Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**x****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**FORTHE QUARTER ENDED DECEMBER 31, 2008**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**COMMISSIONFILE NUMBER: 814-00237**

 

**GLADSTONE CAPITAL CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

**1521 WESTBRANCH DRIVE, SUITE 200**

**MCLEAN, VIRGINIA 22102**

(Address of principal executive office)

 

**(703) 287-5800**

(Registrant’s telephone number, 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 x No o.

 

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

 

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

 

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

 

Indicate the number of shares outstandingof each of the issuer’s classes of common stock, as of the latest practicabledate.  The number of shares of the issuer’sCommon Stock, $0.001 par value, outstanding as of February 3, 2009 was21,087,574.

 

 

 

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Table of Contents

 

**GLADSTONECAPITAL CORPORATION**

**TABLE OF CONTENTS**

 
| PART I.  |   | FINANCIAL INFORMATION                                                                                                  |   |   |
|---------------|--------|------------------------------------------------------------------------------------------------------------------------|--------|--------|
|          |   |                                                                                                                   |   |   |
| Item 1.       |   | Financial Statements (Unaudited)                                                                                       |   |   |
|          |   |                                                                                                                   |   |   |
|          |   | Condensed Consolidated  Statements of Assets and Liabilities as of December 31, 2008 and  September 30, 2008 |   | 2      |
|          |   | Condensed Consolidated Schedules of Investments as of  December 31, 2008 and September 30, 2008              |   | 3      |
|          |   | Condensed Consolidated Statements of Operations for  the three months ended December 31, 2008 and 2007            |   | 16     |
|          |   | Condensed Consolidated Statements of Changes in Net  Assets for the three months ended December 31, 2008 and 2007 |   | 17     |
|          |   | Condensed Consolidated Statements of Cash Flows for  the three months ended December 31, 2008 and 2007            |   | 18     |
|          |   | Financial  Highlights for the three months ended December 31, 2008 and 2007                                       |   | 19     |
|          |   | Notes  to Condensed Consolidated Financial Statements                                                                  |   | 20     |
|          |   |                                                                                                                   |   |   |
| Item 2.       |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                            |   | 33     |
|          |   | Overview                                                                                                               |   | 33     |
|          |   | Results  of Operations                                                                                                 |   | 35     |
|          |   | Liquidity and Capital Resources                                                                                        |   | 38     |
|          |   |                                                                                                                   |   |   |
| Item 3.       |   | Quantitative and  Qualitative Disclosure About Market Risk                                                             |   | 45     |
|          |   |                                                                                                                   |   |   |
| Item 4.       |   | Controls and  Procedures                                                                                               |   | 46     |
|          |   |                                                                                                                   |   |   |
| PART II. |   | OTHER INFORMATION                                                                                                      |   |   |
|          |   |                                                                                                                   |   |   |
| Item 1.       |   | Legal Proceedings                                                                                                      |   | 46     |
|          |   |                                                                                                                   |   |   |
| Item 1A.      |   | Risk Factors                                                                                                           |   | 46     |
|          |   |                                                                                                                   |   |   |
| Item 2.       |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                           |   | 48     |
|          |   |                                                                                                                   |   |   |
| Item 3.       |   | Defaults Upon  Senior Securities                                                                                       |   | 48     |
|          |   |                                                                                                                   |   |   |
| Item 4.       |   | Submission of  Matters to a Vote of Security Holders                                                                   |   | 48     |
|          |   |                                                                                                                   |   |   |
| Item 5.       |   | Other Information                                                                                                      |   | 48     |
|          |   |                                                                                                                   |   |   |
| Item 6.       |   | Exhibits                                                                                                               |   | 48     |
|          |   |                                                                                                                   |   |   |
| SIGNATURES    |   | 48                                                                                                                     |

 

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Table of Contents

 

**GLADSTONECAPITAL CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF ASSETSAND LIABILITIES**

**(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PERSHARE DATA)**

**(UNAUDITED)**

 
| ** **                                                                                                                                                        | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                                                                        | ** ** | **2008**              | ** ** | **2008**               | ** ** |
| ASSETS                                                                                                                                                            |       |                  |       |                   |       |
| Non-Control/Non-Affiliate investments (Cost  12/31/08: $437,657; 9/30/08: $448,356)                                                                               |       | $                     | 384,012    |                   | $          | 407,153 |   |
| Control investments (Cost 12/31/08: $13,112;  9/30/08: $12,514)                                                                                                   |       | 566                   |       | 780                    |       |
| Total investments at fair value (Cost 12/31/08:  $450,769; 9/30/08: $460,870)                                                                                     |       | 384,578               |       | 407,933                |       |
| Cash                                                                                                                                                              |       | 5,756                 |       | 6,493                  |       |
| Interest receivable – investments in debt securities                                                                                                         |       | 2,762                 |       | 3,588                  |       |
| Interest receivable – employees (Refer to Note 4)                                                                                                            |       | 15                    |       | 91                     |       |
| Due from custodian                                                                                                                                                |       | 7,303                 |       | 4,544                  |       |
| Deferred financing fees                                                                                                                                           |       | 1,208                 |       | 1,905                  |       |
| Prepaid assets                                                                                                                                                    |       | 321                   |       | 306                    |       |
| Other assets                                                                                                                                                      |       | 1,044                 |       | 838                    |       |
| TOTAL ASSETS                                                                                                                                                      |       | $                     | 402,987    |                   | $          | 425,698 |   |
|                                                                                                                                                              |       |                  |       |                   |       |
| LIABILITIES                                                                                                                                                       |       |                  |       |                   |       |
| Accounts payable                                                                                                                                                  |       | $                     | 8          |                   | $          | 8 |   |
| Interest payable                                                                                                                                                  |       | 544                   |       | 646                    |       |
| Fee due to Administrator (Refer to Note 4)                                                                                                                        |       | 227                   |       | 247                    |       |
| Fees due to Adviser (Refer to Note 4)                                                                                                                             |       | 725                   |       | 457                    |       |
| Borrowings under line of credit                                                                                                                                   |       | 146,470               |       | 151,030                |       |
| Accrued expenses and deferred liabilities                                                                                                                         |       | 1,147                 |       | 1,328                  |       |
| Funds held in escrow                                                                                                                                              |       | 76                    |       | 234                    |       |
| TOTAL LIABILITIES                                                                                                                                                 |       | 149,197               |       | 153,950                |       |
| NET ASSETS                                                                                                                                                        |       | $                     | 253,790    |                   | $          | 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 December 31,  2008 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                                                                                                                        |       | (66,191               | )          | (52,937                | )          |
| Unrealized depreciation on derivative                                                                                                                             |       | (304                  | )          | (304                   | )          |
| Distributions in excess of net investment income                                                                                                                  |       | (4,706                | )          | —                 |       |
| TOTAL NET ASSETS                                                                                                                                                  |       | $                     | 253,790    |                   | $          | 271,748 |   |
| NET ASSETS PER SHARE                                                                                                                                              |       | $                     | 12.04      |                   | $          | 12.89 |   |

 

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

 

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Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS**

**AS OF DECEMBER 31,2008**

**(DOLLAR AMOUNTS INTHOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**                       | ** ** | **Industry**                    | ** ** | **Investment (2)**               | ** ** | **Cost** | ** ** | **Fair Value** |   |
|--------------------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|----------|------------|---------------------|--------|
|                                       |       |                            |       |                                  |       |     |       |                |   |
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS** |       |                            |       |                                  |       |     |       |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| Access  Television Network,                |       | Service-cable  airtime          |       | Senior Term Debt  (5)                 |       | $        | 1,618      |                | $      | 1,452 |   |
| Inc.                                       |       | (infomercials)                  |       | (10.5%, Due  3/2009)                  |       |     |       |                |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| ACE Expediters,  Inc                       |       | Service -  over-the-ground      |       | Line of Credit,  $850 available       |       | —   |       | —              |   |
|                                       |       | logistics                       |       | (4.3%, Due  1/2011)                   |       |     |       |                |   |
|                                       |       |                            |       | Senior Term Debt  (5)                 |       | 11,387   |       | 10,477              |   |
|                                       |       |                            |       | (7.8%, Due  1/2012)                   |       |     |       |                |   |
|                                       |       |                            |       | Common Stock  Warrants (8) (14)  |       | 200      |       | 183                 |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| ActivStyle  Acquisition Co.                |       | Service-medical  products       |       | Line of Credit,  $1,500 available (5) |       | 1,100    |       | 1,053               |   |
|                                       |       | distribution                    |       | (6.2%, Due  7/2009)                   |       |     |       |                |   |
|                                       |       |                            |       | Senior Term Debt  (5)                 |       | 4,524    |       | 4,247               |   |
|                                       |       |                            |       | (8.5%, Due  9/2012)                   |       |     |       |                |   |
|                                       |       |                            |       | Senior Term Debt  (3) (5)        |       | 4,435    |       | 4,047               |   |
|                                       |       |                            |       | (10.5%, Due  9/2012)                  |       |     |       |                |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| AKQA Holdings                              |       | Service - market  and           |       | Senior Term Debt  (6)                 |       | 8,319    |       | 8,271               |   |
|                                       |       | advertising                     |       | (6.0%, Due  3/2013)                   |       |     |       |                |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| Allison  Publications, LLC                 |       | Service-publisher  of consumer  |       | Line of Credit,  $1,000 available     |       | —   |       | —              |   |
|                                       |       | oriented  magazines             |       | (10.0%, Due  9/2010)                  |       |     |       |                |   |
|                                       |       |                            |       | Senior Term Debt  (5)                 |       | 10,174   |       | 8,293               |   |
|                                       |       |                            |       | (10.0%, Due  9/2012)                  |       |     |       |                |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| Anitox  Acquisition Company                |       | Manufacturing-preservatives     |       | Line of Credit,  $3,000 available (5) |       | 2,000    |       | 1,847               |   |
|                                       |       | for animal feed                 |       | (6.2%, Due  1/2010)                   |       |     |       |                |   |
|                                       |       |                            |       | Senior Term Debt  (5)                 |       | 3,288    |       | 3,037               |   |
|                                       |       |                            |       | (8.5%, Due  1/2012)                   |       |     |       |                |   |
|                                       |       |                            |       | Senior Term Debt  (3) (5)        |       | 3,688    |       | 3,338               |   |
|                                       |       |                            |       | (10.5%, Due  1/2012)                  |       |     |       |                |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| Badanco  Acquisition Corp.                 |       | Service-luggage  design and     |       | Senior  Subordinated Term Debt (5)    |       | 9,409    |       | 8,280               |   |
|                                       |       | distribution                    |       | (11.5%, Due  7/2012)                  |       |     |       |                |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| BAS Broadcasting                           |       | Service-radio  station operator |       | Senior Term Debt  (5)                 |       | 7,300    |       | 6,926               |   |
|                                       |       |                            |       | (11.5%, Due  7/2013)                  |       |     |       |                |   |
|                                       |       |                            |       | Senior Term Debt  (3) (5)        |       | 950      |       | 936                 |   |
|                                       |       |                            |       | (12.0%, Due  7/2009)                  |       |     |       |                |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| Bresnan  Communications,                   |       | Service-telecommunications      |       | Senior Term Debt  (6)                 |       | 3,001    |       | 2,279               |   |
| LLC                                        |       |                            |       | (4.2%, Due  9/2013)                   |       |     |       |                |   |
|                                       |       |                            |       | Senior  Subordinated Term Debt (6)    |       | 1,508    |       | 1,322               |   |
|                                       |       |                            |       | (7.6%, Due  3/2014)                   |       |     |       |                |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| CCS, LLC                                   |       | Service-cable TV  franchise     |       | Senior Term Debt  (5) (13)       |       | 631      |       | 252                 |   |
|                                       |       | owner                           |       | (7.3%, Due  8/2008)                   |       |     |       |                |   |
|                                       |       |                            |       |                                  |       |     |       |                |   |
| CHG  Companies, Inc.                  |       | Service-healthcare  staffing    |       | Letter of  Credit, $400 available (6) |       | 400      |       | 321                 |   |
|                                       |       |                            |       | (6.0%, Due  12/2012)                  |       |     |       |                |   |
|                                       |       |                            |       | Senior Term Debt  (6)                 |       | 1,523    |       | 1,254               |   |
|                                       |       |                            |       | (3.0%, Due  12/2012)                  |       |     |       |                |   |
|                                       |       |                            |       | Senior  Subordinated Term Debt (6)    |       | 500      |       | 385                 |   |
|                                       |       |                            |       | (6.5%, Due  12/2013)                  |       |     |       |                |   |
|                                            |            |                                 |            |                                       |            |          |            |                     |        |  |  |

 

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Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**AS OF DECEMBER 31,2008**

**(DOLLAR AMOUNTS INTHOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**               | ** ** | **Industry**                     | ** ** | **Investment (2)**                     | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
|------------------------------------|------------|----------------------------------|------------|---------------------------------------------|------------|----------|------------|---------------------|------------|
|                               |       |                             |       |                                        |       |     |       |                |       |
| Chinese Yellow  Pages              |       | Service-publisher  of Chinese    |       | Line of Credit,  $700 available (5)         |       | $        | 675        |                | 598        |   |
| Company                            |       | language  directories            |       | (7.3%, Due  9/2010)                         |       |     |       |                |       |
|                               |       |                             |       | Senior Term Debt  (5)                       |       | 656      |       | 575                 |       |
|                               |       |                             |       | (7.3%, Due  9/2010)                         |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| Clinton  Holdings, LLC             |       | Distribution-aluminum  sheets    |       | Senior  Subordinated Term Debt (5)          |       | 15,500   |       | 14,357              |       |
|                               |       | and stainless  steel             |       | (12.0%, Due  1/2013)                        |       |     |       |                |       |
|                               |       |                             |       | Common Stock  Warrants (8) (14)        |       | 109      |       | —              |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| CMI Acquisition,  LLC              |       | Service-recycling                |       | Senior Subordinated  Term Debt (5)          |       | 6,414    |       | 5,805               |       |
|                               |       |                             |       | (7.4%, Due  11/2012)                        |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| Defiance  Acquisition              |       | Manufacturing-trucking  parts    |       | Senior Term Debt  (3) (5)              |       | 6,085    |       | 4,564               |       |
| Corporation                        |       |                             |       | (11.0%, Due  4/2010)                        |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| Doe &  Ingalls Management |       | Distributor-specialty  chemicals |       | Senior Term Debt  (5)                       |       | 2,900    |       | 2,726               |       |
| LLC                                |       |                             |       | (6.8%, Due  11/2010)                        |       |     |       |                |       |
|                               |       |                             |       | Senior Term Debt  (3) (5)              |       | 4,399    |       | 4,113               |       |
|                               |       |                             |       | (7.8%, Due  11/2010)                        |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| Emdeon Business  Services,         |       | Service-healthcare  technology   |       | Senior Term Debt  (6)                       |       | 2,353    |       | 1,761               |       |
| Inc.                               |       | solutions                        |       | (3.5%, Due  11/2013)                        |       |     |       |                |       |
|                               |       |                             |       | Senior  Subordinated Term Debt (6)          |       | 2,011    |       | 1,425               |       |
|                               |       |                             |       | (3.0%, Due  5/2014)                         |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| Finn Corporation                   |       | Manufacturing-landscape          |       | Common Stock  Warrants (8) (14)        |       | 37       |       | 1,815               |       |
|                               |       | equipment                        |       |                                        |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| GFRC Holdings  LLC                 |       | Manufacturing-glass-fiber        |       | Line of Credit,  $3,000 available           |       | —   |       | —              |       |
|                               |       | reinforced  concrete             |       | (6.2%, Due  12/2010)                        |       |     |       |                |       |
|                               |       |                             |       | Senior Term Debt  (5)                       |       | 7,168    |       | 6,792               |       |
|                               |       |                             |       | (9.0%, Due  12/2012)                        |       |     |       |                |       |
|                               |       |                             |       | Senior  Subordinated Term Debt (3) (5) |       | 6,699    |       | 6,239               |       |
|                               |       |                             |       | (11.5%, Due  12/2012)                       |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| Global Materials                   |       | Manufacturing-steel  wool        |       | Senior Term Debt  (3) (5)              |       | 4,560    |       | 4,047               |       |
| Technologies, Inc.            |       | products and  metal fibers       |       | (13.0%, Due  11/2009)                       |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| GTM Holdings, Inc.            |       | Manufacturing-socks              |       | Senior Term Debt  (6)                       |       | 490      |       | 399                 |       |
|                               |       |                             |       | (8.5%, Due  10/2013)                        |       |     |       |                |       |
|                               |       |                             |       | Senior  Subordinated Term Debt (6)          |       | 500      |       | 426                 |       |
|                               |       |                             |       | (11.8%, Due  4/2014)                        |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| Greatwide  Logistics               |       | Service -  logistics and         |       | Senior  Subordinated Term Debt (7) (9) |       | 2,000    |       | 40                  |       |
| Services, Inc.                     |       | transportation                   |       | (non-accrual,  Due 6/2014)                  |       |     |       |                |       |
|                               |       |                             |       |                                        |       |     |       |                |       |
| Harrington  Holdings, Inc.    |       | Service -  healthcare products   |       | Senior Term Debt  (6)                       |       | 2,456    |       | 1,810               |       |
|                               |       | distribution                     |       | (2.7%, Due  1/2014)                         |       |     |       |                |       |
|                               |       |                             |       | Senior Subordinated  Term Debt (6)          |       | 5,000    |       | 3,835               |       |
|                               |       |                             |       | (6.5%, Due  1/2014)                         |       |     |       |                |       |
|                                    |            |                                  |            |                                             |            |          |            |                     |            |  |

 

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Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**AS OF DECEMBER 31,2008**

**(DOLLAR AMOUNTS INTHOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**            | ** ** | **Industry**                           | ** ** | **Investment (2)**                       | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|-----------------------------------------------|------------|----------|------------|---------------------|------------|
|                            |       |                                   |       |                                          |       |     |       |                |       |
| Heartland  Communications       |       | Service-radio  station operator        |       | Line of Credit, $500  available (5) (10) |       | $        | 105        |                | $          | 68 |   |
| Group, LLC                      |       |                                   |       | (10.0%, Due  12/2008)                         |       |     |       |                |       |
|                            |       |                                   |       | Senior Term Debt  (5)                         |       | 4,468    |       | 2,882               |       |
|                            |       |                                   |       | (10.0%, Due  5/2011)                          |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| Interfilm  Holdings, Inc.  |       | Service-slitter  and distributor       |       | Senior Term Debt  (5)                         |       | 4,988    |       | 4,588               |       |
|                            |       | of plastic films                       |       | (10.5%, Due  10/2012)                         |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| International  Junior Golf      |       | Service-golf  training                 |       | Line of Credit,  $1,500 available (5)         |       | 1,400    |       | 1,318               |       |
| Training  Acquisition           |       |                                   |       | (9.0%, Due  5/2010)                           |       |     |       |                |       |
| Company                         |       |                                   |       | Senior Term Debt  (5)                         |       | 2,451    |       | 2,225               |       |
|                            |       |                                   |       | (6.2%, Due  5/2012)                           |       |     |       |                |       |
|                            |       |                                   |       | Senior Term Debt  (3) (5)                |       | 2,500    |       | 2,213               |       |
|                            |       |                                   |       | (10.5%, Due  5/2012)                          |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| It’s Just Lunch            |       | Service-dating  service                |       | Line of Credit,  $750 available (5)           |       | 550      |       | 220                 |       |
| International, LLC              |       |                                   |       | (5.9%, Due  6/2009)                           |       |     |       |                |       |
|                            |       |                                   |       | Senior Term Debt  (5)                         |       | 3,300    |       | 1,320               |       |
|                            |       |                                   |       | (6.2%, Due  6/2011)                           |       |     |       |                |       |
|                            |       |                                   |       | Senior Term Debt  (3) (5) (11)      |       | 500      |       | 200                 |       |
|                            |       |                                   |       | (10.5%, Due  6/2011)                          |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| John Henry  Holdings, Inc. |       | Manufacturing-packaging                |       | Senior  Subordinated Term Debt (6)            |       | 8,000    |       | 7,497               |       |
|                            |       | products                               |       | (8.2%, Due  6/2011)                           |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| Kinetek  Acquisition Corp.      |       | Manufacturing-custom                   |       | Senior Term Debt  (6)                         |       | 1,440    |       | 1,037               |       |
|                            |       | engineered  motors & controls |       | (3.0%, Due  11/2013)                          |       |     |       |                |       |
|                            |       |                                   |       | Senior  Subordinated Term Debt (6)            |       | 1,507    |       | 1,258               |       |
|                            |       |                                   |       | (6.0%, Due  5/2014)                           |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| KMBQ Corporation                |       | Service-AM/FM  radio                   |       | Line of Credit,  $200 available (5)           |       | 153      |       | 134                 |       |
|                            |       | broadcaster                            |       | (11.0%, Due  3/2010)                          |       |     |       |                |       |
|                            |       |                                   |       | Senior Term Debt  (5)                         |       | 1,790    |       | 1,558               |       |
|                            |       |                                   |       | (11.0%, Due  3/2010)                          |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| Legend Communications  of       |       | Service-operator  of radio             |       | Line of Credit,  $500 available (5)           |       | 497      |       | 476                 |       |
| Wyoming LLC                     |       | stations                               |       | (11.0%, Due  6/2011)                          |       |     |       |                |       |
|                            |       |                                   |       | Senior Term Debt  (5)                         |       | 9,250    |       | 8,857               |       |
|                            |       |                                   |       | (11.0%, Due  6/2013)                          |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| Lindmark Outdoor                |       | Service-advertising                    |       | Senior  Subordinated Term Debt (5)            |       | 11,906   |       | 8,929               |       |
| Advertising LLC                 |       |                                   |       | (11.0%, Due  10/2012)                         |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| Multi-Ag Media  LLC             |       | Service-dairy  magazine                |       | Senior Term Debt  (5)                         |       | 1,936    |       | 1,685               |       |
|                            |       | publisher/information                  |       | (7.3%, Due  12/2009)                          |       |     |       |                |       |
|                            |       | database                               |       |                                          |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| Newhall  Holdings, Inc.    |       | Service-distributor  of                |       | Line of Credit,  $4,000 available (12)        |       | 2,100    |       | 2,100               |       |
|                            |       | personal care  products and            |       | (5.4%, Due  5/2010)                           |       |     |       |                |       |
|                            |       | supplements                            |       | Senior Term Debt  (5)                         |       | 4,050    |       | 3,442               |       |
|                            |       |                                   |       | (8.3%, Due  5/2012)                           |       |     |       |                |       |
|                            |       |                                   |       | Senior Term Debt  (3) (5)                |       | 4,455    |       | 3,787               |       |
|                            |       |                                   |       | (11.3%, Due  5/2012)                          |       |     |       |                |       |
|                            |       |                                   |       |                                          |       |     |       |                |       |
| Northern  Contours, Inc.   |       | Manufacturing-veneer  and              |       | Senior  Subordinated Term Debt (5)            |       | 6,825    |       | 5,878               |       |
|                            |       | laminate  components                   |       | (10.0%, Due  5/2010)                          |       |     |       |                |       |
|                                 |            |                                        |            |                                               |            |          |            |                     |            |  |  |

 

5

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**AS OF DECEMBER 31,2008**

**(DOLLAR AMOUNTS INTHOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**            | ** ** | **Industry**                    | ** ** | **Investment (2)**               | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
|---------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|----------|------------|---------------------|------------|
|                            |       |                            |       |                                  |       |     |       |                |       |
| Pinnacle  Treatment Centers,    |       | Service-Addiction  treatment    |       | Line of Credit,  $500 available       |       | $        | —     |                | $          | — |   |
| Inc.                            |       | centers                         |       | (6.2%, Due  12/2009)                  |       |     |       |                |       |
|                            |       |                            |       | Senior Term Debt  (5)                 |       | 3,350    |       | 3,099               |       |
|                            |       |                            |       | (8.5%, Due  12/2011)                  |       |     |       |                |       |
|                            |       |                            |       | Senior Term Debt  (3) (5)        |       | 7,500    |       | 6,853               |       |
|                            |       |                            |       | (10.5%, Due  12/2011)                 |       |     |       |                |       |
|                            |       |                            |       |                                  |       |     |       |                |       |
| Precision  Acquisition          |       | Manufacturing-consumable        |       | Equipment Note,  $1,500 available (5) |       | 1,000    |       | 980                 |       |
| Group Holdings, Inc.       |       | components for  the             |       | (8.5%, Due  10/2011)                  |       |     |       |                |       |
|                            |       | aluminum industry               |       | Senior Term Debt  (5)                 |       | 4,625    |       | 4,532               |       |
|                            |       |                            |       | (8.5%, Due  10/2010)                  |       |     |       |                |       |
|                            |       |                            |       | Senior Term Debt  (3) (5)        |       | 4,137    |       | 4,054               |       |
|                            |       |                            |       | (11.5%, Due  10/2010)                 |       |     |       |                |       |
|                            |       |                            |       |                                  |       |     |       |                |       |
| PROFITSystems                   |       | Service-design  and develop     |       | Line of Credit,  $1,250 available     |       | —   |       | —              |       |
| Acquisition Co.                 |       | ERP software                    |       | (6.2%, Due  7/2009)                   |       |     |       |                |       |
|                            |       |                            |       | Senior Term Debt  (5)                 |       | 2,050    |       | 1,842               |       |
|                            |       |                            |       | (8.5%, Due  7/2011)                   |       |     |       |                |       |
|                            |       |                            |       | Senior Term Debt  (3) (5)        |       | 2,900    |       | 2,559               |       |
|                            |       |                            |       | (10.5%, Due  7/2011)                  |       |     |       |                |       |
|                            |       |                            |       |                                  |       |     |       |                |       |
| Puerto Rico  Cable              |       | Service-telecommunications      |       | Senior  Subordinated Term Debt (6)    |       | 7,185    |       | 5,926               |       |
| Acquisition  Company, Inc. |       |                            |       | (8.0%, Due  1/2012)                   |       |     |       |                |       |
|                            |       |                            |       |                                  |       |     |       |                |       |
| RCS Management  Holding         |       | Service-healthcare  supplies    |       | Senior Term Debt  (3) (6)        |       | 2,813    |       | 2,595               |       |
| Co.                             |       |                            |       | (8.5%, Due  1/2011)                   |       |     |       |                |       |
|                            |       |                            |       | Senior Term Debt  (4) (6)        |       | 3,060    |       | 2,777               |       |
|                            |       |                            |       | (10.5%, Due  1/2011)                  |       |     |       |                |       |
|                            |       |                            |       |                                  |       |     |       |                |       |
| RedPrairie  Holding, Inc.  |       | Service-design  and develop     |       | Senior Term Debt  (6)                 |       | 4,390    |       | 3,564               |       |
|                            |       | supply chain  software          |       | (5.3%, Due  7/2012)                   |       |     |       |                |       |
|                            |       |                            |       | Senior  Subordinated Term Debt (6)    |       | 3,000    |       | 2,306               |       |
|                            |       |                            |       | (9.2%, Due  1/2013)                   |       |     |       |                |       |
|                            |       |                            |       |                                  |       |     |       |                |       |
| Reliable  Biopharmaceutical     |       | Manufacturing-pharmaceutical    |       | Line of Credit,  $5,000 available (5) |       | 800      |       | 760                 |       |
| Holdings, Inc.             |       | and biochemical  intermediates  |       | (9.0%, Due  10/2010)                  |       |     |       |                |       |
|                            |       |                            |       | Mortgage Note  (5)                    |       | 7,389    |       | 7,093               |       |
|                            |       |                            |       | (9.5%, Due  10/2014)                  |       |     |       |                |       |
|                            |       |                            |       | Senior Term Debt  (5)                 |       | 1,733    |       | 1,646               |       |
|                            |       |                            |       | (9.0%, Due  10/2012)                  |       |     |       |                |       |
|                            |       |                            |       | Senior Term Debt  (3) (5)        |       | 11,903   |       | 11,130              |       |
|                            |       |                            |       | (11.0%, Due  10/2012)                 |       |     |       |                |       |
|                            |       |                            |       | Senior  Subordinated Term Debt (5)    |       | 6,000    |       | 5,085               |       |
|                            |       |                            |       | (12.0%, Due  10/2013)                 |       |     |       |                |       |
|                            |       |                            |       | Common Stock  Warrants (8) (14)  |       | 209      |       | —              |       |
|                            |       |                            |       |                                  |       |     |       |                |       |
| RiskMetrics  Group              |       | Service -  develop risk and     |       | Senior Term Debt  (6)                 |       | 1,937    |       | 1,448               |       |
| Holdings, LLC                   |       | wealth  management solutions    |       | (3.5%, Due  1/2014)                   |       |     |       |                |       |
|                            |       |                            |       |                                  |       |     |       |                |       |
| Saunders &  Associates |       | Manufacturing-equipment         |       | Line of Credit,  $2,500 available     |       | —   |       | —              |       |
|                            |       | provider for  frequency control |       | (6.4%, Due  5/2009)                   |       |     |       |                |       |
|                            |       | devices                         |       | Senior Term Debt  (5)                 |       | 10,890   |       | 10,509              |       |
|                            |       |                            |       | (9.8%, Due  5/2013)                   |       |     |       |                |       |
|                            |       |                            |       |                                  |       |     |       |                |       |
| SCI  Cable, Inc.           |       | Service-cable,  internet, voice |       | Senior Term Debt  (5) (13)       |       | 2,710    |       | 678                 |       |
|                            |       | provider                        |       | (9.3%, Due  10/2008)                  |       |     |       |                |       |
|                                 |            |                                 |            |                                       |            |          |            |                     |            |  |  |

 

6

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**AS OF DECEMBER 31,2008**

**(DOLLAR AMOUNTS INTHOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**                             | ** ** | **Industry**                    | ** ** | **Investment (2)**               | ** **  | **Cost**   | ** ** | **Fair Value** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|---------------------------------------|-------------|------------|------------|---------------------|------------|
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Sunburst Media -  Louisiana,                     |       | Service-radio  station operator |       | Senior Term Debt  (5)                 |        | $          | 7,852      |                | $          | 6,581 |   |
| LLC                                              |       |                            |       | (9.5%, Due  6/2011)                   |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Sunshine Media  Holdings                         |       | Service-publisher  regional     |       | Line of Credit,  $3,000 available (5) |        | 700        |       | 630                 |       |
|                                             |       | B2B trade  magazines            |       | (11.0%, Due  5/2010)                  |        |       |       |                |       |
|                                             |       |                            |       | Senior Term Debt  (5)                 |        | 17,000     |       | 15,640              |       |
|                                             |       |                            |       | (11.0%, Due  5/2012)                  |        |       |       |                |       |
|                                             |       |                            |       | Senior Term Debt  (3) (5)        |        | 10,000     |       | 9,000               |       |
|                                             |       |                            |       | (13.5%, Due  5/2012)                  |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Thibaut  Acquisition Co.                         |       | Service-design  and disbribute  |       | Line of Credit,  $1,000 available (5) |        | 1,000      |       | 900                 |       |
|                                             |       | wall covering                   |       | (6.9%, Due  1/2011)                   |        |       |       |                |       |
|                                             |       |                            |       | Senior Term Debt  (5)                 |        | 1,838      |       | 1,654               |       |
|                                             |       |                            |       | (6.4%, Due  1/2011)                   |        |       |       |                |       |
|                                             |       |                            |       | Senior Term Debt  (3) (5)        |        | 3,000      |       | 2,625               |       |
|                                             |       |                            |       | (10.5%, Due  1/2011)                  |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Tulsa Welding  School                            |       | Service-private  welding        |       | Line of credit,  $2,000 available (5) |        | 137        |       | —              |       |
|                                             |       | school                          |       | (9.5%, 9/2011)                        |        |       |       |                |       |
|                                             |       |                            |       | Senior Term Debt  (5)                 |        | 3,900      |       | 3,822               |       |
|                                             |       |                            |       | (9.5%, 9/2013)                        |        |       |       |                |       |
|                                             |       |                            |       | Senior Term Debt  (5)                 |        | 8,000      |       | 7,790               |       |
|                                             |       |                            |       | (12.8%, 9/2013)                       |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| United Maritime  Group, LLC                      |       | Service-cargo  transport        |       | Senior  Subordinated Term Debt (6)    |        | 5,511      |       | 4,927               |       |
|                                             |       |                            |       | (9.0%, Due  12/2013)                  |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Vanta Core                                       |       | Service-acquisition  of         |       | Senior  Subordinated Term Debt (5)    |        | 13,865     |       | 13,518              |       |
|                                             |       | aggregate quarries              |       | (12.0%, 8/2013)                       |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Viapack, Inc.                               |       | Manufacturing-polyethylene      |       | Senior Real  Estate Term Debt (5)     |        | 825        |       | 738                 |       |
|                                             |       | film                            |       | (6.4%, Due  3/2011)                   |        |       |       |                |       |
|                                             |       |                            |       | Senior Term Debt  (3) (5)        |        | 4,064      |       | 3,617               |       |
|                                             |       |                            |       | (11.3%, Due  3/2011)                  |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Visual Edge  Technology,                         |       | Service-office  equipment       |       | Senior  Subordinated Term Debt (5)    |        | 5,000      |       | 3,000               |       |
| Inc.                                             |       | distribution                    |       | (13.5%, Due  8/2011)                  |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Wesco  Holdings, Inc.                       |       | Service-aerospace  parts and    |       | Senior Term Debt  (6)                 |        | 2,450      |       | 1,822               |       |
|                                             |       | distribution                    |       | (2.7%, Due  9/2013)                   |        |       |       |                |       |
|                                             |       |                            |       | Senior  Subordinated Term Debt (6)    |        | 2,267      |       | 1,621               |       |
|                                             |       |                            |       | (6.2%, Due  3/2014)                   |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Westlake  Hardware, Inc.                    |       | Retail-hardware  and variety    |       | Senior  Subordinated Term Debt (5)    |        | 15,000     |       | 13,519              |       |
|                                             |       |                            |       | (9.0%, Due 1/2011)                    |        |       |       |                |       |
|                                             |       |                            |       | Senior  Subordinated Term Debt (5)    |        | 10,000     |       | 8,788               |       |
|                                             |       |                            |       | (10.3%, Due  1/2011)                  |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| Winchester  Electronics                          |       | Manufacturing-high              |       | Senior Term Debt  (5)                 |        | 1,694      |       | 1,542               |       |
|                                             |       | bandwidth connectors  and       |       | (6.7%, Due  5/2013)                   |        |       |       |                |       |
|                                             |       | cables                          |       | Senior  Subordinated Term Debt (5)    |        | 9,925      |       | 8,883               |       |
|                                             |       |                            |       | (14.0%, Due  6/2013)                  |        |       |       |                |       |
|                                             |       |                            |       |                                  |        |       |       |                |       |
| WP Evenflo Group  Holdings                       |       | Manufacturing-infant  and       |       | Senior Term Debt  (6)                 |        | 1,910      |       | 1,315               |       |
| Inc.                                             |       | juvenile  products              |       | (4.7%, Due  2/2013)                   |        |       |       |                |       |
|                                             |       |                            |       | Senior  Subordinated Term Debt (6)    |        | 2,000      |       | 1,445               |       |
|                                             |       |                            |       | (8.2%, Due  2/2014)                   |        |       |       |                |       |
| **Total  Non-Control/Non-Affiliate Investments** |       |                            |       | **$**                                 | **437,657** | ** ** | **$**      | **384,012**         |       |

 

7

----

Table of Contents

 

**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**AS OF DECEMBER 31,2008**

**(DOLLAR AMOUNTS INTHOUSANDS)**

**(UNAUDITED)**

 
| **Company (1)**            | ** ** | **Industry**                 | ** ** | **Investment (2)**                         | ** ** | **Cost**   | ** **  | **Fair Value** |       |
|---------------------------------|------------|------------------------------|------------|-------------------------------------------------|------------|------------|-------------|---------------------|------------|
|                            |       |                         |       |                                            |       |       |        |                |       |
| **CONTROL  INVESTMENTS**        |       |                         |       |                                            |       |       |        |
|                            |       |                         |       |                                            |       |       |        |                |       |
| BERTL, Inc.                |       | Service-web-based  evaluator |       | Line of Credit,  $700 available (14) (15)       |       | $          | 759         |                | $          | — |   |
|                            |       | of digital  imaging products |       | (8.2%, Due  10/2009)                            |       |       |        |                |       |
|                            |       |                         |       | Common Stock  (8) (15)                     |       | 424        |        | —              |       |
|                            |       |                         |       |                                            |       |       |        |                |       |
| LYP Holdings  Corp.             |       | Service-yellow  pages        |       | Line of credit,  $500 available (15)            |       | 175        |        | —              |       |
|                            |       | publishing                   |       | (10.0%, 5/2009)                                 |       |       |        |                |       |
|                            |       |                         |       | Line of Credit,  $3,000 available (9) (15) |       | 1,170      |        | —              |       |
|                            |       |                         |       | (non-accrual,  Due 6/2009)                      |       |       |        |                |       |
|                            |       |                         |       | Senior Term Debt  (9) (15)                 |       | 2,688      |        | —              |       |
|                            |       |                         |       | (non-accrual,  Due 6/2011)                      |       |       |        |                |       |
|                            |       |                         |       | Senior Term Debt  (3) (9) (15)        |       | 2,750      |        | —              |       |
|                            |       |                         |       | (non-accrual,  Due 6/2011)                      |       |       |        |                |       |
|                            |       |                         |       | Common Stock  Warrants (8) (15)            |       | 1          |        | —              |       |
|                            |       |                         |       |                                            |       |       |        |                |       |
| U.S. Healthcare                 |       | Service-magazine  publisher/ |       | Line of credit,  $200 available (9) (15)   |       | 169        |        | 169                 |       |
| Communications, Inc.       |       | operator                     |       | (non-accrual,  Due 3/2010)                      |       |       |        |                |       |
|                            |       |                         |       | Line of credit,  $450 available (9) (15)   |       | 450        |        | 397                 |       |
|                            |       |                         |       | (non-accrual,  Due 3/2010)                      |       |       |        |                |       |
|                            |       |                         |       | Common Stock  (8) (15)                     |       | 2,470      |        | —              |       |
|                            |       |                         |       |                                            |       |       |        |                |       |
| Western  Directories, Inc. |       | Service-directory  publisher |       | Line of credit,  $1,000 available (15)          |       | 471        |        | —              |       |
|                            |       |                         |       | (10%, Due  8/2009)                              |       |       |        |                |       |
|                            |       |                         |       | Preferred Stock  (8) (15)                  |       | 1,584      |        | —              |       |
|                            |       |                         |       | Common Stock  (8) (15)                     |       | 1          |        | —              |       |
|                            |       |                         |       |                                            |       |       |        |                |       |
| **Total  Control Investments**  | ** ** | ** **                   | ** ** | ** **                                      | ** ** | **$**      | **13,112**  | ** **          | **$**      | **566** | ** ** |
| ** **                      | ** ** | ** **                   | ** ** | ** **                                      | ** ** | ** ** | ** **  | ** **          | ** ** |
| **Total  Investments**          | ** ** | ** **                   | ** ** | ** **                                      | ** ** | **$**      | **450,769** | ** **          | **$**      | **384,578** | ** ** |

 

----

| (1)  | Certain of the listed securities are issued by  affiliate(s) of the indicated portfolio company.                                                                                                                                                               |
|------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  | Percentage represents interest rates in effect at  December 31, 2008 and due date represents the contractual maturity date.                                                                                                                                    |
| (3)  | Last Out Tranche of senior debt, meaning if the portfolio  company is liquidated then the holder of the Last Out Tranche is paid after  the senior debt.                                                                                                            |
| (4)  | Last Out Tranche of senior debt, meaning if the portfolio  company is liquidated then the holder of the Last Out Tranche is paid after  the senior debt, however, the debt is also junior to another Last Out  Tranche.                                             |
| (5)  | Fair value was based on opinions of value submitted by  Standard & Poor’s Securities Evaluations, Inc.                                                                                                                                           |
| (6)  | Security valued using internally-developed, risk-adjusted  discounted cash flow methodologies as of December 31, 2008.                                                                                                                                         |
| (7)  | Security valued based on the indicative bid price on or near  December 31, 2008, offered by the respective originating syndication  agent’s trading desk, or secondary desk.                                                                              |
| (8)  | Security is non-income producing.                                                                                                                                                                                                                                   |
| (9)  | Greatwide, LYP Holdings and U.S. Healthcare are currently past  due on interest payments and are on non-accrual.                                                                                                                                                    |
| (10) | Heartland’s line of credit was cancelled subsequent to  December 31, 2008 and the balance was added to the term loan.                                                                                                                                     |
| (11) | It’s Just Lunch may borrow an additional $1,750 of the senior  term debt facility, subject to certain conditions including Gladstone  Capital’s approval. Borrowings of $500 were outstanding at December 31,  2008.                                 |
| (12) | Newhall’s line of credit was valued at cost due to payoff  subsequent to December 31, 2008. In addition, the line of credit limit  was reduced from $4,000 to $3,000.                                                                                     |
| (13) | CCS’s loan expired in August 2008 and SCI Cable’s loan expired  in October 2008. The Company is   actively working to recover amounts due under these loans, however,  there is no assurance that there will be a full recovery of amounts past due. |
| (14) | BERTL’s line of credit was overdrawn by $59 as of  December 31, 2008. The Company is currently restructuring the line of  credit. BERTL’s interest is currently being capitalized as Paid in Kind  (“PIK”) interest.                       |
| (15) | Fair value was based on the total enterprise value of the  portfolio company, which was calculated using a liquidity waterfall approach.                                                                                                                            |

* *

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

 

8

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**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS**

**AS OF SEPTEMBER 30,2008**

**(DOLLAR AMOUNTS INTHOUSANDS)**

 
| **Company**                                    | ** ** | **Industry**                             | ** ** | **Investment (1)**                                             | ** ** | **Cost**   | ** **  | **Fair Value** | ** ** |
|------------------------------------------------|------------|------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|-------------|---------------------|------------|
| ** **                                     | ** ** | ** **                               | ** ** | ** **                                                          | ** ** | ** ** | ** **  | ** **          | ** ** |
| **NON-CONTROL/NON-AFFILIATE INVESTMENTS** |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| Access Television                         |       | Service-cable airtime               |       | Senior Term Debt (6)                                 |       | $          |  1,923 |                | $          |  1,774 |   |
| Network, Inc. (2)                    |       | (infomercials)                           |       | (10.5%, Due 3/2009)                                       |       |       |        |                |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| ACE Expediters, Inc                  |       | Service - over-the-            |       | Line of Credit, $ 850 available            |       | —     |        | —              |       |
|                                           |       | ground logistics                    |       | (6.0%, Due 1/2011)                                        |       |       |        |                |       |
|                                           |       |                                     |       | Senior Term Debt (6)                                 |       | 11,966     |        | 11,248              |       |
|                                           |       |                                     |       | (9.8%, Due 1/2012)                                        |       |       |        |                |       |
|                                           |       |                                     |       | Common Stock Warrants (8)                            |       | 200        |        | 142                 |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| ActivStyle Acquisition Co. (2)  |       | Service-medical products            |       | Line of Credit, $ 1,500 available (6) |       | 1,100      |        | 1,059               |       |
|                                           |       | distribution                             |       | (6.7%, Due 7/2009)                                        |       |       |        |                |       |
|                                           |       |                                     |       | Senior Term Debt (6)                                 |       | 4,721      |        | 4,543               |       |
|                                           |       |                                     |       | (8.5%, Due 9/2012)                                        |       |       |        |                |       |
|                                           |       |                                     |       | Senior Term Debt (3) (6)                        |       | 4,435      |        | 4,213               |       |
|                                           |       |                                     |       | (10.5%, Due 9/2012)                                       |       |       |        |                |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| AKQA Holdings                             |       | Service -                           |       | Senior Term Debt (7)                                 |       | 8,273      |        | 7,980               |       |
|                                           |       |  market and advertising   |       | (7.7%, Due 3/2013)                                        |       |       |        |                |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| Allison Publications, LLC (2)   |       | Service-publisher of consumer  |       | Line of Credit, $ 4,000 available          |       | —     |        | —              |       |
|                                           |       | oriented magazines                  |       | (9.0%, Due 9/2010)                                        |       |       |        |                |       |
|                                           |       |                                     |       | Senior Term Debt (6)                                 |       | 10,465     |        | 9,568               |       |
|                                           |       |                                     |       | (9.0%, Due 9/2012)                                        |       |       |        |                |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| Anitox Acquisition Company (2)  |       | Manufacturing-preservatives              |       | Line of Credit, $ 3,000 available (6) |       | 2,000      |        | 1,880               |       |
|                                           |       | for animal feed                     |       | (6.7%, Due 1/2010)                                        |       |       |        |                |       |
|                                           |       |                                     |       | Senior Term Debt (6)                                 |       | 3,388      |        | 3,185               |       |
|                                           |       |                                     |       | (8.5%, Due 1/2012)                                        |       |       |        |                |       |
|                                           |       |                                     |       | Senior Term Debt (3) (6)                        |       | 3,688      |        | 3,388               |       |
|                                           |       |                                     |       | (10.5%, Due 1/2012)                                       |       |       |        |                |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| Badanco Acquisition Corp.            |       | Service-luggage design and     |       | Senior Subordinated Term Debt (6)               |       | 9,458      |        | 8,795               |       |
|                                           |       | distribution                             |       | (11.5%, Due 7/2012)                                       |       |       |        |                |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| BAS Broadcasting                          |       | Service-radio station operator |       | Senior Term Debt (5)                                 |       | 7,300      |        | 7,209               |       |
|                                           |       |                                     |       | (11.5%, Due 7/2013)                                       |       |       |        |                |       |
|                                           |       |                                     |       | Senior Term Debt (3) (5)                        |       | 1,000      |        | 988                 |       |
|                                           |       |                                     |       | (12.0%, Due 7/2009)                                       |       |       |        |                |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| Bresnan Communications, LLC          |       | Service-telecommunications               |       | Senior Term Debt (7)                                 |       | 3,001      |        | 2,670               |       |
|                                           |       |                                     |       | (4.8%, Due 9/2013)                                        |       |       |        |                |       |
|                                           |       |                                     |       | Senior Subordinated Term Debt (7)               |       | 1,508      |        | 1,305               |       |
|                                           |       |                                     |       | (7.6%, Due 3/2014)                                        |       |       |        |                |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| CCS, LLC                                  |       | Service-cable TV                    |       | Senior Term Debt (6)                                 |       | 728        |        | 364                 |       |
|                                           |       | franchise owner                     |       | (9.0%, Due 8/2008)                                        |       |       |        |                |       |
|                                           |       |                                     |       |                                                                |       |       |        |                |       |
| CHG Companies, Inc. (2)         |       | Service-healthcare staffing         |       | Letter of Credit, $ 400 available (7) |       | 400        |        | 356                 |       |
|                                           |       |                                     |       | (6.0%, Due 12/2012)                                       |       |       |        |                |       |
|                                           |       |                                     |       | Senior Term Debt (7)                                 |       | 1,572      |        | 1,399               |       |
|                                           |       |                                     |       | (5.3%, Due 12/2012)                                       |       |       |        |                |       |
|                                           |       |                                     |       | Senior Subordinated Term Debt (7)               |       | 500        |        | 425                 |       |
|                                           |       |                                     |       | (8.5%, Due 12/2013)                                       |       |       |        |                |       |
|                                                |            |                                          |            |                                                                     |            |            |             |                     |            |  |  |

 

9

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**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**SEPTEMBER 30, 2008**

**(DOLLARAMOUNTS IN THOUSANDS)**

 
| **Company**                                 | ** ** | **Industry**                             | ** ** | **Investment (1)**                                           | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
|---------------------------------------------|------------|------------------------------------------|------------|-------------------------------------------------------------------|------------|----------|------------|---------------------|------------|
| Chinese Yellow Pages Company |       | Service-publisher of Chinese   |       | Line of Credit, $ 700 available (6) |       | $        |  575  |                | 529        |   |
|                                        |       | language directories                |       | (9.0%, Due 9/2010)                                      |       |     |       |                |       |
|                                        |       |                                     |       | Senior Term Debt (6)                               |       | 702      |       | 638                 |       |
|                                        |       |                                     |       | (9.0%, Due 9/2010)                                      |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| Clinton Holdings, LLC (2)    |       | Distribution-aluminum sheets        |       | Senior Subordinated Term  Debt (6)                 |       | 15,500   |       | 14,880              |       |
|                                        |       | and stainless steel            |       | (12.0%, Due 1/2013)                                     |       |     |       |                |       |
|                                        |       |                                     |       | Common Stock Warrants (8)                          |       | 109      |       | —              |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| CMI Acquisition, LLC (2)     |       | Service-recycling                        |       | Senior Subordinated Term  Debt (6)                 |       | 6,414    |       | 6,061               |       |
|                                        |       |                                     |       | (10.2%, Due 11/2012)                                    |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| Community Media Corporation       |       | Service-publisher                        |       | Senior Term Debt (6)                               |       | 987      |       | 936                 |       |
|                                        |       | of free weekly  newspapers     |       | (7.0%, Due 8/2012)                                      |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| Country Road                           |       | Service-telecommunications               |       | Senior Subordinated Term  Debt (7)                 |       | 5,973    |       | 5,880               |       |
| Communications LLC (2)            |       |                                     |       | (11.5%, Due 7/2013)                                     |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| Defiance Acquisition                   |       | Manufacturing-trucking parts        |       | Senior Term Debt (3) (6)                      |       | 6,165    |       | 5,055               |       |
| Corporation                                 |       |                                     |       | (11.0%, Due 4/2010)                                     |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| Doe & Ingalls Management |       | Distributor-specialty                    |       | Senior Term Debt (6)                               |       | 3,100    |       | 2,945               |       |
| LLC (2)                                |       |  chemicals                          |       | (6.8%, Due 11/2010)                                     |       |     |       |                |       |
|                                        |       |                                     |       | Senior Term Debt (3) (6)                      |       | 4,410    |       | 4,167               |       |
|                                        |       |                                     |       | (7.8%, Due 11/2010)                                     |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| Emdeon Business Services,         |       | Service-healthcare technology       |       | Senior Term Debt (7)                               |       | 2,359    |       | 2,027               |       |
| Inc.                                        |       | solutions                                |       | (5.8%, Due 11/2013)                                     |       |     |       |                |       |
|                                        |       |                                     |       | Senior Subordinated Term Debt (7)             |       | 2,011    |       | 1,720               |       |
|                                        |       |                                     |       | (8.8%, Due 5/2014)                                      |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| Finn Corporation                       |       | Manufacturing-landscape                  |       | Common Stock Warrants (8)                          |       | 37       |       | 1,578               |       |
|                                        |       | equipment                                |       |                                                              |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| GFRC Holdings LLC                 |       | Manufacturing-glass-fiber                |       | Line of Credit, $ 3,000  available            |       | —   |       | —              |       |
|                                        |       | reinforced concrete                 |       | (6.7%, Due 12/2010)                                     |       |     |       |                |       |
|                                        |       |                                     |       | Senior Term Debt (6)                               |       | 7,362    |       | 7,105               |       |
|                                        |       |                                     |       | (9.3%, Due 12/2012)                                     |       |     |       |                |       |
|                                        |       |                                     |       | Senior Subordinated Term Debt (3) (6)    |       | 6,716    |       | 6,414               |       |
|                                        |       |                                     |       | (11.8%, Due 12/2012)                                    |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| Global Materials                       |       | Manufacturing-steel wool            |       | Senior Term Debt (3) (6)                      |       | 4,640    |       | 4,153               |       |
| Technologies, Inc.                     |       | products and metal fibers |       | (13.0%, Due 11/2009)                                    |       |     |       |                |       |
|                                        |       |                                     |       |                                                              |       |     |       |                |       |
| GTM Holdings, Inc. (2)       |       | Manufacturing-socks                      |       | Senior Term Debt (7)                               |       | 491      |       | 359                 |       |
|                                        |       |                                     |       | (8.5%, Due 10/2013)                                     |       |     |       |                |       |
|                                        |       |                                     |       | Senior Subordinated Term Debt (7)             |       | 500      |       | 325                 |       |
|                                        |       |                                     |       | (11.8%, Due 4/2014)                                     |       |     |       |                |       |
|                                             |            |                                          |            |                                                                   |            |          |            |                     |            |  |

 

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**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**SEPTEMBER 30, 2008**

**(DOLLARAMOUNTS IN THOUSANDS)**

 
| **Company**                                        | ** ** | **Industry**                                    | ** ** | **Investment (1)**                                           | ** ** | **Cost** | ** **  | **Fair Value** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------------------------|------------|----------|-------------|---------------------|------------|
| Greatwide Logistics                           |       | Service - logistics and          |       | Senior Term Debt (7) (10)                     |       | $        |  3,950 |                | $          |  2,765 |   |
| Services, Inc.                                |       | transportation                                  |       | (non-accrual, Due 12/2013)                              |       |     |        |                |       |
|                                               |       |                                            |       | Senior Subordinated Term Debt (7) (10)   |       | 2,000    |        | 700                 |       |
|                                               |       |                                            |       | (non-accrual, Due 6/2014)                               |       |     |        |                |       |
|                                               |       |                                            |       |                                                              |       |     |        |                |       |
| Harrington Holdings, Inc. (2)       |       | Service - healthcare products    |       | Senior Term Debt (7)                               |       | 2,463    |        | 2,192               |       |
|                                               |       | distribution                                    |       | (6.0%, Due 1/2014)                                      |       |     |        |                |       |
|                                               |       |                                            |       | Senior Subordinated Term Debt (7)             |       | 5,000    |        | 3,750               |       |
|                                               |       |                                            |       | (9.7%, Due 1/2014)                                      |       |     |        |                |       |
|                                               |       |                                            |       |                                                              |       |     |        |                |       |
| Heartland Communications                      |       | Service-radio station operator        |       | Line of Credit, $ 500 available (6) |       | 105      |        | 79                  |       |
| Group, LLC (2)                           |       |                                            |       | (10.0%, Due 12/2008)                                    |       |     |        |                |       |
|                                               |       |                                            |       | Senior Term Debt (6)                               |       | 4,523    |        | 3,386               |       |
|                                               |       |                                            |       | (10.0%, Due 5/2011)                                     |       |     |        |                |       |
|                                               |       |                                            |       |                                                              |       |     |        |                |       |
| Interfilm Holdings, Inc.                 |       | Service-slitter and distributor                 |       | Senior Term Debt (6)                               |       | 5,000    |        | 4,750               |       |
|                                               |       | of plastic films                           |       | (10.5%, Due 10/2012)                                    |       |     |        |                |       |
|                                               |       |                                            |       |                                                              |       |     |        |                |       |
| International Junior Golf                |       | Service-golf training                      |       | Line of Credit, $ 1,500  available (6)   |       | 1,400    |        | 1,288               |       |
| Training Acquisition Company             |       |                                            |       | (9.2%, Due 5/2010)                                      |       |     |        |                |       |
|                                               |       |                                            |       | Senior Term Debt (6)                               |       | 2,551    |        | 2,347               |       |
|                                               |       |                                            |       | (6.7%, Due 5/2012)                                      |       |     |        |                |       |
|                                               |       |                                            |       | Senior Term Debt (3) (6)                      |       | 2,500    |        | 2,288               |       |
|                                               |       |                                            |       | (10.5%, Due 5/2012)                                     |       |     |        |                |       |
|                                               |       |                                            |       |                                                              |       |     |        |                |       |
| It’s Just Lunch International, |       | Service-dating service                     |       | Line of Credit, $ 750 available (6) |       | 550      |        | 275                 |       |
| LLC                                                |       |                                            |       | (6.5%, Due 6/2009)                                      |       |     |        |                |       |
|                                               |       |                                            |       | Senior Term Debt (6)                               |       | 3,300    |        | 1,650               |       |
|                                               |       |                                            |       | (6.7%, Due 6/2011)                                      |       |     |        |                |       |
|                                               |       |                                            |       | Senior Term Debt (3) (6) (9)             |       | 500      |        | 250                 |       |
|                                               |       |                                            |       | (10.5%, Due 6/2011)                                     |       |     |        |                |       |
|                                               |       |                                            |       |                                                              |       |     |        |                |       |
| John Henry Holdings, Inc. (2)  |       | Manufacturing-packaging                         |       | Senior Subordinated Term Debt (7)             |       | 8,000    |        | 7,600               |       |
|                                               |       | products                                        |       | (11.6%, Due 6/2011)                                     |       |     |        |                |       |
|                                               |       |                                            |       |                                                              |       |     |        |                |       |
| Kinetek Acquisition Corp.                |       | Manufacturing-custom                            |       | Senior Term Debt (7)                               |       | 1,478    |        | 1,326               |       |
|                                               |       | engineered motors & controls |       | (6.2%, Due 11/2013)                                     |       |     |        |                |       |
|                                               |       |                                            |       | Senior Subordinated Term Debt (7)             |       | 1,508    |        | 1,275               |       |
|                                               |       |                                            |       | (9.2%, Due 5/2014)                                      |       |     |        |                |       |
|                                               |       |                                            |       |                                                              |       |     |        |                |       |
| KMBQ Corporation                              |       | Service-AM/FM radio                        |       | Line of Credit, $ 200 available (6) |       | 153      |        | 137                 |       |
|                                               |       | broadcaster                                     |       | (11.0%, Due 3/2010)                                     |       |     |        |                |       |
|                                               |       |                                            |       | Senior Term Debt (6)                               |       | 1,792    |        | 1,594               |       |
|                                               |       |                                            |       | (11.0%, Due 3/2010)                                     |       |     |        |                |       |
|                                               |       |                                            |       |                                                              |       |     |        |                |       |
| Legend Communications  of                     |       | Service-operator of radio                       |       | Line of Credit, $ 500 available (5) |       | 397      |        | 392                 |       |
| Wyoming LLC                                   |       | stations                                        |       | (11.0%, Due 6/2011)                                     |       |     |        |                |       |
|                                               |       |                                            |       | Senior Term Debt (5)                               |       | 9,250    |        | 9,134               |       |
|                                               |       |                                            |       | (11.0%, Due 6/2013)                                     |       |     |        |                |       |
|                                                    |            |                                                 |            |                                                                   |            |          |             |                     |            |  |  |

 

11

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**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**SEPTEMBER 30, 2008**

**(DOLLARAMOUNTS IN THOUSANDS)**

 
| **Company**                                     | ** ** | **Industry**                                 | ** ** | **Investment (1)**                                             | ** ** | **Cost** | ** **   | **Fair Value** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------|------------|----------|--------------|---------------------|------------|
| Lindmark Outdoor Advertising               |       | Service-advertising                          |       | Senior Subordinated Term Debt (6)               |       | $        |  11,421 |                | $          |  9,651 |   |
| LLC                                             |       |                                         |       | (11.0%, Due 10/2012)                                      |       |     |         |                |       |
|                                            |       |                                         |       |                                                                |       |     |         |                |       |
| Multi-Ag Media LLC (2)           |       | Service-dairy  magazine                 |       | Senior Term Debt (6)                                 |       | 2,072    |         | 1,853               |       |
|                                            |       | publisher/ information                       |       | (9.0%, Due 12/2009)                                       |       |     |         |                |       |
|                                            |       | database                                     |       |                                                                |       |     |         |                |       |
|                                            |       |                                         |       |                                                                |       |     |         |                |       |
| Newhall Holdings, Inc. (2)       |       | Service-distributor of personal    |       | Line of Credit, $ 4,000 available (6) |       | 2,100    |         | 1,880               |       |
|                                            |       | care products and supplements |       | (6.0%, Due 5/2010)                                        |       |     |         |                |       |
|                                            |       |                                         |       | Senior Term Debt (6)                                 |       | 4,230    |         | 3,807               |       |
|                                            |       |                                         |       | (8.3%, Due 5/2012)                                        |       |     |         |                |       |
|                                            |       |                                         |       | Senior Term Debt (3) (6)                        |       | 4,500    |         | 4,016               |       |
|                                            |       |                                         |       | (11.3%, Due 5/2012)                                       |       |     |         |                |       |
|                                            |       |                                         |       |                                                                |       |     |         |                |       |
| Northern Contours, Inc. (2)      |       | Manufacturing-veneer and                |       | Senior Subordinated Term Debt (6)               |       | 6,912    |         | 6,082               |       |
|                                            |       | laminate components                     |       | (10.0%, Due 5/2010)                                       |       |     |         |                |       |
|                                            |       |                                         |       |                                                                |       |     |         |                |       |
| Pinnacle Treatment Centers, Inc. |       | Service-Addiction treatment             |       | Line of Credit, $ 500 available            |       | —   |         | —              |       |
|                                            |       | centers                                      |       | (6.7%, Due 12/2009)                                       |       |     |         |                |       |
|                                            |       |                                         |       | Senior Term Debt (6)                                 |       | 3,550    |         | 3,319               |       |
|                                            |       |                                         |       | (8.5%, Due 12/2011)                                       |       |     |         |                |       |
|                                            |       |                                         |       | Senior Term Debt (3) (6)                        |       | 7,500    |         | 6,938               |       |
|                                            |       |                                         |       | (10.5%, Due 12/2011)                                      |       |     |         |                |       |
|                                            |       |                                         |       |                                                                |       |     |         |                |       |
| Precision Acquisition Group           |       | Manufacturing-consumable                     |       | Equipment Note, $ 1,500                              |       |     |         |                |       |
| Holdings, Inc. (2)                    |       | components for the aluminum   |       | available (6)                                                  |       | 1,000    |         | 993                 |       |
|                                            |       | industry                                     |       | (8.5%, Due 10/2011)                                       |       |     |         |                |       |
|                                            |       |                                         |       | Senior Term Debt (6)                                 |       | 4,750    |         | 4,714               |       |
|                                            |       |                                         |       | (8.5%, Due 10/2010)                                       |       |     |         |                |       |
|                                            |       |                                         |       | Senior Term Debt (3) (6)                        |       | 4,158    |         | 4,127               |       |
|                                            |       |                                         |       | (11.5%, Due 10/2010)                                      |       |     |         |                |       |
|                                            |       |                                         |       |                                                                |       |     |         |                |       |
| PROFITSystems Acquisition                       |       | Service-design and develop         |       | Line of Credit, $ 1,250  available              |       | —   |         | —              |       |
| Co. (2)                                    |       | ERP software                            |       | (6.7%, Due 7/2009)                                        |       |     |         |                |       |
|                                            |       |                                         |       | Senior Term Debt (6)                                 |       | 2,200    |         | 2,027               |       |
|                                            |       |                                         |       | (8.5%, Due 7/2011)                                        |       |     |         |                |       |
|                                            |       |                                         |       | Senior Term Debt (3) (6)                        |       | 2,900    |         | 2,657               |       |
|                                            |       |                                         |       | (10.5%, Due 7/2011)                                       |       |     |         |                |       |
|                                            |       |                                         |       |                                                                |       |     |         |                |       |
| Puerto Rico Cable  Acquisition        |       | Service-telecommunications                   |       | Senior Subordinated Term Debt (7)               |       | 7,189    |         | 5,570               |       |
| Company, Inc.                              |       |                                         |       | (11.3%, Due 1/2012)                                       |       |     |         |                |       |
|                                            |       |                                         |       |                                                                |       |     |         |                |       |
| RCS Management Holding Co.       |       | Service-healthcare supplies             |       | Senior Term Debt (3) (6)                        |       | 2,875    |         | 2,695               |       |
|                                            |       |                                         |       | (8.5%, Due 1/2011)                                        |       |     |         |                |       |
|                                            |       |                                         |       | Senior Term Debt (4) (6)                        |       | 3,060    |         | 2,815               |       |
|                                            |       |                                         |       | (10.5%, Due 1/2011)                                       |       |     |         |                |       |
|                                            |       |                                         |       |                                                                |       |     |         |                |       |
| RedPrairie Holding, Inc. (2)     |       | Service-design and develop         |       | Senior Term Debt (7)                                 |       | 4,412    |         | 4,014               |       |
|                                            |       | supply chain software              |       | (6.1%, Due 7/2012)                                        |       |     |         |                |       |
|                                            |       |                                         |       | Senior Subordinated Term Debt (7)               |       | 3,000    |         | 2,550               |       |
|                                            |       |                                         |       | (9.3%, Due 1/2013)                                        |       |     |         |                |       |
|                                                 |            |                                              |            |                                                                     |            |          |              |                     |            |  |  |

 

12

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**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**SEPTEMBER 30, 2008**

**(DOLLARAMOUNTS IN THOUSANDS)**

 
| **Company**                               | ** ** | **Industry**                                   | ** ** | **Investment (1)**                                             | ** ** | **Cost** | ** **  | **Fair Value** | ** ** |
|-------------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------------------------------|------------|----------|-------------|---------------------|------------|
| Reliable Biopharmaceutical           |       | Manufacturing-                                 |       | Line of Credit, $ 5,000  available (6)     |       | $        |  1,600 |                | $          |  1,528 |   |
| Holdings, Inc.                       |       | pharmaceutical and                             |       | (9.0%, Due 10/2010)                                       |       |     |        |                |       |
|                                      |       |  biochemical intermediates                |       | Mortgage Note (6)                                         |       | 7,407    |        | 7,147               |       |
|                                      |       |                                           |       | (9.5%, Due 10/2014)                                       |       |     |        |                |       |
|                                      |       |                                           |       | Senior Term Debt (6)                                 |       | 1,800    |        | 1,719               |       |
|                                      |       |                                           |       | (9.0%, Due 10/2012)                                       |       |     |        |                |       |
|                                      |       |                                           |       | Senior Term Debt (3) (6)                        |       | 11,933   |        | 11,352              |       |
|                                      |       |                                           |       | (11.0%, Due 10/2012)                                      |       |     |        |                |       |
|                                      |       |                                           |       | Senior Subordinated Term  Debt (6)                   |       | 6,000    |        | 5,445               |       |
|                                      |       |                                           |       | (12.0%, Due 10/2013)                                      |       |     |        |                |       |
|                                      |       |                                           |       | Common Stock Warrants (8)                            |       | 209      |        | —              |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| RiskMetrics Group Holdings,     |       | Service - develop risk and |       | Senior Term Debt (7)                                 |       | 1,936    |        | 1,812               |       |
| LLC                                       |       | wealth management solutions          |       | (5.8%, Due 1/2014)                                        |       |     |        |                |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| Saunders & Associates       |       | Manufacturing-equipment                        |       | Line of Credit, $ 2,500  available              |       | —   |        | —              |       |
|                                      |       |  provider  for frequency             |       | (6.9%, Due 5/2009)                                        |       |     |        |                |       |
|                                      |       | control devices                           |       | Senior Term Debt (6)                                 |       | 10,945   |        | 10,740              |       |
|                                      |       |                                           |       | (9.8%, Due 5/2013)                                        |       |     |        |                |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| SCI Cable, Inc.                 |       | Service-cable, internet, voice       |       | Senior Term Debt (6)                                 |       | 2,712    |        | 1,355               |       |
|                                      |       | provider                                       |       | (11.0%, Due 10/2008)                                      |       |     |        |                |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| Sunburst  Media-Louisiana, LLC            |       | Service-radio station operator       |       | Senior Term Debt (6)                                 |       | 7,857    |        | 6,728               |       |
|                                      |       |                                           |       | (9.5%, Due 6/2011)                                        |       |     |        |                |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| Sunshine Media Holdings         |       | Service-publisher  regional          |       | Line of Credit, $ 3,000 available (6) |       | 700      |        | 627                 |       |
|                                      |       | B2B trade magazines                       |       | (11.0%, Due 5/2010)                                       |       |     |        |                |       |
|                                      |       |                                           |       | Senior Term Debt (6)                                 |       | 17,000   |        | 15,300              |       |
|                                      |       |                                           |       | (11.0%, Due 5/2012)                                       |       |     |        |                |       |
|                                      |       |                                           |       | Senior Term Debt (3) (6)                        |       | 10,000   |        | 8,750               |       |
|                                      |       |                                           |       | (13.5%, Due 5/2012)                                       |       |     |        |                |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| Thibaut Acquisition Co.         |       | Service-design and  disbribute            |       | Line of Credit, $ 2,000 available (6) |       | 2,000    |        | 1,838               |       |
|                                      |       | wall covering                             |       | (7.0%, Due 1/2011)                                        |       |     |        |                |       |
|                                      |       |                                           |       | Senior Term Debt (6)                                 |       | 2,013    |        | 1,849               |       |
|                                      |       |                                           |       | (7.0%, Due 1/2011)                                        |       |     |        |                |       |
|                                      |       |                                           |       | Senior Term Debt (3) (6)                        |       | 3,000    |        | 2,685               |       |
|                                      |       |                                           |       | (10.5%, Due 1/2011)                                       |       |     |        |                |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| Tulsa Welding School            |       | Service-private welding                        |       | Line of credit, $ 2,000  available              |       | —   |        | —              |       |
|                                      |       | school                                         |       | (9.5%, 9/2011)                                                 |       |     |        |                |       |
|                                      |       |                                           |       | Senior Term Debt (5)                                 |       | 4,000    |        | 4,000               |       |
|                                      |       |                                           |       | (9.5%, 9/2013)                                                 |       |     |        |                |       |
|                                      |       |                                           |       | Senior Term Debt (5)                                 |       | 8,000    |        | 8,000               |       |
|                                      |       |                                           |       | (12.8%, 9/2013)                                                |       |     |        |                |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| United Maritime Group, LLC |       | Service-cargo transport                   |       | Senior Subordinated Term  Debt (7)                   |       | 1,000    |        | 950                 |       |
|                                      |       |                                           |       | (11.2%, Due 12/2013)                                      |       |     |        |                |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| Vanta Core                           |       | Service-acquisition of                         |       | Senior Subordinated Term  Debt (6)                   |       | 13,100   |        | 12,936              |       |
|                                      |       |  aggregate quarries                       |       | (12.0%, 8/2013)                                                |       |     |        |                |       |
|                                      |       |                                           |       |                                                                |       |     |        |                |       |
| Viapack, Inc. (2)               |       | Manufacturing-polyethylene                     |       | Senior Real Estate Term   Debt (6)         |       | 850      |        | 780                 |       |
|                                      |       | film                                           |       | (7.0%, Due 3/2011)                                        |       |     |        |                |       |
|                                      |       |                                           |       | Senior Term Debt (3) (6)                        |       | 4,091    |        | 3,733               |       |
|                                      |       |                                           |       | (11.3%, Due 3/2011)                                       |       |     |        |                |       |
|                                           |            |                                                |            |                                                                     |            |          |             |                     |            |  |  |

 

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**GLADSTONE CAPITAL CORPORATION**

**CONDENSEDCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)**

**SEPTEMBER 30, 2008**

**(DOLLARAMOUNTS IN THOUSANDS)**

 
| **Company**                                               | ** ** | **Industry**                               | ** ** | **Investment (1)**                                                        | ** **        | **Cost**   | ** **        | **Fair Value** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------------------------------------------|-------------------|------------|-------------------|---------------------|------------|
| Visual Edge Technology, Inc. (2)      |       | Service-office equipment              |       | Senior Subordinated Term   Debt (6)                        |              | $          |  5,000       |                | $          |  2,925 |   |
|                                                      |       | distribution                               |       | (11.5%, Due 8/2011)                                                  |              |       |              |                |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| Wesco Holdings, Inc. (2)                   |       | Service-aerospace parts and      |       | Senior Term Debt (7)                                            |              | 2,451      |              | 2,212               |       |
|                                                      |       | distribution                               |       | (6.0%, Due 9/2013)                                                   |              |       |              |                |       |
|                                                      |       |                                       |       | Senior Subordinated Term Debt (7)                          |              | 2,267      |              | 1,980               |       |
|                                                      |       |                                       |       | (9.5%, Due 3/2014)                                                   |              |       |              |                |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| Westlake Hardware, Inc. (2)                |       | Retail-hardware and variety      |       | Senior Subordinated Term   Debt (6)                        |              | 15,000     |              | 13,800              |       |
|                                                      |       |                                       |       | (9.0%, Due 1/2011)                                                   |              |       |              |                |       |
|                                                      |       |                                       |       | Senior Subordinated Term Debt (6)                          |              | 10,000     |              | 9,000               |       |
|                                                      |       |                                       |       | (10.3%, Due 1/2011)                                                  |              |       |              |                |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| Winchester Electronics                               |       | Manufacturing-high                         |       | Senior Term Debt (6)                                            |              | 1,699      |              | 1,563               |       |
|                                                      |       | bandwidth connectors  and                  |       | (8.0%, Due 5/2013)                                                   |              |       |              |                |       |
|                                                      |       | cables                                     |       | Senior Subordinated Term Debt (6)                          |              | 9,950      |              | 9,055               |       |
|                                                      |       |                                       |       | (13.0%, Due 6/2013)                                                  |              |       |              |                |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| WP Evenflo Group                                |       | Manufacturing-infant and              |       | Senior Term Debt (7)                                            |              | 1,910      |              | 1,595               |       |
| Holdings Inc. (2)                               |       | juvenile products                     |       | (5.3%, Due 2/2013)                                                   |              |       |              |                |       |
|                                                      |       |                                       |       | Senior Subordinated Term Debt (7)                          |              | 2,000      |              | 1,600               |       |
|                                                      |       |                                       |       | (8.8%, Due 2/2014)                                                   |              |       |              |                |       |
| **Total Non-Control/Non-Affiliate Investments** |       |                                       |       | **$**                                                                          | ** 448,356** |       | **$**             | ** 407,153**   |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| **CONTROL INVESTMENTS**                              |       |                                       |       |                                                                           |              |       |              |                |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| BERTL, Inc.                                          |       | Service-web-based evaluator           |       | Line of Credit, $ 700 available (11) (12)   |              | $          |  742         |                | $          |  — |   |
|                                                      |       | of digital imaging products |       | (8.7%, Due 10/2009)                                                  |              |       |              |                |       |
|                                                      |       |                                       |       | Common Stock (8)                                                     |              | 424        |              | —              |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| LYP Holdings Corp.                              |       | Service-yellow pages                       |       | Line of credit, $ 500 available (12)             |              | 75         |              | —              |       |
|                                                      |       | publishing                                 |       | (10.0%, 5/2009)                                                           |              |       |              |                |       |
|                                                      |       |                                       |       | Line of Credit, $ 3,000 available (10) (12) |              | 1,170      |              | —              |       |
|                                                      |       |                                       |       | (non-accrual, Due 6/2009)                                            |              |       |              |                |       |
|                                                      |       |                                       |       | Senior Term Debt (10) (12)                                 |              | 2,688      |              | —              |       |
|                                                      |       |                                       |       | (non-accrual, Due 6/2011)                                            |              |       |              |                |       |
|                                                      |       |                                       |       | Senior Term Debt (3) (10)  (12)                            |              | 2,750      |              | —              |       |
|                                                      |       |                                       |       | (non-accrual, Due 6/2011)                                            |              |       |              |                |       |
|                                                      |       |                                       |       | Common Stock Warrants (8)                                       |              | 1          |              | —              |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| U.S. Healthcare                                      |       | Service-magazine                           |       | Line of credit, $ 200 available (10)             |              | 90         |              | 90                  |       |
| Communications, Inc.                                      |       | publisher/operator                         |       | (non-accrual, Due 3/2010)                                            |              |       |              |                |       |
|                                                      |       |                                       |       | Line of credit, $ 450 available (10)             |              | 450        |              | 450                 |       |
|                                                      |       |                                       |       | (non-accrual, Due 3/2010)                                            |              |       |              |                |       |
|                                                      |       |                                       |       | Common Stock (8)                                                     |              | 2,470      |              | 240                 |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| Western Directories, Inc.                       |       | Service-directory publisher           |       | Line of credit, $ 1,000 available (12)           |              | 69         |              | —              |       |
|                                                      |       |                                       |       | (10%, Due 8/2009)                                                    |              |       |              |                |       |
|                                                      |       |                                       |       | Preferred Stock (8)                                                  |              | 1,584      |              | —              |       |
|                                                      |       |                                       |       | Common Stock (8)                                                     |              | 1          |              | —              |       |
|                                                      |       |                                       |       |                                                                           |              |       |              |                |       |
| **Total Control Investments**                   |       |                                       |       |                                                                           |              | **$**      | ** 12,514**  | ** **          | **$**      | ** 780** |   |
| ** **                                                |       |                                       |       |                                                                           |              | ** ** | ** **        | ** **          |       |
| **Total Investments**                                |       |                                       |       |                                                                           |              | **$**      | ** 460,870** | ** **          | **$**      | ** 407,933** |   |

 

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| (1)  | Percentage  represents interest rates in effect at September 30, 2008 and due date  represents the contractual maturity date.                                                                                                                                                                               |
|------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  | Certain of the listed securities are issued by  affiliate(s) of the indicated portfolio company.                                                                                                                                                                                                            |
| (3)  | Last Out Tranche of senior debt, meaning if the company is  liquidated then the holder of the Last Out Tranche is paid after the senior  debt.                                                                                                                                                                   |
| (4)  | Last Out Tranche of senior debt, meaning if the company is  liquidated then the holder of the Last Out Tranche is paid after the senior  debt, however the debt is junior to another Last Out Tranche.                                                                                                           |
| (5)  | Investment valued at cost due to recent acquisition.                                                                                                                                                                                                                                                             |
| (6)  | Fair value was based on opinions of value submitted by  Standard & Poor’s Securities Evaluations, Inc.                                                                                                                                                                                        |
| (7)  | Marketable securities, such as syndicated loans, are valued  based on the indicative bid price, as of September 30, 2008, from the  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 the senior  term debt facility, subject to certain conditions including Gladstone  Capital’s approval, borrowings of $500 were outstanding at September 30,  2008.                                                                             |
| (10) | Greatwide, LYP Holdings and U.S. Healthcare are currently 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 currently restructuring the line of  credit. BERTL interest is currently being capitalized as Paid in Kind (“PIK”)  interest. Please refer to Note 2 “Summary of Significant Accounting  Policies.” |
| (12) | Fair value was based on the total enterprise value of the  issuer, which was calculated using a liquidity waterfall approach.                                                                                                                                                                                    |

 

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

 

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**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(UNAUDITED)**

 
| ** **                                                                         | ** ** | **Three Months Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| INVESTMENT INCOME                                                                  |       |                                                    |       |   |   |
| Interest income – Non-Control/Non-Affiliate  investments                      |       | $                                                       | 11,661     |   | $ | 11,125 |   |
| Interest income – Control investments                                         |       | 20                                                      |       | 14 |   |
| Interest income – Cash                                                        |       | 10                                                      |       | 144 |   |
| Interest income – Notes receivable from employees  (Refer to Note 4)          |       | 117                                                     |       | 118 |   |
| Total investment income                                                            |       | 11,808                                                  |       | 11,401 |   |
|                                                                               |       |                                                    |       |   |   |
| EXPENSES                                                                           |       |                                                    |       |   |   |
| Interest expense                                                                   |       | 2,461                                                   |       | 2,356 |   |
| Loan servicing fee (Refer to Note 4)                                               |       | 1,623                                                   |       | 1,381 |   |
| Base management fee (Refer to Note 4)                                              |       | 434                                                     |       | 578 |   |
| Incentive fee (Refer to Note 4)                                                    |       | 1,176                                                   |       | 1,461 |   |
| Administration fee (Refer to Note 4)                                               |       | 227                                                     |       | 212 |   |
| Professional fees                                                                  |       | 313                                                     |       | 129 |   |
| Amortization of deferred financing fees                                            |       | 719                                                     |       | 74 |   |
| Stockholder related costs                                                          |       | 89                                                      |       | 120 |   |
| Directors fees                                                                     |       | 48                                                      |       | 54 |   |
| Insurance expense                                                                  |       | 57                                                      |       | 54 |   |
| Other expenses                                                                     |       | 66                                                      |       | 65 |   |
| Expenses before credit from Adviser                                                |       | 7,213                                                   |       | 6,484 |   |
| Credit to base management and incentive fees from  Adviser (Refer to Note 4)       |       | (1,286                                                  | )          | (2,386 | ) |
| Total expenses net of credit to base management and  incentive fees                |       | 5,927                                                   |       | 4,098 |   |
|                                                                               |       |                                                    |       |   |   |
| NET INVESTMENT INCOME                                                              |       | 5,881                                                   |       | 7,303 |   |
|                                                                               |       |                                                    |       |   |   |
| REALIZED AND UNREALIZED (LOSS) GAIN ON INVESTMENTS  AND DERIVATIVE:                |       |                                                    |       |   |   |
|                                                                               |       |                                                    |       |   |   |
| Net realized loss on sale of investments                                           |       | (1,731                                                  | )          | — |   |
| Realized gain on settlement of derivative                                          |       | —                                                  |       | 6 |   |
| Net unrealized depreciation on derivative                                          |       | —                                                  |       | (11 | ) |
| Net unrealized depreciation on investments                                         |       | (13,253                                                 | )          | (5,398 | ) |
| Net loss on investments                                                            |       | (14,984                                                 | )          | (5,403 | ) |
|                                                                               |       |                                                    |       |   |   |
| NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM  OPERATIONS                   |       | $                                                       | (9,103     | ) | $ | 1,900 |   |
|                                                                               |       |                                                    |       |   |   |
| NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM  OPERATIONS PER COMMON SHARE: |       |                                                    |       |   |   |
| Basic and Diluted                                                                  |       | $                                                       | (0.43      | ) | $ | 0.11 |   |
|                                                                               |       |                                                    |       |   |   |
| WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING:                               |       |                                                    |       |   |   |
| Basic and Diluted                                                                  |       | 21,087,574                                              |       | 16,953,703 |   |

 

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

 

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**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                                       | ** ** | **Three Months Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| *Operations:*                                                    |       |                                                    |       |   |   |
| Net investment income                                            |       | $                                                       | 5,881      |   | $ | 7,303 |   |
| Net realized loss on sale of investments                         |       | (1,731                                                  | )          | — |   |
| Realized gain on settlement of derivative                        |       | —                                                  |       | 6 |   |
| Unrealized depreciation on derivative                            |       | —                                                  |       | (11 | ) |
| Net unrealized depreciation on investments                       |       | (13,253                                                 | )          | (5,398 | ) |
| Net (decrease) increase in net assets from  operations           |       | (9,103                                                  | )          | 1,900 |   |
|                                                             |       |                                                    |       |   |   |
| *Capital transactions:*                                          |       |                                                    |       |   |   |
| Issuance of common stock under shelf offering                    |       | —                                                  |       | 50,801 |   |
| Shelf offering costs                                             |       | (3                                                      | )          | (279 | ) |
| Distributions to stockholders                                    |       | (8,856                                                  | )          | (7,355 | ) |
| Repayment of principal on employee notes                         |       | 4                                                       |       | 6 |   |
| Net (decrease) increase in net assets from capital  transactions |       | (8,855                                                  | )          | 43,173 |   |
|                                                             |       |                                                    |       |   |   |
| Total (decrease) increase in net assets                          |       | (17,958                                                 | )          | 45,073 |   |
| Net assets at beginning of year                                  |       | 271,748                                                 |       | 220,959 |   |
| Net assets at end of period                                      |       | $                                                       | 253,790    |   | $ | 266,032 |   |

 

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

 

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**GLADSTONE CAPITALCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(DOLLARAMOUNTS IN THOUSANDS)**

**(UNAUDITED)**

 
| ** **                                                                                                                                         | ** ** | **Three Months ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                                           |       |                                                    |       |   |   |
| Net (decrease) increase in net assets resulting from  operations                                                                                   |       | $                                                       | (9,103     | ) | $ | 1,900 |   |
| Adjustments to reconcile net (decrease) increase in  net assets resulting from operations to net cash provided by (used in)  operating activities: |       |                                                    |       |   |   |
| Purchase of investments                                                                                                                            |       | (8,702                                                  | )          | (73,341 | ) |
| Principal repayments on investments                                                                                                                |       | 14,927                                                  |       | 4,047 |   |
| Proceeds from sale of investments                                                                                                                  |       | 2,212                                                   |       | — |   |
| Net amortization of premiums and discounts                                                                                                         |       | (49                                                     | )          | 93 |   |
| Increase in investment balance due to payment in  kind interest                                                                                    |       | (17                                                     | )          | (10 | ) |
| Realized loss on investments                                                                                                                       |       | 1,731                                                   |       | — |   |
| Amortization of deferred financing fees                                                                                                            |       | 719                                                     |       | 74 |   |
| Unrealized depreciation on derivative                                                                                                              |       | —                                                  |       | 11 |   |
| Change in net unrealized depreciation on investments                                                                                               |       | 13,253                                                  |       | 5,398 |   |
| Decrease in interest receivable                                                                                                                    |       | 902                                                     |       | 174 |   |
| Increase in funds due from custodian                                                                                                               |       | (2,760                                                  | )          | (1,586 | ) |
| Decrease in prepaid assets                                                                                                                         |       | (15                                                     | )          | (68 | ) |
| (Increase) decrease in other assets                                                                                                                |       | (203                                                    | )          | 66 |   |
| Increase in accounts payable                                                                                                                       |       | —                                                  |       | 1 |   |
| (Decrease) increase in interest payable                                                                                                            |       | (103                                                    | )          | 8 |   |
| Decrease in accrued expenses and deferred  liabilities                                                                                             |       | (181                                                    | )          | (53 | ) |
| Increase (decrease) in fees due to affiliate (Refer  to Note 4)                                                                                    |       | 268                                                     |       | (697 | ) |
| Decrease in administration fee due to Gladstone  Administration (Refer to Note 4)                                                                  |       | (20                                                     | )          | (26 | ) |
| (Decrease) increase in funds held in escrow                                                                                                        |       | (158                                                    | )          | 157 |   |
| Net cash provided by (used in) operating activities                                                                                                |       | 12,701                                                  |       | (63,852 | ) |
|                                                                                                                                               |       |                                                    |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                                                          |       |                                                    |       |   |   |
| Net proceeds from the issuance of common stock                                                                                                     |       | (3                                                      | )          | 50,522 |   |
| Borrowings from the line of credit                                                                                                                 |       | 22,500                                                  |       | 75,000 |   |
| Repayments on the line of credit                                                                                                                   |       | (27,060                                                 | )          | (57,609 | ) |
| Distributions paid                                                                                                                                 |       | (8,856                                                  | )          | (7,355 | ) |
| Receipt of principal on notes receivable – employees  (Refer to Note 4)                                                                       |       | 4                                                       |       | 6 |   |
| Deferred financing fees                                                                                                                            |       | (23                                                     | )          | (20 | ) |
| Net cash (used in) provided by financing activities                                                                                                |       | (13,438                                                 | )          | 60,544 |   |
|                                                                                                                                               |       |                                                    |       |   |   |
| **NET DECREASE IN CASH**                                                                                                                           |       | (737                                                    | )          | (3,308 | ) |
| **CASH, BEGINNING OF PERIOD**                                                                                                                      |       | 6,493                                                   |       | 8,839 |   |
| **CASH, END OF PERIOD**                                                                                                                            |       | $                                                       | 5,756      |   | $ | 5,531 |   |

 

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

 

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**GLADSTONE CAPITALCORPORATION**

**FINANCIALHIGHLIGHTS**

**(DOLLAR AMOUNTS INTHOUSANDS, EXCEPT PER SHARE AND PER UNIT DATA)**

**(UNAUDITED)**

 
| ** **                                                       | ** ** | **Three Months Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| Per Share Data (1)                                               |       |                                                    |       |   |   |
| Net asset value at beginning of period                           |       | $                                                       | 12.89      |   | $ | 14.97 |   |
| *Income from investment operations:*                             |       |                                                    |       |   |   |
| Net investment income (2)                                        |       | 0.28                                                    |       | 0.43 |   |
| Net realized loss on sale of investments (2)                     |       | (0.08                                                   | )          | — |   |
| Net unrealized depreciation on investments (2)                   |       | (0.63                                                   | )          | (0.32 | ) |
| Total from investment operations                                 |       | (0.43                                                   | )          | 0.11 |   |
|                                                             |       |                                                    |       |   |   |
| Distributions to stockholders (3)                                |       | (0.42                                                   | )          | (0.42 | ) |
| Issuance of common stock under shelf offering                    |       | —                                                  |       | 0.44 |   |
| Offering costs                                                   |       | —                                                  |       | (0.02 | ) |
| Net asset value at end of period                                 |       | $                                                       | 12.04      |   | $ | 15.08 |   |
|                                                             |       |                                                    |       |   |   |
| Per share market value at beginning of period                    |       | $                                                       | 15.24      |   | $ | 19.52 |   |
| Per share market value at end of period                          |       | $                                                       | 8.09       |   | $ | 17.01 |   |
| Total return (4)(5)                                              |       | (44.09                                                  | )%         | (10.86 | )% |
| Shares outstanding at end of period                              |       | 21,087,574                                              |       | 17,637,574 |   |
|                                                             |       |                                                    |       |   |   |
| Statement of Assets and Liabilities Data:                        |       |                                                    |       |   |   |
| Net assets at end of period                                      |       | $                                                       | 253,790    |   | $ | 266,032 |   |
| Average net assets (6)                                           |       | $                                                       | 262,001    |   | $ | 265,360 |   |
| Senior Securities Data:                                          |       |                                                    |       |   |   |
| Borrowings under line of credit                                  |       | $                                                       | 146,470    |   | $ | 161,831 |   |
| Asset coverage ratio (7)(8)                                      |       | 273                                                     | %          | 264 | % |
| Asset coverage per unit (8)                                      |       | $                                                       | 2,733      |   | $ | 2,644 |   |
| Ratios/Supplemental Data:                                        |       |                                                    |       |   |   |
| Ratio of expenses to average net assets-annualized  (9)          |       | 11.01                                                   | %          | 9.77 | % |
| Ratio of net expenses to average net  assets-annualized (10)     |       | 9.05                                                    | %          | 6.18 | % |
| Ratio of net investment income to average net  assets-annualized |       | 8.98                                                    | %          | 11.01 | % |

 

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

(4)         Total return equals the change in 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)         Asa business development company, the Company is generally required to maintain aratio of at least 200% of total assets, less all liabilities and indebtednessnot represented by senior securities, to total borrowings.

(8)         Assetcoverage ratio is the ratio of the carrying value of the Company’s totalconsolidated assets, less all liabilities and indebtedness not represented bysenior securities, to the aggregate amount of senior securities representingindebtedness. Asset coverage per unit is the asset coverage ratio expressed interms of dollar amounts per $1,000 of indebtedness.

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

(10) Ratioof net expenses to average net assets is computed using total expenses net ofcredits from Adviser to the base management and incentive fees and includingincome tax expense.

 

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

 

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**GLADSTONECAPITAL CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIALSTATEMENTS**

**DECEMBER31, 2008**

**(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, or BDC, under the Investment Company Act of 1940, asamended (the “1940 Act”).  In addition,the Company has elected to be treated for tax purposes as a regulatedinvestment company (“RIC”) under the Internal Revenue Code of 1986, as amended(the “Code”).  The Company’s investmentobjectives are to achieve a high level of current income by investing in debtand equity securities of established private businesses.

 

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

 

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 OF SIGNIFICANT 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 management, alladjustments, consisting solely of normal recurring accruals, necessary for thefair statement of financial statements for the interim periods have beenincluded.  The current period’s resultsof operations are not necessarily indicative of results that ultimately may beachieved for the year.  The interimfinancial statements and notes thereto should be read in conjunction with thefinancial statements and notes thereto included in the Company’s Form 10-Kfor the fiscal year ended September 30, 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 Boardof Directors and each quarter the Board of Directors reviews whether theAdviser has applied the Policy consistently, and votes whether or not to acceptthe recommended valuation of the Company’s investment portfolio.

 

The Company uses generally accepted 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 would use such appraisals to value the investment the Company has inthat business if it was determined that the appraisals were the best estimateof fair value.

 

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

 

**Securities for which a limited market exists:**The Company 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, evaluates variances inprices and other market insights to determine if any available quote prices arereliable.  If the Company concludes thatquotes based on active markets or trading activity may be relied upon, firm bidprices are requested; however, if a firm bid price is unavailable, the Companybases the value of the security upon the indicative bid price offered by therespective originating syndication agent’s trading desk, or secondary desk, onor near the valuation date. To the extent that the Company uses the indicativebid price as a basis for valuing the security, the Adviser may take furthersteps to consider additional information to validate that price in accordancewith the Policy.

 

In the event these limited markets become illiquid such that marketprices are no longer readily available, the Company will value its syndicatedloans using estimated net present values of the future cash flows or discountedcash flows (“DCF”). The use of a DCF methodology follows that prescribed byFASB Staff Position No. 157-3, “*Determiningthe Fair Value of a Financial Asset When the Market for That Asset Is NotActive”* (“FSP No. 157-3”), which provides guidance on the useof 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, the Companyconsidered multiple inputs such as a risk-adjusted discount rate thatincorporates adjustments that market participants would make both fornonperformance and liquidity risks.  Assuch, the Company developed a modified discount rate approach that incorporatesrisk premiums including, among others, increased probability of default, orhigher loss given default, or increased liquidity risk.

 

The DCF valuationsapplied to the syndicated loans provide an estimate of what the Companybelieves a market participant would pay to purchase a syndicated loan in anactive market, thereby establishing a fair value.  The Company will continue to apply the DCFmethodology in illiquid markets until quoted prices based on trading activityare deemed reliable.

 

**Securities for which no market exists:**The valuation 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 and equity securities; and (3) portfolioinvestments in non-controlled companies comprised of a bundle of securities,which can include debt and/or equity securities.

 

**(1)****         Portfolio investmentscomprised solely of debt securities:** Debt securities that are not publiclytraded on an established securities market, or for which a limited market doesnot exist (“Non-Public Debt Securities”), and that are issued by portfoliocompanies where the Company has no equity, or equity-like securities, are fairvalued in accordance with the terms of the Policy, which utilizes opinions ofvalue submitted to the Company by Standard & Poor’s SecuritiesEvaluations, Inc. (“SPSE”). The Company may also submit Paid in Kind (“PIK”)interest to SPSE for their evaluation when it is determined the PIK interest islikely to be received.

 

**(2)****         Portfolio investments incontrolled companies comprised of a bundle of investments, which can includedebt and equity securities:** The Company values Non-Public Debt Securitiesand equity or equity-like securities (e.g. preferred equity, equity, or otherequity-like securities) that are purchased together as part of a package, wherewe have control or could gain control through an option or warrant security,both the debt and equity securities of the portfolio investment would exit inthe mergers and acquisition market as the principal market, generally through asale or recapitalization of the portfolio company.

 

**(3)****         Portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and/or equity securities:**The Company values Non-Public DebtSecurities and/or equity or equity-like securities that are purchased togetherfrom the same “non-controlled” portfolio company, or issuer, by valuing thedebt portion with SPSE (as described above) and valuing the equity portionbased principally on the total enterprise value of the issuer, which iscalculated using a liquidity waterfall approach.

 

Due to the uncertainty inherent in the valuationprocess, such estimates of fair value may differ significantly from the valuesthat would have been obtained had a ready market for the securities existed,and the differences could be material. Additionally, changes in the marketenvironment and other events that may occur over the life of the investmentsmay cause the gains or losses 

 

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ultimately realized on these investments to bedifferent than the valuations currently assigned. There is no single standardfor determining fair value in good faith, as fair value depends upon circumstancesof each individual case. In general, fair value is the amount that the Companymight reasonably expect to receive upon the current sale of the security in anarms-length transaction in the security’s principal market.

 

*Interest Income Recognition*

 

Interest income, adjusted for amortizationof premiums and acquisition costs and for the accretion of discounts, isrecorded on the accrual basis to the extent that such amounts are expected tobe collected. The Company stops accruing interest on its investments when it isdetermined that interest is no longer collectible.  At December 31, 2008, oneNon-Control/Non-Affiliate investment and two Control investments were onnon-accrual with an aggregate cost basis of approximately $9.2 million or 2.0%of the 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 $13.1 million 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.

 

*Paid in Kind Interest*

 

TheCompany has a 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 $17 and $14for the three months ended December 31, 2008 and 2007, respectively, frominvestments on the accompanying consolidated statements of operations.

 

*Recent Accounting Pronouncements*

 

In October 2008, the Financial AccountingStandards Board issued FSP No. 157-3, *“Determining the Fair Value of a FinancialAsset When the Market for That Asset Is Not Active*.*”*  FSP No. 157-3clarifies the application of SFAS No. 157 in a market that is not active.More specifically, FSP No. 157-3 states that significant judgment shouldbe applied to determine if observable data in a dislocated market representsforced liquidations or distressed sales and are not representative of fairvalue in an orderly transaction.  FSP No. 157-3also provides further guidance that the use of a reporting entity’s ownassumptions about future cash flows and appropriately risk-adjusted discountrates is acceptable when relevant observable inputs are not available.  In addition, FSP No. 157-3 providesguidance on the level of reliance of broker quotes or pricing services whenmeasuring fair value in a non active market stating that less reliance shouldbe placed on a quote that does not reflect actual market transactions and aquote that is not a binding offer.  Theguidance in FSP No. 157-3 is effective upon issuance for all financialstatements that have not been issued and any changes in valuation techniques asa result of applying FSP No. 157-3 are accounted for as a change inaccounting estimate. The Company adopted this pronouncement during the quarterended December 31, 2008.

 

In March 2008, the FASB issued SFAS No. 161,“*Disclosures about Derivative Instruments and HedgingActivities*” (“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 Company does not believe the adoption of this pronouncement willhave a material impact on the reporting of its derivatives.

 

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

 

In February 2007, the FASB issued SFAS No. 159,*“The Fair Value Option for Financial Assets and Financial Liabilities”*(“SFAS 159”).  Among other requirements,SFAS 159 permits entities to choose to measure many financial instruments andcertain other items at fair value.  SFAS159 is effective for the first fiscal year that begins after November 15,2007.  The Company adopted SFAS 159 on October 1,2008.  Based upon its review, the Companyelected not to adopt SFAS 159 for financial liabilities that were in itsportfolio as of September 30, 2008. However, the Company may elect to apply SFAS 159 to future financialliabilities. The impact on its financials from the potential application ofSFAS 159 to a future liability would depend upon the attributes of the specificfinancial 

 

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liability.  TheCompany’s adoption of SFAS 159 had no material impact on its consolidatedfinancial statements as of December 31, 2008.

 

**NOTE 3. INVESTMENTS**

 

In September 2006, the FASB issued SFAS No. 157, *“Fair ValueMeasurements”* (“SFAS 157”), which, for financial assets, iseffective for fiscal years beginning after November 15, 2007, with earlyadoption permitted. The Company adopted SFAS 157 on October 1, 2008.  The adoption of SFAS 157 did not have amaterial impact on the consolidated financial statements as of and for thethree months ended December 31, 2008. In part, SFAS 157 defines fair value, establishes a framework formeasuring 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 valuationmethodology are quoted prices (unadjusted) for identical assets orliabilities in active markets;

 

·                  *Level 2 –* inputs to the valuationmethodology include quoted prices for similar assets and liabilities in activemarkets, and inputs that are observable for the asset or liability, eitherdirectly or indirectly, for substantially the full term of the financialinstrument. Level 2 inputs are in those markets for which there are fewtransactions, the prices are not current, little public information exists orinstances where prices vary substantially over time or among brokered marketmakers; and

 

·                  *Level 3*– inputs to the valuationmethodology are unobservable and significant to the fair value measurement.Unobservable inputs are those inputs that reflect the Company’s own assumptionsthat market participants would use to price the asset or liability based uponthe best available information.

 

At December 31, 2008, all of the Company’s assets were valuedusing Level 3 inputs.

 

The following table presents the financial instruments carried at fairvalue as of December 31, 2008, by caption on the accompanying condensedconsolidated statements of assets and liabilities for each of the three levelsof hierarchy established by SFAS 157:

 
| ** **                            | ** ** | **As of December 31, 2008** | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|
| ** **                            | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                            | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in Condensed** | ** ** |
| ** **                            | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated Statements of** | ** ** |
| ** **                            | ** ** | **Level 1**                                | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Non-Control/Non-Affiliate investments |       | $                                               | —     |   | $ | — |   | $ | 384,012 |   | $ | 384,012 |   |
| Control investments                   |       | —                                          |       | — |   | 566 |   | 566 |   |
| Total investments at fair value       |       | $                                               | —     |   | $ | — |   | $ | 384,578 |   | $ | 384,578 |   |

 

*Changes in Level 3 Fair ValueMeasurements*

 

The following table provides a roll-forward in the changes in fairvalue during the three-month period from September 30, 2008 to December 31,2008 for all investments for which the Company determines fair value using unobservable(Level 3) factors. When a determination is made to classify a financialinstrument within Level 3 of the valuation hierarchy, the determination isbased upon the significance of the unobservable factors to the overall fairvalue measurement. However, Level 3 financial instruments typically include, inaddition to the unobservable or Level 3 components, observable components (thatis, components that are actively quoted and can be validated to externalsources). Accordingly, the losses in the table below include changes in fairvalue due in part to observable factors that are part of the valuationmethodology.

 

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

 
| ** **                                        | ** ** | **Non-Control/**  | ** ** | ** **      | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                        | ** ** | **Non-Affiliate** | ** ** | **Control**     | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **Investments**   | ** ** | **Investments** | ** ** | **Total**  | ** ** |
| **Three months ended December 31, 2008:**    |       |              |       |            |       |       |       |
| Fair value at September 30, 2008             |       | $                 | 407,153    |            | $          | 780        |       | $ | 407,933 |   |
| Total realized/unrealized losses (a)              |       | (14,172           | )          | (812            | )          | (14,984    | )          |
| New investments, repayments, and settlements, net |       | (8,969            | )          | 598             |       | (8,371     | )          |
| Transfers in (out) of Level 3                     |       | —            |       | —          |       | —     |       |
| Fair value as of December 31, 2008           |       | $                 | 384,012    |            | $          | 566        |       | $ | 384,578 |   |

 

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(a)          Realized/unrealizedlosses are reported on the accompanying condensed consolidated statements ofoperations for the three months ended December 31, 2008.

 

*Non-Control/Non-Affiliate Investments*

 

At December 31, 2008 and September 30, 2008, the Company heldNon-Control/Non-Affiliate investments in the aggregate of approximately $384.0million and $407.2 million, at fair value, respectively.

 

*Control Investments*

 

At December 31, 2008 and September 30, 2008, the Company heldControl investments in the aggregate of approximately $0.6 million and $0.8million at fair value, respectively.  At December 31,2008, the control investments were comprised of BERTL, Inc. (“BERTL”),U.S. Healthcare Communications, Inc. (“U.S. Healthcare”), LYP HoldingsCorp. (“LYP Holdings”) and Western Directories, Inc. “(Western Directories”).

 

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

 

·                  *U.S. Healthcare:* The Company offered at public sale certainassets of U.S Healthcare Communications, LLC on January 30, 2008, consistinggenerally of all fixtures of tangible and intangible personal property.  The Company acquired these assets in thesale, through a newly formed subsidiary, U.S. Healthcare, and intends tocontinue the business under its control. U.S. Healthcare is a service-magazine operator.

 

·                  *LYP Holdings:*On July 2, 2008, the Company acquiredfrom the previous owner certain assets of LocalTel, Inc, consisting of alltangible and intangible personal property. The Company acquired these assets through a newly formed subsidiary, LYPHoldings, and intends to continue the business under its control.  LYP Holdings is a publisher of communityyellow page directories.

 

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

 

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*Investment Concentrations*

 

Approximately 64.5% of the aggregate fair value of theCompany’s investment portfolio at December 31, 2008 was senior debt,approximately 35.0% was senior subordinated debt, no investments were in juniorsubordinated debt, and approximately 0.5% was in equity securities.  At December 31, 2008, the Company hadaggregate investments in 61 portfolio companies.  The following table outlines the Company’sinvestments by type at December 31, 2008 and September 30, 2008:

 
| ** **                    | ** ** | **December 31, 2008** | ** ** | **September 30, 2008** | ** ** |
|-------------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **                    | ** ** | **Cost**                        | ** ** | **Fair Value**              | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Senior Term Debt              |       | $                               | 288,204    |                             | $          | 247,886 |   | $ | 297,910 |   | $ | 265,297 |   |
| Senior Subordinated Term Debt |       | 157,532                         |       | 134,694                          |       | 157,927 |   | 140,676 |   |
| Preferred Equity Securities   |       | 1,584                           |       | —                           |       | 1,584 |   | — |   |
| Common Equity Securities      |       | 3,449                           |       | 1,998                            |       | 3,449 |   | 1,960 |   |
| Total Investments             |       | $                               | 450,769    |                             | $          | 384,578 |   | $ | 460,870 |   | $ | 407,933 |   |

 

Investmentsat fair value consisted of the following industry classifications as of December 31,2008 and September 30, 2008:

 
| ** **                                                   | ** ** | **December 31, 2008** | ** ** | **September 30, 2008** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **                                                   | ** ** | ** **                      | ** ** | **Percentage**                   | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Industry Classification**                             | ** ** | **Fair Value**             | ** ** | **Total  Investments**           | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Aerospace & Defense                                 |       | $                               | 3,443      |                             | 0.9        | % | 1.4 | % | $ | 4,192 |   | 1.0 | % | 1.6 | % |
| Automobile                                                   |       | 4,564                           |       | 1.2                              | %          | 1.8 | % | 5,055 |   | 1.2 | % | 1.9 | % |
| Broadcast (TV & Radio)                              |       | 49,257                          |       | 12.8                             | %          | 19.4 | % | 52,336 |   | 12.8 | % | 19.2 | % |
| Buildings and Real Estate                                    |       | 13,031                          |       | 3.4                              | %          | 5.1 | % | 13,519 |   | 3.3 | % | 5.0 | % |
| Cargo Transport                                              |       | 15,626                          |       | 4.1                              | %          | 6.2 | % | 15,805 |   | 3.9 | % | 5.8 | % |
| Chemicals, Plastics & Rubber                        |       | 15,783                          |       | 4.1                              | %          | 6.2 | % | 16,375 |   | 4.0 | % | 6.0 | % |
| Diversified/Conglomerate Manufacturing                       |       | 2,760                           |       | 0.7                              | %          | 1.1 | % | 3,195 |   | 0.8 | % | 1.2 | % |
| Diversified Natural Resources, Precious Metals and  Minerals |       | 13,518                          |       | 3.5                              | %          | 5.3 | % | 12,936 |   | 3.2 | % | 4.8 | % |
| Electronics                                                  |       | 33,501                          |       | 8.7                              | %          | 13.2 | % | 35,208 |   | 8.6 | % | 13.0 | % |
| Farming & Agriculture                               |       | 10,038                          |       | 2.6                              | %          | 4.0 | % | 10,031 |   | 2.5 | % | 3.7 | % |
| Finance                                                      |       | 1,448                           |       | 0.4                              | %          | 0.6 | % | 1,812 |   | 0.4 | % | 0.7 | % |
| Healthcare, Education & Childcare                   |       | 72,787                          |       | 18.9                             | %          | 28.7 | % | 76,642 |   | 18.8 | % | 28.2 | % |
| Home & Office Furnishings                           |       | 14,057                          |       | 3.7                              | %          | 5.6 | % | 15,379 |   | 3.8 | % | 5.7 | % |
| Leisure, Amusement, Movies & Entertainment          |       | 7,495                           |       | 1.9                              | %          | 2.9 | % | 8,097 |   | 2.0 | % | 3.0 | % |
| Machinery                                                    |       | 9,567                           |       | 2.5                              | %          | 3.8 | % | 9,834 |   | 2.4 | % | 3.6 | % |
| Mining, Steel, Iron & Non-Precious Metals           |       | 24,209                          |       | 6.3                              | %          | 9.5 | % | 25,095 |   | 6.2 | % | 9.2 | % |
| Personal and Non-durable Consumer Products                   |       | 9,329                           |       | 2.4                              | %          | 3.7 | % | 9,703 |   | 2.4 | % | 3.6 | % |
| Printing & Publishing                               |       | 52,756                          |       | 13.7                             | %          | 20.8 | % | 60,440 |   | 14.8 | % | 22.2 | % |
| Retail Stores                                                |       | 22,306                          |       | 5.8                              | %          | 8.8 | % | 22,800 |   | 5.6 | % | 8.4 | % |
| Textiles & Leather                                  |       | 9,104                           |       | 2.4                              | %          | 3.6 | % | 9,479 |   | 2.3 | % | 3.5 | % |
| **Total**                                                    |       | $                               | 384,578    |                             | 100.0      | % |   |   | $ | 407,933 |   | 100.0 | % |   |   |

 

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Theinvestments at fair value were included in the following geographic regions ofthe United States at December 31, 2008 and September 30, 2008:

 
| ** **             | ** ** | **December 31, 2008** | ** ** | **September 30, 2008** | ** ** |
|------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **             | ** ** | ** **                      | ** ** | **Percentage**                   | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Geographic  Region** | ** ** | **Fair Value**             | ** ** | **Total  Investments**           | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Midwest                |       | $                               | 192,866    |                             | 50.1       | % | 76.0 | % | $ | 206,271 |   | 50.6 | % | 69.4 | % |
| West                   |       | 81,777                          |       | 21.3                             | %          | 32.2 | % | 85,294 |   | 20.9 | % | 29.0 | % |
| Southeast              |       | 51,042                          |       | 13.3                             | %          | 20.1 | % | 49,374 |   | 12.1 | % | 20.4 | % |
| Mid-Atlantic           |       | 42,542                          |       | 11.1                             | %          | 16.8 | % | 50,807 |   | 12.4 | % | 14.7 | % |
| Northeast              |       | 10,425                          |       | 2.7                              | %          | 4.1 | % | 10,617 |   | 2.6 | % | 4.3 | % |
| U.S. Territory         |       | 5,926                           |       | 1.5                              | %          | 2.3 | % | 5,570 |   | 1.4 | % | 1.9 | % |
|                   |       | $                               | 384,578    |                             | 100.0      | % |   |   | $ | 407,933 |   | 100.0 | % |   |   |

 

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

 

*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 nine months ending  September 30: |       | 2009                                                                                 |       | $          | 21,826     |   |
| For the fiscal year ending September 30:            |       | 2010                                                                                 |       | 47,503     |       |
|                                                     |       | 2011                                                                                 |       | 102,541    |       |
|                                                     |       | 2012                                                                                 |       | 93,819     |       |
|                                                     |       | 2013                                                                                 |       | 137,924    |       |
|                                                     |       | 2014                                                                                 |       | 37,100     |       |
|                                                     |       | Thereafter                                                                           |       | 6,851      |       |
| ** **                                               |       | **Total Contractual Repayments**                                                     |       | 447,564    |       |
|                                                     |       | Investments in Equity Securities                                                     |       | 5,033      |       |
|                                                     |       | Unamortized premiums, discounts and investment  acquisition costs on debt securities |       | (1,828     | )          |
| ** **                                               |       | **Total**                                                                            |       | $          | 450,769    |   |

 

**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 theCompany’s previous investment adviser, Gladstone Capital Advisers, Inc.,for the exercise of options under the Amended and Restated 2001 EquityIncentive Plan (the “2001 Plan”), which has since been terminated and is nolonger in operation.  The loans requirethe quarterly payment of interest at the market rate in effect at the date ofissue, have varying terms not exceeding ten years and have been recorded as areduction of net assets.  The loans areevidenced by full recourse notes that are due upon maturity or 60 daysfollowing termination of employment, and the shares of common stock purchasedwith the proceeds of the loan are posted as collateral.  No new loans were issued during the threemonths ended December 31, 2008 or December 31, 2007. The Companyreceived $4 and $6 of principal repayments during the three months ended December 31,2008 and 2007, respectively.  The Companyrecognized interest income from all employee stock option loans of $117 and$118 for the three months ended December 31, 2008 and 2007, 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”).

 

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*Terms of the Advisory Agreement*

 

Underthe Advisory Agreement, the Company pays the Adviser an annual base managementfee of 2% of its average gross assets, which is defined as total assets lesscash and cash equivalents pledged to creditors calculated as of the end of thetwo most recently completed fiscal quarters and also consists of a two-partincentive fee.

 

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

 

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

 

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

 

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

 

The second part of the incentive fee is a capital gains incentive feethat is determined and payable in arrears as of the end of each fiscal year (orupon termination of the Advisory Agreement, as of the termination date) andequals 20% of the Company’s realized capital gains as of the end of the fiscalyear. In determining the capital gains incentive fee payable to the Adviser,the Company calculates the cumulative aggregate realized capital gains andcumulative aggregate realized capital losses since the Company’s inception, andthe aggregate unrealized capital depreciation as of the date of thecalculation, as applicable, with respect to each of the investments in itsportfolio. For this purpose, cumulative aggregate realized capital gains, ifany, equals the sum of the differences between the net sales price of eachinvestment, when sold, and the original cost of such investment since theCompany’s inception. Cumulative aggregate realized capital losses equals thesum of the amounts by which the net sales price of each investment, when sold,is less than the original cost of such investment since the Company’sinception. Aggregate unrealized capital depreciation equals the sum of thedifference, if negative, between the valuation of each investment as of theapplicable calculation date and the original cost of such investment. At theend of the applicable year, the amount of capital gains that serves as thebasis for the Company’s calculation of the capital gains incentive fee equalsthe cumulative aggregate realized capital gains less cumulative aggregaterealized capital losses, less aggregate unrealized capital depreciation, withrespect to the Company’s portfolio of investments. If this number is positiveat the end of such year, then the capital gains incentive fee for such yearequals 20% of such amount, less the aggregate amount of any capital gainsincentive fees paid in respect of the Company’s portfolio in all prior years.

 

Because pre-incentive fee net investment income wasbelow the hurdle rate of 1.75% of net assets, no income-based incentive fee wasrecorded for the three months ended December 31, 2008 or 2007.  No capital gains incentive fee was recordedfor the three months ended December 31, 2008 or 2007, as cumulativeunrealized capital depreciation exceeded cumulative realized capital gains netof cumulative realized capital losses for each period.

 

TheAdviser’s board of directors voluntarily and irrevocably waived, for the threemonths ended December 31, 2008 and December 31, 2007, the annual 2.0%base management fee to 0.5% for senior syndicated loan participations and alsowaived the entire incentive fee due for the three months ended December 31,2008 and December 31, 2007.

 

Inaddition to the base management and incentive fees under the AdvisoryAgreement, certain fees received by the Adviser from the Company’s portfoliocompanies are credited against the investment advisory fee.  For the three months ended December 30,2008 and December 31, 2007, 50% of certain of the fees received by theAdviser were voluntarily and irrevocably credited against the base managementfee.  The Company will continue to payits direct expenses including, but not limited to, directors’ fees, legal andaccounting fees, stockholder related expenses, and directors and officersinsurance under the Advisory Agreement.

 

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

 
| ** **                                                                                                  | ** ** | **Three months ended**  | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                  | ** ** | **December 31,   2008** | ** ** | **December 31,   2007** | ** ** |
| Base management fee                                                                                         |       | $                                 | 434        |   | $ | 578 |   |
| Credit for fees received by Adviser from the  portfolio companies                                           |       | (5                                | )          | (822 | ) |
| Fee reduction for the voluntary, irrevocable waiver  of 2% fee on senior syndicated loans to 0.5% per annum |       | (105                              | )          | (103 | ) |
| Net base management fee                                                                                     |       | $                                 | 324        |   | $ | (347 | ) |
|                                                                                                        |       |                              |       |   |   |
| Incentive fee                                                                                               |       | $                                 | 1,176      |   | $ | 1,461 |   |
| Credit from voluntary, irrevocable waiver issued by  Adviser’s board of directors                      |       | (1,176                            | )          | (1,461 | ) |
| Net incentive fee                                                                                           |       | $                                 | —     |   | $ | — |   |
|                                                                                                        |       |                              |       |   |   |
| Credit for fees received by Adviser from the  portfolio companies                                           |       | $                                 | (5         | ) | $ | (822 | ) |
| Fee reduction for the voluntary, irrevocable waiver  of 2% fee on senior syndicated loans to 0.5% per annum |       | (105                              | )          | (103 | ) |
| Incentive fee credit                                                                                        |       | (1,176                            | )          | (1,461 | ) |
| Credit to base management and incentive fees from  Adviser                                                  |       | $                                 | (1,286     | ) | $ | (2,386 | ) |

 

AtDecember 31, 2008 and September 30, 2008, the Company owed $324 and$83, respectively, of base management fee to the Adviser, which is recorded inFees due to Adviser in the accompanying consolidated statements of assets andliabilities.  Overall, the basemanagement fee due to the Adviser cannot exceed 2% of total assets (as reducedby cash and cash equivalents pledged to creditors) during any given fiscal year.

 

*LoanServicing and Portfolio Company Fees*

 

TheAdviser also services the loans held by Business Loan, in return for which itreceives a 1.5% annual fee based on the monthly aggregate outstanding balanceof the loans pledged under the Company’s line of credit.  Since the Company owns these loans, all loanservicing fees paid to the Adviser are treated as reductions directly againstthe 2% base management fee under the Advisory Agreement.  Effective in April 2006, the Adviser’sboard of directors voluntarily reduced the annual servicing fee rate on thesenior syndicated loans to 0.5%. For the three months ended December 31,2008 and 2007, these loan servicing fees totaled $1,623 and $1,381,respectively, all of which were deducted against the 2% base management fee inorder to derive the base management fee which is presented as the line itemBase management fee in the accompanying consolidated statements ofoperations.  At December 31, 2008and September 30, 2008, the Company owed $401 and $374, respectively, ofunpaid loan servicing fees to the Adviser, which is recorded in Fees due toAdviser in the accompanying consolidated statements of assets andliabilities.  Under the AdvisoryAgreement, the Adviser has also provided and continues to provide managerialassistance and other services to the Company’s portfolio companies and mayreceive fees for services other than managerial assistance services.

 

*AdministrationAgreement*

 

OnOctober 1, 2006, the Company entered into an administration agreement (the“Administration Agreement”) with Gladstone Administration, LLC (the “Administrator”),a wholly-owned subsidiary of the Adviser. Under the Administration Agreement, the Company pays separately foradministrative services.  TheAdministration Agreement provides for payments equal to the Company’s allocableportion of the Administrator’s overhead expenses in performing its obligationsunder the Administration Agreement, including, but not limited to, rent foremployees of the Administrator, and the allocable portion of salaries andbenefits expenses of the Company’s chief financial officer, controller, chiefcompliance officer, treasurer and their respective staffs.  The Company recorded an administration fee of$227 and $212, for the three months ended December 31, 2008 and 2007,respectively.  At December 31, 2008and September 30, 2008, the Company owed $227 and $247, respectively, ofunpaid administration fees to the Adviser, which is recorded in the Fee due toAdministrator in the accompanying consolidated statements of assets andliabilities.

 

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

 

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*LicenseAgreement*

 

The Company has entered into a license agreement with the Adviser,pursuant to which the Adviser has granted the Company a non-exclusive licenseto use the name “Gladstone” and the Diamond G trademark. The amount of the feeis negotiated on an annual basis by the Company’s compensation committee, andmust be approved by a majority of the Company’s independent directors. The feewas increased to ten dollars per quarter effective at the beginning of the lastcontract term, which began on December 20, 2007, and as a result of themost recent negotiations, the fee will remain at ten dollars for the currentcontract term, which began on December 20, 2008. The license arrangementwill terminate in the event that Gladstone Management Corporation is no longerthe Company’s Adviser.

 

**NOTE5. LINE OF CREDIT**

 

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

 

As of December 31,2008, the outstanding principal balance under the DB Facility was approximately$146,470 at a stated interest rate of approximately 2.85%, plus a 2.50% programfee.  The Company is also charged anunused commitment fee of 0.75% per annum. Available borrowings are subject to various constraints imposed underthe credit agreement, based on the aggregate loan balance pledged by BusinessLoan, which varies as loans are added and repaid, regardless of whether suchrepayments are early prepayment or are made as contractually required.  At December 31, 2008, the remainingborrowing capacity available under the DB Facility was $153,530.  The weighted average borrowings outstandingunder the DB Facility for the three months ended December 31, 2008 and2007 were $150,408 and $145,416, respectively, at a weighted average annualinterest cost of 8.5% and 6.7%, respectively, which was computed by using theannual stated interest rate plus commitment and other fees, plus theamortization of deferred financing fees divided by the weighted average debtoutstanding.

 

The DB Facilitycontains covenants that require Business Loan to maintain its status as aseparate entity; prohibit certain significant corporate transactions (such asmergers, consolidations, liquidations or dissolutions); and restrict materialchanges to the Company’s credit and collection policies. The DB Facility alsorestricts some of the terms and provisions (including terms to maturity andpayments schedules) and limits the borrower and industry concentrations ofloans that are eligible to secure advances. As of December 31, 2008, Business Loan was in compliance with allof the DB Facility covenants.

 

The administrativeagent also requires that any interest or principal payments on pledged loans beremitted directly by the borrower into a lockbox account with the Bank of NewYork Mellon Corp. as custodian.  DeutscheBank AG is also the trustee of the account and once a month remits thecollected funds to the Company. At December 31, 2008 and September 30,2008, the amount due from custodian was $7,303 and $4,544, respectively.

 

The Adviser alsoservices the loans pledged under the DB Facility.  As a condition to this servicing arrangement,the Company executed a performance guaranty pursuant to which it guaranteedthat the Adviser would comply fully with all of its obligations under the DBFacility.  The performance guarantyrequires that the Company maintain a minimum net worth of $100 million and 75%of equity issuances after May 2003 and maintain “asset coverage” withrespect to “senior securities representing indebtedness” of at least 200%, inaccordance with Section 18 of the 1940 Act.  As of December 31, 2008, the Company wasin compliance with all covenants under the performance guaranty.  However, continued compliance with thesecovenants depends on many factors, some of which are beyond the Company’scontrol.  In particular, depreciation inthe valuation of the Company’s assets, which valuation is subject to changingmarket conditions which are presently very volatile, affects the Company’sability to comply with these covenants.

 

Availability underthe DB Facility will terminate on May 21, 2009.  If the DB Facility is not renewed or extendedby this date, all principal and interest will be immediately due and payablewithin one year of the maturity date.

 

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**NOTE6. INTEREST RATE CAP AGREEMENT**

 

Pursuant to the DBFacility, the Company has an interest rate cap agreement, with an initial notionalamount of $35.0 million at a cost of $304, that effectively limits the interestrate on a portion of the borrowings under the line of credit.

 

The interest ratecap agreement’s current notional amount is $0.8 million and it has a nominalfair market value which is recorded in other assets on the Company’sconsolidated statement of assets and liabilities at December 31,2008.  At September 30, 2008, theinterest rate cap agreement had a nominal fair market value.  The Company records 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 consolidated statement of operations. The interestrate cap agreement expires in February 2009. The agreement provides thatthe Company’s floating interest rate or cost of funds on a portion of theportfolio’s borrowings will be capped at 5% when the LIBOR rate is in excess of5%.  During the three months ended December 31,2008, the Company recorded $0, as compared to $6 for the three months ended December 31,2007, of income from the interest rate cap agreement, recorded as a realizedgain on the settlement of derivative on the Company’s consolidated statementsof operations.

 

The use of a capinvolves risks that are different from those associated with ordinary portfoliosecurities transactions.  Cap agreementsmay be considered to be illiquid.  Althoughthe Company will not enter into any such agreements unless it believes that theother party to the transaction is creditworthy, the Company does bear the riskof loss of the amount expected to be received under such agreements in theevent of default or bankruptcy of the agreement counterparty.

 

**NOTE7. 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 December 31, 2008  |       | 21,087,574 |       | $                    | 334,161    |   |

 

**NOTE8. NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS PER COMMONSHARE**

 

Thefollowing table sets forth the computation of basic and diluted net (decrease)increase in net assets per common share resulting from operations per share forthe three months ended December 31, 2008 and 2007:

 
| ** **                                                                                                 | ** ** | **Three Months Ended   December 31** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| Numerator for basic and diluted net (decrease)  increase in net assets resulting from operations per share |       | $                                                        | (9,103     | ) | $ | 1,900 |   |
|                                                                                                       |       |                                                     |       |   |   |   |   |
| Denominator for basic and diluted shares                                                                   |       | 21,087,574                                               |       | 16,953,703 |   |
| Basic and diluted net (decrease) increase in net  assets resulting from operations per share               |       | $                                                        | (0.43      | ) | $ | 0.11 |   |

 

**NOTE9. DISTRIBUTIONS**

 

***Distributions***

 

Thefollowing table lists the per share distributions paid for the three monthsended December 31, 2008 and 2007:

 
| **Fiscal Year** | ** ** | **Record Date**   | ** ** | **Payment Date**  | ** ** | **Distribution   per Share** | ** ** |
|----------------------|------------|------------------------|------------|------------------------|------------|----------------------------------------|------------|
| 2009                 |       | 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                  |       | $                                      | 0.42       |   |
|                 |       |                   |       |                   |       |                                   |       |
| 2008                 |       | 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                  |       | $                                      | 0.42       |   |

 

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Aggregate distributions declared and paid for the three months ended December 31,2008 and 2007 were approximately $8.9 million and $7.4 million,respectively.  All distributions weredeclared based on estimates of net investment income for the respective fiscalyears, 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) noticealong with the payment of distributions for any payment which includes adistribution estimated to be paid from any other source other than netinvestment income.  The estimates ofthe source of the distribution are interim estimates based on GAAP that are subjectto revision, and the exact character of the distributions for tax purposescannot be determined until the final books and records of the Company arefinalized for the calendar year. Following the calendar year end, after definitive information has been determinedby the Company, if the Company has made distributions of taxable income (orreturn of capital), the Company will deliver a Form 1099-DIV to itsstockholders specifying such amount and the tax characterization of suchamount.  Therefore, these estimates aremade solely in order to comply with the requirements of Section 19(a) ofthe 1940 Act and should not be relied upon for tax reporting or any otherpurposes and could differ significantly from the actual character ofdistributions for tax purposes.

 

Thefollowing GAAP estimates were made by the Board of Directors during the quarterended December 31, 2008:

 
| **Month Ended**   | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Distribution** | ** ** |
|------------------------|------------|--------------------------|------------|---------------------------------|------------|-----------------------------|------------|
| December 31, 2008 |       | $                        | 0.109      |                            | $          | 0.031                       |       | $ | 0.140 |   |
| November 30, 2008 |       | 0.110                    |       | 0.030                           |       | 0.140                       |       |
| October 31, 2008  |       | 0.108                    |       | 0.032                           |       | 0.140                       |       |
|                        |            |                          |            |                                 |            |                             |            |  |  |  |

 

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 endedDecember 31, 2008, the following corrections were made to the above listedestimates for that quarter:

 
| **Month Ended**   | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Distribution** | ** ** |
|------------------------|------------|--------------------------|------------|---------------------------------|------------|-----------------------------|------------|
| December 31, 2008 |       | $                        | 0.086      |                            | $          | 0.054                       |       | $ | 0.140 |   |
| November 30, 2008 |       | 0.093                    |       | 0.047                           |       | 0.140                       |       |
| October 31, 2008  |       | 0.100                    |       | 0.040                           |       | 0.140                       |       |
|                        |            |                          |            |                                 |            |                             |            |  |  |  |

 

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** | ** ** |
|------------------------|------------|--------------------------|------------|---------------------------------|------------|-----------------------------|------------|
| March 31, 2009    |       | $                        | 0.104      |                            | $          | 0.036                       |       | $ | 0.140 |   |
| February 28, 2009 |       | 0.105                    |       | 0.035                           |       | 0.140                       |       |
| January 31, 2009  |       | 0.105                    |       | 0.035                           |       | 0.140                       |       |
|                        |            |                          |            |                                 |            |                             |            |  |  |  |

 

**NOTE10. COMMITMENT AND CONTINGENCIES**

 

AtDecember 31, 2008, the Company was not party to any signed term sheets forpotential investments.

 

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**NOTE11. SUBSEQUENT EVENTS**

 

*Distributions*

In January 2009, the Company’s Board of Directors declaredthe following monthly cash distributions:

 
| **Record Date**   | ** ** | **Payment Date**  | ** ** | **Distribution   per Share** | ** ** |
|------------------------|------------|------------------------|------------|----------------------------------------|------------|
| March 23, 2009    |       | March 31, 2009    |       | $                                      | 0.140      |   |
| February 19, 2009 |       | February 27, 2009 |       | $                                      | 0.140      |   |
| January 22, 2009  |       | January 30, 2009  |       | $                                      | 0.140      |   |

 

*Investment Activity*

Subsequent to December 31, 2008, the Company extendedapproximately $4.2 million of revolver draws and additional investments toexisting portfolio companies.  TheCompany also received approximately $3.7 million of scheduled and unscheduledloan repayments.

 

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

 

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

 

**The following analysis of our financial conditionand results of operations should be read in conjunction with our consolidatedfinancial statements and the notes thereto contained 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 Corporation Laws of the State ofMaryland on May 30, 2001. Our investment objectives are to achieve a highlevel of current income by investing in debt securities, consisting primarilyof senior notes, senior subordinated notes and junior subordinated notes, ofestablished private businesses that are substantially owned by leveraged buyoutfunds, venture capital funds, individual investors or are family-ownedbusinesses, with a particular focus on senior notes. In addition, we mayacquire existing loans that meet this profile from leveraged buyout funds,venture capital funds and others. We also seek to provide our stockholders withlong-term capital growth through the appreciation in the value of warrants or otherequity instruments that we may receive when we make loans. We operate as aclosed-end, non-diversified management investment company, and have elected tobe treated as a business development company under the Investment Company Actof 1940 (the “1940 Act”).  In addition,for tax purposes we have elected to be treated as a regulated investmentcompany (“RIC”) under the Internal Revenue Code of 1986, as amended (the “Code”).

 

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

 

**BusinessEnvironment**

 

The current economic conditions generally andthe disruptions in the capital markets in particular have decreased liquidityand increased our cost of debt and equity capital, where available. The longerthese conditions persist, the greater the probability that these factors couldcontinue to increase 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.  The economic downturnhas affected the availability of credit generally and may prevent us fromreplacing or renewing our credit facility on reasonable terms, if at all.  We do not know when market conditions willstabilize, if adverse conditions will intensify or the full extent to which thedisruptions will affect us.  If marketinstability persists or intensifies, we may experience difficulty in raisingcapital.

 

Challenges in the current market areintensified for us by certain regulatory limitations under the Code andthe 1940 Act, as well as contractual restrictions under the agreement governingour credit facility that further constrain our ability to access the capitalmarkets.  To maintain our qualificationas a RIC, we must satisfy, among other requirements, an annual distributionrequirement to pay out at

 

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least 90% of ourordinary income and short-term capital gains to our stockholders on an annualbasis.  Because we are required todistribute our income in this manner, and because the illiquidity of many ofour investments makes it difficult for us to finance new investments throughthe sale of current investments, our ability to make new investments is highlydependent upon external financing.  Ourexternal financing sources include the issuance of equity securities, debtsecurities or other leverage such as borrowings under our line of credit.  Our ability to seek external debt financing,to the extent that it is available under current market conditions, is furthersubject to the asset coverage limitations of the 1940 Act, which require us tohave at least a 200% asset coverage ratio, meaning generally that for everydollar of debt, we must have two dollars of assets.

 

Recent marketconditions have also affected the trading price of our common stock and thusour ability to finance new investments through the issuance of equity.  On January 22, 2009, the closing marketprice of our common stock was $8.10, which price represented a 33% discount toour December 31, 2008 net asset value (“NAV”) per share.  When our stock is trading below NAV, as ithas consistently traded subsequent to September 30, 2008, our ability toissue equity is constrained by provisions of the 1940 Act which generallyprohibit the issuance and sale of our common stock below NAV per share withoutstockholder approval other than through sales to our then-existing stockholderspursuant to a rights offering.  Wecurrently do not have stockholder approval to sell our common stock below NAV,although our stockholders will consider a proposal which would allow us to doso for a period of one year at the upcoming annual stockholders’ meetingscheduled for February 19, 2009.

 

The economic downturn may also continue todecrease the value of collateral securing some of our loans, as well as thevalue of our equity investments, which has impacted and may continue to impactour ability to borrow under our credit facility.  For the quarter ended December 31,2008, we recorded net unrealized depreciation on our portfolio of investmentsof $13.3 million, which was mainly attributable to the decrease in fair valueof our portfolio.  We may see further decreasesin the value of our portfolio, which will further limit our ability to borrowunder our current credit facility. Additionally, our credit facility contains covenants regarding themaintenance of certain minimum net worth requirements which are affected by thedecrease in value of our portfolio. Failure to meet these requirements would result in a default which, ifwe are unable to obtain a waiver from our lenders, would result in theacceleration of our repayment obligations under the credit facility.

 

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

 

**Use ofInternally-Developed Discount Cash Flow Methodologies**

 

Given the continuedeconomic downturn, the market for syndicated loans has become increasinglyilliquid with limited or no transactions for many of those securities which wehold. FASB Staff Position 157-3 (“FSP 157-3”), *“Determiningthe Fair Value of a Financial Asset When the Market for That Asset is NotActive,”* provides guidance on the use of a discounted cash flow (“DCF”)methodology to value investments in an illiquid market.  Under FSP 157-3, indications of an illiquidmarket include cases where the volume and level of trading activity in theasset have declined significantly, the available prices vary significantly overtime or amongst market participants, or the prices are not current. The marketplace for which we obtain indicative bids for purposes of determining fairvalue for our syndicated loan investments have recently shown these attributesof illiquidity.  In accordance with SFAS157, our valuation procedures specify the use of third-party indicative bidquotes for valuing syndicated loans where there is a liquid public market forthose loans and market pricing quotes are readily available. However, due tothe market illiquidity and the lack of transactions during the quarter ended December 31,2008, 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 market place.  As such, we have valued the majority of oursyndicated loans using a DCF method for the quarter ended December 31,2008.  As of December 31, 2008, the portionof our investment portfolio that was valued using DCF was approximately $57.7million, or 15% of the fair value of our total portfolio of investments.

 

**InvestmentHighlights**

 

During the threemonths ended December 31, 2008, we extended $8.7 million of investments toexisting portfolio companies through revolver draws or the additions of newterm notes.  During the three monthsended December 31, 2008, 2 borrowers made payments in full ahead ofcontractual maturity of $7.0 million, we sold one syndicated loan of $2.2 million, and weexperienced contractual amortization, revolver repayments and some principalpayments received ahead of schedule of $7.9 million, for total principalrepayments of $17.1 million.  Since ourinitial public offering in August 2001, we have made 254 different loansto, or investments in,

 

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132 companies fora total of approximately $940.7 million, before giving effect to principalrepayments on investments and divestitures.

 

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

 

***Comparisonof the Three Months Ended December 31, 2008 to the Three Months Ended December 31,2007***

 

**Investment Income**

 

Investment incomefor the three months ended December 31, 2008 was $11,808, as compared to$11,401 for the three months ended December 31, 2007.

 

Interest incomefrom our investments in debt securities of private companies was $11,681 forthe three months ended December 31, 2008, as compared to $11,139 for thethree months ended December 31, 2007. The level of interest income from investments is directly related to thebalance, at cost, of the interest-bearing investment portfolio outstandingduring the period multiplied by the weighted average yield.  The weighted average yield varies from periodto period based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.  Interest income from our investmentsincreased $542, or 4.9%, during the three months ended December 31, 2008compared to the prior year period.  Thisincrease was based on the overall growth in the cost basis of our investments,offset by the decrease in the weighted average yield on our portfolio.  The cost basis of our interest bearinginvestment portfolio was approximately $442.6 million for the three monthsended December 31, 2008 as compared to $386.9 million for the three monthsended December 31, 2007.  Incontrast, the annualized weighted average yield on our portfolio was 9.8% forthe three months ended December 31, 2008 as compared to 11.0% for thethree months ended December 31, 2007. The decrease in the annualized weighted average yield primarily resultedfrom a reduction in the average LIBOR from the prior year, as well as threeinvestments being on non-accrual during the three months ended December 31,2008 (Greatwide, LYP Holdings, and U.S. Healthcare) whereas two investmentswere on non-accrual during the three months ended December 31, 2007 (LYPHoldings and U.S. Healthcare).

 

Interest incomefrom Non-Control/Non-Affiliate investments was $11,661 for the three monthsended December 31, 2008, as compared to $11,125 for the comparable prioryear period.  This increase resulted froman overall increase in the aggregate Non-Control/Non-Affiliate investments heldat December 31, 2008 compared to the prior year period, offset by adecrease in LIBOR due to the instability and tightening of the creditmarkets.  The success fees earned duringthe three months ended December 31, 2008 and 2007 were $0 and $346,respectively.  The success fee earnedduring the three months ended December 31, 2007 resulted from arefinancing by Westlake Hardware, Inc.

 

Interest incomefrom Control investments was $20 for the three months ended December 31,2008, as compared to $14 in the comparable prior year period.  The increase is attributable to threeadditional Control investments held during the quarter ended December 31,2008 as compared to the prior year period.

 

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

 

**Three months ended December 31, 2008**

 
| **Company**               | ** ** | **Interest   Income** | ** ** | **% of   Total** | ** ** |
|---------------------------|------------|----------------------------|------------|----------------------------|------------|
| Sunshine Media            |       | $                          | 843        |                       | 7.2        | % |
| Reliable Biopharma        |       | 772                        |       | 6.6                        | %          |
| Westlake Hardware         |       | 616                        |       | 5.3                        | %          |
| Clinton Aluminum          |       | 475                        |       | 4.1                        | %          |
| Vanta Core                |       | 441                        |       | 3.8                        | %          |
| **Subtotal**              | ** ** | **$**                      | **3,147**  | ** **                 | **26.9**   | **%** |
| Other companies           |       | 8,534                      |       | 73.1                       | %          |
| **Total interest income** | ** ** | **$**                      | **11,681** | ** **                 | **100.0**  | **%** |

 

**Three months ended December 31, 2007**

 
| **Company**               | ** ** | **Interest   Income** | ** ** | **% of   Total** | ** ** |
|---------------------------|------------|----------------------------|------------|----------------------------|------------|
| Westlake Hardware         |       | $                          | 1,020      |                       | 9.2        | % |
| Sunshine Media            |       | 710                        |       | 6.4                        | %          |
| Reliable Biopharma        |       | 584                        |       | 5.2                        | %          |
| Clinton Aluminum          |       | 487                        |       | 4.4                        | %          |
| Winchester Electronics    |       | 357                        |       | 3.2                        | %          |
| **Subtotal**              | ** ** | **$**                      | **3,158**  | ** **                 | **28.4**   | **%** |
| Other companies           |       | 7,981                      |       | 71.6                       | %          |
| **Total interest income** | ** ** | **$**                      | **11,139** | ** **                 | **100.0**  | **%** |

 

Interest incomefrom invested cash for the three months ended December 31, 2008 was $10,as compared to $144 for the three months ended December 31, 2007. Interestincome decreased from the prior year period due to the amount of cash that washeld in interest bearing accounts and the interest earned on our custodialaccount prior to disbursement.

 

Interest incomefrom loans to our employees, in connection with the exercise of employee stockoptions, for the three months ended December 31, 2008 and December 31,2007, was $117 and $118, respectively.

 

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**Operating Expenses**

 

Operatingexpenses, net of credits from the Adviser for fees earned and voluntary andirrevocable waivers to the base management and incentive fees, were $5,927 forthe three months ended December 31, 2008, as compared to $4,098 for thethree months ended December 31, 2007. Operating expenses for the threemonths ended December 31, 2008 reflected an increase in loan servicingfees and a significant increase in amortization of deferred financing feesincurred in connection with certain amendments to our credit facility withDeutsche Bank AG.

 

Interest expensefor the three months ended December 31, 2008 was $2,461, as compared to$2,356 for the three months ended December 31, 2007.  This increase is primarily a result ofincreased borrowings under our line of credit during the three months ended December 31,2008, which borrowings were partially used to finance our increasedinvestments.

 

Loan servicingfees for the three months ended December 31, 2008 were $1,623, as comparedto $1,381 for the three months ended December 31, 2007.  These fees were incurred in connection with aloan servicing agreement between Business Loan and our Adviser, which is basedon the size of the portfolio.

 

Base managementfee for the three months ended December 31, 2008 was $434, as compared to$578 for the three months ended December 31, 2007.  The base management fee is computed quarterlyas described under *“Investment Advisory andManagement Agreement”* in Note 4 of the condensed consolidatedfinancial statements, and is summarized in the table below:

 
| ** **                                                                                                      | ** ** | **Three months ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                      | ** ** | **December 31, 2008**  | ** ** | **December 31, 2007** | ** ** |
| Base management fee (1)                                                                                         |       | $                                | 434        |   | $ | 578 |   |
| Credit for fees received by Adviser from the  portfolio companies                                               |       | (5                               | )          | (822 | ) |
| Fee reduction for the voluntary, irrevocable waiver  of 2% fee on senior syndicated loans to 0.5% per annum (2) |       | (105                             | )          | (103 | ) |
| Net base management fee                                                                                         |       | $                                | 324        |   | $ | (347 | ) |

 

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(1)         Base management fee isnet of loan servicing fees per the terms of the Amended Advisory Agreement.

 

(2)         The board of our Adviservoluntarily and irrevocably waived, for the three months ended December 31,2008 and 2007, the annual 2.0% base management fee to 0.5% for seniorsyndicated loan participations.

 

Incentive fee forthe three months ended December 31, 2008 was $1,176, as compared to $1,461for the three months ended December 31, 2007.  The board of our Adviser waived the entireincentive fee for the three months ended December 31, 2008 and threemonths ended December 31, 2007.  Theincentive fee and associated credits are summarized in the table below:

 
| ** **                                                                             | ** ** | **Three months ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                             | ** ** | **December 31, 2008**  | ** ** | **December 31, 2007** | ** ** |
| Incentive fee                                                                          |       | $                                | 1,176      |   | $ | 1,461 |   |
| Credit from voluntary, irrevocable waiver issued by  Adviser’s board of directors |       | (1,176                           | )          | (1,461 | ) |
| Net incentive fee                                                                      |       | $                                | —     |   | $ | — |   |

 

Administration feefor the three months ended December 31, 2008 was $227 as compared to $212for the three months ended December 31, 2007. The slight increase is dueto an increase of administration staff and related expenses.

 

Professional fees,consisting primarily of legal and audit fees, for the three months ended December 31,2008 were $313, as compared to $129 for the three months ended December 31,2007.  The increase is due to legal feesincurred in connection with troubled loans.

 

Amortization ofdeferred financing fees, in connection with our line of credit, was $719 forthe three months ended December 31, 2008, as compared to $74 for the threemonths ended December 31, 2007.  Theincrease is due to the amortization of additional fees incurred with our lineof credit. In February 2008, we increased the DB Facility from $220million to $250 million and in April 2008, increased the DB Facility to$300 million and added Branch Banking and Trust Company (“BB&T”) as a committedlender. In June 2008, we renewed the DB Facility. The fees incurred forthe above amendments are recorded in deferred financing fees on ourconsolidated statement of assets and liabilities, and amortized over the lifeof the DB Facility.

 

Stockholderrelated costs for the three months ended December 31, 2008 were $89, ascompared to $120 for the three months ended December 31, 2007.  Stockholder related costs include suchrecurring items as transfer agent fees, NASDAQ listing fees, costs 

 

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associated withSEC filings, and the annual report printing and distribution costs. Thedecrease was primarily attributed to the decrease in annual report printingfees.

 

Directors’ feesfor the three months ended December 31, 2008 and 2007 were $48 and $54respectively, and consisted of amortization of their annual stipend andindividual meeting fees. The decrease is due to fewer committee meetings heldin the current year period.

 

Insurance expensefor the three months ended December 31, 2008 was $57, as compared to $54for the three months ended December 31, 2007. The increase was primarilythe result of an increase of our directors and officers insurance policypremiums.

 

Other expenses forthe three months ended December 31, 2008 were $66, as compared to $65 forthe three months ended December 31, 2007. The expenses primarily represent direct expenses such as travel relatedspecifically to our portfolio companies, loan evaluation services for ourportfolio companies, press releases and backup servicer expenses.

 

**NetRealized Loss on Sale of Investments**

 

During the threemonths ended December 31, 2008, we realized a net loss of $1,731, whichconsisted of a $1,758 loss from the sale of the Greatwide syndicated loan,offset by a $27 gain from the Country Road payoff. There were no realized gainsor losses in the three months ended December 31, 2007.

 

**RealizedGain on Settlement of Derivative**

 

During the threemonths ended December 31, 2008, we did not receive any interest rate capagreement payments. During the three months ended December 31, 2007, wereceived interest rate cap agreement payments of $6 as a result of the onemonth LIBOR increasing. We receive payments when the one month LIBOR is over5%.

 

**NetUnrealized Depreciation on Derivative**

 

For the threemonths ended December 31, 2008, we recorded nominal unrealizeddepreciation, as compared to $11 for the three months ended December 31,2007, due to a decrease in the fair market value of our interest rate capagreement.

 

**NetUnrealized Depreciation on Investments**

 

For the three monthsended December 31, 2008, we recorded net unrealized depreciation oninvestments of $13,253, as compared to $5,398, for the three months ended December 31,2007.  The unrealized depreciation ismainly attributable to the decrease in fair value on our portfolio, mostnotably in the following investments: Lindmark Outdoor Advertising, AllisonPublications, Wesco Holdings, SCI Cable, and RedPrairie Holding. We believethat our investment portfolio was valued at a depreciated value due primarilyto the general instability of the loan markets. Although our investmentportfolio has depreciated, our entire portfolio was fair valued at 85% of costas of December 31, 2008.  Theunrealized depreciation of our investments does not have an impact on ourcurrent ability to pay distributions to stockholders; however, it may be anindication of future realized losses, which could ultimately reduce our incomeavailable for distribution.

 

**Net (Decrease) Increase in Net AssetsResulting from Operations**

 

Overall, we realized a net decrease in net assets resulting fromoperations of $(9,103) for the three months ended December 31, 2008.  Based on a weighted-average of 21,087,574basic and diluted shares outstanding, our net decrease in net assets fromoperations per weighted-average common share for the three months ended December 31, 2008 was $(0.43), basic anddiluted. For the three months ended December 31, 2007, we realized a net increase in netassets resulting from operations of $1,900. Based on a weighted-average of 16,953,703 basic and diluted sharesoutstanding, our net increase in net assets from operations perweighted-average common share for the three months ended December 31, 2007was $0.11 basic and diluted.

 

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

 

**OperatingActivities**

 

At December 31, 2008, wehad investments in debt securities of, or loans to, 61 private companies,totaling approximately $450,769 (cost basis) of total assets. During the threemonths ended December 31,2008 and December 31,2007, the following investment activity occurred:

 
| **Quarter  Ended**     | ** ** | **New  Investments (1)** | ** ** | **Principal  Repayments (2)** | ** ** | **Investments  Sold** | ** ** | **Net Loss on   Disposal** | ** ** |
|------------------------|------------|-------------------------------|------------|------------------------------------|------------|-----------------------|------------|-------------------------------------------|------------|
| December 31, 2008 |       | $                             | 8,702      |                               | $          | 14,927                |       | $                                         | 2,212      |   | $ | (1,731 | ) |
|                   |       |                          |       |                               |       |                  |       |                                      |       |
| December 31, 2007 |       | $                             | 73,341     |                               | $          | 4,047                 |       | $                                         | —     |   | $ | — |   |

 

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**(1)   New Investments**

 

During the three months ended December 31,2008, we extended $8.7 million of investments to existing portfolio companies throughrevolver draws or the additions of new term notes.

 

During the three months ended December 31,2007, we extended, directly or through participations, $58.0 million of loanoriginations to 5 new portfolio companies and $15.3 million of investments toexisting portfolio companies through revolver draws or the additions ofnew term notes, for total new investments of $73.3 million.

 

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

 

During the three months ended December 31,2008, 2 borrowers made unscheduled payoffs of $7.0 million, and we experiencedcontractual amortization, revolver repayments and some principal paymentsreceived ahead of schedule of $7.9 million, for total principal repayments of$14.9 million.

 

During the three months ended December 31,2007 we experienced contractual amortization, revolver repayments and someprincipal payments received ahead of schedule of $4.0 million.

 

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

 

During the three months ended December 31,2008, we sold one $2.2 million syndicated loan (Greatwide Senior Term Debt).

 

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

 
| ** **                                               | ** ** | ** **                                                                           | ** ** | **Amount** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|------------|------------|
| For the remaining nine months ending  September 30: |       | 2009                                                                                 |       | $          | 21,826     |   |
| For the fiscal year ending September 30:            |       | 2010                                                                                 |       | 47,503     |       |
|                                                     |       | 2011                                                                                 |       | 102,541    |       |
|                                                     |       | 2012                                                                                 |       | 93,819     |       |
|                                                     |       | 2013                                                                                 |       | 137,924    |       |
|                                                     |       | 2014                                                                                 |       | 37,100     |       |
|                                                     |       | Thereafter                                                                           |       | 6,851      |       |
| ** **                                               | ** ** | **Total Contractual Repayments**                                                     |       | 447,564    |       |
|                                                     |       | Investments in Equity  Securities                                                    |       | 5,033      |       |
| ** **                                               |       | Unamortized premiums,  discounts and investment acquisition costs on debt securities |       | (1,828     | )          |
| ** **                                               | ** ** | **Total**                                                                            |       | $          | 450,769    |   |

 

Net cash provided by operating activities for the three monthsended December 31, 2008, consisting primarily of the items described in *“Results of Operations”* and the investment activitydescribed above, was $12,701 as compared to net cash used in operatingactivities of $63,852 for the three months ended December 31, 2007.

 

**Financing Activities**

 

Net cash used in financing activities for the three months ended December 31,2008 was $13,438 and mainly consisted of distribution payments of $8,856 andnet repayments on our line of credit of $4,560. Net cash provided by financing activities was $60,544 for the 

 

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three months endedDecember 31,2007 and consisted of an offering of common stock for net proceeds of $50,801,net borrowings on our line of credit of $17,391, partially offset bydistribution payments of $7,355.

 

**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. In accordance with these requirements, wedeclared and paid monthly cash distributions of $0.14 per common share forOctober, November and December 2008. In January 2009, our Board of Directors declared a monthlydistribution of $0.14 per common share for each of January, February and March 2009.

 

**Issuanceof Equity**

 

During fiscal year2007, we filed a registration statement on Form N-2 (File No. 333-143027) (the “RegistrationStatement”) with the SEC that permits us to issue, through one or moretransactions, up to an aggregate of $300 million in securities, consistingof common stock, or debt securities, of which to date we have issued $123.8million in common stock, which leaves a remaining capacity of $176.2 million.

 

We anticipateissuing equity securities to obtain additional capital in the future. However,we cannot determine the terms of any future equity issuances or whether we willbe able to issue equity on terms favorable to us, or at all. Additionally, whenour common stock is trading below NAV, we will have regulatory constraintsunder the 1940 Act on our ability to obtain additional capital in this manner. Generally,the 1940 Act provides that we may not issue and sell our common stock at aprice below our NAV per share, other than to our then existing stockholderspursuant to a rights offering, without first obtaining approval from ourstockholders and our independent directors. As of December 31, 2008, ourNAV per share was $12.04 and our closing market price was $8.09 per share. Tothe extent that our common stock continues to trade at a market price below ourNAV per share, we will generally be precluded from raising equity capitalthrough public offerings of our common stock, other than pursuant to a rightsoffering. The asset coverage requirement of a BDC under the 1940 Acteffectively limits our ratio of debt to equity to 1:1.  To the extent that we are unable to raisecapital through the issuance of equity, our ability to raise capital throughthe issuance of debt may also be inhibited to the extent of our regulatory debtto equity ratio limits.

 

Additionally,listed for a vote at the upcoming annual meeting of stockholders scheduled for February 19,2009, is a proposal which, if approved, would authorize us to sell shares ofour common stock at a price below our then current NAV per share for a periodof one year, provided that our Board of Directors makes certain determinationsprior to any such sale.

 

**RevolvingCredit Facility**

 

Through ourwholly-owned subsidiary, Business Loan, we have a $300 million revolving creditfacility (the “DB Facility”) with Deutsche Bank AG, as administrative agent. Pursuantto the DB Facility, Business Loan has pledged the loans it holds to securefuture advances by certain institutional lenders. The interest rate charged onthe advances under the DB Facility is based on the Commercial Paper (“CP”)rate, which is equivalent to the weighted average per annum rates paid by theDB Facility’s CP lenders in respect of CP notes issued by the CP lender duringsuch period. Business Loan also has the ability to borrow at an alternativerate from the committed lenders if CP lenders are unable to fund advances. Thealternative rate is the London Interbank Offered Rate (“LIBOR”), or if LIBOR isunavailable, the Prime Rate or the Federal Funds Rate plus 1.0%.  In February 2008, we increased the DBFacility from $220 million to $250 million, and in April 2008, increasedthe DB Facility to $300 million and added Branch Banking and Trust Company (“BB&T”)as a committed lender. In June 2008, we renewed the DB Facility, whichmatures on May 21, 2009.

 

As of December 31, 2008, theoutstanding principal balance under this credit facility was approximately$146,470 at an interest rate of approximately 2.85% plus a 2.50% program fee. Weare also charged an unused commitment fee of 0.75% per annum. Availableborrowings are subject to various constraints imposed by Deutsche Bank AG,based on the aggregate loan balance pledged by Business Loan, which varies asloans are added and repaid, regardless of whether such repayments are earlyprepayment or are made as contractually required. At December 31, 2008, the remaining borrowing capacityavailable under the DB Facility was $153,530.

 

The DB Facilitycontains covenants that require Business Loan to maintain its status as aseparate entity; prohibit certain significant corporate transactions (such asmergers, consolidations, liquidations or dissolutions); and restrict materialchanges to our credit and collection policies. The facility also restricts someof the terms and provisions (including interest rates, terms to maturity andpayments schedules) and limits the borrower and industry concentrations ofloans that are eligible to secure advances. As of December 31, 2008,Business Loan was in compliance with all of the DB Facility covenants.

 

The administrativeagent also requires that any interest or principal payments on pledged loans beremitted directly by the borrower into a lockbox account with the Bank of New YorkMellon Corp. as custodian. Deutsche Bank AG is also the trustee of the account 

 

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and once a monthremits the collected funds to us. At December 31, 2008 and September 30, 2008, theamount due from custodian was $7,303 and $4,544, respectively.

 

Our Adviser alsoservices the loans pledged under the DB Facility. As a condition to thisservicing arrangement, we executed a performance guaranty pursuant to which weguaranteed that our Adviser would comply fully with all of its obligationsunder the facility. The performance guaranty requires us to maintain a minimumnet worth of $100 million plus 75% of equity issued after May 2003 and tomaintain “asset coverage” with respect to “senior securities representingindebtedness” of at least 200%, in accordance with Section 18 of the 1940Act. As of December 31,2008, we were in compliance with our covenants under the performance guaranty. However,our continued compliance with these covenants depends on many factors, some ofwhich are beyond our control. In particular, depreciation in the valuation ofour assets, which valuation is subject to changing market conditions which arepresently very volatile, affects our ability to comply with these covenants. Duringthe nine months ended December 31, 2008, net unrealized depreciation onour investments was approximately $13,253, compared to $5,398 during the comparableperiod in the prior year. Given the further deterioration in the capitalmarkets and pricing levels subsequent to this period, net unrealizeddepreciation in our portfolio may continue to increase in future periods andthreaten our ability to comply with the covenants under our DB Facility. Accordingly,there are no assurances that we will continue to comply with these covenants. Failureto comply with these covenants would result in a default which, if we wereunable to obtain a waiver from the lenders, could accelerate our repaymentobligations under the DB Facility and thereby have a material adverse impact onour liquidity, financial condition, results of operations and ability to paydistributions.

 

Availability underthe DB Facility will terminate on May 21, 2009.  If the DB Facility is not renewed or extendedby this date, all principal and interest will be due and payable within oneyear of the maturity date. There can be no guarantee that we will be able torenew, extend or replace the DB Facility on terms that are favorable to us, orat all. Our ability to obtain replacement financing will be constrained bycurrent economic conditions affecting the credit markets, which havesignificantly deteriorated over the last several months and may declinefurther. Consequently, any renewal, extension or refinancing of the DB Facilitywill likely result in significantly higher interest rates and related chargesand may impose significant restrictions on the use of borrowed funds withregard to our ability to fund investments or maintain distributions. If we arenot able to renew, extend or refinance the DB Facility, this would likely havea material adverse effect on our liquidity and ability to fund new investmentsor maintain our distributions. Our inability to pay distributions could resultin us failing to qualify as a RIC. Consequently, any income or gains could becometaxable at corporate rates. If we are unable to secure replacement financing,we may be forced to sell certain assets on disadvantageous terms, which mayresult in realized losses, and such realized losses could materially exceed theamount of any unrealized depreciation on these assets as of our most recentbalance sheet date, which would have a material adverse effect on our resultsof operations. In addition to selling assets, or as an alternative, we mayissue equity in order to repay amounts outstanding under the DB Facility. Basedon the recent trading prices of our stock, such an equity offering may have asubstantial dilutive impact on our existing stockholders’ interest in ourearnings and assets and voting interest in us.

 

**ContractualObligations**

 

As of December 31, 2008, wewere not party to any signed term sheets for potential investments.

 

**Off-BalanceSheet Arrangements**

 

We did not haveany off-balance sheet arrangements as defined in Item 303(a)(4)(ii) ofRegulation S-K as of December 31, 2008.

 

**CriticalAccounting Policies**

 

The preparation offinancial statements and related disclosures in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported consolidated amounts ofassets and liabilities, and disclosure of contingent assets and liabilities atthe date of the financial statements, and revenues and expenses during theperiod reported. Actual results could differ materially from those estimates. Wehave identified our investment valuation process, which was amended during thequarter ended December 31, 2008, as our most critical account policy.

 

***Investment Valuation***

 

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

 

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

 

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

 

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

 

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

 

·                  Publicly-traded securities;

·                  Securities for which a limited marketexists; and

·                  Securities for which no marketexists.

 

*ValuationMethods:*

 

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

 

**Securitiesfor which a limited market exists:**We value securities thatare not traded on an established secondary securities market, but for which alimited market for the security exists, such as certain participations in, orassignments of, syndicated loans, at the quoted bid price. In valuing theseassets, we assess trading activity in an asset class, evaluate variances inprices and other market insights to determine if any available quote prices arereliable. If we conclude that quotes based on active markets or tradingactivity may be relied upon, firm bid prices are requested; however, if a firmbid price is unavailable, we base the value of the security upon the indicativebid price offered by the respective originating syndication agent’s tradingdesk, or secondary desk, on or near the valuation date. To the extent that weuse the indicative bid price as a basis for valuing the security, our Advisermay take further steps to consider additional information to validate thatprice in accordance with the Policy.

 

In the event theselimited markets become illiquid such that market prices are no longer readilyavailable, we will value our syndicated loans using estimated net presentvalues of the future cash flows or discounted cash flows (“DCF”). The use of aDCF methodology follows that prescribed by 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 thepurposes of using DCF to provide fair value estimates, we considered multipleinputs such as a risk-adjusted discount rate that incorporates adjustments thatmarket participants would make both for nonperformance and liquidity risks. Assuch, we developed a modified discount rate approach that incorporates riskpremiums including, among others, increased probability of default, or higherloss given default, or increased liquidity risk.

 

The DCF valuationsapplied to the syndicated loans provide an estimate of what we believe a marketparticipant would pay to purchase a syndicated loan in an active market, therebyestablishing a fair value. We will continue to apply the DCF methodology inilliquid markets until quoted prices based on trading activity are deemedreliable.

 

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

 

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

 

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In the case of Non-Public Debt Securities, we have engaged SPSE tosubmit opinions of value for our debt securities that are issued by portfoliocompanies in which we own no equity, or equity-like securities. SPSE’s opinionsof value are based on the valuations prepared by our portfolio management teamas described below. We request that SPSE also evaluate and assign values to successfees (conditional interest included in some loan securities) when we determinethat the probability of receiving a success fee on a given loan is above 6-8%,a threshold of significance. SPSE will only evaluate the debt portion of ourinvestments for which we specifically request evaluation, and may decline tomake requested evaluations for any reason at its sole discretion. Uponcompleting our collection of data with respect to the investments (which mayinclude the information described below under “Credit Information,” the riskratings of the loans described below under “Loan Grading and Risk Rating” andthe factors described hereunder), this valuation data is forwarded to SPSE forreview and analysis. SPSE makes its independent assessment of the data that wehave assembled and assesses its independent data to form an opinion as to whatthey consider to be the market values for the securities. With regard to itswork, SPSE has issued the following paragraph:

 

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

 

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

 

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

 

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

 

·                  the issuer’s ability to makepayments;

·                  the earnings of the issuer;

·                  recent sales to third parties ofsimilar securities;

·                  the comparison to publicly tradedsecurities; and

·                  discounted cash flow or otherpertinent factors.

 

In gathering the sales to third parties of similar securities, we mayreference industry statistics and use outside experts. Once we have estimatedthe total enterprise value of the issuer, we subtract the value of all the debtsecurities of the issuer; which are valued at the contractual principal balance.Fair values of these debt securities are discounted for any shortfall of totalenterprise value over the total debt outstanding for the issuer. Once thevalues 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.

 

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

 

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

 

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

 

·                  the nature and realizablevalue of the collateral;

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

·                  the markets in which theportfolio company does business;

·                  the comparison to publiclytraded companies; and

·                  discounted cash flow andother relevant factors.

 

Because such valuations, particularly valuations of privatesecurities and private companies, are not susceptible to precise determination,may fluctuate over short periods of time, and may be based on estimates, ourdeterminations of fair value may differ from the values that might haveactually resulted had a readily available market for these securities beenavailable.

 

*CreditInformation:*  OurAdviser monitors a wide variety of key credit statistics that provideinformation regarding our portfolio companies to help us assess credit qualityand portfolio performance. We and our Adviser participate in the periodic boardmeetings of our portfolio companies in which we hold control and affiliate investmentsand also require them to provide annual audited and monthly unaudited financialstatements. Using these statements or comparable information and boarddiscussions, our Adviser calculates and evaluates the credit statistics.

 

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

 

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

 
| **Company’s   System** | ** ** | **First  NRSRO** | ** ** | **Second  NRSRO** | ** ** | **Gladstone Capital’s Description(a)**                                                 |
|----------------------------------|------------|------------------|------------|-------------------|------------|-------------------------------------------------------------------------------------------------------|
| **>10**                       |       | Baa2             |       | BBB               |       | Probability of Default  (PD) during the next ten years is 4% and the Expected Loss (EL) is 1% or less |
| **10**                           |       | Baa3             |       | BBB-              |       | PD is 5% and the EL is  1% to 2%                                                                      |
| **9**                            |       | Ba1              |       | BB+               |       | PD is 10% and the EL is  2% to 3%                                                                     |
| **8**                            |       | Ba2              |       | BB                |       | PD is 16% and the EL is  3% to 4%                                                                     |
| **7**                            |       | Ba3              |       | BB-               |       | PD is 17.8% and the EL  is 4% to 5%                                                                   |
| **6**                            |       | B1               |       | B+                |       | PD is 22% and the EL is  5% to 6.5%                                                                   |
| **5**                            |       | B2               |       | B                 |       | PD is 25% and the EL is  6.5% to 8%                                                                   |
| **4**                            |       | B3               |       | B-                |       | PD is 27% and the EL is  8% to 10%                                                                    |

 

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| **Company’s   System** | ** ** | **First   NRSRO** | ** ** | **Second   NRSRO** | ** ** | **Gladstone Capital’s Description(a)**                   | ** ** |
|----------------------------------|------------|------------------------|------------|-------------------------|------------|-------------------------------------------------------------------------|------------|
| **3**                            |       | Caa1                   |       | CCC+                    |       | PD is 30% and the EL is  10% to 13.3%                                   |       |
| **2**                            |       | Caa2                   |       | CCC                     |       | PD is 35% and the EL is  13.3% to 16.7%                                 |       |
| **1**                            |       | Caa3                   |       | CC                      |       | PD is 65% and the EL is  16.7% to 20%                                   |       |
| **0**                            |       | N/a                    |       | D                       |       | PD is 85% or there is a  payment default and the EL is greater than 20% |       |

 

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(a)*                                  Thedefault rates set forth are for a ten year term debt security. If a debt securityis less than ten years, then the probability of default is adjusted to a lowerpercentage for the shorter period, which may move the security higher on ourrisk rating scale.*

 

The above scalegives an indication of the probability of default and the magnitude of the lossif there is a default. Our policy is to stop accruing interest on an investmentif we determine that interest is no longer collectible. At December 31,2008 and 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.

 

The followingtable lists the risk ratings for all non-syndicated loans in our portfolio at December 31,2008 and September 30, 2008, representing approximately 83%, of all loansin our portfolio at the end of each period:

 
| **Rating**       | ** ** | **Dec. 31, 2008** | ** ** | **Sept. 30, 2008** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **7.3**                     | ** ** | **7.3**                      | ** ** |
| Weighted Average | ** ** | **6.9**                     | ** ** | **7.0**                      | ** ** |
| Highest          | ** ** | **9.0**                     | ** ** | **9.0**                      | ** ** |
| Lowest           | ** ** | **5.0**                     | ** ** | **5.0**                      | ** ** |

 

The followingtable lists the risk ratings for all syndicated loans in our portfolio thatwere not rated by an NRSRO at December 31, 2008 and September 30,2008, representing approximately 6% of all loans in our portfolio at the end ofeach period:

 
| **Rating**       | ** ** | **Dec. 31, 2008** | ** ** | **Sept. 30, 2008** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **6.5**                     | ** ** | **6.6**                      | ** ** |
| Weighted Average | ** ** | **6.5**                     | ** ** | **6.7**                      | ** ** |
| Highest          | ** ** | **7.0**                     | ** ** | **7.0**                      | ** ** |
| Lowest           | ** ** | **6.0**                     | ** ** | **6.0**                      | ** ** |

 

For syndicatedloans that are currently rated by a NRSRO, we risk rate such loans inaccordance with the risk rating systems of major risk rating organizations,such as those provided by a NRSRO. The following table lists the risk ratingsfor all syndicated loans in our portfolio that were rated by an NRSRO at December 31,2008 and September 30, 2008, representing approximately 11% of all loansin our portfolio at the end of each period:

 
| **Rating**       | ** ** | **Dec. 31, 2008** | ** ** | **Sept.30, 2008** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------|------------|
| Average          |       | CCC+/Caa1                   |       | CCC+/Caa1              |       |
| Weighted Average |       | CCC+/Caa1                   |       | CCC+/Caa1              |       |
| Highest          |       | BB/Ba3                      |       | BB/Ba3                 |       |
| Lowest           |       | CCC/Ca                      |       | CC/C                   |       |

 

***Tax Status***

 

We intend tocontinue to qualify for treatment as a RIC under Subtitle A, Chapter 1 ofSubchapter M of the Code. As a RIC, we are not subject to federal income tax onthe portion of our taxable income and gains distributed to stockholders. Toqualify as a RIC, we are required to distribute to stockholders at least 90% ofour investment company taxable income, as defined by the Code.  We have a policy to pay out as a distributionup to 100% of that amount.

 

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

 

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***Revenue Recognition***

 

*Interest IncomeRecognition*

 

Interest income isrecorded on the accrual basis to the extent that such amounts are expected tobe collected. We will stop accruing interest on investments and write off anypreviously accrued and uncollected interest when it is determined that interestis no longer collectible. At December 31,2008, one Non-Control/Non-Affiliate investment and two Control investments wereon non-accrual with an aggregate cost basis of approximately $9.2 million or2.0% of the 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 $13.1 million at September 30,2008, or 2.8% of the cost basis of all loans in the Company’s portfolio.  Conditional interest or a success feeis recorded when earned upon full repayment of a loan investment.

 

*Paid in Kind Interest*

 

We may hold loansin our portfolio which contain a PIK interest provision. The PIK interest,computed at the contractual rate specified in each loan agreement, is added tothe principal balance of the loan and recorded as interest income. To maintainour status as a RIC, this non-cash source of income must be paid out tostockholders in the form of distributions, even though we have not yetcollected the cash.  As of December 31,2008, one loan in our portfolio bore PIK interest.

 

*Services Provided to Portfolio Companies*

 

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

 

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

 

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

 

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

 

**RecentAccounting Pronouncements**

 

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

 

**ITEM 3. QUANTITATIVEAND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.**

 

We are subject tofinancial market risks, including changes in interest rates.  We estimatethat ultimately approximately 20% of the loans in our portfolio will be made atfixed rates and approximately 80% will be made at variable rates.  As of December 31, 2008, our portfolioconsisted of the following:

 
| 70  | % | variable rates with a  floor               |   |
|-----|---|--------------------------------------------|--------|
| 2   | % | variable rates with a  floor and ceiling   |   |
| 25  | % | variable rates without  a floor or ceiling |   |
| 3   | % | fixed rate                                 |   |
| 100 | % | total                                      |   |

 

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There have been nomaterial changes in the quantitative and qualitative market risk disclosuresfor the three months ended December 31, 2008 from that disclosed in ourAnnual Report on Form 10-K for the fiscal year ended September 30,2008, as filed with the Securities and Exchange Commission on December 2,2008.

 

**ITEM4. CONTROLS AND PROCEDURES.**

 

a) Evaluation of Disclosure Controls and Procedures

 

As of December 31, 2008, we, including our Chief ExecutiveOfficer and Chief Financial Officer, evaluated the effectiveness of the designand operation of our disclosure controls and procedures (as defined inExchange Act Rules 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 December 31, 2008, thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II–OTHERINFORMATION**

 

**ITEM 1. LEGALPROCEEDINGS.**

 

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

 

**ITEM 1A. RISKFACTORS.**

 

Our business issubject to certain risks and events that, if they occur, could adversely affectour financial condition and results of operations and the trading price of ourcommon stock.  For a discussion of theserisks, please refer to the “Risk Factors” section of our Annual Report on Form 10-Kfor the fiscal year ended September 30, 2008, filed by us with theSecurities and Exchange Commission on December 2, 2008.  In connection with our preparation of thisquarterly report, management has reviewed and considered these risk factors andhas determined that the following risk factors should be read in connectionwith the existing risk factors disclosed in the Form 10-K.

 

***Risk related to our external financing***

 

*Inaddition to regulatory limitations on our ability to raise capital, our creditfacility contains various covenants which, if not complied with, couldaccelerate our repayment obligations under the facility, thereby materially andadversely affecting our liquidity, financial condition, results of operationsand ability to pay distributions.*

 

The agreementgoverning our credit facility requires us to comply with certain financial andoperational covenants. These covenants require us to, among other things,maintain certain financial ratios, including asset coverage, debt to equity andinterest coverage, and a minimum net worth. As of December 31, 2008, we were in compliance with thesecovenants. However, our continued compliance with these covenants depends onmany factors, some of which are beyond our control.  In particular, depreciation in the valuationof our assets, which valuation is subject to changing market conditions whichare presently very volatile, may affect our ability to comply with thesecovenants.  During the three months endedDecember 31, 2008, net unrealized depreciation on our investments wasapproximately $13.3 million, compared to $5.4 million during the priorperiod.  Given the continueddeterioration in the capital markets, net unrealized depreciation in ourportfolio may continue to increase in future periods and threaten our abilityto comply with the covenants under our credit facility.  Accordingly, there are no assurances that wewill continue to comply with these covenants. Failure to comply with these covenants would result in a default which,if we were unable to obtain a waiver from the lenders, could accelerate ourrepayment obligations under the facility and thereby have a material adverseimpact on our liquidity, financial condition, results of operations, ability tofund new investments and ability to pay distributions.

 

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***Risk related to investment in our common stock***

 

*Shares of closed-end investment companiesfrequently trade at a discount from net asset value.*

 

Shares of closed-end investment companies frequentlytrade at a discount from net asset value. Although our common stock historically has generally traded above netasset value, recently it has traded below the December 31, 2008 net assetvalue of $12.04 per share.  Subsequent toDecember 31, 2008, our stock has consistently traded at discounts of up to54% of net asset value.  Thischaracteristic of shares of closed-end investment companies is separate anddistinct from the risk that our net asset value per share will decline.  As with any stock, the price of our shareswill fluctuate with market conditions and other factors.  If shares are sold, the price received may bemore or less than the original investment. Whether investors will realize gains or losses upon the sale of our shareswill not depend directly upon our net asset value, but will depend upon themarket price of the shares at the time of sale. Since the market price of our shares will be affected by such factors asthe relative demand for and supply of the shares in the market, general marketand economic conditions and other factors beyond our control, we cannot predictwhether the shares will trade at, below or above our net asset value.  Under the 1940 Act, we are generally not ableto issue additional shares of our common stock at a price below net asset valueper share to purchasers other than our existing stockholders through a rightsoffering without first obtaining the approval of our stockholders and ourindependent directors. Additionally, at times when our stock is trading belowits net asset value per share, our dividend yield may exceed the weightedaverage returns that we would expect to realize on new investments that wouldbe made with the proceeds from the sale of such stock, making it unlikely thatwe would determine to issue additional shares in such circumstances. Thus, foras long as our common stock trades below net asset value we will be subject tosignificant constraints on our ability to raise capital through the issuance ofcommon stock. Additionally, an extended period of time in which we are unableto raise capital may restrict our ability to grow and adversely impact ourability to increase or maintain our distribution.

 

***Risk related to our investments***

 

*Becausethe loans we make and equity securities we receive when we make loans are notpublicly traded, there will be uncertainty regarding the value of our privatelyheld securities that could adversely affect our determination of our net assetvalue.*

 

Our portfolioinvestments are, and we expect will continue to be, in the form of securitiesthat are not publicly traded. The fair value of securities and otherinvestments that are not publicly traded may not be readily determinable. OurBoard of Directors has established an investment valuation policy andconsistently applied valuation procedures used to determine the fair value ofthese securities quarterly. These procedures for the determination of value ofmany of our debt securities rely on the opinions of value submitted to us byStandard and Poor’s Securities Evaluations, Inc (“SPSE”), the use of internallydeveloped discounted cash flow methodologies (“DCF”), specifically for oursyndicated loans, or internal methodologies based on the total enterprise value(“TEV”) of the issuer used for certain of our equity investments. SPSE willonly evaluate the debt portion of our investments for which we specificallyrequest evaluation, and SPSE may decline to make requested evaluations for anyreason in its sole discretion.  However,to date, SPSE has accepted each of our requests for evaluation.

 

Our use of thesefair valuation methods is inherently subjective and is based on estimates andassumptions of each security.  In theevent that we are required to sell a security, which likelihood is heightenedas we approach the maturity of our credit facility in May 2009, we may ultimatelysell for an amount materially less than the estimated fair value calculated bySPSE, TEV or the DCF methodology.

 

Our proceduresalso include provisions whereby our Adviser will establish the fair value ofany equity securities we may hold where SPSE or third party agent banks areunable to provide evaluations. The types of factors that may be considered indetermining the fair value of our debt and equity securities include some orall of the following:

 

·  thenature and realizable value of any collateral;

·  theportfolio company’s earnings and cash flows and its ability to make payments onits obligations;

·  themarkets in which the portfolio company does business;

·  thecomparison to publicly traded companies; and

· discounted cash flow and other relevant factors.

 

Because suchvaluations, particularly valuations of private securities and privatecompanies, are not susceptible to precise determination, may fluctuate overshort periods of time, and may be based on estimates, our determinations offair value may differ from the values that might have actually resulted had areadily available market for these securities been available.

 

A portion of ourassets are, and will continue to be, comprised of equity securities that arevalued based on internal assessment using our own valuation methods approved byour Board of Directors, without the input of SPSE or any other third-party evaluator.We believe that our equity valuation methods reflect those regularly used asstandards by other professionals in our industry who value equity securities.However, determination of fair value for securities that are not publiclytraded, whether or not we use the recommendations of an independent third-partyevaluator, necessarily involves the exercise of subjective judgment. Our netasset value could be adversely affected if our determinations regarding thefair value of our investments were materially higher than the values that weultimately realize upon the disposal of such securities.

 

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In April 2008,we adopted the provisions of FASB Statement No. 157, *Fair Value Measurements*and we have followed the guidance of FASBStaff Position No. 157-3, “*Determiningthe Fair Value of a Financial Asset When the Market for That Asset Is NotActive,”*which focused on**fair market value accounting. Theimpact on our consolidated financial statements for future periods cannot bedetermined at this time as it will be influenced by the estimates of fair valuefor those periods, the number and amount of investments we originate, acquireor exit and the effect of any additional guidance or any changes in theinterpretation of this statement. If we are required to make furtherwrite-downs of our investment portfolio due to changes in market conditions,this could negatively impact the availability under our line of credit and ourability to draw on the line of credit.

 

**ITEM 2. UNREGISTERED SALESOF EQUITY SECURITIES ANDUSE OF PROCEEDS.**

 

Not applicable.

 

**ITEM 3. DEFAULTS UPONSENIOR SECURITIES.**

 

Not applicable.

 

**ITEM 4. SUBMISSION OFMATTERS TO A VOTE OFSECURITY HOLDERS.**

 

Not applicable.

 

**ITEM 5. OTHERINFORMATION.**

 

Not applicable

 

**ITEM 6.  EXHIBITS**

 

See the exhibit index.

 

**SIGNATURE**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

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

 

Date: February 3, 2009

 

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**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                    |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                               |
| 3.1         |       | Articles of Amendment and Restatement of  the Articles of Incorporation, incorporated by reference to Exhibit a.2  to Pre-Effective Amendment No. 1 to the Registration Statement on  Form N-2 (File No. 333-63700), filed July 27, 2001. |
|        |       |                                                                                                                                                                                                                                                               |
| 3.2         |       | By-laws, incorporated by reference to  Exhibit b to Pre-Effective Amendment No. 1 to the Registration  Statement on Form N-2 (File No. 333-63700), filed July 27,  2001.                                                                  |
|        |       |                                                                                                                                                                                                                                                               |
| 3.3         |       | Amendment to by-laws, incorporated by  reference to Exhibit 3.3 to the Company’s Quarterly Report on  Form 10-Q for the quarter ended December 31, 2003 (File  No. 814-00237), filed February 17, 2004.                              |
|        |       |                                                                                                                                                                                                                                                               |
| 3.4         |       | Second amendment to by-laws,  incorporated by reference to Exhibit 99.1 to the Company’s Current  Report on Form 8-K (File No. 814-00237), filed July 10, 2007.                                                                           |
|        |       |                                                                                                                                                                                                                                                               |
| 11          |       | Computation of Per Share Earnings  (included in the notes to the unaudited consolidated financial statements  contained in this report).                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                               |
| 31.1        |       | Certification of Chief Executive Officer  pursuant to section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                               |
| 31.2        |       | Certification of Chief Financial Officer  pursuant to section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                               |
| 32.1        |       | Certification of Chief Executive Officer  pursuant to section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                               |
| 32.2        |       | Certification of Chief Financial Officer  pursuant to section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                               |

 

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

 

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