**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.20549**

 

**FORM 10-Q**

 

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

 

**FOR THE QUARTER ENDEDMARCH 31, 2008**

 

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

 

**COMMISSION FILENUMBER: 814-00237**

 

**GLADSTONECAPITAL CORPORATION**

(Exact name of registrant as specified inits charter)

 

| **MARYLAND**                                                    | ** ** | **54-2040781**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or  other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification No.) |
|                                                            |       |                                  |
| **1521 WESTBRANCH DRIVE, SUITE 200**                            |
| **MCLEAN, VIRGINIA 22102**                                      |
| (Address  of principal executive office)                        |
|                                                            |       |                                  |
| **(703) 287-5800**                                              |
| (Registrant’s  telephone number, including area code)      |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x No o.

 

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

 

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

 

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

 

Indicate the number of shares outstandingof each of the issuer’s classes of common stock, as of the latest practicabledate.  The number of shares of the issuer’sCommon Stock, $0.001 par value, outstanding as of May 5, 2008 was21,087,574.

 

 

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**GLADSTONE CAPITAL CORPORATION**

 

**TABLE OF CONTENTS**

 
| PART I.  | FINANCIAL INFORMATION                                                                                    |
|---------------|----------------------------------------------------------------------------------------------------------|
|          |                                                                                                     |
| Item 1.       | Financial Statements (Unaudited)                                                                         |
|          |                                                                                                     |
|          | Consolidated Statements of  Assets and Liabilities as of March 31, 2008 and September 30, 2007 |
|          | Consolidated  Schedules of Investments as of March 31, 2008 and September 30,  2007            |
|          | Consolidated Statements of Operations for the three  and six months ended March 31, 2008 and 2007   |
|          | Consolidated Statements of Changes in Net Assets for  the six months ended March 31, 2008 and 2007  |
|          | Consolidated  Statements of Cash Flows for the six months ended March 31, 2008 and  2007            |
|          | Financial Highlights for the three and six months  ended March 31, 2008 and 2007                    |
|          | 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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**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATEDSTATEMENTS OF ASSETS AND LIABILITIES**

**(Unaudited)**

 
| ** **                                                                                                                               | ** ** | **March 31,** | ** **  | **September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|------------------------|------------|
| ** **                                                                                                                               | ** ** | **2008**           | ** **  | **2007**               | ** ** |
| ASSETS                                                                                                                                   |       |               |        |                   |       |
| Non-Control/Non-Affiliate investments (Cost 3/31/08:  $438,864,462; 9/30/07: $354,835,652)                                               |       | $                  | 412,286,047 |                   | $          | 348,920,982 |   |
| Control investments (Cost 3/31/08: $3,531,250;  9/30/07: $923,548)                                                                       |       | 451,389            |        | 923,548                |       |
| Total investments at fair value (Cost 3/31/08:  $442,395,712; 9/30/07 $355,759,200)                                                      |       | 412,737,436        |        | 349,844,530            |       |
| Cash and cash equivalents                                                                                                                |       | 6,916,356          |        | 8,838,658              |       |
| U.S. Treasury bill                                                                                                                       |       | —             |        | 2,484,464              |       |
| Interest receivable – investments in debt securities                                                                                |       | 3,314,982          |        | 2,425,555              |       |
| Interest receivable – employees                                                                                                     |       | 7,604              |        | 21,417                 |       |
| Due from custodian                                                                                                                       |       | 3,070,386          |        | 3,230,385              |       |
| Deferred financing fees                                                                                                                  |       | 255,262            |        | 186,270                |       |
| Prepaid assets                                                                                                                           |       | 279,730            |        | 337,106                |       |
| Other assets                                                                                                                             |       | 265,602            |        | 360,753                |       |
| TOTAL ASSETS                                                                                                                             |       | $                  | 426,847,358 |                   | $          | 367,729,138 |   |
|                                                                                                                                     |       |               |        |                   |       |
| LIABILITIES                                                                                                                              |       |               |        |                   |       |
| Accounts payable                                                                                                                         |       | $                  | 17,447      |                   | $          | 6,013 |   |
| Interest payable                                                                                                                         |       | 367,165            |        | 587,514                |       |
| Fee due to Administrator (Refer to Note 4)                                                                                               |       | 240,579            |        | 237,510                |       |
| Fees due to Adviser (Refer to Note 4)                                                                                                    |       | 692,985            |        | 708,517                |       |
| Borrowings under lines of credit                                                                                                         |       | 123,459,000        |        | 144,440,000            |       |
| Accrued expenses and deferred liabilities                                                                                                |       | 998,040            |        | 790,849                |       |
| Funds held in escrow                                                                                                                     |       | 223,543            |        | —                 |       |
| TOTAL LIABILITIES                                                                                                                        |       | 125,998,759        |        | 146,770,403            |       |
| NET ASSETS                                                                                                                               |       | $                  | 300,848,599 |                   | $          | 220,958,735 |   |
|                                                                                                                                     |       |               |        |                   |       |
| ANALYSIS OF NET ASSETS                                                                                                                   |       |               |        |                   |       |
| Common stock, $0.001 par value, 50,000,000 shares  authorized and 21,087,574 and 14,762,574 shares issued and outstanding,  respectively |       | $                  | 21,088      |                   | $          | 14,763 |   |
| Capital in excess of par value                                                                                                           |       | 341,411,120        |        | 235,906,665            |       |
| Notes receivable – employees                                                                                                        |       | (9,181,676         | )           | (9,230,502             | )          |
| Net unrealized depreciation on investments                                                                                               |       | (29,658,276        | )           | (5,914,670             | )          |
| Unrealized depreciation on derivative                                                                                                    |       | (303,995           | )           | (291,686               | )          |
| (Distributions in excess of) accumulated  undistributed net investment income                                                            |       | (1,439,662         | )           | 474,165                |       |
| TOTAL NET ASSETS                                                                                                                         |       | $                  | 300,848,599 |                   | $          | 220,958,735 |   |
| NET ASSETS PER SHARE                                                                                                                     |       | $                  | 14.27       |                   | $          | 14.97 |   |

 

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

 

2

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**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATEDSCHEDULE OF INVESTMENTS**

**AS OF MARCH 31,2008**

**(UNAUDITED)**

 
| **Company**                                | ** ** | **Industry**                                      | ** ** | **Investment (1)**               | ** ** | **Cost**   | ** **      | **Fair Value** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------|------------|------------|-----------------|---------------------|------------|
| ** **                                 | ** ** | ** **                                        | ** ** | ** **                            | ** ** | ** ** | ** **      | ** **          |       |
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS** | ** ** | ** **                                        | ** ** | ** **                            | ** ** | ** ** |            |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| Access Television                          |       | Service-cable airtime                             |       | Senior Term Debt (6)                  |       | $          |  2,432,568 |                | $          |  2,316,492 |   |
| Network, Inc. (2)                          |       | (infomercials)                                    |       | (9.3% Due 3/2009)                     |       |       |            |                |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| ACE Expediters, Inc                        |       | Service - over-the-ground                         |       | Line of Credit (5)(9)                 |       | —     |            | —              |       |
|                                       |       | logistics                                         |       | (7.1% Due 1/2011)                     |       |       |            |                |       |
|                                       |       |                                              |       | Senior Term Debt (5)                  |       | 13,121,941 |            | 13,121,941          |       |
|                                       |       |                                              |       | (11.4% Due 1/2012)                    |       |       |            |                |       |
|                                       |       |                                              |       | Warrants (5) (8)                      |       | 200,000    |            | 200,000             |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| ActivStyle Acquisition Co. (2)             |       | Service-medical products                          |       | Line of Credit (6) (10)               |       | 1,100,000  |            | 1,068,375           |       |
|                                       |       | distribution                                      |       | (7.4%, Due 7/2009)                    |       |       |            |                |       |
|                                       |       |                                              |       | Senior Term Debt (6)                  |       | 4,982,750  |            | 4,839,496           |       |
|                                       |       |                                              |       | (8.5%, Due 9/2012)                    |       |       |            |                |       |
|                                       |       |                                              |       | Senior Term Debt (3) (6)              |       | 4,435,000  |            | 4,257,600           |       |
|                                       |       |                                              |       | (10.5%, Due 9/2012)                   |       |       |            |                |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| Allison Publications, LLC (2)              |       | Service-publisher of consumer                     |       | Line of Credit (11)                   |       | —     |            | —              |       |
|                                       |       | oriented magazines                                |       | (9.0%, Due 12/2010)                   |       |       |            |                |       |
|                                       |       |                                              |       | Senior Term Debt (6)                  |       | 11,075,078 |            | 10,780,000          |       |
|                                       |       |                                              |       | (9.0%, Due 12/2011)                   |       |       |            |                |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| Anitox Acquisition Company (2)             |       | Manufacturing-preservatives for animal  feed      |       | Senior Real Estate Term Debt (6)      |       | 3,104,272  |            | 2,983,500           |       |
|                                       |       |                                              |       | (8.8%, Due 1/2012)                    |       |       |            |                |       |
|                                       |       |                                              |       | Line of Credit (12)                   |       | 2,000,000  |            | 1,950,000           |       |
|                                       |       |                                              |       | (7.4%, Due 1/2010)                    |       |       |            |                |       |
|                                       |       |                                              |       | Senior Term Debt (6)                  |       | 2,650,000  |            | 2,583,750           |       |
|                                       |       |                                              |       | (8.5%, Due 1/2012)                    |       |       |            |                |       |
|                                       |       |                                              |       | Senior Term Debt (3) (6)              |       | 2,750,000  |            | 2,646,875           |       |
|                                       |       |                                              |       | (10.5%, Due 1/2012)                   |       |       |            |                |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| Badanco Acquisition Corp.                  |       | Service-luggage design and distribution           |       | Senior Subordinated Term Debt (6)     |       | 9,555,000  |            | 9,340,013           |       |
|                                       |       |                                              |       | (11.5%, Due 7/2012)                   |       |       |            |                |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| Bresnan Communications, LLC                |       | Service-telecommunications                        |       | Senior Term Debt (7)                  |       | 3,001,646  |            | 2,677,500           |       |
|                                       |       |                                              |       | (5.0%, Due 9/2013)                    |       |       |            |                |       |
|                                       |       |                                              |       | Senior Subordinated Term Debt (7)     |       | 1,509,232  |            | 1,305,000           |       |
|                                       |       |                                              |       | (7.5%, Due 3/2014)                    |       |       |            |                |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| CCS, LLC                                   |       | Service-cable tv franchise owner                  |       | Senior Term Debt (6)                  |       | 3,426,892  |            | 3,298,383           |       |
|                                       |       |                                              |       | (9.3%, Due 3/2008)                    |       |       |            |                |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| CHG Companies, Inc. (2)                    |       | Service-healthcare staffing                       |       | Letter of Credit (6) (7)              |       | 400,000    |            | 354,000             |       |
|                                       |       |                                              |       | (4.9%, Due 12/2012)                   |       |       |            |                |       |
|                                       |       |                                              |       | Senior Term Debt (6) (7)              |       | 1,584,000  |            | 1,401,840           |       |
|                                       |       |                                              |       | (5.5%, Due 12/2012)                   |       |       |            |                |       |
|                                       |       |                                              |       | Senior Subordinated Term Debt (6) (7) |       | 500,000    |            | 415,000             |       |
|                                       |       |                                              |       | (11.2%, Due 12/2012)                  |       |       |            |                |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| Chinese Yellow Pages Company               |       | Service-publisher of Chinese                      |       | Line of Credit (6) (13)               |       | 855,071    |            | 827,281             |       |
|                                       |       | language directories                              |       | (9.3%, Due 9/2010)                    |       |       |            |                |       |
|                                       |       |                                              |       | Senior Term Debt (6)                  |       | 793,974    |            | 757,977             |       |
|                                       |       |                                              |       | (9.3%, Due 9/2010)                    |       |       |            |                |       |
|                                       |       |                                              |       |                                  |       |       |            |                |       |
| Clinton Holdings, LLC (2)                  |       | Distribution-aluminum sheets and  stainless steel |       | Senior Subordinated Term Debt (5)     |       | 15,500,000 |            | 15,500,000          |       |
|                                       |       |                                              |       | (12.0%, Due 1/2013)                   |       |       |            |                |       |
|                                       |       |                                              |       | Common Stock Warrants (8)             |       | 109,124    |            | —              |       |
|                                            |            |                                                   |            |                                       |            |            |                 |                     |            |  |  |

 

3

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| **Company**                            | ** ** | **Industry**                     | ** ** | **Investment (1)**               | ** ** | **Cost**   | ** **      | **Fair Value** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|---------------------------------------|------------|------------|-----------------|---------------------|------------|
| ** **                             | ** ** | ** **                       | ** ** | ** **                            | ** ** | ** ** | ** **      | ** **          |       |
| CMI Acquisition, LLC (2)               |       | Service-recycling                |       | Senior Subordinated Term Debt (6)     |       | $          |  6,500,000 |                | $          |  6,142,500 |   |
|                                   |       |                             |       | (11.9%, Due 11/2012)                  |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Community Media Corporation            |       | Service-publisher of free weekly |       | Senior Term Debt (6)                  |       | 2,919,122  |            | 2,816,061           |       |
|                                   |       | newspapers                       |       | (7.3%, Due 8/2012)                    |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Country Road   Communications LLC (2)  |       | Service-telecommunications       |       | Senior Subordinated Term Debt (6) (7) |       | 5,970,072  |            | 5,820,000           |       |
|                                   |       |                             |       | (12.6%, Due 7/2013)                   |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Defiance Acquisition                   |       | Manufacturing-trucking parts     |       | Senior Term Debt (3) (6) (14)         |       | 6,325,000  |            | 6,011,280           |       |
| Corporation                            |       |                             |       | (11.1%, Due 4/2010)                   |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Doe & Ingalls Management           |       | Distributor-specialty chemicals  |       | Senior Term Debt (6)                  |       | 3,500,000  |            | 3,447,500           |       |
| LLC (2)                                |       |                             |       | (7.5%, Due 11/2010)                   |       |       |            |                |       |
|                                   |       |                             |       | Senior Term Debt (3) (6)              |       | 4,432,500  |            | 4,332,769           |       |
|                                   |       |                             |       | (7.6%, Due 11/2010)                   |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Emdeon Business Services,              |       | Service-healthcare technology    |       | Senior Term Debt (7)                  |       | 2,371,625  |            | 2,144,318           |       |
| Inc.                                   |       | solutions                        |       | (4.7%, Due 11/2013)                   |       |       |            |                |       |
|                                   |       |                             |       | Senior Subordinated Term Debt (7)     |       | 2,011,984  |            | 1,720,000           |       |
|                                   |       |                             |       | (7.7%, Due 5/2014)                    |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Express Courier International,         |       | Service-ground delivery and      |       | Line of Credit (6) (15)               |       | 900,000    |            | 886,500             |       |
| Inc.                                   |       | logistics                        |       | (7.4%, Due 6/2009)                    |       |       |            |                |       |
|                                   |       |                             |       | Senior Term Debt (6)                  |       | 3,642,500  |            | 3,587,863           |       |
|                                   |       |                             |       | (8.5%, Due 6/2011)                    |       |       |            |                |       |
|                                   |       |                             |       | Senior Term Debt (3) (6)              |       | 4,194,150  |            | 4,110,267           |       |
|                                   |       |                             |       | (10.5%, Due 6/2011)                   |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Finn Corporation                       |       | Manufacturing-landscape          |       | Common Stock Warrants (8)             |       | 37,000     |            | 3,192,483           |       |
|                                   |       | equipment                        |       |                                  |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| GFRC Holdings LLC                      |       | Manufacturing-glass-fiber        |       | Line of Credit (6) (16)               |       | —     |            | —              |       |
|                                   |       | reinforced concrete              |       | (7.4%, Due 12/2010)                   |       |       |            |                |       |
|                                   |       |                             |       | Senior Term Debt (6)                  |       | 7,750,000  |            | 7,653,125           |       |
|                                   |       |                             |       | (10.0%, Due 12/2012)                  |       |       |            |                |       |
|                                   |       |                             |       | Senior Subordinated Term Debt (3) (6) |       | 6,750,000  |            | 6,615,000           |       |
|                                   |       |                             |       | (12.5%, Due 12/2012)                  |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Global Materials                       |       | Manufacturing-steel wool         |       | Senior Term Debt (3) (6)              |       | 4,970,000  |            | 4,646,950           |       |
| Technologies, Inc.                     |       | products and metal fibers        |       | (13.0%, Due 11/2009)                  |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| GTM Holdings, Inc. (2)                 |       | Manufacturing-socks              |       | Senior Term Debt (7)                  |       | 493,750    |            | 392,531             |       |
|                                   |       |                             |       | (6.0%, Due 10/2013)                   |       |       |            |                |       |
|                                   |       |                             |       | Senior Subordinated Term Debt (7)     |       | 500,000    |            | 350,000             |       |
|                                   |       |                             |       | (9.3%, Due 4/2014)                    |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Greatwide Logistics                    |       | Service - logistics and          |       | Senior Term Debt (7)                  |       | 3,950,000  |            | 3,081,000           |       |
| Services, Inc.                         |       | transportation                   |       | (6.2%, Due 12/2013)                   |       |       |            |                |       |
|                                   |       |                             |       | Senior Subordinated Term Debt (7)     |       | 4,000,000  |            | 2,720,000           |       |
|                                   |       |                             |       | (9.2%, Due 6/2014)                    |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| GS Maritime Intermediate  Holdings LLC |       | Service-cargo transport          |       | Senior Subordinated Term Debt (7)     |       | 1,000,000  |            | 980,000             |       |
|                                   |       |                             |       | (10.2%, Due 12/2013)                  |       |       |            |                |       |
|                                   |       |                             |       |                                  |       |       |            |                |       |
| Harrington Holdings, Inc. (2)          |       | Service - healthcare products    |       | Senior Term Debt (7)                  |       | 2,475,000  |            | 2,215,125           |       |
|                                   |       | distribution                     |       | (5.0%, Due 1/2014)                    |       |       |            |                |       |
|                                   |       |                             |       | Senior Subordinated Term Debt (7)     |       | 5,000,000  |            | 4,000,000           |       |
|                                   |       |                             |       | (8.7%, Due 1/2014)                    |       |       |            |                |       |
|                                        |            |                                  |            |                                       |            |            |                 |                     |            |  |  |

 

4

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| **Company**                         | ** ** | **Industry**                       | ** ** | **Investment (1)**           | ** ** | **Cost**   | ** ** | **Fair Value** | ** ** |
|-------------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|------------|------------|---------------------|------------|
|                                |       |                               |       |                              |       |       |       |                |       |
| Heartland Communications            |       | Service-radio station operator     |       | Line of Credit (6) (17)           |       | $          | 105,000    |                | $          |  89,775 |   |
| Group, LLC (2)                      |       |                               |       | (10.0%, Due 12/2008)              |       |       |       |                |       |
|                                |       |                               |       | Senior Term Debt (6)              |       | 4,686,089  |       | 3,968,367           |       |
|                                |       |                               |       | (10.0%, Due 5/2011)               |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| Interfilm Holdings, Inc.            |       | Service-slitter and distributor of |       | Senior Term Debt (6)              |       | 5,000,000  |       | 4,887,500           |       |
|                                |       | plastic films                      |       | (10.5%, Due 10/2012)              |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| IJGT Acquisition Company            |       | Service-golf training              |       | Line of Credit (6) (18)           |       | 1,050,000  |       | 1,021,125           |       |
|                                |       |                               |       | (8.9%, Due 5/2010)                |       |       |       |                |       |
|                                |       |                               |       | Senior Term Debt (6)              |       | 2,650,000  |       | 2,583,750           |       |
|                                |       |                               |       | (7.4%, Due 5/2012)                |       |       |       |                |       |
|                                |       |                               |       | Senior Term Debt (3) (6)          |       | 2,500,000  |       | 2,412,500           |       |
|                                |       |                               |       | (10.5%, Due 5/2012)               |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| It’s Just Lunch International, |       | Service-dating service             |       | Line of Credit (6) (19)           |       | 550,000    |       | 357,500             |       |
| LLC                                 |       |                               |       | (7.1%, Due 6/2009)                |       |       |       |                |       |
|                                |       |                               |       | Senior Term Debt (6)              |       | 3,300,000  |       | 2,145,000           |       |
|                                |       |                               |       | (7.4%, Due 6/2011)                |       |       |       |                |       |
|                                |       |                               |       | Senior Term Debt (3) (6) (19)     |       | 500,000    |       | 325,000             |       |
|                                |       |                               |       | (10.5%, Due 6/2011)               |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| John Henry Holdings, Inc. (2)       |       | Manufacturing-packaging products   |       | Senior Subordinated Term Debt (7) |       | 8,000,000  |       | 7,200,000           |       |
|                                |       |                               |       | (11.6%, Due 6/2011)               |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| Kinetek Acquisition Corp.           |       | Manufacturing-custom               |       | Senior Term Debt (7)              |       | 1,486,284  |       | 1,355,344           |       |
|                                |       | engineered motors & controls   |       | (5.2%, Due 11/2013)               |       |       |       |                |       |
|                                |       |                               |       | Senior Subordinated Term Debt (7) |       | 1,508,192  |       | 1,350,000           |       |
|                                |       |                               |       | (8.2%, Due 5/2014)                |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| KMBQ Corporation                    |       | Service-AM/FM radio                |       | Line of Credit (6) (20)           |       | 152,000    |       | 143,640             |       |
|                                |       | broadcaster                        |       | (10.3%, Due 3/2010)               |       |       |       |                |       |
|                                |       |                               |       | Senior Term Debt (6)              |       | 1,795,942  |       | 1,683,042           |       |
|                                |       |                               |       | (10.3%, Due 3/2010)               |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| Lindmark Outdoor Advertising LLC    |       | Service-advertising                |       | Senior Subordinated Term Debt (6) |       | 10,000,000 |       | 9,787,500           |       |
|                                |       |                               |       | (11.0%, Due 10/2012)              |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| LocalTel, Inc.                      |       | Service-yellow pages               |       | Line of Credit (6) (21) (30)      |       | 1,170,000  |       | 234,000             |       |
|                                |       | publishing                         |       | (non-accrual, Due 6/2009)         |       |       |       |                |       |
|                                |       |                               |       | Senior Term Debt (6) (30)         |       | 2,687,500  |       | 537,500             |       |
|                                |       |                               |       | (non-accrual, Due 6/2011)         |       |       |       |                |       |
|                                |       |                               |       | Senior Term Debt (3) (6) (30)     |       | 2,750,000  |       | 550,000             |       |
|                                |       |                               |       | (non-accrual, Due 6/2011)         |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| Macfadden Performing Arts           |       | Service-magazine publisher         |       | Line of Credit (6) (22)           |       | 1,015,979  |       | 985,500             |       |
| Media, LLC                          |       |                               |       | (7.8%, Due 6/2009)                |       |       |       |                |       |
|                                |       |                               |       | Senior Term Debt (6)              |       | 6,416,668  |       | 6,174,050           |       |
|                                |       |                               |       | (7.8%, Due 6/2009)                |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| Meteor Holding Corporation (2)      |       | Manufacturing-bar code             |       | Senior Term Debt (7)              |       | 2,336,400  |       | 2,126,124           |       |
|                                |       | scanning and data capture          |       | (5.7%, Due 12/2013)               |       |       |       |                |       |
|                                |       |                               |       | Senior Subordinated Term Debt (7) |       | 1,500,000  |       | 1,350,000           |       |
|                                |       |                               |       | (9.0%, Due 12/2013)               |       |       |       |                |       |
|                                |       |                               |       |                              |       |       |       |                |       |
| Multi-Ag Media LLC (2)              |       | Service-dairy magazine             |       | Senior Term Debt (6)              |       | 2,328,358  |       | 2,256,882           |       |
|                                |       | publisher/information database     |       | (9.3%, Due 12/2009)               |       |       |       |                |       |
|                                     |            |                                    |            |                                   |            |            |            |                     |            |  |  |

 

5

----

 
| **Company**                                  | ** ** | **Industry**                                  | ** ** | **Investment (1)**               | ** ** | **Cost**   | ** **   | **Fair Value** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------|------------|------------|--------------|---------------------|------------|
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| Newhall Holdings, Inc. (2)                   |       | Service-distributor of personal               |       | Line of Credit (6) (23)               |       | $          |  — |                | $          |  — |   |
|                                         |       | care products and supplements                 |       | (6.6%, Due 5/2010)                    |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (3) (6)              |       | 4,410,000  |         | 4,310,775           |       |
|                                         |       |                                          |       | (8.3%, Due 5/2012)                    |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (3) (6)              |       | 4,500,000  |         | 4,365,000           |       |
|                                         |       |                                          |       | (11.3%, Due 5/2012)                   |       |       |         |                |       |
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| Northern Contours, Inc. (2)                  |       | Manufacturing-veneer and laminate  components |       | Senior Subordinated Term Debt (6)     |       | 7,000,000  |         | 6,615,000           |       |
|                                         |       |                                          |       | (10.1%, Due 5/2010)                   |       |       |         |                |       |
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| Pinnacle Treatment Centers, Inc.             |       | Service-Addiction treatment                   |       | Line of Credit (6) (24)               |       | —     |         | —              |       |
|                                         |       | centers                                       |       | (7.4%, Due 12/2009)                   |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (6)                  |       | 2,375,000  |         | 2,309,688           |       |
|                                         |       |                                          |       | (8.5%, Due 12/2011)                   |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (3) (6)              |       | 4,500,000  |         | 4,342,500           |       |
|                                         |       |                                          |       | (10.5%, Due 12/2011)                  |       |       |         |                |       |
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| Precision Acquisition Group                  |       | Manufacturing-consumable                      |       | Equipment Note (6) (25)               |       | 806,220    |         | 804,204             |       |
| Holdings, Inc. (2)                           |       | components for the aluminum                   |       | (8.5%, Due 10/2011)                   |       |       |         |                |       |
|                                         |       | industry                                      |       | Senior Term Debt (6)                  |       | 5,000,000  |         | 4,987,500           |       |
|                                         |       |                                          |       | (8.5%, Due 10/2010)                   |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (3) (6)              |       | 4,200,000  |         | 4,189,500           |       |
|                                         |       |                                          |       | (11.5%, Due 10/2010)                  |       |       |         |                |       |
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| PROFITSystems                                |       | Service-design and develop                    |       | Line of Credit (6) (26)               |       | —     |         | —              |       |
| Acquisition Co. (2)                          |       | ERP software                                  |       | (7.4%, Due 7/2009)                    |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (6)                  |       | 2,500,000  |         | 2,412,500           |       |
|                                         |       |                                          |       | (8.5%, Due 7/2011)                    |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (3) (6)              |       | 2,900,000  |         | 2,773,125           |       |
|                                         |       |                                          |       | (10.5%, Due 7/2011)                   |       |       |         |                |       |
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| Puerto Rico Cable  Acquisition Company, Inc. |       | Service-telecommunications                    |       | Senior Subordinated Term Debt (6) (7) |       | 7,791,170  |         | 6,421,295           |       |
|                                         |       |                                          |       | (10.3%, Due 1/2012)                   |       |       |         |                |       |
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| RCS Management Holding Co.                   |       | Service-healthcare supplies                   |       | Senior Term Debt (3) (6)              |       | 3,000,000  |         | 2,850,000           |       |
|                                         |       |                                          |       | (8.5%, Due 1/2011)                    |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (4) (6)              |       | 3,060,000  |         | 2,853,450           |       |
|                                         |       |                                          |       | (10.5%, Due 1/2011)                   |       |       |         |                |       |
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| Reading Broadcasting, Inc.                   |       | Service-television station                    |       | Senior Term Debt (6)                  |       | 7,586,397  |         | 7,520,016           |       |
|                                         |       | operator                                      |       | (9.8%, Due 3/2008)                    |       |       |         |                |       |
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| RedPrairie Holding, Inc. (2)                 |       | Service-design and develop                    |       | Senior Term Debt (7)                  |       | 4,423,750  |         | 3,760,187           |       |
|                                         |       | supply chain software                         |       | (6.1%, Due 7/2012)                    |       |       |         |                |       |
|                                         |       |                                          |       | Senior Subordinated Term Debt (7)     |       | 3,000,000  |         | 2,640,000           |       |
|                                         |       |                                          |       | (9.6%, Due 1/2013)                    |       |       |         |                |       |
|                                         |       |                                          |       |                                  |       |       |         |                |       |
| Reliable Biopharmaceutical                   |       | Manufacturing-pharmaceutical                  |       | Line of Credit (5) (27)               |       | 700,000    |         | 700,000             |       |
| Holdings, Inc.                               |       | and biochemical intermediates                 |       | (6.6%, Due 10/2010)                   |       |       |         |                |       |
|                                         |       |                                          |       | Mortgage Note (5)                     |       | 7,437,245  |         | 7,437,245           |       |
|                                         |       |                                          |       | (9.5%, Due 10/2014)                   |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (5)                  |       | 1,800,000  |         | 1,800,000           |       |
|                                         |       |                                          |       | (9.0%, Due 10/2012)                   |       |       |         |                |       |
|                                         |       |                                          |       | Senior Term Debt (3) (5)              |       | 11,993,441 |         | 11,993,441          |       |
|                                         |       |                                          |       | (11.0%, Due 10/2012)                  |       |       |         |                |       |
|                                         |       |                                          |       | Senior Subordinated Term Debt (5)     |       | 6,000,000  |         | 6,000,000           |       |
|                                         |       |                                          |       | (12%, Due 10/2013)                    |       |       |         |                |       |
|                                         |       |                                          |       | Common Stock Warrants (8)             |       | 208,675    |         | 385,756             |       |
|                                              |            |                                               |            |                                       |            |            |              |                     |            |  |  |

 

6

----

 
| **Company**                      | ** ** | **Industry**                          | ** ** | **Investment (1)**           | ** ** | **Cost**   | ** **      | **Fair Value** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|------------|-----------------|---------------------|------------|
|                             |       |                                  |       |                              |       |       |            |                |       |
| RiskMetrics Group Holdings,      |       | Service - develop risk and            |       | Senior Term Debt (7)              |       | $          |  1,980,000 |                | $          |  1,885,950 |   |
| LLC                              |       | wealth management solutions           |       | (4.9%, Due 1/2014)                |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| SCI Cable, Inc.                  |       | Service-cable, internet, voice        |       | Senior Term Debt (6)              |       | 2,721,960  |            | 2,398,350           |       |
|                             |       | provider                              |       | (11.3%, Due 10/2008)              |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| SCS Acquisition Corp. (2)        |       | Service-chemically treated            |       | Senior Term Debt (6)              |       | 3,954,811  |            | 3,885,602           |       |
|                             |       | equipment distribution                |       | (7.1%, Due 12/2011)               |       |       |            |                |       |
|                             |       |                                  |       | Senior Term Debt (3) (6)          |       | 6,475,000  |            | 6,232,188           |       |
|                             |       |                                  |       | (9.1%, Due 12/2011)               |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| Sunburst Media - Louisiana, LLC  |       | Service-radio station operator        |       | Senior Term Debt (6)              |       | 7,867,626  |            | 7,215,000           |       |
|                             |       |                                  |       | (10.1%, Due 6/2011)               |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| Sunshine Media Holdings          |       | Service-publisher regional B2B        |       | Credit Facility (6) (28)          |       | 700,000    |            | 670,250             |       |
|                             |       | trade magazines                       |       | (9.0%, Due 5/2010)                |       |       |            |                |       |
|                             |       |                                  |       | Senior Term Debt (6)              |       | 17,000,000 |            | 16,341,250          |       |
|                             |       |                                  |       | (9.0%, Due 5/2012)                |       |       |            |                |       |
|                             |       |                                  |       | Senior Term Debt (3) (6)          |       | 10,000,000 |            | 9,550,000           |       |
|                             |       |                                  |       | (11.5%, Due 5/2012)               |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| Thibaut Acquisition Co.          |       | Service-design and disbribute         |       | Credit Facility (6) (29)          |       | 2,000,000  |            | 1,955,000           |       |
|                             |       | wall covering                         |       | (7.6%, Due 1/2011)                |       |       |            |                |       |
|                             |       |                                  |       | Senior Term Debt (6)              |       | 2,362,500  |            | 2,309,344           |       |
|                             |       |                                  |       | (7.6%, Due 1/2011)                |       |       |            |                |       |
|                             |       |                                  |       | Senior Term Debt (3) (6)          |       | 3,000,000  |            | 2,910,000           |       |
|                             |       |                                  |       | (10.5%, Due 1/2011)               |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| Viapack, Inc. (2)                |       | Manufacturing-polyethylene            |       | Senior Real Estate Term Debt      |       | 925,000    |            | 892,625             |       |
|                             |       | film                                  |       | (7.6%, Due 3/2011)                |       |       |            |                |       |
|                             |       |                                  |       | Senior Term Debt (3) (6)          |       | 4,170,313  |            | 4,008,713           |       |
|                             |       |                                  |       | (11.3%, Due 3/2011)               |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| Visual Edge Technology, Inc. (2) |       | Service-office equipment distribution |       | Senior Subordinated Term Debt (6) |       | 5,000,000  |            | 3,175,000           |       |
|                             |       |                                  |       | (11.5%, Due 8/2011)               |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| Wesco Holdings, Inc. (2)         |       | Service-aerospace parts and           |       | Senior Term Debt (7)              |       | 2,452,475  |            | 2,291,453           |       |
|                             |       | distribution                          |       | (5.0%, Due 9/2013)                |       |       |            |                |       |
|                             |       |                                  |       | Senior Subordinated Term Debt (7) |       | 2,269,083  |            | 2,103,750           |       |
|                             |       |                                  |       | (8.4%, Due 3/2014)                |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| West Coast Yellow Pages, Inc.    |       | Service-directory publisher           |       | Senior Term Debt (6) (30)         |       | 1,556,133  |            | 770,222             |       |
|                             |       |                                  |       | (non-accrual, Due 8/2010)         |       |       |            |                |       |
|                             |       |                                  |       |                              |       |       |            |                |       |
| Westlake Hardware, Inc. (2)      |       | Retail-hardware and variety           |       | Senior Subordinated Term Debt (6) |       | 15,000,000 |            | 14,587,500          |       |
|                             |       |                                  |       | (10.3%, Due 1/2011)               |       |       |            |                |       |
|                             |       |                                  |       | Senior Subordinated Term Debt (6) |       | 10,000,000 |            | 9,650,000           |       |
|                             |       |                                  |       | (11.5%, Due 1/2011)               |       |       |            |                |       |
|                                  |            |                                       |            |                                   |            |            |                 |                     |            |  |  |

 

7

----

 
| **Company**                                      | ** ** | **Industry**                 | ** ** | **Investment (1)**           | ** **      | **Cost**   | ** **            | **Fair Value**   | ** ** |
|--------------------------------------------------|------------|------------------------------|------------|-----------------------------------|-----------------|------------|-----------------------|-----------------------|------------|
|                                             |       |                         |       |                              |            |       |                  |                  |       |
| Winchester Electronics                           |       | Manufacturing-high bandwidth |       | Senior Term Debt (6)              |            | $          |  1,990,000       |                  | $          |  1,935,274 |   |
|                                             |       | connectors and cables        |       | (6.9%, Due 5/2013)                |            |       |                  |                  |       |
|                                             |       |                         |       | Senior Subordinated Term Debt (6) |            | 10,000,000 |                  | 9,650,000             |       |
|                                             |       |                         |       | (12.0%, Due 4/2013)               |            |       |                  |                  |       |
|                                             |       |                         |       |                              |            |       |                  |                  |       |
| WP Evenflo Group                                 |       | Manufacturing-infant and     |       | Senior Term Debt (7)              |            | 1,980,000  |                  | 1,683,000             |       |
| Holdings Inc. (2)                                |       | juvenile products            |       | (5.6%, Due 2/2013)                |            |       |                  |                  |       |
|                                             |       |                         |       | Senior Subordinated Term Debt (7) |            | 2,000,000  |                  | 1,700,000             |       |
|                                             |       |                         |       | (9.1%, Due 2/2014)                |            |       |                  |                  |       |
| **Total  Non-Control/Non-Affiliate Investments** | ** ** | ** **                   | ** ** | **$**                             | **438,864,462** | ** ** | **$**                 | ** 412,286,047** |       |
| * *                                         |       |                         |       |                              |            |       |                  |                  |       |
| **CONTROL INVESTMENTS**                          |       |                         |       |                              |            |       |                  |
|                                             |       |                         |       |                              |            |       |                  |                  |       |
| BERTL, Inc.                                      |       | Service-web-based evaluator  |       | Line of Credit (31) (32)          |            | 637,948    |                  | —                |       |
|                                             |       | of digital imaging products  |       | (9.4%, Due 10/2009)               |            |       |                  |                  |       |
|                                             |       |                         |       | Common Stock (8)                  |            | 423,548    |                  | —                |       |
|                                             |       |                         |       |                              |            |       |                  |                  |       |
| U.S. HealthCare, Inc.                            |       | Service-magazine publisher/  |       | Common Stock (8)                  |            | $          |  2,469,754       |                  | $          |  451,389 |   |
|                                             |       | operator                     |       |                              |            |       |                  |                  |       |
| **Total Control  Investments**                   | ** ** | ** **                   | ** ** | ** **                        | ** **      | **$**      | ** 3,531,250**   | ** **            | **$**      | ** 451,389** |   |
| ** **                                       | ** ** | ** **                   | ** ** | ** **                        | ** **      | ** ** | ** **            | ** **            |       |
| **Total Investments**                            |       |                         |       |                              | ** **      | **$**      | ** 442,395,712** | ** **            | **$**      | ** 412,737,436** |   |

 

----

(1)  Percentage represents interest rates in effect at March 31,2008 and due date represents the contractual maturity date.

(2)  Certain of the listed securities are issued by affiliate(s) ofthe indicated portfolio company.

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

(4)  Last Out Tranche of senior debt, meaning if the companyis liquidated then the holder of the Last Out Tranche is paid after the seniordebt, however the debt is also junior to another Last Out Tranche.

(5)  Investment valued at cost due to recent acquisition.

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

(7)  Marketable securities, such as syndicated loans, arevalued based on the indicative bid price, on or near March 31, 2008,offered by the respective originating syndication agent’s trading desk, orsecondary desk.

(8)  Security is non-income producing.

(9)  Availability under the Ace Expediters credit facilitytotals $850,000.  There were noborrowings outstanding as of March 31, 2008.

(10) Availability under the ActivStyle credit facility totals$1,500,000.  Borrowings of $1,100,000were outstanding at March 31, 2008.

(11)  Availability under theAllison credit facility totals $4,000,000. There were no borrowings outstanding at March 31, 2008.

(12)  Availability under theAnitox credit facility totals $3,000,000. Borrowings of $2,000,000 were outstanding at March 31, 2008.

(13) Availability under the Chinese Yellow Pages creditfacility totals $950,000.  Borrowings of$855,071 were outstanding at March 31, 2008.

(14) Defiance includes a success fee with a fair value of$223,905.

(15) Availability under the Express Courier credit facility totals$1,200,000.  Borrowings of $900,000 wereoutstanding at March 31, 2008.

(16) Availability under the GFRC credit facility totals$3,000,000.  There were no borrowingsoutstanding at March 31, 2008.

(17) Availability under the Heartland credit facility totals$500,000.  Borrowings of $105,000 wereoutstanding at March 31, 2008.

(18) Availability under the International Junior Golf Tour (IJGT)credit facility totals $1,500,000. Borrowings of $1,050,000 were outstanding at March 31, 2008.

(19) Availability under the It’s Just Lunch revolving creditfacility totals $750,000. Borrowings of $550,000 were outstanding at March 31,2008.  The company may borrow anadditional $1,750,000 of the senior term debt facility, subject to certainconditions including Gladstone Capital’s approval. Borrowings of $500,000 wereoutstanding at March 31, 2008.

(20) Availability under the KMBQ credit facility totals$200,000.  Borrowings of $152,000 wereoutstanding at March 31, 2008.

(21) Availability under the LocalTel credit facility totals$3,000,000.  Borrowings of $1,170,000were outstanding at March 31, 2008.

(22) Availability under the MacFadden credit facility totals$1,400,000.  Borrowings of $1,015,979were outstanding at March 31, 2008.

(23) Availability under the Newhall credit facility totals$4,000,000.  There were no borrowingsoutstanding as of March 31, 2008.

 

8

----

 

(24)  Availability under thePinnacle credit facility totals $500,000. There were no borrowings outstanding at March 31, 2008.

(25) Precision may borrow up to $1,000,000 for purposes ofacquiring equipment. Borrowings of $806,220 were outstanding at March 31,2008.

(26) Availability under the ProfitSystems credit facility totals$1,250,000.  There were no borrowingsoutstanding at March 31, 2008.

(27)  Availability under theReliable credit facility totals $5,000,000. Borrowings of $700,000 wereoutstanding at March 31, 2008.

(28) Availability under the Sunshine credit facility totals$3,000,000.  Borrowings of $700,000 wereoutstanding at March 31, 2008.

(29) Availability under the Thibaut credit facility totals$2,000,000.  The facility was fully drawnat March 31, 2008.

(30) LocalTel and West Coast Yellow Pages are currently pastdue on interest payments and are on non-accrual.

(31) Availability under the BERTL credit facility totals$700,000.  Borrowings of $637,948 wereoutstanding at March 31, 2008.

(32) BERTL interest is currently being capitalized as Paid in Kind(“PIK”) interest.  Please refer to Note 2“Summary of Significant Accounting Policies.”

 

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

 

9

----

 

**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATEDSCHEDULE OF INVESTMENTS**

**AS OF SEPTEMBER 30,2007**

 
| **Company**                                | ** ** | **Industry**                                      | ** ** | **Investment (1)**                     | ** ** | **Cost**   | ** ** | **Fair Value** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                                 | ** ** | ** **                                        | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** **          | ** ** |
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS** | ** ** | ** **                                        | ** ** | ** **                                  | ** ** | ** ** | ** ** |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| Access Television                          |       | Service-cable airtime                             |       | Line of Credit (9)                          |       | $          | —     |                | $          | — |   |
| Network, Inc. (2)                     |       | (infomercials)                                    |       | (11.8% Due 3/2009)                          |       |       |       |                |       |
|                                       |       |                                              |       | Senior Term Debt (6)                        |       | 2,616,283  |       | 2,557,844           |       |
|                                       |       |                                              |       | (11.8% Due 3/2009)                          |       |       |       |                |       |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| ActivStyle Acquisition  Co. (2)            |       | Service-medical  products                         |       | Line of Credit (6) (10)                |       | 600,000    |       | 597,000             |       |
|                                       |       | distribution                                      |       | (10.0%, Due 7/2009)                         |       |       |       |                |       |
|                                       |       |                                              |       | Senior Term Debt (6)                        |       | 5,245,000  |       | 5,218,775           |       |
|                                       |       |                                              |       | (10.0%, Due 9/2012)                         |       |       |       |                |       |
|                                       |       |                                              |       | Senior Term Debt  (3) (6)              |       | 4,435,000  |       | 4,407,281           |       |
|                                       |       |                                              |       | (12.6%, Due 9/2012)                         |       |       |       |                |       |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| Allison Publications,  LLC (2)             |       | Service-publisher of  consumer                    |       | Senior Term Debt (6)                        |       | 7,884,092  |       | 7,779,503           |       |
|                                       |       | oriented magazines                                |       | (9.8%, Due 12/2011)                         |       |       |       |                |       |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| Anitox Acquisition  Company (2)            |       | Manufacturing-preservatives  for                  |       | Senior Real Estate Term  Debt               |       | 3,110,050  |       | 3,060,000           |       |
|                                       |       | animal feed                                       |       | (8.8%, Due 1/2012)                          |       |       |       |                |       |
|                                       |       |                                              |       | Line of Credit (11)                         |       | —     |       | —              |       |
|                                       |       |                                              |       | (10.0%, Due 1/2010)                         |       |       |       |                |       |
|                                       |       |                                              |       | Senior Term Debt (6)                        |       | 2,750,000  |       | 2,736,250           |       |
|                                       |       |                                              |       | (10.0%, Due 1/2012)                         |       |       |       |                |       |
|                                       |       |                                              |       | Senior Term Debt  (3) (6)              |       | 2,750,000  |       | 2,736,250           |       |
|                                       |       |                                              |       | (12.3%, Due 1/2012)                         |       |       |       |                |       |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| Badanco Acquisition  Corp.                 |       | Service-luggage design  and distribution          |       | Senior Subordinated  Term Debt (6)          |       | 9,652,500  |       | 9,628,369           |       |
|                                       |       |                                              |       | (12.4%, Due 7/2012)                         |       |       |       |                |       |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| Bresnan Communications,  LLC               |       | Service-telecommunications                        |       | Senior Term Debt (7)                        |       | 3,001,802  |       | 2,910,000           |       |
|                                       |       |                                              |       | (7.4%, Due 9/2013)                          |       |       |       |                |       |
|                                       |       |                                              |       | Senior Subordinated  Term Debt (7)          |       | 1,510,006  |       | 1,485,000           |       |
|                                       |       |                                              |       | (9.9%, Due 3/2014)                          |       |       |       |                |       |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| CCS, LLC                                   |       | Service-cable tv  franchise owner                 |       | Senior Term Debt (6)                        |       | 3,432,830  |       | 3,416,330           |       |
|                                       |       |                                              |       | (11.8%, Due 10/2007)                        |       |       |       |                |       |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| CHG  Companies, Inc. (2)              |       | Service-healthcare  staffing                      |       | Letter of Credit  (6) (7)              |       | 400,000    |       | 385,000             |       |
|                                       |       |                                              |       | (7.1%, Due 12/2012)                         |       |       |       |                |       |
|                                       |       |                                              |       | Senior Term Debt  (6) (7)              |       | 1,588,000  |       | 1,528,450           |       |
|                                       |       |                                              |       | (7.9%, Due 12/2012)                         |       |       |       |                |       |
|                                       |       |                                              |       | Senior Subordinated  Term Debt (6) (7) |       | 500,000    |       | 480,000             |       |
|                                       |       |                                              |       | (11.9%, Due 12/2012)                        |       |       |       |                |       |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| Chinese Yellow  Pages Company         |       | Service-publisher of  Chinese                     |       | Line of Credit  (6) (12)               |       | 230,071    |       | 228,633             |       |
|                                       |       | language directories                              |       | (11.8%, Due 9/2010)                         |       |       |       |                |       |
|                                       |       |                                              |       | Senior Term Debt (6)                        |       | 1,070,643  |       | 1,051,383           |       |
|                                       |       |                                              |       | (11.8%, Due 9/2010)                         |       |       |       |                |       |
|                                       |       |                                              |       |                                        |       |       |       |                |       |
| Clinton Holdings, LLC  (2)                 |       | Distribution-aluminum  sheets and stainless steel |       | Senior Subordinated  Term Debt              |       | 15,500,000 |       | 15,500,000          |       |
|                                       |       |                                              |       | (13.0%, Due 1/2013)                         |       |       |       |                |       |
|                                       |       |                                              |       | Common Stock Warrants  (8)                  |       | 109,124    |       | 222,777             |       |
|                                            |            |                                                   |            |                                             |            |            |            |                     |            |  |  |

 

10

----

 
| **Company**                          | ** ** | **Industry**                      | ** ** | **Investment (1)**                     | ** ** | **Cost**  | ** ** | **Fair Value** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|---------------------------------------------|------------|-----------|------------|---------------------|------------|
| CMI Acquisition, LLC  (2)            |       | Service-recycling                 |       | Senior Subordinated  Term Debt (6)          |       | $         | 6,500,000  |                | $          | 6,451,250 |   |
|                                 |       |                              |       | (12.4%, Due 11/2012)                        |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Community Media  Corporation         |       | Service-publisher of  free weekly |       | Senior Term Debt (6)                        |       | 2,510,974 |       | 2,481,780           |       |
|                                 |       | newspapers                        |       | (9.8%, Due 8/2012)                          |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Country Road  Communications LLC (2) |       | Service-telecommunications        |       | Senior Subordinated  Term Debt (6) (7) |       | 5,967,246 |       | 5,880,000           |       |
|                                 |       |                              |       | (13.1%, Due 7/2013)                         |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Defiance Acquisition                 |       | Manufacturing-trucking  parts     |       | Senior Term Debt  (3) (6)              |       | 6,325,000 |       | 6,245,938           |       |
| Corporation                          |       |                              |       | (13.8%, Due 4/2010)                         |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Doe & Ingalls  Management   |       | Distributor-specialty  chemicals  |       | Senior Term Debt (6)                        |       | 3,900,000 |       | 3,900,000           |       |
| LLC (2)                              |       |                              |       | (9.3%, Due 11/2010)                         |       |      |       |                |       |
|                                 |       |                              |       | Senior Term Debt  (3) (6)              |       | 4,455,000 |       | 4,455,000           |       |
|                                 |       |                              |       | (10.3%, Due 11/2010)                        |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Emdeon Business  Services,           |       | Service-healthcare  technology    |       | Senior Term Debt (7)                        |       | 2,433,992 |       | 2,382,949           |       |
| Inc.                                 |       | solutions                         |       | (7.4%, Due 11/2013)                         |       |      |       |                |       |
|                                 |       |                              |       | Senior Subordinated  Term Debt (7)          |       | 2,012,968 |       | 1,985,000           |       |
|                                 |       |                              |       | (10.2%, Due 5/2014)                         |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Express Courier  International,      |       | Service-ground delivery  and      |       | Line of Credit  (6) (13)               |       | 900,000   |       | 898,875             |       |
| Inc.                                 |       | logistics                         |       | (10.0%, Due 6/2009)                         |       |      |       |                |       |
|                                 |       |                              |       | Senior Term Debt (6)                        |       | 4,112,500 |       | 4,107,359           |       |
|                                 |       |                              |       | (10.0%, Due 6/2011)                         |       |      |       |                |       |
|                                 |       |                              |       | Senior Term Debt  (3) (6)              |       | 3,950,000 |       | 3,945,063           |       |
|                                 |       |                              |       | (12.3%, Due 6/2011)                         |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Finn Corporation                     |       | Manufacturing-landscape           |       | Common Stock Warrants  (8)                  |       | 37,000    |       | 3,005,333           |       |
|                                 |       | equipment                         |       |                                        |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Global Materials                     |       | Manufacturing-steel  wool         |       | Senior Term Debt  (3) (6)              |       | 5,100,000 |       | 4,883,250           |       |
| Technologies, Inc.              |       | products and metal  fibers        |       | (14.8%, Due 11/2009)                        |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| GTM Holdings, Inc.  (2)         |       | Manufacturing-socks               |       | Senior Term Debt (7)                        |       | 496,250   |       | 481,363             |       |
|                                 |       |                              |       | (8.1%, Due 10/2013)                         |       |      |       |                |       |
|                                 |       |                              |       | Senior Subordinated  Term Debt (7)          |       | 500,000   |       | 495,000             |       |
|                                 |       |                              |       | (11.4%, Due 4/2014)                         |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Greatwide Logistics                  |       | Service - logistics and           |       | Senior Term Debt (7)                        |       | 3,970,000 |       | 3,453,900           |       |
| Services, Inc.                  |       | transportation                    |       | (8.7%, Due 12/2013)                         |       |      |       |                |       |
|                                 |       |                              |       | Senior Subordinated  Term Debt (7)          |       | 4,000,000 |       | 3,280,000           |       |
|                                 |       |                              |       | (11.7%, Due 6/2014)                         |       |      |       |                |       |
|                                 |       |                              |       |                                        |       |      |       |                |       |
| Harrington  Holdings, Inc. (2)  |       | Service - healthcare  products    |       | Senior Term Debt (7)                        |       | 2,487,500 |       | 2,419,094           |       |
|                                 |       | distribution                      |       | (7.4%, Due 1/2014)                          |       |      |       |                |       |
|                                 |       |                              |       | Senior Subordinated  Term Debt (7)          |       | 5,000,000 |       | 4,825,000           |       |
|                                 |       |                              |       | (11.2%, Due 1/2014)                         |       |      |       |                |       |
|                                      |            |                                   |            |                                             |            |           |            |                     |            |  |  |

 

11

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| **Company**                          | ** ** | **Industry**                           | ** ** | **Investment (1)**                  | ** ** | **Cost**  | ** ** | **Fair Value** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|------------------------------------------|------------|-----------|------------|---------------------|------------|
| Heartland  Communications            |       | Service-radio station  operator        |       | Line of Credit  (6) (14)            |       | $         | 9,856      |                | $          | 9,807 |   |
| Group, LLC (2)                       |       |                                   |       | (11.3%, Due 5/2008)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Term Debt (6)                     |       | 4,824,340 |       | 4,533,921           |       |
|                                 |       |                                   |       | (11.3%, Due 5/2011)                      |       |      |       |                |       |
|                                 |       |                                   |       |                                     |       |      |       |                |       |
| IJGT Acquisition  Company            |       | Service-golf training                  |       | Line of Credit  (6) (15)            |       | 500,000   |       | 497,500             |       |
|                                 |       |                                   |       | (10.0%, Due 5/2010)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Term Debt (6)                     |       | 2,650,000 |       | 2,636,750           |       |
|                                 |       |                                   |       | (10.0%, Due 5/2012)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Term Debt  (3) (6)           |       | 2,500,000 |       | 2,481,250           |       |
|                                 |       |                                   |       | (12.3%, Due 5/2012)                      |       |      |       |                |       |
|                                 |       |                                   |       |                                     |       |      |       |                |       |
| It’s Just Lunch  International, |       | Service-dating service                 |       | Line of Credit  (6) (16)            |       | 550,000   |       | 492,250             |       |
| LLC                                  |       |                                   |       | (9.8%, Due 6/2009)                       |       |      |       |                |       |
|                                 |       |                                   |       | Senior Term Debt (6)                     |       | 3,300,000 |       | 2,953,500           |       |
|                                 |       |                                   |       | (10.0%, Due 6/2011)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Term Debt  (3) (6) (16) |       | 500,000   |       | 447,500             |       |
|                                 |       |                                   |       | (12.3%, Due 6/2011)                      |       |      |       |                |       |
|                                 |       |                                   |       |                                     |       |      |       |                |       |
| John Henry  Holdings, Inc. (2)  |       | Manufacturing-packaging  products      |       | Senior Subordinated  Term Debt (7)       |       | 8,000,000 |       | 8,000,000           |       |
|                                 |       |                                   |       | (12.8%, Due 6/2011)                      |       |      |       |                |       |
|                                 |       |                                   |       |                                     |       |      |       |                |       |
| Kinetek Acquisition  Corp.           |       | Manufacturing-custom                   |       | Senior Term Debt (7)                     |       | 1,494,240 |       | 1,444,087           |       |
|                                 |       | engineered  motors & controls |       | (7.6%, Due 11/2013)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Subordinated  Term Debt (7)       |       | 1,508,870 |       | 1,440,000           |       |
|                                 |       |                                   |       | (10.6%, Due 5/2014)                      |       |      |       |                |       |
|                                 |       |                                   |       |                                     |       |      |       |                |       |
| KMBQ Corporation                     |       | Service-AM/FM radio                    |       | Line of Credit (17)                      |       | 152,000   |       | 151,240             |       |
|                                 |       | broadcaster                            |       | (12.8%, Due 3/2010)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Term Debt (6)                     |       | 1,813,174 |       | 1,785,518           |       |
|                                 |       |                                   |       | (12.8%, Due 3/2010)                      |       |      |       |                |       |
|                                 |       |                                   |       |                                     |       |      |       |                |       |
| LocalTel, Inc.                  |       | Service-yellow pages                   |       | Line of Credit  (6) (18)            |       | 1,135,000 |       | 947,725             |       |
|                                 |       | publishing                             |       | (10.3%, Due 6/2009)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Term Debt (6)                     |       | 2,687,500 |       | 2,244,063           |       |
|                                 |       |                                   |       | (10.3%, Due 6/2011)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Term Debt  (3) (6)           |       | 2,750,000 |       | 2,200,000           |       |
|                                 |       |                                   |       | (12.8%, Due 6/2011)                      |       |      |       |                |       |
|                                 |       |                                   |       |                                     |       |      |       |                |       |
| Macfadden Performing  Arts           |       | Service-magazine  publisher            |       | Line of Credit  (6) (19)            |       | 515,979   |       | 510,175             |       |
| Media, LLC                           |       |                                   |       | (10.8%, Due 6/2009)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Term Debt (6)                     |       | 6,705,338 |       | 6,558,379           |       |
|                                 |       |                                   |       | (10.8%, Due 6/2009)                      |       |      |       |                |       |
|                                 |       |                                   |       |                                     |       |      |       |                |       |
| Meteor Holding  Corporation (2)      |       | Manufacturing-bar code  scanning       |       | Senior Term Debt (7)                     |       | 2,348,200 |       | 2,324,718           |       |
|                                 |       | and data capture                       |       | (8.2%, Due 12/2013)                      |       |      |       |                |       |
|                                 |       |                                   |       | Senior Subordinated  Term Debt (7)       |       | 1,500,000 |       | 1,425,000           |       |
|                                 |       |                                   |       | (11.5%, Due 12/2013)                     |       |      |       |                |       |
|                                      |            |                                        |            |                                          |            |           |            |                     |            |  |  |

 

12

----

 
| **Company**                                       | ** ** | **Industry**                                  | ** ** | **Investment (1)**                     | ** ** | **Cost**  | ** ** | **Fair Value** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|-----------|------------|---------------------|------------|
| Multi-Ag Media LLC (2)                            |       | Service-dairy magazine  publisher/            |       | Senior Term Debt (6)                        |       | $         | 2,548,152  |                | $          | 2,523,045 |   |
|                                              |       | information database                          |       | (11.8%, Due 12/2009)                        |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| Newhall  Holdings, Inc.(2)                   |       | Service-distributor of  personal              |       | Line of Credit  (6) (20)               |       | —    |       | —              |       |
|                                              |       | care products and  supplements                |       | (8.8%, Due 5/2010)                          |       |      |       |                |       |
|                                              |       |                                          |       | Senior Term Debt  (3) (6)              |       | 4,500,000 |       | 4,488,750           |       |
|                                              |       |                                          |       | (9.5%, Due 5/2012)                          |       |      |       |                |       |
|                                              |       |                                          |       | Senior Term Debt  (3) (6)              |       | 4,500,000 |       | 4,488,750           |       |
|                                              |       |                                          |       | (11.8%, Due 5/2012)                         |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| Northern  Contours, Inc. (2)                 |       | Manufacturing-veneer  and laminate components |       | Senior Subordinated  Term Debt (6)          |       | 7,000,000 |       | 6,982,500           |       |
|                                              |       |                                          |       | (12.8%, Due 5/2010)                         |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| Pinnacle Treatment  Centers, Inc.            |       | Service-Addiction  treatment                  |       | Line of Credit (21)                         |       | —    |       | —              |       |
|                                              |       | centers                                       |       | (10.0%, Due 12/2009)                        |       |      |       |                |       |
|                                              |       |                                          |       | Senior Term Debt (6)                        |       | 2,500,000 |       | 2,487,500           |       |
|                                              |       |                                          |       | (10.0%, Due 12/2011)                        |       |      |       |                |       |
|                                              |       |                                          |       | Senior Term Debt  (3) (6)              |       | 4,500,000 |       | 4,466,250           |       |
|                                              |       |                                          |       | (12.8%, Due 12/2011)                        |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| Precision Acquisition  Group                      |       | Manufacturing-consumable                      |       | Equipment Note  (6) (22)               |       | 671,850   |       | 671,850             |       |
| Holdings, Inc. (2)                           |       | components for the  aluminum                  |       | (10.3%, Due 10/2011)                        |       |      |       |                |       |
|                                              |       | industry                                      |       | Senior Term Debt (6)                        |       | 5,000,000 |       | 5,006,250           |       |
|                                              |       |                                          |       | (10.3%, Due 10/2010)                        |       |      |       |                |       |
|                                              |       |                                          |       | Senior Term Debt  (3) (6)              |       | 4,200,000 |       | 4,205,250           |       |
|                                              |       |                                          |       | (12.3%, Due 10/2010)                        |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| PROFITSystems                                     |       | Service-design and  develop                   |       | Line of Credit (23)                         |       | —    |       | —              |       |
| Acquisition Co. (2)                               |       | ERP software                                  |       | (10.0%, Due 7/2009)                         |       |      |       |                |       |
|                                              |       |                                          |       | Senior Term Debt (6)                        |       | 2,800,000 |       | 2,796,500           |       |
|                                              |       |                                          |       | (10.0%, Due 7/2011)                         |       |      |       |                |       |
|                                              |       |                                          |       | Senior Term Debt  (3) (6)              |       | 2,900,000 |       | 2,896,375           |       |
|                                              |       |                                          |       | (12.3%, Due 7/2011)                         |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| Puerto Rico Cable Acquisition  Company, Inc. |       | Service-telecommunications                    |       | Senior Subordinated  Term Debt (6) (7) |       | 7,798,538 |       | 7,388,358           |       |
|                                              |       |                                          |       | (11.5%, Due 1/2012)                         |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| Reading  Broadcasting, Inc.                  |       | Service-television  station                   |       | Senior Term Debt (6)                        |       | 7,560,031 |       | 7,497,971           |       |
|                                              |       | operator                                      |       | (12.3%, Due 3/2008)                         |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| RCS Management Holding  Co.                       |       | Service-healthcare  supplies                  |       | Senior Term Debt  (3) (6)              |       | 3,000,000 |       | 2,880,000           |       |
|                                              |       |                                          |       | (10.3%, Due 1/2011)                         |       |      |       |                |       |
|                                              |       |                                          |       | Senior Term Debt  (4) (6)              |       | 3,000,000 |       | 2,865,000           |       |
|                                              |       |                                          |       | (12.8%, Due 1/2011)                         |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| RedPrairie  Holding, Inc. (2)                |       | Service-design and  develop                   |       | Senior Term Debt (7)                        |       | 4,457,500 |       | 4,234,625           |       |
|                                              |       | supply chain software                         |       | (8.5%, Due 7/2012)                          |       |      |       |                |       |
|                                              |       |                                          |       | Senior Subordinated  Term Debt (7)          |       | 3,000,000 |       | 2,850,000           |       |
|                                              |       |                                          |       | (11.9%, Due 1/2013)                         |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| RiskMetrics Group  Holdings,                      |       | Service - develop risk  and                   |       | Senior Term Debt (7)                        |       | 1,990,000 |       | 1,965,125           |       |
| LLC                                               |       | wealth management  solutions                  |       | (7.4%, Due 1/2014)                          |       |      |       |                |       |
|                                              |       |                                          |       | Senior Subordinated  Term Debt (7)          |       | 500,000   |       | 495,000             |       |
|                                              |       |                                          |       | (10.7%, Due 7/2014)                         |       |      |       |                |       |
|                                              |       |                                          |       |                                        |       |      |       |                |       |
| SCI Cable, Inc.                              |       | Service-cable,  internet, voice               |       | Senior Term Debt (6)                        |       | 2,482,106 |       | 2,398,388           |       |
|                                              |       | provider                                      |       | (13.8%, Due 10/2008)                        |       |      |       |                |       |
|                                                   |            |                                               |            |                                             |            |           |            |                     |            |  |  |

 

13

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| **Company**                                      | ** ** | **Industry**                           | ** ** | **Investment (1)**                   | ** **      | **Cost**   | ** **      | **Fair Value** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------|-----------------|------------|-----------------|---------------------|------------|
| SCS Acquisition Corp.  (2)                       |       | Service-chemically  treated            |       | Senior Term Debt  (6) (18)           |            | $          | 5,117,311       |                | $          | 5,110,914 |   |
|                                             |       | equipment distribution                 |       | (9.8%, Due 12/2011)                       |            |       |            |                |       |
|                                             |       |                                   |       | Senior Term Debt  (3) (6) (18)  |            | 6,493,750  |            | 6,477,516           |       |
|                                             |       |                                   |       | (11.8%, Due 12/2011)                      |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| Sunburst Media -  Louisiana, LLC                 |       | Service-radio station  operator        |       | Senior Term Debt (6)  (11.5%, Due 6/2011) |            | 7,878,036  |            | 7,800,000           |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| Sunshine Media Holdings                          |       | Service-publisher  regional B2B        |       | Credit Facility  (6) (24)            |            | 700,000    |            | 694,750             |       |
|                                             |       | trade magazines                        |       | (9.8%, Due 5/2010)                        |            |       |            |                |       |
|                                             |       |                                   |       | Senior Term Debt (6)                      |            | 17,000,000 |            | 16,915,000          |       |
|                                             |       |                                   |       | (9.8%, Due 5/2012)                        |            |       |            |                |       |
|                                             |       |                                   |       | Senior Term Debt  (3) (6)            |            | 10,000,000 |            | 9,925,000           |       |
|                                             |       |                                   |       | (12.3%, Due 5/2012)                       |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| Thibaut Acquisition Co.                          |       | Service-design and  disbribute         |       | Credit Facility  (6) (25)            |            | 800,000    |            | 798,000             |       |
|                                             |       | wall covering                          |       | (10.3%, Due 1/2011)                       |            |       |            |                |       |
|                                             |       |                                   |       | Senior Term Debt (6)                      |            | 2,712,500  |            | 2,709,109           |       |
|                                             |       |                                   |       | (10.3%, Due 1/2011)                       |            |       |            |                |       |
|                                             |       |                                   |       | Senior Term Debt  (3) (6)            |            | 3,000,000  |            | 2,992,500           |       |
|                                             |       |                                   |       | (12.8%, Due 1/2011)                       |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| U.S. HealthCare                                  |       | Service-magazine  publisher/           |       | Senior Term Debt  (6) (26)           |            | 2,244,657  |            | 1,809,158           |       |
| Communications, LLC                              |       | operator                               |       | (non-accrual, Due  4/2011)                |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| Viapack, Inc. (2)                           |       | Manufacturing-polyethylene             |       | Senior Real Estate Term  Debt             |            | 975,000    |            | 975,000             |       |
|                                             |       | film                                   |       | (10.3%, Due 3/2011)                       |            |       |            |                |       |
|                                             |       |                                   |       | Senior Term Debt  (3) (6)            |            | 4,223,438  |            | 4,191,762           |       |
|                                             |       |                                   |       | (11.8%, Due 3/2011)                       |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| Visual Edge  Technology, Inc. (2)           |       | Service-office  equipment distribution |       | Senior Subordinated  Term Debt (6)        |            | 5,000,000  |            | 3,575,000           |       |
|                                             |       |                                   |       | (13.8%, Due 8/2011)                       |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| Wesco  Holdings, Inc. (2)                   |       | Service-aerospace parts  and           |       | Senior Term Debt (7)                      |            | 2,454,430  |            | 2,382,625           |       |
|                                             |       | distribution                           |       | (7.5%, Due 9/2013)                        |            |       |            |                |       |
|                                             |       |                                   |       | Senior Subordinated  Term Debt (7)        |            | 2,270,690  |            | 2,233,125           |       |
|                                             |       |                                   |       | (11.0%, Due 3/2014)                       |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| West Coast Yellow  Pages, Inc.              |       | Service-directory  publisher           |       | Senior Term Debt (6)                      |            | 1,584,335  |            | 1,518,441           |       |
|                                             |       |                                   |       | (13.3%, Due 8/2010)                       |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| Westlake  Hardware, Inc. (2)                |       | Retail-hardware and  variety           |       | Senior Subordinated  Term Debt (6)        |            | 15,000,000 |            | 14,986,500          |       |
|                                             |       |                                   |       | (13.0%, Due 1/2011)                       |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| Winchester Electronics                           |       | Manufacturing-high  bandwidth          |       | Senior Term Debt (6)                      |            | 1,995,000  |            | 1,990,013           |       |
|                                             |       | connectors and cables                  |       | (9.5%, Due 5/2013)                        |            |       |            |                |       |
|                                             |       |                                   |       | Senior Subordinated  Term Debt (6)        |            | 10,000,000 |            | 9,950,000           |       |
|                                             |       |                                   |       | (12.8%, Due 4/2013)                       |            |       |            |                |       |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| WP Evenflo Group                                 |       | Manufacturing-infant  and              |       | Senior Term Debt (7)                      |            | 1,990,000  |            | 1,850,700           |       |
| Holdings Inc. (2)                                |       | juvenile products                      |       | (8.0%, Due 2/2013)                        |            |       |            |                |       |
|                                             |       |                                   |       | Senior Subordinated  Term Debt (7)        |            | 2,000,000  |            | 1,860,000           |       |
|                                             |       |                                   |       | (11.5%, Due 2/2014)                       |            |       |            |                |       |
| **Total  Non-Control/Non-Affiliate Investments** | ** ** | ** **                             | ** ** | **$**                                     | **354,835,652** | ** ** | **$**           | **348,920,982**     | ** ** |
| * *                                         | * *   | * *                               | * *   | * *                                  | * *        | * *   | * *        | * *            | * *   |
| **CONTROL  INVESTMENTS**                         | ** ** | ** **                             | ** ** | ** **                                | ** **      | ** ** | ** **      | ** **          | ** ** |
|                                             |       |                                   |       |                                      |            |       |            |                |       |
| BERTL, Inc.                                 |       | Service-web-based  evaluator           |       | Common Stock  (5) (8)                |            | 923,548    |            | 923,548             |       |
|                                             |       | of digital imaging  products           |       |                                      |            |       |            |                |       |
| **Total  Investments (27)**                      | ** ** | ** **                             | ** ** | ** **                                | ** **      | **$**      | **355,759,200** | ** **          | **$**      | **349,844,530** | ** ** |

 

14

----

 

----

(1)  Percentage represents interest rates in effect at September 30,2007 and due date represents the contractual maturity date.

(2)  Certain of the listed securities are issued by affiliate(s) ofthe indicated portfolio company.

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

(4)  Last Out Tranche of senior debt, meaning if the companyis liquidated then the holder of the Last Out Tranche is paid after the seniordebt, however the debt is also junior to another Last Out Tranche.

(5)  Investment valued at cost due to recent acquisition.

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

(7)  Marketable securities, such as syndicated loans, arevalued based on the indicative bid price, on or near September 28, 2007,offered by the respective originating syndication agent’s trading desk, orsecondary desk.

(8)  Security is non-income producing.

(9)  Availability under the Access TV credit facility totals$500,000. There were no borrowings outstanding as of September 30, 2007.

(10)  Availability under the ActivStyle credit facilitytotals $1,500,000.  Borrowings of$600,000 were outstanding at September 30, 2007.

(11)  Availability under theAnitox credit facility totals $3,000,000. There were no borrowings outstanding at September 30, 2007.

(12) Availability under the Chinese Yellow Pages creditfacility totals $950,000.  Borrowings of$230,071 were outstanding at September 30, 2007.

(13) Availability under the Express Courier credit facility totals$1,500,000.  Borrowings of $900,000 wereoutstanding at September 30, 2007.

(14) Availability under the Heartland credit facility totals $500,000.  Borrowings of $9,856 were outstanding at September 30,2007.

(15) Availability under the International Junior Golf creditfacility totals $1,000,000.  Borrowingsof $500,000 were outstanding at September 30, 2007.

(16) Availability under the It’s Just Lunch revolving creditfacility totals $750,000. Borrowings of $550,000 were outstanding at September 30,2007.  The company may borrow anadditional $1,750,000 of the senior term debt facility, subject to certainconditions including Gladstone Capital’s approval. Borrowings of $500,000 wereoutstanding at September 30, 2007.

(17) Availability under the KMBQ credit facility totals$200,000.  Borrowings of $152,000 wereoutstanding at September 30, 2007.

(18) Availability under the LocalTel credit facility totals$3,000,000.  Borrowings of $1,135,000were outstanding at September 30, 2007.

(19) Availability under the MacFadden credit facility totals$1,400,000.  Borrowings of $515,979 wereoutstanding at September 30, 2007.

(20) Availability under the Newhall credit facility totals$4,000,000.  There were no borrowingsoutstanding as of September 30, 2007.

(21)  Availability under thePinnacle credit facility totals $500,000. There were no borrowings outstanding at September 30, 2007.

(22) Precision may borrow up to $1,000,000 for purposes ofacquiring equipment. Borrowings of $671,850 were outstanding at September 30,2007.

(23) Availability under the ProfitSystems credit facility totals$1,250,000.  There were no borrowingsoutstanding at September 30, 2007.

(24) Availability under the Sunshine credit facility totals$3,000,000.  Borrowings of $700,000 wereoutstanding at September 30, 2007.

(25) Availability under the Thibaut credit facility totals$1,000,000.  Borrowings of $800,000 wereoutstanding at September 30, 2007.

(26) US Healthcare Communications, LLC is currently past due oninterest payments and is on non-accrual.

(27) Aggregate gross unrealized depreciation for federal incometax purposes is $9,107,156; aggregate gross unrealized appreciation for federalincome tax purposes is $3,192,486.  Netunrealized depreciation is $5,914,670 based on a tax cost of $355,759,200.

 

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

 

15

----

 

**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(UNAUDITED)**

 
| ** **                                                                         | ** ** | **Three Months Ended March 31,** | ** **  | **Six Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------|-------------|----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                             | ** **  | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| INVESTMENT INCOME                                                                  |       |                                                 |        |                                               |       |   |   |   |   |
| Interest income – investments                                                 |       | $                                                    | 11,124,025  |                                               | $          | 8,254,459 |   | $ | 22,263,003 |   | $ | 16,153,059 |   |
| Interest income – cash and cash equivalents                                   |       | 102,436                                              |        | 31,645                                             |       | 246,921 |   | 68,914 |   |
| Interest income – notes receivable from employees                             |       | 118,106                                              |        | 132,931                                            |       | 236,282 |   | 271,122 |   |
| Prepayment fees and other income                                                   |       | 5,000                                                |        | 224,743                                            |       | 5,000 |   | 384,401 |   |
| Total investment income                                                            |       | 11,349,567                                           |        | 8,643,778                                          |       | 22,751,206 |   | 16,877,496 |   |
|                                                                               |       |                                                 |        |                                               |       |   |   |   |   |
| EXPENSES                                                                           |       |                                                 |        |                                               |       |   |   |   |   |
| Interest expense                                                                   |       | 1,854,815                                            |        | 1,811,019                                          |       | 4,211,130 |   | 2,931,276 |   |
| Loan servicing fee (Refer to Note 4)                                               |       | 1,561,941                                            |        | 760,623                                            |       | 2,943,248 |   | 1,479,775 |   |
| Base management fee (Refer to Note 4)                                              |       | 556,507                                              |        | 599,608                                            |       | 1,134,427 |   | 1,150,702 |   |
| Incentive fee (Refer to Note 4)                                                    |       | 1,288,428                                            |        | 1,158,995                                          |       | 2,749,085 |   | 2,307,478 |   |
| Administration fee (Refer to Note 4)                                               |       | 240,579                                              |        | 168,766                                            |       | 452,254 |   | 294,851 |   |
| Professional fees                                                                  |       | 410,034                                              |        | 109,081                                            |       | 539,287 |   | 220,001 |   |
| Amortization of deferred financing fees                                            |       | 183,780                                              |        | 68,200                                             |       | 257,579 |   | 126,500 |   |
| Stockholder related costs                                                          |       | 138,346                                              |        | 87,288                                             |       | 258,115 |   | 151,016 |   |
| Directors fees                                                                     |       | 56,970                                               |        | 56,970                                             |       | 111,220 |   | 111,220 |   |
| Insurance expense                                                                  |       | 58,717                                               |        | 62,398                                             |       | 112,930 |   | 125,092 |   |
| Other expenses                                                                     |       | 94,685                                               |        | 48,975                                             |       | 159,816 |   | 137,460 |   |
| Expenses before credit from Adviser                                                |       | 6,444,802                                            |        | 4,931,923                                          |       | 12,929,091 |   | 9,035,371 |   |
|                                                                               |       |                                                 |        |                                               |       |   |   |   |   |
| Credit to base management and incentive fees from  Adviser (Refer to Note 4)       |       | (1,537,374                                           | )           | (2,012,502                                         | )          | (3,923,309 | ) | (3,045,158 | ) |
| Total expenses net of credit to base management and  incentive fees                |       | 4,907,428                                            |        | 2,919,421                                          |       | 9,005,782 |   | 5,990,213 |   |
|                                                                               |       |                                                 |        |                                               |       |   |   |   |   |
| NET INVESTMENT INCOME                                                              |       | 6,442,139                                            |        | 5,724,357                                          |       | 13,745,424 |   | 10,887,283 |   |
|                                                                               |       |                                                 |        |                                               |       |   |   |   |   |
| REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:                                |       |                                                 |        |                                               |       |   |   |   |   |
| Realized gain on sale of investments                                               |       | —                                               |        | 84,205                                             |       | — |   | 86,519 |   |
| Realized gain on settlement of derivative                                          |       | 1,204                                                |        | 10,239                                             |       | 6,810 |   | 22,793 |   |
| Unrealized depreciation on derivative                                              |       | (1,756                                               | )           | (15,801                                            | )          | (12,309 | ) | (25,613 | ) |
| Net unrealized depreciation on investments                                         |       | (18,345,765                                          | )           | (1,718,149                                         | )          | (23,743,606 | ) | (2,722,528 | ) |
| Net loss on investments                                                            |       | (18,346,317                                          | )           | (1,639,506                                         | )          | (23,749,105 | ) | (2,638,829 | ) |
|                                                                               |       |                                                 |        |                                               |       |   |   |   |   |
| NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM  OPERATIONS                   |       | $                                                    | (11,904,178 | )                                                  | $          | 4,084,851 |   | $ | (10,003,681 | ) | $ | 8,248,454 |   |
|                                                                               |       |                                                 |        |                                               |       |   |   |   |   |
| NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM  OPERATIONS PER COMMON SHARE: |       |                                                 |        |                                               |       |   |   |   |   |
| Basic and Diluted                                                                  |       | $                                                    | (0.61       | )                                                  | $          | 0.33 |   | $ | (0.55 | ) | $ | 0.67 |   |
|                                                                               |       |                                                 |        |                                               |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING:                               |       |                                                 |        |                                               |       |   |   |   |   |
| Basic and Diluted                                                                  |       | 19,670,333                                           |        | 12,249,683                                         |       | 18,312,018 |   | 12,272,012 |   |

 

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

 

16

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**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN NET ASSETS**

**(UNAUDITED)**

 
| ** **                                                   | ** ** | **Six Months Ended March 31** | ** **  |
|--------------------------------------------------------------|------------|---------------------------------------------------|-------------|
| ** **                                                   | ** ** | **2008**                                          | ** **  | **2007** | ** ** |
| *Operations:*                                                |       |                                              |        |   |   |
| Net investment income                                        |       | $                                                 | 13,745,424  |   | $ | 10,887,283 |   |
| Net realized gain on sale of investments                     |       | —                                            |        | 86,519 |   |
| Realized gain on settlement of derivative                    |       | 6,810                                             |        | 22,793 |   |
| Unrealized depreciation on derivative                        |       | (12,309                                           | )           | (25,613 | ) |
| Net unrealized depreciation on investments                   |       | (23,743,606                                       | )           | (2,722,528 | ) |
| Net (decrease) increase in net assets from  operations       |       | (10,003,681                                       | )           | 8,248,454 |   |
|                                                         |       |                                              |        |   |   |
| *Capital transactions:*                                      |       |                                              |        |   |   |
| Issuance of common stock under shelf offering                |       | 106,225,500                                       |        | — |   |
| Distributions from net investment income                     |       | (15,666,062                                       | )           | (10,307,794 | ) |
| Repayment of principal on employee notes                     |       | 48,826                                            |        | 300,941 |   |
| Shelf offering costs                                         |       | (714,719                                          | )           | — |   |
| Stock surrendered in settlement of withholding tax           |       | —                                            |        | (1,488,193 | ) |
| Increase (decrease) in net assets from capital  transactions |       | 89,893,545                                        |        | (11,495,046 | ) |
|                                                         |       |                                              |        |   |   |
| Total increase (decrease) in net assets                      |       | 79,889,864                                        |        | (3,246,592 | ) |
| Net assets at beginning of year                              |       | 220,958,735                                       |        | 172,570,487 |   |
| Net assets at end of period                                  |       | $                                                 | 300,848,599 |   | $ | 169,323,895 |   |

 

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

 

17

----

 

**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
| ** **                                                                                                                           | ** ** | **Six Months Ended March 31,** | ** **  |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|-------------|
| ** **                                                                                                                           | ** ** | **2008**                                           | ** **  | **2007** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                             |       |                                               |        |   |   |
|                                                                                                                                 |       |                                               |        |   |   |
| Net (decrease) increase in net assets resulting from  operations                                                                     |       | $                                                  | (10,003,681 | ) | $ | 8,248,454 |   |
| Adjustments to reconcile net (decrease) increase in  net assets resulting from operations to net cash used in operating  activities: |       |                                               |        |   |   |
| Purchase of investments                                                                                                              |       | (93,824,204                                        | )           | (127,641,175 | ) |
| Principal repayments on investments                                                                                                  |       | 7,046,734                                          |        | 62,230,246 |   |
| Net amortization of premiums and discounts                                                                                           |       | 166,922                                            |        | 19,351 |   |
| Amortization of deferred financing fees                                                                                              |       | 257,579                                            |        | 126,500 |   |
| Realized loss on investments                                                                                                         |       | —                                             |        | 69,114 |   |
| Unrealized depreciation on derivative                                                                                                |       | 12,309                                             |        | 25,613 |   |
| Change in net unrealized depreciation on investments                                                                                 |       | 23,743,606                                         |        | 2,722,528 |   |
| Increase in interest receivable                                                                                                      |       | (875,614                                           | )           | (729,834 | ) |
| Decrease (increase) in funds due from custodian                                                                                      |       | 159,999                                            |        | (1,241,695 | ) |
| Decrease (increase) in prepaid assets                                                                                                |       | 57,376                                             |        | (14,343 | ) |
| Increase in due from affiliate                                                                                                       |       | —                                             |        | (28,768 | ) |
| Decrease (increase) in other assets                                                                                                  |       | 82,840                                             |        | (300,893 | ) |
| Increase in accounts payable                                                                                                         |       | 11,434                                             |        | 933 |   |
| (Decrease) increase in interest payable                                                                                              |       | (220,349                                           | )           | 281,206 |   |
| Increase (decrease) in accrued expenses and deferred  liabilities                                                                    |       | 207,192                                            |        | (234,957 | ) |
| Decrease in fees due to affiliate (Refer to Note 4)                                                                                  |       | (15,532                                            | )           | (240,363 | ) |
| Increase in administration fee due to Gladstone  Administration (Refer to Note 4)                                                    |       | 3,069                                              |        | 168,766 |   |
| Increase in funds held in escrow                                                                                                     |       | 223,543                                            |        | 29 |   |
| Increase in investment balance due to payment in  kind interest                                                                      |       | (25,964                                            | )           | — |   |
| Net cash used in operating activities                                                                                                |       | (72,992,741                                        | )           | (56,539,288 | ) |
|                                                                                                                                 |       |                                               |        |   |   |
| **CASH FLOW FROM INVESTING ACTIVITIES**                                                                                              |       |                                               |        |   |   |
|                                                                                                                                 |       |                                               |        |   |   |
| Redemption of U.S. Treasury Bill                                                                                                     |       | 2,484,464                                          |        | — |   |
| Net cash provided by investing activities                                                                                            |       | 2,484,464                                          |        | — |   |
|                                                                                                                                 |       |                                               |        |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                                            |       |                                               |        |   |   |
|                                                                                                                                 |       |                                               |        |   |   |
| Net proceeds from the issuance of common shares                                                                                      |       | 106,225,500                                        |        | — |   |
| Borrowings from the line of credit                                                                                                   |       | 95,900,000                                         |        | 146,900,000 |   |
| Repayments on the line of credit                                                                                                     |       | (116,881,000                                       | )           | (76,593,000 | ) |
| Distributions paid                                                                                                                   |       | (15,666,062                                        | )           | (10,307,794 | ) |
| Receipt of principal on notes receivable - employees                                                                                 |       | 48,826                                             |        | 300,941 |   |
| Deferred financing fees                                                                                                              |       | (326,570                                           | )           | (31,275 | ) |
| Shelf offering costs                                                                                                                 |       | (714,719                                           | )           | — |   |
| Withholding tax obligation settlement                                                                                                |       | —                                             |        | (1,488,193 | ) |
| Net cash provided by financing activities                                                                                            |       | 68,585,975                                         |        | 58,780,679 |   |
|                                                                                                                                 |       |                                               |        |   |   |
| **NET (DECREASE) INCREASE IN CASH AND CASH  EQUIVALENTS (1)**                                                                        |       | (1,922,302                                         | )           | 2,241,391 |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                                                                   |       | 8,838,658                                          |        | 731,744 |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                                                                         |       | $                                                  | 6,916,356   |   | $ | 2,973,135 |   |
|                                                                                                                                 |       |                                               |        |   |   |
| **CASH PAID DURING PERIOD FOR INTEREST**                                                                                             |       | $                                                  | 4,431,479   |   | $ | 2,650,071 |   |

 

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

 

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

 

18

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**GLADSTONECAPITAL CORPORATION**

**FINANCIALHIGHLIGHTS**

**(UNAUDITED)**

 
| ** **                                                       | ** ** | **Three Months Ended March 31,** | ** **  | **Six Months Ended March 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------|-------------|----------------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                             | ** **  | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Per Share Data (1)                                               |       |                                                 |        |                                               |       |   |   |   |   |
| Net asset value at beginning of period                           |       | $                                                    | 15.08       |                                               | $          | 13.88 |   | $ | 14.97 |   | $ | 14.02 |   |
| *Income from investment operations:*                             |       |                                                 |        |                                               |       |   |   |   |   |
| Net investment income (2)                                        |       | 0.33                                                 |        | 0.47                                               |       | 0.75 |   | 0.89 |   |
| Net unrealized depreciation on investments (2)                   |       | (0.94                                                | )           | (0.14                                              | )          | (1.30 | ) | (0.22 | ) |
| Total from investment operations                                 |       | (0.61                                                | )           | 0.33                                               |       | (0.55 | ) | 0.67 |   |
|                                                             |       |                                                 |        |                                               |       |   |   |   |   |
| Distributions to stockholders                                    |       | (0.42                                                | )           | (0.42                                              | )          | (0.84 | ) | (0.84 | ) |
| Issuance of common stock under shelf offering                    |       | 0.24                                                 |        | —                                             |       | 0.73 |   | — |   |
| Offering costs                                                   |       | (0.02                                                | )           | —                                             |       | (0.04 | ) | — |   |
| Repayment of principal on notes receivable                       |       | —                                               |        | 0.02                                               |       | — |   | 0.02 |   |
| Stock surrendered to settle withholding tax obligation           |       | —                                               |        | —                                             |       | — |   | (0.06 | ) |
| Net asset value at end of period                                 |       | $                                                    | 14.27       |                                               | $          | 13.82 |   | $ | 14.27 |   | $ | 13.82 |   |
|                                                             |       |                                                 |        |                                               |       |   |   |   |   |
| Per share market value at beginning of period                    |       | $                                                    | 17.01       |                                               | $          | 23.86 |   | $ | 19.52 |   | $ | 22.01 |   |
| Per share market value at end of period                          |       | 18.71                                                |        | 23.68                                              |       | 18.71 |   | 23.68 |   |
| Total return (3)(4)                                              |       | 12.69                                                | %           | 1.08                                               | %          | 0.45 | % | 11.50 | % |
| Shares outstanding at end of period                              |       | 21,087,574                                           |        | 12,249,683                                         |       | 21,087,574 |   | 12,249,683 |   |
|                                                             |       |                                                 |        |                                               |       |   |   |   |   |
| Ratios/Supplemental Data                                         |       |                                                 |        |                                               |       |   |   |   |   |
| Net assets at end of period                                      |       | $                                                    | 300,848,599 |                                               | $          | 169,323,895 |   | $ | 300,848,599 |   | $ | 169,323,895 |   |
| Average net assets (5)                                           |       | $                                                    | 293,158,407 |                                               | $          | 169,055,526 |   | $ | 279,259,377 |   | $ | 169,693,656 |   |
| Ratio of expenses to average net assets-annualized  (6)          |       | 8.79                                                 | %           | 11.32                                              | %          | 9.26 | % | 10.29 | % |
| Ratio of net expenses to average net  assets-annualized (7)      |       | 6.70                                                 | %           | 6.91                                               | %          | 6.45 | % | 7.06 | % |
| Ratio of net investment income to average net  assets-annualized |       | 8.79                                                 | %           | 13.54                                              | %          | 9.84 | % | 12.83 | % |

 

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| (1) |   | Based on actual shares outstanding at  the end of the corresponding period.                                                                                                                                                                                                                                                                                                                                                             |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Based on weighted average basic per  share data.                                                                                                                                                                                                                                                                                                                                                                                        |
| (3) |   | Total return equals the change in the  ending market value of the Company’s common stock from the beginning of the  period taking into account dividends reinvested in accordance with the terms  of our dividend reinvestment plan. Total return does not take into account  dividends that may be characterized as a return of capital. For further  information on estimated character of our dividends please refer to Note 9. |
| (4) |   | Amounts were not annualized.                                                                                                                                                                                                                                                                                                                                                                                                            |
| (5) |   | Average net assets are computed using  the average of the balance of net assets at the end of each month of the  reporting period.                                                                                                                                                                                                                                                                                                      |
| (6) |   | Ratio of expenses to average net assets  is computed using expenses before credits from Adviser to the base management  and incentive fees and including income tax expense.                                                                                                                                                                                                                                                            |
| (7) |   | Ratio of net expenses to average net  assets is computed using total expenses net of credits from Adviser to the  base management and incentive fees and including income tax expense.                                                                                                                                                                                                                                                  |

 

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

 

19

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**GLADSTONE CAPITALCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**MARCH 31, 2008**

**(UNAUDITED)**

 

NOTE1.  ORGANIZATION

 

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

 

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

 

GladstoneSSBIC Corporation (“Gladstone SSBIC”), a wholly-owned subsidiary of theCompany, was established on November 21, 2006 for the purpose of holding alicense to operate as a Specialized Small Business Investment Company.  Gladstone SSBIC acquired this license in February 2007.  This will enable the Company, through thissubsidiary, to make investments in accordance with the United States SmallBusiness Administration guidelines for specialized small business investmentcompanies.  Currently, Gladstone SSBICholds approximately $2.6 million in a money market account from the proceedsfrom the Company’s initial stock purchase in Gladstone SSBIC.

 

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

 

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

 

NOTE2.  SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

 

*UnauditedInterim Financial Statements*

 

Interimfinancial statements of the Company are prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) forinterim financial information and pursuant to the requirements for reporting onForm 10-Q and Article 10 of Regulation S-X.  Accordingly, certain disclosures accompanyingannual financial statements prepared in accordance with GAAP are omitted.  In the opinion of management, all adjustments,consisting solely of normal recurring accruals, necessary for the fairstatement of financial statements for the interim periods have beenincluded.  The current period’s resultsof operations are not necessarily indicative of results that ultimately may beachieved for the year.  The interimfinancial statements and notes thereto should be read in conjunction with thefinancial statements and notes thereto included in the Company’s Form 10-Kfor the fiscal year ended September 30, 2007, as filed with the Securitiesand Exchange Commission (the “SEC”) on December 3, 2007.

 

*Consolidation*

 

Under Article 6of Regulation S-X under the Securities Act of 1933, as amended, and theauthoritative accounting guidance provided by the AICPA Audit and AccountingGuide for Investment Companies, the Company is not permitted to consolidate anysubsidiary or other entity that is not an investment company.

 

*Useof Estimates*

 

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

 

*Reclassifications*

 

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

 

20

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*Cashand Cash Equivalents*

 

TheCompany considers all short-term, highly liquid investments that are bothreadily convertible to cash and have a maturity of three months or less at thetime of purchase to be cash equivalents. Items classified as cash equivalents include temporary investments inU.S. Treasury bills and can also include commercial paper and money-marketfunds.  Cash and cash equivalents arecarried at cost which approximates fair value as of March 31, 2008 and September 30,2007.

 

*Concentrationof Credit Risk*

 

Allof the Company’s cash at March 31, 2008 was deposited with three financialinstitutions, and the Company’s balances exceed federally insurablelimits.  The Company seeks to mitigatethis risk by depositing funds with major financial institutions.

 

*Classificationof Investments*

 

The 1940 Actrequires classification of the Company’s investments by its respective level ofcontrol.  As defined in the 1940 Act, “ControlInvestments” are investments in those portfolio companies that the Company isdeemed to “Control.”  “AffiliateInvestments” are investments in those portfolio companies that are “AffiliatedCompanies” of the Company, as defined in the 1940 Act, other than ControlInvestments.  “Non-Control/Non-AffiliateInvestments” are those that are neither Control Investments nor AffiliateInvestments.  In general, the 1940 Actprescribes that the Company has control over a portfolio company if it ownsgreater than 25% of the voting securities of the portfolio company.  The Company is deemed to be an affiliate of aportfolio company if it owns between 5% and 25% of the voting securities ofsuch portfolio company or has one or more seats on the affiliated company’sboard of directors.  However, if theCompany holds 50% or more contractual representation on a portfolio company’sboard of directors, the Company will be deemed to have control over theportfolio company.

 

*InvestmentValuation*

 

The Companycarries its investments at market value to the extent that market quotations arereadily available, and otherwise at fair value, as determined in good faith byits Board of Directors. In determining the fair value of the Company’sinvestments, the Adviser has established an investment valuation policy (the “policy”).  The policy is approved by the Company’s Boardof Directors and each quarter the Board of Directors reviews whether theAdviser has applied the policy consistently, and votes whether or not to acceptthe recommended valuation of the Company’s investment portfolio.

 

The Company uses generally accepted valuation techniques to value itsportfolio unless the Company has specific information about the value of aninvestment to determine otherwise. From time to time the Company may accept anappraisal of a business in which the Company holds securities. These appraisalsare expensive and occur infrequently but provide a third-party valuationopinion that may differ in results, techniques and scopes used to value theCompany’s investments.  When thesespecific third-party appraisals are engaged or accepted, the Company would usesuch appraisals to value the investment the Company has in that business if itwas determined that the appraisals were the best estimate of fair value.

 

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

 

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

 

**Securitiesfor which a limited market exists:** The Company values securities that are not traded onan established secondary securities market, but for which a limited market forthe security exists, such as certain participations in, or assignments of,syndicated loans, at the firm bid price. If a firm bid price is unavailable, the Company bases the value of thesecurity upon the indicative bid price offered by the respective originatingsyndication agent’s trading desk, or secondary desk, on or near the valuationdate.  To the extent that the Companyuses the indicative bid price as a basis for valuing the security, the Advisermay take further steps to consider additional information to validate thatprice in accordance with the policy.

 

**Securitiesfor which no market exists:** The fair value of the Company’s debt securities thatare not publicly traded, or for which a limited market does not exist, and thatare issued by portfolio companies where the Company has no equity, orequity-like securities, rely on opinions of value submitted to it by Standard &Poor’s Securities Evaluations, Inc. (“SPSE”). The Company may also submitpaid in kind (“PIK”) interest to SPSE for valuation when it is determined thePIK interest is likely to be received. SPSE will only evaluate the debt portionof the Company’s investments for which the Company specifically requestsevaluation, and may decline to 

 

21

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make requestedevaluations for any reason at its sole discretion. SPSE opinions of value aresubmitted to the Board of Directors along with the Adviser’s supplementalassessment and recommendation regarding valuation of each of these investments.

 

The fair value ofconvertible debt, equity, or other equity-like securities is determined basedon the total enterprise value of the portfolio company, or issuer, which iscalculated using a liquidity waterfall approach.  This approach incorporates some or all of thefollowing factors to determine the total 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, and discounted cash flow or other pertinent factors. In gatheringthe sales to third parties of similar securities, the Company may referenceindustry statistics and use outside experts.

 

Debt securitiesthat are issued by 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 as discussed above. Fair values of these debt securities arediscounted for any shortfall of total enterprise value over the total debtoutstanding for the borrower.

 

Finally, theCompany requests that SPSE also evaluate and assign values to success fees(conditional interest included in some loan securities) when the Companydetermines that the probability of receiving a success fee on a given loan isabove 6-8%, a threshold of significance.

 

Due to theuncertainty inherent in the valuation process, such estimates of fair value maydiffer significantly from the values that would have resulted had a readymarket for the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains or losses ultimatelyrealized on these investments to be different than the valuation currentlyassigned. The Board of Directors is ultimately responsible for setting the fairvalue and disclosure of investments in the financial statements.

 

*InterestIncome Recognition*

 

Interest income, adjusted for amortization of premiums and acquisitioncosts and for the accretion of discounts, is recorded on the accrual basis tothe extent that such amounts are expected to be collected. The Company stopsaccruing interest on its investments when it is determined that interest is nolonger collectible.  At March 31,2008, two Non-Control/Non-Affiliate investment were on non-accrual with anaggregate cost basis of approximately $8.2 million, or about 2% of the costbasis of all investments in the Company’s portfolio as compared to September 30,2007, in which one Non-Control/Non-Affiliate investment was on non-accrual witha cost basis of approximately $2.2 million at September 30, 2007, or lessthan 1% of the cost basis of all investments in the Company’s portfolio.  Conditional interest, or a success fee, isrecorded upon full repayment of a loan investment.

 

*Paidin Kind Interest*

 

TheCompany seeks to avoid PIK interest; however, the Company has one loan in itsportfolio that contains a PIK provision. A PIK provision requires the borrowerto accrue a payment to the Company but the borrower does not have to pay thatinterest until the loan is paid in full. The PIK interest is added to theprincipal balance of the loan and recorded as income to the Company even thoughthe cash has not been received.  Tomaintain the Company’s status as a RIC (as discussed in the Dividends policybelow), this non-cash source of income must be paid out to stockholders in theform of cash dividends, even though the Company has not yet collected the cash.The Company recorded PIK interest income of $15,696 and $29,622, respectively,for the three and six months ended March 31, 2008 from investments on theconsolidated statement of operations. There were no PIK loans in the Company’sportfolio during the three and six months ended March 31, 2007.

 

*ServicesProvided to Portfolio Companies*

 

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

 

The Adviserreceives fees for other services it provides to the Company’s portfoliocompanies.  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.  Theservices the Adviser provides to portfolio companies vary by investment, butgenerally include a broad array of services, such as investment bankingservices, arranging bank and equity financing, structuring financing frommultiple lenders and investors, reviewing existing credit facilities,restructuring existing investments, raising equity and debt capital, turnaroundmanagement, merger and acquisition services and recruiting new managementpersonnel.  Effective April 1, 2007,when 

 

22

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the Adviserreceives fees for these services, 50% of certain of those fees are voluntarilycredited against the base management fee that the Company pays to itsAdviser.  Prior to April 1, 2007,100% of such fees were credited against the base management fee.

 

The Adviser alsoreceives fees for monitoring and reviewing portfolio company investments.  These fees are recurring and are generallypaid annually or quarterly in advance to the Adviser throughout the life of theinvestment.  Fees of this nature arerecorded as revenue by the Adviser when earned and are not credited against thebase management fee.

 

The Company mayreceive fees for the origination and closing services it provides to portfoliocompanies through its Adviser. These fees are paid directly to the Company andare recognized as revenue upon closing of the originated investment and arereported as fee income in the consolidated statements of operations.

 

*RealizedGain or Loss and Unrealized Appreciation or Depreciation of PortfolioInvestments*

 

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

 

*DeferredFinance Costs*

 

Costsassociated with the Company’s line of credit facility with Deutsche Bank AG aredeferred and amortized over the life of the credit facility, generally for aperiod of one year.

 

*FederalIncome Taxes*

 

The Company intends tocontinue to qualify for treatment as a RIC under subchapter M of the Code. As aRIC, the Company will not be subject to federal income tax on the portion ofits taxable income and gains distributed to stockholders. To qualify as a RIC,the Company is required to distribute at least 90% of its investment companytaxable income, as defined by the Code. The Company intends to distribute atleast 90% of its ordinary income, and as a result, no income tax provisionshave been recorded. The Company may, but does not intend to, pay out a returnof capital.  The Company may also besubject to federal excise tax if it does not distribute at least 98% of itstaxable income and net capital gains in any calendar year.

 

*Dividends*

 

Distributions tostockholders are recorded on the record date. The Company is required to payout at least 90% of its ordinary income and short-term capital gains for eachtaxable year as a dividend to its stockholders in order to maintain its statusas a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code. It is thepolicy of the Company to pay out as a dividend up to 100% of those amounts. Theamount to be paid out as a dividend is determined by the Board of Directorseach quarter and is based on the annual earnings estimated by the management ofthe Company. Based on that estimate, a dividend is declared each quarter and ispaid out monthly over the course of the respective quarter. At year-end theCompany may pay a bonus dividend, in addition to the monthly dividends, toensure that it has paid out at least 90% of its ordinary income and short-termcapital gains for the year. Long-term capital gains are composed of successfees, prepayment fees and gains from the sale of securities held for one yearor more.  The Company may retainlong-term capital gains from the sale of securities, if any, and not pay themout as dividends; however, the Board of Directors may decide to declare and payout capital gains during any fiscal year. If the Company decides to retain long-term capital gains, the portion ofthe retained 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.

 

*RecentAccounting Pronouncements*

 

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 is effective as of the beginning of an entity’sfirst fiscal year that begins after December 15, 2006. The Company adoptedthis Interpretation on October 1, 2007. The adoption did not have amaterial impact on the consolidated financial statements.

 

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

 

23

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In February 2007, the FASB issued SFAS No. 159, *“The Fair Value Option for Financial Assets and FinancialLiabilities — Including an Amendment of FASB Statement No. 115”*which is effective for fiscal years beginning after November 15, 2007.This pronouncement permits an entity to choose to measure many financialinstruments and certain other items at fair value at specified election dates.Subsequent unrealized gains and losses on items for which the fair value optionhas been elected will be reported in earnings. The Company is currentlyevaluating the potential impact of this pronouncement on its consolidatedfinancial statements.

 

In November 2007, the SEC issued Staff Accounting Bulletin No. 109,*“Written Loan Commitments Recorded at Fair ValueThrough Earnings”* (“SAB 109”)*.* SAB 109provides guidance on the accounting for written loan commitments recorded atfair value under GAAP. Specifically, SAB 109 revises the Staff’s views onincorporating expected net future cash flows related to loan servicingactivities in the fair value measurement of a written loan commitment. SAB 109, which  supersedes  SAB  105,  “*Application  of  Accounting Principles  to  Loan Commitments,”* requires the  expected  net  future  cash  flows  relatedto the associated  servicing of the loan be included in the measurement ofall written loan commitments that are accounted for at fair value throughearnings. SAB 109 is effective in fiscal quarters beginning after December 15,2007. The Company is currently evaluating the impact of this pronouncement onits consolidated financial statements.

 

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

 

In December 2007,the FASB issued SFAS No. 160, “*NoncontrollingInterest in Consolidated Financial Statements”* (“SFAS No. 160”)*.*SFAS No. 160 amendsAccounting Research Bulletin 51 to establish accounting and reporting standardsfor the noncontrolling (minority) interest in a subsidiary and for thedeconsolidation of a subsidiary. It clarifies that a noncontrolling interest ina subsidiary is an ownership interest in the consolidated entity that should bereported as equity in the consolidated financial statements.  SFAS No. 160 is effective for interimperiods beginning on or after December 15, 2008.  The Company is required to adopt SFAS No. 160on October 1, 2009 and is currently evaluating the impact of thispronouncement on its consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, “*Disclosures about Derivative Instruments and Hedging Activities*”(“SFAS No. 161”), which is intended to help investors better understandhow derivative instruments and hedging activities affect an entity’s financialposition, financial performance and cash flows through enhanced disclosurerequirements.  The enhanced disclosuresprimarily surround disclosing the objectives and strategies for usingderivative instruments by their underlying risk as well as a tabular format ofthe fair values of the derivative instruments and their gains and losses.  SFAS No. 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008.  The Company is evaluating theimpact of this pronouncement on the reporting of its derivatives.

 

NOTE3. INVESTMENTS

 

*Non-Control/Non-AffiliateInvestments*

 

At March 31,2008 and September 30, 2007, the Company held investments inNon-Control/Non-Affiliate of approximately $438.9 million and $354.8 million,at cost, respectively.

 

*ControlInvestments*

 

At March 31,2008, the Company had two control investments in BERTL, Inc. (“BERTL”) andU.S. Healthcare, Inc. (“U.S. Healthcare”).

 

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

 

·      *U.S. Healthcare:* The Company offered at publicsale certain assets of U.S. Healthcare on January 30, 2008, consistinggenerally of all fixtures and all tangible and intangible personalproperty.  The Company acquired theseassets in the sale, through a newly formed subsidiary, and will continue thebusiness of U.S. Healthcare under its control. U.S.Healthcare is a service-magazine publisher/operator.

 

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Theinvestments in BERTL and U.S. Healthcare consisted of the following as of March 31,2008 and September 30, 2007:

 
| ** **                    | ** ** | ** **       | ** ** | **March 31, 2008** | ** **    | **September 30, 2007** | ** ** |
|-------------------------------|------------|------------------|------------|-------------------------|---------------|-----------------------------|------------|
| **Company**                   | ** ** | **Investment**   | ** ** | **Cost**                | ** **    | **Fair Value**              | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| BERTL, Inc.              |       | Line of credit   |       | $                       | 637,948       |                        | $          | — |   | $ | — |   | $ | — |   |
|                          |       | Common stock     |       | 423,548                 |          | —                      |       | 923,548 |   | 923,548 |   |
|                          |       |             |       |                    |          |                        |       |   |   |   |   |
| U.S.  Healthcare, Inc.*  |       | Senior Term Debt |       | 2,469,754               |          | 451,389                     |       | — |   | — |   |
| **Total control investments** | ** ** | ** **       | ** ** | **$**                   | **3,531,250** | ** **                  | **$**      | **451,389** | ** ** | **$** | **923,548** | ** ** | **$** | **923,548** | ** ** |

 

----

*U.S. Healthcare, Inc. is a new control investment as of March 31,2008.

 

Investmentsat fair value consisted of the following industry classifications as of March 31,2008 and September 30, 2007:

 
| ** **                                          | ** ** | **March 31, 2008** | ** **  | **September 30, 2007** | ** ** |
|-----------------------------------------------------|------------|-------------------------|-------------|-----------------------------|------------|
| ** **                                          | ** ** | ** **              | ** **  | **Percentage**              | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Industry  Classification**                        | ** ** | **Fair Value**          | ** **  | **Total  Investments**      | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Aerospace & Defense                        |       | $                       | 4,395,203   |                        | 1.1        | % | 1.5 | % | $ | 4,615,750 |   | 1.3 | % | 2.1 | % |
| Automobile                                          |       | 6,011,280               |        | 1.5                         | %          | 2.0 | % | 6,245,938 |   | 1.8 | % | 2.8 | % |
| Broadcast (TV & Radio)                     |       | 48,824,360              |        | 11.8                        | %          | 16.2 | % | 41,934,377 |   | 12.0 | % | 19.0 | % |
| Buildings and Real Estate                           |       | 14,268,125              |        | 3.5                         | %          | 4.7 | % | — |   | — |   | — |   |
| Cargo Transport                                     |       | 28,687,571              |        | 7.0                         | %          | 9.5 | % | 15,685,197 |   | 4.5 | % | 7.1 | % |
| Chemicals, Plastics & Rubber               |       | 27,686,897              |        | 6.7                         | %          | 9.2 | % | 25,110,192 |   | 7.2 | % | 11.4 | % |
| Diversified/Conglomerate Manufacturing              |       | 3,383,000               |        | 0.8                         | %          | 1.1 | % | 3,710,700 |   | 1.1 | % | 1.7 | % |
| Electronics                                         |       | 29,352,554              |        | 7.1                         | %          | 9.8 | % | 31,351,318 |   | 9.0 | % | 14.2 | % |
| Farming & Agriculture                      |       | 13,356,608              |        | 3.2                         | %          | 4.4 | % | 11,537,833 |   | 3.3 | % | 5.2 | % |
| Finance                                             |       | 1,885,950               |        | 0.5                         | %          | 0.6 | % | 2,460,125 |   | 0.7 | % | 1.1 | % |
| Healthcare, Education & Childcare          |       | 63,087,834              |        | 15.2                        | %          | 21.0 | % | 36,927,299 |   | 10.5 | % | 16.7 | % |
| Home & Office Furnishings                  |       | 16,964,344              |        | 4.1                         | %          | 5.6 | % | 17,057,109 |   | 4.9 | % | 7.7 | % |
| Leisure, Amusement, Movies & Entertainment |       | 8,844,875               |        | 2.1                         | %          | 2.9 | % | 9,508,750 |   | 2.7 | % | 4.3 | % |
| Machinery                                           |       | 9,981,204               |        | 2.4                         | %          | 3.3 | % | 9.883,350 |   | 2.8 | % | 4.5 | % |
| Mining, Steel, Iron & Non-Precious Metals  |       | 26,289,450              |        | 6.4                         | %          | 8.7 | % | 27,057,277 |   | 7.7 | % | 12.2 | % |
| Personal and Non-durable Consumer Products          |       | 8,675,775               |        | 2.1                         | %          | 2.9 | % | 8,977,500 |   | 2.6 | % | 4.1 | % |
| Printing & Publishing                      |       | 66,722,362              |        | 16.2                        | %          | 22.2 | % | 72,190,583 |   | 20.6 | % | 32.7 | % |
| Retail Stores                                       |       | 24,237,500              |        | 5.9                         | %          | 8.1 | % | 14,986,500 |   | 4.3 | % | 6.8 | % |
| Textiles & Leather                         |       | 10,082,544              |        | 2.4                         | %          | 3.4 | % | 10,604,732 |   | 3.0 | % | 4.8 | % |
| **Total**                                           |       | $                       | 412,737,436 |                        | 100.0      | % |   |   | $ | 349,844,530 |   | 100.0 | % |   |   |

 

Theinvestments at fair value were included in the following geographic regions ofthe United States at March 31, 2008 and September 30, 2007:

 
| ** **             | ** ** | **March 31, 2008** | ** **  | **September 30, 2007** | ** ** |
|------------------------|------------|-------------------------|-------------|-----------------------------|------------|
| ** **             | ** ** | ** **              | ** **  | **Percentage**              | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Geographic  Region** | ** ** | **Fair Value**          | ** **  | **Total  Investments**      | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Midwest                |       | $                       | 209,958,701 |                        | 50.8       | % | 69.8 | % | $ | 152,927,681 |   | 43.7 | % | 69.2 | % |
| West                   |       | 66,487,683              |        | 16.1                        | %          | 22.1 | % | 70,842,472 |   | 20.2 | % | 32.1 | % |
| Mid-Atlantic           |       | 53,462,074              |        | 13.0                        | %          | 17.8 | % | 56,865,802 |   | 16.3 | % | 25.7 | % |
| Southeast              |       | 63,500,909              |        | 15.4                        | %          | 21.1 | % | 44,488,416 |   | 12.7 | % | 20.1 | % |
| Northeast              |       | 12,906,774              |        | 3.1                         | %          | 4.3 | % | 17,331,801 |   | 5.0 | % | 7.8 | % |
| U.S. Territory         |       | 6,421,295               |        | 1.6                         | %          | 2.1 | % | 7,388,358 |   | 2.1 | % | 3.3 | % |
|                   |       | $                       | 412,737,436 |                        | 100.0      | % |   |   | $ | 349,844,530 |   | 100.0 | % |   |   |
|                        |            |                         |             |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

25

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*InvestmentPrincipal Repayment*

 

The followingtable summarizes the contractual principal repayment and maturity of theCompany’s investment portfolio by fiscal year, assuming no voluntaryprepayments:

 

| ** **                              | ** ** | ** **                        | ** ** | **Amount**  | ** **  |
|-----------------------------------------|------------|-----------------------------------|------------|-------------|-------------|
| For the remaining six  months:          |       | 2008                              |       | $           | 17,670,339  |   |
| For the year ending  September 30: |       | 2009                              |       | 32,518,137  |        |
|                                    |       | 2010                              |       | 46,228,823  |        |
|                                    |       | 2011                              |       | 106,735,171 |        |
|                                    |       | 2012                              |       | 96,287,900  |        |
|                                    |       | 2013                              |       | 90,993,643  |        |
|                                    |       | Thereafter                        |       | 48,513,598  |        |
| ** **                              | ** ** | **Total Contractual Repayments**  |       | $           | 438,947,611 |   |
|                                    |       | Investments in Equity  Securities |       | 3,448,101   |        |
| ** **                              | ** ** | **Total**                         |       | $           | 442,395,712 |   |

 

NOTE4. RELATED PARTY TRANSACTIONS

 

*Loansto Employees*

 

TheCompany provided loans to employees of the Adviser for the exercise of optionsunder the Amended and Restated 2001 Equity Incentive Plan (the “2001 Plan”),which has since been terminated and is no longer in operation.  The loans require the quarterly payment ofinterest at the market rate in effect at the date of issue, have varying termsnot exceeding ten years and have been recorded as a reduction of netassets.  The loans are evidenced by fullrecourse notes that are due upon maturity or 60 days following termination ofemployment, and the shares of common stock purchased with the proceeds of theloan are posted as collateral.  No newloans were issued during the three and six months ended March 31, 2008 or March 31,2007. The Company received $48,826 and $300,941 of principal repayments duringthe six months ended March 31, 2008 and 2007, respectively.  The Company recognized interest income fromall employee stock option loans of $118,106 and $236,282 for the three and sixmonths ended March 31, 2008, as compared to $132,931 and $271,122 for thethree and six months ended March 31, 2007, respectively.

 

*InvestmentAdvisory and Management and Administration Agreements*

 

TheCompany is externally managed by the Adviser, which is controlled by itschairman and chief executive officer, under a contractual investment advisory agreement.  On October 1, 2006, the Company enteredinto the investment advisory agreement (the “Advisory Agreement”).

 

*Termsof the Advisory Agreement*

 

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

 

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

 

·    no incentivefee in any calendar quarter in which its pre-incentive fee net investmentincome does not exceed the hurdle rate (7% annualized);

 

·    100% ofpre-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 theamount of pre-incentive fee net investment income, if any, that exceeds 2.1875%in any calendar quarter (8.75% annualized).

 

Thesecond part of the incentive fee is a capital gains incentive fee that isdetermined and payable in arrears as of the end of each fiscal year (or upontermination of the Advisory Agreement, as of the termination date) and equals20% of the Company’s realized capital 

 

26

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gainsas of the end of the fiscal year. In determining the capital gains incentivefee payable to the Adviser, the Company calculates the cumulative aggregaterealized capital gains and cumulative aggregate realized capital losses sincethe Company’s inception, and the aggregate unrealized capital depreciation asof the date of the calculation, as applicable, with respect to each of theinvestments in its portfolio.

 

TheAdviser’s board of directors voluntarily waived, for the three months ended March 31,2008 and March 31, 2007, the annual 2.0% base management fee to 0.5% forsenior syndicated loan participations and also waived the entire incentive feedue for the three months ended March 31, 2008 and a portion of theincentive fee due for the three months ended March 31, 2007.

 

Inaddition to the base management and incentive fees under the AdvisoryAgreement, certain fees received by the Adviser from the Company’s portfolio companiesare credited against the investment advisory fee.  Effective April 1, 2007, 50% of certainof the fees received by the Adviser have been voluntarily credited against thebase management fee.  In addition, theCompany will continue to pay its direct expenses including, but not limited to,directors’ fees, legal and accounting fees, stockholder related expenses, anddirectors and officers insurance under the Advisory Agreement.

 

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

 
| ** **                                                                           | ** ** | **Three months ended**   | ** ** | **Six months ended**     | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                                                           | ** ** | **March 31,  2008** | ** ** | **March 31,  2007** | ** ** | **March 31,  2008** | ** ** | **March 31,  2007** | ** ** |
| Base management fee                                                                  |       | $                        | 556,507    |                     | $          | 599,608 |   | $ | 1,134,427 |   | $ | 1,150,702 |   |
| Credit for investment  advisory fees received by Adviser                             |       | (150,000                 | )          | (775,000                 | )          | (971,838 | ) | (1,086,000 | ) |
| Fee reduction for the waiver of 2% fee on senior  syndicated loans to 0.5% per annum |       | (98,946                  | )          | (149,124                 | )          | (202,386 | ) | (301,786 | ) |
| Net base management fee                                                              |       | $                        | 307,561    |                     | $          | (324,516 | ) | $ | (39,797 | ) | $ | (237,084 | ) |
|                                                                                 |       |                     |       |                     |       |   |   |   |   |
| Incentive fee                                                                        |       | $                        | 1,288,428  |                     | $          | 1,158,995 |   | $ | 2,749,085 |   | $ | 2,307,478 |   |
| Credit from voluntary  waiver issued by Adviser’s board of directors            |       | (1,288,428               | )          | (1,088,378               | )          | (2,749,085 | ) | (1,657,372 | ) |
| Net incentive fee                                                                    |       | $                        | —     |                     | $          | 70,617 |   | $ | — |   | $ | 650,106 |   |
|                                                                                 |       |                     |       |                     |       |   |   |   |   |
| Credit for investment  advisory fees received by Adviser                             |       | $                        | (150,000   | )                        | $          | (775,000 | ) | $ | (971,838 | ) | $ | (1,086,000 | ) |
| Fee reduction for the waiver of 2% fee on senior  syndicated loans to 0.5% per annum |       | (98,946                  | )          | (149,124                 | )          | (202,386 | ) | (301,786 | ) |
| Incentive fee credit                                                                 |       | (1,288,428               | )          | (1,088,378               | )          | (2,749,085 | ) | (1,657,372 | ) |
| Credit to base management and incentive fees from  Adviser                           |       | $                        | (1,537,374 | )                        | $          | (2,012,502 | ) | $ | (3,923,309 | ) | $ | (3,045,158 | ) |

 

Asof March 31, 2008, the Company owed $307,561 of base management fee to theAdviser, presented in the Fees due to Adviser in the accompanying consolidatedstatements of assets and liabilities. Overall, the base management fee due to the Adviser cannot exceed 2% oftotal assets (as reduced by cash and cash equivalents pledged to creditors)during any given fiscal year.

 

*LoanServicing and Portfolio Company Fees*

 

TheAdviser also services the loans held by Business Loan, in return for which itreceives a 1.5% annual fee based on the monthly aggregate outstanding balanceof the loans pledged under the Company’s line of credit.  Since the Company owns these loans, all loanservicing fees paid to the Adviser are treated as reductions directly againstthe 2% base management fee under the Advisory Agreement.  Effective in April 2006, the Adviser’sboard of directors voluntarily reduced the annual servicing fee rate on theseloans to 0.5%. For the three and six months ended March 31, 2008, theseloan servicing fees totaled $1,561,941 and $2,943,248, respectively, ascompared to loan servicing fees for the three and six months ended March 31,2007 of $760,623 and $1,479,775, respectively, all of which were deductedagainst the 2% base management fee in order to derive the base management feewhich is presented as the line item base management fee in the accompanyingconsolidated statements of operations. At March 31, 2008, the Company owed $385,424 of unpaid loanservicing fees to the Adviser, which are netted and recorded in Fees due toAdviser.  At September 30, 2007, theCompany owed $267,427 in loan servicing fees to the Adviser, recorded in Feesdue to Adviser in the accompanying consolidated statements of assets andliabilities.  Under the AdvisoryAgreement, the Adviser also provides managerial assistance and other servicesto the Company’s portfolio companies and may receive fees for services otherthan managerial assistance services.

 

27

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*AdministrationAgreement*

 

OnOctober 1, 2006, the Company entered into an administration agreement (the“Administration Agreement”) with Gladstone Administration, LLC (the “Administrator”),a wholly-owned subsidiary of the Adviser. Under the Administration Agreement, the Company pays separately foradministrative services.  TheAdministration Agreement provides for payments equal to the Company’s allocableportion of the Administrator’s overhead expenses in performing its obligationsunder the Administration Agreement, including, but not limited to, rent foremployees of the Administrator, and the allocable portion of salaries andbenefits expenses of the Company’s chief financial officer, controller, chiefcompliance officer, treasurer and their respective staffs.  The Company recorded an administration fee of$240,579 and $452,254, respectively, for the three and six months ended March 31,2008, as compared to an administration fee of $168,766 and $294,851,respectively, for the three and six months ended March 31, 2007. As of March 31,2008 and September 30, 2007, $240,579 and $237,510, respectively, wasunpaid and included in the Fee due to Administrator in the accompanyingconsolidated statements of assets and liabilities.

 

NOTE5. LINE OF CREDIT

 

Through BusinessLoan, the Company has a $300 million revolving credit facility (the “DBFacility”) with Deutsche Bank AG, as administrative agent, pursuant to whichBusiness Loan pledges the loans it holds to secure future advances by certaininstitutional lenders. The interest rate charged on the advances under the DBFacility is based on the Commercial Paper (“CP”) rate which is equivalent tothe weighted average per annum rates paid by the DB Facility’s CP lenders inrespect of CP notes issued by the CP lender during such period.  Business Loan also has the ability to borrowat an alternative rate from the committed lenders if CP lenders are unable tofund advances.  The alternative rate isthe London Interbank Offered Rate (“LIBOR”), or if LIBOR is unavailable, thePrime Rate or the Federal Funds Rate, plus 1.0%. In February 2008, theCompany increased the DB Facility to $250 million.  The DB Facility matures on May 23,2008.  As of March 31, 2008, theoutstanding principal balance under the DB Facility was approximately $123.5million at a stated interest rate of approximately 3.31%, plus a 1.20% programfee.  In April 2008, the Companyincreased the DB Facility to $300 million (see further discussion in footnote11. Subsequent Events). Available borrowings are subject to various constraintsimposed under the credit agreement, based on the aggregate loan balance pledgedby Business Loan, which varies as loans are added and repaid, regardless ofwhether such repayments are early prepayment or are made as contractuallyrequired.  At March 31, 2008, theremaining borrowing capacity available under the DB Facility was approximately$126.5 million.  The weighted averageborrowings outstanding under the DB Facility for the six months ended March 31,2008 and 2007 were $142.8 million and $90.8 million, respectively, at aweighted average annual interest cost of 6.26% and 6.74%, respectively, whichwas computed by using the annual stated interest rate plus commitment and otherfees, plus the amortization of deferred financing fees divided by the weightedaverage debt outstanding.

 

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 industry concentrationsof loans that are eligible to secure advances. As of March 31, 2008, Business Loan was in compliance with all ofthe facility covenants.

 

The administrativeagent also requires that any interest or principal payments on pledged loans beremitted directly by the borrower into a lockbox account with the Bank of NewYork Mellon as custodian.  Deutsche BankAG is also the trustee of the account and once a month remits the collectedfunds to the Company. At March 31, 2008 and September 30, 2007, theamount due from custodian was $3,070,386 and $3,230,385, respectively.

 

The Adviser alsoservices the loans pledged under the DB Facility.  As a condition to this servicing arrangement,the Company executed a performance guaranty pursuant to which it guaranteedthat the Adviser would comply fully with all of its obligations under the DBFacility.  The performance guarantyrequires that the Company maintain a minimum net worth of $100 million and 75%of equity issuances after May 2003 and maintain “asset coverage” withrespect to “senior securities representing indebtedness” of at least 200%, inaccordance with Section 18 of the 1940 Act.  As of March 31, 2008, the Company was incompliance 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 capinvolves risks 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 

 

28

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to the transactionis creditworthy, the Company does bear the risk of loss of the amount expectedto be received under such agreements in the event of default or bankruptcy ofthe agreement counterparty.

 

In February 2004,the Company entered into an interest rate cap agreement with a notional amountof $35.0 million at a cost of $304,000. The interest rate cap agreement’s current notional amount is $4.7million and it has a current fair market value of $5 which is recorded in otherassets on the Company’s consolidated balance sheet at March 31, 2008.  At September 30, 2007, the interest ratecap agreement had a fair market value of $12,314.  The Company records changes in the fairmarket value of the interest rate cap agreement monthly based on the currentmarket valuation at month end as unrealized depreciation or appreciation onderivative on the Company’s consolidated statement of operations. The interestrate cap agreement expires in February 2009. The agreement provides thatthe Company’s floating interest rate or cost of funds on a portion of theportfolio’s borrowings will be capped at 5% when the LIBOR rate is in excess of5%.  During the three and six monthsended March 31, 2008, the Company recorded $1,204 and $6,810, as comparedto $10,239 and $22,793 for the three and six months ended March 31, 2007,of income from the interest rate cap agreement, recorded as a realized gain onthe settlement of derivative on the Company’s consolidated statements ofoperations.

 

NOTE7.  COMMON STOCK TRANSACTIONS

 

Transactionsin common stock were as follows:

 
| ** **                                            | ** ** | **Common Stock** | ** ** |
|-------------------------------------------------------|------------|------------------|------------|
| ** **                                            | ** ** | **Shares**       | ** ** | **Amount** | ** ** |
| Balance at  September 30, 2006                   |       | 12,305,008       |       | $ | 12,305 |   |
| Issuance of Common  Stock Under Stock Option Plan     |       | 5,000            |       | 5 |   |
| Shares surrendered for  settlement of withholding tax |       | (60,325          | )          | (60 | ) |
| Balance at  March 31, 2007                       |       | 12,249,683       |       | $ | 12,250 |   |
|                                                  |       |             |       |   |   |
| Balance at  September 30, 2007                   |       | 14,762,574       |       | $ | 14,763 |   |
| Issuance of Common  Stock Under Shelf Offerings       |       | 6,325,000        |       | 6,325 |   |
| Balance at  March 31, 2008                       |       | 21,087,574       |       | $ | 21,088 |   |

 

*Offeringsof Common Stock*

 

On October 19,2007, the Company completed an offering of 2,500,000 shares of its commonstock, at a price of $18.70 per share, less an underwriter’s discount of $1.03per share, under a shelf registration statement on Form N-2 (File No. 333-143027),and pursuant to the terms set forth in a prospectus dated July 5, 2007(the “Registration Statement”), as supplemented by a final prospectussupplement dated October 15, 2007. The underwriter exercised itsover-allotment option and the Company closed on an additional 375,000 shares ofcommon stock on November 19, 2007 Net proceeds of the offering, after deducting underwriting discounts andoffering expenses borne by the Company, were approximately $50.5 million andwere used to repay a portion of outstanding borrowings under the Company’s lineof credit.

 

On February 5,2008, the Company completed an offering of 3,000,000 shares of common stock ata price of $17.00 per share, less an underwriting discount of $0.935 per share,under the Registration Statement and as supplemented by a final prospectussupplement dated January 30, 2008. On February 26, 2008, theunderwriter exercised its over-allotment option and the Company closed on anadditional 450,000 shares of common stock. Net proceeds of the offering, after deducting underwriting discounts andoffering expenses borne by the Company, were approximately $55.0 million andwere used to repay a portion of outstanding borrowings under the Company’s lineof credit.

 

NOTE8. NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS PER SHARE

 

Thefollowing table sets forth the computation of basic and diluted net increase innet assets per share resulting from operations per share for the three and sixmonths ended March 31, 2008 and 2007:

 
| ** **                                                                                                 | ** ** | **Three Months Ended March 31,** | ** **  | **Six Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|-------------|-------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2008**                              | ** **  | **2007**                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Numerator for basic and diluted net (decrease)  increase in net assets resulting from operations per share |       | $                                     | (11,904,178 | )                                   | $          | 4,084,851 |   | $ | (10,003,681 | ) | $ | 8,248,454 |   |
|                                                                                                       |       |                                  |        |                                |       |   |   |   |   |
| Denominator for basic  and diluted shares                                                                  |       | 19,670,333                            |        | 12,249,683                          |       | 18,312,018 |   | 12,272,012 |   |
| Basic and diluted net (decrease) increase in net  assets resulting from operations per share               |       | $                                     | (0.61       | )                                   | $          | 0.33 |   | $ | (0.55 | ) | $ | 0.67 |   |

 

29

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NOTE9. DIVIDENDS

 

***Dividends and Distributions***

 

Thefollowing table lists the per share dividends paid for the six months ended March 31,2008 and 2007:

 

| **Fiscal Year** | ** ** | **Record Date**   | ** ** | **Payment Date**  | ** ** | **Dividend per Share** | ** ** |
|----------------------|------------|------------------------|------------|------------------------|------------|----------------------------------|------------|
| 2008                 |       | March 21, 2008    |       | March 31, 2008    |       | $                                | 0.14       |   |
|                 |       | February 21, 2008 |       | February 29, 2008 |       | $                                | 0.14       |   |
|                 |       | January 23, 2008  |       | January 31, 2008  |       | $                                | 0.14       |   |
|                 |       | December 20, 2007 |       | December 31, 2007 |       | $                                | 0.14       |   |
|                 |       | November 21, 2007 |       | November 30, 2007 |       | $                                | 0.14       |   |
|                 |       | October 23, 2007  |       | October 31, 2007  |       | $                                | 0.14       |   |
|                 |       |                   |       | Total                  |       | $                                | 0.84       |   |
|                 |       |                   |       |                   |       |                             |       |
| 2007                 |       | 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                  |       | $                                | 0.84       |   |

 

***Section 19(a) Disclosure***

 

TheCompany’s Board of Directors estimates the source of the distributions at thetime of their declaration as required by Section 19(a) of the 1940Act.  On a monthly basis, if requiredunder Section 19(a), the Company posts a Section 19(a) noticethrough the Depository Trust Company’s Legal Notice System (“LENS”) and alsosends to its registered stockholders a written Section 19(a) noticealong with the payment of dividends for any payment which includes a dividendestimated to be paid from any other source other than net investmentincome.  The estimates of the sourceof the distribution are interim estimates based on GAAPthat are subject to revision, and the exact character of thedistributions for tax purposes cannot be determined until the final books andrecords of the Company are finalized for the calendar year.  Following the calendar year end, afterdefinitive information has been determined by the Company, if the Company hasmade distributions of taxable income (or return of capital), the Company willdeliver a Form 1099-DIV to its stockholders specifying such amount and thetax characterization of such amount. Therefore, these estimates are made solely in order to comply with therequirements of Section 19(a) of the 1940 Act and should not berelied upon for tax reporting or any other purposes and could differsignificantly from the actual character of distributions for tax purposes.

 

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

 
| **Month Ended**   | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Dividend** | ** ** |
|------------------------|------------|--------------------------|------------|---------------------------------|------------|-------------------------|------------|
| March 31, 2008    |       | $                        | 0.114      |                            | $          | 0.026                   |       | $ | 0.140 |   |
| February 29, 2008 |       | 0.140                    |       | —                          |       | 0.140                   |       |
| January 31, 2008  |       | 0.140                    |       | —                          |       | 0.140                   |       |
|                        |            |                          |            |                                 |            |                         |            |  |  |  |

 

Becausethe Board of Directors declares dividends at the beginning of a quarter, it isdifficult to estimate how much of the Company’s monthly dividends and distributions,based on GAAP, will come from ordinary income, capital gains, and returns ofcapital.  Subsequent to the quarter endedMarch 31, 2008, the following corrections were made to the above listedestimates for that quarter:

 
| **Month Ended**   | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Dividend** | ** ** |
|------------------------|------------|--------------------------|------------|---------------------------------|------------|-------------------------|------------|
| March 31, 2008    |       | $                        | 0.088      |                            | $          | 0.052                   |       | $ | 0.140 |   |
| February 29, 2008 |       | 0.106                    |       | 0.034                           |       | 0.140                   |       |
| January 31, 2008  |       | 0.139                    |       | 0.001                           |       | 0.140                   |       |
|                        |            |                          |            |                                 |            |                         |            |  |  |  |

 

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

 
| **Month Ended** | ** ** | **Ordinary Income** | ** ** | **Return of Capital** | ** ** | **Total Dividend** | ** ** |
|----------------------|------------|--------------------------|------------|---------------------------------|------------|-------------------------|------------|
| June 30, 2008   |       | $                        | 0.125      |                            | $          | 0.015                   |       | $ | 0.140 |   |
| May 31, 2008    |       | 0.121                    |       | 0.019                           |       | 0.140                   |       |
| April 30, 2008  |       | 0.120                    |       | 0.020                           |       | 0.140                   |       |
|                      |            |                          |            |                                 |            |                         |            |  |  |  |

 

NOTE10. COMMITMENT AND CONTINGENCIES

 

Asof March 31, 2008, the Company was a party to signed and non-binding termsheets for three loan originations for an aggregate of $37.1 million.  The Company expects to fund these potentialinvestments within the next 12 months. All prospective investments are subject to, among other things, thesatisfactory completion of the Company’s due diligence investigation of eachborrower, acceptance of terms and structure and receipt of necessary consents.With respect to each prospective loan, the Company will only agree to providethe loan if, among other things, the results of its due diligenceinvestigations are satisfactory, the terms and conditions of the loan areacceptable and all necessary consents are received. The Company has initiatedits due diligence investigations of the potential borrowers, however there canbe no guarantee that facts will not be discovered in the course of completingthe due diligence that would render a particular investment imprudent or thatany of these investments will actually be made.

 

NOTE11. SUBSEQUENT EVENTS

 

*Dividends*

 

In April 2008, the Company’s Board of Directors declared thefollowing monthly cash dividends:

 

| **Fiscal Year** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per  Share** | ** ** |
|----------------------|------------|----------------------|------------|-----------------------|------------|------------------------------|------------|
| 2008                 |       | April 22, 2008  |       | April 30, 2008   |       | $                            | 0.14       |   |
|                 |       | May 21, 2008    |       | May 30, 2008     |       | $                            | 0.14       |   |
|                 |       | June 20, 2008   |       | June 30, 2008    |       | $                            | 0.14       |   |

 

*Amendment to Credit Agreement*

 

On April 25, 2008, the Company,through its wholly-owned subsidiary, Gladstone Business Loan, amended itscredit agreement.  The amendment addedBranch Banking and Trust Company (“BB&T”) as a committed lender, expandedthe facility from $250 million to $300 million and modified certain existing definitionsto the credit agreement.

 

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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. We caution readers not to place undue reliance onany such forward-looking statements. We undertake no obligation to publiclyupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise, after the date of this Form 10-Q**.

 

*The following analysis of our financialcondition and results of operations should be read in conjunction with ourconsolidated financial statements and the notes thereto contained elsewhere inthis report**and our annual report on Form 10-K for the fiscal yearended September 30, 2007**.*

 

**OVERVIEW**

 

We wereincorporated under the General Corporation Laws of the State of Maryland on May 30,2001. Our investment objectives are to achieve a high level of current incomeby investing in debt securities, consisting primarily of senior notes, secondlien notes, and senior subordinated notes of established private businessesthat are backed by leveraged buyout funds, venture capital funds or others, witha particular 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 out smalland medium-sized businesses that meet certain criteria, including some but notall of the following: the potential for growth in cash flow, adequateassets for loan collateral, experienced management teams with a significantownership interest in the borrower, profitable operations based on the borrower’scash flow, reasonable capitalization of the borrower (usually by leveragedbuyout funds or venture capital funds) and the potential to realizeappreciation and gain liquidity in our equity position, if any. We anticipatethat liquidity in our equity position will be achieved through a merger oracquisition of the borrower, a public offering of the borrower’s stock or byexercising our right to require the borrower to repurchase our warrants, thoughthere can be no assurance that we will always have these rights. We lend toborrowers that need funds to finance growth, restructure their balance sheetsor effect a change of control.

 

Our loanstypically range from $5 million to $20 million, although this investment sizemay vary proportionately as the size of our capital base changes, generallymature in no more than seven years and accrue interest at fixed or variablerates. Some of our loans may contain a provision that calls for some portion ofthe interest payments to be deferred and added to the principal balance so thatthe interest is paid, together with the principal, at maturity. This form of deferredinterest is often called “paid in kind” (“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.

 

Because themajority of our portfolio loans consist of term debt of private companies whotypically cannot or will not expend the resources to have their debt securitiesrated by a credit rating agency, we expect that most of the debt securities weacquire will be unrated. We cannot accurately predict what ratings these loansmight receive if they were in fact rated, and thus cannot determine whether ornot they could be considered “investment grade” quality.

 

To the extentpossible, our loans generally are collateralized by a security interest in theborrower’s assets. Interest payments are generally made monthly or quarterly(except to the extent of any PIK interest) with amortization of principalgenerally being deferred for several years. The principal amount of the loansand any accrued but unpaid interest generally become due at maturity at five toseven years. When we receive a warrant to purchase stock in a borrower inconnection with a loan, the warrant will typically have an exercise price equalto the fair value of the portfolio company’s common stock at the time of theloan and entitle us to purchase a modest percentage of the borrower’s stock.

 

Original issuediscounts (“OID”) arise when we extend a loan and receive an equity interest inthe borrower at the same time.  To theextent that the price paid for the equity is not at market value, we mustallocate part 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 

 

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amortization ofOID also 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 income will not be received, if at all, until the equityinstrument is sold.  We seek to avoid OIDand to date do not hold any investments with OID.

 

Our Adviserreceives fees for other services it provides to our portfolio companies. Theseother fees are typically non-recurring, are recognized as revenue when earnedand are generally paid directly to our Adviser by the borrower or potential borrowerupon closing of the investment. The services our 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 our Adviser receives fees for these services,50% of certain of those fees are voluntarily credited against the basemanagement fee that we pay to our Adviser.

 

Our Adviser alsoreceives fees for monitoring and reviewing portfolio company investments. Thesefees are recurring and are generally paid annually or quarterly in advance toour Adviser throughout the life of the investment. Fees of this nature arerecorded as revenue by our Adviser when earned and are not credited against thebase management fee.

 

We may receivefees for the origination and closing services we provide to portfolio companiesthrough our Adviser. These fees are paid directly to us and are recognized asrevenue upon closing of the originated investment and are reported as feeincome in the consolidated statements of operations.

 

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 satisfactory completionof our due diligence investigations of the potential borrower’s business,reaching agreement on the legal documentation for the loan, and the receipt ofall necessary consents. Upon execution of the non-binding term sheet, thepotential borrower generally pays the Adviser a non-refundable fee for itsservices rendered through the date of the non-binding term sheet. These feesare 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 thatwe expend significant effort in considering and negotiating a potentialinvestment that ultimately is not consummated, we generally will seekreimbursement from the proposed borrower for our reasonable expenses incurredin connection with the transaction, including legal fees.  Any amounts collected for expenses incurredby the Adviser in connection with unconsummated investments will be reimbursedto the Adviser.  Amounts collected forthese expenses incurred by us will be reimbursed to us and will be recognizedin the period in which such reimbursement is received, however, there can be noguarantee that we will be successful in collecting any such reimbursements.

 

During the sixmonths ended March 31, 2008, we extended, directly or throughparticipations, approximately $71.9 million of new loan originations, includinga common equity warrant, to a total of 6 new companies and also increased ourinvestments in existing portfolio companies through revolver draws or theadditions of new term notes in the aggregate of $21.9 million, for total newinvestments of $93.8 million. During the six months ended March 31, 2008,one investment repaid in full and we experienced contractual amortization,revolver repayments and some unscheduled partial repayments, for totalprincipal repayments of approximately $7.0 million.  Since our initial public offering in August 2001,we have made 243 different loans to, or investments in, 126 companies for atotal of approximately $859.9 million, before giving effect to principalrepayments on investments and divestitures.

 

**Our Adviser and Administrator**

 

Our Adviser is led by a management team which has extensive experiencein our lines of business. Our Adviser is controlled by David Gladstone, ourchairman and chief executive officer. Mr. Gladstone is also the chairmanand chief executive officer of our Adviser. Terry Lee Brubaker, our vicechairman, chief operating officer, secretary and director, is a member of theboard of directors of our Adviser and its vice chairman and chief operatingofficer. George Stelljes III, our president, chief investment officer anddirector, is a member of the board of directors of our Adviser and itspresident and chief investment officer. Our Adviser also has a wholly-ownedsubsidiary, Gladstone Administration, LLC (the “Administrator”), which employsour chief financial officer, chief compliance officer, controller, treasurerand their respective staffs.

 

Our Adviser and Administrator also provide investment advisory andadministrative services to our affiliates, Gladstone Commercial Corporation, apublicly traded real estate investment trust; Gladstone Investment Corporation,a publicly traded business development company; and Gladstone Land Corporation,a private agricultural real estate company. All of our executive officers serveas either directors or executive officers, or both, of our Adviser, ourAdministrator, Gladstone Commercial Corporation and Gladstone 

 

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Investment Corporation. In the future, our Adviser may provideinvestment advisory and administrative services to other funds, both public andprivate, of which it is the sponsor.

 

Our Adviser was organized as a corporation under the laws of the Stateof Delaware on July 2, 2002, and is a registered investment adviser underthe Investment Advisers Act of 1940, as amended. Our Adviser is headquarteredin McLean, Virginia, a suburb of Washington D.C., and also has offices in NewYork, New Jersey, Pennsylvania, Illinois, Texas and Washington.

 

**InvestmentAdvisory and Management Agreement**

 

We are externallymanaged by our Adviser pursuant to an investment advisory and managementagreement (the “Advisory Agreement”), under which our Adviser has directly employed all of our personnel and paid ourpayroll, benefits, and general expenses directly and we pay our directexpenses including, but not limited to, directors’ fees, legal and accountingfees, stockholder related expenses, and directors and officers insurance.

 

Under the AdvisoryAgreement, we pay the Adviser an annual base management fee of 2% of ouraverage gross assets, which is defined as total assets less cash and cash equivalentspledged to creditors calculated as of the end of the two most recentlycompleted fiscal quarters and also consists of a two-part incentive fee.

 

The first part ofthe incentive fee is an income-based incentive fee which rewards the Adviser ifour quarterly 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 incentivefee in any calendar quarter in which our pre-incentive fee net investmentincome does not 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 theamount of our pre-incentive fee net investment income, if any, that exceeds2.1875% in any 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 Advisory Agreement, as of the termination date) and will equal 20% of ourrealized capital gains as of the end of the fiscal year. In determining thecapital gains incentive fee payable to the Adviser, we will calculate thecumulative aggregate realized capital gains and cumulative aggregate realizedcapital losses since our inception, and the aggregate unrealized capitaldepreciation as of the date of the calculation, as applicable, with respect toeach of the investments in our portfolio.

 

TheAdviser’s board of directors voluntarily waived, for the three months ended March 31,2008 and March 31, 2007, the annual 2.0% base management fee to 0.5% forsenior syndicated loan participations and also waived the entire fee and aportion of the incentive fees due, respectively in the periods.

 

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 in April 2006,the Adviser’s board of directors voted to reduce the portion of the 1.5% annualfee to 0.5% for senior syndicated loans. This fee directly reduces the amount of fee payable under the AdvisoryAgreement.

 

Inaddition to the base management and incentive fees under the AdvisoryAgreement, certain fees received by the Adviser from the Company’s portfoliocompanies are credited against the investment advisory fee.  Effective April 1, 2007, 50% of certainof the fees received by the Adviser are voluntarily credited against the basemanagement fee.  In addition, the Companywill continue to pay its direct expenses including, but not limited to,directors’ fees, legal and accounting fees, stockholder related expenses, anddirectors and officers insurance under the Advisory Agreement.

 

**AdministrationAgreement**

 

Under theadministration agreement we have with our Administrator (the “AdministrationAgreement”), we pay separately for administrative services. The AdministrationAgreement provides for payments equal to our allocable portion of theAdministrator’s overhead expenses in performing its obligations under theAdministration Agreement including, but not limited to, rent for employees ofthe 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 our 

 

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Administrator’stotal expenses by the percentage of our total assets as of the end of eachprior calendar quarter in comparison to the average total assets of the priorquarter of all companies managed by our Adviser, under similar advisory agreements.

 

**Off-BalanceSheet Arrangements**

 

We do not have anyoff-balance sheet arrangements as defined in Item 303(a)(4)(ii) ofSecurities and Exchange Commission (“SEC”) Regulation S-K as of March 31,2008.

 

**RecentAccounting Pronouncements**

 

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 is effective as of the beginning of an entity’sfirst fiscal year that begins after December 15, 2006. We adopted thisInterpretation on October 1, 2007. The adoption did not have a materialimpact on the consolidated financial statements.

 

InSeptember 2006, the FASB issued SFAS No. 157, *“Fair ValueMeasurements”* (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework formeasuring fair value in accordance with GAAP, and expands disclosures aboutfair value measurements.  SFAS No. 157applies broadly 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, 2008and are currently evaluating the impact of this pronouncement on theconsolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, *“The Fair Value Option for Financial Assets and FinancialLiabilities — Including an Amendment of FASB Statement No. 115,”*which is effective for fiscal years beginning after November 15, 2007.This pronouncement permits an entity to choose to measure many financialinstruments and certain other items at fair value at specified election dates.Subsequent unrealized gains and losses on items for which the fair value optionhas been elected will be reported in earnings. We will be required to adoptSFAS No. 159 on October 1, 2008 and are currently evaluating thepotential impact of this pronouncement on the consolidated financialstatements.

 

In November 2007, the SEC issued Staff Accounting Bulletin No. 109,*“Written Loan Commitments Recorded at Fair Value ThroughEarnings”* (“SAB 109”)*.* SAB 109provides guidance on the accounting for written loan commitments recorded atfair value under GAAP. Specifically, SAB 109 revises the Staff’s views onincorporating expected net future cash flows related to loan servicingactivities in the fair value measurement of a written loan commitment. SAB 109, which  supersedes  SAB  105,  “*Application  of  Accounting Principles  to  Loan Commitments,”* requires the  expected  net  future  cash  flows  relatedto the associated  servicing of the loan be included in the measurement ofall written loan commitments that are accounting for at fair value throughearnings. SAB 109 is effective in fiscal quarters beginning after December 15,2007. We are currently evaluating the impact of this pronouncement on theconsolidated financial statements.

 

In December 2007,the FASB issued SFAS No. 141(R) *“Business Combinations”*(“SFAS No. 141(R)”). SFAS No. 141(R) establishes principles andrequirements for how an acquirer recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, anynoncontrolling interest in the acquiree and the goodwill acquired. SFAS No. 141(R) alsoestablishes disclosure requirements to enable the evaluation of the nature andfinancial effects of the business combination. SFAS No. 141(R) iseffective as of the beginning of an entity’s fiscal year that begins after December 15,2008.  We will be required to adopt SFAS No. 141(R) onOctober 1, 2009 and are currently evaluating the impact of thispronouncement on the consolidated financial statements.

 

In December 2007,the FASB issued SFAS No. 160, “*NoncontrollingInterest in Consolidated Financial Statements”*(“SFAS No. 160”)*.*SFAS No. 160 amendsAccounting Research Bulletin 51 to establish accounting and reporting standardsfor the noncontrolling (minority) interest in a subsidiary and for thedeconsolidation of a subsidiary. It clarifies that a noncontrolling interest ina subsidiary is an ownership interest in the consolidated entity that should bereported as equity in the consolidated financial statements.  SFAS No. 160 is effective for fiscalyears, and interim periods within those fiscal years, beginning on or after December 15,2008.  We will be required to adopt SFAS No. 160on October 1, 2009 and are currently evaluating the impact of thispronouncement on the consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, “*Disclosures about Derivative Instruments and Hedging Activities*”(“SFAS No. 161”), which is intended to help investors better understandhow derivative instruments and hedging activities affect an entity’s financialposition, financial performance and cash flows through enhanced disclosurerequirements.  The enhanced disclosures primarilysurround disclosing the objectives and strategies for using derivativeinstruments by their underlying risk as well as a tabular format of the fairvalues of the derivative instruments and their gains and losses.  SFAS No. 161 is effective for financialstatements 

 

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issued for fiscal years and interim periods beginning after November 15,2008.  We are evaluating the impact ofthis pronouncement on the reporting of our derivatives.

 

**CriticalAccounting Policies**

 

The preparation offinancial statements and related disclosures in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported consolidated amounts ofassets and liabilities, and disclosure of contingent assets and liabilities atthe date of the financial statements, and revenues and expenses during theperiod reported. Actual results could differ materially from those estimates.  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.

 

***Investment Valuation***

 

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

 

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

 

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

 

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

 

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

 

·      Publicly-tradedsecurities;

·      Securitiesfor which a limited market exists; and

·      Securitiesfor which no market exists.

 

*ValuationMethods:*

 

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

 

**Securitiesfor which a limited market exists:**We value securities that are not traded on anestablished secondary securities market, but for which a limited market for thesecurity exists, such as certain participations in, or assignments of,syndicated loans, at the firm bid price. If a firm bid price is unavailable, we base the value of the securityupon the indicative bid price offered by the respective originating syndicationagent’s trading desk, or secondary desk, on or near the valuation date.  To the extent that we use the indicative bidprice as a basis for valuing the security, our Adviser may take further stepsto consider additional information to validate that price in accordance withthe policy.

 

**Securitiesfor which no market exists:** Debt securities that are not publicly traded on anestablished securities market, or for which a limited market does not exist (“Non-PublicDebt Securities”), and that are issued by portfolio companies where we have noequity, or equity-like securities, are fair valued in accordance with the termsof the policy, and which utilizes opinions of value submitted to us by Standard &Poor’s Securities Evaluations, Inc. (“SPSE”). We may also submit paid inkind (“PIK”) interest to SPSE for their evaluation when it is determined thePIK interest is likely to be received.

 

In the case ofNon-Public Debt Securities, we have engaged SPSE to submit opinions of valuefor our debt securities that are issued by portfolio companies in which we ownno equity, or equity-like securities. SPSE’s opinions of value are based on the valuations prepared by ourportfolio management team as described below. We request that SPSE also evaluate and assign values to success fees(conditional interest included in some loan securities) when we determine thatthe probability of receiving a success fee on a given 

 

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loan is above6-8%, a threshold of significance. We may also submit PIK interest to SPSE forvaluation when it is determined the PIK interest is likely to be received. SPSEwill only evaluate the debt portion of our investments for which wespecifically request evaluation, and may decline to make requested evaluationsfor any reason at its sole discretion. Upon completing our collection of datawith respect to the investments (including the information described under “CreditInformation,” the risk ratings of the loans described under “Loan Grading andRisk Rating” and the factors described hereunder), this valuation data isforwarded to SPSE for review and analysis. SPSE makes its independentassessment of the data that we have assembled and assesses its independent datato form an opinion as to what they consider to be the market values for thesecurities. 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 ofvalue of our debt securities that are issued by portfolio companies where wehave no equity, or equity-like securities are submitted to our Board ofDirectors along with our Adviser’s supplemental assessment and recommendationregarding valuation of each of these investments. Our Adviser generally acceptsthe opinion of value given by SPSE, however, in certain limited circumstances,such as when our Adviser may learn new information regarding an investmentbetween the time of submission to SPSE and the date of the Board assessment,our Adviser’s conclusions as to value may differ from the opinion of value deliveredby SPSE. Our Board of Directors then reviews whether our Adviser has followedits established procedures for determinations of fair value, and votes toaccept or reject the recommended valuation of our investment portfolio. OurAdviser and our management recommended, and the Board of Directors voted toaccept, the opinions of value delivered by SPSE on the loans in our portfolioas denoted on the Schedule of Investments as of March 31, 2008 included inour consolidated financial statements.

 

Because there is adelay between when we close an investment and when the investment can beevaluated by SPSE, new loans are not valued immediately by SPSE; rather,management makes its own determination about the value of these investments inaccordance with our valuation policy using the methods described herein.

 

We valueNon-Public Debt Securities and equity or equity-like securities (e.g.convertible debt, equity, or other equity-like securities) that are purchasedtogether from the same portfolio company, or issuer, as part of a package basedon the total enterprise value of the issuer, which is calculated using aliquidity waterfall approach.  Under thisapproach, we first calculate the total enterprise value of the issuer. Thiscalculation incorporates some or all of the following factors to determine thetotal enterprise value of the issuer:

 

·      the issuer’sability to make payments;

·      theearnings of the issuer;

·      recentsales to third parties of similar securities;

·      thecomparison to publicly traded securities; and

·      discountedcash flow or other pertinent factors.

 

(In gathering thesales to third parties of similar securities, we may reference industrystatistics and use outside experts.) Once we have estimated the totalenterprise value of the issuer, we subtract the value of all the debtsecurities of those issuers. These debt securities are valued at cost. Fairvalues of these debt securities are discounted for any shortfall of totalenterprise value over the total debt outstanding for the borrower. Once thevalues for all outstanding senior securities (which include the debtsecurities) have been subtracted from the total enterprise value of the issuer,the remaining amount, if any, is used to determine the value the issuer’sequity or equity like securities.

 

Finally, withrespect to success fees (conditional interest included in some loansecurities), we request that SPSE also evaluate and assign values to thesuccess fees whenever we determine that the probability of receiving a successfee on a given loan is above 6-8%, a threshold of significance.

 

Due to theuncertainty inherent in the valuation process, such estimates of fair value maydiffer significantly from the values that would have been obtained 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 valuations currentlyassigned. There is no single standard for determining fair value in good faith,as fair value depends upon circumstances of each individual case. In general,fair value is the amount that we might reasonably expect to receive upon thecurrent sale of the security in an arms-length transaction in the security’sprincipal market.

 

37

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

 

·      the risk rating of the security (see “Loan Grading and RiskRating”);

·      the cost basis and the type of the security;

·      the nature and realizable value of the collateral;

·      the portfolio company’s ability to make payments and discountedcash flow;

·      reports from portfolio company senior management and boardmeetings;

·      reported values of similar securities of the portfoliocompany or comparable companies;

·      changes in the economy affecting the portfolio company;and

·      other third-party appraisals of the portfolio companies.

 

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

 

*LoanGrading and Risk Rating:*  As part of our valuationprocedures above, we risk rate all of our investments in debt securities. Forsyndicated loans that have been rated by a NRSRO (as defined in Rule 2a-7under the 1940 Act), we use the NRSRO’s risk rating for such security. For allother debt securities, we use a proprietary risk rating system. Our risk ratingsystem uses a scale of 0 to 10, with 10 being the lowest probability ofdefault. This system is used to estimate the probability of default on debtsecurities and the probability of loss if there is a default. These types ofsystems are referred to as risk rating systems and are used by banks and ratingagencies. The risk rating system covers both qualitative and quantitativeaspects of the business and the securities we hold.

 

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

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

 

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(a)*           The default rates set forth are for aten year term debt security. If a debt security is less than ten years, thenthe probability of default is adjusted to a lower percentage for the shorterperiod, which may move the security higher on our risk rating scale.*

 

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The above scalegives an indication of the probability of default and the magnitude of the lossif there is a default. Our policy is to stop accruing interest on an investmentif we determine that interest is no longer collectible. At March 31, 2008,two investments were on non-accrual and at September 30, 2007 oneinvestment was on non-accrual. Additionally, we do not risk rate our equity securities.

 

The followingtable lists the risk ratings for all non-syndicated loans in our portfolio at March 31,2008 and September 30, 2007, representing approximately 82% and 79%,respectively, of all loans in our portfolio at the end of each period:

 

| **Rating**       | ** ** | **Mar. 31, 2008** | ** ** | **Sept. 30, 2007** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **7.5**                     | ** ** | **7.3**                      | ** ** |
| Weighted Average | ** ** | **7.1**                     | ** ** | **7.1**                      | ** ** |
| Highest          | ** ** | **9.0**                     | ** ** | **9.0**                      | ** ** |
| Lowest           | ** ** | **5.0**                     | ** ** | **4.0**                      | ** ** |

 

The followingtable lists the risk ratings for syndicated loans in our portfolio that werenot rated by an NRSRO at March 31, 2008 and September 30, 2007,representing approximately 4% of all loans in our portfolio at the end of eachperiod:

 

| **Rating**       | ** ** | **Mar. 31, 2008** | ** ** | **Sept. 30, 2007** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------------|------------|
| Average          | ** ** | **6.3**                     | ** ** | **6.0**                      | ** ** |
| Weighted Average | ** ** | **6.1**                     | ** ** | **6.0**                      | ** ** |
| Highest          | ** ** | **7.0**                     | ** ** | **6.0**                      | ** ** |
| Lowest           | ** ** | **6.0**                     | ** ** | **6.0**                      | ** ** |

 

For syndicatedloans that are currently rated by an NRSRO, we risk rate such loans inaccordance with the risk rating systems of major risk rating organizations,such as those provided by a NRSRO. The following table lists the risk ratingsfor all syndicated loans in our portfolio that were rated by an NRSRO at March 31,2008 and September 30, 2007, representing approximately 13% and 17%,respectively, of all loans in our portfolio at the end of each period:

 

| **Rating**       | ** ** | **Mar. 31, 2008** | ** ** | **Sept.30, 2007** | ** ** |
|------------------|------------|-----------------------------|------------|------------------------|------------|
| Average          |       | CCC+/Caa1                   |       | CCC+/Caa1              |       |
| Weighted Average |       | CCC+/Caa1                   |       | CCC+/Caa1              |       |
| Highest          |       | BB/Ba3                      |       | B/B3                   |       |
| Lowest           |       | CCC/Caa2                    |       | CCC/Caa2               |       |

 

For the six monthsended March 31, 2008, we had total unrealized depreciation ofapproximately $23.7 million, which was primarily derived from ourNon-Control/Non-Affiliate investments. The loan market continued to beextremely volatile during the six months ended March 31, 2008 and, as aresult, certain of our loan investments experienced significant declines infair market value.

 

***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 to avoidcertain excise taxes imposed on RICs, we currently intend to distribute duringeach calendar year, an amount at least equal to the sum of (1) 98% of ourordinary income for the calendar year, (2) 98% of our capital gains inexcess of capital losses for the one-year period ending on October 31 ofthe calendar year and (3) any ordinary income and net capital gains forpreceding years that were not distributed during such years.

 

***Revenue Recognition***

* *

*Interest Income Recognition*

 

Interest income 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.

 

39

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*Paid in Kind Interest*

 

We may hold loansin our portfolio which contain a PIK interest provision. The PIK interest,computed at the contractual rate specified in each loan agreement, is added tothe principal balance of the loan and recorded as interest income. To maintainour status as a RIC, this non-cash source of income must be paid out to stockholdersin the form of dividends, even though we have not yet collected the cash.

 

*Services Provided to Portfolio Companies*

 

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

 

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

 

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

 

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

 

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**RESULTS OF OPERATIONS**

 

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

** **

**Investment Income**

 

Investment incomefor the three months ended March 31, 2008 was $11,349,567, as compared to$8,643,778 for the three months ended March 31, 2007.

 

Interest incomefrom our investments in debt securities of private companies was $11,124,025for the three months ended March 31, 2008, as compared to $8,254,459 forthe three months ended March 31, 2007. The level of interest income from investments is directly related to thebalance, at cost, of the interest-bearing investment portfolio outstandingduring the period multiplied by the weighted average yield.  The weighted average yield varies from periodto period based on the current stated interest rate on interest-bearing investmentsand the amounts of loans for which interest is not accruing.  Interest income from our investmentsincreased $2.9 million, or 34.8%, during the three months ended March 31,2008 compared to the prior year period based on the overall growth in the costbasis of our investments, offset by the decrease in the weighted averageyield.  The success fees during the threemonths ended March 31, 2008 and 2007 were $0 and $533,000, respectively,with the March 31, 2007 success fee resulting from a refinancing byBadanco Acquisition Corp.

 

·      Theinterest-bearing investment portfolio had an average cost basis ofapproximately $396.9 million for the three months ended March 31, 2008, ascompared to an average cost basis of $248.9 million for the three months ended March 31,2007.  The following table lists theinterest income from investments for the five largest portfolio companiesduring the respective periods:

 

**Three months ended March 31, 2008**

 
| **Company**               | ** ** | **Interest  Income** | ** **     | **%**      | ** ** |
|---------------------------|------------|----------------------|----------------|------------|------------|
| Reliable Biopharma        |       | $                    | 748,645        |       | 6.7        | % |
| Westlake Hardware         |       | 703,172              |           | 6.3        | %          |
| Sunshine Media            |       | 693,369              |           | 6.2        | %          |
| Clinton Aluminum          |       | 470,167              |           | 4.2        | %          |
| GFRC Cladding             |       | 406,573              |           | 3.7        | %          |
| **Subtotal**              | ** ** | **$**                | **3,021,926**  | ** ** | **27.1**   | **%** |
| Other companies           |       | 8,102,099            |           | 72.9       | %          |
| **Total interest income** | ** ** | **$**                | **11,124,025** | ** ** | **100.0**  | **%** | ** ** |

 

**Three months ended March 31, 2007**

 
| **Company**               | ** ** | **Interest  Income** | ** **    | **%**      | ** ** |
|---------------------------|------------|----------------------|---------------|------------|------------|
| Badanco                   |       | $                    | 865,469       |       | 10.5       | % |
| Westlake Hardware         |       | 471,400              |          | 5.7        | %          |
| Specialty Coatings        |       | 316,447              |          | 3.8        | %          |
| Doe and Ingalls           |       | 259,965              |          | 3.1        | %          |
| Allied Extruders          |       | 250,965              |          | 3.0        | %          |
| **Subtotal**              | ** ** | **$**                | **2,164,246** | ** ** | **26.1**   | **%** |
| Other companies           |       | 6,090,213            |          | 73.9       | %          |
| **Total interest income** | ** ** | **$**                | **8,254,459** | ** ** | **100.0**  | **%** |

 

·      Theannualized weighted average yield on our portfolio for the three months ended March 31,2008 was 10.1% compared to 12.0% for the three months ended March 31,2007.  The weighted average yields werenot materially impacted by the PIK interest, which were $15,696 and $0 for thethree months ended March 31, 2008 and 2007, respectively.  The decrease in the annualized weightedaverage yield primarily resulted from a reduction in the average LIBOR, whichwas 3.62% for the three months ended March 31, 2008, compared to 5.32% inthe prior year period, as well as two investments being on non-accrual duringthe three months ended March 31, 2008 (LocalTel, Inc. and West CostYellow Pages, Inc.) and none in the prior year period.

 

Interest incomefrom invested cash and cash equivalents for the three months ended March 31,2008 was $102,436, as compared to $31,645 for the three months ended March 31,2007. Interest income increased from the prior year due to the amount of cashthat was held in interest bearing accounts and the interest earned on ourcustodial account prior to disbursement.

 

Interest incomefrom loans to our employees, in connection with the exercise of employee stockoptions, for the three months ended March 31, 2008 and March 31,2007, was $118,106 and $132,931, respectively. The decrease is due to the cancellation in full of one employee loanduring the fourth quarter of the prior fiscal year.

 

Prepayment feesand other income for the three months ended March 31, 2008 was $5,000 ascompared to $224,743 for the three months ended March 31, 2007.  The income for the prior period consisted ofprepayment penalty fees received upon the full repayment of certain loaninvestments ahead of contractual maturity and prepayment fees received upon theearly unscheduled principal repayments, which was based on a percentage of theoutstanding principal amount of the loan at the date of prepayment.

 

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**Operating Expenses**

** **

Operatingexpenses, net of credits from the Adviser for fees earned and voluntary waiversto the base management and incentive fees, were $4,907,428 for the three monthsended March 31, 2008, as compared to $2,919,421 for the three months endedMarch 31, 2007. Operating expenses for the three months ended March 31,2008 reflected a significant increase in loan servicing fees and a decrease incredits to base management and incentive fees.

 

Interest expensefor the three months ended March 31, 2008 was $1,854,815, as compared to$1,811,019 for the three months ended March 31, 2008.  This increase is primarily a result ofincreased borrowings under our line of credit during the three months ended March 31,2008, which borrowings were partially used to finance our increasedinvestments.

 

Loan servicing feesfor the three months ended March 31, 2008 were $1,561,941, as compared to$760,623 for the three months ended March 31, 2007.  These fees were incurred in connection with aloan servicing agreement between Business Loan and our Adviser, which is based onthe size of the portfolio.  The averagesize of our investment portfolio, excluding equity investments and controlinvestments, was approximately $409.0 million for the three months ended March 31,2008 as compared to approximately $261.8 million for the three months ended March 31,2007.  These fees were reduced againstthe amount of the base management fee due to our Adviser.

 

Base managementfee for the three months ended March 31, 2008 was $556,507, as compared to$599,608 for the three months ended March 31, 2007.  The base management fee is computed quarterlyas described under *“Investment Advisory andManagement Agreement,”* and is summarized in the table below:

 
| ** **                                                                     | ** ** | **Three months ended** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                     | ** ** | **March 31, 2008**     | ** ** | **March 31, 2007** | ** ** |
| Base management fee                                                            |       | $                                | 556,507    |   | $ | 599,608 |   |
| Credit for investment advisory fees received by  Adviser  (1)             |       | (150,000                         | )          | (775,000 | ) |
| Fee reduction for the waiver of 2% fee on senior  syndicated loans to 0.5% (2) |       | (98,946                          | )          | (149,124 | ) |
| Net base management fee                                                        |       | $                                | 307,561    |   | $ | (324,516 | ) |

 

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(1)   Effective April 1, 2007, the board ofour Adviser reduced the amount of voluntary credit for investment advisory feesreceived by our Adviser from 100% of the fees received to 50% of the feesreceived.  Therefore, the three months endedMarch 31, 2008 reflects the reduced credit for fees received by ourAdviser.

 

(2)   The board of our Adviser voluntarily waived,for the three months ended March 31, 2008 and 2007, the annual 2.0% basemanagement fee to 0.5% for senior syndicated loan participations.

 

Incentive fee forthe three months ended March 31, 2008 was $1,288,428, as compared to$1,158,995 for the three months ended March 31, 2007.  The board of our Adviser waived the entireincentive fee for the three months ended March 31, 2008 and a portion of theincentive fee due for the three months ended March 31, 2007.  The incentive fees and associated credits aresummarized in the table below:

 
| ** **                                                                | ** ** | **Three months ended** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                | ** ** | **March 31, 2008**     | ** ** | **March 31, 2007** | ** ** |
| Incentive fee                                                             |       | $                                | 1,288,428  |   | $ | 1,158,995 |   |
| Credit from voluntary waiver issued by Adviser’s  board of directors |       | (1,288,428                       | )          | (1,088,378 | ) |
| Net incentive fee                                                         |       | $                                | —     |   | $ | 70,617 |   |

 

Administrationfee for the three months ended March 31, 2008 was $240,579 as compared to$168,766 for the three months ended March 31, 2007. The increase is due tothe addition of administration staff and related expenses.

 

Professional fees,consisting primarily of legal and audit fees, for the three months ended March 31,2008 were $410,034, as compared to $109,081 for the three months ended March 31,2007.  The increase is due to therecording of audit accruals and non reimbursable legal fees.

 

Amortization ofdeferred financing fees, in connection with our line of credit, was $183,780for the three months ended March 31, 2008, as compared to $68,200 for thethree months ended March 31, 2007. 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.

 

Stockholderrelated costs for the three months ended March 31, 2008 were $138,346, ascompared to $87,288 for the three months ended March 31, 2007.  Stockholder related costs include suchrecurring items as transfer agent fees, NASDAQ listing fees, SEC 

 

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filing fees, andthe production of our annual report. These fees increased during the three months ended March 31, 2008due to the additional filing fees as compared to the prior year.

 

Directors’ feesfor the three months ended March 31, 2008 and 2007 were $56,970 andconsisted of amortization of their annual stipend and meeting stipends.

 

Insurance expensefor the three months ended March 31, 2008 was $58,717, as compared to$62,398 for the three months ended March 31, 2007. The decrease wasprimarily the result of a decrease of our directors and officers insurancepolicy premiums.

 

Other expenses forthe three months ended March 31, 2008 were $94,685, as compared to $48,975for the three months ended March 31, 2007. The expenses primarily represent direct expenses such as travel relatedspecifically to our portfolio companies, loan evaluation services for ourportfolio companies, press releases and backup servicer expenses.

 

**NetRealized Gain on Sale of Investments**

** **

During the threemonths ended March 31, 2008, we did not realize any gains or losses, ascompared to a realized net gain of $84,205 from the sale or repayment of ninesyndicate loan investments in the three months ended March 31, 2007.

 

**RealizedGain on Settlement of Derivative**

** **

During the threemonths ended March 31, 2008, we received interest rate cap agreementpayments of $1,204 as a result of the one month LIBOR having a downward trend,as opposed to an increasing trend in the three months ended March 31, 2007in which we received payments of $10,239. We receive payments when the one month LIBOR is over 5% and continues togrow month over month, not when the one month LIBOR decreases.

 

**NetUnrealized Depreciation on Derivative**

 

During the threemonths ended March 31, 2008, we recorded net unrealized depreciation of$1,756 due to a decrease in the fair market value of our interest rate capagreement, as compared to unrealized depreciation of $15,801 during the threemonths ended March 31, 2007.

 

**NetUnrealized Depreciation on Investments**

 

For the threemonths ended March 31, 2008, we recorded net unrealized depreciation oninvestments of $18,345,765, as compared to net unrealized depreciation of$1,718,149, for the three months ended March 31, 2007.  The unrealized depreciation is mainly attributableto the decrease in fair value on our portfolio, most notably in the followinginvestments:  LocalTel, Inc.,Greatwide Logistics Services, Inc., Visual Edge Technology, Inc., andU.S. Healthcare Communications, LLC.  Ourinvestment portfolio was valued at a depreciated value due primarily to thegeneral instability of the loan markets. Although our investment portfolio has depreciated, our entire portfoliois fair valued at 93% of cost as of March 31, 2008.  The unrealized depreciation of our investmentsdoes not have an impact on our current ability to pay distributions tostockholders.

 

**Net Increase in Net Assets from Operations**

 

Overall, we realized a net decrease in net assets resulting fromoperations of $11,904,178 for the three months ended March 31, 2008.  Based on a weighted-average of 19,670,333basic and diluted shares outstanding, our net decrease in net assets fromoperations per weighted-average common share for the three months ended March 31,2008 was $0.61, basic and diluted.

 

For the three months ended March 31,2007, we realized a net increase in net assets resulting from operationsof $4,084,851.  Based on aweighted-average of 12,249,683 basic and diluted shares outstanding, our netincrease in net assets from operations per weighted-average common share forthe three months ended March 31, 2007 was $0.33, basic and diluted.

 

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***Comparisonof the Six Months Ended March 31, 2008 to the Six Months Ended March 31,2007***

** **

**Investment Income**

 

Investment incomefor the six months ended March 31, 2008 was $22,751,206, as compared to$16,877,496 for the six months ended March 31, 2007.

 

Interest incomefrom our investments in debt securities of private companies was $22,263,003for the six months ended March 31, 2008, as compared to $16,153,059 forthe six months ended March 31, 2007. The level of interest income from investments is directly related to thebalance, at cost, of the interest-bearing investment portfolio outstandingduring the period multiplied by the weighted average yield.  The weighted average yield varies from periodto period based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.  Interest income from our investmentsincreased $6.1 million, or 37.8%, during the six months ended March 31,2008 compared to the prior year period based on the overall growth in the costbasis of our investments, offset by the decrease in the weighted averageyield.  The success fees during the sixmonths ended March 31, 2008 and 2007 were $346,000 and $1,733,000,respectively.  The success fee for thesix months ending March 31, 2008 resulted from a refinancing by WestlakeHardware, Inc., while the success fee for the six months ended March 31,2007 resulted from a refinancing by Badanco Acquisition Corp. and a fullrepayment by Mistras Holdings Corp.

 

·      Theinterest-bearing investment portfolio had an average cost basis ofapproximately $396.6 million for the six months ended March 31, 2008, ascompared to an average cost basis of $248.8 million for the six months ended March 31,2007.  The following table lists theinterest income from investments for the five largest portfolio companiesduring the respective periods:

 

**Six months ended March 31, 2008**

 
| **Company**               | ** ** | **Interest  Income** | ** **     | **%**      | ** ** |
|---------------------------|------------|----------------------|----------------|------------|------------|
| Sunshine Media            |       | $                    | 1,402,945      |       | 6.3        | % |
| Westlake Hardware         |       | 1,377,568            |           | 6.2        | %          |
| Reliable Biopharma        |       | 1,332,490            |           | 6.0        | %          |
| Clinton Aluminum          |       | 956,979              |           | 4.3        | %          |
| Winchester Electronics    |       | 699,940              |           | 3.1        | %          |
| **Subtotal**              | ** ** | **$**                | **5,769,922**  | ** ** | **25.9**   | **%** |
| Other companies           |       | 16,493,081           |           | 74.1       | %          |
| **Total interest income** | ** ** | **$**                | **22,263,003** | ** ** | **100.0**  | **%** |

 

**Six months ended March 31, 2007**

 
| **Company**               | ** ** | **Interest  Income** | ** **     | **%**      | ** ** |
|---------------------------|------------|----------------------|----------------|------------|------------|
| Badanco                   |       | $                    | 1,307,499      |       | 8.1        | % |
| Westlake Hardware         |       | 953,661              |           | 5.9        | %          |
| Specialty Coatings        |       | 651,403              |           | 4.0        | %          |
| Doe and Ingalls           |       | 531,347              |           | 3.3        | %          |
| Allied Extruders          |       | 507,738              |           | 3.1        | %          |
| **Subtotal**              | ** ** | **$**                | **3,951,648**  | ** ** | **24.4**   | **%** |
| Other companies           |       | 12,201,411           |           | 75.6       | %          |
| **Total interest income** | ** ** | **$**                | **16,153,059** | ** ** | **100.0**  | **%** |

 

·      Theannualized weighted average yield on our portfolio for the six months ended March 31,2008 was 10.6% compared to 12.6% for the six months ended March 31,2007.  The weighted average yields werenot materially impacted by the PIK interest, which were $29,622 and $0 for thesix months ended March 31, 2008 and 2007, respectively.  The decrease in the annualized weightedaverage yield primarily resulted from a reduction in the average LIBOR, whichwas 4.32% for the six months ended March 31, 2008, compared to 5.33% inthe prior year period, as well as two investments being on non-accrual duringthe six months ended March 31, 2008 (LocalTel, Inc. and West CostYellow Pages, Inc.) and none in the prior year period.

 

Interest incomefrom invested cash and cash equivalents for the six months ended March 31,2008 was $246,921, as compared to $68,914 for the six months ended March 31,2007 due to the amount of cash that was held in interest bearing accounts andthe interest earned on our custodial account prior to disbursement.

 

Interest incomefrom loans to our employees, in connection with the exercise of employee stockoptions, for the six months ended March 31, 2008 and March 31, 2007,was $236,282 and $271,122, respectively. The decrease is due to the cancellation in full of one employee loanduring the fourth quarter of the prior fiscal year.

 

Prepayment feesand other income for the six months ended March 31, 2008 was $5,000, ascompared to $384,401 for the six months ended March 31, 2007.  The income for the prior period consisted ofprepayment penalty fees received upon the full repayment of certain loaninvestments ahead of contractual maturity and prepayment fees received upon theearly unscheduled principal repayments, which was based on a percentage of theoutstanding principal amount of the loan at the date of prepayment.

 

**Operating Expenses**

** **

Operatingexpenses, net of credits from the Adviser for fees earned and voluntary waiversto the base management and incentive fees, were $9,005,782 for the six monthsended March 31, 2008, as compared to $5,990,213 for the six months ended March 31,2007. Operating expenses for the six months ended March 31, 2007 reflecteda significant increase in interest expense and loan servicing fees.

 

44

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Interest expensefor the six months ended March 31, 2008 was $4,211,130, as compared to$2,931,276 for the six months ended March 31, 2007.   This increase is primarily a result ofincreased borrowings under our line of credit during the six months ended March 31,2008, 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.

 

Loan servicingfees for the six months ended March 31, 2008 were $2,943,248, as comparedto $1,479,775 for the six months ended March 31, 2007.  These fees were incurred in connection with aloan servicing agreement between Business Loan and our Adviser, which is basedon the size of the portfolio.  Theaverage size of our investment portfolio, excluding equity investments andcontrol investments, was approximately $377.1 million for the six months ended March 31,2008 as compared to approximately $248.2 million for the six months ended March 31,2007.  These fees were reduced againstthe amount of the base management fee due to our Adviser.

 

Base managementfee for the six months ended March 31, 2008 was $1,134,427, as compared to$1,150,702 for the six months ended March 31, 2007.  The base management fee is computed quarterlyas described under *“Investment Advisory andManagement Agreement,”* and is summarized in the table below:

 
| ** **                                                                     | ** ** | **Six months ended** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                     | ** ** | **March 31, 2008**   | ** ** | **March 31, 2007** | ** ** |
| Base management fee                                                            |       | $                              | 1,134,427  |   | $ | 1,150,702 |   |
| Credit for investment advisory fees received by  Adviser  (1)             |       | (971,838                       | )          | (1,086,000 | ) |
| Fee reduction for the waiver of 2% fee on senior  syndicated loans to 0.5% (2) |       | (202,386                       | )          | (301,786 | ) |
| Net base management fee                                                        |       | $                              | (39,797    | ) | $ | (237,084 | ) |

 

----

(1)   Effective April 1, 2007, the board ofour Adviser reduced the amount of voluntary credit for investment advisory feesreceived by our Adviser from 100% of the fees received to 50% of the feesreceived.  Therefore, the six months endedMarch 31, 2008 reflects the reduced credit for fees received by ourAdviser.

 

(2)   The board of our Adviser voluntarily waived,for the six months ended March 31, 2008 and 2007, the annual 2.0% basemanagement fee to 0.5% for senior syndicated loan participations.

 

Incentive fee forthe six months ended March 31, 2008 was $2,749,085, as compared to$2,307,478 for the six months ended March 31, 2007.  The board of our Adviser waived the entireincentive fee for the six months ended March 31, 2008 and a portion of theincentive fee due for the six months ended March 31, 2007.  The incentive fees and associated credits aresummarized in the table below:

 
| ** **                                                                | ** ** | **Six months ended** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                | ** ** | **March 31, 2008**   | ** ** | **March 31, 2007** | ** ** |
| Incentive fee                                                             |       | $                              | 2,749,085  |   | $ | 2,307,478 |   |
| Credit from voluntary waiver issued by Adviser’s  board of directors |       | (2,749,085                     | )          | (1,657,372 | ) |
| Net incentive fee                                                         |       | $                              | —     |   | $ | 650,106 |   |

 

Administration feefor the six months ended March 31, 2008 was $452,254, compared to $294,851for the six months ended March 31, 2007. The increase is due to the addition of administration staff and relatedexpenses.

 

Professional fees,consisting primarily of legal and audit fees, for the six months ended March 31,2008 were $539,287, as compared to $220,001 for the six months ended March 31,2007.  The increase is due to therecording of audit accruals and non reimbursable legal fees.

 

Amortization ofdeferred financing costs, in connection with our line of credit, was $257,579for the six months ended March 31, 2008, as compared to $126,500 for the sixmonths ended March 31, 2007.  Theincrease is due to the amortization of additional fees incurred with our lineof credit which were not in place during the prior year period.

 

Stockholderrelated costs for the six months ended March 31, 2008 were $258,115, ascompared to $151,016 for the six months ended March 31, 2007.  Stockholder related costs include suchrecurring items as transfer agent fees, NASDAQ listing fees, SEC filing feesand annual report printing fees.  Thesefees increased during the six months ended March 31, 2008 due to the sizeand quantity of our annual report and additional filing fees as compared to theprior year.

 

Directors’ feesfor the six months ended March 31, 2008 and 2007 were $111,220 andconsisted of amortization of their annual stipend and meeting stipends.

 

45

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Insurance expensefor the six months ended March 31, 2008 was $112,930, as compared to$125,092 for the six months ended March 31, 2007. The increase isprimarily the result of a decrease in the amortization of our directors andofficers insurance policy premiums.

 

Other expenses forthe six months ended March 31, 2008 was $159,816, as compared to $137,460for the six months ended March 31, 2007. The expenses primarily represent direct expenses such as travel relatedspecifically to our portfolio companies, loan evaluation services for ourportfolio companies, press releases and backup servicer expenses.

 

**NetRealized Gain on Sale of Investments**

** **

During the sixmonths ended March 31, 2008, we did not realize any gains or losses, ascompared to a realized net gain of $86,519 from the sale or repayment of elevensyndicate loan investments in the six months ended March 31, 2007.

 

**RealizedGain on Settlement of Derivative**

** **

During the sixmonths ended March 31, 2008 and March 31, 2007, we received interestrate cap agreement payments of  $6,810and $22,793, respectively, as a result of the one month LIBOR exceeding 5%.

 

**NetUnrealized Depreciation on Derivative**

 

During the sixmonths ended March 31, 2008, we recorded net unrealized depreciation of$12,309 due to a decrease in the fair market value of our interest rate capagreement, as compared to unrealized depreciation of $25,613 during the sixmonths ended March 31, 2007.

 

**NetUnrealized Depreciation on Investments**

 

For the six monthsended March 31, 2008, we recorded net unrealized depreciation oninvestments of $23,743,606, as compared to net unrealized depreciation of$2,722,528, for the six months ended March 31, 2007.  The unrealized depreciation is mainlyattributable to the decrease in fair value on our portfolio, most notably inthe following investments:  LocalTel, Inc.,Greatwide Logistics Services, Inc., Visual Edge Technology, Inc., andU.S. Healthcare Communications, LLC.  Ourinvestment portfolio was valued at a depreciated value due primarily to thegeneral instability of the loan markets. Although our investment portfolio has depreciated, our entire portfoliois fair valued at 93% of cost as of March 31, 2008.  The unrealized depreciation of ourinvestments does not have an impact on our current ability to pay distributionsto stockholders.

 

**Net Increase in Net Assets from Operations**

 

Overall, we realized a net decrease in net assets resulting fromoperations of $10,003,681 for the six months ended March 31, 2008.  Based on a weighted-average of 18,312,018basic and diluted shares outstanding, our net decrease in net assets fromoperations per weighted-average common share for the six months ended March 31,2007 was $0.55, basic and diluted.

 

For the six months ended March 31,2007, we realized a net increase in net assets resulting from operationsof $8,248,454.  Based on aweighted-average of 12,272,012 basic and diluted shares outstanding, our netincrease in net assets from operations per weighted-average common share forthe six months ended March 31, 2007 was $0.67, basic and diluted.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

** **

**OperatingActivities**

 

At March 31,2008, we had investments in debt securities of, or loans to, 62 privatecompanies, totaling approximately $442.4 million (cost basis) of total assets.

 

During the sixmonths ended March 31, 2008 and March 31, 2007, the followinginvestment activity occurred:

 

| **Quarter  Ended**     | ** ** | **New  Investments** | ** **  | **Principal  Repayments *** | ** ** | **Net Gain (Loss)  on Disposal** | ** ** |
|------------------------|------------|----------------------|-------------|----------------------------------|------------|-------------------------------------------------|------------|
| March 31, 2008    |       | $                    | 20,483,354  |                             | $          | 3,000,023                                       |       | $ | — |   |
| December 31, 2007 |       | 73,340,781           |        | 4,046,711                        |       | —                                          |       |
|                   |       | $                    | 93,824,204  |                             | $          | 7,046,734                                       |       | $ | — |   |
|                   |       |                 |        |                             |       |                                            |       |
| March 31, 2007    |       | $                    | 75,330,167  |                             | $          | 38,263,017                                      |       | $ | 84,205 |   |
| December 31, 2006 |       | 52,311,008           |        | 23,967,229                       |       | 2,314                                           |       |
|                   |       | $                    | 127,641,175 |                             | $          | 62,230,246                                      |       | $ | 86,519 |   |

 

----

* The principal repayment activity during the six months ended March 31,2007 of $62.2 million was substantially higher than the $7.0 million repaymentactivity during the current year period due to higher than normal levels ofrefinancing that occurred in 2007.

 

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

 

| ** **                             | ** ** | ** **                       | ** ** | **Amount**  | ** **  |
|----------------------------------------|------------|----------------------------------|------------|-------------|-------------|
| For the remaining six months:          |       | 2008                             |       | $           | 17,670,339  |   |
| For the year ending September 30: |       | 2009                             |       | 32,518,137  |        |
|                                   |       | 2010                             |       | 46,228,823  |        |
|                                   |       | 2011                             |       | 106,735,171 |        |
|                                   |       | 2012                             |       | 96,287,900  |        |
|                                   |       | 2013                             |       | 90,993,643  |        |
|                                   |       | Thereafter                       |       | 48,513,598  |        |
| ** **                             |       | **Total Contractual Repayments** |       | $           | 438,947,611 |   |
|                                   |       | Investments in Equity Securities |       | 3,448,101   |        |
| ** **                             |       | **Total**                        |       | $           | 442,395,712 |   |

 

Net cash used in operating activities for the six months ended March 31,2008, consisting primarily of the items described in *“Results ofOperations”* and the investment activity described above, was$72,992,741 as compared to net cash used in operating activities of $56,539,288for the six months ended March 31, 2007.

 

**Investing Activities**

** **

Net cash provided by investing activities for the six months endedMarch 31, 2008 was $2,484,464, which resulted from the redemption of theU.S. Treasury bill held by Gladstone SSBIC.

 

**Financing Activities**

 

Net cash provided by financing activities for the six months endedMarch 31, 2008 was $68,585,975 and mainly consisted of two offerings ofcommon stock for net proceeds of approximately $106.2 million, net repaymentson our line of credit of approximately $21.0 million, and approximately $15.7million for the payment of dividends.  Net cash provided by financing activitieswas $58,780,679 for the six months ended March 31, 2007 and consistedprimarily of net borrowings on our line of credit of approximately $70.3million and the payment of dividends of approximately $10.3 million.

 

**Dividends**

** **

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 

 

47

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January, February andMarch 2008 and also January, February and March 2007.  In April 2008, our Board of Directorsdeclared a monthly dividend of $0.14 per common share for each of April, May,and June 2008.

 

**Issuanceof Equity**

** **

We anticipateborrowing funds and issuing additional equity securities to obtain additionalcapital. During fiscal year 2007, we filed a registration statement on Form N-2(File No. 333-143027) (the “Registration Statement”) with theSEC that permits usto issue, through one or more transactions, up to an aggregate of$300 million in securities, consisting of common stock, or debtsecurities, of which to date we have issued $123.8 million in common stock,which leaves a remaining capacity of $176.2 million.

 

On October 19,2007, we completed an offering of 2,500,000 shares of our common stock at aprice of $18.70 per share, less an underwriting discount of $1.03 per share,under the Registration Statement and as supplemented by a final prospectussupplement dated October 15, 2007. On November 19, 2007, the underwriter exercised its over-allotmentoption and we closed on an additional 375,000 shares of common stock, at thesame price.  Net proceeds of theoffering, after deducting underwriting discounts and offering expenses borne byus, were approximately $50.5 million and were used to repay a portion ofoutstanding borrowings under our line of credit.

 

On February 5,2008, we completed an offering of 3,000,000 shares of our common stock at aprice of $17.00 per share, less an underwriting discount of $0.935 per share,under the Registration Statement and as supplemented by a final prospectussupplement dated January 30, 2008. On February 26, 2008, theunderwriter exercised its over-allotment option and we closed on an additional450,000 shares of common stock, at the same price.  Net proceeds of the offering, after deductingunderwriting discounts and offering expenses borne by us, were approximately$55.0 million and were used to repay a portion of outstanding borrowings underour line of credit.

 

**RevolvingCredit Facility**

 

Through ourwholly-owned subsidiary, Business Loan, we have a $300 million revolving creditfacility (the “DB Facility”) with Deutsche Bank AG, as administrative agent,which is scheduled to mature on May 23, 2008.  Pursuant to the DB Facility, Business Loanhas pledged the loans it holds to secure future advances by certaininstitutional lenders.  The interest ratecharged on the advances under the DB Facility is based on the Commercial Paper(“CP”) rate, which is equivalent to the weighted average per annum rates paidby the DB Facility’s CP lenders in respect of CP notes issued by the CP lenderduring such period.  Business Loan alsohas the ability to borrow at an alternative rate from the committed lenders ifCP lenders are unable to fund advances. The alternative rate is the London Interbank Offered Rate (“LIBOR”), orif LIBOR is unavailable, the Prime Rate or the Federal Funds Rate plus 1.0%. Asof March 31, 2008, the outstanding principal balance under this creditfacility was approximately $123.5 million at an interest rate of approximately3.31% plus a 1.20% program fee.  In April 2008,we increased the DB Facility to $300 million. Available borrowings are subject to various constraints imposed by DeutscheBank AG, based on the aggregate loan balance pledged by Business Loan, whichvaries as loans are added and repaid, regardless of whether such repayments areearly prepayment or are made as contractually required.  At March 31, 2008, the remaining borrowingcapacity available under the DB Facility was approximately $126.5 million.  We are currently working to renew the DBFacility.  In the event that we are notable to renew or refinance the DB Facility once it matures, this could have amaterial adverse impact on our liquidity and ability to fund new investments.

 

The DB Facilitycontains covenants that require Business Loan to maintain its status as aseparate entity; prohibit certain significant corporate transactions (such asmergers, consolidations, liquidations or dissolutions); and restrict materialchanges to our credit and collection policies. The facility also restricts some of the terms and provisions (includinginterest rates, terms to maturity and payments schedules) and limits theborrower and industry concentrations of loans that are eligible to secureadvances.  As of March 31, 2008,Business Loan was in compliance with all of the facility covenants.  We currently intend to securitize the loansheld by Business Loan and if we are able to do so, we will use the proceedsfrom the securitization to pay down any amounts then outstanding under therevolving credit facility.

 

The administrativeagent also requires that any interest or principal payments on pledged loans beremitted directly by the borrower into a lockbox account with the Bank of NewYork Mellon as custodian.  Deutsche BankAG is also the trustee of the account and once a month remits the collectedfunds to us. At March 31, 2008 and September 30, 2007, the amount duefrom custodian was $3,070,386 and $3,230,385, respectively.

 

Our Adviser alsoservices the loans pledged under the DB Facility.  As a condition to this servicing arrangement,we executed a performance guaranty pursuant to which we guaranteed that ourAdviser would comply fully with all of its obligations under the facility. Theperformance guaranty requires us to maintain a minimum net worth of $100million plus 75% of equity issued after May 2003 and to maintain “assetcoverage” with respect to “senior securities representing indebtedness” of atleast 200%, in accordance with Section 18 of the 1940 Act.  As of March 31, 2008, we were incompliance with our covenants under the performance guaranty.

 

48

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**ContractualObligations**

 

Asof March 31, 2008, we were a party to signed and non-binding term sheetsfor three loan originations for an aggregate of $37.1 million.  We expect to fund these potential investmentswithin the next 12 months.

 

**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 approximately62% 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 32% of the total loan portfolio cost basisat variable rates without a floor or ceiling and approximately 4% 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 $300million revolving credit facility, based on variable rates, with Deutsche BankAG which matures in May 2008.

 

In February 2004, weentered into an interest rate cap agreement in order to fulfill an obligationunder our line of credit to enter into certain hedging transactions inconnection with our borrowings under the line of credit.  We purchasedthis interest rate cap agreement with a notional amount of $35 million (whichis amortized quarterly) for a one-time, up-front payment of $304,000.  Theinterest rate cap agreement entitles us to receive payments, if any, equal tothe amount by which interest payments on the current notional amount at one month LIBOR exceed the paymentson the current notional amount at 5%.  The cap expires in February 2009. This interest rate cap agreement effectively caps our interest paymentson our line of credit borrowing, up to the notional amount of the interest ratecap, at five percent.  This mitigates our exposure to increases ininterest rates on our borrowings on our lines of credit, which are at variablerates.  At March 31, 2008, the capagreement had a fair market value of $5 and a current notional amount of $4.7million.  The one month LIBOR rate ineffect on our investment portfolio at March 31, 2008 was approximately 2.7%.

 

To illustrate thepotential impact of changes in interest rates on our net increase in net assetsresulting from operations, we have performed the following analysis, whichassumes that our balance sheet remains constant and no further actions beyondthe interest rate cap agreement are taken to alter our existing interest ratesensitivity.  Under this analysis, ahypothetical increase in the one month LIBOR or the Prime Rate by 1% would increaseour net increase in net assets resulting from operations by approximately $0.34million, or 10.3%, over the next twelve months. A hypothetical decrease in the one month LIBOR or the Prime Rate by 1%would decrease our net increase in net assets resulting from operations byapproximately $0.04 million, or 1.3%, over the next twelve months.  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 thatwe securitize a portion of our loan portfolio, we believe that we will likelybe required to enter into further hedging arrangements in the future withrespect to securitized loans. While hedging activities may mitigate ourexposure to adverse fluctuations in interest rates, certain hedgingtransactions that we may enter into in the future, such as interest rate swapagreements, may also limit our ability to participate in the benefits of lowerinterest rates with respect to our portfolio of investments.

 

We may alsoexperience risk associated with investing in securities of companies withforeign operations. We currently do not anticipate investing in debt or equityof foreign 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.

 

49

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**ITEM 4. CONTROLS ANDPROCEDURES.**

 

As of March 31, 2008, we, including our Chief ExecutiveOfficer and Chief Financial Officer, evaluated the effectiveness of the designand operation 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 March 31, 2008, that havematerially affected, or are reasonably likely to materially affect, our internalcontrol over financial reporting.

 

50

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**PART II–OTHERINFORMATION**

 

**ITEM 1. LEGALPROCEEDINGS.**

 

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

 

**ITEM 1A. RISKFACTORS.**

 

Our business issubject to certain risks and events that, if they occur, could adversely affectour financial condition and results of operations and the trading price of ourcommon stock. For a discussion of these risks, please refer to the “RiskFactors” section of our Prospectus dated January 23, 2008, filed by uswith the Securities and Exchange Commission on January 23, 2008.

 

*We maynot be able to extend or renew our credit facility on terms reasonablyacceptable to us, if at all.*

 

We are reliant onour credit facility, which is scheduled to mature on May 23, 2008, inorder to be able to continue to obtain capital to finance our loans.  In the event that we are not able to renewour facility on terms reasonably acceptable to us, if at all, we may not beable to finance new investments and may be forced to liquidate a portion of ourinvestments at terms that may not be favorable to us.  This could ultimately have a material adverseeffect on our business, financial condition and results of operations.

 

**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.**

 

The 2008 AnnualMeeting of Stockholders was held on February 21, 2008. The stockholdersvoted and approved the following matters:

 

·                  The election of three directors to hold office until the 2011 AnnualMeeting of Stockholders.

 

| **Nominee**                      | ** ** | **Shares Voted  For** | ** ** | **Authority  Withheld** | ** ** |
|----------------------------------|------------|----------------------------|------------|-------------------------|------------|
| Michela English (2011)           |       | 15,534,403                 |       | 563,060                 |       |
| Anthony W. Parker (2011)         |       | 15,534,927                 |       | 562,536                 |       |
| George Stelljes, III (2011) |       | 15,499,968                 |       | 597,495                 |       |

 

The other directors whose terms of office continued after the meetingare listed below:

 

| **Director**       | ** ** | **End of term** | ** ** |
|--------------------|------------|---------------------------|------------|
| Terry Lee Brubaker |       | 2009                      |       |
| Maurice W. Coulon  |       | 2009                      |       |
| David A. R. Dullum |       | 2009                      |       |
| Gerard Mead        |       | 2009                      |       |
| Paul Adelgren      |       | 2010                      |       |
| David Gladstone    |       | 2010                      |       |
| John H. Outland    |       | 2010                      |       |

 

·                  To approve a series of amendments to our fundamental policies to repealsuch policies as follows:

 
| ** ** | ** **                                                                                                                                        | ** ** | **Number of Shares** | ** ** | ** **         | ** ** |
|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------|------------|
| ** ** | ** **                                                                                                                                        | ** ** | **Shares  Voted For**     | ** ** | **Voted  Against** | ** ** | **Abstained** | ** ** | **Broker  Non-Votes** | ** ** |
| A.         | To repeal the  policy which relates to our ability to invest in securities of a particular  issuer.                                               |       | 9,657,535                      |       | 418,755            |       | 151,501 |   | 5,869,672 |   |
| B.         | To repeal the  policy which relates to our underwriting activities.                                                                               |       | 9,609,854                      |       | 455,430            |       | 162,507 |   | 5,869,672 |   |
| C.         | To repeal the  policy which relates to our ability to purchase or sell real estate or  interests in real estate or real estate investment trusts. |       | 9,681,665                      |       | 398,735            |       | 147,391 |   | 5,869,672 |   |

 

51

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| ** ** | ** **                                                                                                                                                | ** ** | **Number of Shares** | ** ** | ** **         | ** ** |
|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------|------------|
| ** ** | ** **                                                                                                                                                | ** ** | **Shares  Voted For**     | ** ** | **Voted  Against** | ** ** | **Abstained** | ** ** | **Broker  Non-Votes** | ** ** |
| D.         | To repeal the  policy which relates to our ability to sell securities short.                                                                              |       | 9,477,443                      |       | 588,465            |       | 161,883 |   | 5,869,672 |   |
| E.         | To repeal the  policy which relates to our ability to purchase securities on margin.                                                                      |       | 9,436,987                      |       | 629,461            |       | 161,343 |   | 5,869,672 |   |
| F.         | To repeal the  policy which relates to our ability to write or by put or call options.                                                                    |       | 9,504,882                      |       | 555,682            |       | 167,227 |   | 5,869,672 |   |
| G.         | To repeal the  policy which relates to our ability to engage in the purchase or sale of  commodities or commodity contracts, including futures contracts. |       | 9,461,196                      |       | 608,956            |       | 157,639 |   | 5,869,672 |   |
| H.         | To repeal the  policy which relates to our ability to acquire voting stock of, or investing  in, any securities issued by any other investment company.   |       | 9,687,718                      |       | 377,059            |       | 163,014 |   | 5,869,672 |   |

 

·                  To approve a proposal to authorize us to offer and issue long-termrights, including warrants, to purchase shares of our common stock at anexercise price that, at the time such rights are issued, will not be less thanthe greater of the market value of our common stock or the net asset value ofour common stock.  Such rights may bepart of or accompanied by other securities of ours such as convertible debt.

** **

| **Number of Shares** | ** ** | ** **         | ** ** |
|--------------------------------|------------|--------------------|------------|
| **Shares  Voted For**     | ** ** | **Voted  Against** | ** ** | **Abstained** | ** ** | **Broker  Non-Votes** | ** ** |
| 9,323,930                      |       | 746,748            |       | 157,113 |   | 5,869,672 |   |

** **

·                  To ratify the selection by the AuditCommittee of the Board of Directors of PricewaterhouseCoopers LLP as ourindependent registered public accounting firm for our fiscal year ending September 30,2008.

** **

| **Number of Shares** | ** ** | ** **         | ** ** |
|--------------------------------|------------|--------------------|------------|
| **Shares  Voted For**     | ** ** | **Voted  Against** | ** ** | **Abstained** | ** ** | ** ** | ** ** |
| 15,844,802                     |       | 126,145            |       | 126,516 |   |   |   |

** **

**ITEM 5. OTHERINFORMATION.**

 

Not applicable

 

**ITEM 6.  EXHIBITS**

** **

See the exhibit index.

 

**SIGNATURE**

 

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

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

 

Date: May 5, 2008

 

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**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                 |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                                                            |
| 3.1         |       | Articles of Amendment and Restatement of  the Articles of Incorporation, incorporated by reference to Exhibit a.2  to Pre-Effective Amendment No. 1 to the Registration Statement on  Form N-2 (File No. 333-63700), filed July 27, 2001.                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                            |
| 3.2         |       | By-laws, incorporated by reference to  Exhibit b to Pre-Effective Amendment No. 1 to the Registration  Statement on Form N-2 (File No. 333-63700), filed July 27,  2001.                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                                                                            |
| 3.3         |       | Amendment to by-laws, incorporated by  reference to Exhibit 3.3 to the Company’s Quarterly Report on  Form 10-Q for the quarter ended December 31, 2003 (File  No. 814-00237), filed February 17, 2004.                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                                                                            |
| 3.4         |       | Second amendment to by-laws,  incorporated by reference to Exhibit 99.1 to the Company’s Current  Report on Form 8-K (File No. 814-00237), filed July 10, 2007.                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.1        |       | Amendment No. 5 to the Amended and  Restated Credit Agreement by and among Gladstone Business Loan LLC, Deutsche  Bank AG, and certain other parties, dated as of February 26, 2008,  incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K (File No. 814-00237), filed February 26,  2008. |
|        |       |                                                                                                                                                                                                                                                                                                                                                            |
| 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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