All statements contained herein, other than historical facts, may constitute "forward-looking statements." These statements may relate to, among other things, future events or our future performance or financial condition. In some cases, you can identify forward-looking statements by terminology such as "estimate," "may," "might," "believe," "will," "provided," "anticipate," "future," "could," "growth," "plan," "intend," "expect," "should," "would," "if," "seek," "possible," "potential," "likely" or the negative of such terms or comparable terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. We caution readers not to place undue reliance on any such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this Form 10-Q.

The following analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the notes thereto contained elsewhere in this report and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2012.

OVERVIEW

General

We were incorporated under the General Corporation Law of the State of Maryland on May 30, 2001. Our board of directors (our "Board of Directors") approved revisions to our investment objectives (as noted below) and strategies, which went into effect on January 1, 2013. See "Recent Developments - Board of Director Actions" for more information. Our investment objectives are to:
(1) achieve and grow current income by investing in debt securities of established businesses that we believe will provide stable earnings and cash flow to pay expenses, make principal and interest payments on our outstanding indebtedness and make distributions to stockholders that grow over time; and
(2) provide our stockholders with long-term capital appreciation in the value of our assets by investing in equity securities of established businesses that we believe can grow over time to permit us to sell our equity investments for capital gains. To achieve our objectives, our investment strategy is to invest in several categories of debt and equity securities, with each investment generally ranging from $5 million to $30 million, although investment size may vary, depending upon our total assets or available capital at the time of investment. We aim to maintain a portfolio consisting of approximately 95% debt investment and 5% equity investment, at cost.

We operate as a closed-end, non-diversified management investment company, and have elected to be treated as a business development company ("BDC") under the Investment Company Act of 1940, as amended (the "1940 Act"). In addition, for federal tax purposes we have elected to be treated as a regulated investment company ("RIC") under the Internal Revenue Code of 1986, as amended (the "Code").

Business Environment

While economic conditions generally appear to be improving, we remain cautious about a long-term economic recovery. The recent recession in general, and the disruptions in the capital markets in particular, have impacted our liquidity options and increased our cost of debt and equity capital. Many of our portfolio companies, as well as those that we evaluate for possible investment, are impacted by these economic conditions and if these conditions persist, it may affect their ability to repay our loans or engage in a liquidity event, such as a sale, recapitalization or initial public offering. The economic conditions could also disproportionately impact some of the industries in which we have invested, causing us to be more vulnerable to losses in our portfolio, which could cause the number of our non-performing assets to increase and the fair market value of our portfolio to decrease. In addition, there is increased competitive pressure in the BDC and investment company marketplace for senior and senior subordinated debt resulting in lower yields for increasingly riskier investments. We do not know if market and industry conditions will continue to improve or if adverse conditions will again intensify, and we do not know the full extent to which the economic downturn will affect us. If market instability persists or intensifies, we may experience continued difficulty in raising additional capital.

While conditions remain challenging, we are seeing an increase in the number of new investment opportunities consistent with our investment objectives and strategies. During the first quarter of 2013, we were able to invest in several proprietary and syndicate investments totaling $50.2 million; however, we experienced a net contraction in our overall portfolio of a net decrease of two portfolio companies, primarily due to seven portfolio companies paying off early during this period, for an aggregate of $48.9 million in unscheduled principal repayments. In 2013, we are continuing to focus on building our pipeline and making investments that meet our objectives and strategies and that provide appropriate returns given the risks. Subsequent to December 31, 2012, we have made two new syndicated investments for an aggregate total of $6.0 million.

Despite the challenges during these uncertain economic times, during the fiscal year ended September 30, 2012, we completed both a preferred stock offering and a renewal of our $137.0 million line of credit (our "Credit Facility," described more fully under "Revolving Credit Facility" below). In November 2011, we issued 1.5 million shares of term preferred stock (our "Term Preferred Stock," defined under "Equity - Term Preferred Stock" below) for gross proceeds of $38.5 million. In January 2012, we amended our Credit Facility to extend its maturity until January 2015 and in January 2013, we amended our Credit Facility to remove the London Interbank Offered Rate ("LIBOR") minimum of 1.5% on advances (see "Recent Developments - Amendment of Credit Facility" for more information).

In addition, in July 2012, the U.S. Securities and Exchange Commission (the "SEC") granted us an exemptive order that expands our ability to co-invest with certain affiliates by permitting us, under certain circumstances, to co-invest with Gladstone Investment Corporation and any future business development company or closed-end management investment company that is advised by Gladstone Management Corporation, our investment adviser (the "Adviser") (or sub-advised by the Adviser if it controls the fund) or any combination of the foregoing subject to the conditions approved in the SEC's order. We believe this ability to co-invest will enhance our ability to further our investment objectives and strategies.

We believe that market conditions have affected the trading price of our common stock and our ability to finance new investments through the issuance of equity. On January 28, 2013, the closing market price of our common stock was $8.98, a 2.1% discount to our December 31, 2012, net asset value ("NAV") per common share of $9.17. When our stock trades below NAV per common share, as it has consistently traded over the last three years, our ability to issue equity is constrained by provisions of the 1940 Act, which generally prohibits the issuance and sale of our common stock below out then current NAV per common share without stockholder approval other than through sales to our then existing stockholders pursuant to a rights offering. At our annual meeting of stockholders held on February 16, 2012, our stockholders approved a proposal authorizing us to sell shares of our common stock at a price below our then current NAV per common share subject to certain limitations (including, but not limited to, that the cumulative number of shares issued and sold pursuant to such authority does not exceed 25% of our then outstanding common stock immediately prior to each such sale) for a period of one year from the date of approval, provided that our Board of Directors makes certain determinations prior to any such sale. At the upcoming annual stockholders meeting scheduled on February 14, 2013, our stockholders will again be asked to vote in favor of renewing this proposal for another year.

Challenges in the current market are intensified for us by certain regulatory limitations under the Code and the 1940 Act, as well as contractual restrictions under the agreement governing our Credit Facility that further constrain our ability to access the capital markets. To maintain our ability to be taxed as a RIC, we must satisfy an annual distribution requirement to pay out at least 90% of our ordinary income and short-term capital gains to our stockholders. Because we are required to distribute our income in this manner, and because the illiquidity of many of our investments makes it difficult for us to finance new investments through the sale of current investments, our ability to make new investments is highly dependent upon external financing. Our external financing sources include the issuance of equity securities, debt securities or other leverage, such as borrowings under our Credit Facility. Our ability to seek external debt financing, to the extent that it is available under current market conditions, is further subject to the asset coverage limitations of the 1940 Act that require us to have an asset coverage ratio (as defined in Section 18(h) of the 1940 Act) of at least 200% on our senior securities representing indebtedness and our senior securities that are stock.

The continued unsteady economic recovery may also continue to cause the value of the collateral securing some of our loans to fluctuate, as well as the value of our equity investments, which has impacted and may continue to impact our ability to borrow under our Credit Facility. Additionally, our Credit Facility contains covenants regarding the maintenance of certain minimum loan concentrations and net worth covenants, which are affected by the decrease in value of our portfolio. Failure to meet these requirements would result in a default which, if we are unable to obtain a waiver from our lenders, would cause an acceleration of our repayment obligations under our Credit Facility. As of December 31, 2012, we were in compliance with all of our Credit Facility's covenants.

We expect that, given these regulatory and contractual constraints in combination with current market conditions, debt and equity capital may be costly or difficult for us to access in the near term. However, we believe that our public offering of Term Preferred Stock in November 2011, our change in our interest rate on advances on our Credit Facility and our new ability to co-invest with Gladstone Investment Corporation and other affiliated investment funds, will increase our ability to make investments in businesses that we believe will weather the current economic conditions and will be likely to produce attractive long-term returns for our stockholders.

Investment Highlights

During the three months ended December 31, 2012, we extended an aggregate of $50.2 million of investments to six new portfolio companies and an aggregate of $1.6 million of investments to existing portfolio companies. Also, during the three months ended December 31, 2012, we sold one portfolio company for net proceeds of approximately $5.9 million, and we received scheduled and unscheduled contractual principal repayments of approximately $50.6 million from existing portfolio companies, including seven early payoffs. Since our initial public offering in August 2001, we have made 325 different loans to, or investments in, 164 companies for a total of approximately $1.2 billion, before giving effect to principal repayments on investments and divestitures.

Investment Activity

During the three months ended December 31, 2012, we executed the following transactions with certain of our portfolio companies:

Purchases

During the three months ended December 31, 2012, we extended an aggregate of $33.7 million of investments to two new proprietary portfolio companies and an aggregate of $16.5 million to four new syndicated portfolio companies (First American Payment Systems, L.P., SumTotal Systems, Inc., Wall Street Systems Holdings, Inc. and John Henry Holdings, Inc.).

• In December 2012, we invested $14.0 million in AG Transportation Holdings, LLC ("AG Trucking") through a combination of senior subordinated term debt and equity. AG Trucking, headquartered in Goshen, Indiana, is a regional food-grade liquid and dry bulk carrier providing a variety of bulk transportation services, including liquid transportation, dry bulk dumps, freight brokering, private fleet conversion and project runs to large international agricultural and food manufacturing firms.

• In December 2012, we invested $19.5 million in Allen Edmonds Shoe Corporation ("Allen Edmonds") through senior subordinated term debt that we purchased from one of Allen Edmonds' existing lenders. Allen Edmonds, headquartered in Port Washington, Wisconsin, manufactures premium men's footwear and accessories which it sells through its retail stores, catalog and internet site and also wholesale and e-commerce channels.

Repayments and Exits:

During the three months ended December 31, 2012, 24 borrowers made principal repayments totaling $50.6 million in the aggregate, consisting of $47.7 million of unscheduled early payoffs as well as $2.9 million in contractual amortization, revolver repayments and principal payments.

• Included in the unscheduled principal payments were the net proceeds at par from early payoffs of the following:

• Syndicated investments: Blue Coat Systems, Inc. of $8.5 million, HGI Holdings, Inc. of $1.6 million, Wall Street Systems Holdings, Inc. of $3.0 million, Mood Media Corporation of $8.0 million, Keypoint Government Solutions of $6.4 million, and WP Evenflo Group Holdings, Inc. of $0.3 million. In connection with these early payoffs, we received an aggregate of $0.5 million in prepayment fees during the three months ended December 31, 2012; and

• Proprietary investments: Westlake Hardware, Inc. ("Westlake") of $20.0 million. In relation to the Westlake exit, we received $1.1 million in success fees during the three months ended December 31, 2012.

• In November 2012, we sold our investments in Viapack, Inc. ("Viapack") for net proceeds of $5.9 million, which resulted in a realized loss of $2.4 million recorded in the three months ended December 31, 2012. Viapack had partially been on non-accrual status at the time of the sale.

• In November 2012, we wrote off our investment in Access Television Network, Inc. ("Access TV") which resulted in a realized loss of $0.9 million recorded in the three months ended December 31, 2012. Access TV had been on non-accrual status at the time of the write off.

Recent Developments

Amendment of Credit Facility

On January 29, 2013, we entered into Amendment No. 4 to our Credit Facility, through Gladstone Business Loan, LLC ("Business Loan"), to remove the LIBOR minimum of 1.5% on advances. We incurred fees of $0.6 million in January 2013 in connection with this amendment, which will be amortized through the maturity date of our Credit Facility. All other terms of our Credit Facility remained unchanged.

Registration Statement

On November 29, 2012, we filed a registration statement (our "Registration Statement") on Form N-2 (File No. 333-185191) that was amended on January 17, 2013, and which the SEC declared effective on January 18, 2013. The Registration Statement permits us to issue, through one or more transactions, up to an aggregate of $300.0 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities and warrants to purchase common stock or preferred stock, including through a combined offering of such securities. We have not issued any securities to date under this Registration Statement.

Departure of Executive Officer and Director

On November 27, 2012, George Stelljes III informed the Company that he intended to resign as president and chief investment officer and director of the Company, although no effective date for his resignation has been determined. He will continue to perform his duties for the Company until his resignation is effective.

Board of Director Actions

In October 2012, our Board of Directors expanded our board of directors from nine to ten members and appointed Terry Earhart as a new independent director to our board to fill the resulting vacancy. Mr. Earhart was also appointed as a member of our compensation and ethics, nominating and corporate governance committees.

Also in October 2012, our Board of Directors approved limited revisions to our investment objectives and strategies, which went into effect on January 1, 2013. All of our current portfolio investments fit within the scope of our revised investment objectives and strategies and no changes were made to our current portfolio as a result of this revision.

Also in October 2012, we terminated our equity distribution agreement with BB&T Capital Markets, a division of Scott & Stringfellow, LLC, under which we had the ability to issue up to 2 million shares of common stock from time to time. We did not issue any common shares under this agreement. Prepaid costs of $0.2 million related to the origination of this agreement were expensed in the three months ended September 30, 2012.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended December 31, 2012, to the Three Months
Ended December 31, 2011



                                                       For the Three Months Ended December 31,
                                                2012             2011         $ Change         % Change
INVESTMENT INCOME
Interest income                              $    8,180        $  9,320       $  (1,140 )          (12.2 )%
Other income                                      1,648              -            1,648               NM

Total investment income                           9,828           9,320             508              5.5

EXPENSES
Base management fee                               1,432           1,556            (124 )           (8.0 )
Incentive fee                                     1,215           1,035             180             17.4
Administration fee                                  150             195             (45 )          (23.1 )
Interest expense                                    856           1,139            (283 )          (24.8 )
Dividend expense on mandatorily
redeemable preferred stock                          686             434             252             58.1
Amortization of deferred financing fees             256             457            (201 )          (44.0 )
Other                                               575             536              39              7.3

Expenses before credits from Adviser              5,170           5,352            (182 )           (3.4 )
Credits to fees from Adviser                       (201 )          (450 )           249            (55.3 )

Total expenses net of credits                     4,969           4,902              67              1.4


NET INVESTMENT INCOME                             4,859           4,418             441             10.0

REALIZED AND UNREALIZED GAIN (LOSS):
Realized loss on investments                     (3,048 )        (8,249 )         5,201             63.1
Net unrealized appreciation of
investments                                       4,885           2,243           2,642            117.8
Net unrealized depreciation of borrowings         1,670             299           1,371            458.5

Net gain (loss) from investments and
borrowings                                        3,507          (5,707 )         9,214               NM

NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS                    $    8,366        $ (1,289 )     $   9,655               NM %

NM = Not Meaningful

Investment Income

Interest income on our investments in debt securities decreased for the three months ended December 31, 2012, by 12.2%, as compared to the three months ended December 31, 2011, primarily due to the increase in early payoffs at par during the second half of fiscal year 2012 and first quarter of fiscal year 2013, partially offset by a increase in our weighted average yield on our interest bearing investment portfolio. The level of interest income from investments is directly related to the principal balance of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The weighted average principal balance of our interest-bearing investment portfolio during the three months ended December 31, 2012, was $278.3 million, compared to $333.2 million for the prior year period. The annualized weighted average yield on our interest-bearing investment portfolio for the three months ended December 31, 2012 was 11.6%, compared to 11.0% for the prior year period. The weighted average yield varies from period to period based on the current stated interest rate on interest-bearing investments. The weighted average yield on our portfolio increased during the three months ended December 31, 2012, as compared to the prior year period, due to the purchase of new proprietary investments during the quarter, and the early payoffs of several of our syndicated loans, which generally bear lower interest rates than our proprietary investments.

During the three months ended December 31, 2012, four of our portfolio companies were on non-accrual with an aggregate debt cost of approximately $56.6 million, or 16.4%, of the cost basis of all debt investments in our portfolio. During the prior year period, six portfolio companies were on non-accrual with an aggregate debt cost of approximately $28.8 million, or 8.0%, of the cost basis of all debt investments in our portfolio.

Other income for the three months ended December 31, 2012, consisted primarily of $1.1 million in success fees received from the early payoff of Westlake. In addition, we received prepayment fees in the aggregate of $0.5 million in the three months ended December 31, 2012, related to early payoffs of four syndicate investments during the period. For the three months ended December 31, 2011, no other income was received.

The following tables list the investment income for our five largest portfolio company investments at fair value during the respective periods:

                                             As of December 31, 2012                     Three Months Ended December 31, 2012
                                                                                        Investment                 % of Total
Company                                Fair Value            % of Portfolio               Income                    Revenues
Reliable Biopharmaceutical
Holdings, Inc.                       $       25,867                      9.6 %       $             810                        8.2 %
Allen Edmonds Shoe
Corporation(A)                               19,483                      7.2                        79                        0.8
Midwest Metal Distribution,
Inc.                                         17,847                      6.6                       565                        5.7
Francis Drilling Fluids, Ltd.                15,473                      5.7                       460                        4.7
AG Transportation Holdings,
LLC.(A)                                      14,000                      5.2                        40                        0.4

Subtotal-five largest
investments                                  92,670                     34.3                     1,954                       19.8
Other portfolio companies                   177,843                     65.7                     7,820                       79.6
Other non-portfolio company
revenue                                          -                        -                         54                        0.6

Total investment portfolio           $      270,513                    100.0 %       $           9,828                      100.0 %

                                             As of December 31, 2011                     Three Months Ended December 31, 2011
                                                                                        Investment                 % of Total
Company                                Fair Value            % of Portfolio               Income                    Revenues
Reliable Biopharmaceutical
Holdings, Inc.                       $       25,670                      8.8 %       $             785                        8.4 %
Westlake Hardware, Inc.(B)                   19,415                      6.6                       652                        7.0
Midwest Metal Distribution,
Inc.                                         17,641                      6.0                       565                        6.1
Defiance Integrated
Technologies, Inc.                           16,106                      5.5                       209                        2.2
CMI Acquisition, LLC                         14,354                      4.9                       493                        5.3

Subtotal-five largest
investments                                  93,186                     31.8                     2,704                       29.0
Other portfolio companies                   199,660                     68.2                     6,543                       70.2
Other non-portfolio company
revenue                                          -                        -                         73                        0.8

Total investment portfolio           $      292,846                    100.0 %       $           9,320                      100.0 %

(A) New investment during the applicable period.

(B) Investment exited during the three months ended December 31, 2012.

Operating Expenses

Operating expenses, net of credits to fees from the Adviser, decreased for the three months ended December 31, 2012, by 3.4%, as compared to the prior year period. This decrease was primarily due to a decrease in interest expense on our Credit Facility and a decrease in amortization of deferred financing fees, partially offset by an increase in our dividend expense on our mandatorily redeemable preferred stock.

Interest expense decreased for the three months ended December 31, 2012, as compared to the prior year period, primarily due to decreased borrowings under . . .