**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**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 JUNE 30, 2007**

** **

**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 of registrant as specified in its charter)
| **MARYLAND**                                                   | **54-2040781**                       |
|----------------------------------------------------------------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |

 

**1521 WESTBRANCH DRIVE, SUITE 200MCLEAN, VIRGINIA 22102**

(Address of principal executive office)

 

**(703) 287-5800**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months and (2) has been subject to suchfiling requirements for the past 90 days. Yes x No o.

Indicate by check mark whether the registrant is large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12 b-2 of the Exchange Act. (CheckOne):

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

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

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the latestpracticable date. The number of shares of the issuer’s Common Stock, $0.001 parvalue, outstanding as of July 31, 2007 was 14,612,574.

 

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**GLADSTONE CAPITAL CORPORATIONTABLE OF CONTENTS**
| PART I.  | FINANCIAL  INFORMATION                                                                               |
|---------------|------------------------------------------------------------------------------------------------------|
|          |                                                                                                 |
| Item 1.  | Financial  Statements (Unaudited)                                                                    |
|          |                                                                                                 |
|          | Consolidated Statements of Assets and Liabilities as  of June 30, 2007 and September 30, 2006        |
|          | Consolidated Schedules of Investments as of June 30,  2007 and September 30, 2006                    |
|          | Consolidated Statements of Operations for the three  months ended June 30, 2007 and 2006             |
|          | Consolidated Statements of Operations for the nine  months ended June 30, 2007 and 2006              |
|          | Consolidated Statements of Changes in Net Assets for  the nine months ended June 30, 2007 and 2006   |
|          | Consolidated Statements of Cash Flows for the nine  months ended June 30, 2007 and 2006              |
|          | Financial  Highlights for the three months ended June 30, 2007 and 2006                              |
|          | Financial  Highlights for the nine months ended June 30, 2007 and 2006                               |
|          | 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    |

 

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**PART I.FINANCIAL INFORMATION**

**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES(Unaudited)**
| ** **                                                                                                                               | ** ** | **June 30, 2007** | ** **  | **September 30, 2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-------------|----------------------------------|------------|
| ASSETS                                                                                                                                   |       |                        |        |                             |       |
| Investments at fair  value (Cost 6/30/2007: $369,975,398; 9/30/2006: $216,202,986)                                                       |       | $                           | 368,949,247 |                             | $          | 217,642,750 |   |
| Cash and cash  equivalents                                                                                                               |       | 3,491,495                   |        | 731,744                          |       |
| Interest receivable —  investments in debt securities                                                                               |       | 2,221,606                   |        | 1,394,942                        |       |
| Interest receivable —  employees                                                                                                    |       | 32,739                      |        | 37,396                           |       |
| Due from custodian                                                                                                                       |       | 3,129,891                   |        | 3,587,152                        |       |
| Deferred financing fees                                                                                                                  |       | 246,333                     |        | 145,691                          |       |
| Prepaid assets                                                                                                                           |       | 186,643                     |        | 226,747                          |       |
| Due from employees                                                                                                                       |       | —                      |        | 1,803,283                        |       |
| Other assets                                                                                                                             |       | 352,796                     |        | 213,510                          |       |
| TOTAL ASSETS                                                                                                                             |       | $                           | 378,610,750 |                             | $          | 225,783,215 |   |
|                                                                                                                                     |       |                        |        |                             |       |
| LIABILITIES                                                                                                                              |       |                        |        |                             |       |
| Accounts payable                                                                                                                         |       | $                           | 5,160       |                             | $          | 4,072 |   |
| Interest payable                                                                                                                         |       | 516,780                     |        | 247,530                          |       |
| Administration fee due  to Administrator                                                                                                 |       | 186,895                     |        | —                           |       |
| Fees due to Adviser  (Refer to Notes 4 and 5)                                                                                            |       | 404,240                     |        | 240,363                          |       |
| Borrowings under line  of credit                                                                                                         |       | 161,188,000                 |        | 49,993,000                       |       |
| Withholding taxes  payable                                                                                                               |       | —                      |        | 1,803,283                        |       |
| Accrued expenses and  deferred liabilities                                                                                               |       | 854,322                     |        | 721,287                          |       |
| Funds held in escrow                                                                                                                     |       | 202,433                     |        | 203,193                          |       |
| TOTAL LIABILITIES                                                                                                                        |       | 163,357,830                 |        | 53,212,728                       |       |
| NET ASSETS                                                                                                                               |       | $                           | 215,252,920 |                             | $          | 172,570,487 |   |
|                                                                                                                                     |       |                        |        |                             |       |
| ANALYSIS OF NET ASSETS                                                                                                                   |       |                        |        |                             |       |
| Common stock, $0.001  par value, 50,000,000 shares authorized and 14,249,683 and 12,305,008 shares  issued and outstanding, respectively |       | $                           | 14,250      |                             | $          | 12,305 |   |
| Capital in excess of  par value                                                                                                          |       | 225,449,718                 |        | 181,270,565                      |       |
| Notes receivable —  employees                                                                                                       |       | (9,947,366                  | )           | (10,248,308                      | )          |
| Net unrealized appreciation  on investments                                                                                              |       | (1,026,151                  | )           | 1,439,764                        |       |
| Unrealized depreciation  on derivative                                                                                                   |       | (279,593                    | )           | (253,716                         | )          |
| Realized loss on sale  of investments                                                                                                    |       | (780,197                    | )           | (861,695                         | )          |
| Realized gain on  settlement of derivative                                                                                               |       | 46,212                      |        | 15,014                           |       |
| Accumulated undistributed  net investment income                                                                                         |       | 1,776,047                   |        | 1,196,558                        |       |
| TOTAL NET ASSETS                                                                                                                         |       | $                           | 215,252,920 |                             | $          | 172,570,487 |   |
| NET ASSETS PER SHARE                                                                                                                     |       | $                           | 15.11       |                             | $          | 14.02 |   |

 

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

2

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**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTSAS OF JUNE 30, 2007(UNAUDITED)**
| Company(1)                                   | ** ** | **Industry**                            | ** ** | **Investment(2)**                                           | ** ** | **Cost**  | ** ** | **Fair Value** |
|----------------------------------------------|------------|-----------------------------------------|------------|-------------------------------------------------------------|------------|-----------|------------|----------------|
| Access Television Network, Inc.              |       | Service-cable airtime (infomercials)    |       | Line of Credit (7)(8)                                       |       | $         | —     |           | $ | — |
| AccessTV PIN Acquisition LLC                 |       |                                    |       | (12.3% Due 3/2009)                                          |       |      |       |           |
| Product Information Network                  |       |                                    |       | Senior Term Debt (7)                                        |       | 2,979,835 |       | 2,948,401      |
| Venture                                      |       |                                    |       | (12.3% Due 3/2009)                                          |       |      |       |           |
|                                         |       |                                    |       |                                                        |       |      |       |           |
| ActivStyle  Acquisition Co. ActivStyle, Inc. |       | Service-medical products distribution   |       | Line of Credit (5) (9)  (9.6%, Due 7/2009)                  |       | 450,000   |       | 448,313        |
|                                         |       |                                    |       | Senior Term Debt (5)  (9.6%, Due 7/2011)                    |       | 2,960,000 |       | 2,956,300      |
|                                         |       |                                    |       | Senior Term Debt (3) (5)  (11.8%, Due 7/2011)               |       | 2,500,000 |       | 2,496,875      |
|                                              |       |                                    |       |                                                        |       |      |       |           |
| Advanced Homecare Management, Inc.           |       | Service-home health nursing services    |       | Senior Subordinated Term Debt (5) (6)  (11.9%, Due 12/2013) |       | 6,300,000 |       | 6,300,000      |
|                                         |       |                                    |       |                                                        |       |      |       |           |
| Allison  Publications, LLC                   |       | Service-publisher of consumer           |       | Senior Term Debt (7)                                        |       | 8,014,728 |       | 7,933,000      |
| D. Magazine  Partners, L.P.                  |       | oriented magazines                      |       | (10.3%, Due 12/2011)                                        |       |      |       |           |
| Allison Media,  Inc.                         |       |                                    |       |                                                        |       |      |       |           |
| City Newspapers,  LP                         |       |                                    |       |                                                        |       |      |       |           |
| City Newspapers,  Management, LLC            |       |                                    |       |                                                        |       |      |       |           |
|                                              |       |                                    |       |                                                        |       |      |       |           |
| Anitox Acquisition Company                   |       | Manufacturing-preservatives for         |       | Senior Real Estate Term Debt                                |       | 3,412,939 |       | 3,360,000      |
| Anitox Holding, Inc.                         |       | animal feed                             |       | (8.8%, Due 1/2012)                                          |       |      |       |           |
|                                              |       |                                    |       | Line of Credit (10)                                         |       | —    |       | —         |
|                                              |       |                                    |       | (9.6%, Due 1/2010)                                          |       |      |       |           |
|                                              |       |                                    |       | Senior Term Debt (5)                                        |       | 2,750,000 |       | 2,746,563      |
|                                              |       |                                    |       | (9.6%, Due 1/2012)                                          |       |      |       |           |
|                                              |       |                                    |       | Senior Term Debt (3) (5)                                    |       | 2,750,000 |       | 2,746,563      |
|                                              |       |                                    |       | (11.8%, Due 1/2012)                                         |       |      |       |           |
|                                         |       |                                    |       |                                                        |       |      |       |           |
| Badanco  Acquisition Corp.                   |       | Service-luggage design and distribution |       | Senior Subordinated Term Debt (5)  (12.1%, Due 7/2012)      |       | 9,701,250 |       | 9,701,250      |
|                                              |       |                                    |       |                                                        |       |      |       |           |
| Bresnan Communications, LLC                  |       | Service-telecommunications              |       | Senior Term Debt (6)  (7.3%, Due 9/2013)                    |       | 3,001,880 |       | 2,992,500      |
|                                              |       |                                    |       | Senior Subordinated Term Debt (6)  (9.9%, Due 3/2014)       |       | 1,510,393 |       | 1,505,625      |
|                                         |       |                                    |       |                                                        |       |      |       |           |
| CCS, LLC                                     |       | Service-cable tv franchise owner        |       | Senior Term Debt (7)  (12.3%, Due 7/2007)                   |       | 3,455,580 |       | 3,424,146      |
|                                              |       |                                    |       |                                                        |       |      |       |           |
| CHG Companies, Inc.                          |       | Service-healthcare staffing             |       | Letter of Credit (5) (6)                                    |       | 400,000   |       | 404,000        |
| CHG Medical Staffing, Inc.                   |       |                                    |       | (7.9%, Due 12/2012)                                         |       |      |       |           |
|                                              |       |                                    |       | Senior Term Debt (5) (6)  (7.8%, Due 12/2012)               |       | 1,596,000 |       | 1,605,975      |
|                                              |       |                                    |       | Senior Subordinated Term Debt (5) (6)  (11.3%, Due 12/2012) |       | 500,000   |       | 503,125        |
|                                              |            |                                         |            |                                                             |            |           |            |                |  |  |

 

3

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**GLADSTONECAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF JUNE 30, 2007(UNAUDITED)**
| Company(1)                                              | ** ** | **Industry**                                | ** ** | **Investment(2)**                                       | ** ** | **Cost**   | ** ** | **Fair Value** |
|---------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------------------|------------|------------|------------|----------------|
| Chinese Yellow Pages Company                            |       | Service-publisher of Chinese                |       | Line of Credit (7)(11)                                  |       | $          | 150,071    |           | $ | 150,071 |
|                                                         |       | language directories                        |       | (12.3%, Due 9/2010)                                     |       |       |       |           |
|                                                         |       |                                        |       | Senior Term Debt (7)                                    |       | 1,235,008  |       | 1,222,435      |
|                                                         |       |                                        |       | (12.3%, Due 9/2010)                                     |       |       |       |           |
|                                                    |       |                                        |       |                                                    |       |       |       |           |
| Clinton Holdings,  LLC                                  |       | Distribution-aluminum sheets                |       | Senior Subordinated Term Debt (5)                       |       | 15,500,000 |       | 15,519,375     |
| Clinton Aluminum  Acquisition,                          |       | and stainless steel                         |       | (12.6%, Due 1/2013)                                     |       |       |       |           |
| LLC                                                     |       |                                        |       | Common Stock Warrants                                   |       | 109,124    |       | 125,864        |
| Metal  Transportation, LLC                              |       |                                        |       |                                                    |       |       |       |           |
| Clinton  Distribution Center, LLC                       |       |                                        |       |                                                    |       |       |       |           |
|                                                         |       |                                        |       |                                                    |       |       |       |           |
| CMI Acquisition, LLC  (d/b/a Triangle Metal Industries) |       | Service-recycling                           |       | Senior Subordinated Term Debt (7)  (12.3%, Due 11/2012) |       | 6,500,000  |       | 6,500,000      |
| TMC Acquisition, LLC                                    |       |                                        |       |                                                    |       |       |       |           |
|                                                    |       |                                        |       |                                                    |       |       |       |           |
| Community Media  Corporation                            |       | Service-publisher of free weekly newspapers |       | Senior Term Debt (7)  (10.8%, Due 7/2007)               |       | 2,572,497  |       | 2,547,350      |
|                                                         |       |                                        |       |                                                    |       |       |       |           |
| Country Road                                            |       | Service-telecommunications                  |       | Senior Subordinated Term Debt (5) (6)                   |       | 5,965,833  |       | 6,030,000      |
| Communications LLC                                      |       |                                        |       | (13.2%, Due 7/2013)                                     |       |       |       |           |
| Country Road Management, Inc.                           |       |                                        |       |                                                    |       |       |       |           |
|                                                    |       |                                        |       |                                                    |       |       |       |           |
| Defiance  Acquisition Corporation                       |       | Manufacturing-trucking parts                |       | Senior Term Debt (3) (5)  (13.3%, Due 4/2010)           |       | 6,325,000  |       | 6,317,094      |
|                                                         |       |                                        |       |                                                    |       |       |       |           |
| Doe & Ingalls Management LLC                        |       | Distributor-specialty chemicals             |       | Senior Term Debt (5)  (8.8%, Due 11/2010)               |       | 4,100,000  |       | 4,110,250      |
| Doe & Ingalls of North Carolina  Operating LLC      |       |                                        |       | Senior Term Debt (3) (5)  (9.8%, Due 11/2010)           |       | 4,466,250  |       | 4,471,833      |
| Doe & Ingalls of Florida Operating  LLC             |       |                                        |       |                                                    |       |       |       |           |
| Doe & Ingalls of Virginia Operating  LLC            |       |                                        |       |                                                    |       |       |       |           |
| Doe & Ingalls of Maryland Operating  LLC            |       |                                        |       |                                                    |       |       |       |           |
|                                                    |       |                                        |       |                                                    |       |       |       |           |
| Emdeon Business  Services, Inc.                         |       | Service-healthcare technology solutions     |       | Senior Term Debt (6)  (7.6%, Due 11/2013)               |       | 2,440,341  |       | 2,450,020      |
|                                                    |       |                                        |       | Senior Subordinated Term Debt (6)  (10.4%, Due 5/2014)  |       | 2,013,460  |       | 2,020,000      |
|                                                         |       |                                        |       |                                                    |       |       |       |           |
| Express Courier International, Inc.                     |       | Service-ground delivery and logistics       |       | Line of Credit (12)  (9.6%, Due 6/2009)                 |       | —     |       | —         |
|                                                         |       |                                        |       | Senior Term Debt (5)  (9.6%, Due 6/2011)                |       | 4,347,500  |       | 4,347,500      |
|                                                         |       |                                        |       | Senior Term Debt (3) (5)  (11.8%, Due 6/2011)           |       | 3,950,000  |       | 3,950,000      |
|                                                         |            |                                             |            |                                                         |            |            |            |                |  |  |

 

4

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**GLADSTONECAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF JUNE 30, 2007(UNAUDITED)**
| Company(1)                               | ** ** | **Industry**                                       | ** ** | **Investment(2)**                                      | ** ** | **Cost**  | ** ** | **Fair Value** |
|------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------------|------------|-----------|------------|----------------|
| Finn Corporation                         |       | Manufacturing-landscape equipment                  |       | Common Stock Warrants                                  |       | $         | 37,000     |           | $ | 2,972,858 |
|                                     |       |                                               |       |                                                   |       |      |       |           |
| Florida Cable,  Inc.                     |       | Service-cable and internet                         |       | Senior Term Debt (7)                                   |       | 5,906,391 |       | 5,849,810      |
| Lakepointe  Limited Partnership          |       | system operator                                    |       | (11.8%, Due 7/2010)                                    |       |      |       |           |
|                                          |       |                                               |       |                                                   |       |      |       |           |
| FR X Ohmstede Holdings, LLC              |       | Service & Manufacturing-heat                   |       | Senior Term Debt (6)                                   |       | 2,739,130 |       | 2,756,250      |
| FR X Ohmstede Acquisitions Co.           |       | exchangers                                         |       | (7.9%, Due 8/2013)                                     |       |      |       |           |
|                                          |       |                                               |       | Senior Subordinated Term Debt (6)  (12.4%, Due 8/2014) |       | 3,011,190 |       | 3,015,000      |
|                                     |       |                                               |       |                                                   |       |      |       |           |
| Global Materials Technologies,  Inc.     |       | Manufacturing-steel wool products and metal fibers |       | Senior Term Debt (3) (5)  (14.3%, Due 11/2009)         |       | 5,150,000 |       | 4,944,000      |
|                                          |       |                                               |       |                                                   |       |      |       |           |
| GTM Holdings, Inc.                       |       | Manufacturing-socks                                |       | Senior Term Debt (6)                                   |       | 497,500   |       | 499,988        |
| Gold Toe Investment Corp.                |       |                                               |       | (8.1%, Due 10/2013)                                    |       |      |       |           |
|                                          |       |                                               |       | Senior Subordinated Term Debt (6)  (11.4%, Due 4/2014) |       | 500,000   |       | 505,000        |
|                                     |       |                                               |       |                                                   |       |      |       |           |
| Greatwide  Logistics Services, Inc.      |       | Service - logistics and transportation             |       | Senior Term Debt (6)  (8.6%, Due 12/2013)              |       | 3,980,000 |       | 3,880,500      |
|                                     |       |                                               |       | Senior Subordinated Term Debt (6)  (11.9%, Due 6/2014) |       | 4,000,000 |       | 3,840,000      |
|                                          |       |                                               |       |                                                   |       |      |       |           |
| Harrington Holdings, Inc.                |       | Service - healthcare products                      |       | Senior Term Debt (6)                                   |       | 2,493,750 |       | 2,506,219      |
| Harrington Acquisition Corp.             |       | distribution                                       |       | (7.8%, Due 1/2014)                                     |       |      |       |           |
|                                          |       |                                               |       | Senior Subordinated Term Debt (6)  (11.4%, Due 1/2014) |       | 5,000,000 |       | 5,025,000      |
|                                     |       |                                               |       |                                                   |       |      |       |           |
| Heartland  Communications Group, LLC     |       | Service-radio station operator                     |       | Line of Credit (7)(13)  (11.8%, Due 5/2008)            |       | 9,856     |       | 9,856          |
| Heartland Comm.  License, LLC            |       |                                               |       | Senior Term Debt (7)                                   |       | 4,873,531 |       | 4,823,237      |
| Heartland Comm.  Houghton                |       |                                               |       | (11.8%, Due 5/2011)                                    |       |      |       |           |
| License, LLC                             |       |                                               |       |                                                   |       |      |       |           |
| Tu-Mar  Broadcasting, Inc.               |       |                                               |       |                                                   |       |      |       |           |
|                                          |       |                                               |       |                                                   |       |      |       |           |
| International Junior Golf                |       | Service-golf training                              |       | Line of Credit (5) (14)  (9.6%, Due 5/2010)            |       | 500,000   |       | 499,375        |
|                                          |       |                                               |       | Senior Term Debt (5)  (9.6%, Due 5/2012)               |       | 2,650,000 |       | 2,646,688      |
|                                          |       |                                               |       | Senior Term Debt (3) (5)  (11.8%, Due 5/2012)          |       | 2,500,000 |       | 2,493,750      |
|                                     |       |                                               |       |                                                   |       |      |       |           |
| It’s Just Lunch  International, LLC |       | Service-dating service                             |       | Line of Credit (5) (15)  (9.3%, Due 6/2009)            |       | 550,000   |       | 514,250        |
|                                     |       |                                               |       | Senior Term Debt (5)  (9.6%, Due 6/2011)               |       | 3,300,000 |       | 3,085,500      |
|                                     |       |                                               |       | Senior Term Debt (3) (5) (15)  (11.8%, Due 6/2011)     |       | 500,000   |       | 467,500        |
|                                          |            |                                                    |            |                                                        |            |           |            |                |  |  |

 

5

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**GLADSTONECAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF JUNE 30, 2007(UNAUDITED)**
| Company(1)                                                 | ** ** | **Industry**                                                   | ** ** | **Investment(2)**                                      | ** ** | **Cost**  | ** ** | **Fair Value** |
|------------------------------------------------------------|------------|----------------------------------------------------------------|------------|--------------------------------------------------------|------------|-----------|------------|----------------|
| John Henry Holdings, Inc. Multi  Packaging Solutions, Inc. |       | Manufacturing-packaging products                               |       | Senior Subordinated Term Debt (6)  (12.3%, Due 6/2011) |       | $         | 8,000,000  |           | $ | 8,000,000 |
|                                                       |       |                                                           |       |                                                   |       |      |       |           |
| Kinetek  Acquisition Corp.                                 |       | Manufacturing-custom engineered motors & controls          |       | Senior Term Debt (6)  (7.8%, Due 11/2013)              |       | 1,498,218 |       | 1,492,500      |
|                                                       |       |                                                           |       | Senior Subordinated Term Debt (6)  (10.8%, Due 5/2014) |       | 1,509,209 |       | 1,507,500      |
|                                                            |       |                                                           |       |                                                   |       |      |       |           |
| KMBQ Corporation                                           |       | Service-AM/FM radio broadcaster                                |       | Line of Credit (7) (16)  (13.3%, Due 3/2010)           |       | 150,000   |       | 150,000        |
|                                                            |       |                                                           |       | Senior Term Debt (7)  (13.3%, Due 3/2010)              |       | 1,825,404 |       | 1,806,543      |
|                                                       |       |                                                           |       |                                                   |       |      |       |           |
| LocalTel, Inc.                                             |       | Service-yellow pages publishing                                |       | Line of Credit (5) (17)  (9.8%, Due 6/2009)            |       | 1,275,000 |       | 1,096,500      |
|                                                       |       |                                                           |       | Senior Term Debt (5)  (9.8%, Due 6/2011)               |       | 2,687,500 |       | 2,311,250      |
|                                                       |       |                                                           |       | Senior Term Debt (3) (5)  (12.3%, Due 6/2011)          |       | 2,750,000 |       | 2,282,500      |
|                                                            |       |                                                           |       |                                                   |       |      |       |           |
| Macfadden Performing Arts Media, LLC                       |       | Service-magazine publisher                                     |       | Line of Credit (7)  (11.3%, Due 6/2009)                |       | 515,979   |       | 515,979        |
|                                                            |       |                                                           |       | Senior Term Debt (7)  (11.3%, Due 6/2009)              |       | 6,775,441 |       | 6,700,000      |
|                                                       |       |                                                           |       |                                                   |       |      |       |           |
| MCA Communications,  LLC                                   |       | Service-internet-based data                                    |       | Line of Credit (7)                                     |       | 798,349   |       | 792,063        |
| MCA Internet, LLC                                          |       | publisher                                                      |       | (non-accrual, Due 9/2006)                              |       |      |       |           |
|                                                            |       |                                                           |       |                                                   |       |      |       |           |
| Meteor Holding Corporation                                 |       | Manufacturing-bar code scanning                                |       | Senior Term Debt (6)                                   |       | 2,354,100 |       | 2,364,281      |
| Metrologic Instruments, Inc.                               |       | and data capture                                               |       | (8.3%, Due 12/2013)                                    |       |      |       |           |
|                                                            |       |                                                           |       | Senior Subordinated Term Debt (6)                      |       | 1,500,000 |       | 1,509,375      |
|                                                            |       |                                                           |       | (11.6%, Due 12/2013)                                   |       |      |       |           |
|                                                       |       |                                                           |       |                                                   |       |      |       |           |
| Multi-Ag Media  LLC                                        |       | Service-dairy magazine publisher/                              |       | Senior Term Debt (7)                                   |       | 2,643,911 |       | 2,618,764      |
| HFW  Communications, Inc.                                  |       | information database                                           |       | (12.3%, Due 12/2009)                                   |       |      |       |           |
| Dairy Radio, LLC                                           |       |                                                           |       |                                                   |       |      |       |           |
| DPW Publishing,  Inc.                                      |       |                                                           |       |                                                   |       |      |       |           |
| Phoenix Data  Processing, LLC                              |       |                                                           |       |                                                   |       |      |       |           |
|                                                            |       |                                                           |       |                                                   |       |      |       |           |
| Newhall Holdings, Inc. (d/b/a Newhall  Laboratories)       |       | Service-distributor of personal care products and  supplements |       | Line of Credit (7) (20)  (8.8%, Due 5/2010)            |       | —    |       | —         |
| Golden Sun, Inc.                                           |       |                                                           |       | Senior Term Debt (3) (7)  (9.1%, Due 5/2012)           |       | 4,500,000 |       | 4,500,000      |
|                                                            |       |                                                           |       | Senior Term Debt (3) (7)  (11.3%, Due 5/2012)          |       | 4,500,000 |       | 4,500,000      |
|                                                            |            |                                                                |            |                                                        |            |           |            |                |  |  |

 

6

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**GLADSTONECAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF JUNE 30, 2007(UNAUDITED)**
| Company(1)                                   | ** ** | **Industry**                                            | ** ** | **Investment(2)**                                         | ** ** | **Cost**  | ** ** | **Fair Value** |
|----------------------------------------------|------------|---------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------|------------|----------------|
| Northern Contours                            |       | Manufacturing-veneer and                                |       | Senior Subordinated Term Debt (5)                         |       | $         | 7,000,000  |           | $ | 7,008,750 |
| Northern Contours of Kentucky, Inc.          |       | laminate components                                     |       | (12.3%, Due 5/2010)                                       |       |      |       |           |
| Norcon Holding LLC                           |       |                                                    |       |                                                      |       |      |       |           |
| Norcon Lewis LLC                             |       |                                                    |       |                                                      |       |      |       |           |
|                                         |       |                                                    |       |                                                      |       |      |       |           |
| Pinnacle  Treatment Centers, Inc.            |       | Service-Addiction treatment centers                     |       | Line of Credit (21)  (9.6%, Due 12/2009)                  |       | —    |       | —         |
|                                         |       |                                                    |       | Senior Term Debt (5)  (9.6%, Due 12/2011)                 |       | 2,500,000 |       | 2,496,875      |
|                                         |       |                                                    |       | Senior Term Debt (3)(5)  (12.3%, Due 12/2011)             |       | 4,500,000 |       | 4,494,375      |
|                                              |       |                                                    |       |                                                      |       |      |       |           |
| Precision Acquisition Group                  |       | Manufacturing-consumable                                |       | Equipment Note (5) (22)                                   |       | 591,228   |       | 591,228        |
| Holdings, Inc.                               |       | components for the aluminum                             |       | (9.8%, Due 10/2011)                                       |       |      |       |           |
| Precision Asset Acquisition                  |       | industry                                                |       | Senior Term Debt (5)                                      |       | 5,000,000 |       | 5,012,500      |
| Company, LLC                                 |       |                                                    |       | (9.8%, Due 10/2010)                                       |       |      |       |           |
|                                              |       |                                                    |       | Senior Term Debt (3)(5)  (11.8%, Due 10/2010)             |       | 4,200,000 |       | 4,210,500      |
|                                         |       |                                                    |       |                                                      |       |      |       |           |
| PROFITSystems  Acquisition Co.               |       | Service-design and develop                              |       | Line of Credit (23)                                       |       | —    |       | —         |
| PROFITSystems,  Inc.                         |       | ERP software                                            |       | (9.6%, Due 7/2009)                                        |       |      |       |           |
|                                         |       |                                                    |       | Senior Term Debt (5)  (9.6%, Due 7/2011)                  |       | 2,875,000 |       | 2,878,594      |
|                                         |       |                                                    |       | Senior Term Debt (3)(5)  (11.8%, Due 7/201)               |       | 2,900,000 |       | 2,903,625      |
|                                              |       |                                                    |       |                                                      |       |      |       |           |
| Puerto Rico Cable Acquisition Company,  Inc. |       | Service-telecommunications                              |       | Senior Subordinated Term Debt (5)(6)  (11.6%, Due 1/2012) |       | 7,802,222 |       | 7,755,841      |
|                                         |       |                                                    |       |                                                      |       |      |       |           |
| Reading  Broadcasting, Inc.                  |       | Service-television station operator                     |       | Senior Term Debt (7)  (12.8%, Due 12/2011)                |       | 7,087,084 |       | 7,017,930      |
|                                              |       |                                                    |       |                                                      |       |      |       |           |
| RCS Management Holding Co.                   |       | Service-healthcare supplies                             |       | Senior Term Debt (3) (5)  (9.8%, Due 1/2011)              |       | 3,000,000 |       | 2,910,000      |
|                                              |       |                                                    |       | Senior Term Debt (4) (5)  (12.3%, Due 1/2011)             |       | 3,000,000 |       | 2,895,000      |
|                                         |       |                                                    |       |                                                      |       |      |       |           |
| RedPrairie  Holding, Inc.                    |       | Service-design and develop                              |       | Senior Term Debt (6)                                      |       | 4,457,500 |       | 4,457,500      |
| RedPrairie  Corporation                      |       | supply chain software                                   |       | (8.4%, Due 7/2012)                                        |       |      |       |           |
| Blue Cube  Software, Inc.                    |       |                                                    |       | Senior Subordinated Term Debt (6)  (11.9%, Due 1/2013)    |       | 3,000,000 |       | 3,000,000      |
|                                              |       |                                                    |       |                                                      |       |      |       |           |
| RiskMetrics Group Holdings, LLC              |       | Service - develop risk and wealth management  solutions |       | Senior Term Debt (6)  (7.6%, Due 1/2014)                  |       | 1,995,000 |       | 1,999,988      |
|                                              |       |                                                    |       | Senior Subordinated Term Debt (6)  (10.9%, Due 7/2014)    |       | 500,000   |       | 505,000        |
|                                         |       |                                                    |       |                                                      |       |      |       |           |
| SCI Cable, Inc.                              |       | Service-cable, internet, voice provider                 |       | Senior Term Debt (7) (14.3%, Due 10/2008)                 |       | 2,485,032 |       | 2,459,885      |
|                                              |            |                                                         |            |                                                           |            |           |            |                |  |  |

 

7

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**GLADSTONECAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS (Continued)AS OF JUNE 30, 2007(UNAUDITED)**
| Company(1)                                                | ** ** | **Industry**                                       | ** ** | **Investment(2)**                                      | ** ** | **Cost**   | ** **      | **Fair Value** |
|-----------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------------|------------|------------|-----------------|----------------|
| SCS Acquisition Corp. (d/b/a Specialty  Coatings Systems) |       | Service-chemically treated equipment distribution  |       | Senior Term Debt (5) (17)  (9.3%, Due 12/2011)         |       | $          | 5,442,311       |           | $ | 5,442,311 |
|                                                           |       |                                               |       | Senior Term Debt (3) (5) (17)  (11.3%, Due 12/2011)    |       | 6,531,250  |            | 6,531,250      |
|                                                      |       |                                               |       |                                                   |       |       |            |           |
| Sunburst Media -  Louisiana, LLC                          |       | Service-radio station operator                     |       | Senior Term Debt (7)  (12.0%, Due 6/2011)              |       | 7,875,441  |            | 7,800,000      |
|                                                           |       |                                               |       |                                                   |       |       |            |           |
| Sunshine Media Holdings                                   |       | Service-publisher regional B2B trade magazines     |       | Credit Facility (5) (24)  (9.3%, Due 5/2010)           |       | 600,000    |            | 598,500        |
|                                                           |       |                                               |       | Senior Term Debt (5)  (9.3%, Due 5/2012)               |       | 17,000,000 |            | 16,978,750     |
|                                                           |       |                                               |       | Senior Term Debt (3) (5)  (11.8%, Due 5/2012)          |       | 10,000,000 |            | 9,975,000      |
|                                                      |       |                                               |       |                                                   |       |       |            |           |
| Thibaut  Acquisition Co.                                  |       | Service-design and disbribute wall covering        |       | Credit Facility (5) (25)  (9.8%, Due 1/2011)           |       | 500,000    |            | 499,375        |
|                                                      |       |                                               |       | Senior Term Debt (5)  (9.8%, Due 1/2011)               |       | 2,887,500  |            | 2,887,500      |
|                                                      |       |                                               |       | Senior Term Debt (3) (5)  (12.3%, Due 1/2011)          |       | 3,000,000  |            | 3,000,000      |
|                                                           |       |                                               |       |                                                   |       |       |            |           |
| U.S. HealthCare Communications, LLC                       |       | Service-magazine publisher/operator                |       | Senior Term Debt (7)  (11.3%, Due 4/2011)              |       | 2,244,182  |            | 2,219,035      |
|                                                      |       |                                               |       |                                                   |       |       |            |           |
| Viapack, Inc.                                             |       | Manufacturing-polyethylene                         |       | Senior Real Estate Term Debt                           |       | 975,000    |            | 975,000        |
| P&O Packaging  Acquisition LLC                        |       | film                                               |       | (9.8%, Due 3/2011)                                     |       |       |            |           |
|                                                      |       |                                               |       | Senior Term Debt (3) (5) (19)  (11.3%, Due 3/2011)     |       | 4,223,438  |            | 4,202,320      |
|                                                           |       |                                               |       |                                                   |       |       |            |           |
| Visual Edge Technology, Inc.                              |       | Service-office equipment                           |       | Senior Subordinated Term Debt (5)                      |       | 5,000,000  |            | 3,625,000      |
| Graphic Enterprises, Inc.                                 |       | distribution                                       |       | (13.3%, Due 8/2011)                                    |       |       |            |           |
| Copeco, Inc.                                              |       |                                               |       |                                                   |       |       |            |           |
|                                                      |       |                                               |       |                                                   |       |       |            |           |
| Wesco Holdings,  Inc.                                     |       | Service-aerospace parts and                        |       | Senior Term Debt (6)                                   |       | 2,478,317  |            | 2,466,436      |
| Wesco Aircraft  Hardware Corp.                            |       | distribution                                       |       | (7.6%, Due 9/2013)                                     |       |       |            |           |
|                                                      |       |                                               |       | Senior Subordinated Term Debt (6)  (11.1%, Due 3/2014) |       | 2,271,494  |            | 2,289,375      |
|                                                           |       |                                               |       |                                                   |       |       |            |           |
| West Coast Yellow Pages, Inc.                             |       | Service-directory publisher                        |       | Senior Term Debt (7)  (13.8%, Due 8/2010)              |       | 1,624,251  |            | 1,605,390      |
|                                                      |       |                                               |       |                                                   |       |       |            |           |
| Westlake  Hardware, Inc.                                  |       | Retail-hardware and variety                        |       | Senior Subordinated Term Debt (5)                      |       | 15,000,000 |            | 14,925,000     |
| WHI Holding Corp.                                         |       |                                               |       | (12.6%, Due 1/2011)                                    |       |       |            |           |
|                                                           |       |                                               |       |                                                   |       |       |            |           |
| Winchester Electronics                                    |       | Manufacturing-high bandwidth connectors and cables |       | Senior Term Debt (5)  (9.1%, Due 6/2012)               |       | 2,000,000  |            | 2,002,500      |
|                                                           |       |                                               |       | Senior Subordinated Term Debt (5)  (12.3%, Due 6/2012) |       | 10,000,000 |            | 10,012,500     |
|                                                      |       |                                               |       |                                                   |       |       |            |           |
| WP Evenflo Group  Holdings Inc.                           |       | Manufacturing-infant and                           |       | Senior Term Debt (6)                                   |       | 1,990,000  |            | 1,999,950      |
| WP Evenflo  Acquisition, Inc.                             |       | juvenile products                                  |       | (7.8%, Due 2/2013)                                     |       |       |            |           |
|                                                      |       |                                               |       | Senior Subordinated Term Debt (6)  (11.3%, Due 2/2014) |       | 2,000,000  |            | 2,000,000      |
| **Total:**                                                | ** ** | ** **                                         | ** ** | ** **                                             | ** ** | **$**      | **369,975,398** | ** **     | **$** | **368,949,247** |

----

8

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(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 June 30, 2007 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 June 29,2007, from the respective originating syndication agent’s trading desk.

(7)             Investment valued at cost due torecent acquisition.

(8)             Availability under the Access TVcredit facility totals $500,000. There were no borrowings outstanding as ofJune 30, 2007.

(9)             Availability under the ActivStylecredit facility totals $1,500,000. Borrowings of $450,000 were outstanding at June 30, 2007.

(10)       Availability under the Anitoxcredit facility totals $3,000,000.  Therewere no borrowings outstanding at June 30, 2007.

(11)       Availability under the ChineseYellow Pages credit facility totals $950,000. Borrowings of $150,071 were outstanding at June 30, 2007.

(12)       Availability under the ExpressCourier credit facility totals $1,500,000. There were no borrowings outstanding at June 30, 2007.

(13)       Availability under the Heartlandcredit facility totals $500,000. Borrowings of $9,856 were outstanding at June 30, 2007.

(14)       Availability under theInternational Junior Golf credit facility totals $1,000,000.  Borrowings of $500,000 were outstanding atJune 30, 2007.

(15)       Remaining availability under the It’sJust Lunch revolving credit facility totals $200,000, borrowings of $550,000were outstanding at June 30, 2007.  Thecompany may borrow an additional $1,750,000 of the senior term debt facility,subject to certain conditions including Gladstone Capital’s approval,borrowings of $500,000 were outstanding at June 30, 2007.

(16)       Availability under the KMBQ creditfacility totals $200,000.  Borrowings of$150,000 were outstanding at June 30, 2007.

(17)       Availability under the LocalTelcredit facility totals $3,000,000. Borrowings of $1,275,000 were outstanding at June 30, 2007.

(18)       Availability under the MacFaddencredit facility totals $1,400,000. Borrowings of $515,979 were outstanding at June 30, 2007.

(19)       The MCA credit facility was maturedas of June 30, 2007.  The investment iscurrently not income producing.

(20)       Availability under the Newhallcredit facility totals $4,000,000.  Therewere no borrowings outstanding as of June 30, 2007.

(21)       Availability under the Pinnaclecredit facility totals $500,000.  Therewere no borrowings outstanding at June 30, 2007.

(22)       Precision may borrow up to$1,000,000 for purposes of acquiring equipment. Borrowings of $591,228 wereoutstanding at June 30, 2007.

(23)       Availability under theProfitSystems credit facility totals $1,250,000.  There were no borrowings outstanding at June30, 2007.

(24)       Availability under the Sunshinecredit facility totals $3,000,000. Borrowings of $600,000 were outstanding at June 30, 2007.

(25)       Availability under the Thibaut creditfacility totals $500,000.  Borrowings of$500,000 were outstanding at June 30, 2007.

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

9

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**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATED SCHEDULEOF INVESTMENTS**

**ASOF SEPTEMBER 30, 2007**
| Company (1)                                             | ** ** | **Industry**                                       | ** ** | **Investment (2)**                           | ** ** | **Cost**          | ** ** | **Fair Value** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|-------------------|------------|---------------------|------------|
| ActivStyle Acquisition Co.                                   |       | Service-medical                                    |       | Line  of Credit (16)                              |       | $                 | —     |                | $          | — |   |
| ActivStyle, Inc.                                             |       | products  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                               |       | Senior  Subordinated Term                         |       |              |       |                |       |
|                                                         |       | nursing                                            |       | Debt(5)(6)                                        |       | 5,000,000         |       | 5,000,000           |       |
|                                                         |       | services                                           |       | (11.33%,  Due 12/2013)                            |       |              |       |                |       |
| Allied Extruders, LLC  P&O Packaging Acquisition LLC     |       | Manufacturing-polyethylene                         |       | Senior  Real Estate Term Debt  (9.8%, Due 3/2011) |       | 1,000,000         |       | 1,000,000           |       |
|                                                              |       | film                                               |       | 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-                      |       | Senior  Term Debt (5)                             |       | 2,112,500         |       | 2,144,187           |       |
|                                                              |       | dust  management systems for the coal and electric |       | (10.3%,  Due 5/2009)  Senior Term Debt (3) (5)    |       |  

3,046,875 |       |  

3,107,813   |       |
|                                                              |       | utility  industries                                |       | (13.3%,  Due 5/2009)                              |       |              |       |                |       |
| Bresnan Communications,  LLC                                 |       | Service-telecommunications                         |       | Senior  Term Debt (6)  (7.2%, Due 9/2013)         |       | 1,002,115         |       | 997,500             |       |
|                                                         |       |                                               |       | 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  Communications LLC                            |       | Service-telecommunications                         |       | Senior  Subordinated Term  Debt (5) (6)           |       | 5,961,594         |       | 6,015,000           |       |
| Country Road Management,  Inc.                               |       |                                               |       | (13.3%,  Due 7/2013)                              |       |              |       |                |       |
| Defiance Stamping Company                                    |       | Manufacturing-trucking  parts                      |       | Senior  Term Debt (3) (5)  (13.3%, Due 4/2010)    |       | 6,325,000         |       | 6,332,906           |       |
| Doe  & Ingalls ManagementLLC  Doe & Ingalls of North |       | Distributor-specialty  chemicals                   |       | Senior  Term Debt (5)  (9.8%, Due 11/2010)        |       | 4,700,000         |       | 4,723,500           |       |
| Carolina Operating LLC                                       |       |                                               |       | Senior  Term Debt (3) (5)                         |       | 4,500,000         |       | 4,516,875           |       |
| Doe & Ingalls of  Florida                                |       |                                               |       | (13.3%,  Due 11/2010)                             |       |              |       |                |       |
| Operating LLC                                                |       |                                               |       |                                              |       |              |       |                |       |
| Doe & Ingalls of  Virginia                               |       |                                               |       |                                              |       |              |       |                |       |
| Operating LLC                                                |       |                                               |       |                                              |       |              |       |                |       |
| Express Courier International, Inc.                          |       | Service-ground  delivery and logistics             |       | Line  of Credit (7)  (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                                          |       |                                              |       |              |       |                |       |
|                                                              |            |                                                    |            |                                                   |            |                   |            |                     |            |  |  |

 

10

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**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATED SCHEDULEOF INVESTMENTS (Continued)**

**AS OF SEPTEMBER 30, 2007**
| **Company (1)**                                        | ** ** | **Industry**                                   | ** ** | **Investment (2)**                                    | ** ** | **Cost**  | ** ** | **Fair Value** |   |
|-------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------------|------------|-----------|------------|---------------------|--------|
| FR X Ohmstede Holdings, LLC                                 |       | Service  &                                 |       | Senior  Term Debt (6)                                      |       | 3,000,000 |       | 3,026,250           |   |
| FR X Ohmstede Acquisitions Co.                              |       | Manufacuring-heat                              |       | (8.5%,  Due 8/2013)                                        |       |      |       |                |   |
|                                                             |       | exchangers                                     |       | 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.  Multi Packaging Solutions, Inc. |       | Manufacturing-packaging  products              |       | Senior  Subordinated Term Debt (6)  (12.5%, Due 6/2011)    |       | 8,000,000 |       | 8,000,000           |   |
| 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 and host     |       | Senior  Term Debt (6)  (10.4%, Due 1/2012)                 |       | 4,464,358 |       | 4,499,747           |   |
| Northern  Contours  Northern Contours                       |       | Manufacturing-veneer  and  laminate components |       | Senior  Subordinated Term Debt (5)  (12.3%, Due 5/2010)    |       | 7,000,000 |       | 7,017,500           |   |
| of Kentucky, Inc.                                           |       |                                           |       |                                                       |       |      |       |                |   |
| Norcon Holding LLC                                          |       |                                           |       |                                                       |       |      |       |                |   |
| Norcon Lewis LLC                                            |       |                                           |       |                                                       |       |      |       |                |   |
| PROFITSystems Acquisition Co.  PROFITSystems, Inc.          |       | Service-design  and develop ERP                |       | Line  of Credit (17)  (9.6%, Due 7/2009)                   |       | —    |       | —              |   |
|                                                             |       | software                                       |       | 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  Acquisition Company, Inc.               |       | Service-telecommunications                     |       | Senior  Subordinated Term Debt (5)(6)  (11.6%, Due 1/2012) |       | 7,813,274 |       | 7,775,183           |   |
| QCE, LLC (d/b/a Quiznos Corp.)                              |       | Service-restaurant  franchisor                 |       | Senior  Term Debt (6)  (7.6%, Due 5/2013)                  |       | 3,010,713 |       | 2,977,538           |   |
|                                                             |       |                                           |       | Senior  Term Debt (3) (6)                                  |       | 3,045,560 |       | 3,033,750           |   |
|                                                             |       |                                           |       | (11.1%,  Due 11/2013)                                      |       |      |       |                |   |

 

11

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**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATED SCHEDULEOF INVESTMENTS (Continued)**

**AS OF SEPTEMBER 30, 2007**
| **Company (1)**                                     | ** ** | **Industry**                             | ** ** | **Investment (2)**                                 | ** ** | **Cost**   | ** **      | **Fair Value** |   |
|----------------------------------------------------------|------------|------------------------------------------|------------|---------------------------------------------------------|------------|------------|-----------------|---------------------|--------|
| RCS Management Holding Co.                               |       | Service-healthcare                       |       | Senior  Term Debt (3) (5)                               |       | 3,000,000  |            | 3,003,750           |   |
|                                                          |       | supplies                                 |       | (9.8%,  Due 1/2011)                                     |       |       |            |                |   |
|                                                          |       |                                     |       | Senior  Term Debt (4) (5)                               |       | 3,000,000  |            | 3,003,750           |   |
|                                                          |       |                                     |       | (12.3%,  Due 1/2011)                                    |       |       |            |                |   |
| RedPrairie  Holding, Inc.  RedPrairie Corporation        |       | Service-design  and develop supply chain |       | Senior  Term Debt (6)  (8.4%, Due 7/2012)               |       | 3,990,000  |            | 3,990,000           |   |
| Blue Cube Software, Inc.                                 |       | software                                 |       | Senior  Subordinated Term Debt (6)  (11.9%, Due 1/2013) |       | 2,000,000  |            | 2,005,000           |   |
| SCPH Holdings, Inc.  Sea Con Phoenix, Inc.               |       | Manufacturing-underwater                 |       | Credit  Facility (8)  (9.8%, Due 2/2007)                |       | —     |            | —              |   |
| Phoenix Optix, Inc.                                      |       | and  harsh environment                   |       | Senior  Term Debt (5)                                   |       | 2,625,000  |            | 2,631,563           |   |
|                                                          |       | components                               |       | (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 equipment    |       | Senior  Term Debt (3) (5) (9)  (9.3%, Due 12/2011)      |       | 6,250,000  |            | 6,257,812           |   |
|                                                     |       | distribution                             |       | Senior  Term Debt (3) (5) (10)                          |       | 6,568,750  |            | 6,576,961           |   |
|                                                     |       |                                     |       | (11.3%,  Due 12/2011)                                   |       |       |            |                |   |
| Thibaut Acquisition Co.                                  |       | Design  and                              |       | Credit  Facility (11)                                   |       | —     |            | —              |   |
|                                                          |       | Disbtribution-wall                       |       | (9.8%,  Due 1/2011)                                     |       |       |            |                |   |
|                                                          |       | coverings                                |       | 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)  (13.3%, Due 8/2011) |       | 5,000,000  |            | 4,987,500           |   |
| Copeco, Inc.                                             |       |                                     |       |                                                    |       |       |            |                |   |
| Westlake Hardware, Inc.  WHI Holding Corp.               |       | Retail-hardware  and variety             |       | Senior  Subordinated Term Debt (5)  (12.6%, Due 1/2011) |       | 15,000,000 |            | 14,981,250          |   |
| Winchester Electronics                                   |       | Manufacturing-high                       |       | Senior  Term Debt (3) (5)                               |       | 6,000,000  |            | 6,007,500           |   |
|                                                     |       | bandwidth  connectors                    |       | (12.3%,  Due 6/2012)                                    |       |       |            |                |   |
|                                                     |       | and  cables                              |       |                                                    |       |       |            |                |   |
| Xspedius Communications  LLC                             |       | Service-telecommunications               |       | Senior  Subordinated Term Debt (5)  (15.8%, Due 3/2010) |       | 5,157,821  |            | 5,306,110           |   |
| **Total:**                                               | ** ** | ** **                               | ** ** | ** **                                              | ** ** | **$**      | **216,202,986** | ** **          | **$**  | **217,642,750** | ** ** |
|                                                          |            |                                          |            |                                                         |            |            |                 |                     |        |  |  |

----

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

(2)             Percentagerepresents interest rates in effect at September 30, 2006 and due daterepresents the contractual maturity date.

(3)             LastOut Tranche of senior debt, meaning if the company is liquidated then theholder of the Last Out Tranche is paid after the senior debt.

(4)             LastOut Tranche of senior debt, meaning if the company is liquidated then theholder of the Last Out Tranche is paid after the senior debt, however the debtis junior to another Last Out Tranche.

(5)             Fairvalue was based on opinions of value submitted by Standard & Poor’sSecurities Evaluations, Inc.

(6)             Marketablesecurities, such as syndicated loans, are valued based on the indicative bidprice, as of September 30, 2006 from the respective originating syndicationagent’s trading desk.

(7)             Availabilityunder the credit facility totals $1,500,000. There were no borrowings outstanding at September 30, 2006.

(8)             Availabilityunder the credit facility totals $500,000. There were no borrowings outstanding at September 30, 2006.

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

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

(11)       Availabilityunder the credit facility totals $1,000,000. There were no borrowings outstanding at September 30, 2006.

(12)       Availabilityunder the credit facility totals $750,000. Borrowings of $200,000 were outstanding at September 30, 2006.

12

----

(13)       Thecompany may borrow an additional $500,000 under the senior term debt facility,subject to certain conditions including Gladstone Capital’s approval.

(14)       Thecompany may borrow an additional $2,250,000 under the senior term debt facility,subject to certain conditions including Gladstone Capital’s approval.

(15)       Availabilityunder the credit facility totals $3,000,000. Borrowings of $350,000 were outstanding at September 30, 2006.

(16)       Availabilityunder the credit facility totals $1,500,000. There were no borrowings outstanding at September 30, 2006

(17)       Availabilityunder the credit facility totals $1,250,000. There were no borrowings outstanding at September 30, 2006

(18)       Includesa success fee with a fair value of $742,000 and no cost basis.

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

 

13

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**GLADSTONECAPITAL CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                                   | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| INVESTMENT INCOME                                                            |       |                                                |       |   |   |
| Interest income  — investments                                          |       | $                                                   | 8,911,643  |   | $ | 5,775,522 |   |
| Interest income  — cash and cash equivalents                            |       | 109,269                                             |       | 8,178 |   |
| Interest income  — notes receivable from employees                      |       | 132,795                                             |       | 108,877 |   |
| Prepayment fees  and other income                                            |       | 47,572                                              |       | 630,239 |   |
| Total investment  income                                                     |       | 9,201,279                                           |       | 6,522,816 |   |
|                                                                         |       |                                                |       |   |   |
| EXPENSES                                                                     |       |                                                |       |   |   |
| Interest expense                                                             |       | 1,762,249                                           |       | 702,449 |   |
| Loan servicing  (Refer to Notes 4 and 5)                                     |       | 897,634                                             |       | 693,965 |   |
| Base management  fee (Refer to Note 4)                                       |       | 727,259                                             |       | 334,814 |   |
| Incentive fee  (Refer to Note 4)                                             |       | 1,166,529                                           |       | — |   |
| Administration  fee (Refer to Note 4)                                        |       | 186,895                                             |       | — |   |
| Professional  fees                                                           |       | 148,609                                             |       | 166,405 |   |
| Amortization of  deferred financing fees                                     |       | 72,133                                              |       | 36,036 |   |
| Stockholder  related costs                                                   |       | 39,434                                              |       | 28,371 |   |
| Directors fees                                                               |       | 56,250                                              |       | 27,500 |   |
| Insurance  expense                                                           |       | 66,246                                              |       | 50,589 |   |
| Stock option  compensation                                                   |       | —                                              |       | 202,296 |   |
| Other expenses                                                               |       | 82,062                                              |       | 35,083 |   |
| Expenses before  credit from Adviser                                         |       | 5,205,300                                           |       | 2,277,508 |   |
| Credit to base  management and incentive fees from Adviser (Refer to Note 4) |       | (1,708,888                                          | )          | (542,774 | ) |
| Total expenses  net of credits to base management and incentive fees         |       | 3,496,412                                           |       | 1,734,734 |   |
| NET INVESTMENT INCOME                                                        |       | 5,704,867                                           |       | 4,788,082 |   |
|                                                                         |       |                                                |       |   |   |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS:                         |       |                                                |       |   |   |
| Realized loss on  sale of investments                                        |       | (5,021                                              | )          | (100,850 | ) |
| Realized gain on  settlement of derivative                                   |       | 8,405                                               |       | 1,367 |   |
| Unrealized  (depreciation) appreciation on derivative                        |       | (264                                                | )          | 41,486 |   |
| Net unrealized  appreciation on investments                                  |       | 256,613                                             |       | 812,991 |   |
| Net gain on  investments                                                     |       | 259,733                                             |       | 754,994 |   |
|                                                                         |       |                                                |       |   |   |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS                        |       | $                                                   | 5,964,600  |   | $ | 5,543,076 |   |
|                                                                         |       |                                                |       |   |   |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE:      |       |                                                |       |   |   |
| Basic                                                                        |       | $                                                   | 0.44       |   | $ | 0.49 |   |
| Diluted                                                                      |       | $                                                   | 0.44       |   | $ | 0.48 |   |
|                                                                         |       |                                                |       |   |   |
| WEIGHTED AVERAGE SHARES  OF COMMON STOCK OUTSTANDING:                        |       |                                                |       |   |   |
| Basic                                                                        |       | 13,561,511                                          |       | 11,337,291 |   |
| Diluted                                                                      |       | 13,561,511                                          |       | 11,570,425 |   |

 

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

14

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**GLADSTONECAPITAL CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                                   | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| INVESTMENT INCOME                                                            |       |                                               |       |   |   |
| Interest income  — investments                                          |       | $                                                  | 25,064,702 |   | $ | 18,497,893 |   |
| Interest income  — cash and cash equivalents                            |       | 178,183                                            |       | 21,714 |   |
| Interest income  — notes receivable from employees                      |       | 403,917                                            |       | 323,003 |   |
| Prepayment fees  and other income                                            |       | 431,973                                            |       | 711,225 |   |
| Total investment  income                                                     |       | 26,078,775                                         |       | 19,553,835 |   |
|                                                                         |       |                                               |       |   |   |
| EXPENSES                                                                     |       |                                               |       |   |   |
| Interest expense                                                             |       | 4,693,525                                          |       | 2,302,693 |   |
| Loan servicing  (Refer to Notes 4 and 5)                                     |       | 2,377,409                                          |       | 2,144,024 |   |
| Base management  fee (Refer to Note 4)                                       |       | 1,806,075                                          |       | 955,894 |   |
| Incentive fee  (Refer to Note 4)                                             |       | 3,474,007                                          |       | — |   |
| Administration  fee (Refer to Note 4)                                        |       | 481,746                                            |       | — |   |
| Professional  fees                                                           |       | 368,610                                            |       | 399,758 |   |
| Amortization of  deferred financing fees                                     |       | 198,633                                            |       | 94,572 |   |
| Stockholder  related costs                                                   |       | 190,450                                            |       | 273,170 |   |
| Directors fees                                                               |       | 167,470                                            |       | 81,712 |   |
| Insurance  expense                                                           |       | 191,338                                            |       | 151,956 |   |
| Stock option  compensation                                                   |       | —                                             |       | 279,618 |   |
| Other expenses                                                               |       | 219,522                                            |       | 151,663 |   |
| Expenses before  credit from Adviser                                         |       | 14,168,785                                         |       | 6,835,060 |   |
| Credit to base  management and incentive fees from Adviser (Refer to Note 4) |       | (4,682,160                                         | )          | (1,765,774 | ) |
| Total expenses  net of credits to base management and incentive fees         |       | 9,486,625                                          |       | 5,069,286 |   |
|                                                                         |       |                                               |       |   |   |
| NET INVESTMENT INCOME  BEFORE INCOME TAXES                                   |       | 16,592,150                                         |       | 14,484,549 |   |
| Income tax  expense                                                          |       | —                                             |       | 50,237 |   |
| NET INVESTMENT INCOME                                                        |       | 16,592,150                                         |       | 14,434,312 |   |
|                                                                         |       |                                               |       |   |   |
| REALIZED AND UNREALIZED  GAIN (LOSS) ON INVESTMENTS:                         |       |                                               |       |   |   |
| Net realized  gain (loss) on sale of investments                             |       | 81,498                                             |       | (903,945 | ) |
| Realized gain on  settlement of derivative                                   |       | 31,198                                             |       | 1,367 |   |
| Unrealized  (depreciation) appreciation on derivative                        |       | (25,877                                            | )          | 65,252 |   |
| Net unrealized  (depreciation) appreciation on investments                   |       | (2,465,915                                         | )          | 5,769,820 |   |
| Net (loss) gain  on investments                                              |       | (2,379,096                                         | )          | 4,932,494 |   |
|                                                                         |       |                                               |       |   |   |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS                        |       | $                                                  | 14,213,054 |   | $ | 19,366,806 |   |
|                                                                         |       |                                               |       |   |   |
| NET INCREASE IN NET  ASSETS RESULTING FROM OPERATIONS PER COMMON SHARE:      |       |                                               |       |   |   |
| Basic                                                                        |       | $                                                  | 1.12       |   | $ | 1.71 |   |
| Diluted                                                                      |       | $                                                  | 1.12       |   | $ | 1.68 |   |
|                                                                         |       |                                               |       |   |   |
| WEIGHTED AVERAGE SHARES  OF COMMON STOCK OUTSTANDING:                        |       |                                               |       |   |   |
| Basic                                                                        |       | 12,701,845                                         |       | 11,317,437 |   |
| Diluted                                                                      |       | 12,701,845                                         |       | 11,549,054 |   |

 

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

15

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**GLADSTONECAPITAL CORPORATIONCONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS(UNAUDITED)**
| ** **                                                         | ** ** | **Nine Months Ended June 30,** | ** **  |
|--------------------------------------------------------------------|------------|----------------------------------------------------|-------------|
| ** **                                                         | ** ** | **2007**                                           | ** **  | **2006** | ** ** |
| *Operations:*                                                      |       |                                               |        |   |   |
| Net investment  income                                             |       | $                                                  | 16,592,150  |   | $ | 14,434,312 |   |
| Net realized  gain (loss) on sale of investments                   |       | 81,498                                             |        | (903,945 | ) |
| Realized gain on  settlement of derivative                         |       | 31,198                                             |        | 1,367 |   |
| Unrealized  (depreciation) appreciation on derivatives             |       | (25,877                                            | )           | 65,252 |   |
| Net unrealized  (depreciation) appreciation on investments         |       | (2,465,915                                         | )           | 5,769,820 |   |
| Net increase in  net assets from operations                        |       | 14,213,054                                         |        | 19,366,806 |   |
|                                                               |       |                                               |        |   |   |
| *Capital transactions:*                                            |       |                                               |        |   |   |
| Issuance of  common stock under shelf offering                     |       | 46,075,000                                         |        | — |   |
| Distributions to  stockholders                                     |       | (16,012,661                                        | )           | (13,751,539 | ) |
| Shelf offering  costs                                              |       | (405,708                                           | )           | — |   |
| Repayment of  principal on employee notes                          |       | 300,941                                            |        | 129,943 |   |
| Stock option  compensation                                         |       | —                                             |        | 279,618 |   |
| Issuance of  common stock under stock option plan                  |       | —                                             |        | 1,150,245 |   |
| Stock  surrendered in settlement of withholding tax                |       | (1,488,193                                         | )           | — |   |
| Increase  (decrease) in net assets from capital share transactions |       | 28,469,379                                         |        | (12,191,733 | ) |
|                                                               |       |                                               |        |   |   |
| Total increase in net  assets                                      |       | 42,682,433                                         |        | 7,175,073 |   |
| Net assets at beginning  of year                                   |       | 172,570,487                                        |        | 151,610,683 |   |
| Net assets at end of period                                        |       | $                                                  | 215,252,920 |   | $ | 158,785,756 |   |

 

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

16

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**GLADSTONECAPITAL CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**
| ** **                                                                                                                              | ** ** | **Nine Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                              | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                                                                               |       |                                               |       |   |   |
| ** **                                                                                                                              |       |                                               |       |   |   |
| Net increase in  net assets resulting from operations                                                                                   |       | $                                                  | 14,213,054 |   | $ | 19,366,806 |   |
| Adjustments to  reconcile net increase in net assets resulting from operations to net cash  (used in) provided by operating activities: |       |                                               |       |   |   |
| Purchase of  investments                                                                                                                |       | (253,727,829                                       | )          | (105,076,400 | ) |
| Principal  repayments on investments                                                                                                    |       | 99,802,867                                         |       | 107,876,077 |   |
| Net amortization  of premiums and discounts                                                                                             |       | 29,872                                             |       | (144,501 | ) |
| Amortization of  deferred financing fees                                                                                                |       | 198,633                                            |       | 94,572 |   |
| Stock  compensation expense                                                                                                             |       | —                                             |       | 279,618 |   |
| Realized loss on  investments                                                                                                           |       | 122,680                                            |       | 1,329,458 |   |
| Unrealized  depreciation (appreciation) on derivative                                                                                   |       | 25,877                                             |       | (65,252 | ) |
| Change in net  unrealized depreciation (appreciation) on investments                                                                    |       | 2,465,915                                          |       | (5,769,820 | ) |
| (Increase)  decrease in interest receivable                                                                                             |       | (822,007                                           | )          | 276,230 |   |
| Decrease in  funds due from custodian                                                                                                   |       | 457,261                                            |       | 130,150 |   |
| Decrease in  prepaid assets                                                                                                             |       | 40,102                                             |       | 105,902 |   |
| Increase in due  from affiliate                                                                                                         |       | —                                             |       | (207,960 | ) |
| Increase in  other assets                                                                                                               |       | (165,163                                           | )          | (27,845 | ) |
| Increase in  accounts payable                                                                                                           |       | 1,088                                              |       | 23,449 |   |
| Increase in  interest payable                                                                                                           |       | 269,250                                            |       | 4,685 |   |
| Increase  (decrease) in accrued expenses and deferred liabilities                                                                       |       | 133,035                                            |       | (125,298 | ) |
| Increase  (decrease) in fees due to affiliate                                                                                           |       | 163,877                                            |       | (209,924 | ) |
| Increase in  administration fee due to Gladstone Administration                                                                         |       | 186,895                                            |       | — |   |
| (Decrease)  increase in funds held in escrow                                                                                            |       | (760                                               | )          | 40 |   |
| Increase in  investment balance due to payment in kind interest                                                                         |       | —                                             |       | (74,701 | ) |
| Net cash (used  in) provided by operating activities                                                                                    |       | (136,605,353                                       | )          | 17,785,286 |   |
|                                                                                                                                    |       |                                               |       |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                                                                                               |       |                                               |       |   |   |
| ** **                                                                                                                              |       |                                               |       |   |   |
| Receipt of  principal on notes receivable - employees                                                                                   |       | 300,941                                            |       | 129,943 |   |
| Net cash  provided by investing activities                                                                                              |       | 300,941                                            |       | 129,943 |   |
|                                                                                                                                    |       |                                               |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                                                                                               |       |                                               |       |   |   |
| ** **                                                                                                                              |       |                                               |       |   |   |
| Net proceeds  from issuance of common shares                                                                                            |       | 45,669,292                                         |       | — |   |
| Borrowings from  the lines of credit                                                                                                    |       | 277,800,000                                        |       | 113,090,000 |   |
| Repayments on  the lines of credit                                                                                                      |       | (166,605,000                                       | )          | (118,278,064 | ) |
| Distributions  paid                                                                                                                     |       | (16,012,661                                        | )          | (13,751,539 | ) |
| Exercise of  employee stock options                                                                                                     |       | —                                             |       | 1,150,245 |   |
| Deferred  financing fees                                                                                                                |       | (299,275                                           | )          | (173,333 | ) |
| Withholding tax  obligation settlement                                                                                                  |       | (1,488,193                                         | )          | — |   |
| Net cash  provided by (used in) financing activities                                                                                    |       | 139,064,163                                        |       | (17,962,691 | ) |
|                                                                                                                                    |       |                                               |       |   |   |
| **NET INCREASE (DECREASE) IN CASH  AND CASH EQUIVALENTS(1)**                                                                            |       | 2,759,751                                          |       | (47,462 | ) |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**                                                                                     |       | 731,744                                            |       | 503,776 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**                                                                                           |       | $                                                  | 3,491,495  |   | $ | 456,314 |   |
|                                                                                                                                    |       |                                               |       |   |   |
| **CASH PAID DURING PERIOD FOR  INTEREST**                                                                                               |       | $                                                  | 4,424,275  |   | $ | 2,298,008 |   |
| **NON-CASH FINANCING ACTIVITIES**                                                                                                       |       |                                               |       |   |   |
| Notes receivable issued in exchange for common stock associated with  the exercise of employee stock options                            |       | $                                                  | —     |   | $ | 199,980 |   |

----

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

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

17

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**GLADSTONECAPITAL CORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**
| ** **                                                       | ** ** | **Three Months Ended June 30,** | ** **  |
|------------------------------------------------------------------|------------|-----------------------------------------------------|-------------|
| ** **                                                       | ** ** | **2007**                                            | ** **  | **2006** | ** ** |
| Per Share Data(1)                                                |       |                                                |        |   |   |
| Net asset value  at beginning of period                          |       | $                                                   | 13.82       |   | $ | 13.84 |   |
| *Income  from investment operations:*                            |       |                                                |        |   |   |
| Net investment  income(2)                                        |       | 0.42                                                |        | 0.42 |   |
| Realized gain  (loss) on sale of investments(2)                  |       | —                                              |        | (0.01 | ) |
| Net unrealized  (loss) gain on investments(2)                    |       | 0.02                                                |        | 0.07 |   |
| Net unrealized  gain on derivatives(2)                           |       | —                                              |        | 0.01 |   |
| Total from  investment operations                                |       | 0.44                                                |        | 0.49 |   |
| Less  distributions:                                             |       |                                                |        |   |   |
| Distributions  from net investment income                        |       | (0.42                                               | )           | (0.41 | ) |
| Total  distributions                                             |       | (0.42                                               | )           | (0.41 | ) |
| Issuance of  common stock under shelf offering                   |       | 1.50                                                |        | — |   |
| Offering costs  and underwriting discount                        |       | (0.23                                               | )           | — |   |
| Issuance of  common stock under stock option plan                |       | —                                              |        | 0.10 |   |
| Repayment of  principal on notes receivable                      |       | —                                              |        | 0.01 |   |
| Dilutive effect  of share issuance                               |       | —                                              |        | (0.08 | ) |
| Net asset value  at end of period                                |       | $                                                   | 15.11       |   | $ | 13.95 |   |
|                                                             |       |                                                |        |   |   |
| Per share market  value at beginning of period                   |       | $                                                   | 23.68       |   | $ | 21.55 |   |
| Per share market  value at end of period                         |       | 21.46                                               |        | 21.39 |   |
| Total return(3)(4)                                               |       | -7.69                                               | %           | 1.11 | % |
| Shares  outstanding at end of period                             |       | 14,249,683                                          |        | 11,384,363 |   |
|                                                             |       |                                                |        |   |   |
| Ratios/Supplemental  Data                                        |       |                                                |        |   |   |
| Net assets at  end of period                                     |       | $                                                   | 215,252,920 |   | $ | 158,785,756 |   |
| Average net  assets(5)                                           |       | $                                                   | 197,994,217 |   | $ | 156,053,816 |   |
| Ratio of  expenses to average net assets-annualized(6)           |       | 10.52                                               | %           | 5.83 | % |
| Ratio of net  expenses to average net assets-annualized(7)       |       | 7.06                                                | %           | 4.45 | % |
| Ratio of net investment  income to average net assets-annualized |       | 11.53                                               | %           | 12.27 | % |

----

(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 ordecrease of the ending market value over the beginning market value plus monthlydividends divided by the monthly beginning market value, assuming monthlydividend reinvestment.

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

18

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**GLADSTONECAPITAL CORPORATIONFINANCIAL HIGHLIGHTS(UNAUDITED)**
| ** **                                                       | ** ** | **Nine Months Ended June 30,** | ** **  |
|------------------------------------------------------------------|------------|----------------------------------------------------|-------------|
| ** **                                                       | ** ** | **2007**                                           | ** **  | **2006** | ** ** |
| Per Share Data(1)                                                |       |                                               |        |   |   |
| Net asset value  at beginning of period                          |       | $                                                  | 14.02       |   | $ | 13.41 |   |
| *Income  from investment operations:*                            |       |                                               |        |   |   |
| Net investment  income(2)                                        |       | 1.31                                               |        | 1.28 |   |
| Realized loss on  sale of investments(2)                         |       | —                                             |        | (0.08 | ) |
| Net unrealized  (loss) gain on investments(2)                    |       | (0.19                                              | )           | 0.51 |   |
| Total from  investment operations                                |       | 1.12                                               |        | 1.71 |   |
| Less  distributions:                                             |       |                                               |        |   |   |
| Distributions  from net investment income                        |       | (1.26                                              | )           | (1.22 | ) |
| Total  distributions                                             |       | (1.26                                              | )           | (1.22 | ) |
| Issuance of  common stock under shelf offering                   |       | 1.50                                               |        | — |   |
| Offering costs  and underwriting discount                        |       | (0.23                                              | )           | — |   |
| Issuance of  common stock under stock option plan                |       | —                                             |        | 0.10 |   |
| Repayment of  principal on notes receivable                      |       | 0.02                                               |        | 0.01 |   |
| Stock  surrendered to settle withholding tax obligation          |       | (0.06                                              | )           | — |   |
| Dilutive effect  of share issuance                               |       | —                                             |        | (0.06 | ) |
| Net asset value  at end of period                                |       | $                                                  | 15.11       |   | $ | 13.95 |   |
|                                                             |       |                                               |        |   |   |
| Per share market  value at beginning of period                   |       | $                                                  | 22.01       |   | $ | 22.55 |   |
| Per share market  value at end of period                         |       | 21.46                                              |        | 21.39 |   |
| Total  return(3)(4)                                              |       | 2.92                                               | %           | 0.35 | % |
| Shares  outstanding at end of period                             |       | 14,249,683                                         |        | 11,384,363 |   |
|                                                             |       |                                               |        |   |   |
| Ratios/Supplemental  Data                                        |       |                                               |        |   |   |
| Net assets at  end of period                                     |       | $                                                  | 215,252,920 |   | $ | 158,785,756 |   |
| Average net  assets(5)                                           |       | $                                                  | 179,127,176 |   | $ | 153,804,303 |   |
| Ratio of  expenses to average net assets-annualized(6)           |       | 10.55                                              | %           | 5.97 | % |
| Ratio of net  expenses to average net assets-annualized(7)       |       | 7.06                                               | %           | 4.44 | % |
| Ratio of net investment  income to average net assets-annualized |       | 12.35                                              | %           | 12.51 | % |

----

(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 ordecrease of the ending market value over the beginning market value plusmonthly dividends divided by the monthly beginning market value, assumingmonthly dividend reinvestment.

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

19

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**GLADSTONE CAPITALCORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTSJUNE 30, 2007(UNAUDITED)**

NOTE 1. ORGANIZATION

Gladstone CapitalCorporation (the “Company”) was incorporated under the General Corporation Lawsof the State of Maryland on May 30, 2001. The Company is a closed-end,non-diversified management investment company that has elected to be treated asa business development company, or BDC, under the Investment Company Act of1940, as amended (the “1940 Act”). In addition, the Company has elected to betreated for tax purposes as a regulated investment company (“RIC”) under theInternal Revenue Code of 1986, as amended (the “Code”). The Company’sinvestment objectives are to achieve a high level of current income byinvesting in debt and equity securities of established private businesses.

Gladstone Business LoanLLC (“Business Loan”), a wholly-owned subsidiary of the Company, wasestablished on February 3, 2003 for the purpose of holding the Company’sportfolio of loan investments. Gladstone Capital Advisers, Inc. is also awholly-owned subsidiary.

Gladstone SSBICCorporation (“Gladstone SSBIC”), a wholly-owned subsidiary of the Company, wasestablished on November 21, 2006 for the purpose of holding a license tooperate as a Specialized Small Business Investment Company. Gladstone SSBICacquired this license in February 2007. This will enable the Company, throughthis subsidiary, to make investments in accordance with the United States SmallBusiness Administration guidelines for specialized small business investmentcompanies.

The financial statementsof the subsidiaries are consolidated with those of the Company.

The Company is externallymanaged by Gladstone Management Corporation (the “Adviser”), an unconsolidatedaffiliate of the Company.

NOTE 2. SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES

*Unaudited Interim FinancialStatements*

Interim financialstatements of the Company are prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”) for interimfinancial information and pursuant to the requirements for reporting on Form10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosuresaccompanying annual financial statements prepared in accordance with GAAP areomitted. In the opinion of management, all adjustments, consisting solely ofnormal recurring accruals, necessary for the fair statement of financialstatements for the interim periods have been included. The current period’sresults of operations are not necessarily indicative of results that ultimatelymay be achieved for the year. The interim financial statements and notesthereto should be read in conjunction with the financial statements and notesthereto included in the Company’s Form 10-K for the fiscal year ended September30, 2006, as filed with the Securities and Exchange Commission (the “SEC”) onDecember 6, 2006.

*Use of Estimates*

The preparation offinancial statements in conformity with GAAP requires management to makeestimates 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.

*Reclassifications*

Certain amounts in theprior year’s financial statements have been reclassified to conform to thecurrent year presentation with no effect to net increase in net assetsresulting from operations.

20

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*Investment Valuation*

The Companycarries its investments at fair value, as determined by its Board of Directors.Securities that are publicly traded are valued at the closing price on thevaluation date. Securities for which a limited market exists, such as certainparticipations in syndicated loans, are valued at the indicative bid price onor near the valuation date from the respective originating syndication agent’strading desk. Debt and equity securities that are not publicly traded, or forwhich a limited market does not exist, are valued at fair value. The Company’sBoard of Directors has established a valuation policy and consistently appliedvaluation procedures used to determine the fair value of these securitiesquarterly.

The procedures forthe determination of value of the Company’s debt securities that that are notpublicly traded and that are issued to portfolio companies where the Companyhas no equity, or equity-like securities, rely on the opinions of valuesubmitted to us by Standard & Poor’s Securities Evaluations, Inc. (“SPSE”).The Company may also submit paid in kind (“PIK”) interest to SPSE for valuationwhen it is determined the PIK interest is likely to be received. SPSE will onlyevaluate the debt portion of the Company’s investments for which the Companyspecifically requests evaluation, and may decline to make requested evaluationsfor any reason at its sole discretion. SPSE opinions of value are submitted tothe Board of Directors along with the Adviser’s supplemental assessment andrecommendation regarding valuation of each of these investments. Lastly, theCompany adds any amortized original issue discount (“OID”) interest to the fairvalue, unless adverse factors lead to a determination of a lesser valuation.

The fair value ofconvertible debt, equity, success or exit fees or other equity-like securitiesis determined based on the collateral, the enterprise value of the issuer, theissuer’s ability to make payments, the earnings of the issuer, recent sales tothird parties of similar securities, the comparison to publicly tradedsecurities, discounted cash flow or other pertinent factors. In gathering thesales to third parties of similar securities, the Company may referenceindustry statistics and use outside experts.

Debt securitiesthat are issued to portfolio companies where the Company has equity, orequity-like securities are valued at cost, if there is adequate totalenterprise value determined when valuing the Company’s equity securities of theportfolio company. Fair values are discounted for any shortfall of total enterprisevalue over the total debt outstanding for the borrower.

The Board ofDirectors then reviews whether the Adviser has followed its establishedprocedures for determinations of fair value, and votes whether or not to acceptthe recommended valuation of the Company’s investment portfolio.

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 currently assigned.Because there is a delay between when the Company closes an investment and whenthe investment can be evaluated by SPSE, new investments are not valuedimmediately by SPSE; rather, the Adviser makes its own determination about therecommended value of these investments in accordance with the Company’svaluation policy without the input of SPSE during the specific quarter in whichthe investment is made. Because SPSE does not currently perform independentvaluations of mortgage loans or equity securities for the Company, the Adviseralso determines a recommendation for the fair value of these investments, ifany, without the input of SPSE. The Adviser considers a number of qualitativeand quantitative factors in current market conditions when performing valuations.The Board of Directors then determines whether or not to accept the Adviser’srecommendations for the aggregate valuation of the Company’s portfolio ofinvestments. The Board of Directors is ultimately responsible for setting thefair value and disclosure of investments in the financial statements.

*Interest Income 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 be collected.The Company stops accruing interest on its investments when it is determinedthat interest is no longer collectible. At June 30, 2007, one investment was onnon-accrual. Conditional interest or a success fee is recorded when earned uponfull repayment of a loan investment.

*Paid in Kind Interest*

The Company seeks toavoid PIK interest, however, the Company had one loan in its portfolio thatcontained a PIK provision during the six months ended March 31, 2006 and noloans with PIK provisions for the remainder of fiscal year 2006. A PIKprovision requires the borrower to accrue a payment to the Company but theborrower does not have to pay that interest until the loan is paid in full. ThePIK interest is added to the principal balance of the loan and recorded asincome to the Company even though the cash has not been received. To maintainthe Company’s status as a RIC (as discussed in Note 10), this non-cash sourceof income must be paid out to stockholders in the form of cash dividends, eventhough the Company has not yet collected the cash. The Company recorded no PIKinterest income for the three and nine months ended June 30, 2007 and $63,217,respectively, for the nine months ended June 30, 2006, there were no PIK loansin the Company’s portfolio during the three months ended June 30, 2006.

21

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*Services Provided to PortfolioCompanies*

The 1940 Act requiresthat a business development company make available managerial assistance to itsportfolio companies by providing significant guidance and counsel concerningthe management, operations, or business objectives and policies of therespective portfolio company. The Company provides these and other services toits portfolio companies through its Adviser. Currently, neither the Company northe Adviser charges a fee for managerial assistance.

The Adviser receives feesfor other services it provides to portfolio companies. These other fees aretypically non-recurring, are recognized as revenue when earned and aregenerally paid directly to the Adviser by the borrower or potential borrowerupon closing of the investment. The services the Adviser provides to portfoliocompanies vary by investment, but generally include a broad array of services,such as investment banking services, arranging bank and equity financing,structuring financing from multiple lenders and investors, reviewing existingcredit facilities, restructuring existing investments, raising equity and debtcapital, turnaround management, merger and acquisition services and recruitingnew management personnel. When the Adviser receives fees for these services,fifty percent of certain of those fees are credited to the base management feesdue to the Adviser from the Company. Any services of this nature subsequent tothe closing would typically generate a separate fee at the time of completion.

The Adviser also receivesfees for monitoring and reviewing portfolio company investments. These fees arerecurring and are generally paid annually or quarterly in advance to theAdviser throughout the life of the investment. Fees of this nature are recordedas revenue by the Adviser when earned and are not credited against the basemanagement fees.

While the Adviserreceives all fees in connection with the Company’s investments, such feesreceived by the Adviser, with the exception of monitoring and review fees, arecredited to the Company as a reduction of the advisory fee payable under theadvisory agreement between the Company and the Adviser. Prior to April 1, 2007,these fees were entirely credited against the advisory fee payable and startingon April 1, 2007, these fees were credited at 50% against the advisory feepayable. For the three and nine months ended June 30, 2007, the Adviserreceived $1,061,750 and $2,147,750, respectively, of such fees, of which $530,875and $1,616,875, respectively, were credited against the base management feepayable for the three and nine months ended June 30, 2007, as compared to$539,000 and $1,762,000, respectively, for the three and nine months ended June30, 2006 and the advisory fee payable by the Company to the Adviser was reducedby these amounts. None of these fees were for managerial assistance even thoughthe Adviser provided managerial assistance to many of the Company’s portfoliocompanies.

*Cash and Cash Equivalents*

Cash and cash equivalentsconsist of demand deposits and highly liquid investments with originalmaturities of three months or less when purchased. Cash and cash equivalentsare carried at cost which approximates fair value as of June 30, 2007 andSeptember 30, 2006.

*Realized Gain or Loss andUnrealized Appreciation or Depreciation of Portfolio Investments*

Realized gain or loss isrecognized when an investment is disposed of and is computed as the differencebetween the Company’s cost basis in the investment at the disposition date andthe net proceeds received from such disposition. Unrealized appreciation ordepreciation displays the difference between the fair market value of theinvestment and the cost basis of such investment.

*Federal and State Income Taxes*

The Company intends tocontinue to qualify for treatment as a RIC under Subchapter M of the Code. As aRIC, the Company is not subject to federal or state income tax on the portionof its taxable income and gains distributed to stockholders. To qualify as aRIC, the Company is required to distribute to its stockholders at least 90% ofits investment company taxable income, as defined by the Code and, as such, noincome tax provisions have been recorded for the individual companies ofGladstone Capital Corporation and Gladstone Business Loan LLC.

During the nine monthsended June 30, 2006, Gladstone Capital Corporation recorded approximately$50,000 in connection with penalties incurred on misclassified revenue on itsfiscal year 2004 corporate tax return.

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*Recent Accounting Pronouncements*

In May 2005, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 154, *“Accounting Changes andError Corrections,”* a replacement of APB Opinion No. 20, *“Accounting Changes,”* and SFAS No. 3, *“ReportingAccounting Changes in Interim Financial Statements”* and changed therequirements for the accounting for and reporting of a change in accountingprinciple. SFAS No. 154 applies to all voluntary changes in accounting principleand also applies to changes required by an accounting pronouncement in theunusual instance that the pronouncement does not include specific transitionprovisions. SFAS No. 154 requires retrospective application to prior periods’financial statements of changes in accounting principle. SFAS No. 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. The Company adopted the provisions of SFASNo. 154, as applicable, on October 1, 2006.

In February 2006, theFASB issued SFAS No. 155, *“Accounting for CertainHybrid Financial Instruments, an amendment of FASB statements No. 133 and 140”*(“SFAS No. 155”). SFAS No. 155 allows financial instruments that have embeddedderivatives to be accounted for as a whole (eliminating the need to bifurcatethe derivative from its host) as long as the entire instrument is valued on afair value basis. The statement also resolves and clarifies other specific SFASNo. 133 and SFAS No. 140 related issues. SFAS No. 155 is effective for allfinancial instruments acquired or issued after the beginning of an entity’sfirst fiscal year that begins after September 15, 2006. The Company adoptedSFAS No. 155 on October 1, 2006 and has not realized a material impact of thefinancial statements since all investments are valued on a fair value basis.

In June 2006, the FASBissued FASB Interpretation No. 48, *“Accounting forUncertainty in Income Taxes—an interpretation of FASB Statement No. 109,”*which clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with SFAS No. 109, *“Accounting for Income Taxes.”* This Statement shall beeffective as of the beginning of an entity’s first fiscal year that begins afterDecember 15, 2006. The Company will adopt this Interpretation effective October1, 2007. The Company is currently evaluating the impact of this pronouncementon its consolidated financial statements.

In September 2006, theFASB issued SFAS No. 157, *“Fair Value Measurements”*(“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework formeasuring fair value in accordance with GAAP, and expands disclosures aboutfair value measurements. SFAS No. 157 applies broadly to securities and othertypes 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 adoptSFAS No. 157 on October 1, 2008 and is currently evaluating the impact of thispronouncement on its consolidated financial statements.

In September 2006, theSEC issued Staff Accounting Bulletin No. 108 (“SAB 108”). SAB 108 addresses howthe effects of prior year uncorrected misstatements should be considered whenquantifying misstatements in current year financial statements and requiresregistrants to consider the effect of all carry over and reversing effects ofprior year misstatements when quantifying errors in current year financial statements.SAB 108 does not change the SEC’s previous guidance in SAB No. 99, *“Materiality,”* on evaluating the materiality ofmisstatements. A registrant applying the new guidance for the first time thatidentifies material errors in existence at the beginning of the first fiscalyear ending after November 15, 2006, may correct those errors through aone-time cumulative effect adjustment to beginning-of-year retained earnings.The cumulative effect alternative is available only if the application of thenew guidance results in a conclusion that a material error exists as of thebeginning of the first fiscal year ending after November 15, 2006, and thosemisstatements were determined to be immaterial based on a proper application ofthe registrant’s previous method for quantifying misstatements. The adoption ofSAB 108 did not have an impact on the Company’s consolidated financialstatements.

In February 2007, theFASB issued SFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment of FASBStatement No. 115”* which is effective for fiscal years beginningafter November 15, 2007. This pronouncement permits an entity to choose tomeasure many financial instruments and certain other items at fair value atspecified election dates. Subsequent unrealized gains and losses on items forwhich the fair value option has been elected will be reported in earnings. TheCompany is currently evaluating the potential impact of this pronouncement onits consolidated financial statements.

NOTE 3. INVESTMENTS

Investments at fair valueconsisted of the following industry classifications as of June 30, 2007 andSeptember 30, 2006:

23

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| ** **                                     | ** ** | **June 30, 2007** | ** **  | **September 30, 2006**      | ** ** |
|------------------------------------------------|------------|-----------------------------|-------------|---------------------------------------|------------|
| **Industry Classification**               | ** ** | **Fair Value**         | ** **  | **% of Total  Investments** | ** ** | **% of  Net Assets** | ** ** | **Fair Value** | ** ** | **% of Total  Investments** | ** ** | **% of  Net Assets** | ** ** |
| Aerospace &  Defense                       |       | $                           | 4,755,812   |                                  | 1.3        | % | 2.2 | % | $ | 5,529,891 |   | 2.5 | % | 3.2 | % |
| Automobile                                     |       | 6,442,958                   |        | 1.8                                   | %          | 3.0 | % | 6,332,906 |   | 2.9 | % | 3.7 | % |
| Broadcasting  (TV, Radio & Cable)          |       | 36,289,808                  |        | 9.8                                   | %          | 16.9 | % | — |   | — |   | — |   |
| Cargo Transport                                |       | 16,018,000                  |        | 4.3                                   | %          | 7.4 | % | 8,650,000 |   | 4.0 | % | 5.0 | % |
| Chemicals,  Plastics & Rubber              |       | 25,732,964                  |        | 7.0                                   | %          | 12.0 | % | 31,105,148 |   | 14.3 | % | 18.0 | % |
| Diversified/Conglomerate  Manufacturing        |       | 3,999,950                   |        | 1.1                                   | %          | 1.9 | % | — |   | — |   | — |   |
| Electronics                                    |       | 32,128,375                  |        | 8.7                                   | %          | 14.9 | % | 33,360,123 |   | 15.4 | % | 19.3 | % |
| Entertainment                                  |       | —                      |        | —                                |       | — |   | 3,491,250 |   | 1.6 | % | 2.0 | % |
| Farming &  Agriculture                     |       | 11,825,984                  |        | 3.2                                   | %          | 5.5 | % | 709,431 |   | 0.3 | % | 0.4 | % |
| Finance                                        |       | 2,504,988                   |        | 0.7                                   | %          | 1.2 | % | — |   | — |   | — |   |
| Healthcare,  Education & Childcare         |       | 39,512,077                  |        | 10.7                                  | %          | 18.4 | % | 16,707,500 |   | 7.7 | % | 9.7 | % |
| Home &  Office Furnishings                 |       | 17,020,625                  |        | 4.6                                   | %          | 7.9 | % | 20,636,991 |   | 9.5 | % | 12.0 | % |
| Leisure,  Amusement & Movies               |       | 9,707,063                   |        | 2.6                                   | %          | 4.5 | % | — |   | — |   | — |   |
| Machinery                                      |       | 9,814,228                   |        | 2.7                                   | %          | 4.6 | % | — |   | — |   | — |   |
| Mining, Steel,  Iron & Non-precious Metals |       | 26,963,375                  |        | 7.3                                   | %          | 12.5 | % | 5,233,750 |   | 2.4 | % | 3.0 | % |
| Oil & Gas                                  |       | 5,771,250                   |        | 1.6                                   | %          | 2.7 | % | 6,056,250 |   | 2.8 | % | 3.5 | % |
| Personal, Food  and Miscellaneous Services     |       | —                      |        | —                                |       | — |   | 6,011,288 |   | 2.8 | % | 3.5 | % |
| Personal &  Nondurable Consumer Products   |       | 9,000,000                   |        | 2.4                                   | %          | 4.2 | % | — |   | — |   | — |   |
| Printing,  Publishing & Broadcasting       |       | 85,830,553                  |        | 23.3                                  | %          | 39.9 | % | 16,203,000 |   | 7.4 | % | 9.4 | % |
| Retail Stores                                  |       | 14,925,000                  |        | 4.0                                   | %          | 6.9 | % | 14,981,250 |   | 6.9 | % | 8.7 | % |
| Telecommunications                             |       | —                      |        | —                                |       | — |   | 23,596,040 |   | 10.8 | % | 13.7 | % |
| Textiles &  Leather                        |       | 10,706,237                  |        | 2.9                                   | %          | 5.0 | % | 13,785,932 |   | 6.3 | % | 8.0 | % |
| Utilities                                      |       | —                      |        | —                                |       | — |   | 5,252,000 |   | 2.4 | % | 3.0 | % |
| **Total**                                      |       | $                           | 368,949,247 |                                  | 100.0      | % |   |   | $ | 217,642,750 |   | 100.0 | % |   |   |

 

The investments at fairvalue consisted of the following geographic regions of the United States atJune 30, 2007 and September 30, 2006:
| ** **                 | ** ** | **June 30, 2007** | ** **  | **September 30, 2006**      | ** ** |
|----------------------------|------------|-----------------------------|-------------|---------------------------------------|------------|
| **Geographic Region** | ** ** | **Fair Value**         | ** **  | **% of Total  Investments** | ** ** | **Fair Value** | ** ** | **% of Total  Investments** | ** ** |
| Midwest                    |       | $                           | 163,405,522 |                                  | 44.3       | % | $ | 99,413,970 |   | 45.7 | % |
| West                       |       | 72,358,060                  |        | 19.6                                  | %          | 15,502,538 |   | 7.1 | % |
| Mid-Atlantic               |       | 57,231,151                  |        | 15.5                                  | %          | 53,044,805 |   | 24.4 | % |
| Southeast                  |       | 50,493,423                  |        | 13.7                                  | %          | 24,697,113 |   | 11.3 | % |
| Northeast                  |       | 17,705,250                  |        | 4.8                                   | %          | 17,209,141 |   | 7.9 | % |
| US Territory               |       | 7,755,841                   |        | 2.1                                   | %          | 7,775,183 |   | 3.6 | % |
|                       |       | $                           | 368,949,247 |                                  | 100.0      | % | $ | 217,642,750 |   | 100.0 | % |

 

The geographic regiondepicts the location of the headquarters for the Company’s portfolio companies.A portfolio company may have a number of other locations in other geographicregions.

NOTE 4. RELATED PARTYTRANSACTIONS

*Loans to Employees*

The Company providedloans to employees of the Adviser for the exercise of options under the Amendedand Restated 2001 Equity Incentive Plan (the “2001 Plan”), which has since beenterminated and is no longer in operation. The loans require the quarterlypayment of interest at the market rate in effect at the date of issue, havevarying terms not exceeding ten years and have been recorded as a reduction ofnet assets. The loans are evidenced by full recourse notes that are due uponmaturity or 60 days following termination of employment, and the shares ofcommon stock purchased with the proceeds of the loan are posted as collateral. Nonew loans were issued during the three and nine months ended June 30, 2007 andthe Company received $300,941 of principal repayments during the nine monthsended June 30, 2007. During the nine months ended June 30, 2006, the Companyissued one loan to an employee for $199,980 and received principal repaymentsof $129,943 in connection with the full repayment of one loan and a partial 

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repayment on anotherloan. The Company recognized interest income from all employee stock optionloans of $132,795 and $403,917, respectively, for the three and nine monthsended June 30, 2007, as compared to $108,877 and $323,003, respectively, forthe three and nine months ended June 30, 2006.

*Investment Advisory andManagement and Administration Agreements*

The Company is externallymanaged by the Adviser, which is controlled by our chairman and chief executiveofficer, under a contractual investment advisory agreement. On October 1, 2006,the Company entered into an amended and restated investment advisory agreement(the “Amended Advisory Agreement”). Prior to October 1, 2006, the relationshipwas governed by the initial advisory agreement (the “Initial Advisory Agreement”).

*Terms of the Amended AdvisoryAgreement*

Under the AmendedAdvisory Agreement, the Company pays the Adviser an annual base management feeof 2% of its average gross assets, which is defined as total assets less cashand cash equivalents pledged to creditors calculated as of the end of the twomost recently completed fiscal quarters and also consists of a two-partincentive fee.

The first part of theincentive fee is an income-based incentive fee which rewards the Adviser if theCompany’s quarterly net investment income (before giving effect to anyincentive fee) exceeds 1.75% of the Company’s net assets (the “hurdle rate”).The Company pays the Adviser an income incentive fee with respect to itspre-incentive fee net investment income in each calendar quarter as follows:

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

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

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

The second part of theincentive fee is a capital gains incentive fee that is determined and payablein arrears as of the end of each fiscal year (or upon termination of theAmended Advisory Agreement, as of the termination date) and equals 20% of theCompany’s realized capital gains as of the end of the fiscal year. Indetermining the capital gains incentive fee payable to the Adviser, the Companycalculates the cumulative aggregate realized capital gains and cumulativeaggregate realized capital losses since the Company’s inception, and theaggregate unrealized capital depreciation as of the date of the calculation, asapplicable, with respect to each of the investments in its portfolio.

The Adviser’s board ofdirectors voluntarily waived, for the fiscal quarter ended June 30, 2007, theannual 2.0% base management fee to 0.5% for senior syndicated loanparticipations and also waived a portion of the incentive fee due.

In addition to the basemanagement and incentive fees under the Amended Advisory Agreement, certainfees received by the Adviser from the Company’s portfolio companies werecredited against the investment advisory fee under the Initial AdvisoryAgreement, and will continue to be paid to the Adviser and credited under theAmended Advisory Agreement. Effective April 1, 2007, 50% of certain of the feesreceived by the Adviser are credited against the base management fee. Inaddition, the Company will continue to pay its direct expenses including, butnot limited to, directors’ fees, legal and accounting fees, stockholder relatedexpenses, and directors and officers insurance under the Amended AdvisoryAgreement.

For the three monthsended June 30, 2007, the Company recorded a base management fee of $727,259,after reductions for loan servicing fees paid to the Adviser of $897,634, lessa 50% credit of $530,875 for fees received by the Adviser and a $139,261 feereduction for the waiver of the 2% fee on senior syndicated loans to 0.5%, fora net base management fee of $57,123 as compared to a base management fee of$334,814, after reductions for loan servicing fees paid to the Adviser of$693,965, less a credit of $539,000 for fees received by the Adviser and a$3,774 fee reduction for the waiver of the 2% fee on senior syndicated loans to0.5%, for a net base management fee credit of $207,960 for the three monthsended June 30, 2006. For the nine months ended June 30, 2007, the Companyrecorded a base management fee of $1,806,075, after reductions for loanservicing fees paid to the Adviser of $2,377,409, less a credit of $1,616,875for fees received by the Adviser and a $369,161 fee reduction for the waiver ofthe 2% fee on senior syndicated loans to 0.5%, for a net base management feecredit of $179,961 as compared to a base management fee of $955,894, afterreductions for loan servicing fees paid to the Adviser of $2,144,024, less acredit of $1,762,000 for fees received by the Adviser and a $3,774 feereduction for the waiver of the 2% fee on senior syndicated loans to 0.5%, fora net base management fee credit of $809,880 for the nine months ended June 30,2006. The Company also recorded a gross incentive fee of $1,166,529 and$3,474,007, 

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for the three and ninemonths ended June 30, 2007, respectively, offset by a credit from a voluntary waiverissued by the Adviser’s board of directors of $1,038,752 and $2,696,124, forthe three and nine months ended June 30, 2007, respectively, for a netincentive fee of $127,777 and $777,883, for the three and nine months endedJune 30, 2007, respectively. There was no incentive fee in effect at June 30,2006. As of June 30, 2007, the Company owed $57,123 of unpaid base managementfee due to the Adviser and owed $127,777 of unpaid incentive fees to theAdviser, presented in the net fees due to Adviser in the accompanyingconsolidated statements of assets and liabilities. The credits to the basemanagement fee and incentive fee are reflected on the consolidated statement ofoperations as credits to base management and incentive fees. Overall, the basemanagement fee due to the Adviser cannot exceed 2% of total assets (as reducedby cash and cash equivalents pledged to creditors) during any given fiscalyear.

*Terms of the Initial AdvisoryAgreement*

As compensation for itsservices, under the Initial Advisory Agreement, the Company paid the Adviser anannual advisory fee of 1.25% of total assets (as reduced by cash and cashequivalents pledged to creditors), payable in quarterly computed increments of0.3125%, and an annual administrative fee of 0.75% of total assets (as reducedby cash and cash equivalents pledged to creditors), payable in quarterlycomputed increments of 0.1875%, for a total annual management fee of 2.0%(0.50% quarterly) of total assets (as reduced by cash and cash equivalentspledged to creditors). The Company also paid all of its direct expensesincluding, but not limited to, directors’ fees, legal and accounting fees,stockholder related expenses, and directors and officers insurance.

*Loan Servicing and PortfolioCompany Fees*

The Adviser also servicesthe loans held by Business Loan, in return for which it receives a 1.5% annualfee based on the monthly aggregate outstanding balance of the loans pledgedunder the Company’s line of credit. Since the Company owns these loans, allloan servicing fees paid to the Adviser have been and continue to be treated asreductions directly against the 2% management fee, under both the Initial andAmended Advisory Agreements. Effective in April 2006, the Adviser’s board ofdirectors voluntarily agreed to a waiver of the annual servicing fee rate forsenior syndicated loans that, on a temporary basis, reduced the annualservicing fee rate on these loans to 0.5%. For the three and nine months endedJune 30, 2007, these loan servicing fees totaled $897,634 and $2,377,409,respectively, as compared to the loan servicing fees for the three and ninemonths ended June 30, 2006 of $693,965 and $2,144,024, respectively, all ofwhich were deducted against the 2% base management fee in order to derive thebase management fee which is presented as the line item base management fee inthe consolidated statements of operations. At June 30, 2007, the Company owed$219,339 of unpaid loan servicing fees to the Adviser, which are netted andrecorded in fees due to Adviser. At September 30, 2006, the Company owed$214,608 in loan servicing fees to the Adviser, recorded in fees due to Adviserin the consolidated statements of assets and liabilities. Under the Initial andAmended Advisory Agreements, the Adviser has also provided and continues toprovide managerial assistance and other services to the Company’s portfoliocompanies and may receive fees for services other than managerial assistanceservices.

*Administration Agreement*

On October 1, 2006, theCompany entered into an administration agreement (the “Administration Agreement”)with Gladstone Administration, LLC (the “Administrator”), a wholly-ownedsubsidiary of the Adviser. Under the Administration Agreement, the Company paysseparately for administrative services. The Administration Agreement providesfor payments equal to the Company’s allocable portion of the Administrator’soverhead expenses in performing its obligations under the AdministrationAgreement, including, but not limited to, rent for employees of the Administrator,and the allocable portion of salaries and benefits expenses of the Company’schief financial officer, controller, chief compliance officer, treasurer andtheir respective staffs. The Company recorded an administration fee of $186,895and $481,746, respectively, for the three and nine months ended June 30, 2007. Theadministration fee was not in effect during the three and nine months endedJune 30, 2006.

*Sale of Investments to Affiliate*

During the three and ninemonths ended June 30, 2007, the Company sold to its affiliate, GladstoneInvestment Corporation (“Gladstone Investment”), certain of its investments insyndicated loan participations at market value totaling approximately $9.7million and approximately $22.1 million, respectively. An independent brokerwas engaged to execute these transactions between the Company and GladstoneInvestment. The independent broker accepted the quotes from the respectiveagent bank for each syndicated loan and then executed these transactionsbetween the Company and Gladstone Investment. The cumulative effect of thesetransactions, net of any unamortized premiums or discounts associated with theloans, resulted in a realized net gain of $26,965 and $83,182, respectively,for the three and nine months ended June 30, 2007. The sales that occurredduring the three months ended June 30, 2007 were all initiated during the threemonths ended March 31, 2007.

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NOTE5. LINE OF CREDIT

Through BusinessLoan, the Company has a $220 million revolving credit facility (the “DBFacility”) with Deutsche Bank AG, as administrative agent, pursuant to whichBusiness Loan pledges the loans it holds to secure future advances by certaininstitutional lenders. The interest rate charged on the advances under the DBFacility is based on the 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 23, 2008.  As of June 30, 2007, the outstandingprincipal balance under the DB Facility was $161,188,000 at an interest rate ofapproximately 5.3%.  Available borrowingsare subject to various constraints imposed under the credit agreement, based onthe aggregate loan balance pledged by Business Loan, which varies as loans areadded and repaid, regardless of whether such repayments are early prepayment orare made as contractually required.  AtJune 30, 2007, the remaining borrowing capacity available under the DB Facilitywas approximately $58.8 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 alsorestricts some of the terms and provisions (including interest rates, terms tomaturity and payments schedules) and limits the borrower and industryconcentrations of loans that are eligible to secure advances.  As of June 30, 2007, Business Loan was incompliance with all of the facility covenants. 

The administrativeagent also requires that any interest or principal payments on pledged loans beremitted directly by the borrower into a lockbox account with the Bank of NewYork as custodian.  Deutsche Bank AG isalso the trustee of the account and once a month remits the collected funds tothe Company. At June 30, 2007, the amount due from custodian was $3,129,891 andat 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 andmaintain “asset coverage” with respect to “senior securities representingindebtedness” of at least 200%, in accordance with Section 18 of the 1940Act.  As of June 30, 2007, the Companywas in compliance with all covenants under the performance guaranty.  

NOTE6. INTEREST RATE CAP AGREEMENT

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

The use of a 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 $8.8 million and ithas a current fair value of $24,407 which is recorded in other assets on theCompany’s consolidated balance sheet at June 30, 2007.  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 and nine months ended June 30, 2007, the Companyrecorded $8,405 and $31,198, respectively, as compared to $1,367 for the threeand nine months ended June 30, 2006 of income from the interest rate capagreement recorded as a realized gain on the settlement of derivative on theCompany’s consolidated statements of operations.  

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NOTE7.  COMMON STOCK TRANSACTIONS

Asof June 30, 2006 and June 30, 2007, 50,000,000 shares of $0.001 par valuecommon stock were authorized and 11,384,363 and 14,249,683 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    |       | 80,853                |       | 81 |   |
| Balance at June  30, 2006                            |       | 11,384,363            |       | $ | 11,385 |   |
|                                                 |       |                  |       |   |   |
| Balance at  September 30, 2006                       |       | 12,305,008            |       | $ | 12,305 |   |
| Issuance of Common  Stock Under Shelf Offering       |       | 2,000,000             |       | 2,000 |   |
| Issuance of Common  Stock Under Stock Option Plan    |       | 5,000                 |       | 5 |   |
| Stock  surrendered for settlement of withholding tax |       | (60,325               | )          | (60 | ) |
| Balance at June 30,  2007                            |       | 14,249,683            |       | $ | 14,250 |   |

 

InMay 2007, the Company completed a public offering of 2,000,000 shares of itscommon stock at $24.25 per share, less an underwriting discount of $1.21 pershare or 5%.  In October 2006, 5,000shares of common stock were issued as a result of an option exercise which tookplace on the last business day of the prior fiscal year.  These shares were issued by the transferagent at the start of the current fiscal year and during the nine months endedJune 30, 2007, 60,325 shares of stock were surrendered to the Company fromcertain optionees who exercised non-qualified stock options during the thirdand fourth quarters of fiscal year 2006 in order to satisfy settlement ofwithholding taxes that were paid by the Company with respect to the sharesunderlying the exercise of such options. 

NOTE8. STOCK OPTIONS

There were no stock options outstanding at June 30,2007.  Prior to its termination onSeptember 30, 2006, the Company had authorized 2,000,000 shares of capitalstock for the issuance of options under the 2001 Plan to employees anddirectors. Options granted under the 2001 Plan originally could have beenexercised during a term not to exceed ten years from the date of grant. Onlyemployees of the Company and its affiliates were eligible to receive incentivestock options and both employees and non-employee directors were eligible toreceive 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.”*

On October 1, 2005, the Company adopted SFASNo. 123 (revised 2004) “*Share-based Payment”*(“SFAS No. 123(R)”) using the modified prospective approach. Under themodified prospective approach, stock-based compensation expense was recordedfor the unvested portion of previously issued awards that remained outstandingat October 1, 2005 using the same estimate of the grant date fair valueand the same attribution method previously used to determine the pro formadisclosure under SFAS No. 123. SFAS No. 123(R) also requires that allshare-based payments to employees after October 1, 2005, includingemployee stock options, be recognized in the financial statements asstock-based compensation expense based on the fair value on the date ofgrant.  

For the three and ninemonths ended June 30, 2006, the Company recorded stock option compensationexpense for the cost of stock options issued under the 2001 Plan of $202,296and $279,618, respectively. The Company’s expensing of stock options decreasedboth basic and diluted net increase to net assets resulting from operations pershare by $0.02 for the three and nine months ended June 30, 2006,respectively.  Additionally, SFASNo. 123(R) states that any potential tax benefits associated withincentive stock options should be recognized only at the time of settlement ifthose options settle through a disqualifying disposition. Thus, the relatedstock-based compensation expense must be treated as a permanent differenceuntil that time which, in turn, results in an increase to the Company’seffective tax rate.  The Company did notrecord tax benefits associated with the expensing of stock options since theCompany intends to qualify as a RIC under Subchapter M of the Code and as suchthe Company is not subject to federal income tax on the portion of its taxableincome and gains distributed to stockholders, provided that at least 90% of thetaxable income is distributed.

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NOTE9. 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 and nine monthsended June 30, 2007 and June 30, 2006:
| ** **                                                                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2007**                                            | ** ** | **2006**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                                             |       |                                                |       |                                               |       |   |   |   |   |
| Numerator for  basic and diluted net increase in net assets resulting from operations per  share |       | $                                                   | 5,964,600  |                                               | $          | 5,543,076 |   | $ | 14,213,054 |   | $ | 19,366,806 |   |
|                                                                                             |       |                                                |       |                                               |       |   |   |   |   |
| Denominator for  basic weighted average shares                                                   |       | 13,561,511                                          |       | 11,337,291                                         |       | 12,701,845 |   | 11,317,437 |   |
| Dilutive effect  of stock options                                                                |       | —                                              |       | 233,134                                            |       | — |   | 231,617 |   |
| Denominator for  diluted weighted average shares                                                 |       | 13,561,511                                          |       | 11,570,425                                         |       | 12,701,845 |   | 11,549,054 |   |
|                                                                                             |       |                                                |       |                                               |       |   |   |   |   |
| Basic net  increase in net assets resulting from operations per share                            |       | $                                                   | 0.44       |                                               | $          | 0.49 |   | $ | 1.12 |   | $ | 1.71 |   |
|                                                                                             |       |                                                |       |                                               |       |   |   |   |   |
| Diluted net increase in  net assets resulting from operations per share                          |       | $                                                   | 0.44       |                                               | $          | 0.48 |   | $ | 1.12 |   | $ | 1.68 |   |

 

Therewere no stock options outstanding at June 30, 2007. There were 1,224,645options outstanding to purchase common stock at June 30, 2006. Of these,336,000 options were not included in the computation of diluted earnings pershare for the three and nine months ended June 30, 2006, because the options’exercise prices were greater than the average market price of the common sharesfor the period and, therefore, were anti-dilutive. 

NOTE10. 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 for 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 nine months ended June 30, 2007 and 2006:

29

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| Fiscal Year | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend  per Share** | ** ** |
|------------------|------------|----------------------|------------|-----------------------|------------|------------------------------|------------|
| 2007             |       | June  21, 2007       |       | June  29, 2007        |       | $                            | 0.14       |   |
|             |       | May  22, 2007        |       | May  31, 2007         |       | $                            | 0.14       |   |
|             |       | April  20, 2007      |       | April  30, 2007       |       | $                            | 0.14       |   |
|             |       | March  22, 2007      |       | March  30, 2007       |       | $                            | 0.14       |   |
|             |       | February  20, 2007   |       | February  28, 2007    |       | $                            | 0.14       |   |
|             |       | January  23, 2007    |       | January  31, 2007     |       | $                            | 0.14       |   |
|             |       | December  20, 2006   |       | December  29, 2006    |       | $                            | 0.14       |   |
|             |       | November  21, 2006   |       | November  30, 2006    |       | $                            | 0.14       |   |
|             |       | October  23, 2006    |       | October  31, 2006     |       | $                            | 0.14       |   |
|             |       |                 |       | Total                 |       | $                            | 1.26       |   |
|             |       |                 |       |                  |       |                         |       |
| 2006             |       | June  22, 2006       |       | June  30, 2006        |       | $                            | 0.135      |   |
|             |       | May  22, 2006        |       | May  31, 2006         |       | $                            | 0.135      |   |
|             |       | April  20, 2006      |       | April  28, 2006       |       | $                            | 0.135      |   |
|             |       | March  23, 2006      |       | March  31, 2006       |       | $                            | 0.135      |   |
|             |       | February  20, 2006   |       | February  28, 2006    |       | $                            | 0.135      |   |
|             |       | January  19, 2006    |       | January  31, 2006     |       | $                            | 0.135      |   |
|             |       | December  21, 2005   |       | December  30, 2005    |       | $                            | 0.135      |   |
|             |       | November  21, 2005   |       | November  30, 2005    |       | $                            | 0.135      |   |
|             |       | October  21, 2005    |       | October  31, 2005     |       | $                            | 0.135      |   |
|             |       |                 |       | Total                 |       | $                            | 1.215      |   |

 

NOTE11. CONTRACTUAL OBLIGATIONS

Asof June 30, 2007, the Company was a party to signed and non-binding term sheetsfor two loan originations for an aggregate of $15.0 million.  The Company expects to fund these potentialinvestments as follows:
|                                  | ** ** | ** ** | ** ** | **Payment Due by Period** | ** ** |
|----------------------------------|------------|------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **Less than 1 Year**      | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** |
|                             |       |       |       |                                     |       |   |   |   |   |   |   |
| Investments                      |       | 15,000,000 |       | 15,000,000                               |       | — |   | — |   | — |   |
| Total                            |       | $          | 15,000,000 |                                     | $          | 15,000,000 |   | $ | — |   | $ | — |   | $ | — |   |
|                                  |            |            |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

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.

Asof July 31, 2007, the above mentioned investments had not yet funded.

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NOTE12. SUBSEQUENT EVENTS

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

| Fiscal Year | ** ** | **Record Date**     | ** ** | **Payment Date**    | ** ** | **Dividend per  Share** |
|-------------|------------|---------------------|------------|---------------------|------------|-------------------------|
| 2007        |       | July 23, 2007       |       | July 31, 2007       |       | $0.14                   |
|        |       | August 23, 2007     |       | August 31, 2007     |       | $0.14                   |
|        |       | September 20,  2007 |       | September 28,  2007 |       | $0.14                   |

 

On July 24, 2007, the Company completed anoffering of 400,000 shares of its common stock, at a price of $20.41 per share,under a shelf registration statement on Form N-2 (File No. 333-143027), andpursuant to the terms set forth in a prospectus dated July 5, 2007, assupplemented by a final prospectus dated July 24, 2007.  Net proceeds of the offering, after offeringexpenses, were approximately $8,149,000 and were used to repay outstandingborrowings under the Company’s line of credit.

On July 26, 2007, a loan to an employee,and the shares pledged as collateral under the loan under a separatepledge agreement, were cancelled due to an event of default which wastriggered by a stop loss provision in the employee’s promissory noteand pledge agreement.  The provision specified that in the event thatthe aggregate value of the shares pledged under the note, as determined by theintra-day price of the shares on Nasdaq, became less than or equal tothe aggregate outstanding principal amount of the note, the note would becomeimmediately due and collectible through cancellation of the shares under theterms of the pledge agreement.  The Company cancelled 37,109 shareswhich, in turn, cancelled via a non-cash transaction the remaining outstandingprincipal of the note of approximately $716,711.

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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-lookingstatements.” These statements may relate to, among other things, future eventsor our future performance or financial condition. In some cases, you canidentify forward-looking statements by terminology such as “may,” “might,” “believe,”“will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,”“expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” orthe negative of such terms or comparable terminology. These forward-lookingstatements involve known and unknown risks, uncertainties and other factorsthat may cause our actual results, levels of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by suchforward-looking statements. 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 and our Quarterly Report on Form 10-Q as filed with theSecurities and Exchange Commission on May 2, 2007. We caution readers not toplace undue reliance on any such forward-looking statements, which speak onlyas of the date made. We undertake no obligation to publicly update or reviseany forward-looking statements, whether as a result of new information, futureevents 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) reasonablecapitalization of the borrower (usually by buyout funds or venture capitalfunds) and (6) the potential to realize appreciation and gain liquidity in ourequity position, if any. We anticipate that liquidity in our equity positionwill be achieved through a merger or acquisition of the borrower, a publicoffering by the borrower or by exercise of our right to require the borrower tobuy back its warrants. We lend to borrowers that need funds to, among otherthings, effect a change of control, restructure their balance sheets, orfinance 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 ofJune 30, 2007.

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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”) providesthese 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.  Fees for certain of theseservices are credited 50% 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 investments, 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 nine monthsended June 30, 2007, we extended, directly or through participations oracquisitions, approximately $253.7 million of new loans to a total of 52companies.  This includes an acquisitionof approximately $63.3 million in senior debt with 16 different borrowers inJune 2007.  Also, during the nine monthsended June 30, 2007, four borrowers repaid their loans ahead of contractualmaturity, one borrower refinanced its investment and we sold or were repaid infull on twenty four syndicated loans of approximately $90.8 million, and wereceived scheduled contractual principal repayments of approximately $9.0million, for total principal repayments of approximately $99.8 million.  Since our initial public offering in August2001, we have made 227 different loans to, or investments in, 120 companies fora total of approximately $760.2 million, before giving effect to principalrepayments on investments and divestitures.

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 Washington.

**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 us and our Administrator, both of which became effective on October 1,2006.  The Amended Advisory Agreementreplaced the original advisory agreement (the “Initial Advisory Agreement”),which terminated on September 30, 2006. We will continue to pay our direct expenses including, but not limitedto, directors’ fees, legal and accounting fees, stockholder related expenses,and directors and officers insurance 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 and ninemonths ended June 30, 2007.

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 the1.5% annual fee to 0.5% for senior syndicated loans.  This fee directly reduces the amount of feepayable under both the Initial and Amended Advisory Agreements.

**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.

**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 of June 30, 2007.

**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 No. 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 No. 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple.  SFAS No. 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005.  We adopted theprovisions of SFAS No. 154, as applicable, on October 1, 2006.

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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 financialstatements.

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. The adoption of SAB 108 did not have an impacton the consolidated financial statements.

In February 2007, theFASB issued SFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment ofFASB Statement No. 115,”* which is effective for fiscal yearsbeginning after November 15, 2007. This pronouncement permits an entity tochoose to measure many financial instruments and certain other items at fairvalue at specified election dates. Subsequent unrealized gains and losses onitems for which the fair value option has been elected will be reported inearnings. We are currently evaluating the potential 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 the periodreported. Actual results could differ materially from those estimates.  Our accounting policies are more fullydescribed in the “Notes to Consolidated Financial Statements” containedelsewhere in this report.  We haveidentified our investment valuation process as our most critical accountingpolicy.

***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 respective originating syndication agent’s desk on or near thevaluation date.

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Debt and equitysecurities that are not publicly traded, for which a limited market does notexist, or for which a limited market exists but that have not been rated by aNRSRO (or for which we have various degrees of trading restrictions) are valuedat fair value as determined in good faith by or under the direction of ourBoard of Directors. In making the good faith determination of the value ofthese securities, we start with the cost basis of the security, which includesthe amortized OID and PIK interest, if any. We then apply the methods set outbelow in *“Valuation Methods.”* Members of ourAdviser’s portfolio management team prepare the valuations of our investmentsin portfolio companies using the most recent portfolio company financialstatements and forecasts. These individuals also consult with portfolio companysenior management and ownership to obtain further updates on the portfoliocompany’s performance, including information such as industry trends, newproduct development, and other operational issues. Due to the uncertaintyinherent in the valuation process, such estimates of fair value may differsignificantly from the values that would have been obtained had a ready marketfor the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains or losses ultimatelyrealized on these investments to be different than the valuations currentlyassigned. There is no single standard for determining fair value in good faith,as fair value depends upon circumstances of each individual case. In general,fair value is the amount that we might reasonably expect to receive upon thecurrent sale of the security.

At June 30, 2007, 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. We mayalso submit paid in kind (“PIK”) interest to SPSE for valuation when it isdetermined the PIK interest is likely to be received. SPSE will only evaluatethe debt portion of our investments for which we specifically requestevaluation, and may decline to make requested evaluations for any reason at itssole discretion.  We also add anyamortized original issue discount (“OID”) interest to the fair value, unlessadverse factors lead to a determination of a lesser valuation. Upon completingour collection of data with respect to the investments (including theinformation 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 evaluated price opinions which are reflective of whatSPSE believes the bid side of the market would be for each loan after carefulreview and analysis of descriptive, market and credit information. Each pricereflects SPSE’s best judgment based upon careful examination of a variety ofmarket factors. Because of fluctuation in the market and in other factorsbeyond its control, SPSE cannot guarantee these evaluations. The evaluationsreflect the market prices, or estimates thereof, on the date specified. Theprices are based on comparable market prices for similar securities. Marketinformation has been obtained from reputable secondary market sources. Althoughthese sources are considered reliable, SPSE cannot guarantee their accuracy.

SPSE opinions of 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, in certainlimited circumstances, such as when our Adviser may learn new informationregarding an investment between the time of submission to SPSE and the date ofthe Board assessment, our Adviser’s conclusions as to value may differ from theopinion of value delivered by SPSE. Our Board of Directors then reviews whetherour Adviser has followed its established procedures for determinations of fairvalue, and votes whether to accept the recommended valuation of our investmentportfolio. Our Adviser and our management recommended, and the Board ofDirectors voted to accept, the opinions of value delivered by SPSE on the loansin our portfolio as denoted on the schedule of investments as of June 30, 2007and 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 our equitysecurities, our Adviser determines the fair value of these investments usingvaluation policies approved by our Board of Directors.

*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

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probability of loss if there is a default. These typesof systems are referred to as risk rating systems and are used by banks andrating agencies. The risk rating system covers both qualitative andquantitative aspects of the business and the securities 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 the designationsused by two NRSROs as they risk rate debt securities of major companies.Because our system rates debt securities of companies that are unrated by anyNRSRO, there can be no assurance that the correlation to the NRSRO set outbelow is accurate. We believe our risk rating would be significantly higherthan a typical NRSRO risk rating because the risk rating of the typical NRSROis designed for larger businesses. However, our risk rating has been designedto risk rate the securities of smaller businesses that are not rated by atypical NRSRO. Therefore, when we use our risk rating on larger businesssecurities, the risk rating is higher than a typical NRSRO rating. The primarydifference between our risk rating and the rating of a typical NRSRO is that ourrisk rating uses more quantitative determinants and includes qualitativedeterminants that we believe are not used in the NRSRO rating. It is ourunderstanding that most debt securities of medium-sized companies do not exceedthe grade of BBB on a NRSRO scale, so there would be no debt securities in themiddle market that would meet the definition of AAA, AA or A. Therefore, ourscale begins with the designation 10 as the best risk rating which may beequivalent to a BBB from a NRSRO, however, no assurance can be given that a 10on our scale is equal to a BBB on a NRSRO scale.

 
| **Company’s **

**ystem** | ** ** | **First  NRSRO** | ** ** | **Second  NRSRO** | ** ** | **Gladstone Capital’s Description(a)**                                                  | ** ** |
|-------------------------------------|------------|------------------|------------|-------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| **>10**                          |       | Baa2             |       | BBB               |       | Probability  of Default (PD during the next ten years is 4% and the Expected

Loss  (EL) is 1% or less |       |
| **10**                              |       | Baa3             |       | BBB-              |       | PD  is 5% and the EL is 1% to 2%                                                                       |       |
| **9**                               |       | Ba1              |       | BB+               |       | PD  is 10% and the EL is 2% to 3%                                                                      |       |
| **8**                               |       | Ba2              |       | BB                |       | PD  is 16% and the EL is 3% to 4%                                                                      |       |
| **7**                               |       | Ba3              |       | BB-               |       | PD  is 17.8% and the EL is 4% to 5%                                                                    |       |
| **6**                               |       | B1               |       | B+                |       | PD  is 22% and the EL is 5% to 6.5%                                                                    |       |
| **5**                               |       | B2               |       | B                 |       | PD  is 25% and the EL is 6.5% to 8%                                                                    |       |
| **4**                               |       | B3               |       | B-                |       | PD  is 27% and the EL is 8% to 10%                                                                     |       |
| **3**                               |       | Caa1             |       | CCC+              |       | PD  is 30% and the EL is 10% to 13.3%                                                                  |       |
| **2**                               |       | Caa2             |       | CCC               |       | PD  is 35% and the EL is 13.3% to 16.7%                                                                |       |
| **1**                               |       | Caa3             |       | CC                |       | PD  is 65% and the EL is 16.7% to 20%                                                                  |       |
| **0**                               |       | N/a              |       | D                 |       | PD is 85% or there is a  Payment Default: and the EL is greater than 20%                               |       |

----

*(a)**          Thedefault rates set 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 stop accruinginterest on an investment if we determine that interest is no longercollectible.  Currently, our investmentin MCA Communications LLC is on non-accrual, the investment is currently notaccruing interest nor is it paying any past due interest.  Additionally, we do not risk rate our equitysecurities.

The following table liststhe risk ratings for all non-syndicated loans in our portfolio at June 30, 2007and September 30, 2006, representing approximately 76% and 73%, respectively,of all loans in our portfolio:

| Rating           | ** ** | **June 30, 2007** | ** ** | **Sept. 30, 2006** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **7.1**                     | ** ** | **7.2**                      | ** ** |
| Weighted Average | ** ** | **7.0**                     | ** ** | **7.2**                      | ** ** |
| Highest          | ** ** | **9.0**                     | ** ** | **9.0**                      | ** ** |
| Lowest           | ** ** | **4.0**                     | ** ** | **6.0**                      | ** ** |

 

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The following table liststhe risk ratings for syndicated loans in our portfolio that are not currentlyrated by an NRSRO at June 30, 2007 and September 30, 2006, representingapproximately 6% and 17%, respectively, of all loans in our portfolio:

| Rating           | ** ** | **June 30, 2007** | ** ** | **Sept. 30, 2006** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **6.0**                     | ** ** | **6.1**                      | ** ** |
| Weighted Average | ** ** | **6.0**                     | ** ** | **6.3**                      | ** ** |
| Highest          | ** ** | **6.0**                     | ** ** | **8.0**                      | ** ** |
| Lowest           | ** ** | **6.0**                     | ** ** | **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 June 30, 2007 andSeptember 30, 2006, representing approximately 18% and 10%, respectively, ofall loans in our portfolio:

| Rating           | ** ** | **June 30, 2007** | ** ** | **Sept. 30, 2006** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **CCC+/Caa1**               | ** ** | **CCC+/Caa1**                | ** ** |
| Weighted Average | ** ** | **CCC+/Caa1**               | ** ** | **CCC+/Caa1**                | ** ** |
| Highest          | ** ** | **B/B3**                    | ** ** | **B-/B3**                    | ** ** |
| Lowest           | ** ** | **CCC/Caa2**                | ** ** | **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 certain participations in syndicated loans, at theindicative bid price offered by the respective originating syndication agent’strading desk on or near the valuation date. At June 30, 2007, none of the debt securities in our portfolio werepublicly traded and there was a limited market for 31 debt securities in ourportfolio.  At September 30, 2006, noneof the debt securities in our portfolio were publicly traded and there was alimited market for 9 debt securities in our portfolio.

Debt securitiesthat are issued to portfolio companies where we have an equity, or equity-likeinterest that are not publicly traded, for which there is no market, or forwhich there is a market but the securities have not been rated by a NRSRO, arevalued at cost, if there is adequate total enterprise value determined whenvaluing our equity holdings in the borrower. Fair values are discounted for anyshortfall of total enterprise value over the total debt outstanding for theborrower.  At June 30, 2007, for our debtinvestment in Clinton Aluminum Holdings LLC, where we hold a warrant, wesolicited and were provided an opinion of value by SPSE.  Prospectively, in accordance with ourvaluation policies, due to its accompanying equity-like security, the debtsecurities for this investment will not be assessed by SPSE.

Debt securities that arenot publicly traded and that are issued to portfolio companies where we have noequity or equity-like securities, for which there is no market, or for whichthere is a market but have not been rated by a NRSRO, we begin with the riskrating designation of the security as described above.  Using this risk rating designation, we seekto determine the value of the security as if we currently intended to sell the securityand consider some or 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 or exit fees or other equity-like securities for whichthere is a market based on the market prices for such securities, even if thatmarket is not robust. At June 30, 2007 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 also includediscounted cash flow of the expected sale price in the future, valuation of thesecurities based on recent sales to third parties in comparable transactions,or a review of similar companies that are publicly traded and the marketmultiple of their equity securities.  Ingathering the sales to third parties of similar securities, we may referenceindustry statistics and use outside experts. At June 30, 2007 and September 30,2006, we had $146,124 and $37,000, respectively, invested, at cost, in equitysecurities compared to our debt portfolio with a cost basis of $369,829,274 and$216,165,986, respectively.

At June 30, 2007, we hadtotal unrealized depreciation of $4,288,673, which was mainly comprised ofunrealized deprecation of $1,375,000 on our senior subordinated term debtinvestment in Visual Edge Technology, Inc., unrealized depreciation of$1,022,250, on the aggregate of our investments in LocalTel, Inc. andunrealized depreciation of $282,750 on our senior term debt investment in It’sJust Lunch International, LLC. Unrealized appreciation of $3,262,522 was primarily composed ofunrealized appreciation of $2,935,858 on our warrants in Finn Corporation.  In the aggregate, we recorded net unrealizeddepreciation of $1,026,151 on our total investment portfolio as of June 30,2007.

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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 as of September30, 2006.

***Tax Status***

*Federal Income Taxes*

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

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

***Revenue Recognition***

*Interest Income Recognition*

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

*Paid in Kind Interest*

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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**RESULTSOF OPERATIONS**

*Comparison of theThree Months Ended June 30, 2007 to the Three Months Ended June 30, 2006*

**InvestmentIncome**

Investment income for thethree months ended June 30, 2007 was $9,201,279, as compared to $6,522,816 forthe three months ended June 30, 2006.

Interest income from ourinvestments in debt securities of private companies was $8,911,643 for thethree months ended June 30, 2007, as compared with $5,775,522 for the threemonths ended June 30, 2006. This increase consisted of approximately $88.5million of net new investments. As a result of repayments by Allied ExtrudersLLC, and SCPH Holdings during the three months ended June 2007, we recordedsuccess fees of approximately $515,000. In June 2007, we purchased a seniordebt portfolio of approximately $63.3 million to 16 different lenders, which isincluded in the net new investments described above

The annualized weightedaverage yield on our portfolio for the three months ended June 30, 2007 was11.8%; there was no PIK interest accrued during the three months ended June 30,2007. The annualized weighted average yield on our portfolio for the threemonths ended June 30, 2006 was 11.7% (with and without giving effect to PIKinterest).

Interest income frominvested cash and cash equivalents for the three months ended June 30, 2007 was$109,269, as compared to $8,178 for the three months ended June 30, 2006.Interest income increased from the prior year due to the amount of cash thatwas held in interest bearing accounts and the interest earned on our custodialaccount prior to disbursement.

For the three monthsended June 30, 2007 and June 30, 2006, we recorded $132,795 and $108,877,respectively, in interest income from loans to our employees in connection withthe exercise of employee stock options. The increase is the result ofadditional loans issued in connection with employee stock option exercisesduring the fourth quarter of the previous fiscal year.

For the three monthsended June 30, 2007, we recorded $47,572 of prepayment fees and other income,as compared to $630,239 for the three months ended June 30, 2006. The incomefor both periods consisted of prepayment penalty fees received upon the fullrepayment of certain loan investments ahead of contractual maturity andprepayment fees received upon the early unscheduled principal repayments which,in both instances, were based on a percentage of the outstanding principalamount of the loan at the date of prepayment.

**OperatingExpenses**

Operating expenses, priorto credit from the Adviser for fees earned and voluntary waivers to the basemanagement fees and incentive fees, for the three months ended June 30, 2007were $5,205,300, as compared to $2,277,508 for the three months ended June 30,2006. Operating expenses for the three months ended June 30, 2007 reflected asignificant increase in interest expense and management fees, prior to credits,as well as the addition of the incentive and administration fees, prior to credits,under the Amended Advisory and Administration Agreements.

Loan servicingfees of $897,634 were incurred for the three months ended June 30, 2007, ascompared to $693,965 for the three months ended June 30, 2006. These fees wereincurred in connection with a loan servicing agreement between Business Loanand our Adviser, which is based on the size of the portfolio. These fees werereduced against the amount of the base management fee due to our Adviser.

For the threemonths ended June 30, 2007, we incurred a base management fee of $727,259 ,after reductions for loan servicing fees received by our Adviser of $897,634,less credits for fees received by our Adviser of $530,875 and a $139,261 feereduction for the waiver of the 2% fee on senior syndicated loans to 0.5%, fora net base management fee of $57,123 as compared to the three months ended June30, 2006, in which we incurred a base management fee of $334,814 afterreductions for loan servicing fees received by our Adviser of $693,965, lesscredits for fees received by our Adviser of $539,000 and a $3,774 fee reductionfor the waiver of the 2% fee on senior syndicated loans to 0.5%, for a net basemanagement credit of $207,960. The base management fee is computed quarterly asdescribed under *“Investment Advisory and ManagementAgreement.”* Effective April 1, 2007, the board of our Adviserreduced the amount of credit for fees received by our Adviser from 100% of thefees received to 50% of the fees received, therefore the three months endedJune 30, 2007 reflects the reduced credit for fees received by our Adviser. Thegross base management fee before the reduction for loan servicing fees for thethree months ended June 30, 2007 and June 30, 2006, was $1,624,893 and$1,028,779, respectively, increased in the current period due to the growth ofthe investment portfolio as compared to the same period of the prior year.

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Effective October1, 2006, the income based incentive fee became effective and as such werecorded a gross incentive fee of $1,166,529, which was reduced by a voluntarywaiver issued by our Adviser’s board of directors of $1,038,752, which resultedin a net incentive fee of $127,777, which is recorded in fees due to Adviser onour consolidated statements of assets and liabilities at June 30, 2007. Therewas no incentive fee recorded for the three months ended June 30, 2006, as theAmended Advisory Agreement was not in effect.

Effective October 1,2006, the Administration Agreement became effective in which we providepayments 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 respective staffs. Weincurred an administration fee of $186,895 for the three months ended June 30,2007. There was no administration fee recorded during the three months endedJune 30, 2006, as the Administration Agreement was not in effect.

Professional fees,consisting primarily of legal and audit fees, for the three months ended June30, 2007 were $148,609, as compared to $166,405 for the three months ended June30, 2006. The decrease is due to the reimbursement of certain legal fees at thetime of the investment funding.

Amortization of deferredfinancing costs, in connection with our line of credit, was $72,133 for thethree months ended June 30, 2007 and $36,036 for the three months ended June30, 2006. The increase is due to the amortization of additional fees incurredwith our line of credit which were not in place during the prior year period.

Interest expense for thethree months ended June 30, 2007 was $1,762,249, as compared to $702,449 forthe three months ended June 30, 2006. This increase is primarily a result ofincreased borrowings under our line of credit during the three months endedJune 30, 2007, which borrowings were partially used to finance our increased investments,borrowings remaining outstanding for longer periods of time and an increase inthe interest rates on our borrowings.

Stockholder related costsfor the three months ended June 30, 2007 were $39,434, as compared to $28,371for the three months ended June 30, 2006. Stockholder related costs includesuch recurring items as transfer agent fees, NASDAQ listing fees, SEC filingfees and annual report printing fees. These fees increased during the threemonths ended June 30, 2007 due to additional filing fees as compared to theprior year.

Directors’ fees for thethree months ended June 30, 2007 were $56,250, as compared to $27,500 for thethree months ended June 30, 2006 due to the increase in annual stipend fees andtheir related monthly amortization.

Insurance expense for thethree months ended June 30, 2007 was $66,246, as compared to $50,589 for thethree months ended June 30, 2006. The increase was primarily the result of anincrease in the amortization of our directors and officers insurance policypremiums.

There was no stock optioncompensation expense recorded for the three months ended June 30, 2007 as therewas no longer a stock option plan in effect. Stock option compensation expensefor the three months ended June 30, 2006 was $202,296 and was the result of theadoption of the SFAS No. 123 (revised 2004) “*Share-basedPayment.”*

Other expenses were$82,062 for the three months ended June 30, 2007, as compared to $35,083 forthe three months ended June 30, 2006. The expenses primarily represent directexpenses such as travel related specifically to our portfolio companies, loanevaluation services for our portfolio companies, press releases and backupservicer expenses.

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

During the three monthsended June 30, 2007, we sold or were repaid in full on eleven syndicate loaninvestments for a net loss of $5,021, as compared to a realized net loss of$100,850 as a result of the repayment in full of syndicate investments thatcontained unamortized premiums during the three months ended June 30, 2006.

**Realized Gain on Settlement ofDerivative**

During the three monthsended June 30, 2007, we received interest rate cap agreement payments of $8,405as a result of the one month LIBOR exceeding 5% as compared to $1,367 duringthe three months ended June 30, 2006.

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**Net Unrealized Depreciation onDerivative**

During the three monthsended June 30, 2007, we recorded net unrealized depreciation of $264 due to adecrease in the fair market value of our interest rate cap agreement, ascompared to unrealized appreciation of $41,486 during the three months endedJune 30, 2006.

**Net Unrealized Appreciation onInvestments**

For the three monthsended June 30, 2007, we recorded net unrealized appreciation on investments of$256,613, as compared to net unrealized appreciation of $812,991, for the threemonths ended June 30, 2006. The unrealized appreciation is mainly attributableto the increase in fair value on our portfolio due to the repayment in full ofcertain underperforming investments, most notably Consolidated Bedding, Inc.

**NetIncrease in Net Assets from Operations**

Overall, we realized a net increase in net assets resulting fromoperations of $5,964,600 for the three months ended June 30, 2007. Based on aweighted-average of 13,561,511 basic and diluted shares outstanding, our netincrease in net assets from operations per weighted-average common share forthe three months ended June 30, 2007 was $0.44, basic and diluted.

For the three months ended June 30,2006, werealized a net increase in net assets resulting from operations of $5,543,076. Basedon a weighted-average of 11,337,291 (basic) and 11,570,425 (diluted) sharesoutstanding, our net increase in net assets from operations perweighted-average common share for the three months ended June 30, 2006 was$0.49 (basic) and $0.48 (diluted).

*Comparison of the Ninemonths ended June 30, 2007 to the Nine months ended June 30, 2006*

**InvestmentIncome**

Investment income for thenine months ended June 30, 2007 was $26,078,775, as compared to $19,553,835 forthe nine months ended June 30, 2006.

Interest income from ourinvestments in debt securities of private companies was $25,064,702 for thenine months ended June 30, 2007 as compared with $18,497,893 for the ninemonths ended June 30, 2006, which included $63,217 of PIK interest. Thisincrease consisted of net new investments of approximately $153.9 million forthe nine months ended June 30, 2007, as compared to net new investments ofapproximately $2.8 million for the nine months ended June 30, 2006. As a resultof a refinancing by Badanco Acquisition Corp. and a full repayment by MistrasHoldings Corp., Allied Extruders LLC, and SCPH Holdings we recorded successfees of approximately $2,250,000 during the nine months ended June 30, 2007. InJune 2007, we purchased a senior debt portfolio of approximately $63.3 millionto 16 different lenders, which is included in the net new investments describedabove.

The annualized weightedaverage yield on our portfolio for the nine months ended June 30, 2007 was12.3%; there was no PIK interest accrued during the nine months ended June 30,2007. The annualized weighted average yield on our portfolio for the ninemonths ended June 30, 2006 was 12.3% (with and without giving effect to PIKinterest).

Interest income frominvested cash and cash equivalents for the nine months ended June 30, 2007 was$178,183, as compared to $21,714 for the nine months ended June 30, 2006. Interestincome increased from the prior year due to the amount of cash that was heldinterest bearing accounts and the interest earned on our custodial accountprior to disbursement.

For the nine months endedJune 30, 2007 and June 30, 2006, we recorded $403,917 and $323,003,respectively, in interest income from loans to our employees in connection withthe exercise of employee stock options. The increase is the result ofadditional loans issued in connection with employee stock option exercisesduring the fourth quarter of the previous fiscal year.

For the nine months endedJune 30, 2007, we recorded $431,973 of prepayment fees and other income, ascompared to $711,225 for the nine months ended June 30, 2006. The income forboth periods consisted of prepayment penalty fees received upon the fullrepayment of certain loan investments ahead of contractual maturity andprepayment fees received upon the early unscheduled principal repayments which,in both instances, were based on a percentage of the outstanding principalamount of the loan at the date of prepayment.

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**OperatingExpenses**

Operating expenses, priorto credit from the Adviser for fees earned and voluntary waivers to the basemanagement and incentive fees, for the nine months ended June 30, 2007 were$14,168,785, as compared to $6,835,060 for the nine months ended June 30, 2006.Operating expenses for the nine months ended June 30, 2007 reflected asignificant increase in interest expense and management fees, prior to credits,as well as the addition of the incentive and administration fees, prior tocredits, under the Amended Advisory and Administration Agreements.

Loan servicingfees of $2,377,409 were incurred for the nine months ended June 30, 2007, ascompared to $2,144,024 for the nine months ended June 30, 2006. These fees wereincurred in connection with a loan servicing agreement between Business Loanand our Adviser, which is based on the size of the portfolio. These fees werereduced against the amount of the base management fee due to our Adviser.

For the ninemonths ended June 30, 2007, we incurred a base management fee of $1,806,075after reductions for loan servicing fees received by our Adviser of $2,377,409,less credits for fees received by our Adviser of $1,616,875 and a $369,161 feereduction for the waiver of the 2% fee on senior syndicated loans to 0.5%, for anet base management fee credit of $179,961, as compared to the nine monthsended June 30, 2006, in which we incurred a base management fee of $955,894after reductions for loan servicing fees received by our Adviser of $2,144,024,less credits for fees received by our Adviser of $1,762,000 and a $3,774 feereduction for the waiver of the 2% fee on senior syndicated loans to 0.5%, fora net base management credit of $809,880. The base management fee is computedquarterly as described under *“Investment Advisory andManagement Agreement.”* Effective April 1, 2007, the board of ourAdviser reduced the amount of credit for fees received by our Adviser from 100%of the fees received to 50% of the fees received, therefore, the three monthsended June 30, 2007 reflect the reduced credit for fees received by ourAdviser. The gross base management fee before the reduction for loan servicingfees for the nine months ended June 30, 2007 and June 30, 2006, was $4,183,484and $3,099,918, respectively, which increased in the current period due to thegrowth of the investment portfolio as compared to the same period of the prioryear and fewer credits for fees received by our Adviser.

Effective October1, 2006, the income based incentive fee became effective and as such we recordeda gross incentive fee of $3,474,007, which was reduced by a voluntary waiverissued by our Adviser’s board of directors of $2,696,124, which resulted in anet incentive fee of $777,883, which is recorded in fees due to Adviser on ourconsolidated statements of assets and liabilities at June 30, 2007. There wasno incentive fee recorded for the nine months ended June 30, 2006, as theAmended Advisory Agreement was not in effect.

Effective October 1,2006, the Administration Agreement became effective in which we providepayments 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 respective staffs. Weincurred an administration fee of $481,746 for the nine months ended June 30,2007. There was no administration fee recorded during the nine months endedJune 30, 2006, as the Administration Agreement was not in effect.

Professional fees,consisting primarily of legal and audit fees, for the nine months ended June30, 2007 were $368,610, as compared to $399,758 for the nine months ended June30, 2006. The slight decrease is due to the reimbursement of certain legal feesat the time of investment funding.

Amortization of deferredfinancing costs, in connection with our line of credit, was $198,633 for thenine months ended June 30, 2007 and $94,572 for the nine months ended June 30,2006. The increase is due to the amortization of additional fees incurred withour line of credit which were not in place during the prior year period.

Interest expense for thenine months ended June 30, 2007 was $4,693,525, as compared to $2,302,693 forthe nine months ended June 30, 2006. This increase is primarily a result ofincreased borrowings under our line of credit during the nine months ended June30, 2007, which borrowings were partially used to finance our increasedinvestments, borrowings remaining outstanding for longer periods of time and anincrease in the interest rates on our borrowings.

Stockholder related costsfor the nine months ended June 30, 2007 were $190,450, as compared to $273,170for the nine months ended June 30, 2006. Stockholder related costs include suchrecurring items as transfer agent fees, NASDAQ listing fees, SEC filing feesand annual report printing fees. These fees decreased during the nine months endedJune 30, 2007 since there were no special proxy solicitation or stock optiontermination notices filed as there were during the nine months ended June 30,2006.

Directors’ fees for thenine months ended June 30, 2007 were $167,470, as compared to $81,712 for thenine months ended June 30, 2006 due to the increase in annual stipend fees andtheir related monthly amortization.

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Insurance expense for thenine months ended June 30, 2007 was $191,338, as compared to $151,956 for thenine months ended June 30, 2006. The increase is primarily the result of anincrease in the amortization of our directors and officers insurance policypremiums.

There was no stock optioncompensation expense recorded for the nine months ended June 30, 2007 as therewas no longer a stock option plan in effect. Stock option compensation expensefor the nine months ended June 30, 2006 was $279,618 and was the result of theadoption of the SFAS No. 123 (revised 2004) “*Share-basedPayment*.”

Other expenses were$219,552 for the nine months ended June 30, 2007, as compared to $151,663 forthe nine months ended June 30, 2006. The expenses primarily represent directexpenses such as travel related specifically to our portfolio companies, loanevaluation services for our portfolio companies, press releases and backupservicer expenses.

**Income Tax Expense**

During the nine monthsended June 30, 2006, Gladstone Capital Corporation recorded approximately$50,000 in connection with penalties incurred on misclassified revenue on itsfiscal year 2004 corporate tax return.

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

During the nine monthsended June 30, 2007, we sold or were repaid in full on 24 syndicate loaninvestments for a net gain of $81,498, as compared to an aggregate net loss of$903,945, which was composed of $1,180,595 loss from the sale of twoinvestments and a net gain of $276,650 from the sale and repayments ofsyndicate investments during the nine months ended June 30, 2006.

**Realized Gain on Settlement ofDerivative**

During the nine monthsended June 30, 2007, we received interest rate cap agreement payments of$31,198 as a result of the one month LIBOR exceeding 5%, as compared to $1,367received during the nine months ended June 30, 2006.

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

During the nine monthsended June 30, 2007, we recorded net unrealized depreciation of $25,877 due toa decrease in the fair market value of our interest rate cap agreement, ascompared to unrealized appreciation of $65,252 during the nine months endedJune 30, 2006.

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

For the nine months endedJune 30, 2007, we recorded net unrealized depreciation on investments of$2,465,915, as compared to net unrealized appreciation of $5,769,820, for thenine months ended June 30, 2006. The unrealized depreciation is mainlyattributable to the depreciated fair value on certain investments, most notablyunrealized depreciation on Its Just Lunch International LLC, LocalTel, Inc. andVisual Edge Technology, Inc., partially offset by appreciation of our warrantsin Finn Corporation.

**NetIncrease in Net Assets from Operations**

Overall, we realized a net increase in net assets resulting fromoperations of $14,213,054 for the nine months ended June 30, 2007. Based on aweighted-average of 12,701,845 basic and diluted shares outstanding, our netincrease in net assets from operations per weighted-average common share forthe nine months ended June 30, 2007 was $1.12, basic and diluted.

For the nine months ended June 30, 2006,we realized anet increase in net assets resulting from operations of $19,366,806. Based on aweighted-average of 11,317,437 (basic) and 11,549,054 (diluted) sharesoutstanding, our net increase in net assets from operations per weighted-averagecommon share for the nine months ended June 30, 2006 was $1.71 (basic) and$1.68 (diluted).

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**LIQUIDITY AND CAPITAL RESOURCES**

At June 30, 2007, we hadinvestments in debt securities of, or loans to, 59 private companies, totalingapproximately $370.0 million (cost basis) of total assets.

During the nine monthsended June 30, 2007 and June 30, 2006, the following investment activityoccurred:
| **Quarter Ended** | ** ** | **New Investments** | ** **  | **Principal  Repayments** | ** ** | **Net Gain/(Loss)  on Disposal** | ** ** |
|------------------------|------------|--------------------------|-------------|---------------------------|------------|--------------------------------------------|------------|
| June 30, 2007          |       | $                        | 126,086,654 |                      | $          | 37,572,621                                 |       | $ | (5,021 | ) |
| March 31, 2007         |       | 75,330,167               |        | 38,263,017                |       | 84,205                                     |       |
| December 31,  2006     |       | 52,311,008               |        | 23,967,229                |       | 2,314                                      |       |
|                   |       | $                        | 253,727,829 |                      | $          | 99,802,867                                 |       | $ | 81,498 |   |
|                   |       |                     |        |                      |       |                                       |       |
| June 30, 2006          |       | $                        | 39,916,834  |                      | $          | 44,358,944                                 |       | $ | (100,850 | ) |
| March 31, 2006         |       | 38,471,109               |        | 24,815,067                |       | 377,500                                    |       |
| December 31,  2005     |       | 26,688,457               |        | 38,702,066                |       | (1,180,595                                 | )          |
|                   |       | $                        | 105,076,400 |                      | $          | 107,876,077                                |       | $ | (903,945 | ) |

 

The following table summarizes the contractual principalamortization and maturity of our investment portfolio by fiscal year:
| **Fiscal Year Ended September 30,** | ** ** | **Amount**  | ** **  |
|---------------------------------------------------------|------------|-------------|-------------|
| 2007                                                    |       | $           | 8,358,133   |   |
| 2008                                                    |       | 9,922,956   |        |
| 2009                                                    |       | 26,109,512  |        |
| 2010                                                    |       | 43,759,511  |        |
| 2011                                                    |       | 94,200,816  |        |
| Thereafter                                              |       | 187,624,470 |        |
|                                                    |       | $           | 369,975,398 |   |

 

Net cash used in operating activities for the nine months endedJune 30, 2007, consisting primarily of the items described in *“Results of Operations”* and the investment activitydescribed above, was approximately $136.6 million as compared to net cashprovided by operating activities of approximately $17.8 million for the ninemonths ended June 30, 2006. Net cash provided by investing activities consistedof $300,941 and $129,943 for the nine months ended June 30, 2007 and June 30,2006, respectively, and consisted of the principal repayments of employeeloans. Net cash provided by financing activities for the nine months ended June30, 2007 was approximately $139.1 million and mainly consisted of an offeringof common stock for net proceeds of approximately $45.7 million, borrowings onour line of credit of approximately $277.8 million, offset by repayments online of credit borrowings of approximately $166.6 million, and approximately$16.0 million for the payment of dividends. Net cash used in financingactivities was approximately $18.0 million for the nine months ended June 30,2006 and consisted primarily of net repayments on our line of credit ofapproximately $5.2 million and the payment of dividends of approximately $13.8million.

During the nine months ended June 30, 2007, cash and cashequivalents increased from approximately $732,000 to approximately $3.5million.

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 January, February,March, April, May and June 2007 and $0.135 per common share for January,February, March, April, May and June 2006, and October, November and December2005. In July 2007, our Board of Directors declared a monthly dividend of $0.14per common share for each of July, August, and September 2007.

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We anticipate continuingto borrow funds and, from time to time issuing additional equity securities, toobtain additional capital to make further investments. On May 2, 2007, we completed apublic offering of 2,000,000 shares of our common stock, at a price of $24.25per share, under a shelf registration statement on Form N-2 (File No.333-100385), and pursuant to the terms set forth in a prospectus dated April16, 2007, as supplemented by a final prospectus dated April 27, 2007. Netproceeds of the offering, after underwriting discounts and offering expenseswere approximately $45,669,292 and were used to repay outstanding borrowingsunder our line of credit. In May 2007, we filed with the SEC a new shelf registrationstatement on Form N-2 (File No. 333-143027) (the “Registration Statement”)which the SEC declared effective on July 5, 2007 that would permit us to issue,through one or more transactions, up to an aggregate of $300 million insecurities, consisting of common stock, preferred stock and/or debt securities.On July 24, 2007, we completed an offering of 400,000 shares of our commonstock, at a price of $20.41 per share, under the Registration Statement, andpursuant to the terms set forth in a prospectus dated July 5, 2007, assupplemented by a final prospectus dated July 24, 2007. Net proceeds from thisoffering, after offering expenses, were approximately $8,149,000 and were usedto repay outstanding borrowings under our line of credit. After this offering,we have the capacity to issue up to an aggregate of approximately $291.8million in securities under the Registration Statement.

**Revolving Credit Facilities**

Through ourwholly-owned subsidiary, Business Loan, we have a $220 million revolving creditfacility (the “DB Facility”) with Deutsche Bank AG, as administrative agent,which is scheduled to mature on May 23, 2008. Pursuant to the DB Facility,Business Loan has pledged the loans it holds to secure future advances bycertain institutional lenders. Interest rates charged on the advances under theDB Facility will be based on LIBOR, the Prime Rate or the Federal Funds Rate,depending on market conditions, and will adjust periodically. As of June 30,2007, our outstanding principal balance under the DB Facility was approximately$161.2 million at an interest rate of approximately 5.3%. Available borrowingsare subject to various constraints imposed by Deutsche Bank AG, based on theaggregate loan balance pledged by Business Loan, which varies as loans areadded and repaid, regardless of whether such repayments are early prepayment orare made as contractually required. At June 30, 2007, the remaining borrowingcapacity available under the DB Facility was approximately $58.8 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 DBFacility also restricts some of the terms and provisions (including interestrates, terms to maturity and payments schedules) and limits the borrower andindustry concentrations of loans that are eligible to secure advances. As ofJune 30, 2007, Business Loan was in compliance with all of the DB Facilitycovenants. We currently intend to securitize all of the loans held by BusinessLoan and to use the proceeds from the securitization to pay down any amounts thenoutstanding under the revolving credit facility. However, there can be noassurance that we will be able to successfully securitize any of these loans onterms 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 is also the trustee of the account and oncea month remits the collected funds to us. For the nine months ended June 30,2007, the amount due from custodian decreased by $457,261.

Our Adviser,services the loans pledged under the DB Facility. As a condition to thisservicing arrangement, we executed a performance guaranty pursuant to which weguaranteed that our Adviser would comply fully with all of its obligationsunder the facility. The performance guaranty requires us to maintain a minimumnet worth of $100 million and to maintain “asset coverage” with respect to “seniorsecurities representing indebtedness” of at least 200%, in accordance withSection 18 of the 1940 Act. As of June 30, 2007, we were in compliance with ourcovenants under the performance guaranty.

The DB facility isavailable for general corporate purposes.

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**Contractual Obligations**

As of June 30, 2007, wewere a party to signed and non-binding term sheets for two loan originationsfor an aggregate of $15.0 million. To date, these investments have not yetfunded and we expect to fund these 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                      |       | 15,000,000 |       | 15,000,000                               |       | — |   | — |   | — |   |
| Total                            |       | $          | 15,000,000 |                                     | $          | 15,000,000 |   | $ | — |   | $ | — |   | $ | — |   |
|                                  |            |            |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

We are subject tofinancial market risks, including changes in interest rates.  We estimatethat ultimately approximately 20% of the loans in our portfolio will be made atfixed rates and approximately 80% will be made at variable rates.  Currently our portfolio has approximately 51%of the total loan portfolio cost basis at variable rates with a floor,approximately 2% of the total loan portfolio cost basis at a variable rate witha floor and ceiling, approximately 46% of the total loan portfolio cost basisat variable rates without a floor or ceiling and approximately 1% of the totalloan portfolio cost basis is at a fixed rate. All of our variable based loans have rates associated with either thecurrent Prime Rate or LIBOR.

We have a $220 millionrevolving credit facility, based on variable rates, with Deutsche Bank AG whichmatures May 2008. 

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 June 30, 2007, the cap agreement had a fair market value of $24,407and a current notional amount of $8.8 million. At June30, 2007, the one month LIBOR rate was approximately 5.32%. 

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 or the Prime Rate by 1% would increase our net increasein net assets resulting from operations by approximately $2.0 million, or10.5%, over the next twelve months, compared to the net increase in net assetsresulting from operations for the twelve months ended June 30, 2007.  A hypothetical decrease in the one monthLIBOR or the Prime Rate by 1% would decrease net increase in net assetsresulting from operations by approximately $2.0 million, or 10.5%, over thenext twelve months, compared to the net increase in net assets resulting fromoperations for the twelve months ended June 30, 2007.  Although management believes that thisanalysis is indicative of our existing interest rate sensitivity, it does notadjust for potential changes in credit quality, size and composition of ourloan portfolio on the balance sheet and other business developments that couldaffect net increase in net assets resulting from operations.  Accordingly, no assurances can be given thatactual results would not differ materially from the results under this hypotheticalanalysis.

In the event that we securitizea portion of our loan portfolio, we believe that we will likely be required toenter into further hedging arrangements in the future with respect tosecuritized 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 haveoperations located outside the United States. These risks include, but are notlimited to, fluctuations in foreign currency exchange rates, imposition offoreign taxes, changes in exportation regulations and political and socialinstability.

**ITEM 4. CONTROLS ANDPROCEDURES.**

As of June 30, 2007, we, including our Chief Executive Officer andChief 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 June 30, 2007, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

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**PARTII—OTHER INFORMATION**

**ITEM 1. LEGALPROCEEDINGS.**

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

**ITEM 1A. RISKFACTORS.**

Our business 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 and our Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2007, filed by us with the Securities and Exchange Commission on May2, 2007.

**ITEM 2. UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

Not applicable.

**ITEM 3. DEFAULTS UPONSENIOR SECURITIES.**

Not applicable.

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

No matters were submitted to a vote ofsecurity holders during the three months ended June 30, 2007.

**ITEM 5. OTHER INFORMATION.**

Not applicable

**ITEM 6.  EXHIBITS**

See the exhibit index.

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**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: August 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.                                                                                                           |
|    |       |                                                                                                                                                                                                                                                                                                                   |
| 3.4     |       | Second amendment  to bylaws, incorporated by reference to Exhibit 99.1 to the Company’s Current  Report on Form 8-K (File No. 814-00237), filed July 10, 2007.                                                                                                                                                    |
|    |       |                                                                                                                                                                                                                                                                                                                   |
| 10.1    |       | Amendment No. 3  to the Amended and Restated Credit Agreement by and among Gladstone Business  Loan LLC, Deutsche Bank AG, and certain other parties, dated as of May 25,  2007, incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K (File No. 814-00237), filed May 29, 2007. |
|    |       |                                                                                                                                                                                                                                                                                                                   |
| 11      |       | Computation of  Per Share Earnings (included in the notes to the unaudited consolidated  financial statements contained in this report).                                                                                                                                                                               |
|    |       |                                                                                                                                                                                                                                                                                                                   |
| 31.1    |       | Certification of  Chief Executive Officer pursuant to section 302 of The Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                  |
|    |       |                                                                                                                                                                                                                                                                                                                   |
| 31.2    |       | Certification of  Chief Financial Officer pursuant to section 302 of The Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                  |
|    |       |                                                                                                                                                                                                                                                                                                                   |
| 32.1    |       | Certification of  Chief Executive Officer pursuant to section 906 of The Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                  |
|    |       |                                                                                                                                                                                                                                                                                                                   |
| 32.2    |       | Certification of  Chief Financial Officer pursuant to section 906 of The Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                  |

 

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

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