acquisition costs on debt securities |       | 535        |       |
| ** **                                                | ** ** | **Total**                                                                            |       | $          | 386,128    |   |

 

**NOTE 4. RELATED PARTY TRANSACTIONS**

 

*Loans to Employees*

 

TheCompany provided loans to employees of the Adviser, who at the time of theloans were joint employees of the Company and either the Adviser or the Company’sprevious investment adviser, Gladstone Capital Advisers, Inc., for theexercise of options under the Amended and Restated 2001 Equity Incentive Plan,which has since been terminated and is no longer in operation.  The loans require the quarterly payment ofinterest at the market rate in effect at the date of issue, have varying termsnot exceeding ten years and have been recorded as a reduction of netassets.  The loans are evidenced by fullrecourse notes that are due upon maturity or 60 days following termination ofemployment, and the shares of common stock purchased with the proceeds of theloan are posted as collateral.  No newloans were issued during the three and nine months ended June 30, 2009 or June 30,2008.  The Company received $4 and $51 ofprincipal repayments during the nine months ended June 30, 2009 and June 30,2008, respectively.  The Companyrecognized interest income from all employee stock option loans of $118 and$352 for the three and nine months ended June 30, 2009, respectively, and$118 and $354 for the three and nine months ended June 30, 2008,respectively.

 

*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.  On July 8, 2009, the Company’s Board ofDirectors approved the renewal of its Advisory Agreement with the Adviserthrough August 31, 2010.

 

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

 
| ** **                                                                                                    | ** ** | **Three  months ended**       | ** ** | **Nine months  ended**  | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------|------------|
| ** **                                                                                                    | ** ** | **June 30,********2009** | ** ** | **June 30,  2008** | ** ** | **June 30,********2009** | ** ** | **June 30,  2008** | ** ** |
| Base management fee                                                                                           |       | $                             | 457        |                    | $          | 529 |   | $ | 1,374 |   | $ | 1,664 |   |
| Credit for fees received by Adviser from the portfolio companies                                              |       | (2                            | )          | (348                    | )          | (87 | ) | (1,320 | ) |
| Fee reduction for the voluntary, irrevocable waiver of 2.0% fee on  senior syndicated loans to 0.5% per annum |       | (51                           | )          | (97                     | )          | (254 | ) | (299 | ) |
| Net base management fee                                                                                       |       | $                             | 404        |                    | $          | 84 |   | $ | 1,033 |   | $ | 45 |   |
|                                                                                                          |       |                          |       |                    |       |   |   |   |   |
| Incentive fee                                                                                                 |       | $                             | 1,060      |                    | $          | 1,340 |   | $ | 3,326 |   | $ | 4,089 |   |
| Credit from voluntary, irrevocable waiver issued by Adviser’s board of  directors                        |       | (1,060                        | )          | (1,340                  | )          | (3,326 | ) | (4,089 | ) |
| Net incentive fee                                                                                             |       | $                             | —     |                    | $          | — |   | $ | — |   | $ | — |   |
|                                                                                                          |       |                          |       |                    |       |   |   |   |   |
| Credit for fees received by Adviser from the portfolio companies                                              |       | $                             | (2         | )                       | $          | (348 | ) | $ | (87 | ) | $ | (1,380 | ) |
| Fee reduction for the voluntary, irrevocable waiver of 2.0% fee on  senior syndicated loans to 0.5% per annum |       | (51                           | )          | (97                     | )          | (254 | ) | (299 | ) |
| Incentive fee credit                                                                                          |       | (1,060                        | )          | (1,340                  | )          | (3,326 | ) | (4,089 | ) |
| Credit to base management and incentive fees from Adviser                                                     |       | $                             | (1,113     | )                       | $          | (1,785 | ) | $ | (3,667 | ) | $ | (5,708 | ) |

 

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:

 
|                                  |   | **June 30,********2009** | ** ** | **September 30,  2008** | ** ** |   |   |   |   |
|---------------------------------------|--------|-------------------------------|------------|------------------------------|------------|--------|--------|--------|--------|
| Unpaid base management fee to Adviser |   | $                             | 404        |                         | $          | 83     |   |   |   |   |   |
| Unpaid loan servicing fees to Adviser |   | 296                           |       | 374                          |       |   |   |   |   |
| Total Due to Adviser                  |   | $                             | 700        |                         | $          | 457    |   |   |   |   |   |

 

*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 are treated as reductions directly againstthe 2.0% base management fee under the Advisory Agreement.  Effective in April 2006, the Adviser’sboard of directors voluntarily reduced the annual servicing fee rate on thesenior syndicated loans to 0.5% and such reduction remained in effectivethrough the quarter ended June 30, 2009. For the three and nine monthsended June 30, 2009 and 2008, these loan servicing fees totaled $1,410 and$4,559, and $1,598 and $4,541, 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.

 

*Administration Agreement*

 

OnOctober 1, 2006, the Company entered into an administration agreement (the“Administration Agreement”) with Gladstone Administration, LLC (the “Administrator”),a wholly-owned subsidiary of the Adviser. Under the Administration Agreement, the Company pays separately foradministrative services.  The Companyrecorded an administration fee of $218 and $285 for the three months ended June 30,2009 and 2008, respectively, and $656 and $737, for the nine months ended June 30,2009 and 2008, respectively.  At June 30,2009 and September 30, 2008, the Company owed $218 and $247, respectively,of unpaid administration fees to the Adviser, which is recorded in the Fee dueto Administrator in the accompanying condensed consolidated statements ofassets and liabilities. On July 8, 2009, the Company’s Board of Directorsapproved the renewal of its Administration Agreement with the Administratorthrough August 31, 2010.

 

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**NOTE 5. LINE OF CREDIT**

 

On May 15, 2009, the Company, through its wholly-owned subsidiary,Gladstone Business Loan, LLC, entered into a third amended and restated creditagreement providing for a $127,000 revolving line of credit arranged by KeyEquipment Finance Inc. “(KEF”) as administrative agent, replacing DeutscheBank, A.G. as administrative agent (the “KEF Facility”).  Branch Banking and Trust Company (“BB&T”)also joined the KEF Facility as a committed lender.  In connection with entering into the KEFFacility, the Company borrowed $35,881 under the KEF Facility to make a finalpayment to Deutsche Bank, A.G. in satisfaction of all unpaid principal andinterest owed to Deutsche Bank under the prior credit agreement.  The KEF Facility may be expanded up to$200,000 through the addition of other committed lenders to the facility.  Without the addition of other committedlenders, the KEF Facility provides a total commitment of $127,000 through December 31,2009, $102,000 from January 1, 2010 to May 11,  2010 and $77,000 thereafter.  The KEF Facility matures on May 14,  2010 and, if the facility is not renewed orextended by this date, all principal and interest will be due and payablewithin one year of the maturity date on May 14, 2011.  Between the maturity date and May 14,2011, the Company’s lenders have the right to apply all interest income toamounts outstanding under the KEF Facility. Advances under the KEF Facilitywill generally bear interest at the 30-day LIBOR or the commercial paper rate(subject to a minimum rate of 2%), plus 4% per annum, with a commitment fee of0.75% per annum on undrawn amounts.  Asof June 30, 2009, there was approximately $91,700 of borrowingsoutstanding under the KEF Facility at an average rate of 6.99%, and theremaining borrowing capacity under the KEF Facility was $35,300.  Available borrowings are subject to variousconstraints imposed under the KEF Facility, based on the aggregate loan balancepledged by Business Loan. Interest is payable monthly during the term of theKEF Facility.  After May 14, 2010,if the Facility is not renewed, all principal collections from the Company’sloans are required to be used to pay outstanding principal on the KEF Facility.

 

The KEF 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 also limits payments ofdistributions. Further, the KEF Facility requires the Company to paydistributions only from estimated net investment income.  As a result ofthat change from its prior credit facility, the Company reduced itsdistribution from 14 cents per share per month to 7 cents per share permonth.  See additional discussion in Note9.

 

As of June 30, 2009, Business Loan was in compliance with all ofthe facility covenants.  Additionally,during the three months ended June 30, 2009, the Company elected to applySFAS No. 159, *The**Fair Value Option for Financial Assets andLiabilities*,**specificallyfor its KEF Facility which requires the Company to apply a fair valuemethodology to the KEF Facility as of June 30, 2009, which is the periodthat this liability became eligible under SFAS No. 159.  Due to the nature of the KEF Facility being ashort-term agreement and the fact that interest is based on a variable interestrate, the Company’s KEF Facility was fair valued at its approximate cost basisas of June 30, 2009.

 

In conjunction with entering into the KEF Facility, the Company amendeda performance guaranty, which remains substantially similar to the form underthe previous facility.  The loandocuments require the Company to maintain a minimum net worth of $200,000 plus50% of all equity issuances after May 2009, to maintain “asset coverage”with respect to “senior securities representing indebtedness” of at least 200%,in accordance with Section 18 of the 1940 Act, and to maintain its statusas a BDC under the 1940 Act and as a RIC under the Code.  As of June 30, 2009, the Company was incompliance with all covenants under the performance guaranty.

 

The Company’scontinued compliance with these covenants, however, depends on many factors,some of which are beyond the Company’s control. In particular, depreciation in the valuation of its assets, whichvaluation is subject to changing market conditions that are presently veryvolatile, affects the Company’s ability to comply with these covenants.  Given the continued deterioration in thecapital markets, net unrealized depreciation in the Company’s portfolio mayoccur in future periods and threaten the Company’s ability to comply with thecovenants under the KEF Facility. Accordingly, there are no assurances that the Company will continue tocomply with these covenants.  Failure tocomply with these covenants would result in a default which, if the Company isunable to obtain a waiver from the lenders, could accelerate the Company’srepayment obligations under the KEF Facility and thereby have a materialadverse impact on its liquidity, financial condition, results of operations andability to pay distributions.

 

The KEF Facility matures on May 14, 2010, and, if the facility isnot renewed or extended by this date, all unpaid principal and interest will bedue and payable within one year of maturity. There can be no guarantee that the Company will be able to renew, extendor replace the KEF Facility on terms that are favorable to the Company, or atall.  The Company’s ability to obtainreplacement financing will be constrained by current economic conditionsaffecting the credit markets, which have significantly deteriorated over thelast several months and may decline further. Consequently, any renewal, extension or refinancing of the KEF Facilitywill likely result in significantly higher interest rates and related chargesand may impose significant restrictions on the use of borrowed funds withregard to its ability to fund investments or maintain distributions.  For instance, in connection with theestablishment of the Company’s KEF Facility in May 2009, the size of theline was reduced from $162,000 under its prior facility to $127,000 under itsKEF Facility and Deutsche Bank A.G., who was a committed lender under its priorcredit facility elected not to participate in the KEF Facility and withdrew itscommitment.  If the Company is not ableto renew, extend or refinance the KEF Facility, this would likely 

 

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have a material adverse effect on its liquidity and ability to fund newinvestments or pay distributions to its stockholders.  The Company’s inability to pay distributionscould result in it failing to qualify as a RIC. Consequently, any income or gains could become taxable at corporaterates.  If the Company is unable tosecure replacement financing, it may be forced to sell certain assets ondisadvantageous terms, which may result in realized losses such as thoserecently recorded in connection withthe syndicated loan sales, which resulted in a realized loss of approximately$10,594 during the quarter ended June 30, 2009.  Such realized losses could materiallyexceed the amount of any unrealized depreciation on these assets as of theCompany’s most recent balance sheet date, which would have a material adverseeffect on its results of operations.  Inaddition to selling assets, or as an alternative, the Company may issue equityin order to repay amounts outstanding under the KEF Facility.  Based on the recent trading prices of itsstock, such an equity offering may have a substantial dilutive impact on theCompany’s existing stockholders’ interest in the Company’s earnings and assetsand voting interest in it.

 

**NOTE 6. INTEREST RATE CAP AGREEMENT**

 

Pursuant to the its previous revolving credit facility (the “DBFacility”), the Company had an interest rate cap agreement, with an initialnotional amount of $35,000 at a cost of $304 that effectively limited theinterest rate on a portion of the borrowings under the line of credit.  The interest rate cap agreement expired in February 2009.

 

At September 30, 2008, the interest rate cap agreement had anominal fair market value, which is recorded in other assets on the Company’scondensed consolidated statement of assets and liabilities.  The Company recorded changes in the fairmarket value of the interest rate cap agreement monthly based on the currentmarket valuation at month end as unrealized depreciation or appreciation onderivative on the Company’s condensed consolidated statement of operations. Theagreement provided that the Company’s floating interest rate or cost of fundson a portion of the portfolio’s borrowings would be capped at 5% when the LIBORrate was in excess of 5%.  During thethree and nine months ended June 30, 2009, the Company recorded $0 and$304 of loss from the interest rate cap agreement, respectively, recorded as arealized loss on the settlement of derivative on the Company’s condensedconsolidated statements of operations. During the three and nine months ended June 30, 2008, the Companyrecorded $0 and $6 of income from the interest rate cap agreement, recorded asa realized gain on the settlement of derivative on the Company’s condensedconsolidated statements of operations.

 

**NOTE 7. COMMON STOCK TRANSACTIONS**

 

Transactionsin common stock were as follows:

 
| ** **                          | ** ** | **Shares** | ** ** | **Total Value** | ** ** |
|-------------------------------------|------------|------------|------------|-----------------|------------|
| Balance at  September 30, 2008 |       | 21,087,574 |       | $               | 334,164    |   |
| Shelf offering  costs               |       | —     |       | (3              | )          |
| Balance at  June 30, 2009      |       | 21,087,574 |       | $               | 334,161    |   |

 

**NOTE 8. NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROMOPERATIONS PER COMMON SHARE**

 

Thefollowing table sets forth the computation of basic and diluted net increase(decrease) in net assets per common share resulting from operations per sharefor the three and nine months ended June 30, 2009 and 2008:

 
| ** **                                                                                                  | ** ** | **Three months ended  June 30,** | ** ** | **Nine months ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Numerator for  basic and diluted net (decrease) increase in net assets resulting from  operations per share |       | $                                     | (788       | )                                   | $          | 2,809 |   | $ | 389 |   | $ | (7,194 | ) |
| Denominator for  basic and diluted shares                                                                   |       | 21,087,574                            |       | 21,087,574                          |       | 21,087,574 |   | 19,237,203 |   |
| Basic and  diluted net (decrease) increase in net assets resulting from operations per  common share        |       | $                                     | (0.04      | )                                   | $          | 0.13 |   | $ | 0.02 |   | $ | (0.37 | ) |

 

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**NOTE 9. DISTRIBUTIONS**

 

*Distributions*

 

Thefollowing table lists the per share distributions paid for the three and ninemonths ended June 30, 2009 and 2008:

 
| **Fiscal Year** | ** ** | **Record Date**        | ** ** | **Payment  Date**      | ** ** | **Distribution  per Share** | ** ** |
|-----------------|------------|------------------------|------------|------------------------|------------|-----------------------------|------------|
| 2009            |       | June 22, 2009     |       | June 30, 2009     |       | $                           | 0.07       |   |
|            |       | May 29, 2009      |       | June 11, 2009     |       | $                           | 0.07       |   |
|            |       | April 27, 2009    |       | May 8, 2009       |       | $                           | 0.07       |   |
|            |       | March 23, 2009    |       | March 30, 2009    |       | $                           | 0.14       |   |
|            |       | February 19, 2009 |       | February 27, 2009 |       | $                           | 0.14       |   |
|            |       | January 22, 2009  |       | January 31, 2009  |       | $                           | 0.14       |   |
|            |       | December 22, 2008 |       | December 31, 2008 |       | $                           | 0.14       |   |
|            |       | November 19, 2008 |       | November 28, 2008 |       | $                           | 0.14       |   |
|            |       | October 23, 2008  |       | October 31, 2008  |       | $                           | 0.14       |   |
|            |       |                   |       | Total                  |       | $                           | 1.05       |   |
|            |       |                   |       |                   |       |                        |       |
| 2008            |       | June 20, 2008     |       | June 30, 2008     |       | $                           | 0.14       |   |
|            |       | May 21, 2008      |       | May 30, 2008      |       | $                           | 0.14       |   |
|            |       | April 22, 2008    |       | April 30, 2008    |       | $                           | 0.14       |   |
|            |       | March 21, 2008    |       | March 31, 2008    |       | $                           | 0.14       |   |
|            |       | February 21, 2008 |       | February 29, 2008 |       | $                           | 0.14       |   |
|            |       | January 23, 2008  |       | January 31, 2008  |       | $                           | 0.14       |   |
|            |       | December 20, 2007 |       | December 31, 2007 |       | $                           | 0.14       |   |
|            |       | November 21, 2007 |       | November 30, 2007 |       | $                           | 0.14       |   |
|            |       | October 23, 2007  |       | October 31, 2007  |       | $                           | 0.14       |   |
|            |       |                   |       | Total                  |       | $                           | 1.26       |   |

 

Aggregate distributions declared and paid for the ninemonths ended June 30, 2009 and 2008 were approximately $22,142 and$24,523, 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.

 

*Section 19(a) Disclosure*

 

TheCompany’s Board of Directors estimates the source of the distributions at thetime of their declaration as required by Section 19(a) of the 1940Act.  On a monthly basis, if requiredunder Section 19(a), the Company posts a Section 19(a) noticethrough the Depository Trust Company’s Legal Notice System (“LENS”) and alsosends to its registered stockholders a written Section 19(a) notice alongwith the payment of distributions for any payment which includes a distributionestimated to be paid from any other source other than net investmentincome.  The estimates of the source ofthe distribution are interim estimates based on GAAP that are subject torevision, and the exact character of the distributions for tax purposes cannotbe determined until the books and records of the Company are finalized for thecalendar year.  Following the calendaryear end, after definitive information has been determined by the Company, ifthe Company has made distributions of taxable income (or return of capital),the Company will deliver a Form 1099-DIV to its stockholders specifyingsuch amount and the tax characterization of such amount.  Therefore, these estimates are made solely inorder to comply with the requirements of Section 19(a) of the 1940Act and should not be relied upon for tax reporting or any other purposes andcould differ significantly from the actual character of distributions for taxpurposes.

 

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Thefollowing GAAP estimates were made by the Board of Directors during the quarterended June 30, 2009:

 
| **Month Ended**      | ** ** | **Ordinary  Income** | ** ** | **Return of  Capital** | ** ** | **Total  Distribution** | ** ** |
|----------------------|------------|----------------------|------------|------------------------|------------|-------------------------|------------|
| June 30,  2009  |       | $                    | 0.073      |                   | $          | (0.003                  | )          | $ | 0.070 |   |
| May 31,  2009   |       | 0.090                |       | (0.020                 | )          | 0.070                   |       |
| April 30,  2009 |       | 0.090                |       | (0.020                 | )          | 0.070                   |       |
|                      |            |                      |            |                        |            |                         |            |  |  |  |

 

Becausethe Board of Directors declares distributions at the beginning of a quarter, itis difficult to estimate how much of the Company’s monthly distributions, basedon GAAP, will come from ordinary income, capital gains and returns ofcapital.  Subsequent to the quarter endedJune 30, 2009, the following corrections were made to the above listedestimates for that quarter:

 
| **Month Ended**      | ** ** | **Ordinary  Income** | ** ** | **Return of  Capital** | ** ** | **Total  Distribution** | ** ** |
|----------------------|------------|----------------------|------------|------------------------|------------|-------------------------|------------|
| June 30,  2009  |       | $                    | 0.070      |                   | $          | —                  |       | $ | 0.070 |   |
| May 31,  2009   |       | 0.090                |       | (0.020                 | )          | 0.070                   |       |
| April 30,  2009 |       | 0.097                |       | (0.027                 | )          | 0.070                   |       |
|                      |            |                      |            |                        |            |                         |            |  |  |  |

 

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

 
| **Month Ended**          | ** ** | **Ordinary  Income** | ** ** | **Return of  Capital** | ** ** | **Total  Distribution** | ** ** |
|--------------------------|------------|----------------------|------------|------------------------|------------|-------------------------|------------|
| September 30,  2009 |       | $                    | 0.086      |                   | $          | (0.016                  | )          | $ | 0.070 |   |
| August 31,  2009    |       | 0.087                |       | (0.017                 | )          | 0.070                   |       |
| July 31,  2009      |       | 0.089                |       | (0.019                 | )          | 0.070                   |       |
|                          |            |                      |            |                        |            |                         |            |  |  |  |

 

**NOTE 10. COMMITMENT AND CONTINGENCIES**

 

AtJune 30, 2009, the Company was not party to any signed term sheets forpotential investments.

 

**NOTE 11. SUBSEQUENT EVENTS**

 

The Company evaluated all events that have occurredsubsequent to June 30, 2009 through the date of the filing of this Form 10-Qon August 3, 2009.

 

*Distributions*

In July 2009, the Company’s Board of Directors declared thefollowing monthly cash distributions:

 
| **Record Date**          | ** ** | **Payment  Date**       | ** ** | **Distribution  per Share** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------------|------------|
| September 22,  2009 |       | September 30, 2009 |       | $                           | 0.070      |   |
| August 21,  2009    |       | August 31, 2009    |       | $                           | 0.070      |   |
| July 23,  2009      |       | July 31, 2009      |       | $                           | 0.070      |   |

 

*Investment Activity*

Subsequent to June 30, 2009, the Company extended approximately$230 of revolver draws and additional investments to existing portfoliocompanies.  The Company also receivedapproximately $8,644 from scheduled and unscheduled loan repayments andsyndicated loan sales.

 

The Company entered into an agreement to sell the John Henry syndicatedloan that was held in its portfolio of investments at June 30, 2009 to aninvestor in the syndicated loan market. The loan had a cost value of approximately $8,000 and fair value of$6,400.  On August 3, 2009, the Companyclosed the sale of the loan for $6,389 in net proceeds.  This loan is included in the Company’scondensed consolidated assets as of June 30, 2009 and the loan is valuedat the sales price.

 

*Renewal of Advisory Agreement*

On July 8, 2009, the Company’s Board of Directors approved therenewal of the Advisory Agreement with the Adviser and its AdministrationAgreement with the Administrator through August 31, 2010.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS (dollar amounts in thousands, except pershare 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 “may,” “might,” “believe,” “will,” “provided,” “anticipate,”“future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,”“seek,” “possible,” “potential,” “likely” or the negative of such terms orcomparable terminology. These forward-looking statements involve known andunknown risks, uncertainties and other factors that may cause our actualresults, levels of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied by such forward-looking statements. Wecaution readers not to place undue reliance on any such forward-lookingstatements. We undertake no obligation to publicly update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise, after the date of this Form 10-Q**.

 

**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, 2008.**

 

**OVERVIEW**

 

**General**

 

We were incorporated under the General CorporationLaws of the State of Maryland on May 30, 2001. Our investment objectivesare to 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 (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 out small and medium-sized private U.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 gainliquidity in our equity position, if any. We anticipate that liquidity in ourequity position will be achieved through a merger or acquisition of theborrower, a public offering of the borrower’s stock or by exercising our rightto require the borrower to repurchase our warrants, though there can be noassurance that we will always have these rights. We lend to borrowers that needfunds to finance growth, restructure their balance sheets or effect a change ofcontrol.

 

**Business Environment**

 

The current economic conditions generally and the disruptions in thecapital markets in particular have decreased liquidity and increased our costof debt and equity capital, where available. The longer these conditionspersist, the greater the probability that these factors could continue toincrease our cost and significantly limit our access to debt and equitycapital, and thus have an adverse effect on our operations and financialresults. Many of the companies in which we have made or will make investmentsmay also be susceptible to the economic downturn, which may affect the abilityof one or more of our portfolio companies to repay our loans or engage in aliquidity event, such as a sale, recapitalization or initial public offering.An economic downturn could also disproportionately impact some of theindustries in which we invest, causing us to be more vulnerable to losses inour portfolio. Therefore, the number of our non-performing assets are likely toincrease and the fair market value of our portfolio is likely to decreaseduring these periods.  We do not knowwhen market conditions will stabilize, if adverse conditions will intensify orthe full extent to which the disruptions will affect us.  If market instability persists orintensifies, we may experience difficulty in raising capital.

 

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 further constrainour ability to access the capital markets. To maintain our qualification as a RIC, we must satisfy, among otherrequirements, an annual distribution requirement to pay out at least 90% of ourordinary income and short-term capital gains to our stockholders on an annualbasis.  Because we 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.

 

Recent market conditions have also affected the trading price of ourcommon stock and thus our ability to finance new investments through theissuance of equity.  On July 31,2009, the closing market price of our common stock was $10.02, which pricerepresented a 16% discount to our June 30, 2009 net asset value (“NAV”)per share.  When our stock is tradingbelow NAV, as it has consistently traded subsequent to September 30, 2008,our ability to issue equity is constrained by provisions of the 1940 Act whichgenerally prohibit the issuance and sale of our common stock below NAV pershare without stockholder approval other than through sales to ourthen-existing stockholders pursuant to a rights offering.  At our annual meeting of stockholders held onFebruary 19, 2009, 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.

 

The economic downturn may also continue to decrease the value ofcollateral securing some of our loans, as well as the value of our equityinvestments, which has impacted and may continue to impact our ability toborrow under our credit facility.  Forthe nine months ended June 30, 2009, we recorded net unrealizedappreciation on our portfolio of investments of $194.  We may see decreases in the value of ourportfolio, which will further limit our ability to borrow under our currentcredit facility.  Additionally, ourcredit facility contains covenants regarding the maintenance of certain minimumnet worth requirements which are affected by the decrease in value of ourportfolio.  Failure to meet theserequirements would result in a default which, if we are unable to obtain awaiver from our lenders, would result in the acceleration of our repaymentobligations under the credit facility.

 

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 for some time.  For so long as this is the case, ournear-term strategy will be focused primarily on retaining capital and buildingthe value of our existing portfolio companies to increase the likelihood ofmaintaining potential future returns.  Wewill also, where prudent and possible, consider the sale of lower-yieldinginvestments.  This has resulted, and maycontinue to result, in significantly reduced investment activity, as ourability to make new investments under these conditions is largely dependent onavailability of proceeds from the sale or exit of existing portfolioinvestments, which events may be beyond our control.  As capital constraints improve, we intend tocontinue our strategy of making conservative investments in businesses that webelieve will weather the current economy and that are likely to produceattractive long-term returns for our stockholders.

 

**Use of Internally-Developed DiscountCash Flow Methodologies**

 

Given thecontinued economic downturn, the market for syndicated loans has becomeincreasingly illiquid with limited or no transactions for many of thosesecurities which we hold. The Financial Accounting Standards Board (“FASB”)Staff Position 157-3, *Determining the FairValue of a Financial Asset When the Market for That Asset is Not Active*(“FSP No. 157-3”), provides guidance on the use of a discounted cash flow(“DCF”) methodology to value investments in an illiquid market.  Under FSP No. 157-3, indications of anilliquid market include cases where the volume and level of trading activity inthe asset have declined significantly, the available prices vary significantlyover time or amongst market participants, or the prices are not current. Themarketplace for which we obtain indicative bids for purposes of determiningfair value for our syndicated loan investments have recently shown theseattributes of illiquidity.  In accordancewith Statement of Financial Accounting Standards (“SFAS”) No. 157, ourvaluation procedures 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. However, due to the marketilliquidity and the lack of transactions during the nine months ended June 30,2009, we determined that the current agent bank non-binding indicative bids forthe majority of our syndicated loans were unreliable and alternative procedureswould need to be performed until liquidity returns to the marketplace.  As such, we have valued the syndicated loansthat were not sold subsequent to June 30, 2009 using a DCF method for thequarter ended June 30, 2009.  As of June 30,2009, the portion of our investment portfolio that was valued using DCF wasapproximately $12,617, or 3.8% of the fair value of our total portfolio ofinvestments.

 

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**Investment Highlights**

 

*Purchases:* During the nine months ended June 30,2009, we extended $24,711 of investments to existing portfolio companiesthrough revolver draws or the additions of new term notes.  The most substantial investments were toUnited Maritime, Saunders & Associates, Lindmark, VantaCore and GFRC.

 

*Repayments:* During the nine months ended June 30,2009, three borrowers refinanced their loans for $14,075, three borrowers madeunscheduled payoffs of $8,653, one borrower made an unscheduled partial payoffof $2,500, and we experienced contractual amortization, revolver repayments andsome principal payments received ahead of schedule for an aggregate of $18,191,for total principal repayments of $43,419.

 

*Sales:* During the nine months ended June 30,2009, we sold 1 non-syndicated loan and 16 syndicated loans (which resulted inour exit from 7 portfolio companies) for an aggregate of $41,962 in netproceeds.

 

Since our initial public offering in August 2001, we have made 260different loans to, or investments in, 126 companies for a total of approximately$952,013, before giving effect to principal repayments on investments anddivestitures.

 

**Financing Highlights**

 

On May 15, 2009 we, through our wholly-owned subsidiary GladstoneBusiness Loan, LLC (“Business Loan”), entered into a third amended and restatedcredit agreement providing for a $127,000 revolving line of credit arranged byKey Equipment Finance Inc. as administrative agent, replacing Deutsche Bank,A.G. as administrative agent (the “KEF Facility”).  Branch Banking and Trust Company (“BB&T”)also joined the KEF Facility as a committed lender.  In connection with entering into the KEFFacility, we borrowed $35,881 under the KEF Facility to make a final payment toDeutsche Bank, A.G. in satisfaction of all unpaid principal and interest owedto Deutsche Bank under the prior credit agreement.  The KEF Facility may be expanded up to$200,000 through the addition of other committed lenders to the facility.  Without the addition of other committedlenders, the KEF Facility provides a total commitment of $127,000 through December 31,2009, $102,000 from January 1, 2010 to May 11, 2010, and $77,000thereafter.  The KEF Facility matures on May 14,2010, and if the facility is not renewed or extended by this date, allprincipal and interest will be due and payable within one year of the maturitydate on May 14, 2011.  Advancesunder the KEF Facility will generally bear interest at the 30-day LIBOR orcommercial paper rate (subject to a minimum rate of 2%), plus 4% per annum,with a commitment fee of 0.75% per annum on undrawn amounts.  As of June 30, 2009, there wasapproximately $91,700 of borrowings outstanding on the KEF Facility at anaverage rate of 6.99%, and the remaining borrowing capacity under the KEFFacility was $35,300.  Available borrowingsare subject to various constraints imposed under the KEF Facility, based on theaggregate loan balance pledged by Business Loan. Interest is payable monthlyduring the term of the KEF Facility. After May 14, 2010, if the KEF Facility is not renewed, allprincipal collections from our loans are required to be used to pay outstandingprincipal on the KEF Facility.

 

During the three months ended June 30, 2009, we elected to applySFAS No. 159, *The**Fair Value Option for Financial Assets andLiabilities*,**specificallyfor our KEF Facility, which requires us to apply a fair value methodology tothe KEF Facility as of June 30, 2009, which is the period that thisliability became eligible under SFAS No. 159.  Due to the nature of the KEF Facility being ashort-term agreement and the fact that interest is based on a variable interestrate, the KEF Facility was fair valued at its approximate cost basis as of June 30,2009.

 

**RESULTSOF OPERATIONS**

 

***Comparison of the Three Months Ended June 30,2009 to the Three Months Ended June 30, 2008***

 

**Investment Income**

 

Investment income for the three months ended June 30, 2009 was$10,598, as compared to $11,420 for the three months ended June 30, 2008.

 

Interest income from our aggregate investment portfolio was $10,480 forthe three months ended June 30, 2009, as compared to $11,236 for the threemonths ended June 30, 2008.  Thelevel of interest income from investments is directly related to the balance,at cost, of the interest-bearing investment portfolio outstanding during theperiod multiplied by the weighted average yield.  The weighted average yield varies from periodto period based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.  Interest income from our investmentsdecreased $756, or 6.7%, during the three months ended June 30, 2009compared to the prior year period.  Thisdecrease was based on the overall reduction in the cost basis of ourinvestments, resulting primarily from the sale of 15 syndicated loans andone-non syndicated loan during the quarter, partially 

 

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offset by a slight increase in the weighted average yield on ourportfolio.  The annualized weightedaverage yield on our portfolio was 10.4% for the three months ended June 30,2009 as compared to 10.1% for the prior year period.  During the three months ended June 30,2009, three investments, for an aggregate of approximately $10,659 at cost, or2.8% of the aggregate cost of our investment portfolio, were on non-accrual andduring the prior year period, three investments, for an aggregate ofapproximately $8,424 at cost, or 1.9% of the aggregate cost of our investmentportfolio, were on non-accrual.

 

Interest income from Non-Control/Non-Affiliate investments was $9,726for the three months ended June 30, 2009, as compared to $11,220 for thecomparable prior year period.  Thisdecrease resulted from an overall decrease in the aggregateNon-Control/Non-Affiliate investments held at June 30, 2009 compared tothe prior year period.  The success feesearned during the three months ended June 30, 2009 and 2008, included ininterest income, were $123 and $0, respectively.   Success fees earned during the three monthsended June 30, 2009 resulted from a refinancing by ActivStyle.

 

Interest income from Control investments was $754 for the three monthsended June 30, 2009, as compared to $16 in the comparable prior yearperiod.  The increase is attributable tothree additional Control investments held during the quarter ended June 30,2009, which were converted from Non-Control/Non-Affiliate investments, ascompared to the prior year period.

 

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

 

**Threemonths ended June 30, 2009**

 
| **Company**                | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|----------------------------|------------|----------------------|------------|-----------------|------------|
| Sunshine Media             |       | $                    | 839        |            | 8.0        | % |
| Reliable  Biopharma        |       | 768                  |       | 7.3             | %          |
| Westlake  Hardware         |       | 600                  |       | 5.7             | %          |
| Clinton Aluminum           |       | 470                  |       | 4.5             | %          |
| VantaCore                  |       | 418                  |       | 4.0             | %          |
| **Subtotal**               | ** ** | **3,095**            | ** ** | **29.5**        | **%**      |
| Other companies            |       | 7,385                |       | 70.5            | %          |
| **Total  interest income** | ** ** | **$**                | **10,480** | ** **      | **100.0**  | **%** |

 

**Threemonths ended June 30, 2008**

 
| **Company**                | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|----------------------------|------------|----------------------|------------|-----------------|------------|
| Reliable  Biopharma        |       | $                    | 758        |            | 6.7        | % |
| Sunshine Media             |       | 693                  |       | 6.2             | %          |
| Defiance  Acquisition      |       | 674                  |       | 6.0             | %          |
| Westlake  Hardware         |       | 521                  |       | 4.6             | %          |
| Clinton Aluminum           |       | 470                  |       | 4.2             | %          |
| **Subtotal**               | ** ** | **$**                | **3,116**  | ** **      | **27.7**   | **%** |
| Other companies            |       | 8,120                |       | 72.3            | %          |
| **Total  interest income** | ** ** | **$**                | **11,236** | ** **      | **100.0**  | **%** |

 

 

Interest income from invested cash for the three months ended June 30,2009 was nominal, as compared to $38 for the three months ended June 30,2008.  Interest income decreased from theprior year due to the amount of cash that was held in interest bearing accountsand the interest earned on our custodial account prior to disbursement.

 

Interest income from loans to our employees, in connection with theexercise of employee stock options, for the three months ended June 30,2009 and June 30, 2008, was $118.

 

Prepayment fees and other income for the three months ended June 30,2009 was $0 compared to $28 for the three months ended June 30, 2008.  The income for the prior period consisted ofprepayment penalty fees received upon the full repayment of certain loaninvestments ahead of contractual maturity.

 

**Operating Expenses**

 

Operating expenses, net of credits from the Adviser for fees earned andvoluntary and irrevocable waivers to the base management and incentive fees,were $5,163 for the three months ended June 30, 2009, as compared to$4,723 for the three months ended June 30, 2008. Operating expenses forthe three months ended June 30, 2009 reflected an increase in amortizationof deferred financing fees incurred in connection with the previous revolvingcredit facility with Deutsche Bank AG (the “DB Facility”) and the new KEFFacility.

 

Interest expense for the three months ended June 30, 2009 was$1,811, as compared to $1,771 for the three months ended June 30,2008.  This increase is primarily aresult of higher 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 for the three months ended June 30, 2009 were$1,410, as compared to $1,598 for the three months ended June 30,2008.  These fees were incurred inconnection with a loan servicing agreement between Business Loan and ourAdviser, which is based on the size of the portfolio.

 

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Base management fee for the three months ended June 30, 2009 was$457, as compared to $529 for the three months ended June 30, 2008.  The base management fee is computed quarterlyas described under *“Investment Advisory andManagement Agreement”* in Note 4 of the notes to the consolidatedfinancial statements in our Annual Report on Form 10-K as filed on December 2,2008, and is summarized in the table below:

 
| ** **                                                                                                         | ** ** | **Three  months ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                         | ** ** | **June 30,  2009** | ** ** | **June 30,  2008** | ** ** |
| Base management  fee (1)                                                                                           |       | $                       | 457        |   | $ | 529 |   |
| Credit for fees  received by Adviser from the portfolio companies                                                  |       | (2                      | )          | (348 | ) |
| Fee reduction  for the voluntary, irrevocable waiver of 2.0% fee on senior syndicated loans  to 0.5% per annum (2) |       | (51                     | )          | (97 | ) |
| Net base  management fee                                                                                           |       | $                       | 404        |   | $ | 84 |   |

 

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

(2)          The board of our Adviser voluntarily and irrevocablywaived, for the three months ended June 30, 2009 and 2008, the annual 2.0%base management fee to 0.5% for senior syndicated loan participations.

 

Incentive fee for the three months ended June 30, 2009 was $1,060,as compared to $1,340 for the three months ended June 30, 2008.  The board of our Adviser waived the entireincentive fee for the three months ended June 30, 2009 and 2008.  The incentive fee and associated credits aresummarized in the table below:

 
| ** **                                                                             | ** ** | **Three  months ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                             | ** ** | **June 30,  2009** | ** ** | **June 30,  2008** | ** ** |
| Incentive fee                                                                          |       | $                       | 1,060      |   | $ | 1,340 |   |
| Credit from  voluntary, irrevocable waiver issued by Adviser’s board of directors |       | (1,060                  | )          | (1,340 | ) |
| Net incentive  fee                                                                     |       | $                       | —     |   | $ | — |   |

 

Administration fee for the three months ended June 30, 2009 was$218 as compared to $285 for the three months ended June 30, 2008. Thedecrease in the current year period is 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 administrative 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 on December 2, 2008.

 

Other operating expenses (including professional fees, deferredfinancing fees, stockholder related costs, director’s fees, insurance and otherdirect expenses) increased over the prior year period driven by amortization ofadditional fees incurred with amending our previous Deutsche Bank facility andentering into the new KEF Facility and legal fees incurred in connection withtroubled loans in the current period.

 

**Net Realized Loss on Investments**

 

During the three months ended June 30, 2009, we realized a netloss of $10,594, as compared to a net loss of $86 for the three months ended June 30,  2008. The loss in the current period resulted from the sale of 15 syndicatedloans and one non-syndicated loan.

 

**Realized (Loss) Gain on Settlement ofDerivative**

 

During the three months ended June 30, 2009, we did not realize again or loss on settlement of derivative as the interest rate cap expired in February 2009and we therefore did not receive any interest rate cap agreement paymentsduring that period.  During the threemonths ended June 30, 2008, we received a nominal interest rate capagreement payments as a result of the one-month LIBOR having a downwardtrend.  We received payments when theone-month LIBOR was over 5%.

 

**NetUnrealized Appreciation (Depreciation) on Derivative**

 

Net unrealized appreciation (depreciation)on derivative is the net change in the fair value of our interest rate cap duringthe reporting period, including the reversal of previously recorded unrealizedappreciation or depreciation when gains and losses are realized.  For the three months ended June 30, 2009, we did notrecord unrealized appreciation on derivative as the interest rate cap expiredin February 2009.  For the three monthsended June 30, 2008, we recorded a nominal unrealized depreciation due to adecrease in the fair market value of our interest rate cap agreement.  

 

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**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.  For the three months ended June 30,2009, we recorded net unrealized appreciation on investments of $4,371, ascompared to unrealized depreciation of ($3,802) for the prior year period.  The unrealized appreciation in the currentperiod is mainly attributable to the following:

 
| · |   | Control investments                                                        |   | $      | (2,703 | )      |
|--------|--------|----------------------------------------------------------------------------|--------|--------|--------|--------|
| · |   | Non-Control/Non-Affiliate  investments                                     |   | (2,067 | )      |
| · |   | Reversal of previously unrealized depreciation upon  realization of losses |   | 9,141  |   |
|   |   | Total                                                                      |   | $      | 4,371  |   |

 

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

 

Overall, we realized a net decrease in net assets resulting fromoperations of $788 for the three months ended June 30, 2009.  Based on a weighted-average of 21,087,574basic and diluted common shares outstanding, our net increase in net assetsfrom operations per weighted-average common share for the three months ended June 30,2009 was $0.04, basic and diluted.  Forthe three months ended June 30, 2008, we realized a net increase in netassets resulting from operations of $2,809. Based on a weighted-average of 21,087,574 basic and diluted commonshares outstanding, our net increase in net assets from operations perweighted-average common share for the three months ended June 30, 2008 was$0.13 basic and diluted.

 

***Comparison of the Nine Months Ended June 30,2009 to the Nine Months Ended June 30, 2008***

 

**Investment Income**

 

Investment income for the nine months ended June 30, 2009 was$33,335, as compared to $34,172 for the nine months ended June 30, 2008.

 

Interest income from our aggregate investment portfolio was $32,972 forthe nine months ended June 30, 2009, as compared to $33,499 for the ninemonths ended June 30, 2008.  Thelevel of interest income from investments is directly related to the balance,at cost, of the interest-bearing investment portfolio outstanding during theperiod multiplied by the weighted average yield.  The weighted average yield varies from periodto period based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.  Interest income from our investmentsdecreased $527, or 1.6%, during the nine months ended June 30, 2009compared to the prior year period.  Thisdecrease was based on the overall reduction in the cost basis of ourinvestments, resulting primarily from the sale of 16 syndicated loans andone-non syndicated loan during the period, as well as a slight decrease in theweighted average yield on our portfolio. The annualized weighted average yield on our portfolio was 10.0% for thenine months ended June 30, 2009 as compared to 10.5% for the nine monthsended June 30, 2008.  During thenine months ended June 30, 2009, three investments were on non-accrual ,for an aggregate of approximately $10,659 at cost, or 2.8% of the aggregatecost of our investment portfolio and during the prior year period, three investmentswere on non-accrual for an aggregate of approximately $8,424 at fair value, or1.9% of the aggregate fair value of our investment portfolio.

 

Interest income from Non-Control/Non-Affiliate investments was $31,716for the nine months ended June 30, 2009, as compared to $33,454 for thecomparable prior year period.  Thisdecrease resulted from an overall decrease in the aggregateNon-Control/Non-Affiliate investments held at June 30, 2009 compared tothe prior year period.  The success feesearned during the nine months ended June 30, 2009 and 2008, included ininterest income, were $145 and $846, respectively.  Success fees earned during the nine monthsended June 30, 2009 resulted from refinancings by ActivStyle and It’s JustLunch.  Success fees earned during thenine months ended June 30, 2008 resulted from refinancings by Defiance andWestlake Hardware.

 

Interest income from Control investments was $1,256 for the nine monthsended June 30, 2009, as compared to $45 in the comparable prior yearperiod.  The increase is attributable tothree additional Control investments held during the nine months ended June 30,2009, which were converted from Non-Control/Non-Affiliate investments, ascompared to the prior year period.

 

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

 

**Nine months ended June 30, 2009**

 
| **Company**                | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|----------------------------|------------|----------------------|------------|-----------------|------------|
| Sunshine Media             |       | $                    | 2,506      |            | 7.6        | % |
| Reliable  Biopharma        |       | 2,298                |       | 7.0             | %          |
| Westlake  Hardware         |       | 1,810                |       | 5.5             | %          |
| Clinton Aluminum           |       | 1,411                |       | 4.3             | %          |
| VantaCore                  |       | 1,276                |       | 3.9             | %          |
| **Subtotal**               | ** ** | **$**                | **9,301**  | ** **      | **28.2**   | **%** |
| Other companies            |       | 23,671               |       | 71.8            | %          |
| **Total  interest income** | ** ** | **$**                | **32,972** | ** **      | **100.0**  | **%** |

 

**Nine months ended June 30, 2008**

 
| **Company**                | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|----------------------------|------------|----------------------|------------|-----------------|------------|
| Westlake  Hardware         |       | $                    | 2,245      |            | 6.7        | % |
| Sunshine Media             |       | 2,096                |       | 6.3             | %          |
| Reliable  Biopharma        |       | 2,090                |       | 6.2             | %          |
| Clinton Aluminum           |       | 1,427                |       | 4.3             | %          |
| Defiance  Acquisition      |       | 1,071                |       | 3.2             | %          |
| **Subtotal**               | ** ** | **$**                | **8,929**  | ** **      | **26.7**   | **%** |
| Other companies            |       | 24,570               |       | 73.3            | %          |
| **Total  interest income** | ** ** | **$**                | **33,499** | ** **      | **100.0**  | **%** |

 

Interest income from invested cash for the nine months ended June 30,2009 was $11, as compared to $285 for the nine months ended June 30,2008.  Interest income came from thefollowing sources:

 
| ** **                                              | ** ** | **Nine  months ended**  | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|
| ** **                                              | ** ** | **June 30,  2009** | ** ** | **June 30,  2008** | ** ** |
| Interest earned  on Gladstone Capital account (1)       |       | $                       | —     |   | $ | 50 |   |
| Interest earned  on Business Loan custodial account (2) |       | 10                      |       | 164 |   |
| Interest earned  on Gladstone Financial account (3)     |       | 1                       |       | 71 |   |
| Total interest  income from invested cash               |       | $                       | 11         |   | $ | 285 |   |

 

----

(1)   Interest earned on our Gladstone Capitalaccount during the nine months ended June 30, 2008 resulted from proceedsreceived from the equity offerings done during the nine month period that wereheld in the account prior to being invested or used to pay down the line ofcredit.

(2)   Interest earned on our Business Loancustodial account during the nine months ended June 30, 2008 resulted fromlarge cash amounts held in the account prior to disbursement.  During this nine month period, we had$107,442 of originations to new portfolio companies.

(3)   Interest earned on our GladstoneFinancial account during the nine months ended June 30, 2008 resulted fromthe U.S. Treasury bill that was held with an original maturity of six months.

 

Interest income from loans to our employees, in connection with theexercise of employee stock options, for the nine months ended June 30,2009 and June 30, 2008, was $352 and $354, respectively.

 

Prepayment fees and other income for the nine months ended June 30,2009 was $0 compared to $34 for the nine months ended June 30, 2008.  The income for the prior period consisted ofprepayment penalty fees received upon the full repayment of certain loaninvestments ahead of contractual maturity.

 

**Operating Expenses**

 

Operating expenses, net of credits from the Adviser for fees earned andvoluntary and irrevocable waivers to the base management and incentive fees,were $16,463 for the nine months ended June 30, 2009, as compared to$13,729 for the nine months ended June 30, 2008. Operating expenses forthe nine months ended June 30, 2009 reflected a significant increase inamortization of deferred financing fees incurred connection with the DBFacility and the new KEF Facility.

 

Interest expense for the nine months ended June 30, 2009 was$6,288, as compared to $5,982 for the nine months ended June 30,2008.  This increase is primarily aresult of higher 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 for the nine months ended June 30, 2009 were$4,559, as compared to $4,541 for the nine months ended June 30,2008.  These fees were incurred inconnection with a loan servicing agreement between Business Loan and ourAdviser, which is based on the size of the portfolio.

 

Base management fee for the nine months ended June 30, 2009 was$1,374 as compared to $1,664 for the nine months ended June 30, 2008.  The base management fee is computed quarterlyas described under *“Investment Advisory andManagement Agreement”* in 

 

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Note 4 of the notes to the consolidated financial statements in ourAnnual Report on Form 10-K as filed on December 2, 2008, and issummarized in the table below:

 
| ** **                                                                                                         | ** ** | **Nine  months ended**  | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                         | ** ** | **June 30,  2009** | ** ** | **June 30,  2008** | ** ** |
| Base management  fee (1)                                                                                           |       | $                       | 1,374      |   | $ | 1,664 |   |
| Credit for fees  received by Adviser from the portfolio companies                                                  |       | (87                     | )          | (1,320 | ) |
| Fee reduction  for the voluntary, irrevocable waiver of 2.0% fee on senior syndicated loans  to 0.5% per annum (2) |       | (254                    | )          | (299 | ) |
| Net base  management fee                                                                                           |       | $                       | 1,033      |   | $ | 45 |   |

 

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

(2)   The board of our Adviser voluntarily andirrevocably waived, for the nine months ended June 30, 2009 and 2008, theannual 2.0% base management fee to 0.5% for senior syndicated loanparticipations.

 

Incentive fee for the nine months ended June 30, 2009 was $3,326,as compared to $4,089 for the nine months ended June 30, 2008.  The board of our Adviser waived the entireincentive fee for the nine months ended June 30, 2009 and June 30,2008.  The incentive fee and associatedcredits are summarized in the table below:

 
| ** **                                                                             | ** ** | **Nine  months ended**  | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                             | ** ** | **June 30,  2009** | ** ** | **June 30,  2008** | ** ** |
| Incentive fee                                                                          |       | $                       | 3,326      |   | $ | 4,089 |   |
| Credit from  voluntary, irrevocable waiver issued by Adviser’s board of directors |       | (3,326                  | )          | (4,089 | ) |
| Net incentive  fee                                                                     |       | $                       | —     |   | $ | — |   |

 

Administration fee for the nine months ended June 30, 2009 was$656 as compared to $737 for the nine months ended June 30, 2008. Thedecrease is due to a decrease of administration staff and related expenses, aswell as a decrease in our total assets in comparison to the total assets of allcompanies managed by our Adviser under similar agreements.  The calculation of the administrative fee isdescribed in detail above under *“InvestmentAdvisory and Management Agreement”* in Note 4 of the notes to theconsolidated financial statements in our Annual Report on Form 10-K asfiled on December 2, 2008.

 

Other operating expenses (including professional fees, deferredfinancing fees, stockholder related costs, director’s fees, insurance and otherdirect expenses) increased over the prior year period driven by amortization ofadditional fees incurred with amending the DB Facility and entering into thenew KEF Facility and legal fees incurred in connection with troubled loans inthe current period.

 

**Net Realized Loss on Investments**

 

During the nine months ended June 30, 2009, we realized a net lossof $14,325, as compared to a loss of $86 for the nine months ended June 30,2008.  The loss in the current periodconsisted of $12,352 loss from the sale of 16 syndicated loans and onenon-syndicated loan and a $2,000 write-off of a portion of the Greatwide secondlien syndicated loan,  partially offsetby a $27 gain from the Country Road payoff.

 

**Realized (Loss) Gain on Settlement ofDerivative**

 

During the nine months ended June 30, 2009, we realized a loss of$304 due to the expiration of the interest rate cap in February 2009.  We did not receive any interest rate capagreement payments during that period as a result of the one-month LIBOR havinga downward trend.  During the threemonths ended June 30, 2008, we received interest rate cap agreementpayments of only $6 as a result of the one-month LIBOR having a downwardtrend.  We receive payments when theone-month LIBOR is over 5%.

 

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

 

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 nine months ended June 30, 2009,we recorded unrealized appreciation on derivative of $304, which resulted fromthe reversal of previously recorded unrealized depreciation when the loss wasrealized during the **t**hree months endedMarch 31, 2009.  For the nine 

 

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months ended June 30, 2008, we recorded unrealized depreciation of$12 due to a decrease in the fair market value of our interest rate capagreement.

 

**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.  For the nine months ended June 30, 2009,we recorded net unrealized depreciation on investments of $2,158, as comparedto net unrealized depreciation of $27,545, for the prior year period.  The unrealized depreciation is mainlyattributable to the net decrease in fair value on our portfolio, most notablyin the following:

 
| · |   | Control investments                                                        |   | $       | 10     |   |
|--------|--------|----------------------------------------------------------------------------|--------|---------|--------|--------|
| · |   | Non-Control/Non-Affiliate  investments                                     |   | (14,454 | )      |
| · |   | Reversal of previously unrealized depreciation upon  realization of losses |   | 12,286  |   |
|   |   | Total                                                                      |   | $       | (2,158 | )      |

 

We believe that our investment portfolio was valued at a depreciatedvalue due primarily to the general instability of the loan markets.  Although our investment portfolio hasdepreciated, our entire portfolio was fair valued at 86% of cost as of June 30,2009.  The 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.

 

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

 

Overall, we realized a net increase in net assets resulting fromoperations of $389 for the nine months ended June 30, 2009.  Based on a weighted-average of 21,087,574basic and diluted common shares outstanding, our net decrease in net assetsfrom operations per weighted-average common share for the nine months ended June 30,2009 was $0.02, basic and diluted.  Forthe nine months ended June 30, 2008, we realized a net decrease in netassets resulting from operations of $ 7,194. Based on a weighted-average of 19,237,203 basic and diluted commonshares outstanding, our net decrease in net assets from operations perweighted-average common share for the nine months ended June 30, 2008 was$0.37 basic and diluted.

 

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

 

**Operating Activities**

 

At June 30, 2009, we had investments in debt securities of, orloans to, 51 private companies, totaling approximately $386,128 (cost basis) oftotal assets.  During the nine monthsended June 30, 2009 and June 30, 2008, the following investmentactivity occurred:

 
| **Quarter********Ended** | ** ** | **New********Investments (1)** | ** ** | **Principal  Repayments (2)** | ** ** | **Investments  Sold** | ** ** | **Net Loss  on  Disposal** | ** ** |
|--------------------------|------------|--------------------------------|------------|-------------------------------|------------|-----------------------|------------|----------------------------|------------|
| June 30,  2009      |       | $                              | 7,582      |                          | $          | 15,439                |       | $                          | 39,750     |   | $ | (10,594 | ) |
| March 31,  2009     |       | 8,427                          |       | 13,053                        |       | —                |       | (2,000                     | )          |
| December 31,  2008  |       | 8,702                          |       | 14,927                        |       | 2,212                 |       | (1,731                     | )          |
|                     |       | $                              | 24,711     |                          | $          | 43,419                |       | $                          | 41,962     |   | $ | (14,325 | ) |
|                     |       |                           |       |                          |       |                  |       |                       |       |
| June 30,  2008      |       | $                              | 43,678     |                          | $          | 40,755                |       | $                          | —     |   | $ | (86 | ) |
| March 31,  2008     |       | 20,483                         |       | 3,000                         |       | —                |       | —                     |       |
| December 31,  2007  |       | 73,341                         |       | 4,047                         |       | —                |       | —                     |       |
|                     |       | $                              | 137,502    |                          | $          | 47,802                |       | $                          | —     |   | $ | (86 | ) |

 

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

During the nine monthsended June 30, 2009, we extended $24,711 of investments to existingportfolio companies through revolver draws or the additions of new termnotes.  The most substantial investmentswere to United Maritime, Saunders & Associates, Lindmark, VantaCoreand GFRC.

 

During the nine monthsended June 30, 2008, we extended, directly or through participations,$107,442 of loan originations to nine new portfolio companies, in one instancereceiving a common equity warrant, and $30,060 of investments to existingportfolio companies through revolver draws or the additions of new term notes,for total new investments of $137,502.  The originations of loans to new portfolio companies by quarter were asfollows:

 

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| **Quarter  ended**     | ** ** | **Originations** | ** **   | **Companies** | ** ** | **Description**                                     |
|------------------------|------------|------------------|--------------|---------------|------------|-----------------------------------------------------|
| June 30, 2008     |       | $                |  35,750 |          | 3          |                                                | Saunders, Legend and BAS Broadcasting |
| March 31, 2008    |       | 13,700           |         | 1             |       | ACE Expediters                                      |
| December 31, 2007 |       | 57,992           |         | 5             |       | Interfilm, Reliable, Lindmark, GS Maritime and GFRC |
| Total                  |       | $                | 107,442      |          | 9          |                                                |   |

 

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

During the nine monthsended June 30, 2009, three borrowers refinanced their loans for $14,075,three borrowers made unscheduled payoffs of $8,653, one borrower made anunscheduled partial payoff of $2,500, and we experienced contractualamortization, revolver repayments and some principal payments received ahead ofschedule of $18,191, for total principal repayments of $43,419.  The refinancings/payoffs by quarter were asfollows:

 
| **Quarter  ended**     | ** ** | **Repayments** | ** ** | **Companies** | ** ** | **Description**                               |
|------------------------|------------|----------------|------------|---------------|------------|-----------------------------------------------|
| June 30, 2009     |       | Payoff         |       | 1             |       | Multi-Ag Media                                |
|                   |       | Partial payoff |       | 1             |       | Saunders & Associates Line of Credit |
|                   |       | Refinancing    |       | 1             |       | ActivStyle                                    |
| March 31, 2009    |       | Refinancing    |       | 2             |       | ACE Expediters and Sunburst Media             |
| December 31, 2008 |       | Payoff         |       | 2             |       | Country Road and Community Media              |

 

During the nine monthsended June 30, 2008, three borrowers made payments in full ahead ofcontractual maturity for an aggregate of $25,073, two borrowers madeunscheduled partial payoffs for an aggregate of $3,560, and we experiencedcontractual amortization, revolver repayments and some principal paymentsreceived ahead of schedule of an aggregate $19,169, for total principalrepayments of $47,802.  The total andpartial payoffs by quarter were as follows:

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

 

**(3)****  ****Investments Sold**

During the nine monthsended June 30, 2009, we sold 1 non-syndicated loan and 16 syndicated loans(which resulted in our exit from 7 portfolio companies) for an aggregate of$41,962 in net proceeds.  The sales byquarter were as follows:

 
| **Quarter ended**      | ** ** | **Sales** | ** **   | **Companies** | ** ** | **Description**                                                    |
|------------------------|------------|-----------|--------------|---------------|------------|--------------------------------------------------------------------|
| June 30, 2009     |       | $         |  39,750 |          | 8          |                                                               | See breakout below |
| March 31, 2009    |       | —    |         | —        |       |                                                               |
| December 31, 2008 |       | 2,212     |         | —        |       | One syndicated sale partially exited (Greatwide  Senior Term Debt) |
| Total                  |       | $         |  41,962 |          | 8          |                                                               |   |

 

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The sales for the quarterended June 30, 2009 are summarized below:

 
| **Companies  exited** | ** ** | **Loans** | *** *** | *** ***                                                         | ** ** | **Proceeds** | ** ** |
|-----------------------|------------|-----------|--------------|----------------------------------------------------------------------|------------|--------------|------------|
|                  |       |      |         | ***Non-syndicated  sale fully exited***                              |       |         |       |
| 1                     |       | 1         |         | It’s Just Lunch - Senior Term Debt                              |       | $            | 4,241      |   |
|                  |       |      |         |                                                                 |       |         |       |
|                  |       |      | *** *** | ***Syndicated sales  fully exited***                                 |       |         |       |
| 1                     |       | 1         |         | AKQA - Senior Term Debt                                              |       | $            | 8,233      |   |
| 2                     |       | 2         |         | Bresnan Communications, LLC - Senior Term Debt                       |       | 2,621        |       |
| 2                     |       | 3         |         | Bresnan Communications, LLC - Senior Subordinated  Term Debt         |       | 1,087        |       |
| 3                     |       | 4         |         | Emdeon Business Services, Inc. - Senior Term  Debt              |       | 2,000        |       |
| 3                     |       | 5         |         | Emdeon Business Services, Inc. - Senior  Subordinated Term Debt |       | 1,460        |       |
| 4                     |       | 6         |         | Harrington Holdings, Inc. - Senior Term Debt                    |       | 2,059        |       |
| 4                     |       | 7         |         | Harrington Holdings, Inc. - Senior Subordinated  Term Debt      |       | 3,045        |       |
| 5                     |       | 8         |         | RedPrairie Holding, Inc. - Senior Term Debt                     |       | 3,045        |       |
| 5                     |       | 9         |         | RedPrairie Holding, Inc. - Senior Subordinated  Term Debt       |       | 1,488        |       |
| 6                     |       | 10        |         | RiskMetrics Group Holdings, LLC - Senior Term Debt                   |       | 1,761        |       |
| 7                     |       | 11        |         | United Maritime - Senior Subordinated Term Debt                      |       | 4,860        |       |
|                  |       |      | ** **   | **Total  syndicated sales fully exited**                             | ** ** | **$**        | **31,659** | ** ** |
|                  |       |      |         |                                                                 |       |         |       |
|                  |       |      | *** *** | ***Syndicated sales  partially exited***                             |       |         |       |
| —                |       | 1         |         | CHG Companies, Inc. - Letter of Credit                          |       | 333          |       |
| —                |       | 2         |         | CHG Companies, Inc. - Senior Term Debt                          |       | 1,262        |       |
| —                |       | 3         |         | GTM Holdings, Inc. - Senior Term Debt                           |       | 271          |       |
| —                |       | 4         |         | Wesco Holdings, Inc. - Senior Term Debt                         |       | 1,984        |       |
|                  |       |      | ** **   | **Total  syndicated sales partially exited**                         | ** ** | **$**        | **3,850**  | ** ** |
|                  |       |      |         |                                                                 |       |         |       |
| **8**                 | ** ** | **16**    | ** **   | **Total  loan sales**                                                | ** ** | **$**        | **39,750** | ** ** |

 

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

 
| ** **                                                | ** ** | ** **                                                                           | ** ** | **Amount** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|------------|------------|
| For the remaining three months ending  September 30: |       | 2009                                                                                 |       | $          | 11,465     |   |
| For the fiscal year ending September 30:             |       | 2010                                                                                 |       | 42,873     |       |
|                                                      |       | 2011                                                                                 |       | 94,731     |       |
|                                                      |       | 2012                                                                                 |       | 90,650     |       |
|                                                      |       | 2013                                                                                 |       | 121,808    |       |
|                                                      |       | 2014                                                                                 |       | 11,738     |       |
|                                                      |       | Thereafter                                                                           |       | 6,851      |       |
| ** **                                                | ** ** | **Total Contractual Repayments**                                                     |       | $          | 380,116    |   |
|                                                      |       | Investments in Equity Securities                                                     |       | 5,477      |       |
| ** **                                                |       | Unamortized premiums, discounts and investment  acquisition costs on debt securities |       | 535        |       |
| ** **                                                | ** ** | **Total**                                                                            |       | $          | 386,128    |   |

 

Net cash provided by operating activities for the nine months ended June 30,2009, consisting primarily of the items described in *“—Results of Operations”* and the investment activitydescribed above, was $81,653 as compared to net cash used in operatingactivities of $72,430 for the nine months ended June 30, 2008.

 

**Investing Activities**

 

Net cash provided by investing activities for the nine months ended June 30,2008 was $2,484, which resulted from the redemption of the U.S. Treasury billheld by Gladstone Financial.

 

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**Financing Activities**

 

Net cash used in financing activities for the nine months ended June 30,2009 was $83,580 and mainly consisted of net payments on the KEF Facility of$59,330, distribution payments of $22,142, and financing fees of $2,109associated with the new credit facility, which was entered into on May 15,2009.  Net cash provided by financingactivities for the nine months ended June 30, 2008 was $66,533 andconsisted of two offerings of common stock for net proceeds of $106,226,partially offset by net repayments on our line of credit of $11,350 anddistribution payments of $24,523.

 

**Distributions**

 

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

 

**Issuance of Equity**

 

During fiscal year 2007, we filed a registration statement on Form N-2(File No. 333-143027) (the “Registration Statement”) with the SEC thatpermits us to issue, through one or more transactions, up to an aggregate of$300,000 in securities, consisting of common stock, or debt securities, ofwhich to date we have issued $123,800 in common stock, which leaves a remainingcapacity of $176,200.

 

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, we will haveregulatory constraints under the 1940 Act on our ability to obtain additionalcapital in this manner.  Generally, the1940 Act provides that we may not issue and sell our common stock at a pricebelow our NAV per share, other than to our then existing stockholders pursuantto a rights offering, without first obtaining approval from our stockholdersand our independent directors.  As of June 30,2009, our NAV per share was $11.86 and our closing market price was $7.53 pershare.  To the extent that our commonstock continues to trade at a market price below our NAV per share, we willgenerally be precluded from raising equity capital through public offerings ofour common stock, other than pursuant to stockholder approval or a rightsoffering.  The asset coverage requirementof a BDC under the 1940 Act effectively limits our ratio of debt to equity to1:1.  To the extent that we are unable toraise capital through the issuance of equity, our ability to raise capitalthrough the issuance of debt may also be inhibited to the extent of ourregulatory debt to equity ratio limits.

 

At our Annual Meeting of Stockholders held on February 19, 2009,stockholders approved a proposal which 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 May 15, 2009 we, through our wholly-owned subsidiary BusinessLoan, entered into the KEF Facility. BB&T also joined the KEF Facility as a committed lender.  In connection with entering into the KEFFacility, we borrowed $35,881 under the KEF Facility to make a final payment toDeutsche Bank, A.G. in satisfaction of all unpaid principal and interest owedto Deutsche Bank under the prior credit agreement.  The KEF Facility may be expanded up to$200,000 through the addition of other committed lenders to the facility.  Without the addition of other committedlenders, the KEF Facility provides a total commitment of $127,000 through December 31,2009, $102,000 from January 1, 2010 to May 11, 2010, and $77,000thereafter.  The KEF Facility matures on May 14,2010, and if the facility is not renewed or extended by this date, allprincipal and interest will be due and payable within one year of the maturitydate on May 14, 2011.  Advancesunder the KEF Facility will generally bear interest at the 30-day LIBOR orcommercial paper rate (subject to a minimum rate of 2%), plus 4% per annum,with a commitment fee of 0.75% per annum on undrawn amounts.  As of June 30, 2009, there was approximately$91,700 of borrowings outstanding on the KEF Facility at an average rate of6.99%, and the remaining borrowing capacity under the KEF Facility was$35,300.  Available borrowings aresubject to various constraints imposed under the KEF Facility, based on theaggregate loan balance pledged by Business Loan. Interest is payable monthlyduring the term of the KEF Facility. After May 14, 2010, if the KEF Facility is not renewed, allprincipal collections from our loans are required to be used to pay outstandingprincipal on the KEF Facility.

 

The KEF Facilitycontains covenants that require Business Loan to maintain its status as aseparate entity; prohibit certain significant corporate transactions (such asmergers, consolidations, liquidations or dissolutions); and restrict materialchanges to our credit and collection policies. The facility also limits payments of distributions. Further, the KEFFacility requires us to pay distributions only 

 

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from estimated netinvestment income.  As of June 30, 2009, Business Loan was incompliance with all of the facility covenants. Additionally, during the three months ended June 30, 2009, weelected to apply SFAS No. 159, *The**Fair Value Option for Financial Assets andLiabilities*,**specificallyfor the KEF Facility which requires us to apply a fair value methodology to theKEF Facility as of June 30, 2009, which is the period that this liabilitybecame eligible under SFAS No. 159. Due to the nature of the KEF Facility being a short-term agreement and thefact that interest is based on a variable interest rate, the KEF Facility wasfair valued at its approximate cost basis as of June 30, 2009.

 

In conjunction with entering into the KEF Facility, we amended aperformance guaranty, which remains substantially similar to the form under theprevious facility.  The loan documentsrequire us to maintain a minimum net worth of $200,000 plus 50% of all equityissuances after May 2009, to maintain “asset coverage” with respect to “seniorsecurities representing indebtedness” of at least 200%, in accordance with Section 18of the 1940 Act, and to maintain our status as a BDC under the 1940 Act and asa RIC under the Code.  As of June 30,2009, we were in compliance with all covenants under the performance guaranty.

 

Our continued compliance with these covenants, however, depends on manyfactors, some of which are beyond our control. In particular, depreciation in the valuation of its assets, whichvaluation is subject to changing market conditions that are presently veryvolatile, affects our ability to comply with these covenants.  Given the continued deterioration in thecapital markets, net unrealized depreciation in our portfolio may occur infuture periods and threaten our ability to comply with the covenants under ourKEF Facility.  Accordingly, there are noassurances that we will continue to comply with these covenants.  Failure to comply with these covenants wouldresult in a default which, if we are unable to obtain a waiver from thelenders, could accelerate our repayment obligations under the KEF Facility andthereby have a material adverse impact on its liquidity, financial condition,results of operations and ability to pay distributions.

 

The KEF Facility matures on May 14, 2010, and, if the facility isnot renewed or extended by this date, all unpaid principal and interest will bedue and payable within one year of maturity. Between the maturity date and May 14, 2011, our lenders have aright to apply all interest income to amounts outstanding under the KEFFacility.  There can be no guarantee thatwe will be able to renew, extend or replace the KEF Facility on terms that arefavorable to us, or at all.  Our abilityto obtain replacement financing will be constrained by current economicconditions affecting the credit markets, which have significantly deterioratedover the last several months and may decline further.  Consequently, any renewal, extension orrefinancing of the KEF Facility will likely result in significantly higherinterest rates and related charges and may impose significant restrictions onthe use of borrowed funds with regard to its ability to fund investments ormaintain distributions.  For instance, inconnection with the establishment of the KEF Facility in May 2009, thesize of the line was reduced from $162,000 under our prior facility to $127,000under the KEF Facility, and Deutsche Bank A.G., who was a committed lenderunder our prior credit facility elected not to participate in the KEF Facilityand withdrew its commitment.  If we arenot able to renew, extend or refinance the KEF Facility, this would likely havea material adverse effect on our liquidity and ability to fund new investmentsor pay distributions to our stockholders. Our inability to pay distributions could result in it failing to qualifyas a RIC.  Consequently, any income orgains could become taxable at corporate rates. If we are unable to secure replacement financing, we may be forced tosell certain assets on disadvantageous terms, which may result in realizedlosses such as those recently recorded in connection with the syndicated loansales, which resulted in a realized loss of approximately $10,594 during thequarter ended June 30, 2009.  Suchrealized losses could materially exceed the amount of any unrealizeddepreciation on these assets as of our most recent balance sheet date, whichwould have a material adverse effect on its results of operations.  In addition to selling assets, or as analternative, we may issue equity in order to repay amounts outstanding underthe KEF Facility.  Based on the recenttrading prices of our stock, such an equity offering may have a substantialdilutive impact on our existing stockholders’ interest in our earnings andassets and voting interest in it.

 

**Contractual Obligations**

 

As of June 30, 2009, we were not party to any signed term sheetsfor potential investments.

 

**Off-Balance Sheet Arrangements**

 

We did not have any off-balance sheet arrangements as defined in Item303(a)(4)(ii) of Regulation S-K as of June 30, 2009.

 

**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, which was amended during the nine monthsended June 30, 2009, as our most critical account policy.

 

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***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.

 

*General Valuation Policy:* We value our investments in accordance with the requirements of the 1940Act.  As discussed more fully below, wevalue securities for which market quotations are readily available and reliableat their market value.  We value allother securities and assets at fair value as determined in good faith by ourBoard of Directors.

 

In September 2006, the FASB issued SFAS No.  157, which, forfinancial assets, is effective for fiscal years beginning after November 15,2007, with early adoption permitted. We adopted SFAS No. 157 on October 1,2008. In part, SFAS No. 157 defines fair value, establishes a frameworkfor measuring fair value, and expands disclosures about assets and liabilitiesmeasured at fair value. The new standard provides a consistent definition offair value that focuses on exit price in the principal, or most advantageous,market and prioritizes, within a measurement of fair value, the use ofmarket-based inputs over entity-specific inputs. The standard also establishesthe following three-level hierarchy for fair value measurements based upon thetransparency of inputs to the valuation of an asset or liability as of themeasurement 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.

 

Refer to Note 3 in the accompanying condensed consolidated financialstatements for additional information regarding fair value measurements and ouradoption of SFAS No. 157.

 

We use generally accepted valuation techniques to value our portfoliounless we have specific information about the value of an investment todetermine otherwise. From time to time we may accept an appraisal of a businessin which we hold securities. These appraisals are expensive and occur infrequentlybut provide a third-party valuation opinion that may differ in results,techniques and scopes used to value our investments.  When these specific third-party appraisalsare engaged or accepted, we would use such appraisals to value the investmentwe have in that business if we determined that the appraisals were the bestestimate of fair value.

 

In determining the value of our investments, our Adviser hasestablished an investment valuation policy (the “Policy”).  The Policy has been approved by our Board ofDirectors, and each quarter the Board of Directors reviews whether our Adviserhas applied the Policy consistently, and votes whether or not to accept therecommended valuation of our investment portfolio.

 

The Policy, which is summarized below, applies to the followingcategories of securities:

 

·                  Publicly-traded securities;

·                  Securities for which a limited market exists; and

·                  Securities for which no market exists.

 

*Valuation Methods:*

 

**Publicly-traded securities:** We determine the value ofpublicly-traded securities based on the closing price for the security on theexchange or securities market on which it is listed and primarily traded on thevaluation date. To the extent that we own restricted securities that are notfreely tradable, but for which a public market otherwise exists, we will use themarket value of that security adjusted for any decrease in value resulting fromthe restrictive feature.

 

**Securities for which a limited marketexists:**We valuesecurities that are not traded on an established secondary securities market,but for which a limited market for the security exists, such as certainparticipations in, or assignments of, syndicated loans, at the quoted bidprice.  In valuing these assets, weassess trading activity in an asset class, evaluate variances in prices andother market insights to determine if any available quote prices arereliable.  If we conclude that quotesbased on active markets or trading activity may be relied upon, firm bid pricesare requested; however, if a firm bid price is unavailable, we base the valueof the security upon 

 

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the indicative bid price offered by the respective originatingsyndication agent’s trading desk, or secondary desk, on or near the valuationdate.  To the extent that we use theindicative bid price as a basis for valuing the security, our Adviser may takefurther steps to consider additional information to validate that price inaccordance 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 FSP No. 157-3, *Determining the Fair Value of a Financial Asset Whenthe Market for That Asset Is Not Active*, 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 the FSP No. 157-3 is the use ofvaluing investments based on DCF.  Forthe purposes of using DCF to provide fair value estimates, we consideredmultiple inputs such as a risk-adjusted discount rate that incorporatesadjustments that market participants would make both for nonperformance andliquidity risks.  As such, we developed amodified discount rate approach that incorporates risk premiums including,among others, increased probability of default, or higher loss given default,or increased liquidity risk.  The DCFvaluations applied to the syndicated loans provide an estimate of what webelieve a market participant would pay to purchase a syndicated loan in anactive market, thereby establishing a fair value.  We will continue to apply the DCF methodologyin illiquid markets until quoted prices are available or are deemed reliablebased on trading activity.

 

**Securities for which no marketexists:** Thevaluation methodology for securities for which no market exists falls intothree categories: (1) portfolio investments comprised solely of debtsecurities; (2) portfolio investments in controlled companies comprised ofa bundle of securities, which can include debt or equity securities, or both;and (3) portfolio investments in non-controlled companies comprised of abundle of investments, which can include debt or equity securities, or both.

 

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

 

In the case of Non-PublicDebt Securities, we have engaged SPSE to submit opinions of value for our debtsecurities that are issued by portfolio companies in which we own no equity, orequity-like securities.  SPSE’s opinionsof value are based on the valuations prepared by our portfolio management teamas described below.  We request that SPSEalso evaluate and assign values to success fees (conditional interest includedin some loan securities) when we determine that the probability of receiving asuccess fee on a given loan is above 6-8%, a threshold of significance. SPSEwill only evaluate the debt portion of our investments for which wespecifically request evaluation, and may decline to make requested evaluationsfor any reason at its sole discretion. Upon completing our collection of datawith respect to the investments (which may include the information describedbelow under “---Credit Information,” the risk ratings of the loans describedbelow under “---Loan Grading and Risk Rating” and the factors describedhereunder), this valuation data is forwarded to SPSE for review and analysis.SPSE makes its independent assessment of the data that we have assembled andassesses its independent data to form an opinion as to what they consider to bethe market values for the securities. With regard to its work, SPSE has issuedthe following paragraph:

 

SPSE provides evaluatedprice opinions which are reflective of what SPSE believes the bid side of themarket would be for each loan after careful review and analysis of descriptive,market and credit information. Each price reflects SPSE’s best judgment basedupon careful examination of a variety of market factors. Because of fluctuationin the market and in other factors beyond its control, SPSE cannot guaranteethese evaluations. The evaluations reflect the market prices, or estimatesthereof, on the date specified. The prices are based on comparable marketprices for similar securities. Market information has been obtained fromreputable secondary market sources. Although these sources are consideredreliable, SPSE cannot guarantee their accuracy.

 

SPSE opinions of value ofour debt securities that are issued by portfolio companies where we have noequity, or equity-like securities are submitted to our Board of Directors alongwith our Adviser’s supplemental assessment and recommendation regardingvaluation of each of these investments. Our Adviser generally accepts theopinion of value given by SPSE, however, in certain limited circumstances, suchas when our Adviser may learn new information regarding an investment betweenthe time of submission to SPSE and the date of the assessment by our Board ofDirectors, our Adviser’s conclusions as to value may differ from the opinion ofvalue delivered by SPSE. Our Board of Directors then reviews whether ourAdviser has followed its established procedures for determinations of fairvalue, and votes to accept or reject the recommended valuation of ourinvestment portfolio. Our Adviser and our management recommended, and the Boardof Directors voted to accept, the opinions of value delivered by SPSE on theloans in our portfolio as denoted on the Schedule of Investments included inour accompanying condensed consolidated financial statements.

 

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Because there is a delaybetween when we close an investment and when the investment can be evaluated bySPSE, new loans are not valued immediately by SPSE; rather, management makesits own determination about the value of these investments in accordance withour valuation policy using the methods described herein.

 

(2)   **Portfolio investments incontrolled companies comprised of a bundle of investments, which can includedebt or equity securities, or both:** The fair value of these investments is determinedbased on the total enterprise value of the company utilizing a liquiditywaterfall approach under SFAS No. 157. For Non-Public Debt Securities andequity 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 SFAS No. 157, we apply the in-use premise of value which assumes the debt and equitysecurities are sold together. Under the liquidity waterfall approach, we continueto use the enterprise value methodology utilizing a liquidity waterfallapproach to determine the fair value of these investments under SFAS No. 157if we have the ability to initiate a sale of a portfolio company as of themeasurement date.  Under this approach,we first calculate the total enterprise value of the issuer by incorporatingsome 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 tothird parties of similar securities, we may reference industry statistics anduse outside experts. Once we have estimated the total enterprise value of theissuer, we subtract the value of all the debt securities of the issuer; whichare valued at the contractual principal balance. Fair values of these debtsecurities are discounted for any shortfall of total enterprise value over thetotal debt outstanding for the issuer. Once the values for all outstandingsenior securities (which include the debt securities) have been subtracted fromthe total enterprise value of the issuer, the remaining amount, if any, is usedto determine the value of the issuer’s equity or equity -like securities.  If, in our Adviser’s judgment, the liquiditywaterfall approach does not accurately reflect the value of the debt component,our Adviser may recommend that we use a valuation by SPSE or, if that isunavailable, a DCF valuation technique.

 

(3)   **Portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt or equity securities, or both:**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 ofthe measurement date, using a hypothetical secondary market as our principalmarket. In accordance with SFAS No. 157, we determine the fair value ofthese debt securities of non-control investments assuming the sale of anindividual debt security using the in-exchange premise of value (as defined inSFAS No. 157). As such, we estimate the fair value of the debt component usingestimates of value provided by SPSE and our own assumptions in the absence ofobservable market data, including synthetic credit ratings, estimated remaininglife, current market yield and interest rate spreads of similar securities asof the measurement date. For equity and equity-like securities of investmentsfor which we do not control or cannot gain control as of the measurement date,we value the equity portion based on the total enterprise value of the issuer,which is calculated using a liquidity waterfall approach as described above.

 

Due to the uncertaintyinherent in the valuation process, such estimates of fair value may differsignificantly from the values that would have been obtained had a ready marketfor the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains or losses ultimatelyrealized on these investments to be different than the valuations currentlyassigned. There is no single standard for determining fair value in good faith,as fair value depends upon circumstances of each individual case. In general,fair value is the amount that we might reasonably expect to receive upon thecurrent sale of the security in an arms-length transaction in the security’sprincipal market.

 

*Valuation Considerations: *From time to time, depending on certain circumstances,the Adviser may use the following valuation considerations, including but notlimited to:

 

·      the nature and realizable value of thecollateral;

·      the portfolio company’s earnings and cashflows and its ability to make payments on its obligations;

·      the markets in which the portfolio companydoes business;

·      the comparison to publicly traded companies;and

·      DCF and other relevant factors.

 

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Because such valuations,particularly valuations of private securities and private companies, are notsusceptible to precise determination, may fluctuate over short periods of time,and may be based on estimates, our determinations of fair value may differ fromthe values that might have actually resulted had a readily available market forthese securities been available.

 

*Credit Information:* Our Adviser monitors a wide variety of key credit statistics thatprovide information regarding our portfolio companies to help us assess creditquality and portfolio performance. We and our Adviser participate in theperiodic board meetings of our portfolio companies in which we hold Control andAffiliate investments and also require them to provide annual audited andmonthly unaudited financial statements. Using these statements or comparableinformation and board discussions, our Adviser calculates and evaluates thecredit statistics.

 

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

 

For the debt securities for which we do not use a third-party NRSROrisk rating, we seek to have our risk rating system mirror the risk ratingsystems of major risk rating organizations, such as those provided by an NRSRO.While we seek to mirror the NRSRO systems, we cannot provide any assurance thatour risk rating system will provide the same risk rating as an NRSRO for thesesecurities. The following chart is an estimate of the relationship of our riskrating system to the designations used by two NRSROs as they risk rate debtsecurities of major companies. Because our system rates debt securities ofcompanies that are unrated by any NRSRO, there can be no assurance that thecorrelation to the NRSRO set out below is accurate. We believe our risk ratingwould be significantly higher than a typical NRSRO risk rating because the riskrating of the typical NRSRO is designed for larger businesses. Our risk rating,on the other hand, has been designed to risk rate the securities of smallerbusinesses that are not rated by a typical NRSRO. Therefore, when we use ourrisk rating on larger business securities, the risk rating is higher than atypical NRSRO rating. The primary difference between our risk rating and therating of a typical NRSRO is that our risk rating uses more quantitativedeterminants and includes qualitative determinants that we believe are not usedin the NRSRO rating. It is our understanding that most debt securities ofmedium-sized companies do not exceed the grade of BBB on an NRSRO scale, sothere would be no debt securities in the middle market that would meet thedefinition of AAA, AA or A. Therefore, our scale begins with the designation 10as the best risk rating which may be equivalent to a BBB from an NRSRO,however, no assurance can be given that a 10 on our scale is equal to a BBB onan 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. At June 30, 2009, two Non-Control/Non-Affiliate investmentsand one Control investment were on non-accrual. At September 30, 2008 one Non-Control/Non-Affiliate investment andtwo 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 June 30, 2009 and September 30, 2008,representing approximately 94% of all loans in our portfolio at the end of eachperiod:

 
| **Rating**       | ** ** | **Jun. 30,  2009** | ** ** | **Sept. 30,  2008** | ** ** |
|------------------|------------|-------------------------|------------|---------------------|------------|
| Average          | ** ** | **7.2**                 | ** ** | **7.3**             | ** ** |
| Weighted Average | ** ** | **7.0**                 | ** ** | **7.0**             | ** ** |
| Highest          | ** ** | **9.0**                 | ** ** | **9.0**             | ** ** |
| Lowest           | ** ** | **5.0**                 | ** ** | **5.0**             | ** ** |

 

The following table lists the risk ratings for all syndicated loans inour portfolio that were not rated by an NRSRO at June 30, 2009 and September 30,2008, representing approximately 2% of all loans in our portfolio at the end ofeach period:

 
| **Rating**       | ** ** | **Jun. 30,  2009** | ** ** | **Sept. 30,  2008** | ** ** |
|------------------|------------|-------------------------|------------|---------------------|------------|
| Average          | ** ** | **7.0**                 | ** ** | **6.6**             | ** ** |
| Weighted Average | ** ** | **7.0**                 | ** ** | **6.7**             | ** ** |
| Highest          | ** ** | **7.0**                 | ** ** | **7.0**             | ** ** |
| Lowest           | ** ** | **7.0**                 | ** ** | **6.0**             | ** ** |

 

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 June 30, 2009 and September 30, 2008, representingapproximately 4% of all loans in our portfolio at the end of each period:

 
| **Rating**       | ** ** | **Jun. 30, 2009** | ** ** | **Sept.30, 2008** | ** ** |
|------------------|------------|------------------------|------------|-------------------|------------|
| Average          |       | CCC/Caa2               |       | CCC+/Caa1         |       |
| Weighted Average |       | CCC+/Caa1              |       | CCC+/Caa1         |       |
| Highest          |       | B-/B3                  |       | BB/Ba3            |       |
| Lowest           |       | D/C                    |       | CC/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 are required to distribute tostockholders at least 90% of our investment company taxable income, as definedby the Code.  We have a policy to pay outas a distribution up to 100% of that amount.

 

In an effort to avoid certain excise taxes imposed on RICs, wecurrently intend to distribute during each calendar year, an amount at leastequal to the sum of (1) 98% of our ordinary income for the calendar year, (2) 98%of our capital gains in excess of capital losses for the one-year period endingon October 31 of the calendar year and (3) any ordinary income andnet capital gains for preceding years that were not distributed during suchyears.

 

***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 isunable to service its debt or other obligations, we will place the loan onnon-accrual status and cease recognizing interest income on that loan until theborrower has demonstrated the ability and intent to pay contractual amountsdue.  However, we remain contractuallyentitled to this interest.  At June 30,2009, two Non-Control/Non-Affiliate investments and one Control investment wereon non-accrual with an aggregate cost basis of approximately $10,659 or 2.8% ofthe cost basis of all investments in our portfolio.  At September 30, 2008, oneNon-Control/Non-Affiliate investment and two Control investments were onnon-accrual with an aggregate cost basis of approximately $13,098 at September 30,2008, or 2.8% of the cost basis of all investments in our portfolio.  Conditional interest, or a success fee, isrecorded when earned upon full repayment of a loan investment.

 

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*Paid in Kind Interest*

 

We may hold loans in our portfolio which contain a PIK interestprovision. The PIK interest, computed at the contractual rate specified in eachloan agreement, is added to the principal balance of the loan and recorded asinterest income. To maintain our status as a RIC, this non-cash source ofincome must be paid out to stockholders in the form of distributions, eventhough we have not yet collected the cash. As of June 30, 2009, one loan in our portfolio bore PIK interest.

 

*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.  Effective April 1, 2007, when ourAdviser receives fees for these services, 50% of certain of those fees arevoluntarily and irrevocably credited against the base management fee that wepay to our Adviser, whereas prior to such date fees were 100% credited.  Any services of this nature subsequent to theclosing would typically generate a separate 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 MARKET RISK.**

 

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 June 30, 2009, our portfolioconsisted of the following:

 
| 81  | % | variable rates with a floor               |   |   |
|-----|---|-------------------------------------------|--------|--------|
| 2   | % | variable rates with a floor and ceiling   |   |   |
| 13  | % | 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 nine months ended June 30, 2009 from thatdisclosed in our Annual Report on Form 10-K for the fiscal year ended September 30,2008, as filed with the SEC on December 2, 2008.

 

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**ITEM 4.CONTROLS AND PROCEDURES.**

 

a) Evaluation of Disclosure Controls and Procedures

 

As of June 30, 2009, 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 on that evaluation, our management, including the Chief ExecutiveOfficer and Chief Financial Officer, concluded that our disclosure controls andprocedures were effective in timely alerting management, including the ChiefExecutive Officer and Chief Financial Officer, of material information about usrequired to be included in periodic Securities and Exchange Commissionfilings.  However, in evaluating thedisclosure controls 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 June 30, 2009, 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 30,2008, filed by us with the SEC on December 2, 2008, and the QuarterlyReports on Form 10-Q for the quarters ended December 31, 2008 and March 31,2009, as filed with the SEC on February 3, 2009 and May 5, 2009,respectively.

 

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

 

Notapplicable.

 

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

 

Notapplicable.

 

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

 

Notapplicable

 

**ITEM 5.OTHER INFORMATION.**

 

Notapplicable

 

**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:August 3, 2009

 

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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        |       | Third Amended and Restated Credit Agreement dated as  of May 15, 2009 by and among Gladstone Business Loan, LLC as Borrower,  Gladstone Management Corporation as Servicer, the Committed Lenders named  therein, the CP 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 May 19, 2009. |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 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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