**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

** **

** **

**FORM 10-Q**

 

**x** QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**FOR THE QUARTER ENDED DECEMBER 31, 2006**

** **

**o** TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**COMMISSION FILE NUMBER: 814-00237**

** **

**GLADSTONE CAPITALCORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

**1521 WESTBRANCH DRIVE, SUITE 200**

**MCLEAN, VIRGINIA 22102**

**(Address of principalexecutive office)**

** **

** **

**(703) 287-5800**

(Registrant’stelephone number, including area code)

 

 

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and(2) has been subject to such filing requirements for the past 90 days. Yes x No o.

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

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

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).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 5, 2007 was12,249,683.

 

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**GLADSTONE CAPITALCORPORATION**

**TABLE OF CONTENTS**

 
| PART I.    |   | FINANCIAL  INFORMATION                                                                                  |
|------------|--------|---------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                    |
| Item 1.    |   | Financial  Statements (Unaudited)                                                                       |
|       |   |                                                                                                    |
|       |   | Consolidated Statements of Assets and Liabilities as  of December 31, 2006 and September 30, 2006       |
|       |   | Consolidated Schedules of Investments as of December  31, 2006 and September 30, 2006                   |
|       |   | Consolidated Statements of Operations for the three  months ended December 31, 2006 and 2005            |
|       |   | Consolidated Statements of Changes in Net Assets for  the three months ended December 31, 2006 and 2005 |
|       |   | Consolidated Statements of Cash Flows for the three  months ended December 31, 2006 and 2005            |
|       |   | Financial Highlights for the three months ended  December 31, 2006 and 2005                             |
|       |   | Notes to Consolidated Financial Statements                                                              |
|       |   |                                                                                                    |
| Item 2.    |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations             |
|       |   | Overview                                                                                                |
|       |   | Results  of Operations                                                                                  |
|       |   | Liquidity and Capital Resources                                                                         |
|       |   |                                                                                                    |
| Item 3.    |   | Quantitative and Qualitative Disclosure About Market  Risk                                              |
|       |   |                                                                                                    |
| Item 4.    |   | Controls and Procedures                                                                                 |
|       |   |                                                                                                    |
| PART  II.  |   | OTHER  INFORMATION                                                                                      |
|       |   |                                                                                                    |
| Item  1.   |   | Legal  Proceedings                                                                                      |
|       |   |                                                                                                    |
| Item  1A.  |   | Risk  Factors                                                                                           |
|       |   |                                                                                                    |
| Item 2.    |   | Unregistered Sales of Equity Securities and Use of  Proceeds                                            |
|       |   |                                                                                                    |
| Item 3.    |   | Defaults Upon Senior Securities                                                                         |
|       |   |                                                                                                    |
| Item 4.    |   | Submission of Matters to a Vote of Security Holders                                                     |
|       |   |                                                                                                    |
| Item  5.   |   | Other  Information                                                                                      |
|       |   |                                                                                                    |
| Item 6.    |   | Exhibits                                                                                                |
|       |   |                                                                                                    |
| SIGNATURES |
|       |   |                                                                                                    |

 

----

 

**GLADSTONE CAPITALCORPORATIONCONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES(Unaudited)**

 
| ** **                                                                                                                               | ** ** | **December 31,** | ** **  | **September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|------------------------|------------|
| ** **                                                                                                                               | ** ** | **2006**              | ** **  | **2006**               | ** ** |
|                                                                                                                                     |       |                  |        |                   |       |
| ASSETS                                                                                                                                   |       |                  |        |                   |       |
| Investments at fair  value (Cost 12/31/2006: $244,537,584; 9/30/2006: $216,202,986)                                                      |       | $                     | 244,972,971 |                   | $          | 217,642,750 |   |
| Cash and cash  equivalents                                                                                                               |       | 5,996,680             |        | 731,744                |       |
| Interest receivable —  investments in debt securities                                                                               |       | 1,923,478             |        | 1,394,942              |       |
| Interest receivable —  employees                                                                                                    |       | 39,130                |        | 37,396                 |       |
| Due from custodian                                                                                                                       |       | 3,884,561             |        | 3,587,152              |       |
| Deferred financing fees                                                                                                                  |       | 113,666               |        | 145,691                |       |
| Prepaid assets                                                                                                                           |       | 280,431               |        | 226,747                |       |
| Due from employees                                                                                                                       |       | —                |        | 1,803,283              |       |
| Other assets                                                                                                                             |       | 209,270               |        | 213,510                |       |
| TOTAL ASSETS                                                                                                                             |       | $                     | 257,420,187 |                   | $          | 225,783,215 |   |
|                                                                                                                                     |       |                  |        |                   |       |
| LIABILITIES                                                                                                                              |       |                  |        |                   |       |
| Accounts payable                                                                                                                         |       | $                     | 10,931      |                   | $          | 4,072 |   |
| Interest payable                                                                                                                         |       | 358,605               |        | 247,530                |       |
| Administration fee due  to Administrator                                                                                                 |       | 126,085               |        | —                 |       |
| Fees due to Adviser  (Refer to Notes 3 and 4)                                                                                            |       | 849,106               |        | 240,363                |       |
| Borrowings under line  of credit                                                                                                         |       | 85,186,000            |        | 49,993,000             |       |
| Withholding taxes  payable                                                                                                               |       | —                |        | 1,803,283              |       |
| Accrued expenses and  deferred liabilities                                                                                               |       | 603,098               |        | 721,287                |       |
| Funds held in escrow                                                                                                                     |       | 203,240               |        | 203,193                |       |
| TOTAL LIABILITIES                                                                                                                        |       | 87,337,065            |        | 53,212,728             |       |
| NET ASSETS                                                                                                                               |       | $                     | 170,083,122 |                   | $          | 172,570,487 |   |
|                                                                                                                                     |       |                  |        |                   |       |
| ANALYSIS OF NET ASSETS                                                                                                                   |       |                  |        |                   |       |
| Common stock, $0.001  par value, 50,000,000 shares authorized and 12,249,683 and 12,305,008 shares  issued and outstanding, respectively |       | $                     | 12,250      |                   | $          | 12,305 |   |
| Capital in excess of  par value                                                                                                          |       | 179,782,427           |        | 181,270,565            |       |
| Notes receivable —  employees                                                                                                       |       | (10,248,156           | )           | (10,248,308            | )          |
| Net unrealized  appreciation on investments                                                                                              |       | 435,385               |        | 1,439,764              |       |
| Unrealized depreciation  on derivative                                                                                                   |       | (263,528              | )           | (253,716               | )          |
| Realized loss on sale  of investments                                                                                                    |       | (859,381              | )           | (861,695               | )          |
| Realized gain on  settlement of derivative                                                                                               |       | 27,568                |        | 15,014                 |       |
| Accumulated  undistributed net investment income                                                                                         |       | 1,196,557             |        | 1,196,558              |       |
| TOTAL NET ASSETS                                                                                                                         |       | $                     | 170,083,122 |                   | $          | 172,570,487 |   |
| NET ASSETS PER SHARE                                                                                                                     |       | $                     | 13.88       |                   | $          | 14.02 |   |

 

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

2

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTSAS OF DECEMBER 31, 2006(UNAUDITED)**
| Company (1)                                         | ** ** | **Industry**                                                | ** ** | **Investment (2)**                                 | ** ** | **Cost**   | ** ** | **Fair Value** |
|----------------------------------------------------------|------------|-------------------------------------------------------------|------------|---------------------------------------------------------|------------|------------|------------|---------------------|
| ** **                                               | ** ** | ** **                                                  | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** **          |
| ACS Media LLC                                            |       | Service-directory advertising                               |       | Senior Term Debt (6)  (7.8%, Due 1/2014)                |       | $2,386,446 |       | $2,385,950          |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| ActivStyle Acquisition Co.  ActivStyle, Inc.             |       | Service-medical products distribution                       |       | Line of Credit (8)  (9.6%, Due 7/2009)                  |       | —     |       | —              |
|                                                          |       |                                                        |       | Senior Term Debt (5)                                    |       | 3,120,000  |       | 3,120,000           |
|                                                          |       |                                                        |       | (9.6%, Due 7/2011)                                      |       |       |       |                |
|                                                          |       |                                                        |       | Senior Term Debt (3) (5)  (11.9%, Due 7/2011)           |       | 2,500,000  |       | 2,500,000           |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Advanced Homecare  Management, Inc.                      |       | Service-home health nursing services                        |       | Senior Subordinated Term Debt (6)  (11.8%, Due 12/2013) |       | 6,100,000  |       | 6,100,000           |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Allied Extruders, LLC  P&O Packaging Acquisition LLC |       | Manufacturing-polyethylene film                             |       | Senior Real Estate Term Debt   (9.9%, Due 3/2011)       |       | 1,000,000  |       | 1,000,000           |
|                                                          |       |                                                        |       | Senior Term Debt (3) (5)                                |       | 8,000,000  |       | 7,990,000           |
|                                                          |       |                                                        |       | (11.4%, Due 3/2011)                                     |       |       |       |                |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Badanco Acquisition Corp.                                |       | Manufacturing-luggage                                       |       | Senior Term Debt (5)  (10.8%, Due 2/2010)               |       | 4,777,519  |       | 4,783,491           |
|                                                          |       |                                                        |       | Senior Term Debt (3) (5) (18)                           |       | 8,552,688  |       | 9,073,118           |
|                                                          |       |                                                        |       | (13.8%, Due 2/2010)                                     |       |       |       |                |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Benetech, Inc.                                           |       | Service & Manufacuring-dust management systems for  the |       | Senior Term Debt (5)  (10.3%, Due 5/2009)               |       | 1,950,000  |       | 1,981,688           |
|                                                          |       | coal and electric utility                                   |       | Senior Term Debt (3) (5)                                |       | 3,006,250  |       | 3,070,133           |
|                                                          |       | industries                                                  |       | (13.3%, Due 5/2009)                                     |       |       |       |                |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Bresnan Communications, LLC                              |       | Service-telecommunications                                  |       | Senior Term Debt (6)                                    |       | 1,002,036  |       | 1,000,000           |
|                                                          |       |                                                        |       | (7.1%, Due 9/2013)                                      |       |       |       |                |
|                                                          |       |                                                        |       | Senior Subordinated Term Debt (6)                       |       | 1,511,167  |       | 1,533,750           |
|                                                          |       |                                                        |       | (9.9%, Due 3/2014)                                      |       |       |       |                |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Consolidated Bedding, Inc.                               |       | Manufacturing-mattresses                                    |       | Senior Subordinated Term Debt (5)                       |       | 2,436,016  |       | 2,174,128           |
|                                                          |       |                                                        |       | (14.4%, Due 3/2009)                                     |       |       |       |                |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Country Road                                             |       | Service-telecommunications                                  |       | Senior Subordinated Term Debt (5) (6)                   |       | 5,963,007  |       | 6,000,000           |
| Communications LLC                                       |       |                                                        |       | (13.3%, Due 7/2013)                                     |       |       |       |                |
| Country Road Management, Inc.                            |       |                                                        |       |                                                    |       |       |       |                |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Dealer Computer Services, Inc.                           |       | Manufacturing & Service-                                |       | Senior Term Debt (6)                                    |       | 949,620    |       | 955,555             |
| (d/b/a Reynolds & Reynolds)                          |       | Systems for automotive retailers                            |       | (7.9%, Due 10/2012)                                     |       |       |       |                |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Defiance Stamping                                        |       | Manufacturing-trucking parts                                |       | Senior Term Debt (3) (5)                                |       | 6,325,000  |       | 6,325,000           |
| Company                                                  |       |                                                        |       | (13.4%, Due 4/2010)                                     |       |       |       |                |
|                                                     |       |                                                        |       |                                                    |       |       |       |                |
| Doe & Ingalls Management LLC                         |       | Distributor-specialty chemicals                             |       | Senior Term Debt (5)                                    |       | 4,700,000  |       | 4,723,500           |
| Doe & Ingalls of North                               |       |                                                        |       | (9.9%, Due 11/2010)                                     |       |       |       |                |
| Carolina Operating LLC                                   |       |                                                        |       | Senior Term Debt (3) (5)                                |       | 4,500,000  |       | 4,516,875           |
| Doe & Ingalls of Florida                             |       |                                                        |       | (13.4%, Due 11/2010)                                    |       |       |       |                |
| Operating LLC                                            |       |                                                        |       |                                                    |       |       |       |                |
| Doe & Ingalls of Virginia                            |       |                                                        |       |                                                    |       |       |       |                |
| Operating LLC                                            |       |                                                        |       |                                                    |       |       |       |                |

 

3

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF DECEMBER 31, 2006(UNAUDITED)**
| Company (1)                        | ** ** | **Industry**                        | ** ** | **Investment (2)**              | ** ** | **Cost**   | ** ** | **Fair Value** |
|-----------------------------------------|------------|-------------------------------------|------------|--------------------------------------|------------|------------|------------|---------------------|
| ** **                              | ** ** | ** **                          | ** ** | ** **                           | ** ** | ** ** | ** ** | ** **          |
| Dresser Holdings, Inc.                  |       | Manufacturing-oilfield & energy |       | Senior Term Debt (6)                 |       | 1,831,236  |       | 1,847,259           |
|                                         |       | products                            |       | (8.1%, Due 10/2013)                  |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| Emdeon Business Services, Inc.          |       | Service-healthcare technology       |       | Senior Term Debt (6)                 |       | 1,500,000  |       | 1,505,625           |
|                                         |       | solutions                           |       | (7.9%, Due 11/2013)                  |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| Employment Solutions                    |       | Service-specialty staffing          |       | Senior Term Debt (5)(6)              |       | 3,000,513  |       | 3,000,000           |
| Management, Inc.                        |       |                                |       | (8.4%, Due 10/2012)                  |       |       |       |                |
| Employbridge                            |       |                                |       | Senior Subordinated Term Debt (5)(6) |       | 3,000,516  |       | 3,000,000           |
|                                         |       |                                |       | (12.4%, Due 10/2013)                 |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| Express Courier International,          |       | Service-ground delivery and         |       | Line of Credit (8)                   |       | —     |       | —              |
| Inc.                                    |       | logistics                           |       | (9.6%, Due 6/2009)                   |       |       |       |                |
|                                         |       |                                |       | Senior Term Debt (5)                 |       | 4,582,500  |       | 4,588,228           |
|                                         |       |                                |       | (9.6%, Due 6/2011)                   |       |       |       |                |
|                                         |       |                                |       | Senior Term Debt (3) (5)             |       | 3,950,000  |       | 3,954,938           |
|                                         |       |                                |       | (11.9%, Due 6/2011)                  |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| Finn Corporation                        |       | Manufacturing-landscape             |       | Common Stock Warrants                |       | 37,000     |       | 768,616             |
|                                         |       | equipment                           |       |                                 |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| FR X Ohmstede Holdings, LLC             |       | Service & Manufacuring-heat     |       | Senior Term Debt (6)                 |       | 2,843,478  |       | 2,875,467           |
| FR X Ohmstede Acquisitions Co.          |       | exchangers                          |       | (8.4%, Due 8/2013)                   |       |       |       |                |
|                                         |       |                                |       | Senior Subordinated Term Debt (6)    |       | 3,011,976  |       | 3,045,000           |
|                                         |       |                                |       | (12.4%, Due 8/2014)                  |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| Generac Acquisition Corp.               |       | Manufacturing-standby power         |       | Senior Term Debt (6)                 |       | 2,380,000  |       | 2,388,925           |
|                                         |       | products                            |       | (7.8%, Due 11/2013)                  |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| Global Materials                        |       | Manufacturing-steel wool            |       | Senior Term Debt (3) (5)             |       | 5,250,000  |       | 5,177,813           |
| Technologies, Inc.                      |       | products and metal fibers           |       | (14.4%, Due 11/2009)                 |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| GTM Holdings, Inc.                      |       | Manufacturing-socks                 |       | Senior Term Debt (6)                 |       | 500,000    |       | 503,750             |
| Gold Toe Investment Corp.               |       |                                |       | (8.1%, Due 10/2013)                  |       |       |       |                |
|                                         |       |                                |       | Senior Subordinated Term Debt (6)    |       | 500,000    |       | 507,500             |
|                                         |       |                                |       | (11.4%, Due 4/2014)                  |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| Hudson Products Holdings, Inc.          |       | Manufacturing-heat transfer         |       | Senior Term Debt (6)                 |       | 1,190,000  |       | 1,192,975           |
|                                         |       | solutions                           |       | (8.1%, Due 12/2013)                  |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| IPC Information Systems, LLC            |       | Manufacturing-specialized           |       | Senior Term Debt (6)                 |       | 238,000    |       | 239,190             |
|                                         |       | telephony systems                   |       | (7.9%, Due 9/2013)                   |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| It’s Just Lunch International, LLC |       | Service-dating service              |       | Line of Credit (5)(9)                |       | 500,000    |       | 499,375             |
|                                         |       |                                |       | (9.4%, Due 6/2009)                   |       |       |       |                |
|                                         |       |                                |       | Senior Term Debt (5)                 |       | 3,400,000  |       | 3,395,750           |
|                                         |       |                                |       | (9.6%, Due 6/2011)                   |       |       |       |                |
|                                         |       |                                |       | Senior Term Debt (3)(10)             |       | 400,000    |       | 400,000             |
|                                         |       |                                |       | (11.9%, Due 6/2011)                  |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| John Henry Holdings, Inc.               |       | Manufacturing-packaging             |       | Senior Subordinated Term Debt (6)    |       | 8,000,000  |       | 8,000,000           |
| Multi Packaging Solutions, Inc.         |       | products                            |       | (12.4%, Due 6/2011)                  |       |       |       |                |
|                                    |       |                                |       |                                 |       |       |       |                |
| Kinetek Acquisition Corp.               |       | Manufacturing-custom                |       | Senior Term Debt (6)                 |       | 1,506,174  |       | 1,505,625           |
|                                         |       | engineered motors & controls    |       | (7.8%, Due 11/2013)                  |       |       |       |                |
|                                         |       |                                |       | Senior Subordinated Term Debt (6)    |       | 1,509,887  |       | 1,509,375           |
|                                         |       |                                |       | (10.8%, Due 5/2014)                  |       |       |       |                |

 

4

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF DECEMBER 31, 2006(UNAUDITED)**
| Company (1)                   | ** ** | **Industry**                     | ** ** | **Investment (2)**              | ** ** | **Cost**  | ** ** | **Fair Value** |
|------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|-----------|------------|---------------------|
|                               |       |                             |       |                                 |       |      |       |                |
| LocalTel, Inc.                     |       | Service-yellow pages             |       | Line of Credit (5) (11)              |       | —    |       | —              |
|                                    |       | publishing                       |       | (9.8%, Due 6/2009)                   |       |      |       |                |
|                                    |       |                             |       | Senior Term Debt (5)                 |       | 2,687,500 |       | 2,479,219           |
|                                    |       |                             |       | (9.9%, Due 6/2011)                   |       |      |       |                |
|                                    |       |                             |       | Senior Term Debt (3) (5)             |       | 2,750,000 |       | 2,420,000           |
|                                    |       |                             |       | (12.4%, Due 6/2011)                  |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| MediMedia USA Inc.                 |       | Service-healthcare and           |       | Senior Term Debt (6)                 |       | 1,075,087 |       | 1,072,329           |
|                                    |       | pharmaceutical marketing         |       | (7.8%, Due 10/2013)                  |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| Network Solutions LLC              |       | Service-internet domain registry |       | Senior Term Debt (5)(6)              |       | 4,453,198 |       | 4,488,413           |
|                                    |       | and host                         |       | (10.4%, Due 1/2012)                  |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| Northern Contours                  |       | Manufacturing-veneer and         |       | Senior Subordinated Term Debt (5)    |       | 7,000,000 |       | 7,017,500           |
| Northern Contours                  |       | laminate components              |       | (12.4%, Due 5/2010)                  |       |      |       |                |
| of Kentucky, Inc.                  |       |                             |       |                                 |       |      |       |                |
| Norcon Holding LLC                 |       |                             |       |                                 |       |      |       |                |
| Norcon Lewis LLC                   |       |                             |       |                                 |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| Pinnacle Treatment Centers, Inc.   |       | Service-Addiction treatment      |       | Line of Credit (7)(12)               |       | —    |       | —              |
|                                    |       | centers                          |       | (9.6%, Due 12/2009)                  |       |      |       |                |
|                                    |       |                             |       | Senior Term Debt (7)                 |       | 2,500,000 |       | 2,500,000           |
|                                    |       |                             |       | (9.6%, Due 12/2011)                  |       |      |       |                |
|                                    |       |                             |       | Senior Term Debt (3)(7)              |       | 4,500,000 |       | 4,500,000           |
|                                    |       |                             |       | (12.4%, Due 12/2011)                 |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| Precision Acquisition Group        |       | Manufacturing-consumable         |       | Equipment Note (5)(13)               |       | —    |       | —              |
| Holdings, Inc.                     |       | components for the aluminum      |       | (9.9%, Due 10/2011)                  |       |      |       |                |
| Precision Asset Acquisition        |       | industry                         |       | Senior Term Debt (5)                 |       | 5,000,000 |       | 5,006,250           |
| Company, LLC                       |       |                             |       | (9.9%, Due 10/2010)                  |       |      |       |                |
|                                    |       |                             |       | Senior Term Debt (3)(5)              |       | 4,200,000 |       | 4,205,250           |
|                                    |       |                             |       | (11.9%, Due 10/2010)                 |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| PROFITSystems Acquisition Co.      |       | Service-design and develop       |       | Line of Credit (14)                  |       | —    |       | —              |
| PROFITSystems, Inc.                |       | ERP software                     |       | (9.6%, Due 7/2009)                   |       |      |       |                |
|                                    |       |                             |       | Senior Term Debt (5)                 |       | 3,025,000 |       | 3,028,781           |
|                                    |       |                             |       | (9.6%, Due 7/2011)                   |       |      |       |                |
|                                    |       |                             |       | Senior Term Debt (3)(5)              |       | 2,900,000 |       | 2,903,625           |
|                                    |       |                             |       | (11.9%, Due 7/201)                   |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| Puerto Rico Cable                  |       | Service-telecommunications       |       | Senior Subordinated Term Debt (5)(6) |       | 7,809,590 |       | 7,775,183           |
| Acquisition Company, Inc.          |       |                             |       | (11.6%, Due 1/2012)                  |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| QCE, LLC (d/b/a Quiznos Corp.)     |       | Service-restaurant franchisor    |       | Senior Term Debt (6)                 |       | 3,002,529 |       | 2,981,269           |
|                                    |       |                             |       | (7.6%, Due 5/2013)                   |       |      |       |                |
|                                    |       |                             |       | Senior Term Debt (3)(6)              |       | 3,043,949 |       | 3,048,750           |
|                                    |       |                             |       | (11.1%, Due 11/2013)                 |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| Radio Systems Corporation          |       | Service-design electronic pet    |       | Senior Term Debt (6)                 |       | 952,000   |       | 955,570             |
|                                    |       | containment products             |       | (8.1%, Due 9/2013)                   |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| Rally Parts, Inc.                  |       | Manufacturing-aftermarket        |       | Senior Term Debt (6)                 |       | 238,000   |       | 238,595             |
| Motorsport Aftermarket Group, Inc. |       | motorcycle parts and accessories |       | (7.9%, Due 11/2013)                  |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
|                               |       |                             |       |                                 |       |      |       |                |
| RCS Management Holding Co.         |       | Service-healthcare supplies      |       | Senior Term Debt (3) (5)             |       | 3,000,000 |       | 2,996,250           |
|                                    |       |                             |       | (9.9%, Due 1/2011)                   |       |      |       |                |
|                                    |       |                             |       | Senior Term Debt (4) (5)             |       | 3,000,000 |       | 2,996,250           |
|                                    |       |                             |       | (12.4%, Due 1/2011)                  |       |      |       |                |

 

5

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF DECEMBER 31, 2006(UNAUDITED)**
| Company (1)              | ** ** | **Industry**                  | ** ** | **Investment (2)**           | ** ** | **Cost**         | ** ** | **Fair Value** |
|-------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|------------------|------------|---------------------|
|                          |       |                          |       |                              |       |             |       |                |
| RedPrairie Holding, Inc.      |       | Service-design and develop    |       | Senior Term Debt (6)              |       | 3,980,000        |       | 3,980,000           |
| RedPrairie Corporation        |       | supply chain software         |       | (8.4%, Due 7/2012)                |       |             |       |                |
| Blue Cube Software, Inc.      |       |                          |       | Senior Subordinated Term Debt (6) |       | 2,000,000        |       | 2,010,000           |
|                               |       |                          |       | (11.9%, Due 1/2013)               |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| SCPH Holdings, Inc.           |       | Manufacturing-underwater      |       | Credit Facility (15)              |       | —           |       | —              |
| Sea Con Phoenix, Inc.         |       | and harsh environment         |       | (9.8%, Due 2/2007)                |       |             |       |                |
| Phoenix Optix, Inc.           |       | components                    |       | Senior Term Debt (5)              |       | 2,450,000        |       | 2,456,125           |
|                               |       |                          |       | (10.3%, Due 2/2010)               |       |             |       |                |
|                               |       |                          |       | Senior Term Debt (3) (5)          |       | 2,850,000        |       | 2,860,688           |
|                               |       |                          |       | (13.3%, Due 2/2010)               |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| SCS Acquisition Corp.         |       | Service-chemically treated    |       | Senior Term Debt (3) (5) (16)     |       | 5,625,000        |       | 5,639,063           |
|                               |       | equipment distribution        |       | (9.4%, Due 12/2011)               |       |             |       |                |
|                               |       |                          |       | Senior Term Debt (3) (5) (16)     |       | 6,550,000        |       | 6,566,375           |
|                               |       |                          |       | (11.4%, Due 12/2011)              |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| Stolle Machinery Company, LLC |       | Manufacturing-can making      |       | Senior Term Debt (6)              |       | 238,000          |       | 239,190             |
| LJ Can Holdings, Inc.         |       | equipment and parts           |       | (7.9%, Due 9/2012)                |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| Thibaut Acquisition Co.       |       | Design and Disbtribution-wall |       | Credit Facility (17)              |       | —           |       | —              |
|                               |       | coverings                     |       | (9.9%, Due 1/2011)                |       |             |       |                |
|                               |       |                          |       | Senior Term Debt (5)              |       | 3,237,500        |       | 3,241,547           |
|                               |       |                          |       | (9.9%, Due 1/2011)                |       |             |       |                |
|                               |       |                          |       | Senior Term Debt (3) (5)          |       | 3,000,000        |       | 3,003,750           |
|                               |       |                          |       | (12.4%, Due 1/2011)               |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| Visual Edge Technology, Inc.  |       | Service-office equipment      |       | Senior Subordinated Term Debt (5) |       | 5,000,000        |       | 4,650,000           |
| Graphic Enterprises, Inc.     |       | distribution                  |       | (13.3%, Due 8/2011)               |       |             |       |                |
| Copeco, Inc.                  |       |                          |       |                              |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| Wesco Holdings, Inc.          |       | Service-aerospace parts and   |       | Senior Term Debt (6)              |       | 2,526,100        |       | 2,518,750           |
| Wesco Aircraft Hardware Corp. |       | distribution                  |       | (7.6%, Due 9/2013)                |       |             |       |                |
|                               |       |                          |       | Senior Subordinated Term Debt (6) |       | 2,273,102        |       | 2,306,250           |
|                               |       |                          |       | (11.1%, Due 3/2014)               |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| West Corporation              |       | Service-business process      |       | Senior Term Debt (6)              |       | 4,760,000        |       | 4,771,900           |
|                               |       | outsourcing                   |       | (8.1%, Due 10/2013)               |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| Westlake Hardware, Inc.       |       | Retail-hardware and variety   |       | Senior Subordinated Term Debt (5) |       | 15,000,000       |       | 14,962,500          |
| WHI Holding Corp.             |       |                          |       | (12.6%, Due 1/2011)               |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| Winchester Electronics        |       | Manufacturing-high bandwidth  |       | Senior Term Debt (3) (5)          |       | 6,000,000        |       | 6,015,000           |
|                               |       | connectors and cables         |       | (12.4%, Due 6/2012)               |       |             |       |                |
|                          |       |                          |       |                              |       |             |       |                |
| **Total:**                    | ** ** | ** **                    | ** ** | ** **                        | ** ** | **$244,537,584** | ** ** | **$244,972,971**    |

 

----

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

(2)             Percentage represents interestrates in effect at December 31, 2006 and due date represents the contractualmaturity date.

(3)             Last Out Tranche of senior debt,meaning if the company is liquidated then the holder of the Last Out Tranche ispaid 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 ispaid after the senior debt, however the debt is junior to another Last OutTranche.

(5)             Fair value was based on opinions ofvalue submitted by Standard & Poor’s Securities Evaluations, Inc.

(6)             Marketable securities, such assyndicated loans, are valued based on the indicative bid price, as of December29, 2006, from the respective originating syndication agent’s trading desk.

(7)             Investment valued at cost due torecent acquisition.

(8)             Availability under the creditfacility totals $1,500,000.  There wereno borrowings outstanding at December 31, 2006.

(9)             Availability under the creditfacility totals $750,000.  Borrowings of$500,000 were outstanding at December 31, 2006.

6

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(10)       The company may borrow anadditional $1,850,000 of the senior term debt facility, subject to certainconditions including Gladstone Capital’s approval.

(11)       Availability under the creditfacility totals $2,000,000.  There wereno borrowings outstanding at December 31, 2006.

(12)       Availability under the creditfacility totals $500,000.  There were noborrowings outstanding at December 31, 2006.

(13)       The company may borrow up to$1,000,000 for purposes of acquiring equipment. There were no borrowingsoutstanding at December 31, 2006.

(14)       Availability under the creditfacility totals $1,250,000.  There wereno borrowings outstanding at December 31, 2006.

(15)       Availability under the creditfacility totals $500,000.  There were noborrowings outstanding at December 31, 2006.

(16)       The company may borrow up to anadditional $875,000 to finance capital expenditures.

(17)       Availability under the creditfacility totals $1,000,000.  There wereno borrowings outstanding at December 31, 2006.

(18)       Includes a success fee with a$360,068 fair value and no cost basis.

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIALSTATEMENTS.*

7

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTSAS OF SEPTEMBER 30, 2006**

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

 

8

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)SEPTEMBER 30, 2006**

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

 

9

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)SEPTEMBER 30, 2006**

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

----

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

(2)             Percentage represents interestrates in effect at September 30, 2006 and due date represents the contractualmaturity date.

(3)             Last Out Tranche of senior debt,meaning if the company is liquidated then the holder of the Last Out Tranche ispaid 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 ispaid after the senior debt, however the debt is junior to another Last OutTranche.

(5)             Fair value was based on opinions ofvalue submitted by Standard & Poor’s Securities Evaluations, Inc.

(6)             Marketable securities, such assyndicated loans, are valued based on the indicative bid price, as of September30, 2006 from the respective originating syndication agent’s trading desk.

10

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(7)             Availability under the creditfacility totals $1,500,000.  There wereno borrowings outstanding at September 30, 2006.

(8)             Availability under the creditfacility totals $500,000.  There were noborrowings outstanding at September 30, 2006.

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

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

(11)       Availability under the credit facilitytotals $1,000,000.  There were noborrowings outstanding at September 30, 2006.

(12)       Availability under the creditfacility totals $750,000.  Borrowings of$200,000 were outstanding at September 30, 2006.

(13)       The company may borrow anadditional $500,000 under the senior term debt facility, subject to certainconditions including Gladstone Capital’s approval.

(14)       The company may borrow anadditional $2,250,000 under the senior term debt facility, subject to certainconditions including Gladstone Capital’s approval.

(15)       Availability under the creditfacility totals $3,000,000.  Borrowingsof $350,000 were outstanding at September 30, 2006.

(16)       Availability under the creditfacility totals $1,500,000.  There wereno borrowings outstanding at September 30, 2006

(17)       Availability under the creditfacility totals $1,250,000.  There wereno borrowings outstanding at September 30, 2006

(18)       Includes a success fee with a fairvalue of $742,000 and no cost basis.

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

 

11

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**

 
| ** **                                                              | ** ** | **Three Months Ended December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| INVESTMENT INCOME                                                       |       |                                                    |       |   |   |
| Interest income  — investments                                     |       | $                                                       | 7,898,600  |   | $ | 5,847,107 |   |
| Interest income  — cash and cash equivalents                       |       | 37,269                                                  |       | 8,912 |   |
| Interest income  — notes receivable from employees                 |       | 138,191                                                 |       | 107,093 |   |
| Prepayment fees  and other income                                       |       | 159,658                                                 |       | 67,207 |   |
| Total investment  income                                                |       | 8,233,718                                               |       | 6,030,319 |   |
|                                                                    |       |                                                    |       |   |   |
| EXPENSES                                                                |       |                                                    |       |   |   |
| Loan servicing  (Refer to Notes 3 and 4)                                |       | 719,152                                                 |       | 715,415 |   |
| Base management  fee (Refer to Note 3)                                  |       | 398,432                                                 |       | 268,701 |   |
| Incentive fee  (Refer to Note 3)                                        |       | 1,148,483                                               |       | — |   |
| Administration  fee (Refer to Note 3)                                   |       | 126,085                                                 |       | — |   |
| Professional  fees                                                      |       | 110,920                                                 |       | 122,466 |   |
| Amortization of  deferred financing fees                                |       | 58,300                                                  |       | 26,250 |   |
| Interest expense                                                        |       | 1,120,257                                               |       | 652,078 |   |
| Stockholder  related costs                                              |       | 63,728                                                  |       | 128,935 |   |
| Directors fees                                                          |       | 54,250                                                  |       | 24,000 |   |
| Insurance  expense                                                      |       | 62,694                                                  |       | 50,777 |   |
| Stock option  compensation                                              |       | —                                                  |       | 43,257 |   |
| Other expenses                                                          |       | 88,485                                                  |       | 55,789 |   |
| Expenses before  credit from Adviser                                    |       | 3,950,786                                               |       | 2,087,668 |   |
| Credits to base  management and incentive fees (Refer to Note 3)        |       | (879,994                                                | )          | (550,000 | ) |
| Total expenses  net of credits to base management and incentive fees    |       | 3,070,792                                               |       | 1,537,668 |   |
|                                                                    |       |                                                    |       |   |   |
| NET INVESTMENT INCOME  BEFORE INCOME TAXES                              |       | 5,162,926                                               |       | 4,492,651 |   |
| Income tax  expense                                                     |       | —                                                  |       | 50,237 |   |
| NET INVESTMENT INCOME                                                   |       | 5,162,926                                               |       | 4,442,414 |   |
|                                                                    |       |                                                    |       |   |   |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS:                    |       |                                                    |       |   |   |
| Net realized  gain (loss) on sale of investments                        |       | 2,314                                                   |       | (1,180,595 | ) |
| Realized gain on  settlement of derivative                              |       | 12,554                                                  |       | — |   |
| Unrealized  depreciation on derivative                                  |       | (9,812                                                  | )          | (892 | ) |
| Net unrealized  (depreciation) appreciation on investments              |       | (1,004,379                                              | )          | 4,972,422 |   |
| Net (loss) gain  on investments                                         |       | (999,323                                                | )          | 3,790,935 |   |
|                                                                    |       |                                                    |       |   |   |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS                   |       | $                                                       | 4,163,603  |   | $ | 8,233,349 |   |
|                                                                    |       |                                                    |       |   |   |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE: |       |                                                    |       |   |   |
| Basic                                                                   |       | $                                                       | 0.34       |   | $ | 0.73 |   |
| Diluted                                                                 |       | $                                                       | 0.34       |   | $ | 0.71 |   |
|                                                                    |       |                                                    |       |   |   |
| WEIGHTED AVERAGE SHARES  OF COMMON STOCK OUTSTANDING:                   |       |                                                    |       |   |   |
| Basic                                                                   |       | 12,294,340                                              |       | 11,306,510 |   |
| Diluted                                                                 |       | 12,294,340                                              |       | 11,573,620 |   |
|                                                                    |       |                                                    |       |   |   |

 

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

12

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS(UNAUDITED)**

 
| ** **                                                 | ** ** | **Three Months Ended December 31,** | ** **  |
|------------------------------------------------------------|------------|---------------------------------------------------------|-------------|
| ** **                                                 | ** ** | **2006**                                                | ** **  | **2005** | ** ** |
| *Operations:*                                              |       |                                                    |        |   |   |
| Net investment income                                      |       | $                                                       | 5,162,926   |   | $ | 4,442,414 |   |
| Net realized gain (loss) on sale of investments            |       | 2,314                                                   |        | (1,180,595 | ) |
| Realized gain on settlement of derivative                  |       | 12,554                                                  |        | — |   |
| Unrealized depreciation on derivative                      |       | (9,812                                                  | )           | (892 | ) |
| Net unrealized (depreciation) appreciation on  investments |       | (1,004,379                                              | )           | 4,972,422 |   |
| Net increase in net assets from operations                 |       | 4,163,603                                               |        | 8,233,349 |   |
|                                                       |       |                                                    |        |   |   |
| *Capital  transactions:*                                   |       |                                                    |        |   |   |
| Distributions to stockholders                              |       | (5,162,927                                              | )           | (4,579,272 | ) |
| Stock option compensation                                  |       | —                                                  |        | 43,257 |   |
| Issuance of common stock under stock option plan           |       | —                                                  |        | 85,900 |   |
| Repayment of principal on employee notes                   |       | 152                                                     |        | 23,094 |   |
| Stock surrendered in settlement of withholding tax         |       | (1,488,193                                              | )           | — |   |
| Decrease in net assets from capital share  transactions    |       | (6,650,968                                              | )           | (4,427,021 | ) |
|                                                       |       |                                                    |        |   |   |
| Total (decrease)  increase in net assets                   |       | (2,487,365                                              | )           | 3,806,328 |   |
| Net assets at  beginning of year                           |       | 172,570,487                                             |        | 151,610,683 |   |
| Net assets at  end of period                               |       | $                                                       | 170,083,122 |   | $ | 155,417,011 |   |

 

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

13

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**GLADSTONE CAPITALCORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**
| ** **                                                                                                                              | ** ** | **Three Months Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                                                              | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                                                               |       |                                                    |       |   |   |
| ** **                                                                                                                              |       |                                                    |       |   |   |
| Net increase in net assets resulting from operations                                                                                    |       | $                                                       | 4,163,603  |   | $ | 8,233,349 |   |
| Adjustments to reconcile net increase in net assets  resulting from operations to net cash (used in) provided by operating  activities: |       |                                                    |       |   |   |
| Purchase of investments                                                                                                                 |       | (52,311,008                                             | )          | (26,688,457 | ) |
| Principal repayments on investments                                                                                                     |       | 23,967,229                                              |       | 38,702,066 |   |
| Net amortization of premiums and discounts                                                                                              |       | 9,181                                                   |       | 32,641 |   |
| Amortization of deferred financing fees                                                                                                 |       | 58,300                                                  |       | 26,250 |   |
| Stock compensation expense                                                                                                              |       | —                                                  |       | 43,257 |   |
| Realized loss on investments                                                                                                            |       | —                                                  |       | 1,180,595 |   |
| Unrealized depreciation on derivative                                                                                                   |       | 9,812                                                   |       | 892 |   |
| Change in net unrealized depreciation (appreciation)  on investments                                                                    |       | 1,004,379                                               |       | (4,972,422 | ) |
| (Increase) decrease in interest receivable                                                                                              |       | (530,270                                                | )          | 457,764 |   |
| (Increase) decrease in funds due from custodian                                                                                         |       | (297,409                                                | )          | 210,954 |   |
| Increase in prepaid assets                                                                                                              |       | (53,686                                                 | )          | (19,277 | ) |
| Increase in due from affiliate                                                                                                          |       | —                                                  |       | (300,638 | ) |
| Increase in other assets                                                                                                                |       | (5,572                                                  | )          | (20,919 | ) |
| Increase (decrease) in accounts payable                                                                                                 |       | 6,859                                                   |       | (11,109 | ) |
| Increase in interest payable                                                                                                            |       | 111,075                                                 |       | 5,683 |   |
| (Decrease) increase in accrued expenses and deferred  liabilities                                                                       |       | (118,189                                                | )          | 2,297 |   |
| Increase (decrease) in fees due to affiliate                                                                                            |       | 608,743                                                 |       | (181,213 | ) |
| Increase in administration fee due to Gladstone  Administration                                                                         |       | 126,085                                                 |       | — |   |
| Increase in funds held in escrow                                                                                                        |       | 47                                                      |       | 1,404 |   |
| Increase in investment balance due to payment in  kind interest                                                                         |       | —                                                  |       | (33,022 | ) |
| Net cash (used  in) provided by operating activities                                                                                    |       | (23,250,821                                             | )          | 16,670,095 |   |
|                                                                                                                                    |       |                                                    |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES**                                                                                               |       |                                                    |       |   |   |
| ** **                                                                                                                              |       |                                                    |       |   |   |
| Receipt of principal on notes receivable - employees                                                                                    |       | 152                                                     |       | 23,094 |   |
| Net cash provided by investing activities                                                                                               |       | 152                                                     |       | 23,094 |   |
|                                                                                                                                    |       |                                                    |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES**                                                                                               |       |                                                    |       |   |   |
| ** **                                                                                                                              |       |                                                    |       |   |   |
| Borrowings from the lines of credit                                                                                                     |       | 69,900,000                                              |       | 41,925,000 |   |
| Repayments on the lines of credit                                                                                                       |       | (34,707,000                                             | )          | (39,235,341 | ) |
| Distributions paid                                                                                                                      |       | (5,162,927                                              | )          | (4,579,272 | ) |
| Exercise of employee stock options                                                                                                      |       | —                                                  |       | 85,900 |   |
| Deferred financing fees                                                                                                                 |       | (26,275                                                 | )          | — |   |
| Stock surrendered to settle withholding tax  obligation                                                                                 |       | (1,488,193                                              | )          | — |   |
| Net cash provided by (used in) financing activities                                                                                     |       | 28,515,605                                              |       | (1,803,713 | ) |
|                                                                                                                                    |       |                                                    |       |   |   |
| **NET  INCREASE IN CASH AND CASH EQUIVALENTS (1)**                                                                                      |       | 5,264,936                                               |       | 14,889,476 |   |
| **CASH  AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                                                                     |       | 731,744                                                 |       | 503,776 |   |
| **CASH  AND CASH EQUIVALENTS, END OF PERIOD**                                                                                           |       | $                                                       | 5,996,680  |   | $ | 15,393,252 |   |
|                                                                                                                                    |       |                                                    |       |   |   |
| **CASH  PAID DURING PERIOD FOR INTEREST**                                                                                               |       | $                                                       | 1,009,182  |   | $ | 646,934 |   |

----

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

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

14

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**GLADSTONE CAPITALCORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**

 
| ** **                                                  | ** ** | **Three Months Ended December 31,** | ** **  |
|-------------------------------------------------------------|------------|---------------------------------------------------------|-------------|
| ** **                                                  | ** ** | **2006**                                                | ** **  | **2005** | ** ** |
| Per Share Data  (1)                                         |       |                                                    |        |   |   |
| Net asset value  at beginning of period                     |       | $                                                       | 14.02       |   | $ | 13.41 |   |
| *Income  from investment operations:*                       |       |                                                    |        |   |   |
| Net investment income (2)                                   |       | 0.42                                                    |        | 0.39 |   |
| Realized gain (loss) on sale of investments (2)             |       | —                                                  |        | (0.10 | ) |
| Net unrealized (loss) gain on investments (2)               |       | (0.08                                                   | )           | 0.44 |   |
| Total from  investment operations                           |       | 0.34                                                    |        | 0.73 |   |
| Less  distributions:                                        |       |                                                    |        |   |   |
| Distributions from net investment income                    |       | (0.42                                                   | )           | (0.41 | ) |
| Total  distributions                                        |       | (0.42                                                   | )           | (0.41 | ) |
| Issuance of common  stock under stock option plan           |       | —                                                  |        | 0.01 |   |
| Dilutive effect  of shares surrendered                      |       | (0.06                                                   | )           | — |   |
| Net asset value  at end of period                           |       | $                                                       | 13.88       |   | $ | 13.74 |   |
|                                                        |       |                                                    |        |   |   |
| Per share market  value at beginning of period              |       | $                                                       | 22.01       |   | $ | 22.55 |   |
| Per share market  value at end of period                    |       | 23.86                                                   |        | 21.38 |   |
| Total return (3)(4)                                         |       | 10.31                                                   | %           | -3.44 | % |
| Shares  outstanding at end of period                        |       | 12,249,683                                              |        | 11,308,510 |   |
|                                                        |       |                                                    |        |   |   |
| Ratios/Supplemental  Data                                   |       |                                                    |        |   |   |
| Net assets at  end of period                                |       | $                                                       | 170,083,122 |   | $ | 155,417,011 |   |
| Average net  assets (5)                                     |       | $                                                       | 170,331,785 |   | $ | 150,961,590 |   |
| Ratio of  expenses to average net assets-annualized (6)     |       | 9.28                                                    | %           | 5.66 | % |
| Ratio of net  expenses to average net assets-annualized (7) |       | 7.21                                                    | %           | 4.21 | % |
| Ratio of net investment  income to average net assets       |       | 12.12                                                   | %           | 11.77 | % |

----

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

(2)             Based on weighted average basic pershare data.

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

(4)             Amounts were not annualized.

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

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

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

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

15

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**GLADSTONE CAPITALCORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2006(UNAUDITED)**

NOTE1.  ORGANIZATION

GladstoneCapital Corporation (the “Company”) was incorporated under the GeneralCorporation Laws of the State of Maryland on May 30, 2001.  The Company is a closed-end, non-diversifiedmanagement investment company that has elected to be treated as a businessdevelopment company, or BDC, under the Investment Company Act of 1940, asamended (the “1940 Act”).  In addition,the Company has elected to be treated for tax purposes as a regulatedinvestment company, or RIC, under the Internal Revenue Code of 1986, as amended(the “Code”).  The Company’s investmentobjectives are to achieve a high level of current income by investing in debtand equity securities of established private businesses.

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

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

NOTE2.  SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

*UnauditedInterim Financial Statements*

Interimfinancial statements of the Company are prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) forinterim financial information and pursuant to the requirements for reporting onForm 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financialstatements prepared in accordance with GAAP are omitted.  In the opinion of management, alladjustments, consisting solely of normal recurring accruals, necessary for thefair statement of financial statements for the interim periods have been included.  The current period’s results of operationsare not necessarily indicative of results that ultimately may be achieved forthe year.  The interim financialstatements and notes thereto should be read in conjunction with the financialstatements and notes thereto included in the Company’s Form 10-K for the fiscalyear ended September 30, 2006, as filed with the Securities and ExchangeCommission (the “SEC”) on December 6, 2006.

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

*Useof Estimates*

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

*InvestmentValuation*

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

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on the collateral, theenterprise value of the issuer, the issuer’s ability to make payments, theearnings of the issuer, sales to third parties of similar securities, thecomparison to publicly traded securities, discounted cash flow and otherpertinent factors.  Due to theuncertainty inherent in the valuation process, such estimates of fair value maydiffer significantly from the values that would have resulted had a readymarket for the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains or losses ultimatelyrealized on these investments to be different than the valuation currentlyassigned.  Because there is a delaybetween when the Company closes an investment and when the investment can beevaluated by SPSE, new investments are not valued immediately by SPSE; rather,the Adviser makes its own determination about the recommended value of theseinvestments in accordance with the Company’s valuation policy without the inputof SPSE during the specific quarter in which the investment is made.  Because SPSE does not currently performindependent valuations of mortgage loans or equity securities for the Company,the Adviser also determines a recommendation for the fair value of theseinvestments without the input of SPSE. The Adviser considers a number of qualitative and quantitative factorsin current market conditions when performing valuations.  The Board of Directors then determineswhether or not to accept the Adviser’s recommendations for the aggregatevaluation of the Company’s portfolio of investments.  The Board of Directors is ultimatelyresponsible for setting the fair value and disclosure of investments in thefinancial statements.

*InterestIncome Recognition*

Interest income,adjusted for amortization of premiums and accretion of discounts, is recordedon the accrual basis to the extent that such amounts are expected to becollected. The Company stops accruing interest on its investments when it isdetermined that interest is no longer collectible.  There were no uncollectible accounts atDecember 31, 2006.  Conditional interestor a success fee is recorded when earned upon full repayment of a loaninvestment.

*Paidin Kind Interest*

TheCompany seeks to avoid PIK interest, however the Company had one loan in itsportfolio at December 31, 2005 that contained a PIK provision. A PIK provisionrequires the borrower to accrue a payment to the Company but the borrower doesnot have to pay that interest until the loan is paid in full. The PIK interestis added to the principal balance of the loan and recorded as income to theCompany even though the cash has not been received.  To maintain the Company’s status as a RIC (asdiscussed in Note 9), this non-cash source of income must be paid out tostockholders in the form of cash dividends, even though the Company has not yetcollected the cash. The Company recorded no PIK interest income for the threemonths ended December 31, 2006 and $32,510 for the three months ended December31, 2005.

*ServicesProvided to Portfolio Companies*

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

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

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

Whilethe Adviser receives all fees in connection with the Company’s investments,such fees received by the Adviser, with the exception of monitoring and reviewfees, are entirely credited to the Company as a reduction of the advisory feepayable under the advisory agreement between the Company and the Adviser.  For the three months ended December 31, 2006and December 31, 2005, the Adviser received $311,000 and $550,000,respectively, of such fees and the advisory fee payable by the Company to theAdviser was reduced by these amounts. None of these fees were for managerial assistance even though theAdviser provided managerial assistance to many of the Company’s portfoliocompanies.

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*Cashand Cash Equivalents*

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

*RealizedGain or Loss and Unrealized Appreciation or Depreciation of Portfolio Investments*

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

*Federaland State Income Taxes*

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

During the three monthsended December 31, 2005, Gladstone Capital Corporation recorded approximately$50,000 in connection with penalties incurred on misclassified revenue on itsfiscal year 2004 corporate tax return.

*RecentAccounting Pronouncements*

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

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

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

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

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

NOTE3. RELATED PARTY TRANSACTIONS

*Loansto Employees*

TheCompany provided loans to employees of the Adviser for the exercise of optionsunder the Amended and Restated 2001 Equity Incentive Plan.  The loans require the quarterly payment ofinterest at the market rate in effect at the date of issue, have varying termsnot exceeding ten years and have been recorded as a reduction of netassets.  The loans are evidenced by fullrecourse notes that are due upon maturity or 60 days following termination ofemployment, and the shares of common stock purchased with the proceeds of theloan are posted as collateral.  No newloans were issued during the three months ended December 31, 2006 and theCompany received $152 of principal repayments. During the three months ended December 31, 2005, the Company receivedprincipal repayments of $23,094 in connection with the full repayment of oneloan and a partial repayment of another loan. The Company recognized interest income from all employee stock optionloans of $138,191 for the three months ended December 31, 2006, as compared to$107,093 for the three months ended December 31, 2005.

*InvestmentAdvisory and Management and Administration Agreements*

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

*Termsof the Amended Advisory Agreement*

Underthe Amended Advisory Agreement, the Company pays the Adviser an annual basemanagement fee of 2% of its average gross assets, which is defined as totalassets less cash and cash equivalents pledged to creditors calculated as of theend of the two most recently completed fiscal quarters and also consists of 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 pre-incentive fee net investment income does notexceed the hurdle rate (7% annualized);

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

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

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

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TheAdviser’s Board of Directors has agreed to voluntarily waive, for the fiscalquarter ended December 31, 2006, the annual 2.0% base management fee to 0.5%for senior syndicated loan participations and also waived a portion of theincentive fee due.

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

Forthe three months ended December 31, 2006, the Company recorded a gross basemanagement fee of $398,432 less a credit of $311,000 for fees received by theAdviser for a net base management fee of $87,432 as compared to a gross basemanagement fee of $268,701, less a credit of $550,000 for fees received by theAdviser, for a net base management fee credit of $281,299 for the three monthsended December 31, 2005.  The Companyalso recorded a gross incentive fee of $1,148,483 offset by a credit from avoluntary waiver issued by the Adviser’s board of directors of $568,994 for anet incentive fee of $579,489.  There wasno incentive fee in effect at December 31, 2005.  As of December 31, 2006, the Company had$87,432 of unpaid base management fees and $579,489 of unpaid incentive feesrecorded in fees due to Adviser in the accompanying consolidated statements ofassets and liabilities.

*Termsof the Initial Advisory Agreement*

Ascompensation for its services, the Company paid the Adviser an annual advisoryfee of 1.25% of total assets (as reduced by cash and cash equivalents pledgedto creditors), payable in quarterly computed increments of 0.3125%, and anannual administrative fee of 0.75% of total assets (as reduced by cash and cashequivalents pledged to creditors), payable in quarterly computed increments of0.1875%, for a total annual management fee of 2.0% (0.50% quarterly) of totalassets (as reduced by cash and cash equivalents pledged to creditors).  The Company also paid all of its directexpenses including, but not limited to, directors’ fees, legal and accountingfees, stockholder related expenses, and directors and officers insurance.

*LoanServicing and Portfolio Company Fees*

TheAdviser also services the loans held by Business Loan, in return for which, itreceives a 1.5% annual fee based on the monthly aggregate outstanding balanceof the loans pledged under the Company’s line of credit.  Since the Company owns these loans, all loanservicing fees paid to the Adviser are also treated as reductions directlyagainst the 2% management fee, under both the Initial and Amended Advisory Agreements.  Effective in April 2006, the Adviser’s Boardof Directors voluntarily agreed to waive, on a temporary basis, and reduce theannual servicing fee rate for senior syndicated loans to 0.5%. For the threemonths ended December 31, 2006, these loan servicing fees totaled $719,152, ascompared to the loan servicing fees for the three months ended December 31,2005 of $715,415, all of which were deducted against the 2% base management feein order to derive the base management fee which is presented as the line itembase management fee in the consolidated statements of operations.  At December 31, 2006, the Company owed$182,185 of unpaid loan servicing fees to the Adviser, which are recorded infees due to Adviser.  At September 30,2006, the Company owed $214,608 in loan servicing fees to the Adviser, recordedin fees due to Adviser in the consolidated statements of assets andliabilities.  Under the Initial andAmended Advisory Agreements, the Adviser also provides managerial assistanceand other services to the Company’s portfolio companies and may receive feesfor services other than managerial assistance services.  To the extent that the Adviser receives anyfees directly from a portfolio company for such services, it credits these feesdirectly against the 2% base management fee. For the three months ended December 31, 2006, the Adviser recorded$311,000, respectively of such fees and credited this amount against the 2%base management fee received from the Company, as compared such fees forDecember 31, 2005 of $550,000, these credits are reflected on the consolidatedstatement of operations as credits to base management and incentive fees.  Overall, the base management fee due to theAdviser cannot exceed 2% of total assets (as reduced by cash and cashequivalents pledged to creditors) during any given fiscal year.

*AdministrationAgreement*

OnOctober 1, 2006, the Company entered into an administration agreement (the “AdministrationAgreement”) with Gladstone Administration, LLC (the “Administrator”), awholly-owned subsidiary of the Adviser. Under the Administration Agreement, the Company pays separately foradministrative services.  TheAdministration Agreement provides for payments equal to the Company’s allocableportion of the Administrator’s overhead expenses in performing its obligationsunder the Administration Agreement, including but not limited to, rent foremployees of the Administrator, and the allocable portion of salaries andbenefits expenses of the Company’s chief financial officer, controller, chiefcompliance officer, treasurer and their respective staffs.  The Company recorded an administration fee of$126,085 for the three months ended December 31, 2006.  The administration fee was not in effectduring the three months ended December 31, 2005.

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NOTE4. LINE OF CREDIT

Through BusinessLoan, the Company has a $150 million revolving credit facility (the “DBFacility”) with Deutsche Bank AG, as administrative agent, pursuant to whichBusiness Loan pledged the loans it holds to secure future advances by certaininstitutional lenders. The interest rate charged on the advances under the DBFacility is based on the London Interbank Offered Rate (“LIBOR”), the PrimeRate or the Federal Funds Rate, depending on market conditions, and adjustsperiodically. The DB Facility is in effect through May 25, 2007.  As of December 31, 2006, the outstandingprincipal balance under the DB Facility was approximately $85.2 million at aninterest rate of approximately 5.3%. Available borrowings are subject to various constraints imposed underthe credit agreement, based on the aggregate loan balance pledged by BusinessLoan, which varies as loans are added and repaid, regardless of whether suchrepayments are early prepayment or are made as contractually required.  At December 31, 2006, the remaining borrowingcapacity available under the DB Facility was approximately $64.8 million.

The DB Facilitycontains covenants that require Business Loan to maintain its status as aseparate entity; prohibit certain significant corporate transactions (such asmergers, consolidations, liquidations or dissolutions); and restrict materialchanges to the Company’s credit and collection policies.  The DB Facility also restricts some of theterms and provisions (including interest rates, terms to maturity and paymentsschedules) and limits the borrower and industry concentrations of loans thatare eligible to secure advances.  As ofDecember 31, 2006, Business Loan was in compliance with all of the facilitycovenants.

The administrativeagent also requires that any interest or principal payments on pledged loans beremitted directly by the borrower into a lockbox account with the Bank of NewYork as custodian.  Deutsche Bank AG isalso the trustee of the account and once a month remits the collected funds tothe Company. At December 31, 2006, the amount due from custodian was $3,884,561and at September 30, 2006, the amount due from custodian was $3,587,152.

The Adviser alsoservices the loans pledged under the DB Facility.  As a condition to this servicing arrangement,the Company executed a performance guaranty pursuant to which it guaranteedthat the Adviser would comply fully with all of its obligations under the DBFacility.  The performance guarantyrequires that the Company maintain a minimum net worth of $100 million 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, 2006, theCompany was in compliance with all covenants under the performance guaranty.

NOTE5. INTEREST RATE CAP AGREEMENT

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

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

In February 2004, theCompany entered into an interest rate cap agreement with a notional amount of$35.0 million at a cost of $304,000.  Theinterest rate cap agreement’s current notional amount is $13.0 million and ithas a current fair value of approximately $40,472 which is recorded in otherassets on the Company’s consolidated balance sheet at December 31, 2006.  At September 30, 2006, the interest rate capagreement had a fair market value of $50,284. The Company records changes in the fair market value of the interestrate cap agreement monthly based on the current market valuation at month endas unrealized depreciation or appreciation on derivative on the Company’sconsolidated statement of operations. The interest rate cap agreement expiresin February 2009. The agreement provides that the Company’s floating interestrate or cost of funds on a portion of the portfolio’s borrowings will be cappedat 5% when the LIBOR rate is in excess of 5%. During the three months ended December 31, 2006, the Company recorded$12,554 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 Company did notrecognize any income from the interest rate cap agreement during the threemonths ended December 31, 2005.

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NOTE6.  COMMON STOCK TRANSACTIONS

Asof December 31, 2005 and December 31, 2006, 50,000,000 shares of $0.001 parvalue common stock were authorized and 11,308,510 and 12,249,683 shares wereoutstanding, respectively.

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

 

InOctober 2006, 5,000 shares of common stock were issued as a result of an optionexercise which took place on the last business day of the prior fiscalyear.  These shares were issued by thetransfer agent at the start of the current fiscal year.  Also during the three months ended December31, 2006, 60,325 shares of stock were surrendered to the Company from certainoptionees who exercised non-qualified stock options during the third and fourthquarters of fiscal year 2006 in order to satisfy settlement of withholdingtaxes that were paid by the Company with respect to the shares underlying theexercise of such options.

NOTE7. STOCK OPTIONS

There were no stock options outstanding at December31, 2006.  Prior to its termination onSeptember 30, 2006, the Company had in place the Amended and Restated 2001Equity Incentive Plan (the “2001 Plan”). The Company had authorized 2,000,000shares of capital stock for the issuance of options under the 2001 Plan toemployees and directors. Options granted under the 2001 Plan originally couldhave been exercised during a term not to exceed ten years from the date ofgrant. Only employees of the Company and its affiliates were eligible toreceive incentive stock options and both employees and non-employee directorswere eligible to receive nonstatutory stock options under the 2001 Plan.  Options granted under the 2001 Plan wereeither incentive stock options or nonstatutory stock options.  The option exercise price was equal to themarket price on the date of the grant. In connection with the externalization of the Company’s management, allof the Company’s officers and employees became direct employees of the Adviser,as of October 1, 2004.  However, theseindividuals continued to be eligible to receive stock options under the 2001Plan.  Effective October 1, 2004, theCompany accounted for any options granted to employees of the Adviser, whoqualify as leased employees of the Company under FASB Interpretation No. 44, *“Accounting for Certain Transactions Involving Stock Compensation, anInterpretation of APB Opinion No. 25.”*

In December 2004, the FASB issued SFASNo. 123 (revised 2004) (“SFAS No. 123(R)”) *Share-basedPayment*. SFAS No. 123(R) replaces SFAS No. 123, *Accounting for Stock-Based Compensation* and supersedesAccounting Principles Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees* (“APB No. 25”). SFAS No. 123(R)is effective for awards that are granted, modified, or settled in cash forannual periods beginning after June 15, 2005.  The Company adopted SFASNo. 123(R) on October 1, 2005 using the modified prospectiveapproach. Under the modified prospective approach, stock-based compensationexpense was recorded for the unvested portion of previously issued awards thatremained outstanding at October 1, 2005 using the same estimate of thegrant date fair value and the same attribution method previously used todetermine the pro forma disclosure under SFAS No. 123. SFASNo. 123(R) also requires that all share-based payments to employees afterOctober 1, 2005, including employee stock options, be recognized in thefinancial statements as stock-based compensation expense based on the fairvalue on the date of grant.

For the three monthsended December 31, 2005, the Company recorded stock option compensation expensefor the cost of stock options issued under the 2001 Plan of $43,257. TheCompany’s expensing of stock options decreased both basic and diluted netincrease to net assets resulting from operations per share by $0.004 for thethree months ended December 31, 2005. Additionally, SFAS No. 123(R) states that any potential taxbenefits associated with incentive stock options should be recognized only atthe time of settlement if those options settle through a disqualifyingdisposition. Thus, the related stock-based compensation expense must be treatedas a permanent difference until that time which, in turn, results in anincrease to the Company’s effective tax rate. The Company does not record tax benefits associated with the expensingof stock options since the Company intends to qualify as a RIC under SubchapterM of the Code and as such the Company is not subject to federal income tax onthe portion of its taxable income and gains distributed to stockholders,provided that at least 90% of the taxable income is distributed.

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The fair value of each option grant was estimated onthe date of grant using the Black-Scholes option pricing model, whichincorporated a risk free interest rate, an expected life, an expectedvolatility factor, and an expected dividend yield.

The following is a summary of the status of theCompany’s 2001 Plan from September 30, 2005 through December 31, 2005:

|                                                                                       | ** ** | **Shares** | ** ** | **Weighted Average   Exercise Price** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------|------------|------------------------------------------------------|------------|
| Options  outstanding at September 30, 2005, of which 1,307,998shares were exercisable |       | 1,307,998  |       | $                                                    | 17.81      |   |
| Granted                                                                               |       | —     |       | $                                                    | —     |   |
| Exercised                                                                             |       | (5,000     | )          | $                                                    | 17.18      |   |
| Forfeited                                                                             |       | (5,000     | )          | $                                                    | 22.55      |   |
| Options  outstanding at December 31, 2005, of which 1,297,998 shares were exercisable |       | 1,297,998  |       | $                                                    | 17.80      |   |

 

There were no options outstanding at December 31, 2006and the following is a detailed summary of the stock options outstanding atDecember 31, 2005:

| Range of   Exercise Prices | ** ** | **Stock   Options   Outstanding** | ** ** | **Weighted   Average   Remaining   Contractual   Life (Years)** | ** ** | **Weighted   Average   Exercise   Price** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
|                                      |       |                                        |       |                                                                                     |       |                                                     |       |
| $15.00 - $21.94                           |       | 968,998                                     |       | 6.23                                                                                     |       | $                                                        | 16.06      |   |
| $22.21 - $24.39                           |       | 329,000                                     |       | 8.39                                                                                     |       | $                                                        | 22.98      |   |
| Total                                     |       | 1,297,998                                   |       | 6.78                                                                                     |       | $                                                        | 17.80      |   |

 

NOTE8. INCREASE IN NET ASSETS PER SHARE RESULTING FROM OPERATIONS

Thefollowing table sets forth the computation of basic and diluted net increase innet assets per share resulting from operations for the three months endedDecember 31, 2006 and December 31, 2005:

|                                                                                                  | ** ** | **Three Months Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
|                                                                                             |       |                                                    |       |   |   |
| Numerator for  basic and diluted net increase in net assets resulting from operations per  share |       | $                                                       | 4,163,603  |   | $ | 8,233,349 |   |
|                                                                                             |       |                                                    |       |   |   |
| Denominator for  basic weighted average shares                                                   |       | 12,294,340                                              |       | 11,306,510 |   |
| Dilutive effect  of stock options                                                                |       | —                                                  |       | 267,110 |   |
| Denominator for  diluted weighted average shares                                                 |       | 12,294,340                                              |       | 11,573,620 |   |
|                                                                                             |       |                                                    |       |   |   |
| Basic net  increase in net assets resulting from operations per share                            |       | $                                                       | 0.34       |   | $ | 0.73 |   |
|                                                                                             |       |                                                    |       |   |   |
| Diluted net  increase in net assets resulting from operations per share                          |       | $                                                       | 0.34       |   | $ | 0.71 |   |
|                                                                                             |       |                                                    |       |   |   |

 

Therewere 1,297,998 options outstanding to purchase common stock at December 31,2005. Of these, 329,000 options were not included in the computation of dilutedearnings per share for the three months ended December 31, 2005, because theoptions’ exercise prices were greater than the average market price of thecommon shares for the period and, therefore, were anti-dilutive.  There were no stock options outstanding atDecember 31, 2006.

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NOTE9. DIVIDENDS

TheCompany is required to pay out as a dividend 90% of its ordinary income andshort-term capital gains for each taxable year in order to maintain its statusas a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code.  It is the policy of the Company to pay out asa dividend up to 100% of those amounts. The amount to be paid out as a dividend is determined by the Board ofDirectors each quarter and is based on the annual earnings estimated by themanagement of the Company.  Based on thatestimate, three monthly dividends are declared each quarter.  At year-end the Company may pay a bonusdividend, in addition to the monthly dividends, to ensure that it has paid outat least 90% of its ordinary income and realized net short-term capital gainsfor the year.  Long-term capital gainsare composed of success fees, prepayment fees and gains from the sale ofsecurities held from one year or more. The Company intends to retain long-termcapital gains from the sale of securities, if any, and not pay them out asdividends, however, the Board of Directors may decide to declare and pay outcapital gains during any fiscal year.  Ifthe Company decides to retain long-term capital gains, the portion of theretained capital gains will be subject to 35% tax.  The tax characteristics of all dividends willbe reported to stockholders on Form 1099 at the end of each calendar year.  The following table lists the per sharedividends paid for the three months ended December 31, 2006 and December 31,2005:

| Fiscal Year | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend  per Share** | ** ** |
|------------------|------------|----------------------|------------|-----------------------|------------|------------------------------|------------|
| 2007             |       | December  20, 2006   |       | December  29, 2006    |       | $                            | 0.14       |   |
|             |       | November  21, 2006   |       | November  30, 2006    |       | $                            | 0.14       |   |
|             |       | October  23, 2006    |       | October  31, 2006     |       | $                            | 0.14       |   |
|             |       |                 |       | Quarterly  Total      |       | $                            | 0.42       |   |
|             |       |                 |       |                  |       |                         |       |
| 2006             |       | December  21, 2005   |       | December  30, 2005    |       | $                            | 0.135      |   |
|             |       | November  21, 2005   |       | November  30, 2005    |       | $                            | 0.135      |   |
|             |       | October  21, 2005    |       | October  31, 2005     |       | $                            | 0.135      |   |
|             |       |                 |       | Quarterly Total       |       | $                            | 0.405      |   |

 

NOTE10. CONTRACTUAL OBLIGATIONS

Asof December 31, 2006, the Company was a party to signed and non-binding termsheets for four allocations of syndicate loan participations for $7.5million.  The Company expects to fundthese potential investments as follows:
| ** **                       | ** ** | ** ** | ** ** | **Payment Due by Period** | ** ** |
|----------------------------------|------------|------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **Less than 1 Year**      | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than 5 Years** | ** ** |
|                             |       |       |       |                                     |       |   |   |   |   |   |   |
| Investments                      |       | $          | 7,500,000  |                                     | 7,500,000  |   | — |   | — |   | — |   |
| Total                            |       | $          | 7,500,000  |                                     | $          | 7,500,000 |   | $ | — |   | $ | — |   | $ | — |   |
|                             |       |       |       |                                     |       |   |   |   |   |   |   |
|                                  |            |            |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

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

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NOTE11. SUBSEQUENT EVENTS

In January 2007, theCompany funded approximately $24.5 million of originations, including theacquisition of warrants in connection with one investment, extendedapproximately $1.2 million in revolver borrowings to five existing portfoliocompanies, and purchased approximately $21.6 million of syndicated loanparticipations.  The Company alsorefinanced $13.3 million of senior term loan investments for an existingportfolio company in exchange for a new $9.8 million senior subordinated termloan investment and received approximately $533,000 of success fees uponclosing.

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

| Fiscal Year | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend   per Share** | ** ** |
|------------------|------------|----------------------|------------|-----------------------|------------|------------------------------------|------------|
| 2007             |       | January  23, 2007    |       | January  31, 2007     |       | $                                  | 0.14       |   |
|             |       | February  20, 2007   |       | February  28, 2007    |       | $                                  | 0.14       |   |
|             |       | March 22, 2007       |       | March 30, 2007        |       | $                                  | 0.14       |   |

 

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

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

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

**OVERVIEW**

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

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

Our loans typically rangefrom $5 million to $15 million, although this investment size may varyproportionately as the size of our capital base changes, generally mature in nomore than seven years and accrue interest at fixed or variable rates. Some ofour loans may contain a provision that calls for some portion of the interestpayments to be deferred and added to the principal balance so that the interestis paid, together with the principal, at maturity. This form of deferredinterest is often called “paid in kind” or “PIK” interest, and, when earned, werecord PIK interest as interest income and add the PIK interest to theprincipal balance of the loans. We seek to avoid PIK interest with allpotential investments under review. We currently do not hold any investmentswith PIK and, therefore, there was no PIK accrued on our balance sheet as of December31, 2006.

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

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

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

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

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

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

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During the three monthsended December 31, 2006, we extended, directly or through participations,approximately $52.3 million of new loans to a total of 20 companies.  Also, during the three months ended December31, 2006, one borrower repaid its loans ahead of contractual maturity and wesold or were repaid in full on two syndicated loans, and we received scheduledcontractual principal repayments of approximately $3.1 million, for totalprincipal repayments of approximately $24.0 million.  Since our initial public offering in August2001, we have made 157 different loans to, or investments in, 88 companies fora total of approximately $550.4 million, before giving effect to principalrepayments on investments and divestitures.

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

**Our Investment Adviser and Administrator**

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

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

We have been externallymanaged by our Adviser pursuant to an investment advisory and managementagreement since October 1, 2004. Our Adviser was organized as a corporationunder the laws of the State of Delaware on July 2, 2002, and is aregistered investment adviser under the Investment Advisers Act of 1940, asamended. Our Adviser is headquartered in McLean, Virginia, a suburb ofWashington D.C., and also has offices in New York, New Jersey, Pennsylvania,Illinois, Texas and Kentucky.

**Investment Advisory andManagement Agreement**

On December 2, 2005, ourstockholders approved a proposal to enter into an amended and restatedinvestment advisory agreement (the “Amended Advisory Agreement”) with theAdviser and an administration agreement (the “Administration Agreement”)between the Company and our Administrator, both of which became effective onOctober 1, 2006.  The Amended AdvisoryAgreement replaced the original advisory agreement (the “Initial AdvisoryAgreement”), which terminated on September 30, 2006.  We will continue to pay our direct expensesincluding, but not limited to, directors fees, legal and accounting fees, andstockholder related expenses under the Amended Advisory Agreement.

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

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

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

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

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

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

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

The Adviser’sBoard of Directors has agreed to voluntarily waive 1.5% of the annual 2.0% basemanagement fee to 0.5% for senior syndicated loans for the three months endedDecember 31, 2006.

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

The Adviserservices our loan portfolio pursuant to a loan servicing agreement withGladstone Business Loan LLC (“Business Loan”) in return for a 1.5% annual fee,based on the monthly aggregate outstanding loan balance of the loans pledgedunder our credit facility.  Effective inApril 2006, the Adviser’s Board of Directors voted to reduce the portion of theannual fee to 0.5% for senior syndicated loans. This fee directly reduces the amount of fee payable under both theInitial and Amended Advisory Agreements. For the three months ended December 31, 2006 and December 31, 2005 weincurred $719,152 and $715,415, respectively, in loan servicing fees.

For the three months endedDecember 31, 2006, the gross base management fee, based on the Amended AdvisoryAgreement, before reductions for loan servicing fees and other fees was$1,117,584.  After being reduced by loanservicing fees of $719,152 and other fees received by the Adviser of $311,000,our net base management fee for the three months ended December 31, 2006 was$87,432.  For the three months endedDecember 31, 2005, the gross base management fee, before reductions for loanservicing fees and other fees was $984,116. After being reduced by loan servicing fees of $715,415 and other feesreceived by the Adviser of $550,000, our net base management fee for the threemonths ended December 31, 2005 was a credit of $281,299.  At December 31, 2006, $182,185 of unpaid loanservicing fees and $87,432 of unpaid base management fee was recorded in feesdue to Adviser in the accompanying consolidated statement of assets andliabilities.

For the three monthsended December 31, 2006, we recorded a gross incentive fee of $1,148,483 whichwas offset by a waiver voluntarily issued by the Adviser’s Board of Directorsof $568,944, which resulted in a net incentive fee payable to the Adviser of$579,489, which is recorded in fees due to Adviser on our consolidatedstatements of assets and liabilities. There was no incentive fee recorded for the three months ended December31, 2005 as the Amended Advisory Agreement was not in effect.

**AdministrationAgreement**

Under theAdministration Agreement, we pay separately for administrative services. TheAdministration Agreement provides for payments equal to our allocable portionof the Administrator’s overhead expenses in performing its obligations underthe Administration Agreement including, but not limited to, rent for employeesof the Administrator, and our allocable portion of the salaries and benefitsexpenses of our chief financial officer, controller, chief compliance officer,treasurer and their respective staffs. Our allocable portion of expenses is derived by multiplying ourAdministrator’s total expenses by the percentage of our average total assets(the total assets at the beginning and end of each quarter) in comparison tothe average total assets of all companies managed by our Adviser.  For the three months ended December 31, 2006,we incurred $126,085 for the administration fee and since the AdministrationAgreement was not in effect at December 31, 2005, no such expense was recorded.

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**Off-Balance Sheet Arrangements**

We do not have anysignificant off-balance sheet arrangements as defined in Item 303(a)(4)(ii) ofSecurities and Exchange Commission (“SEC”) Regulation S-K as ofDecember 31, 2006.

**Recent Accounting Pronouncements**

InMay 2005, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards (“SFAS”) No. 154, *“AccountingChanges and Error Corrections”*, a replacement of APB Opinion No. 20,*“Accounting Changes”*, and SFAS No. 3, *“Reporting Accounting Changes in Interim Financial Statements”*and changes the requirements for the accounting for and reporting of a changein accounting principle.  SFAS 154applies to all voluntary changes in accounting principle and also applies tochanges required by an accounting pronouncement in the unusual instance that thepronouncement does not include specific transition provisions.  SFAS 154 requires retrospective applicationto prior periods’ financial statements of changes in accounting principle.  SFAS 154 is effective for accounting changesand corrections of errors made in fiscal years beginning after December 15,2005.  We adopted the provisions of SFAS154, as applicable, on October 1, 2006.

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

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

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

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

**CriticalAccounting Policies**

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

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***InvestmentValuation***

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

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

Debt and equitysecurities that are not publicly traded, for which a limited market does not exist,or for which a limited market exists but that have not been rated by a NRSRO(or for which we have various degrees of trading restrictions) are valued atfair value as determined in good faith by or under the direction of our Boardof Directors. In making the good faith determination of the value of thesesecurities, we start with the cost basis of the security, which includes theamortized OID and PIK interest, if any. We then apply the methods set out belowin *“Valuation Methods.”* Members of GMC’s portfoliomanagement team prepare the valuations of our investments in portfoliocompanies using the most recent portfolio company financial statements andforecasts. These individuals also consult with portfolio company seniormanagement and ownership to obtain further updates on the portfolio company’sperformance, including information such as industry trends, new productdevelopment, and other operational issues. Due to the uncertainty inherent inthe valuation process, such estimates of fair value may differ significantlyfrom the values that would have been obtained had a ready market for thesecurities existed, and the differences could be material. Additionally,changes in the market environment and other events that may occur over the lifeof the investments may cause the gains or losses ultimately realized on theseinvestments to be different than the valuations currently assigned. There is nosingle standard for determining fair value in good faith, as fair value dependsupon circumstances of each individual case. In general, fair value is theamount that we might reasonably expect to receive upon the current sale of thesecurity.

At December 31, 2006, weengaged Standard & Poor’s Securities Evaluations, Inc. (“SPSE”) to submitopinions of value for most of our loan securities. We request that SPSE alsoevaluate and assign values to success fees (conditional interest included insome loan securities) when we determine that the probability of receiving asuccess fee on a given loan is above 6-8%, a threshold of significance. Uponcompleting our collection of data with respect to the investments (includingthe information described under *“Credit Information,”*the risk ratings of the loans described under *“LoanGrading and Risk Rating”* and the factors described under *“Valuation Methods”*), this valuation data is forwarded alongto SPSE for review and analysis. SPSE makes its independent assessment of thedata that we have assembled and assesses its independent data to form anopinion as to what they consider to be the market values for the securities.With regard to its work, SPSE has issued the following paragraph:

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

SPSE opinions of valueare submitted to our Board of Directors along with our Adviser’s supplementalassessment and recommendation regarding valuation of each of these investments.Our Adviser generally accepts the opinion of value given by SPSE, however incertain limited circumstances, such as when our Adviser may learn newinformation regarding an investment between the time of submission to SPSE andthe date of the board assessment, our Adviser’s conclusions as to value maydiffer from the opinion of value delivered by SPSE. Our Board of Directors thenreviews whether our Adviser has followed its established procedures fordeterminations of fair value, and votes to accept or not accept the recommendedvaluation of our investment portfolio. Our Adviser and our managementrecommended, and the Board of Directors elected to accept, the opinions ofvalue delivered by SPSE on the loans in our portfolio as denoted on theschedule of investments as of December 31, 2006 and September 30, 2006,included in our consolidated financial statements.

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

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

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

For the debt securitiesfor which we do not use a third-party NRSRO risk rating, we seek to have ourrisk rating system mirror the risk rating systems of major risk ratingorganizations, such as those provided by a NRSRO. While we seek to mirror theNRSRO systems, we cannot provide any assurance that our risk rating system willprovide the same risk rating as a NRSRO for these securities. The followingchart is an estimate of the relationship of our risk rating system to thedesignations used by two NRSROs as they risk rate debt securities of majorcompanies. Because our system rates debt securities of companies that areunrated by any NRSRO, there can be no assurance that the correlation to 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%                                                                    |       |
| **3**                            |       | Caa1             |       | CCC+              |       | PD is 30% and  the EL is 10% to 13.3%                                                                 |       |
| **2**                            |       | Caa2             |       | CCC               |       | PD is 35% and  the EL is 13.3% to 16.7%                                                               |       |
| **1**                            |       | Caa3             |       | CC                |       | PD is 65% and  the EL is 16.7% to 20%                                                                 |       |
| **0**                            |       | N/a              |       | D                 |       | PD is 85% or there is a  Payment Default: and the EL is greater than 20%                              |       |

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(a)             Thedefault rates set here are for a ten year term debt security.  If the company’s debt security is less thanten years then the probability of default is adjusted to a lower percentage forthe shorter period which may move the security higher on our risk rating scale.

The above scale gives anindication of the probability of default and the magnitude of the loss if thereis a default.  Our policy is to stopaccruing interest on an investment if we determine that interest is no longercollectible.  Currently, none of ourinvestments are on non-accrual.  AtDecember 31, 2006, no payments were past due on any of our debtsecurities.  Additionally, we do not riskrate our equity securities.

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

| Rating           | ** ** | **Dec. 31, 2006** | ** ** | **Sept. 30, 2006** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **7.1**                     | ** ** | **7.2**                      | ** ** |
| Weighted Average | ** ** | **7.1**                     | ** ** | **7.2**                      | ** ** |
| Highest          | ** ** | **10.0**                    | ** ** | **9.0**                      | ** ** |
| Lowest           | ** ** | **6.0**                     | ** ** | **6.0**                      | ** ** |

 

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

| Rating           | ** ** | **Dec. 31, 2006** | ** ** | **Sept. 30, 2006** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **6.0**                     | ** ** | **6.1**                      | ** ** |
| Weighted Average | ** ** | **6.0**                     | ** ** | **6.3**                      | ** ** |
| Highest          | ** ** | **8.0**                     | ** ** | **8.0**                      | ** ** |
| Lowest           | ** ** | **4.0**                     | ** ** | **4.0**                      | ** ** |

 

For syndicated loans thatare currently rated by an NRSRO, we risk rate such loans in accordance with therisk rating systems of major risk rating organizations such as those providedby a NRSRO. The following table lists the risk ratings for all syndicated loansin our portfolio that are currently rated by an NRSRO at December 31, 2006 andSeptember 30, 2006, representing approximately 19% and 10%, respectively, ofall loans in our portfolio:

| Rating           | ** ** | **Dec. 31, 2006** | ** ** | **Sept. 30, 2006** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **CCC+/Caa**                | **1**      | **B/B2**                     | ** ** |
| Weighted Average | ** ** | **CCC+/Caa**                | **1**      | **B-/B3**                    | ** ** |
| Highest          | ** ** | **B-/B**                    | **3**      | **BB-/Ba2**                  | ** ** |
| Lowest           | ** ** | **CCC/Caa1**                | ** ** | **CCC/Caa1**                 | ** ** |

 

*Valuation Methods:*  We determine the value of publicly-tradeddebt securities based on the closing price for the security on the exchange orsecurities market on which it is listed on the valuation date. We value debtsecurities that are not publicly traded, but for which a limited market for thesecurity exists, such as participations in syndicated loans, at the indicativebid price offered by the syndication agent on the valuation date.  At December 31, 2006, none of the debt securitiesin our portfolio were publicly traded and there was a limited market for 24debt securities in our portfolio.  AtSeptember 30, 2006, none of the debt securities in our portfolio were publiclytraded and there was a limited market for 9 debt securities in our portfolio.

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

·                  the cost basisand the type of the security;

·                  the nature andrealizable value of the collateral;

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

·                  reports fromportfolio company senior management and board meetings;

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

·                  changes in theeconomy affecting the portfolio company.

We value convertibledebt, equity, success fees or other equity-like securities for which there is amarket based on the market prices for such securities, even if that market isnot robust. At December 31, 2006 and September 30, 2006, there was nomarket for any of the equity securities we owned. To value equity securitiesfor which no market exists, we use the same information we would use for a debtsecurity valuation described above, except risk-rating, as well as standardvaluation techniques used by major valuation firms to value the equitysecurities of private companies. These valuation techniques consist ofdiscounted cash flow of the expected sale price in the future, valuation of thesecurities based on recent sales in comparable transactions, and a review ofsimilar companies that are publicly traded and the market multiple of theirequity securities.  At December 31, 2006and September 30, 2006, we had $37,000 invested, at cost, in equity securitiescompared to our debt portfolio with a cost basis of $244,500,584 and $216,165,986,respectively.

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At December 31, 2006, wehad total unrealized appreciation of $1,788,014, which was mainly comprised ofunrealized appreciation of $731,616 on our warrants of Finn Corporation and a$360,068 success fee value on Badanco Acquisition Corp.  The unrealized appreciation was partiallyoffset by unrealized depreciation of $1,352,629, primarily comprised of unrealizeddepreciation of $538,281 on LocalTel Inc., $350,000 on Visual Edge Technology,Inc., and $261,888 on Consolidated Bedding, Inc.  In the aggregate, we recorded net unrealizedappreciation of $435,385.

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

***Tax Status***

*Federal Income Taxes*

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

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

***Revenue Recognition***

*Interest Income Recognition*

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

*Paid in Kind Interest*

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

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**RESULTS OF OPERATIONS**

*Comparisonof the three months ended December 31, 2006 to the three months ended December31, 2005*

**Investment Income**

Investment income for thethree months ended December 31, 2006 was $8,233,718, as compared to $6,030,319for the three months ended December 31, 2005. Interest income from our investment portfolio increased from December31, 2005 due to the increase in new loans of $52,311,008, offset by principalrepayments and investment sales of approximately $23,967,229.

Interest income from ourinvestments in debt securities of private companies was $7,898,600 for thethree months ended December 31, 2006 as compared with $5,847,107 for the threemonths ended December 31, 2005, which included approximately $33,000 of PIKinterest.  This increase consisted of$52,311,008 of new investments, offset by principal repayments and investmentsales of $23,967,229.  As a result of afull repayment by Mistras Holdings Corp. in November 2006, we recorded assuccess fee of approximately $1,200,000.

The annualized weightedaverage yield on our portfolio for the three months ended December 31, 2006 was13.7%; there was no PIK interest accrued during the three months ended December31, 2006. The annualized weighted average yield on our portfolio for the threemonths ended December 31, 2005 was 12.6% (with and without giving effect to PIKinterest).

Interest income frominvested cash and cash equivalents for the three months ended December 31, 2006was $37,269, as compared to $8,912 for the three months ended December 31,2005.

For the three monthsended December 31, 2006 and December 31, 2005, we recorded $138,191 and$107,093, respectively, in interest income from loans to our employees inconnection with the exercise of employee stock options. The increase is theresult of additional loans issued in connection with employee stock optionexercises during the fourth quarter of the previous fiscal year.

For the three monthsended December 31, 2006, we recorded $159,658 of prepayment fees and otherincome as compared to $67,207 for the three months ended December 31,2005.  The income for both periodsconsisted of prepayment penalty fees received upon the full repayment ofcertain loan investments ahead of contractual maturity and prepayment feesreceived upon the early unscheduled principal repayments which, in bothinstances, were based on a percentage of the outstanding principal amount ofthe loan at the date of prepayment.

**OperatingExpenses**

Operating expenses forthe three months ended December 31, 2006 were $3,070,792, as compared to$1,537,668 for the three months ended December 31, 2005. Operating expenses forthe three months ended December 31, 2006 reflected a significant increase ininterest expense and management fees, as well as the addition of the incentiveand administration fees, under the Amended Advisory and AdministrationAgreements.

Loan servicingfees of $719,152 were incurred for the three months ended December 31, 2006, ascompared to $715,415 for the three months ended December 31, 2005.  These fees were incurred in connection with aloan servicing agreement between Business Loan and our Adviser, which is basedon the size of the portfolio.  These feeswere reduced against the amount of the base management fee due to our Adviser.

For the threemonths ended December 31, 2006, we incurred a gross base management fee of$398,432 less credits for fees received by our Adviser of $311,000, for a netbase management fee of $87,432 as compared to the three months ended December31, 2005, in which we incurred a gross base management fee of $268,701, lesscredits for fees received by our Adviser of $550,000, for a net base managementcredit of $281,299. The base management fee is computed quarterly as describedunder *“Investment Advisory and Management Agreement.”*  The fees increased in the current period dueto the growth of the investment portfolio as compared to the same period of theprior year and fewer credits for fees received by our Adviser which reduce thebase management fee.

Effective October1, 2006, the income based incentive fee became effective and as such werecorded a gross incentive fee of $1,148,483, which was reduced by a voluntarywaiver issued by our Adviser’s board of directors of $568,944, which resultedin a net incentive fee of $579,489, which is recorded in fees due to Adviser onour consolidated statements of assets and liabilities.  There was no incentive fee recorded for thethree months ended December 31, 2005, as the Amended Advisory Agreement was notin effect.

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EffectiveOctober 1, 2006, the Administration Agreement became effective in which weprovide payments equal to our allocable portion of our Administrator’s overheadexpenses in performing its obligations under the Administration Agreementincluding, but not limited to, rent for employees of our Administrator, and ourallocable portion of the salaries and benefits expenses of our chief financialofficer, chief compliance officer and controller and their respectivestaffs.  We incurred an administrationfee of $126,085 for the three months ended December 31, 2006.  There was no administration fee recordedduring the three months ended December 31, 2005, as the AdministrationAgreement was not in effect.

Professional fees,consisting primarily of legal and audit fees, for the three months endedDecember 31, 2006 were $110,920, as compared to $122,466 for the three monthsended December 31, 2005.  The slightdecrease is due to the reimbursement of certain legal fees at the time of thefunding of an investment.

Amortization of deferredfinancing costs, in connection with our line of credit, was $58,300 for thethree months ended December 31, 2006 and $26,250 for the three months endedDecember 31, 2005.  The increase is dueto the amortization of additional fees incurred with our line of credit whichwere not in place during the prior year period.

Interest expense for thethree months ended December 31, 2006 was $1,120,257, as compared to $652,078for the three months ended December 31, 2005.  This increase is primarily a result of increased borrowings under ourline of credit during the three months ended December 31, 2006, whichborrowings were used, in part, to finance our increased investments, borrowingsremaining outstanding for longer periods of time and an increase in theinterest rates on our borrowings.

Stockholder related costsfor the three months ended December 31, 2006 were $63,728, as compared to$128,935 for the three months ended December 31, 2005.  Stockholder related costs include suchrecurring items as transfer agent fees, NASDAQ listing fees, SEC filing feesand annual report printing fees.  Thesefees decreased during the three months ended December 31, 2006 since there wasno special proxy solicitation filed as there was during the three months endedDecember 31, 2005.

Directors’ fees for thethree months ended December 31, 2006 were $54,250, as compared to $24,000 forthe three months ended December 31, 2005 due to the increase in annual stipendfees and their related monthly amortization.

Insurance expense for thethree months ended December 31, 2006 was $62,694, as compared to $50,777 forthe three months ended December 31, 2005. The increase is primarily the resultof an increase in the amortization of our directors and officers insurancepolicy premiums.

There was no stock optioncompensation expense recorded for the three months ended December 31, 2006 asthere was no longer a stock option plan in effect.  Stock option compensation expense for thethree months ended December 31, 2005 was $43,257 and was the result of theadoption of the SFAS No. 123 (revised 2004) *Share-basedPayment*.

Other expenses were$88,485 for the three months ended December 31, 2006, as compared to $55,789for the three months ended December 31, 2005. 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.

**Income Tax Expense**

During the three monthsended December 31, 2005, Gladstone Capital Corporation recorded approximately$50,000 in connection with penalties incurred on misclassified revenue on itsfiscal year 2004 corporate tax return.

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

During the three monthsended December 31, 2006, we sold a syndicate loan investment for a gain of$2,314 as compared to an aggregate loss of $1,180,595 from the sale of twoinvestments during the three months ended December 31, 2005.

**Realized Gain on Settlement ofDerivative**

During the three monthsended December 31, 2006, we received interest rate cap agreement payments of$12,554 as a result of the one month LIBOR exceeding 5%.  There was no realization during the threemonths ended December 31, 2005 as the one month LIBOR was below 5%.

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**Net Unrealized Depreciation onDerivative**

During the three monthsended December 31, 2006, we recorded net unrealized depreciation of $9,812 dueto a decrease in the fair market value of our interest rate cap agreement, ascompared to unrealized depreciation of $892 during the three months endedDecember 31, 2005.

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

For the three monthsended December 31, 2006, we recorded net unrealized depreciation on investmentsof $1,004,379, as compared to net unrealized appreciation of $4,972,422, forthe three months ended December 31, 2005. The unrealized depreciation is mainly attributable to the depreciatedfair value on certain investments.  Theunrealized appreciation for the three months ended December 31, 2005 is mainlyattributable to the early repayment or sale of underperforming loans.

**Net Increase in Net Assets from Operations**

Overall, we realized a net increase in net assets resulting fromoperations of $4,163,603 for the three months ended December 31, 2006.  Based on a weighted-average of 12,294,340basic and diluted shares outstanding, our net increase in net assets fromoperations per weighted-average common share for the three months endedDecember 31, 2006 was $0.34, basic and diluted.

For the three months ended December 31,2005, werealized a net increase in net assets resulting from operations of$8,233,349.  Based on a weighted-averageof 11,306,510 (basic) and 11,573,620 (diluted) shares outstanding, our netincrease in net assets from operations per weighted-average common share forthe three months ended December 31, 2005 was $0.73 (basic) and $0.71 (diluted).

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**LIQUIDITY AND CAPITAL RESOURCES**

At December 31, 2006, wehad investments in debt securities of, or loans to, 48 private companies, totalingapproximately $244.5 million (cost basis) of total assets.

During the three monthsended December 31, 2006 and December 31, 2005, the following investmentactivity occurred:

|                        | ** ** | ** **               | ** ** | ** **                    | ** ** | **Net Gain/(Loss)** | ** ** |
|------------------------|------------|--------------------------|------------|-------------------------------|------------|--------------------------|------------|
| **Quarter Ended** | ** ** | **New Investments** | ** ** | **Principal Repayments** | ** ** | **on Disposal**     | ** ** |
|                   |       |                     |       |                          |       |                     |       |
| December 31,  2006     |       | $                        | 52,311,008 |                          | $          | 23,967,229               |       | $ | 2,314 |   |
|                   |       |                     |       |                          |       |                     |       |
| December 31, 2005      |       | $                        | 26,688,457 |                          | $          | 38,702,066               |       | $ | (1,180,595 | ) |

 

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

| Fiscal Year Ended September 30, | ** ** | **Amount** | ** **  |
|-----------------------------------------------------|------------|------------|-------------|
| 2007                                                |       | $          | 7,084,860   |   |
| 2008                                                |       | 11,938,211 |        |
| 2009                                                |       | 18,404,148 |        |
| 2010                                                |       | 38,386,079 |        |
| 2011                                                |       | 78,476,810 |        |
| Thereafter                                          |       | 90,247,476 |        |
|                                                |       | $          | 244,537,584 |   |

 

Net cash used in operating activities for the three months endedDecember 31, 2006, consisting primarily of the items described in *“Results of Operations”* and the investment activitydescribed above, was approximately $23.3 million as compared to net cashprovided by operating activities of approximately $16.7 million for the threemonths ended December 31, 2005.  Net cashprovided by investing activities consisted of $152 and $23,094 for the threemonths ended December 31, 2006 and December 31, 2005, respectively, andconsisted of the principal repayment of employee loans.  Net cash provided by financing activities forthe three months ended December 31, 2006 was approximately $28.5 million andmainly consisted of borrowings on our line of credit of approximately $69.9million, offset by repayments of line of credit borrowings of approximately$34.7 million, and approximately $5.2 million for the payment ofdividends.  Net cash used infinancing activities was approximately $1.8 million for the three months endedDecember 31, 2005 and consisted primarily of net cash provided from borrowingson our line of credit, net of repayments, of approximately $2.7 million, offsetby the payment of dividends of approximately $4.6 million.

During the three months ended December 31, 2006, cash and cashequivalents increased from approximately $732,000 to approximately $6.0million.

Subsequent to December 31, 2006, we funded approximately $24.5million of loan originations, including the acquisition of warrants in connectionwith one investment, extended approximately $1.2 million in revolver borrowingsto existing portfolio companies and purchased approximately $21.6 million ofsyndicated loan participations. Also, an existing portfolio company refinancedtheir $13.3 million senior term loan investments in exchange for a new $9.8million senior subordinated term loan investment.  In connection with this refinancing, wereceived approximately $533,000 of success fees.

In order toqualify as a RIC and to avoid corporate level tax on the income we distributeto our stockholders, we are required, under Subchapter M of the Code, todistribute at least 90% of our ordinary income and short-term capital gains toour stockholders on an annual basis. In accordance with these requirements, wedeclared and paid monthly cash dividends of $0.14 per common share for July,August, September, October, November and December 2006 and $0.135 per commonshare for January, February, March, April, May and June 2006, and October,November and December 2005.  In January2007, our Board of Directors declared a monthly dividend of $0.14 per commonshare for each January, February and March 2007.

We anticipate continuingto borrow funds and, from time to time issuing additional equity securities, toobtain additional capital to make further investments. To this end, we have aneffective registration statement on file with the SEC that would permit us toissue, through one or more transactions, up to an aggregate of $48.8 million insecurities, which may consist of shares of our common stock, preferred stock,and/or debt securities.

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**Revolving Credit Facilities**

Through ourwholly-owned subsidiary, Business Loan, we have a $150 million revolving creditfacility (the “DB Facility”) with Deutsche Bank AG, as administrative agent,which is scheduled to mature on May 27, 2007. Pursuant to the DB Facility, Business Loan has pledged the loans itholds to secure future advances by certain institutional lenders.  Interest rates charged on the advances underthe DB Facility will be based on LIBOR, the Prime Rate or the Federal FundsRate, depending on market conditions, and will adjust periodically.  As of December 31, 2006, our outstandingprincipal balance under the DB Facility was approximately $85.2 million at aninterest rate of approximately 5.3%. Available borrowings are subject to various constraints imposed byDeutsche Bank AG, based on the aggregate loan balance pledged by Business Loan,which varies as loans are added and repaid, regardless of whether suchrepayments are early prepayment or are made as contractually required.  At December 31, 2006, the remaining borrowingcapacity available under the DB Facility was approximately $64.8 million.

The DB Facilitycontains covenants that, among other things, require Business Loan to maintainits status as a separate entity; prohibit certain significant corporatetransactions (such as mergers, consolidations, liquidations or dissolutions);and restrict material changes to our credit and collection policies.  The DB Facility also restricts some of theterms and provisions (including interest rates, terms to maturity and paymentsschedules) and limits the borrower and industry concentrations of loans thatare eligible to secure advances.  As ofDecember 31, 2006, Business Loan was in compliance with all of the DB Facilitycovenants.  We currently intend tosecuritize all of the loans held by Business Loan and to use the proceeds fromthe securitization to pay down any amounts then outstanding under the revolvingcredit facility.  However, there can beno assurance that we will be able to successfully securitize any of these loanson terms acceptable to us, if at all.

The administrativeagent also requires that any interest or principal payments on pledged loans beremitted directly by the borrower into a lockbox account with the Bank of NewYork as custodian.  Deutsche Bank AG isalso the trustee of the account and once a month remits the collected funds tous. For the three months ended December 31, 2006, the amount due from custodiandecreased by approximately $297,000.

Our Adviser,services the loans pledged under the DB Facility.  As a condition to this servicing arrangement,we executed a performance guaranty pursuant to which we guaranteed that ourAdviser would comply fully with all of its obligations under the facility. Theperformance guaranty requires us to maintain a minimum net worth of $100million and to maintain “asset coverage” with respect to “senior securitiesrepresenting indebtedness” of at least 200%, in accordance with Section 18of the 1940 Act.  As of December 31,2006, we were in compliance with our covenants under the performance guaranty.

The DB facility isavailable for general corporate purposes.

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

We are subject tofinancial market risks, including changes in interest rates.  We estimatethat ultimately approximately 20% of the loans in our portfolio will be made atfixed rates and approximately 80% will be made at variable rates.  Currently our portfolio has approximately 58%of the total loan portfolio cost basis at variable rates with a floor,approximately 3% of the total loan portfolio cost basis at a variable rate witha floor and ceiling, and the remaining 39% of the total loan portfolio costbasis at variable rates without a floor or ceiling.

We have a $150 millionrevolving credit facility, based on variable rates, with Deutsche Bank AG whichmatures May 2007.

In February 2004, we entered into an interest rate capagreement in order to fulfill an obligation under our line of credit to enterinto certain hedging transactions in connection with our borrowings under theline of credit.  We purchased this interest rate cap agreement with anotional amount of $35 million (which is amortized quarterly) for a one-time,up-front payment of $304,000.  The interest rate cap agreement entitles usto receive payments, if any, equal to the amount by which interest payments onthe current notional amount at onemonth LIBOR exceed the payments on the current notional amount at 5%. The cap expires in February 2009.  This interest rate cap agreementeffectively caps our interest payments on our line of credit borrowing, up tothe notional amount of the interest rate cap, at five percent.  Thismitigates our exposure to increases in interest rates on our borrowings on ourlines of credit, which are at variable rates. At December 31, 2006, the cap agreement had a fair market value of$40,472 and a current notional amount of $13.0 million.  At December 29, 2006, the one month LIBOR rate wasapproximately 5.33%.

To illustrate the potential impact of changes ininterest rates on our net increase in net assets resulting from operations, wehave performed the following analysis, which assumes that our balance sheetremains constant and no further actions beyond the interest rate cap agreementare taken to alter our existing interest rate sensitivity.  Under this analysis, a hypothetical increasein the one month LIBOR by 1% would increase our net increase in net assetsresulting from operations by approximately $2.3 million or 11.5%, over the nexttwelve months, compared to the net increase in net assets resulting fromoperations for the twelve months ended December 31, 2006.  A hypothetical decrease in the one monthLIBOR by 1% would decrease net increase in net assets resulting from operationsby approximately $2.3 million, or 11.5%, over the next twelve months, comparedto the net increase in net assets resulting from operations for the twelve monthsended December 31, 2006.  Althoughmanagement believes that this analysis is indicative of our existing interestrate sensitivity, it does not adjust for potential changes in credit quality,size and composition of our loan portfolio on the balance sheet and otherbusiness developments that could affect net increase in net assets resultingfrom operations.  Accordingly, noassurances can be given that actual results would not differ materially fromthe results under this hypothetical analysis.

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

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

**ITEM 4. CONTROLS AND PROCEDURES.**

As of December 31, 2006, we, including our Chief Executive Officerand Chief Financial Officer, evaluated the effectiveness of the design andoperation of our disclosure controls and procedures.  Based on that evaluation, our management,including the Chief Executive Officer and Chief Financial Officer, concludedthat our disclosure controls and procedures were effective in timely alertingmanagement, including the Chief Executive Officer and Chief Financial Officer,of material information about us required to be included in periodic Securitiesand Exchange Commission filings. However, in evaluating the disclosure controls and procedures,management recognized that any controls and procedures, no matter how welldesigned and operated can provide only reasonable assurance of achieving thedesired control objectives, and management necessarily was required to applyits judgment in evaluating the cost-benefit relationship of possible controlsand procedures.

There have been no changes in our internal control over financialreporting that occurred during the quarter ended December 31, 2006, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

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**PART II—OTHERINFORMATION**

**ITEM 1. LEGAL PROCEEDINGS.**

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. RISK FACTORS.**

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

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

Not applicable.

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

Not applicable.

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

No matters were submitted to a vote ofsecurity holders during the three months ended December 31, 2006.

**ITEM 5. OTHER INFORMATION.**

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/ HARRY BRILL |
|   |       |                               |   |   |
|   |       | Harry Brill                        |
|   |       | Chief Financial  Officer           |

 

Date: February 6, 2007

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**EXHIBIT INDEX**

 
| Exhibit | ** ** | **Description**                                                                                                                                                                                                                                                     |
|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |       |                                                                                                                                                                                                                                                                |
| 3.1     |       | Articles of  Amendment and Restatement of the Articles of Incorporation, incorporated by  reference to Exhibit a.2 to Pre-Effective Amendment No. 1 to the  Registration Statement on Form N-2 (File No. 333-63700), filed  July 27, 2001. |
|    |       |                                                                                                                                                                                                                                                                |
| 3.2     |       | By-laws, incorporated  by reference to Exhibit b to Pre-Effective Amendment No. 1 to the  Registration Statement on Form N-2 (File No. 333-63700), filed  July 27, 2001.                                                                   |
|    |       |                                                                                                                                                                                                                                                                |
| 3.3     |       | Amendment to  by-laws, incorporated by reference to Exhibit 3.3 to the Company’s  Quarterly Report on Form 10-Q for the quarter ended December 31,  2003 (File No. 814-00237), filed February 17, 2004.                               |
|    |       |                                                                                                                                                                                                                                                                |
| 11      |       | Computation of  Per Share Earnings (included in the notes to the unaudited 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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