UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-09709
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HIGHLAND FLOATING RATE ADVANTAGE FUND
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(Exact name of registrant as specified in charter)
13455 Noel Road, Suite 1300
DALLAS, TEXAS 75240
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(Address of principal executive offices) (Zip code)
James D. Dondero
Highland Capital Management, L.P.
13455 Noel Road, Suite 1300
DALLAS, TEXAS 75240
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(Name and address of agent for service)
registrant's telephone number, including area code: (877) 532-2834
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Date of fiscal year end: AUGUST 31
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Date of reporting period: AUGUST 31, 2005
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Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW,
Washington, DC 20549-0609. The OMB has reviewed this collection of information
under the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
[GRAPHIC OMITTED]
COVER PHOTO
HIGHLAND FLOATING
RATE ADVANTAGE FUND
Annual Report
August 31, 2005
[GRAPHIC OMITTED]
HIGHLAND FUNDS
managed by Highland Capital Management, L.P.
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HIGHLAND FLOATING RATE ADVANTAGE FUND
TABLE OF CONTENTS
Portfolio Managers' Letter .......................................... 1
Fund Profile ........................................................ 3
Performance Information ............................................. 4
Understanding Your Expenses ......................................... 5
Financial Statements ................................................ 6
Investment Portfolio ............................................. 7
Statement of Assets and Liabilities .............................. 16
Statement of Operations .......................................... 17
Statements of Changes in Net Assets .............................. 18
Statement of Cash Flows .......................................... 20
Financial Highlights ............................................. 21
Notes to Financial Statements .................................... 25
Report of Independent Registered Public Accounting Firm ............. 31
Trustees and Officers ............................................... 32
Important Information About This Report ............................. 34
A prospectus must precede or accompany this report. Please read the prospectus
carefully before you invest.
PORTFOLIO MANAGERS' LETTER
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HIGHLAND FLOATING RATE ADVANTAGE FUND
Dear Shareholders:
Highland Floating Rate Advantage Fund (the "Fund") is a non-diversified,
closed-end management investment company that seeks to provide a high level of
current income consistent with preservation of capital.
PERFORMANCE SUMMARY
For the 12-month period ended August 31, 2005, Class A shares of Highland
Floating Rate Advantage Fund returned 6.56% without sales charge. That was
greater than the return of the Fund's benchmark, the Credit Suisse First Boston
("CSFB") Leveraged Loan Index, which was 5.96% for the period. The Fund also did
better than the Lipper Loan Participation Loan Category average, which was
5.83%. We believe the Fund was able to outperform because of favorable security
selection and sector allocation, and also because of the positive effect of
using leverage in a rising market.
LEVERAGE LOAN MARKET OVERVIEW
The year ending August 31, 2005 was another strong year for the leveraged loan
market, which was fueled by improved earnings, and increased demand for floating
rate loans. For the fiscal year ended August 31, 2005, total leveraged loan
volume, as tracked by Standard & Poor's/Leveraged Commentary & Data, increased
strongly to $279 billion, versus $215 billion in the prior year. However, during
the year default rates, as tracked by Standard & Poor's/Loan Syndications &
Trading Association Leveraged Loan Index, increased from a lagging 12-month
default rate of 0.94% as of August 31, 2004, to 1.51% as of August 31, 2005.
As tracked by the CSFB Leveraged Loan Index, spreads on leveraged loans
tightened considerably during the fiscal year of the Fund from a weighted
average spread of 302 basis points at August 31, 2004, to 265 basis points at
August 31, 2005. This spread tightening was offset by a significant increase in
LIBOR (London Interbank Offered Rate) over the fiscal year. LIBOR is the rate of
interest at which banks can borrow funds from other banks, in marketable size,
in the London interbank market. As you can see in the chart below, 1-month LIBOR
rose from 1.67% at August 31, 2004, to 3.70% at August 31, 2005. As a result,
even though spreads tightened, the weighted average coupon on leveraged loans,
as tracked by the CSFB Leveraged Loan Index, increased from 4.71% at August 31,
2004, to 6.34% at August 31, 2005, a change of 1.63% over the fiscal year.
[GRAPHIC OMITTED]
EDGAR REPRESENTATION OF DATA POINTS USED IN GRAPHIC AS FOLLOWS:
3 MONTH LIBOR - 8/31/04-8/31/05*
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8/31/04 1.67%
9/30/04 1.84%
10/31/04 2.00%
11/30/04 2.29%
12/31/04 2.40%
1/31/05 2.59%
2/28/05 2.72%
3/31/05 2.87%
4/30/05 3.09%
5/31/05 3.13%
6/30/05 3.34%
7/31/05 3.52%
8/31/05 3.70%
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* Source British Bankers Association
PORTFOLIO OVERVIEW
During the fiscal year the Fund initiated core positions in several new
investments. Specifically, positions were taken in loans issued by Home
Interiors & Gifts, Inc., a manufacturer and distributor of home decorative
accessories, DS Waters Enterprises LP, a home and office delivery bottled water
operator, and Kerr-McGee Corp., a global energy and chemical company. These
comprise 2.3%, 1.7% and 1.7% of net assets, respectively. These percentages
represent the percentages
1
PORTFOLIO MANAGERS' LETTER (CONTINUED)
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HIGHLAND FLOATING RATE ADVANTAGE FUND
of net assets for each holding as of August 31, 2005 and are subject to change.
The Fund continues to be overweighted in the Cable & Satellite Television
industry, which constituted 11.4% of net assets and performed well for the Fund.
Century Cable Holdings LLC and Charter Communications Operating LLC (1.8% and
1.6% of net assets, respectively) had another strong year for the Fund.
We believe the Fund remains well diversified. As of August 31, 2005, the average
individual loan position represented approximately 0.3% of total assets, while
the average industry sector exposure accounted for roughly 2.9%.
ADDITIONAL FUND INFORMATION
Effective May 23, 2005, the Fund is now able to invest up to 20% of its net
assets in senior loans of foreign borrowers that are foreign currency
denominated. We believe this change will be of a benefit to the Fund and allow
it to invest in senior loans previously unavailable to the Fund.
USE OF LEVERAGE
The Fund utilizes financial leverage in an effort to increase the yield to the
shareholders. As of August 31, 2005, the Fund had borrowings under its credit
facility of $250 million. Total leverage, as a percentage of net assets, was
26.5% at period end. While we believe the use of leverage for investment
purposes increases investment opportunity, it also increases investment risk.
We thank you for your investment in the Fund.
/S/MARK OKADA /S/JOE DOUGHERTY
Mark Okada Joe Dougherty
Portfolio Manager Portfolio Manager
Mark Okada and Joe Dougherty have been portfolio managers of the Highland
Floating Rate Advantage Fund since April 15, 2004.
Just like any other investment, floating rate loan investments present financial
risks. Defaults on the loans in the Portfolio could reduce the Fund's net asset
value and its distributions, as could nonpayment of scheduled interest and
principal. Prepayment of principal by a borrower could result in the Fund's
managers having to replace the loan with a lower-yielding security, which could
affect the valuation of the Portfolio's holdings.
The Fund is a continuously offered, closed-end management investment company
that provides limited liquidity through a quarterly tender offer for between 5%
and 25% of outstanding shares. Each quarter, the Fund's Trustees must approve
the actual tender. Please read the Fund's prospectus and statement of additional
information carefully for more details.
The Fund may invest a high percentage of assets in a limited number of loans, so
the default of any individual holdings can have a greater impact on the Fund's
net asset value than could a default in a more diversified portfolio.
Floating rate loans are not covered by FDIC insurance or other guarantees
relating to timely payment of principal and interest.
Since economic and market conditions change frequently, there can be no
assurance that the trends described here will continue or that the forecasts
will come to pass. The opinions expressed are those of the management of the
Fund and are subject to change.
2
FUND PROFILE
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HIGHLAND FLOATING RATE ADVANTAGE FUND
OBJECTIVE
To provide a high level of current
income consistent with preservation
of capital.
TOTAL NET ASSETS
(AS OF 08/31/05)
$942.8 million
The information below gives you a snapshot of your Fund at the end of the
reporting period. Your Fund is actively managed and the composition of its
portfolio will change over time.
QUALITY BREAKDOWN AS OF 08/31/05 (%)
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Ba 13.9
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B 59.9
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Caa 7.7
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NR 18.5
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TOP 5 SECTORS AS OF 08/31/05 (%)
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Cable & Satellite Television 11.4
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Utilities 8.5
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Oil/Gas 8.2
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Lodging & Casinos 8.0
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Health Care 7.9
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TOP 10 HOLDINGS AS OF 08/31/05 (%)
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Home Interiors & Gifts, Inc., Initial Term Loan, 8.38%, 03/31/11 2.3
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OpBiz LLC, Term Loan A, 6.50%, 08/31/10 1.9
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DS Waters Enterprises LP, Term Loan, 8.17%, 11/07/09 1.7
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General Growth Properties, Inc., Tranche B Term Loan, 5.67%, 11/12/08 1.6
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Cricket Communications, Inc., Term Loan B, 5.99%, 01/10/11 1.6
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Extended Stay America, Inc., Mezzanine Loan, 08/01/08 1.6
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Century Cable Holdings LLC, Term Loan, 8.50%, 06/30/09 1.5
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LNR Property Corp., Tranche B Term Loan, 6.69%, 02/03/08 1.4
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SunGard Data Systems, Inc., U.S. Term Loan, 6.28%, 02/11/13 1.3
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Blockbuster Entertainment Corp., Tranche B Term Loan, 7.26%, 08/20/11 1.3
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Quality is calculated as a percentage of total notes and bonds. Sectors and
holdings are calculated as a percentage of net assets.
3
PERFORMANCE INFORMATION
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HIGHLAND FLOATING RATE ADVANTAGE FUND
VALUE OF $10,000 INVESTMENT 01/13/00 (INCEPTION DATE) - 08/31/05
[GRAPHIC OMITTED]
EDGAR REPRESENTATION OF DATA POINTS USED IN GRAPHIC AS FOLLOWS:
Class A CSFB Leveraged
(with sales charge) Loan Index
01/13/2000 $9,646 $10,000
Aug-00 $10,330 $10,360
Aug-01 $10,916 $10,871
Aug-02 $10,493 $10,662
Aug-03 $12,125 $11,707
Aug-04 $13,717 $12,532
Aug-05 $14,616 $13,279
This chart compares a $10,000 investment made in the Class A Shares of the Fund
to $10,000 investments made in the index, the Credit Suisse First Boston
("CSFB") Leveraged Loan Index. CSFB Leveraged Loan Index is an unmanaged index
that tracks the performance of senior floating rate bank loans. Unlike mutual
funds, indices are not investments, do not incur fees or expenses and are not
professionally managed. It is not possible to invest directly in an index.
Securities in the Fund may not match those in an index. Index performance is
from December 31, 1999.
PERFORMANCE OF A $10,000 INVESTMENT CLASS INCEPTION - 08/31/05 ($)
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Sales Charge Without With
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Class A 15,153 14,616
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Class B 14,866 14,866
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Class C 14,743 14,743
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Class Z 15,446 n/a
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AVERAGE ANNUAL TOTAL RETURNS AS OF 08/31/05 (%)
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Share Class A B C Z
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Class Inception Date 01/13/00 01/13/00 01/13/00 01/13/00
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Sales Charge Without With Without With Without With Without
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1 - YEAR 6.56 2.81 6.19 2.94 6.03 5.03 6.93
5 - YEAR 7.40 6.63 7.06 6.91 6.90 6.90 7.79
SINCE INCEPTION 7.66 6.97 7.29 7.29 7.13 7.13 8.02
THE PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE. PAST PERFORMANCE DOES
NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL
FLUCTUATE SO THAT AN INVESTOR'S SHARES, UPON REDEMPTION, MAY BE WORTH MORE OR
LESS THAN THEIR ORIGINAL COST. CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN
THE PERFORMANCE DATA QUOTED. FOR PERFORMANCE DATA CURRENT TO THE MOST RECENT
MONTH-END, PLEASE VISIT OUR WEBSITE AT WWW.HIGHLANDFUNDS.COM.
PERFORMANCE FIGURES DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER
WOULD PAY ON FUND DISTRIBUTIONS OR REDEMPTIONS OF FUND SHARES. ALL RESULTS SHOWN
ASSUME REINVESTMENT OF DISTRIBUTIONS. RETURN FIGURES REFLECT VOLUNTARY EXPENSE
REIMBURSEMENTS AND FEE WAIVERS. WITHOUT REIMBURSEMENTS OR WAIVERS, FUND RETURNS
WOULD HAVE BEEN LOWER.
TOTAL RETURNS "WITHOUT SALES CHARGE", DOES NOT INCLUDE SALES CHARGE OR
CONTINGENT DEFERRED SALES CHARGE (CDSC). TOTAL RETURNS "WITH SALES CHARGE",
REFLECT THE MAXIMUM SALES CHARGE OF 3.50% ON CLASS A SHARES; THE MAXIMUM CDSC OF
3.25% ON CLASS B SHARES SOLD WITHIN THE FIRST YEAR THEY ARE PURCHASED FOR
CALCULATION OF THE 1-YEAR RETURN AND THE MAXIMUM CDSC OF 1.00% ON CLASS B SHARES
SOLD WITHIN THE FIFTH YEAR THEY ARE PUR CHASED FOR CALCULATION OF THE 5-YEAR
RETURN; AND THE CDSC OF 1.00% ON CLASS C SHARES SOLD WITHIN THE FIRST YEAR THEY
ARE PURCHASED.
4
UNDERSTANDING YOUR EXPENSES
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HIGHLAND FLOATING RATE ADVANTAGE FUND
DISCLOSURE OF FUND EXPENSES: We believe it is important for you to understand
the impact of fees regarding your investment. All mutual funds have operating
expenses. As a shareholder of a mutual fund, you incur ongoing costs, which
include costs for portfolio management, administrative services, and shareholder
reports (like this one), among others. Operating expenses, which are deducted
from a fund's gross income, directly reduce the investment return of the fund. A
fund's expenses are expressed as a percentage of its average daily net assets.
This figure is known as the expense ratio. The following examples are intended
to help you understand the ongoing fees (in dollars) of investing in your Fund
and to compare these costs with those of other mutual funds. The examples are
based on an investment of $1,000 made at the beginning of the period shown and
held for the entire period.
This table illustrates your Fund's costs in two ways:
ACTUAL FUND RETURN: This section helps you to estimate the actual expenses,
after any applicable fee waivers, that you paid over the period. The "Ending
Account Value" shown is derived from the Fund's actual return for the past six
month period, the "Expense Ratio" column shows the period's annualized expense
ratio, and the "Expenses Paid During Period" column shows the dollar amount that
would have been paid by an investor who started with $1,000 in the Fund at the
beginning of the period.
You may use the information here, together with your account value, to estimate
the expenses that you paid over the period. To do so, simply divide your account
value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6),
then multiply the result by the number given for your Fund in the first line
under the heading entitled "Expenses Paid During Period."
HYPOTHETICAL 5% RETURN: This section is intended to help you compare your Fund's
costs with those of other mutual funds. It assumes that the Fund had an annual
return of 5% before expenses, but that the expense ratio is unchanged. In this
case, because the return used is not the Fund's actual return, the results do
not apply to your investment. This example is useful in making comparisons to
other mutual funds because the SEC requires all mutual funds to calculate
expenses based on an assumed 5% annual return. You can assess your Fund's costs
by comparing this hypothetical example with the hypothetical examples that
appear in shareholder reports of other funds.
Please note that the expenses shown in the table are meant to highlight and help
you compare your ongoing costs only and do not reflect any transactional costs
such as sales charges (loads) and redemption fees, which are described in the
Prospectus. If these costs were applied to your account, your costs would be
higher.
MARCH 1, 2005 - AUGUST 31, 2005
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Account Value at the Account Value at the Expenses Paid Fund's annualized
beginning of the period ($) end of the period ($) during the period ($)(1) expense ratio (%)(2)
- ---------------------------------------------------------------------------------------------------------------------------
ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL
CLASS A 1,000.00 1,000.00 1,034.90 1,014.32 11.08 10.97 2.16
CLASS B 1,000.00 1,000.00 1,033.10 1,012.55 12.86 12.73 2.51
CLASS C 1,000.00 1,000.00 1,032.20 1,011.80 13.63 13.49 2.66
CLASS Z 1,000.00 1,000.00 1,036.70 1,016.08 9.29 9.20 1.81
<FN>
(1) Expenses paid during the period are equal to the Fund's annualized expense
ratio, multiplied by the average account value over the period, then
multiplied by the number of days in most recent fiscal half-year and divided
by 365.
(2) Annualized, based on the Fund's most recent fiscal half-year expenses.
</FN>
5
FINANCIAL STATEMENTS
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AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
A GUIDE TO UNDERSTANDING YOUR FUND'S FINANCIAL STATEMENTS
INVESTMENT PORTFOLIO The Investment Portfolio details all of the Fund's
holdings and their market value as of the last day
of the reporting period. Portfolio holdings are
organized by type of asset and industry to
demonstrate areas of concentration and
diversification.
STATEMENT OF ASSETS AND This statement details the Fund's assets,
LIABILITIES liabilities, net assets and share price for each
share class as of the last day of the reporting
period. Net assets are calculated by subtracting
all the Fund's liabilities (including any unpaid
expenses) from the total of the Fund's investment
and non-investment assets. The share price for
each class is calculated by dividing net assets
for that class by the number of shares outstanding
in that class as of the last day of the reporting
period.
STATEMENT OF OPERATIONS This statement details income earned by the Fund
and the expenses accrued by the Fund during the
reporting period. The Statement of Operations also
shows any net gain or loss the Fund realized on
the sales of its holdings during the period, as
well as any unrealized gains or losses recognized
over the period. The total of these results
represents the Fund's net increase or decrease in
net assets from operations.
STATEMENTS OF CHANGES These statements demonstrate how the Fund's
IN NET ASSETS net assets were affected by its operating results,
distributions to shareholders and shareholder
transactions (e.g., subscriptions, redemptions and
dividend reinvestments) during the reporting
period. The Statements of Changes in Net Assets
also details changes in the number of shares
outstanding.
STATEMENT OF CASH FLOWS The Statement of Cash Flows reports net cash and
foreign currency provided or used by operating,
investing and financing activities and the net
effect of those flows on cash, foreign currency
and cash equivalents during the period.
FINANCIAL HIGHLIGHTS The Financial Highlights demonstrate
how the Fund's net asset value per share was
affected by the fund's operating results. The
Financial Highlights table also discloses the
classes' performance and certain key ratios (e.g.,
class expenses and net investment income as a
percentage of average net assets).
NOTES TO FINANCIAL STATEMENTS These notes disclose the organizational background
of the Fund, its significant accounting policies
(including those surrounding security valuation,
income recognition and distributions to
shareholders), federal tax information, fees and
compensation paid to affiliates and significant
risks and contingencies.
6
INVESTMENT PORTFOLIO
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
SENIOR LOAN NOTES (A) - 114.9%
AEROSPACE/DEFENSE - 1.0%
Decrane Aircraft Holdings, Inc.
2,178,433 Term Loan B, 9.02%, 06/30/08 .............. 2,189,325
1,118,362 Term Loan D, 9.52%, 06/30/08 .............. 1,121,158
GenCorp, Inc.
2,625,000 Credit Linked Certificate of Deposit,
6.67%, 12/06/10 ........................... 2,661,146
848,750 Term Loan, 6.86%, 12/06/10 ................ 856,176
2,985,882 Vought Aircraft Industries, Inc.
Term Loan, 6.17%, 12/22/11 ................ 3,038,762
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9,866,567
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AIR TRANSPORT - 1.0%
Continental Airlines, Inc.
857,143 Tranche A-1 Term Loan,
8.73%, 06/01/11 ........................... 860,357
2,142,857 Tranche A-2 Term Loan,
8.73%, 06/01/11 ........................... 2,150,893
2,000,000 Northwest Airlines, Inc.
Tranche C Term Loan,
10.07%, 11/23/10 .......................... 1,967,500
4,456,969 United Airlines, Inc.
Tranche B, 7.96%, 12/30/05 ................ 4,492,268
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9,471,018
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AUTOMOTIVE - 4.2%
4,500,000 Delphi Corp.
Term Loan, 10.30%, 06/14/11 ............... 4,626,173
Federal-Mogul Corp.
1,457,560 Supplemental Revolver,
7.43%, 12/09/05 ........................... 1,308,160
5,000,000 Tranche B Term Loan,
6.18%, 02/24/05 (f) ....................... 4,648,200
573,404 Tranche C Term Loan,
7.43%, 12/09/05 ........................... 574,838
Goodyear Tire & Rubber Co.
5,500,000 Second Lien Term Loan,
6.32%, 04/30/10 ........................... 5,573,370
3,500,000 Third Lien Term Loan,
7.07%, 03/01/11 ........................... 3,492,580
Hayes Lemmerz International, Inc.
4,651,097 Term Loan B, 6.85%, 06/03/09 .............. 4,708,259
1,000,000 Term Loan C, 8.92%, 06/03/10 .............. 1,015,000
Key Plastics LLC
4,538,436 Term Loan B, 6.66%, 06/29/10 .............. 4,572,474
3,495,000 Term Loan C, 9.40%, 06/25/11 .............. 3,433,837
1,331,298 Plastech, Inc.
Term Loan B, 8.24%, 03/31/10 .............. 1,288,031
2,000,000 RJ Tower Corp.
Tranche B DIP Term Loan,
6.63%, 02/02/07 ........................... 2,014,780
2,000,000 Tire Rack Holdings, Inc.
Tranche B Term Loan,
5.82%, 06/24/12 ........................... 2,035,000
723,333 United Components, Inc.
Tranche C Term Loan,
5.75%, 06/30/10 ........................... 735,312
-------------
40,026,014
-------------
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
BEVERAGE & TOBACCO - 3.3%
2,733,333 Caribbean Restaurant LLC
Tranche B, 6.34%, 06/30/09 ................ 2,776,903
1,219,795 Commonwealth Brands, Inc.
Incremental Term Loan,
7.00%, 08/28/07 ........................... 1,242,666
3,907,257 Dr. Pepper Bottling Company of Texas
Tranche B Term Loan,
5.35%, 12/19/10 ........................... 3,968,796
16,024,907 DS Waters Enterprises LP
Term Loan, 8.17%, 11/07/09 ................ 15,680,371
1,995,000 Intabex Netherlands BV
Term Loan B, 6.73%, 05/13/10 .............. 2,024,925
3,750,000 National Distributing Co., Inc.
Second Lien Term Loan,
10.15%, 06/01/10 .......................... 3,759,375
1,235,294 Sunny Delight Beverage Co.
First Lien Term Loan,
7.95%, 08/20/10 ........................... 1,239,926
-------------
30,692,962
-------------
BROADCAST RADIO & TELEVISION - 1.5%
5,500,000 HIT Entertainment PLC
Second Lien Term Loan,
02/17/13 (b) .............................. 5,634,090
Spanish Broadcasting Systems, Inc.
2,992,500 First Lien Term Loan,
5.49%, 06/10/12 ........................... 3,039,273
500,000 Second Lien Term Loan,
7.51%, 06/10/13 ........................... 507,500
2,926,833 Warner Music Group
Term Loan B, 5.70%, 02/28/11 .............. 2,961,311
2,000,000 Young Broadcasting, Inc.
Term Loan, 5.77%, 11/03/12 ................ 2,021,680
-------------
14,163,854
-------------
BUILDING & DEVELOPMENT - 4.9%
4,878,622 Atrium Cos., Inc.
Term Loan, 6.37%, 12/28/11 ................ 4,813,541
2,717,048 CB Richard Ellis Services, Inc.
Term Loan, 5.65%, 03/31/10 ................ 2,744,219
Custom Building Products, Inc.
1,995,000 First Lien Term Loan,
5.74%, 10/20/11 ........................... 2,011,199
1,500,000 Second Lien Term Loan,
8.58%, 04/20/12 ........................... 1,491,570
3,500,000 Harmon Koval Partners LLC
Second Lien Term Loan,
10.55%, 06/30/07 .......................... 3,561,250
1,950,356 Lake at Las Vegas Joint Venture
First Lien Term Loan,
6.31%, 11/01/09 ........................... 1,974,735
LNR Property Corp.
1,866,467 Tranche A Term Loan,
6.53%, 02/03/08 ........................... 1,867,624
13,229,595 Tranche B Term Loan,
6.69%, 02/03/08 ........................... 13,359,510
NATG Holdings LLC
131,418 Credit Linked Certificate of Deposit,
6.11%, 01/23/09 ........................... 123,533
125,466 Term Loan A, 8.20%, 01/23/09 .............. 25,093
91,747 Term Loan B1, 8.70%, 01/23/10 ............. 27,065
9,144 Term Loan B2, 8.70%, 01/23/10 ............. 8,595
990,000 Nortek Holdings, Inc.
Term Loan, 5.91%, 08/27/11 ................ 1,003,405
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 7
INVESTMENT PORTFOLIO (CONTINUED)
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
SENIOR LOAN NOTES (CONTINUED)
BUILDING & DEVELOPMENT (CONTINUED)
3,000,000 Palmdale Hills Property LLC
First Lien Term Loan,
6.61%, 05/19/10 (b) ....................... 3,000,000
1,500,000 Pivotal Group-Promontory
First Lien Term Loan,
08/31/10 (b) .............................. 1,515,000
Ply Gem Industries, Inc.
254,653 Canadian Term Loan,
6.16%, 02/12/11 ........................... 256,563
1,732,983 U S Dollar Term Loan,
6.16%, 02/12/11 ........................... 1,745,981
985,000 St. Mary's Cement, Inc.
Term Loan B, 5.49%, 12/04/09 .............. 996,081
5,500,000 TE/TOUSA Mezzanine LLC
Senior Mezzanine Loan,
9.06%, 08/01/09 ........................... 5,500,000
-------------
46,024,964
-------------
BUSINESS EQUIPMENT & SERVICES - 4.6%
ACI Billing Services, Inc.
975,000 First Lien Term Loan,
6.49%, 04/18/10 ........................... 979,875
997,500 Second Lien Term Loan,
11.25%, 04/18/11 .......................... 1,012,462
3,133,477 American Achievement Corp.
Term Loan B, 5.85%, 03/25/11 .............. 3,178,536
3,990,000 Audio Visual Services Corp.
Term Loan, 6.23%, 05/18/11 ................ 4,039,875
4,416,667 Brickman Group Holdings, Inc.
Term Loan, 8.74%, 11/15/09 ................ 4,405,625
2,512,584 Carey International, Inc.
Second Lien Term Loan,
12.19%, 05/10/12 .......................... 2,135,696
4,383,690 CCC Information Services Group, Inc.
Term Loan, 6.42%, 08/20/10 ................ 4,449,445
2,000,000 ClientLogic Corp.
Second Lien Term Loan,
12.45%, 09/03/12 .......................... 2,021,240
965,242 Data Transmissions Network Corp.
Tranche B Term Loan,
6.61%, 03/17/12 ........................... 974,894
2,000,000 GXS Corp.
Second Lien Term Loan,
12/20/11 (b) (c) .......................... 2,000,000
5,678,125 Hillman Group, Inc.
Term Loan B, 6.69%, 03/30/11 .............. 5,781,013
2,000,000 IPC Acquisition Corp.
First Lien Tranche B Term Loan,
6.31%, 08/05/11 ........................... 2,024,160
6,035,294 Knoll, Inc.
Initial Term Loan, 6.52%, 09/30/11 ........ 6,088,103
1,000,000 Outsourcing Solutions, Inc.
Term Loan, 7.92%, 09/30/10 ................ 1,007,500
2,000,000 Survey Sampling International LLC
Second Lien Term Loan,
10.74%, 05/06/12 .......................... 2,023,760
1,000,000 WestCom Corp.
Second Lien Term Facility,
10.68%, 06/17/11 .......................... 1,022,500
-------------
43,144,684
-------------
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
CABLE & SATELLITE TELEVISION - 11.0%
4,991,627 Adelphia Communications Corp.
Tranche B DIP Term Loan,
6.31%, 03/31/06 ........................... 5,016,585
2,500,000 Atlantic Broadband Finance LLC
Tranche B-1 Term Loan,
6.11%, 09/01/11 ........................... 2,528,125
6,930,000 Bragg Communications, Inc.
Term Loan B, 6.36%, 08/31/11 .............. 7,012,328
3,500,000 Bresnan Communications LLC
Tranche B Term Loan,
7.08%, 09/30/10 ........................... 3,563,000
6,418,750 Cebridge Connections, Inc.
Second Lien Term Loan,
9.66%, 02/23/10 ........................... 6,482,937
Century Cable Holdings LLC
1,000,000 Discretionary Term Loan,
8.50%, 12/31/09 ........................... 990,000
2,500,000 Revolver, 7.25%, 03/31/09 ................. 2,463,550
13,833,333 Term Loan, 8.50%, 06/30/09 ................ 13,731,243
Charter Communications
Operating LLC
4,993,791 Tranche A Term Loan,
6.68%, 04/27/10 ........................... 4,967,674
9,887,707 Tranche B Term Loan,
6.93%, 04/27/11 ........................... 9,919,348
5,506,875 Knology, Inc.
Second Lien Term Loan,
13.68%, 06/29/11 .......................... 5,341,669
3,465,066 Mediacom Broadband Group LLC
Term Loan B, 5.44%, 09/30/10 .............. 3,514,893
1,990,000 Mediacom Communications Corp.
Term Loan B, 5.81%, 03/31/13 .............. 2,022,835
1,994,173 Millennium Digital Media Systems LLC
Facility C Term Loan,
9.00%, 10/31/08 ........................... 2,009,129
Olympus Cable Holdings LLC
6,000,000 Term Loan A, 7.75%, 06/30/10 .............. 5,936,280
7,000,000 Term Loan B, 8.50%, 09/30/10 .............. 6,950,230
3,000,000 Puerto Rico Cable Acquisition Co., Inc.
First Lien Term Loan,
8.75%, 07/28/11 ........................... 3,043,140
1,995,000 Rainbow National Services LLC
Term Loan B, 6.44%, 03/31/12 .............. 2,011,618
997,500 Susquehanna Media Co.
Term Loan B, 5.33%, 03/31/12 .............. 1,009,969
UPC Broadband Holding BV
6,965,000 Term Loan F2, 7.19%, 03/31/09 ............. 7,049,416
1,500,000 Term Loan H2, 6.25%, 09/30/12 ............. 1,516,710
6,417,431 WideOpenWest LLC
Term Loan B, 6.56%, 06/22/11 .............. 6,481,606
-------------
103,562,285
-------------
CHEMICALS/PLASTICS - 3.7%
3,000,000 Berry Plastics Corp.
Term Loan, 5.60%, 12/02/11 ................ 3,053,460
3,500,000 Brenntag AG
Faciltiy B2, 6.81%, 02/27/12 .............. 3,555,440
5,532,949 Celenese
Dollar Term Loan B,
5.74%, 04/06/11 ........................... 5,638,075
5,375,000 Huntsman International LLC
Term B Dollar Loan,
5.32%, 08/16/12 ........................... 5,449,712
8 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
INVESTMENT PORTFOLIO (CONTINUED)
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
SENIOR LOAN NOTES (CONTINUED)
CHEMICALS/PLASTICS (CONTINUED)
583,882 INVISTA Canada Co.
Tranche B-2 Term Loan,
5.75%, 04/29/11 ........................... 594,100
1,345,765 INVISTA S.A.R.L.
Tranche B-1 Term Loan,
5.75%, 04/29/11 ........................... 1,365,951
3,954,143 Kraton Polymers Group of Cos.
Term Loan, 6.29%, 12/23/10 ................ 4,022,115
Nalco Co.
2,720,674 Tranche A-1 Term Loan,
6.06%, 11/04/09 ........................... 2,752,995
2,061,824 Tranche B Term Loan,
5.65%, 11/04/10 ........................... 2,093,864
1,870,000 Polypore, Inc.
U S Term Loan, 5.92%, 11/12/11 ............ 1,880,921
4,477,500 Rockwood Specialties Group, Inc.
Tranche B Term Loan,
5.93%, 07/30/12 ........................... 4,555,856
-------------
34,962,489
-------------
CLOTHING/TEXTILES - 1.0%
2,977,273 Levi Strauss & Co.
Tranche A Term Loan,
10.63%, 09/29/09 .......................... 3,118,068
6,533,333 Polymer Group, Inc.
First Lien Term Loan,
6.73%, 04/27/10 ........................... 6,623,167
-------------
9,741,235
-------------
CONGLOMERATE - 1.0%
3,346,000 Appleton Papers, Inc.
Term Loan, 5.64%, 06/11/10 ................ 3,389,933
1,246,617 Jason, Inc.
Term Loan B, 8.10%, 06/30/07 .............. 1,227,918
1,884,824 Mueller Group, Inc.
Initial Term Loan, 6.37%, 04/23/11 ........ 1,907,216
2,781,120 Youth & Family Centered Services, Inc.
Term Loan B, 7.65%, 05/28/11 .............. 2,781,120
-------------
9,306,187
-------------
CONTAINER/GLASS PRODUCTS - 3.1%
3,465,000 Consolidated Container Co. LLC
Term Loan, 6.69%, 12/15/08 ................ 3,508,312
Graham Packaging International, Inc.
1,500,000 Second Lien Term Loan,
7.75%, 04/07/12 ........................... 1,537,500
8,948,765 Term Loan B, 6.03%, 10/07/11 .............. 9,105,369
3,650,194 Graphic Packaging International, Inc.
Tranche C Term Loan,
6.03%, 08/09/10 ........................... 3,713,744
1,980,000 Kranson Industries, Inc.
Term Loan, 6.24%, 07/30/11 ................ 2,004,750
6,895,000 Solo Cup, Inc.
Term B1 Loan, 5.68%, 02/27/11 ............. 6,971,810
1,975,000 U.S. Can Corp.
Term Loan B, 7.65%, 01/10/10 .............. 1,984,875
-------------
28,826,360
-------------
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
COSMETICS/TOILETRIES - 0.8%
2,238,750 Marietta Intermediate Holdings
First Lien Term Loan,
6.82%, 12/17/10 ........................... 2,259,749
2,000,000 MD Beauty, Inc.
Second Lien Term Loan,
9.90%, 02/18/13 ........................... 2,045,000
2,875,000 Revlon Consumer Products Corp.
Term Loan, 9.52%, 07/09/10 ................ 2,981,605
-------------
7,286,354
-------------
DIVERSIFIED MANUFACTURING - 0.3%
1,000,000 GenTek, Inc.
Second Lien Term Loan,
9.35%, 02/28/12 ........................... 986,660
1,962,342 Propex Fabrics, Inc.
Term Loan, 5.74%, 12/31/11 ................ 1,967,248
-------------
2,953,908
-------------
ECOLOGICAL SERVICE & EQUIPMENT - 1.0%
Allied Waste North America, Inc.
2,092,951 Term Loan, 5.55%, 01/15/12 ................ 2,113,001
798,855 Tranche A Credit Linked Deposit,
2.00%, 01/15/12 ........................... 806,508
1,863,636 Envirocare of Utah LLC
Term Loan, 6.11%, 04/13/10 ................ 1,900,909
4,500,000 Environmental Systems Products
Holdings
Second Lien, 13.70%, 12/12/10 ............. 4,590,000
-------------
9,410,418
-------------
ELECTRONIC/ELECTRIC - 5.5%
3,500,000 Amkor Technology, Inc.
Second Lien Term Loan,
8.33%, 10/27/10 ........................... 3,596,250
3,000,000 Comsys Information Technology
Services, Inc.
Second Lien Term Loan,
11.02%, 04/30/10 .......................... 3,007,500
Corel Corp.
987,500 First Lien Term Loan,
7.86%, 02/22/10 ........................... 987,500
2,000,000 Second Lien Term Loan,
11.73%, 08/15/10 .......................... 2,025,000
1,000,000 Datatel, Inc.
Second Lien Term Loan,
8.85%, 10/05/11 ........................... 1,010,000
Infor Global Solutions European
Finance S.A.R.L.
1,014,228 Euro Revolving Credit,
7.21%, 04/18/10 (h) ....................... 978,730
1,800,000 First Lien Term Loan,
6.75%, 04/18/11 ........................... 1,820,250
1,500,000 Second Lien Lux Term Loan,
10.75%, 04/18/12 .......................... 1,516,875
Magellan Holdings, Inc.
2,200,000 First Lien Term Loan,
6.75%, 04/18/11 ........................... 2,224,750
2,500,000 Second Lien U S Term Loan,
10.75%, 04/18/12 .......................... 2,528,125
6,457,500 ON Semiconductor Corp.
Tranche G Term Loan,
6.50%, 12/15/11 ........................... 6,551,650
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 9
INVESTMENT PORTFOLIO (CONTINUED)
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
SENIOR LOAN NOTES (CONTINUED)
ELECTRONIC/ELECTRIC (CONTINUED)
2,400,000 RedPrairie Corp.
Second Lien Term Loan,
12.50%, 05/23/09 .......................... 2,406,000
12,500,000 SunGard Data Systems, Inc.
U S Term Loan, 6.28%, 02/11/13 ............ 12,682,875
2,250,000 Transfirst Holdings, Inc.
Second Lien Term Loan,
11.00%, 03/31/11 .......................... 2,289,375
2,836,779 UGS Corp.
Term Loan, 5.67%, 05/27/11 ................ 2,881,998
4,975,000 Viasystems, Inc.
Tranche B Term Loan,
7.64%, 09/30/09 ........................... 5,034,103
-------------
51,540,981
-------------
EQUIPMENT LEASING - 1.1%
NES Rentals Holdings, Inc.
1,153,333 First Lien Term Loan,
6.94%, 08/17/09 ........................... 1,159,100
28,182 Revolver, 7.00%, 08/17/09 (h) ............. 28,138
2,981,222 Second Lien Term Loan,
9.71%, 08/17/10 ........................... 3,059,479
United Rentals, Inc.
3,127,083 Initial Term Loan, 5.92%, 02/14/11 ........ 3,164,233
2,723,333 Tranche B Credit Linked Deposit,
2.25%, 02/14/11 ........................... 2,757,375
-------------
10,168,325
-------------
FINANCIAL INTERMEDIARIES - 0.5%
3,000,000 Arias Acquisitions, Inc.
Term Loan, 9.00%, 07/26/11 ................ 3,016,860
Stile Acquisition Corp.
1,493,328 Canadian Term Loan,
5.66%, 04/06/13 ........................... 1,499,241
496,672 U S Dollar Term Loan,
5.66%, 04/06/13 ........................... 498,788
-------------
5,014,889
-------------
FOOD PRODUCTS - 2.5%
3,000,000 CTI Food Holdings Co. LLC
Second Lien Secured Term Loan,
9.58%, 06/02/12 ........................... 3,060,000
1,985,000 Doane Pet Care Co.
Term Loan, 7.41%, 11/05/09 ................ 2,015,609
Interstate Brands Corp.
625,000 Tranche A Term Loan,
7.75%, 07/19/06 ........................... 628,750
935,696 Tranche B Term Loan,
7.72%, 07/19/07 ........................... 942,424
2,895,340 Tranche C Term Loan,
7.77%, 07/19/07 ........................... 2,929,737
Krispy Kreme Doughnuts, Inc.
800,000 Second Lien Tranche A Credit Link
Deposit, 3.58%, 04/01/10 .................. 806,000
3,192,000 Second Lien Tranche B Term
Loan, 9.55%, 04/01/10 ..................... 3,215,940
3,980,893 Luigino's, Inc.
Term Loan, 6.49%, 04/02/11 ................ 4,013,218
3,247,886 Merisant Co.
Tranche B Term Loan,
6.93%, 01/11/10 ........................... 3,217,421
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
FOOD PRODUCTS (CONTINUED)
3,130,151 Pinnacle Foods Holding Corp.
Term Loan, 6.76%, 11/25/10 ................ 3,174,756
-------------
24,003,855
-------------
FOOD SERVICES - 1.1%
1,000,000 AFC Enterprises, Inc.
Tranche B Term Loan,
5.75%, 05/09/11 ........................... 1,012,500
Buffets, Inc.
500,000 Synthetic Letters of Credit,
5.62%, 06/28/09 ........................... 501,250
3,991,619 Term Loan, 7.16%, 06/28/09 ................ 4,031,535
Captain D's Inc., LLC
2,895,000 First Lien Term Loan,
7.42%, 12/27/10 ........................... 2,949,281
2,000,000 Second Lien Term Loan,
9.67%, 06/27/11 ........................... 2,007,500
-------------
10,502,066
-------------
FOOD/DRUG RETAIL - 1.9%
1,000,000 Bi-Lo LLC
Term Loan, 7.56%, 07/01/11 ................ 1,004,380
4,950,000 Jean Coutu Group, Inc.
Term Loan B, 5.94%, 07/30/11 .............. 5,034,249
Michael Foods, Inc.
3,000,000 Floater Term Loan,
6.59%, 11/20/11 ........................... 3,083,460
4,563,758 Term Loan B, 5.15%, 11/21/10 .............. 4,637,919
2,493,750 Reliant Pharmaceuticals, Inc.
First Lien Term Loan,
13.06%, 06/30/08 .......................... 2,496,867
1,995,000 Vitaquest International, Inc.
First Lien Term Loan,
7.07%, 03/07/11 ........................... 1,996,237
-------------
18,253,112
-------------
FOREST PRODUCTS - 0.3%
3,000,000 NewPage Corp.
Term Loan, 6.58%, 05/02/11 ................ 3,048,750
-------------
HEALTH CARE - 7.9%
4,286,361 Alliance Imaging, Inc.
Tranche C1 Term Loan,
5.94%, 12/29/11 ........................... 4,343,970
3,342,633 Alpharma Operating Corp.
Term Loan B, 6.86%, 10/05/08 .............. 3,354,132
1,449,058 American HomePatient, Inc.
Term Loan, 08/01/09 (b) (i) ............... 1,438,191
2,985,000 American Medical Response, Inc.
Term Loan, 5.89%, 02/10/12 ................ 3,034,432
2,773,358 Ameripath, Inc.
Term Loan, 6.92%, 03/27/10 ................ 2,801,092
Carl Zeiss Vision
1,000,000 Term B U S Dollar Loan,
6.24%, 05/04/13 ........................... 1,011,250
2,000,000 Term C U S Dollar Loan,
6.74%, 05/04/14 ........................... 2,015,000
3,000,000 Term D U S Dollar Loan,
8.99%, 11/04/14 ........................... 3,041,250
10 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
INVESTMENT PORTFOLIO (CONTINUED)
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
SENIOR LOAN NOTES (CONTINUED)
HEALTH CARE (CONTINUED)
Cornerstone Healthcare Group
Holding, Inc.
1,000,000 Senior Subordinated Unsecured
Notes, 14.00%, 07/15/12 (i) ............... 1,012,500
2,000,000 Term Loan, 7.84%, 07/15/11 ................ 2,012,500
2,000,000 CRC Health Corp.
Term Loan, 6.24%, 05/11/11 ................ 2,020,000
2,058,824 DaVita, Inc.
Tranche B Term Loan,
05/26/12 (b) .............................. 2,091,147
1,170,970 Encore Medical IHC, Inc.
Term Loan, 6.48%, 10/04/10 ................ 1,189,260
6,500,000 FHC Health Systems, Inc.
Third Lien Term Loan,
12.23%, 01/14/11 .......................... 6,597,500
1,000,000 Genoa Healthcare Group LLC
Second Lien Term Loan,
13.25%, 02/10/13 .......................... 1,025,000
1,974,874 Hanger Orthopedic Group, Inc.
Tranche B Term Loan,
6.99%, 09/30/09 ........................... 2,011,903
HealthSouth Corp.
6,300,000 Term Loan, 6.09%, 06/14/07 ................ 6,374,813
1,700,000 Tranche B Term Loan,
3.34%, 03/08/10 ........................... 1,718,054
7,364,052 InSight Health Services Corp.
Tranche B Term Loan,
7.24%, 10/17/08 ........................... 7,396,306
7,644,444 Knowledge Learning Corp.
Term Loan, 5.99%, 01/07/12 ................ 7,701,778
1,977,519 Leiner Health Products Group, Inc.
Tranche B Term Loan,
6.38%, 05/27/11 ........................... 1,942,912
1,000,000 LifeCare Holdings, Inc.
Term Loan, 5.82%, 08/11/12 ................ 1,005,000
Rural/Metro Operating Co. LLC
720,588 Letter of Credit Term Loan,
3.42%, 03/04/11 ........................... 731,397
2,635,294 Term Loan, 6.03%, 03/04/11 ................ 2,674,824
1,066,667 Select Medical Corp.
Revolver, 6.22%, 02/24/11 (h) ............. 1,061,333
Skilled Healthcare LLC
2,000,000 First Lien Term Loan,
6.42%, 06/15/12 ........................... 2,035,000
3,000,000 Second Lien Term Loan,
11.53%, 12/15/12 .......................... 3,077,520
-------------
74,718,064
-------------
HOME FURNISHINGS - 2.7%
22,983,272 Home Interiors & Gifts, Inc.
Initial Term Loan,
8.38%, 03/31/11 (b) ....................... 21,489,360
Ruby Cone I AB
2,000,000 Facility B Term Loan,
6.29%, 06/01/13 ........................... 2,002,500
1,633,901 Facility C1 Term Loan,
6.78%, 06/01/14 ........................... 1,644,113
-------------
25,135,973
-------------
INDUSTRIAL EQUIPMENT - 1.3%
1,625,000 AIRXCEL, Inc.
First Lien Term Loan,
08/31/12 (b) .............................. 1,637,188
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
INDUSTRIAL EQUIPMENT (CONTINUED)
5,100,710 Copperweld Corp.
Term Loan, 8.17%, 12/17/11 ................ 5,094,334
988,655 Dresser, Inc.
Term Loan C, 5.99%, 04/10/09 .............. 999,363
1,000,000 Penn Engineering & Manufacturing Corp.
Second Lien Term Loan,
9.47%, 05/25/12 ........................... 1,005,000
Terex Corp.
355,412 Incremental Term Loan,
6.18%, 12/31/09 ........................... 360,075
3,535,682 Term Loan, 5.68%, 07/03/09 ................ 3,584,297
-------------
12,680,257
-------------
INSURANCE - 1.1%
5,000,000 American Wholesale Insurance
Group, Inc.
Second Lien Term Loan,
11.86%, 10/13/11 .......................... 5,000,000
1,882,192 Conseco, Inc.
Term Loan, 5.57%, 06/22/10 ................ 1,903,385
2,970,000 Mitchell International, Inc.
Second Lien Term Loan,
9.75%, 08/15/12 ........................... 3,021,975
-------------
9,925,360
-------------
LEISURE GOODS/ACTIVITIES/MOVIES - 5.7%
3,200,742 AMF Bowling Worldwide, Inc.
Term Loan B, 6.67%, 08/27/09 .............. 3,238,671
1,500,000 BLB Investors LLC
Senior Secured Note,
07/18/12 (b) .............................. 1,531,875
12,500,000 Blockbuster Entertainment Corp.
Tranche B Term Loan,
7.26%, 08/20/11 (b) ....................... 12,224,000
2,000,000 Camelbak Products, Inc.
Second Lien Term Loan,
10.54%, 02/04/12 .......................... 1,992,500
5,000,000 CNL Hospitality Partners LP
Mezzanine A-3 Loan,
5.83%, 09/09/06 ........................... 5,012,500
776,949 CNL Hospitality Properties LP
Term Facility, 6.07%, 10/13/06 ............ 778,891
3,000,000 Fender Musical Instruments Corp.
Second Lien Term Loan,
8.10%, 09/30/12 ........................... 3,060,000
9,505,000 Metro-Goldwyn-Mayer Holdings,
Inc./LOC Acquisition Co.
Tranche B Term Loan,
5.74%, 04/08/12 ........................... 9,623,052
2,000,000 Movie Gallery, Inc.
Term Loan B, 6.49%, 04/27/11 .............. 2,012,280
4,000,000 Oriental Trading Co., Inc.
Second Lien Term Loan,
8.25%, 01/08/11 ........................... 4,053,360
2,000,000 Pine Tree Holdings/Pine Tree
Country Club
Second Lien Tranche B Term Loan,
11.64%, 07/15/13 .......................... 2,035,000
1,980,800 Polaroid Corp.
Second Lien Term Loan,
11.75%, 04/27/11 .......................... 1,985,752
6,454,992 Six Flags Theme Parks, Inc.
Tranche B Term Loan,
6.36%, 06/30/09 ........................... 6,531,678
-------------
54,079,559
-------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 11
INVESTMENT PORTFOLIO (CONTINUED)
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
SENIOR LOAN NOTES (CONTINUED)
LODGING & CASINOS - 8.0%
641,901 Ameristar Casinos, Inc.
Term Loan B1, 5.50%, 12/20/06 ............. 648,320
2,550,000 CCM Merger, Inc./MotorCity Casino
Term Loan B, 5.69%, 04/25/12 .............. 2,582,946
3,000,000 CNL Hotel Del Partners LP
First Mezzanine Loan,
7.09%, 02/09/07 ........................... 3,007,500
15,000,000 Extended Stay America, Inc.
Mezzanine Loan, 08/01/08 (b) (c) .......... 15,000,000
Fontainebleu Florida Hotel LLC
3,000,000 Tranche A Term Loan,
6.54%, 05/11/08 ........................... 3,000,000
2,000,000 Tranche B Term Loan,
6.54%, 05/11/08 ........................... 2,000,000
4,018,535 Global Cash Access LLC
Term Loan B, 5.92%, 03/10/10 .............. 4,082,590
3,950,150 Green Valley Ranch Gaming LLC
Term Loan, 5.49%, 12/22/10 ................ 4,001,976
2,200,063 Oak Hill Capital Partners
Mezzanine Loan,
8.39%, 02/09/07 (c) ....................... 2,236,841
OpBiz LLC
17,918,616 Term Loan A, 6.50%, 08/31/10 .............. 18,019,498
43,693 Term Loan B, 7.50%, 08/31/10 .............. 43,893
Penn National Gaming, Inc.
1,333,333 First Lien Term Loan,
05/26/11 (b) .............................. 1,354,533
666,667 Tranche B-2 Term Loan,
05/15/12 (b) .............................. 677,500
10,500,000 Resorts International Holdings Ltd.
Second Lien Term Loan,
9.42%, 04/26/13 (b) ....................... 10,542,630
1,963,583 Term Loan B, 6.20%, 04/26/12 .............. 1,991,564
1,750,000 Trump Entertainment Resorts, Inc.
Term Loan B-1, 6.14%, 05/20/12 ............ 1,780,625
4,000,000 Wynn Las Vegas LLC
Term Loan, 5.81%, 12/14/11 ................ 4,053,120
-------------
75,023,536
-------------
NONFERROUS METALS/MINING - 1.7%
2,000,000 AMR Technologies Inc.
Term Loan, 08/31/09 (b) (c) ............... 2,000,000
992,500 J W Aluminum Co.
First Lien Term Loan,
6.92%, 10/20/10 ........................... 1,007,387
2,500,000 James River Coal Co.
Credit Linked Certificate of Deposit,
3.09%, 11/30/11 ........................... 2,531,250
4,726,250 Murray Energy Corp.
Tranche B Term Loan,
6.86%, 01/28/10 ........................... 4,752,812
5,985,000 Trout Coal Holdings LLC
First Lien Term Loan,
6.02%, 03/23/11 ........................... 6,003,673
-------------
16,295,122
-------------
OIL/GAS - 8.2%
6,000,000 ALON USA
Term Loan, 10.30%, 01/15/09 ............... 6,180,000
9,975,000 ATP Oil & Gas Corp.
Term Loan, 9.14%, 04/14/10 ................ 10,324,125
4,894,895 Basic Energy Services, Inc.
Term Loan B, 6.50%, 10/03/09 .............. 4,931,607
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
OIL/GAS (CONTINUED)
2,500,000 Carrizo Oil & Gas, Inc.
Second Lien Term Loan,
9.87%, 07/21/10 ........................... 2,578,125
Coffeyville Resources LLC
600,000 First Lien Tranche B Term Loan,
6.06%, 06/24/12 ........................... 610,218
400,000 Funded Letter of Credit,
6.06%, 06/24/12 ........................... 406,876
5,000,000 Second Lien Term Loan,
10.31%, 06/24/13 .......................... 5,150,000
1,975,025 Dynegy Holdings, Inc.
Term Loan, 7.49%, 05/27/10 ................ 1,986,441
El Paso Corp.
2,500,000 Deposit Accounts,
3.24%, 11/23/09 ........................... 2,534,200
8,437,839 Term Loan, 6.44%, 11/23/09 ................ 8,572,000
4,000,000 Energy Transfer Partners LP
Term Loan, 6.47%, 06/16/08 ................ 4,056,480
2,791,436 Getty Petroleum Marketing, Inc.
Term Loan, 6.92%, 05/19/10 ................ 2,798,415
4,000,000 Hawkeye Renewables, LLC
Term Loan, 6.93%, 01/31/12 ................ 3,980,000
1,383,352 Headwaters, Inc.
First Lien Term Loan B-1,
5.91%, 04/30/11 ........................... 1,404,102
Kerr-McGee Corp.
11,500,000 Tranche B Term Loan,
6.14%, 05/24/11 ........................... 11,580,845
4,000,000 Tranche X Term Loan,
5.85%, 05/24/07 ........................... 4,013,760
1,000,000 SemCrude LP
U S Term Loan, 6.12%, 03/16/11 ............ 1,013,750
3,000,000 Trident Exploration Corp.
Second Lien Term Loan,
10.61%, 04/26/11 .......................... 3,037,500
1,837,641 Williams Production RMT Co.
Term Loan C, 5.83%, 05/30/07 .............. 1,866,749
-------------
77,025,193
-------------
PUBLISHING - 1.8%
1,875,478 Adams Outdoor Advertising LP
Term Loan, 5.64%, 10/15/11 ................ 1,901,660
4,738,125 American Lawyer Media Holdings, Inc.
First Lien Term Loan,
5.99%, 03/05/10 ........................... 4,752,908
1,980,000 Herald Media, Inc.
First Lien Term Loan,
5.99%, 07/22/11 ........................... 1,992,395
3,000,000 North American Membership Group, Inc.
Second Lien Term Loan,
11.11%, 11/18/11 .......................... 3,015,000
1,300,533 Relizon Co.
Tranche B Term Loan,
6.82%, 02/20/11 ........................... 1,307,035
3,800,000 VISANT Corp.
Tranche C Term Loan,
5.94%, 12/21/11 ........................... 3,860,952
-------------
16,829,950
-------------
REAL ESTATE INVESTMENT TRUST - 2.3%
2,500,000 BioMed Realty LP
Senior Secured Term Loan,
5.76%, 05/31/10 ........................... 2,518,750
1,997,848 Crescent Real Estate Equities, LP
Term Loan, 5.76%, 01/12/06 ................ 2,017,207
12 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
INVESTMENT PORTFOLIO (CONTINUED)
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
SENIOR LOAN NOTES (CONTINUED)
REAL ESTATE INVESTMENT TRUST (CONTINUED)
14,917,752 General Growth Properties, Inc.
Tranche B Term Loan,
5.67%, 11/12/08 ........................... 15,107,655
2,000,000 Trustreet Properties, Inc.
Term Loan, 5.51%, 04/08/10 ................ 2,018,760
-------------
21,662,372
-------------
RETAILERS - 1.1%
2,985,000 Dollarama Group LP
Term Loan B, 5.93%, 11/18/11 .............. 3,037,237
2,984,967 Harbor Freight Tools USA
Term Loan, 6.27%, 07/15/10 ................ 3,020,428
1,000,000 MAPCO Express, Inc./MAPCO
Family Centers, Inc.
Term Loan, 6.21%, 04/28/11 ................ 1,015,620
2,957,550 Prestige Brands Holdings, Inc.
Tranche B Term Loan,
6.31%, 04/06/11 ........................... 2,985,883
-------------
10,059,168
-------------
STEEL - 0.4%
1,250,000 Euramax International, Inc.
First Lien Term Loan,
6.13%, 06/29/13 ........................... 1,263,800
2,812,500 The Techs Industries, Inc.
Term Loan, 6.24%, 01/14/10 ................ 2,819,531
-------------
4,083,331
-------------
SURFACE TRANSPORT - 0.8%
Quality Distribution, Inc.
1,000,000 Synthetic Letters of Credit,
6.09%, 11/13/09 ........................... 1,005,000
974,747 Term Loan, 6.59%, 11/13/09 (d) ............ 981,454
3,396,915 Term Loan, 6.67%, 11/13/09 ................ 3,420,286
2,479,234 Transport Industries LP
Term Loan B, 7.50%, 06/13/10 .............. 2,488,531
-------------
7,895,271
-------------
TELECOMMUNICATIONS/CELLULAR - 3.1%
7,875,000 Consolidated Communications, Inc.
Term Loan D, 5.86%, 10/14/11 .............. 7,993,125
MetroPCS, Inc.
4,000,000 First Lien Tranche B Term Loan,
8.25%, 05/27/11 ........................... 4,122,480
6,000,000 Second Lien Term Loan,
10.75%, 05/27/12 .......................... 6,236,280
Qwest Corp.
4,000,000 Tranche A Term Loan,
8.53%, 06/30/07 ........................... 4,135,360
7,000,000 Tranche B Term Loan,
6.95%, 06/30/10 (i) ....................... 6,994,820
-------------
29,482,065
-------------
TELECOMMUNICATIONS/COMBINATION - 3.2%
4,417,651 Centennial Cellular Operating Co.
Term Loan, 5.70%, 02/09/11 ................ 4,491,867
NTELOS, Inc.
1,248,737 First Lien Term Loan B,
6.17%, 08/24/11 ........................... 1,261,812
1,500,000 Second Lien Term Loan,
8.49%, 02/24/12 ........................... 1,503,750
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
TELECOMMUNICATIONS/COMBINATION (CONTINUED)
5,000,000 NTL, Inc.
B2 Sub-Tranche,
6.41%, 04/14/12 ........................... 5,043,150
8,454,819 PanAmSat Corp.
Tranche B-1 Term Loan,
5.65%, 08/20/11 ........................... 8,571,073
3,952,934 RCN Corp.
Term Loan, 7.94%, 12/21/11 ................ 3,992,464
5,000,000 Woodlands Commercial Property Co.
Bridge Loan, 6.86%, 11/01/05 .............. 5,037,500
-------------
29,901,616
-------------
TELECOMMUNICATIONS/WIRELESS - 3.9%
2,000,000 CellNet Data Systems, Inc.
First Lien Term Loan B,
6.68%, 04/26/12 ........................... 2,015,000
14,925,000 Cricket Communications, Inc.
Term Loan B, 5.99%, 01/10/11 .............. 15,079,026
5,000,000 FairPoint Communications, Inc.
Initial B Term Loan,
5.55%, 02/08/12 ........................... 5,061,250
2,000,000 Maritime Telecommunications
Network, Inc.
First Lien Term Loan,
6.39%, 03/29/11 ........................... 2,010,000
1,980,000 SBA Senior Finance, Inc.
Tranche D Term Loan,
5.58%, 10/31/08 ........................... 1,996,078
2,992,500 Telcordia Technologies, Inc.
Term Loan, 6.61%, 09/15/12 ................ 2,992,500
WilTel Communications Group, Inc.
1,989,446 First Lien Term Loan,
6.99%, 06/30/10 ........................... 2,015,547
5,959,163 Promissory Note, 7.00%,
04/01/10 (i) .............................. 5,124,880
-------------
36,294,281
-------------
TELECOMMUNICATIONS/WIRELINE - 0.2%
1,893,878 Valor Telecommunications
Enterprises LLC
Tranche B Term Loan,
5.65%, 02/14/12 ........................... 1,916,187
-------------
UTILITIES - 6.2%
2,831,815 Allegheny Energy, Inc.
Term Advances, 5.35%, 03/08/11 ............ 2,842,434
2,000,000 ANP Funding I, LLC
Tranche A Term Loan,
7.03%, 07/29/10 ........................... 2,024,680
Boston Generating LLC
15,918 DSR Letter of Credit, 12/31/05 (b) ........ 22,603
45,275 Project Letter of Credit,
12/31/05 (b) .............................. 64,290
828,326 Project Term Loan, 12/31/05 (b) ........... 1,151,373
110,482 Working Capital Letter of Credit,
12/31/05 (b) .............................. 156,884
4,924,623 Calpine Construction Finance Co. LP
First Lien Term Loan,
9.51%, 08/26/09 ........................... 5,189,322
1,613,936 Calpine Corp.
Second Lien Term Loan B,
9.35%, 07/16/07 ........................... 1,315,358
6,720,614 CenterPoint Energy, Inc.
Term Loan, 6.09%, 04/30/10 ................ 6,789,433
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 13
INVESTMENT PORTFOLIO (CONTINUED)
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
SENIOR LOAN NOTES (CONTINUED)
UTILITIES (CONTINUED)
Covanta Energy Corp.
1,658,537 Letter of Credit Term Loan,
6.36%, 06/24/12 ........................... 1,687,561
1,341,463 Term Loan, 6.46%, 06/24/12 ................ 1,364,939
3,240,149 Infrasource, Inc.
Term Loan, 6.24%, 09/30/10 ................ 3,248,249
KGen, LLC
1,995,000 Tranche A Term Loan,
6.12%, 08/05/11 ........................... 1,990,013
34,181 Tranche B Term Loan,
12.49%, 08/05/11 .......................... 33,839
1,393,218 Midwest Generations LLC
Term Loan, 5.45%, 04/27/11 ................ 1,409,631
Mirant Corp.
7,000,000 Revolver, 12/31/05 (e) (f) ................ 6,125,000
2,000,000 Revolver, 07/15/08 (e) (f) ................ 1,751,000
2,500,000 Perryville Claim, 07/17/06 (e) (f) ........ 2,112,500
NRG Energy, Inc.
1,311,266 Credit Linked Certificate of Deposit,
3.39%, 12/24/07 ........................... 1,328,208
1,677,484 Term Loan, 5.26%, 12/24/11 ................ 1,698,151
4,565,367 Riverside Energy Center LLC
Term Loan, 7.93%, 06/24/11 ................ 4,679,501
Rocky Mountain Energy Center LLC
361,073 Credit Linked Certificate of Deposit,
3.58%, 06/24/11 ........................... 368,295
3,159,350 Term Loan, 7.93%, 06/24/11 ................ 3,238,334
Texas Genco LLC
291,577 Delayed Draw Term Loan,
5.41%, 12/14/11 ........................... 296,405
7,005,821 Initial Term Loan, 5.42%, 12/14/11 ........ 7,119,035
-------------
58,007,038
-------------
Total Senior Loan Notes
(Cost $1,072,172,777) ................... 1,082,985,620
-------------
FOREIGN VARIABLE RATE SENIOR LOAN NOTES (A) - 7.3%
FRANCE - 0.3%
EUR
2,500,000 Novalis S.A.S.
Second Lien Term Loan,
7.90%, 12/31/13 ........................... 3,130,327
-------------
GERMANY - 1.2%
EUR
3,625,000 debitel (Netherlands) Holding BV
Second Lien Term Loan,
9.10%, 06/11/14 ........................... 4,565,455
debitel Konzemfinanzierungs GmbH
1,125,000 Term Facility B, 4.85%, 06/11/13 .......... 1,389,969
803,571 Term Facility C1, 5.35%, 06/11/14 ......... 995,217
321,429 Term Facility C2, 5.35%, 06/11/14 ......... 396,790
iesy Hessen GmbH & Co.
1,500,000 Facility B, 4.88%, 02/14/13 ............... 1,850,764
1,500,000 Faciltiy C, 5.38%, 02/14/14 ............... 1,856,299
-------------
11,054,494
-------------
PRINCIPAL AMOUNT/
COMMITMENT ($) VALUE ($)
- ----------------- ---------
ITALY - 0.8%
EUR
Pirelli Cables & Systems, Inc.
4,500,000 Second Lien Term Loan,
01/20/15 (b) .............................. 5,588,266
875,000 Euro Term Loan B, 08/01/12 (b) ............ 1,070,961
875,000 Euro Term Loan C, 08/01/12 (b) ............ 1,072,080
-------------
7,731,307
-------------
UNITED KINGDOM - 5.0%
GBP
1,000,000 Eggborough Power Ltd.
Term Loan, 03/31/22 (b) (i) ............... 3,742,805
Inpower Ltd.
2,120,000 Term Loan A2, 06/30/15 (b) ................ 11,229,136
400,000 Term Loan A3, 12/30/20 (b) 0
3,125,000 PlayPower, Inc. ............................
Add On Term Loan,
12/20/09 (b) .............................. 5,690,759
Red Football Ltd.
1,250,000 Facility B Term Loan,
7.85%, 05/11/13 ........................... 2,281,924
1,250,000 Facility C Term Loan,
8.35%, 05/11/14 ........................... 2,281,924
2,000,000 Term Loan D, 11.10%, 05/11/14 ............. 3,687,050
1,402,875 SunGard UK Holdings Ltd
Term Loan, 02/11/13 (b) ................... 2,557,849
4,000,000 Teesside Power Ltd.
Term Loan, 04/01/08 (b) ................... 7,041,366
Trinitybrook PLC
2,500,000 Term Loan B1, 7.34%, 07/31/13 ............. 4,428,911
2,500,000 Term Loan C, 7.84%, 07/31/14 .............. 4,478,597
-------------
47,420,321
-------------
Total Foreign Variable Rate
Senior Loan Notes
(Cost $67,563,269) ...................... 69,336,449
-------------
CORPORATE NOTES AND BONDS - 0.2%
TELECOMMUNICATIONS/WIRELESS - 0.2%
2,000,000 Dobson Cellular Systems
Floating Rate Note,
8.44%, 11/01/11 ........................... 2,090,000
-------------
Total Corporate Notes and Bonds
(Cost $2,000,000) ....................... 2,090,000
-------------
SHARES
------
COMMON STOCKS (G) - 0.3%
BUSINESS SERVICES - 0.0%
40,800 NATG Holdings LLC (c) ...................... 0
-------------
HEALTH CARE - 0.0%
5,500 Sun Healthcare Group, Inc. ................. 36,135
-------------
TELECOMMUNICATIONS/COMBINATION - 0.0%
2,167 Eningen Realty (c) ......................... 0
-------------
TELECOMMUNICATIONS/WIRELESS - 0.3%
76,137 Leap Wireless International, Inc. .......... 2,600,840
-------------
Total Common Stocks
(Cost $772,407) ......................... 2,636,975
-------------
14 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
INVESTMENT PORTFOLIO (CONTINUED)
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
SHARES VALUE ($)
-------- ---------
PREFERRED STOCK (C) - 0.0%
DIVERSIFIED MANUFACTURING - 0.0%
14,382 Superior Telecom, Inc., Series A ........... 14,382
-------------
Total Preferred Stock
(Cost $14,382) .......................... 14,382
-------------
FOREIGN COMMON STOCK (C) (G) - 0.0%
UTILITY - 0.0%
400,000 Inpower Ltd. ............................... 0
-------------
Total Foreign Common Stock
(Cost $0) ............................... 0
-------------
TOTAL INVESTMENTS - 122.7% ............................... 1,157,063,426
-------------
(cost of $1,142,522,835) (j)
OTHER ASSETS & LIABILITIES, NET - (22.7)% ................ (214,258,440)
-------------
NET ASSETS - 100.0% ...................................... 942,804,986
=============
- ----------------------
(a) Senior loans in which the Fund invests generally pay interest at rates
which are periodically predetermined by reference to a base lending rate
plus a premium. (Unless otherwise identified by (i), all senior loans carry
a variable rate interest). These base lending rates are generally (i) the
prime rate offered by one or more major United States banks, (ii) the
lending rate offered by one or more European banks such as the London
Inter-Bank Offered Rate ("LIBOR") and (iii) the certificate of deposit
rate. Rate shown represents the weighted average rate at August 31, 2005.
Senior loans, while exempt from registration under the Security Act of
1933, as amended, contain certain restrictions on resale and cannot be sold
publicly. Senior secured floating rate interests often require prepayments
from excess cash flow or permit the borrower to repay at its election. The
degree to which borrowers repay, whether as a contractual requirement or at
their election, cannot be predicted with accuracy. As a result, the actual
remaining maturity may be substantially less than the stated maturities
shown.
(b) All or a portion of this position has not settled. Contract rates do not
take effect until settlement date.
(c) Represents fair value as determined in good faith under the direction of
the Board of Trustees.
(d) Loans held on participation.
(e) The issuer is in default of certain debt covenants. Income is not being
accrued.
(f) This issue is under the protection of the Federal bankruptcy court.
(g) Non-income producing security.
(h) Additional unfunded commitment. See Note 10.
(i) Fixed rate senior loan.
(j) Cost for Federal income tax purposes is $1,143,030,347.
DIP Debtor in Possession
DSR Debt Service Reserve
EUR Euro
GBP Great Britain Pound
FOREIGN VARIABLE SENIOR LOAN NOTES
INDUSTRY CONCENTRATION TABLE
(% of Total Net Assets)
Utilities .......................... 2.3%
Leisure Goods/Activities/Movies .... 1.5%
Electronic/Electric ................ 1.1%
Retailers .......................... 0.9%
Telecommunications/Cellular ........ 0.8%
Cable & Satellite Television ....... 0.4%
Clothing/Textiles .................. 0.3%
----
Total .............................. 7.3%
====
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 15
STATEMENT OF ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
($)
- ----------------------------------------------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost $1,142,522,835) ..................................................... 1,157,063,426
Cash and cash equivalents ....................................................................... 64,859,859
Foreign currency (Cost $31,355,771) ............................................................. 31,954,784
Receivable for:
Investments sold ............................................................................. 7,834,348
Fund shares sold ............................................................................. 9,694,406
Interest and fees ............................................................................ 7,684,638
Other assets .................................................................................... 143,816
---------------
Total Assets .............................................................................. 1,279,235,277
LIABILITIES:
Notes payable (Note 8) .......................................................................... 250,000,000
Deferred facility fees (Note 2) ................................................................. 36,337
Net discount and unrealized appreciation on unfunded transactions (Note 10) .................... 274,008
Payable for:
Investments purchased ........................................................................ 82,343,536
Distributions ................................................................................ 1,628,160
Investment advisory fee (Note 4) ............................................................. 494,208
Administration fee (Note 4) .................................................................. 199,533
Trustees' fees (Note 4) ...................................................................... 16,667
Distribution and service fees (Note 4) ....................................................... 456,116
Interest expense (Note 8) .................................................................... 658,438
Accrued expenses and other liabilities .......................................................... 323,288
---------------
Total Liabilities ......................................................................... 336,430,291
---------------
NET ASSETS ......................................................................................... 942,804,986
===============
COMPOSITION OF NET ASSETS
Paid-in capital ................................................................................. 930,949,096
Undistributed net investment income ............................................................. 285,027
Accumulated net realized loss on investments and foreign currency transactions .................. (3,325,947)
Net unrealized appreciation on investments, translation of assets and liabilities denominated
in foreign currency and unfunded transactions ................................................ 14,896,810
---------------
NET ASSETS ......................................................................................... 942,804,986
===============
CLASS A
Net assets ...................................................................................... 351,556,649
Shares outstanding .............................................................................. 28,846,957
Net asset value per share (Net assets/Shares outstanding) ...................................... 12.19(a)
Maximum offering price per share (100 / 96.50 of $12.19) ........................................ 12.63(b)
CLASS B
Net assets ...................................................................................... 124,499,702
Shares outstanding .............................................................................. 10,215,719
Net asset value and offering price per share (Net assets/Shares outstanding) ................... 12.19(a)
CLASS C
Net assets ...................................................................................... 391,455,481
Shares outstanding .............................................................................. 32,118,766
Net asset value and offering price per share (Net assets/Shares outstanding) ................... 12.19(a)
CLASS Z
Net assets ...................................................................................... 75,293,154
Shares outstanding .............................................................................. 6,178,337
Net asset value, offering and redemption price per share (Net assets/Shares outstanding) ........ 12.19
<FN>
- ----------------------------------------------------
(a) Redemption price per share is equal to net asset value less any applicable contingent deferred sales charge.
(b) On sales of $100,000 or more, the offering price is reduced.
</FN>
16 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
($)
- ---------------------------------------------------------------------------------------------------------------------------------
INVESTMENT INCOME
Interest ......................................................................................... 59,275,105
Dividends ........................................................................................ 1,366
Facility and other fees .......................................................................... 1,873,193
--------------
Total Investment Income .................................................................... 61,149,664
EXPENSES
Investment advisory fee (Note 4) ................................................................. 4,358,222
Administration fee (Note 4) ...................................................................... 1,945,292
Accounting services fee (Note 4) ................................................................. 341,819
Distribution fee: (Note 4)
Class A ....................................................................................... 282,486
Class B ....................................................................................... 575,391
Class C ....................................................................................... 1,963,202
Service fee: (Note 4)
Class A ....................................................................................... 706,216
Class B ....................................................................................... 319,662
Class C ....................................................................................... 818,001
Transfer agent fee (Note 4) ...................................................................... 646,887
Professional fees ................................................................................ 146,104
Trustees' fees (Note 4) .......................................................................... 111,925
Custody fee (Note 4) ............................................................................. 114,340
Other expenses ................................................................................... 652,134
--------------
Total Operating Expenses ................................................................... 12,981,681
Interest expense (Note 8) ........................................................................ 4,536,502
Facility expense ................................................................................. 1,217,559
--------------
Total Expenses ............................................................................. 18,735,742
Fees and expenses waived or reimbursed by Investment Adviser (Note 4) ............................ (805,040)
--------------
Net Expenses ............................................................................... 17,930,702
--------------
Net Investment Income ............................................................................ 43,218,962
--------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS
Net realized gain on investments ................................................................. 521,149
Net realized loss on foreign currency transactions ............................................... (73,329)
Net change in unrealized appreciation on investments ............................................. 6,884,240
Net change in unrealized appreciation on unfunded transactions (Note 10) ......................... 72,486
Net change in unrealized appreciation on translation of assets and liabilities denominated in
foreign currency .............................................................................. 283,733
--------------
Net Gain ......................................................................................... 7,688,279
--------------
Net Increase in Net Assets ....................................................................... 50,907,241
==============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 17
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
HIGHLAND FLOATING RATE ADVANTAGE FUND
YEARS ENDED AUGUST 31,
2005 2004
($) ($)
---------------- ---------------
INCREASE IN NET ASSETS:
OPERATIONS
Net investment income ........................................................ 43,218,962 21,146,661
Net realized gain on investments and foreign currency transactions ........... 447,820 9,871,654
Net change in unrealized appreciation on investments translation of assets and
liabilities denominated in foreign currency and unfunded transactions ..... 7,240,459 16,802,971
---------------- ---------------
Net Increase from Operations .............................................. 50,907,241 47,821,286
---------------- ---------------
DISTRIBUTIONS DECLARED TO SHAREHOLDERS From net investment income:
Class A ................................................................... (15,863,369) (7,362,637)
Class B ................................................................... (6,648,815) (4,785,071)
Class C ................................................................... (16,600,896) (7,927,327)
Class Z ................................................................... (4,020,231) (1,318,999)
---------------- ---------------
Total Distributions Declared to Shareholders .............................. (43,133,311) (21,394,034)
---------------- ---------------
SHARE TRANSACTIONS
Class A:
Subscriptions ............................................................. 209,578,268 155,278,295
Distributions reinvested .................................................. 10,245,197 4,387,935
Redemptions ............................................................... (83,335,719) (41,293,262)
---------------- ---------------
Net Increase .............................................................. 136,487,746 118,372,968
Class B:
Subscriptions ............................................................. 10,362,773 55,799,014
Distributions reinvested .................................................. 4,017,411 2,714,846
Redemptions ............................................................... (15,567,850) (17,134,851)
---------------- ---------------
Net Increase (Decrease) ................................................... (1,187,666) 41,379,009
Class C:
Subscriptions ............................................................. 167,261,240 208,181,539
Distributions reinvested .................................................. 11,115,461 5,151,429
Redemptions ............................................................... (68,853,512) (24,993,138)
---------------- ---------------
Net Increase .............................................................. 109,523,189 188,339,830
Class Z:
Subscriptions ............................................................. 40,633,785 50,799,735
Distributions reinvested .................................................. 1,870,278 465,119
Redemptions ............................................................... (20,870,623) (4,503,807)
---------------- ---------------
Net Increase .............................................................. 21,633,440 46,761,047
---------------- ---------------
Net Increase from Share Transactions ...................................... 266,456,709 394,852,854
---------------- ---------------
Total Increase in Net Assets ........................................ 274,230,639 421,280,106
---------------- ---------------
NET ASSETS
Beginning of period .......................................................... 668,574,347 247,294,241
End of period (including undistributed and overdistributed net investment
income of $285,027 and $(215,539), respectively) .......................... 942,804,986 668,574,347
================ ===============
18 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
STATEMENTS OF CHANGES IN NET ASSETS (CONTINUED)
- --------------------------------------------------------------------------------
HIGHLAND FLOATING RATE ADVANTAGE FUND
YEARS ENDED AUGUST 31,
2005 2004
---------------- ---------------
CHANGE IN SHAR0ES
Class A:
Subscriptions ............................................................... 17,322,296 13,068,545
Issued for distributions reinvested ......................................... 846,869 368,106
Redemptions ................................................................. (6,887,056) (3,460,892)
---------------- ---------------
Net Increase ................................................................ 11,282,109 9,975,759
Class B:
Subscriptions ............................................................... 855,878 4,712,112
Issued for distributions reinvested ......................................... 332,132 228,200
Redemptions ................................................................. (1,285,093) (1,433,835)
---------------- ---------------
Net Increase (Decrease) ..................................................... (97,083) 3,506,477
Class C:
Subscriptions ............................................................... 13,815,400 17,547,735
Issued for distributions reinvested ......................................... 918,787 431,547
Redemptions ................................................................. (5,686,448) (2,088,151)
---------------- ---------------
Net Increase ................................................................ 9,047,739 15,891,131
Class Z:
Subscriptions ............................................................... 3,359,211 4,267,378
Issued for distributions reinvested ......................................... 154,587 38,768
Redemptions ................................................................. (1,726,328) (376,712)
---------------- ---------------
Net Increase ................................................................ 1,787,470 3,929,434
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 19
STATEMENT OF CASH FLOWS
- --------------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
($)
- ---------------------------------------------------------------------------------------------------------------------------------
INCREASE IN CASH AND FOREIGN CURRENCY
CASH FLOWS USED FOR OPERATING ACTIVITIES
Net investment income ........................................................................ 43,218,962
ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH USED FOR OPERATING ACTIVITIES
Purchase of investments securities ........................................................... (1,290,874,899)
Proceeds from disposition of investment securities and realized gain (loss) on foreign currency 851,927,901
Sale of short-term portfolio investments, net ................................................ 47,479,000
Increase in unrealized appreciation on unfunded transactions ................................. (72,486)
Increase in interest and fees receivable ..................................................... (3,892,652)
Decrease in receivable for expense reimbursement ............................................. 209,953
Increase in receivable for investments sold .................................................. (7,520,334)
Increase in other assets ..................................................................... (138,761)
Decrease in deferred facility fees ........................................................... (217,586)
Increase in payable for accrued expenses ..................................................... 381,558
Net amortization of premium (discount) ....................................................... (1,081,044)
Increase in payable for investments purchased ................................................ 82,343,536
Increase in mark-to-market on foreign currency and unsettled positions ....................... 283,733
Increase in other liabilities 367,026
---------------
Net cash and foreign currency flow used for operating activities ....................... (277,586,093)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Increase in notes payable .................................................................... 155,000,000
Increase in interest payable ................................................................. 524,346
Proceeds from shares sold .................................................................... 422,578,279
Payment of shares redeemed ................................................................... (188,627,704)
Distributions paid in cash ................................................................... (15,074,941)
---------------
Net cash flow provided by financing activities ......................................... 374,399,980
---------------
Net increase in cash and foreign currency .............................................. 96,813,887
CASH AND FOREIGN CURRENCY
Beginning of the period ...................................................................... 756
---------------
End of the period ............................................................................ 96,814,643
===============
20 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
HIGHLAND FLOATING RATE ADVANTAGE FUND
SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31,
-----------------------------------------------------------------------------
CLASS A SHARES 2005 2004 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING
OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.09
- --------------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.67 0.56 0.81 0.83(b) 1.10
Net realized and unrealized gain (loss)
on investments(a) 0.11 0.89 0.74 (1.26)(b) (0.32)
----------- ---------- ---------- ---------- ----------
Total from Investment Operations 0.78 1.45 1.55 (0.43) 0.78
- --------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.67) (0.59) (0.81) (0.83) (1.13)
From net realized gains -- -- -- -- --(c)
----------- ---------- ---------- ---------- ----------
Total Distributions Declared to
Shareholders (0.67) (0.59) (0.81) (0.83) (1.13)
- --------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74
Total return(d)(e) 6.56%(f) 13.14% 15.55% (3.88)% 6.71%
- --------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Operating expenses 1.28% 1.29%(g) 1.38%(g) 1.38%(g) 1.37%(g)
Interest and facility expenses 0.72% 0.40% 0.73% 0.99% 2.04%
Net expenses 2.00% 1.69%(g) 2.11%(g) 2.37%(g) 3.41%(g)
Net investment income 5.60% 4.73%(g) 7.67%(g) 7.25%(b)(g) 9.24%(g)
Waiver/reimbursement 0.10% 0.18% 0.36% 0.32% 0.32%
Portfolio turnover rate 85% 110% 90% 98% 65%
Net assets, end of period (000's) $ 351,557 $ 212,205 $ 85,166 $ 69,733 $ 108,399
<FN>
- ----------------------------------------------------
(a) Per share data was calculated using average shares outstanding during the
period.
(b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA
Audit and Accounting Guide for Investment Companies and began amortizing
and accreting premium and discount on all debt securities. The effect of
this change for the year ended August 31, 2002, on the net investment
income and net realized and unrealized loss per share was less than $0.01.
The impact to the ratio of net investment income to average net assets was
less than 0.01%. Per share data and ratios for periods prior to August 31,
2002 have not been restated to reflect this change in presentation.
(c) Rounds to less than $0.01.
(d) Total return at net asset value assuming all distributions reinvested and
no initial sales charge or contingent deferred sales charge ("CDSC").
(e) Had the Fund's investment adviser not waived or reimbursed a portion of
expenses, total return would have been reduced.
(f) Total return is calculated using the Net Asset Value used for trading at
the close of business on August 31, 2005.
(g) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
</FN>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 21
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
HIGHLAND FLOATING RATE ADVANTAGE FUND
SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31,
-----------------------------------------------------------------------------
CLASS B SHARES 2005 2004 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING
OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07
- --------------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.63 0.53 0.78 0.78(b) 1.05
Net realized and unrealized gain (loss)
on investments(a) 0.11 0.88 0.73 (1.25)(b) (0.30)
----------- ---------- ---------- ---------- ----------
Total from Investment Operations 0.74 1.41 1.51 (0.47) 0.75
- --------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.63) (0.55) (0.77) (0.79) (1.08)
From net realized gains -- -- -- -- --(c)
----------- ---------- ---------- ---------- ----------
Total Distributions Declared to
Shareholders (0.63) (0.55) (0.77) (0.79) (1.08)
- --------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74
Total return(d)(e) 6.19%(f) 12.75% 15.16% (4.22)% 6.52%
- --------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Operating expenses 1.63% 1.64%(g) 1.73%(g) 1.73%(g) 1.72%(g)
Interest and facility expenses 0.72% 0.40% 0.73% 0.99% 2.04%
Net expenses 2.35% 2.04%(g) 2.46%(g) 2.72%(g) 3.76%(g)
Net investment income 5.25% 4.50%(g) 7.34%(g) 6.90%(b)(g) 8.89%(g)
Waiver/reimbursement 0.10% 0.18% 0.36% 0.32% 0.32%
Portfolio turnover rate 85% 110% 90% 98% 65%
Net assets, end of period (000's) $ 124,500 $ 124,589 $ 76,379 $ 68,157 $ 80,609
<FN>
- ----------------------------------------------------
(a) Per share data was calculated using average shares outstanding during the
period.
(b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA
Audit and Accounting Guide for Investment Companies and began amortizing
and accreting premium and discount on all debt securities. The effect of
this change for the year ended August 31, 2002, on the net investment
income and net realized and unrealized loss per share was less than $0.01.
The impact to the ratio of net investment income to average net assets was
less than 0.01%. Per share data and ratios for periods prior to August 31,
2002 have not been restated to reflect this change in presentation.
(c) Rounds to less than $0.01.
(d) Total return at net asset value assuming all distributions reinvested and
no CDSC.
(e) Had the Fund's investment adviser not waived or reimbursed a portion of
expenses, total return would have been reduced.
(f) Total return is calculated using the Net Asset Value used for trading at
the close of business on August 31, 2005.
(g) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
</FN>
22 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
HIGHLAND FLOATING RATE ADVANTAGE FUND
SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31,
-----------------------------------------------------------------------------
CLASS C SHARES 2005 2004 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING
OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07
- --------------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.61 0.50 0.76 0.76(b) 1.03
Net realized and unrealized gain (loss)
on investments(a) 0.11 0.89 0.74 (1.25)(b) (0.30)
----------- ---------- ---------- ---------- ----------
Total from Investment Operations 0.72 1.39 1.50 (0.49) 0.73
- --------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.61) (0.53) (0.76) (0.77) (1.06)
From net realized gains -- -- -- -- --(c)
----------- ---------- ---------- ---------- ----------
Total Distributions Declared to
Shareholders (0.61) (0.53) (0.76) (0.77) (1.06)
- --------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74
Total return(d)(e) 6.03%(f) 12.57% 14.99% (4.36)% 6.35%
- --------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Operating expenses 1.78% 1.79%(g) 1.88%(g) 1.88%(g) 1,87%(g)
Interest and facility expenses 0.72% 0.40% 0.73% 0.99% 2.04%
Net expenses 2.50% 2.19%(g) 2.61%(g) 2.87%(g) 3.91%(g)
Net investment income 5.10% 4.19%(g) 7.14%(g) 6.75%(b)(g) 8.74%(g)
Waiver/reimbursement 0.10% 0.18% 0.36% 0.32% 0.32%
Portfolio turnover rate 85% 110% 90% 98% 65%
Net assets, end of period (000's) $ 391,455 $ 278,731 $ 80,572 $ 61,811 $ 64,074
<FN>
- ----------------------------------------------------
(a) Per share data was calculated using average shares outstanding during the
period.
(b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA
Audit and Accounting Guide for Investment Companies and began amortizing
and accreting premium and discount on all debt securities. The effect of
this change for the year ended August 31, 2002, on the net investment
income and net realized and unrealized loss per share was less than $0.01.
The impact to the ratio of net investment income to average net assets was
less than 0.01%. Per share data and ratios for periods prior to August 31,
2002 have not been restated to reflect this change in presentation.
(c) Rounds to less than $0.01.
(d) Total return at net asset value assuming all distributions reinvested and
no CDSC.
(e) Had the Fund's investment adviser not waived or reimbursed a portion of
expenses, total return would have been reduced.
(f) Total return is calculated using the Net Asset Value used for trading at
the close of business on August 31, 2005.
(g) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
</FN>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 23
FFINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
HIGHLAND FLOATING RATE ADVANTAGE FUND
SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31,
-----------------------------------------------------------------------------
CLASS Z SHARES 2005 2004 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING
OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.08
- ---------------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.71 0.59 0.78 0.86(b) 1.14
Net realized and unrealized gain (loss)
on investments(a) 0.11 0.90 0.81 (1.25)(b) (0.31)
----------- ---------- ---------- ---------- ----------
Total from Investment Operations 0.82 1.49 1.59 (0.39) 0.83
- ---------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.71) (0.63) (0.85) (0.87) (1.17)
From net realized gains -- -- -- -- --(c)
----------- ---------- ---------- ---------- ----------
Total Distributions Declared to
Shareholders (0.71) (0.63) (0.85) (0.87) (1.17)
- ---------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74
Total return(d)(e) 6.93%(f) 13.52% 15.95% (3.53)% 7.17%
- ---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Operating expenses 0.93% 0.94%(g) 1.03%(g) 1.03%(g) 1.02%(g)
Interest and facility expenses 0.72% 0.40% 0.73% 0.99% 2.04%
Net expenses 1.65% 1.34%(g) 1.76%(g) 2.02%(g) 3.06%(g)
Net investment income 5.95% 4.93%(g) 7.21%(g) 7.60%(b)(g) 9.59%(g)
Waiver/reimbursement 0.10% 0.18% 0.36% 0.32% 0.32%
Portfolio turnover rate 85% 110% 90% 98% 65%
Net assets, end of period (000's) $ 75,293 $ 53,049 $ 5,178 $ 140 $ 2,850
<FN>
- ----------------------------------------------------
(a) Per share data was calculated using average shares outstanding during the
period.
(b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA
Audit and Accounting Guide for Investment Companies and began amortizing
and accreting premium and discount on all debt securities. The effect of
this change for the year ended August 31, 2002, on the net investment
income and net realized and unrealized loss per share was less than $0.01.
The impact to the ratio of net investment income to average net assets was
less than 0.01%. Per share data and ratios for periods prior to August 31,
2002 have not been restated to reflect this change in presentation.
(c) Rounds to less than $0.01.
(d) Total return at net asset value assuming all distributions reinvested.
(e) Had the Fund's investment adviser not waived or reimbursed a portion of
expenses, total return would have been reduced.
(f) Total return is calculated using the Net Asset Value used for trading at
the close of business on August 31, 2005.
(g) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
</FN>
24 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
NOTE 1. ORGANIZATION
Highland Floating Rate Advantage Fund (the "Fund") is a Massachusetts business
trust registered under the Investment Company Act of 1940, as amended (the "1940
Act"), as a non-diversified, closed-end management investment company.
INVESTMENT GOAL
The Fund seeks to provide a high level of current income consistent with
preservation of capital.
FUND SHARES
The Fund may issue an unlimited number of shares and continuously offers three
classes of shares: Class A, Class C and Class Z. Certain share classes have
their own sales charge and bear class specific expenses, which include
distribution fees and service fees.
On March 3, 2005, the Board of Trustees of the Fund approved the closing of the
Fund's Class B shares to purchases by new and existing shareholders. The Fund
discontinued selling Class B shares to new and existing investors following the
close of business on May 2, 2005. Existing investors may still reinvest
distributions in Class B shares.
Class A shares are subject to a maximum front-end sales charge of 3.50% based on
the amount of initial investment. Class A shares purchased without an initial
sales charge by accounts aggregating $1 million to $25 million at the time of
purchase are subject to a 1.00% contingent deferred sales charge ("CDSC") on
shares sold within eighteen months. Class B shares are subject to a maximum CDSC
of 3.25% based upon the holding period after purchase. Class B shares will
convert to Class A shares eight years after purchase. Please read the Fund's
prospectus for additional details on Class B CDSC. Class C shares are subject to
a 1.00% CDSC on shares sold within one year after purchase. Class Z shares are
not subject to a sales charge. There are certain restrictions on the purchase of
Class Z shares, as described in the Fund's prospectus.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP") requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates. The
following is a summary of significant accounting policies consistently followed
by the Fund in the preparation of its financial statements.
SECURITY VALUATION
The value of the Fund's assets is based on the current market value of its
investments. For securities with readily available market quotations, the Fund
uses those quotations for pricing. When portfolio securities are traded on the
relevant day of valuation, the valuation will be the last reported sale price on
that day. If there are no such sales on that day, the security will be valued at
the mean between the most recently quoted bid and asked prices from principal
market makers. Securities without a sale price or bid and ask quotations on the
valuation day will be priced by an independent pricing service. If securities do
not have readily available market quotations or pricing service prices,
including circumstances under which such are determined not to be accurate or
current (including when events materially affect the value of securities
occurring between the time when market price is determined and calculation of
the Fund's net asset value), such securities are valued at their fair value, as
determined by the Investment Adviser in good faith in accordance with procedures
approved by the Fund's Board of Trustees. Using a fair value pricing methodology
to price securities may result in a value that is different from a security's
most recent sale price and from the prices used by other investment companies to
calculate their net asset values. There can be no assurance that the Fund's
valuation of a security will not differ from the amount that it realizes upon
the sale of such security.
SECURITY TRANSACTIONS
Security transactions are accounted for on the trade date. Cost and gains
(losses) are determined based upon the specific identification method for both
financial statement and federal income tax purposes.
FOREIGN CURRENCY
Foreign currencies, investments and other assets and liabilities are translated
into U.S. dollars at the exchange rates using the current 4:00 p.m. London Time
Spot Rate. Fluctuations in the value of the foreign currencies and other assets
and liabilities resulting from changes in exchange rates, between trade and
settlement dates on securities transactions and between the accrual and payment
dates on dividends, interest income and foreign withholding taxes, are recorded
as unrealized foreign currency gains (losses). Realized gains (losses) and
unrealized appreciation (depreciation) on investment securities and income and
expenses are translated on the respective dates of such transactions. The effect
of changes in foreign currency exchange rates on investments in securities are
not segregated in the statement of operations
25
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
from the effects of changes in market prices of those securities, but are
included with the net realized and unrealized gain or loss on investment
securities.
REPURCHASE AGREEMENTS
The Fund may engage in repurchase agreement transactions with institutions that
the Fund's investment adviser has determined are creditworthy. The Fund, through
its custodian, receives delivery of underlying securities collateralizing a
repurchase agreement. Collateral is at least equal, at all times, to the value
of the repurchase obligation including interest. A repurchase agreement
transaction involves certain risks in the event of default or insolvency of the
counterparty. These risks include possible delays or restrictions upon the
Fund's ability to dispose of the underlying securities and a possible decline in
the value of the underlying securities during the period while the Fund seeks to
assert its rights.
INCOME RECOGNITION
Interest income is recorded on the accrual basis and includes accretion of
discounts and amortization of premiums, if any. As of April 2004, facility fees
received are recorded as a reduction of cost to the loan and amortized through
the maturity of the loan. Prior to May 2004, facility fees received were treated
as deferred revenue and amortized over two years. Unamortized facility fees are
reflected as deferred fees on the Statement of Assets and Liabilities.
DETERMINATION OF CLASS NET ASSET VALUES
All income, expenses (other than distribution fees and service fees, which are
class-specific expenses, as shown on the Statement of Operations) and realized
and unrealized gains (losses) are allocated to each class of the Fund on a daily
basis for purposes of determining the net asset value of each class. Income and
expenses are allocated to each class based on the settled shares method, while
realized and unrealized gains (losses) are allocated based on the relative net
assets of each class.
FEDERAL INCOME TAX STATUS
The Fund intends to qualify each year as a "Regulated Investment Company" under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), and
will distribute substantially all of its taxable income, if any, for its tax
year, and as such will not be subject to federal income taxes.
DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income are declared daily and paid monthly. Net
realized capital gains, if any, are distributed at least annually.
STATEMENT OF CASH FLOWS
Information on financial transactions which have been settled through the
receipt or disbursement of cash are presented in the Statement of Cash Flows.
The cash and foreign currency amount shown in the Statement of Cash Flows is the
amount included within the Fund's Statement of Assets and Liabilities and
includes cash and foreign currency on hand at its custodian bank and
sub-custodian bank, respectively, and does not include any short-term
investments.
NOTE 3. FEDERAL TAX INFORMATION
The timing and character of income and capital gain distributions are determined
in accordance with Federal income tax regulations, which may differ from GAAP.
As a result, net investment income (loss) and net realized gain (loss) on
investment transactions for a reporting period may differ significantly from
distributions during such period.
Reclassifications are made to the Fund's capital accounts for permanent tax
differences to reflect income and gains available for distribution (or available
capital loss carryforwards) under income tax regulations.
For the year ended August 31, 2005, permanent differences resulting primarily
from differing treatments for discount accretion/premium amortization on debt
securities and Section 988 gain (loss) were identified and reclassified among
the components of the Fund's net assets as follows:
- ----------------------------------------
Overdistributed Accumulated
Net Investment Net Realized
Income Loss
- ----------------------------------------
$414,915 $(414,915)
- ----------------------------------------
Net investment income and net realized gains (losses), as disclosed on the
Statement of Operations, and net assets were not affected by these
reclassifications.
The tax character of distributions paid during the years ended August 31, 2005
and August 31, 2004 was as follows:
- ----------------------------------------------------------
2005 2004
- ----------------------------------------------------------
Distributions paid from:
- ----------------------------------------------------------
Ordinary income* $43,133,311 $21,394,034
- ----------------------------------------------------------
Long-term capital gains -- --
- ----------------------------------------------------------
*For tax purposes short-term capital gains distributions, if any, are considered
ordinary income distributions.
26
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
As of August 31, 2005, the components of distributable earnings on a tax basis
were as follows:
- ------------------------------------------------------------
Undistributed Undistributed
Ordinary Long-Term Net Unrealized
Income Capital Gains Appreciation*
- ------------------------------------------------------------
$2,422,808 $-- $14,316,812
- ------------------------------------------------------------
*The differences between book-basis and tax-basis net unrealized appreciation
(depreciation) are primarily due to deferral of losses from wash sales and
accretion/amortization on debt securities.
Unrealized appreciation and depreciation at August 31, 2005, based on cost of
investments for federal income tax purposes, and excluding any unrealized
appreciation (depreciation) from changes in the value of other assets and
liabilities resulting from changes in exchange rates, was:
- -------------------------------------------------------------
Unrealized appreciation $ 16,725,423
- -------------------------------------------------------------
Unrealized depreciation (2,692,344)
------------
Net unrealized appreciation $ 14,033,079
- -------------------------------------------------------------
The following capital loss carryforwards may be available to reduce taxable
income arising from future net realized gains on investments, if any, to the
extent permitted by the Code:
- -------------------------------------------------------------
Year of Capital Loss
Expiration Carryforward
- -------------------------------------------------------------
2011 $ 3,018,341
- -------------------------------------------------------------
Under current laws, certain capital losses realized after October 31 may be
deferred and treated as occurring on the first day of the following fiscal year.
For the fiscal year ended August 31, 2005, the Fund has elected to defer net
realized capital losses of $236,386 and net realized currency losses of $73,329
incurred from November 1, 2004 to August 31, 2005.
NOTE 4. ADVISORY, ADMINISTRATION, SERVICE AND DISTRIBUTION, TRUSTEE, AND OTHER
FEES
INVESTMENT ADVISORY FEE
Effective April 15, 2004, Highland Capital Management, L.P. ("Highland") is the
investment adviser to the Fund. Highland receives a monthly investment advisory
fee based on the Fund's average daily managed net assets at the following annual
rates:
- ----------------------------------------------------------
Average Daily Managed Net Assets Annual Fee Rate
- ----------------------------------------------------------
First $1billion 0.45%
- ----------------------------------------------------------
Next $1billion 0.40%
- ----------------------------------------------------------
Over $2 billion 0.35%
- ----------------------------------------------------------
Average daily managed net assets of the Fund means the average daily value of
the total assets of the Fund less all accrued liabilities of the Fund (other
than the aggregate amount of any outstanding borrowing constituting financial
leverage).
For the year ended August 31, 2005, the Portfolio's effective investment
advisory fee rate was 0.45%.
Prior to April 15, 2004, the Fund's investment advisory agreement provided for
an investment advisory fee based on the Fund's average daily managed assets,
which includes assets acquired with leverage. Although the Fund's board and
shareholders were informed that the new advisory agreements implemented
commencing on April 15, 2004 in connection with a change in investment adviser
would not change the fee structure, the text of the agreement submitted to
shareholders inadvertently provides for a fee based on the Fund's average daily
net assets, which would not include assets acquired with leverage. This change
was inadvertent, and Highland will ask the Board of Trustees to approve an
amendment reverting retroactively as of April 15, 2004 to the intended formula
based on the Fund's average daily managed assets, and submit the amendment to
shareholders for approval. The Fund believes that approval of this amendment is
appropriate and probable. Accordingly, the Fund has not modified its financial
statements to reflect the lower fee that would be in effect if the fee were
based on net assets rather than managed assets. The Fund will, however, hold
back the difference between the two fee levels until it receives these
approvals. If the amendment is not approved, the Fund will retain the
differential and the fee formula will be based on net assets.
ADMINISTRATION FEES
Effective October 18, 2004, Highland provides administrative services to the
Fund for a monthly administration fee at the annual rate of 0.20% of the Fund's
average daily managed net assets. Under a separate sub-administration agreement,
Highland has delegated certain administrative functions to PFPC Inc. ("PFPC").
For the period ended August 31, 2005, Highland received $1,741,375 in
administrative fees, and paid PFPC $87,069 for their services. This amount is
included in the "Administration fee" on the Statement of Operations of the Fund.
Prior to October 18, 2004, Columbia Management Advisors, Inc. ("Columbia
Management") provided administrative and other services to the Fund for a
monthly administration fee at the annual rate of 0.20% of the Fund's average
daily managed net assets managed daily.
27
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
For the period September 1, 2004 through October 17, 2004, Columbia Management
received $203,917 in administration fees, which are included in the
"Administration fee" on the Statement of Operations of the Fund.
ACCOUNTING SERVICES FEES
Effective October 18, 2004, the Fund entered into an accounting services
agreement with PFPC. For the period October 18, 2004 through August 31, 2005,
PFPC received $241,658 for this service. This fee is included in the "Accounting
services fee" on the Statement of Operations.
Prior to October 18, 2004, Columbia Management was responsible for providing
pricing and bookkeeping services to the Fund under a pricing and bookkeeping
agreement. Under a separate agreement (the "Outsourcing Agreement"), Columbia
Management delegated those functions to State Street Bank and Trust Company
("State Street"). As a result, Columbia Management paid the total fees collected
under the Outsourcing Agreement to State Street.
Under its pricing and bookkeeping agreement with the Fund, Columbia Management
received from the Fund an annual flat fee of $10,000 paid monthly, and in any
month that the Fund's average daily net assets exceeded $50 million, an
additional monthly fee. The additional fee rate was calculated by taking into
account the fees payable to State Street under the Outsourcing Agreement. This
rate was applied to the average daily net assets of the Fund for that month. The
Fund also paid additional fees for pricing services based on the number of
securities held by the Fund. For the period September 1, 2004 through October
17, 2004, Columbia Management received $24,100 of pricing and bookkeeping fees.
This fee is included in the "Accounting services fee" on the Statement of
Operations of the Fund.
TRANSFER AGENT FEE
Effective October 18, 2004, PFPC provides shareholder services to the Fund. For
the period October 18, 2004 through August 31, 2005, PFPC received $356,714 for
this service. This fee is included in the "Transfer agent fee" on the Statement
of Operations.
Prior to October 18, 2004, Columbia Funds Services, Inc. ("Columbia Services"),
an affiliate of Columbia Management, provided shareholder services to the Fund.
For such services, Columbia Services received a fee, paid monthly, at the annual
rate of $34 per open account. Columbia Services also received reimbursement for
certain out-of-pocket expenses. For the period September 1, 2004 through October
17, 2004, Columbia Services received $86,380 for transfer agent services,
excluding out-of-pocket expenses. This amount is included in the "Transfer agent
fee" on the Statement of Operations of the Fund.
SERVICE AND DISTRIBUTION FEES
PFPC Distributors, Inc. (the "Distributor") serves as the principal underwriter
and distributor of the Fund's shares. The Distributor is paid a CDSC on certain
redemptions of Class A, Class B and Class C Shares. For the year ended August
31, 2005, the Distributor received $66,496, $250,244 and $126,898 of CDSC on
Class A, Class B and Class C share redemptions, respectively.
The Fund has adopted a plan pursuant to Rule 12b-1 under the 1940 Act (the
"Plan"), which requires the payment of a monthly service fee to the Distributor
at the annual rate not to exceed 0.25% of the average daily net assets
attributable to Class A, Class B and Class C shares of the Fund. The Plan also
requires the payment of a monthly distribution fee to the Distributor on an
annual basis, not to exceed 0.10%, 0.45% and 0.60% of the average daily net
assets attributable to Class A, Class B and Class C shares, respectively.
The CDSC and the fees received from the Plan are used principally as repayment
for amounts paid to dealers who sold such shares.
EXPENSE LIMITS AND FEE REIMBURSEMENTS
Highland has voluntarily agreed to waive fees and reimburse certain expenses to
the extent that total expenses (exclusive of investment advisory fees,
administration fees, distribution and service fees, brokerage commissions,
interest, facility expense, taxes and extraordinary expenses, if any) exceed
0.15% annually of the Fund's average daily net assets. This arrangement may be
revised or discontinued by Highland at any time.
CUSTODY
Effective October 18, 2004, PFPC Trust Company ("PFPC Trust") is the custodian
to the Fund. For the period October 18, 2004 through August 31, 2005, PFPC Trust
received $118,720 for this service. This fee is included in the "Custody fee" on
the Statement of Operations.
For the period September 1, 2004 through October 17, 2004, the Fund had an
agreement with its prior custodian bank, State Street, under which custody fees
could have been reduced by balance credits. The Fund could have invested a
portion of the assets utilized in connection with the expense offset arrangement
in an income-producing asset if it had not entered into such an agreement.
28
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
FEES PAID TO OFFICERS AND TRUSTEES
The Fund pays no compensation to its officers, all of whom are employees of
Highland.
The Fund pays Trustees who are not interested persons (as defined in the 1940
Act) each an annual retainer of $25,000 for services provided as Trustees of the
Fund.
NOTE 5. PORTFOLIO INFORMATION
For the year ended August 31, 2005, the cost of purchases and proceeds from
sales of securities, excluding short-term obligations, were $1,290,874,899 and
$852,001,230, respectively.
NOTE 6. PERIODIC REPURCHASE OFFERS
The Fund has adopted a fundamental policy to offer each fiscal quarter to
repurchase a specified percentage (between 5% and 25%) of the shares then
outstanding at NAV ("Repurchase Offers"). Repurchase Offers are scheduled to
occur on or about the 15th day (or the next business day if the 15th is not a
business day) in the months of February, May, August, and November. It is
anticipated that normally the date on which the repurchase price of shares will
be determined (the "Repurchase Pricing Date") will be the same date as the
deadline for shareholders to provide their repurchase requests to the
Distributor (the "Repurchase Request Deadline"), and if so, the Repurchase
Request Deadline will be set for a time no later than the close of regular
trading on the NYSE on such date. The Repurchase Pricing Date will occur no
later than the 14th day after the Repurchase Request Deadline, or the next
business day if the 14th day is not a business day. Repurchase proceeds will be
paid to shareholders no later than seven days after the Repurchase Pricing Date.
For the year ended August 31, 2005, there were four Repurchase Offers. For each
Repurchase Offer, the Fund offered to repurchase 10% of its shares. In the
November, February, May and August Repurchase Offers 5.03%, 5.61%, 5.64% and
5.51%, respectively, of shares outstanding were repurchased.
NOTE 7. SENIOR LOAN PARTICIPATION COMMITMENTS
The Fund invests at least 80% of its net assets (plus any borrowings for
investment purposes) in adjustable rate senior loans ("Senior Loans"), the
interest rates of which float or vary periodically based upon a benchmark
indicator of prevailing interest rates to domestic foreign corporations,
partnerships and other entities ("Borrowers"). If the lead lender in a typical
lending syndicate becomes insolvent, enters FDIC receivership or, if not FDIC
insured enters into bankruptcy, the Fund may incur certain costs and delays in
receiving payment or may suffer a loss of principal and/or interest. When the
Fund purchases a participation of a Senior Loan interest, the Fund typically
enters into a contractual agreement with the lender or other third party selling
the participation, not with the borrower directly. As such, the Fund assumes the
credit risk of the Borrower, selling participant or other persons
interpositioned between the Fund and the Borrower. The ability of Borrowers to
meet their obligations may be affected by economic developments in a specific
industry.
At August 31, 2005, the following sets forth the selling participants with
respect to interests in Senior Loans purchased by the Fund on a participation
basis.
- --------------------------------------------------------------
Principal
Selling Participant Amount Value
- --------------------------------------------------------------
CSFB:
Quality Distributions, Inc.
Term Loan $974,747 $981,454
- --------------------------------------------------------------
NOTE 8. LOAN AGREEMENT
Effective October 18, 2004, the Fund entered into a new $300,000,000 secured
loan agreement with Citicorp North America, Inc. ("Citicorp") replacing a
previous agreement. The Fund is required to maintain certain asset coverage with
respect to amounts outstanding under the agreement.
For the period September 1, 2004 through October 17, 2004, the Fund had a loan
agreement with Citicorp, under which the Fund could borrow up to $150,000,000.
At August 31, 2005, the Fund had one term loan outstanding with Citicorp,
totaling $250,000,000 expiring on October 14, 2005. The interest rate charged on
this loan at August 31, 2005 was 3.60%. The average daily loan balance was
$167,273,973 at a weighted average interest rate of 2.59%. The Fund was required
to maintain certain asset coverage with respect to the loan. Interest expense of
$4,536,502 is included on the Statement of Operations.
NOTE 9. LOAN AGREEMENT ASSET COVERAGE REQUIREMENTS
- ----------------------------------------------------------------
Asset
Coverage per
Total Amount $1,000 of
Date Outstanding Indebtedness
- ----------------------------------------------------------------
08/31/2005 $ 250,000,000 $5,129
- ----------------------------------------------------------------
08/31/2004 95,000,000 8,038
- ----------------------------------------------------------------
08/31/2003 59,500,000 5,156
- ----------------------------------------------------------------
08/31/2002 74,000,000 3,701
- ----------------------------------------------------------------
08/31/2001 88,000,000 3,908
- ----------------------------------------------------------------
08/31/2000 19,000,000 6,739
- ----------------------------------------------------------------
29
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
NOTE 10. UNFUNDED LOAN COMMITMENTS
As of August 31, 2005, the Portfolio had unfunded loan commitments of
$21,250,487, which could be extended at the option of the Borrower, pursuant to
the following loan agreements:
- ----------------------------------------------------------------------
Unfunded
Loan
Borrower Commitment
- ----------------------------------------------------------------------
CCM Merger, Inc./MotorCity Casino $ 450,000
- ----------------------------------------------------------------------
Covanta Energy Corp. 1,000,000
- ----------------------------------------------------------------------
Cricket Communications, Inc. 5,000,000
- ----------------------------------------------------------------------
Dobson Cellular Systems, Inc. 625,000
- ----------------------------------------------------------------------
Federal-Mogul Corp. 117,897
- ----------------------------------------------------------------------
Infor Global Solutions European Finance S.A.R.L. 1,235,772
- ----------------------------------------------------------------------
Interstate Bakeries Corp. 7,500,000
- ----------------------------------------------------------------------
Midwest Generations LLC 2,000,000
- ----------------------------------------------------------------------
NES Rentals Holdings, Inc. 638,484
- ----------------------------------------------------------------------
Select Medical Corp. 933,334
- ----------------------------------------------------------------------
Trump Entertainment Resorts, Inc. 1,750,000
- ----------------------------------------------------------------------
$ 21,250,487
- ----------------------------------------------------------------------
NOTE 11. DISCLOSURE OF SIGNIFICANT RISKS AND CONTINGENCIES
INDUSTRY FOCUS
The Fund may focus its investments in certain industries, subjecting it to
greater risk than a fund that is more diversified.
NON-PAYMENT RISK
Senior Loans, like other corporate debt obligations, are subject to the risk of
non-payment of scheduled interest and/or principal. Non-payment would result in
a reduction of income to the Fund, a reduction in the value of the Senior Loan
experiencing non-payment and a potential decrease in the net asset value of the
Fund.
CREDIT RISK
Investments rated below investment grade are commonly referred to as high-yield,
high risk or "junk debt." They are regarded as predominantly speculative with
respect to the issuing company's continuing ability to meet principal and/or
interest payments. Investments in high yield Senior Loans may result in greater
net asset value fluctuation than if the Fund did not make such investments.
CURRENCY RISK
A portion of the Fund's assets may be quoted or denominated in non-U.S.
currencies. These securities may be adversely affected by fluctuations in
relative currency exchange rates and by exchange control regulations. The Fund's
investment performance may be negatively affected by a devaluation of a currency
in which the Fund's investments are quoted or denominated. Further, the Fund's
investment performance may be significantly affected, either positively or
negatively, by currency exchange rates because the U.S. dollar value of
securities quoted or denominated in another currency will increase or decrease
in response to changes in the value of such currency in relation to the U.S.
dollar.
LEGAL PROCEEDINGS
Prior to April 15, 2004, the Fund was advised by Columbia Management and was
part of the Columbia Funds Complex (the "Columbia Funds"). Several Columbia
Funds are defendants in civil lawsuits that have been transferred and
consolidated for pretrial proceedings in the United States District Court for
the District of Maryland in the Special Multi-District Litigation proceeding
(Index No. 04-MO-15863) created for actions involving market timing issues
against mutual fund complexes. The lawsuits have been commenced as putative
class actions on behalf of investors who purchased, held or redeemed shares of
the Funds during specified periods or as derivative actions on behalf of the
Funds. The lawsuits seek, among other things, unspecified compensatory damages
plus interest and, in some cases, punitive damages, the rescission of investment
advisory contracts, the return of fees paid under those contracts, and
restitution. The consolidated amended class action complaint against
Columbia-affiliated defendants was filed on September 29, 2004 and does not name
the Fund as a defendant or nominal defendant. The consolidated amended fund
derivative complaint against Columbia-affiliated defendants was also filed on
September 29, 2004 and names the Columbia Funds, collectively, as nominal
defendants.
On March 2, 2005, four civil revenue sharing actions alleging, among other
things, that various mutual funds (including the Fund) advised by Columbia
Management and Columbia Wanger Asset Management L.P. inappropriately used fund
assets to pay brokers to promote the funds by directing fund brokerage
transactions to such brokers and did not fully disclose such arrangements to
shareholders, and charged excessive 12b-1 fees, were consolidated into a single
action in the United States District Court for Massachusetts (In re Columbia
Entities Litigation, Civil Action No. 04-11704-REK). On June 9, 2005, plaintiffs
filed a consolidated amended class action complaint and a motion for class
certification. On or about August 8, 2005, all defendants (including the Fund)
filed motions to dismiss the consolidated amended complaint. The court has not
decided either the class certification or dismissal motions.
30
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
TO THE TRUSTEES AND SHAREHOLDERS OF HIGHLAND FLOATING RATE ADVANTAGE FUND:
In our opinion, the accompanying statement of assets and liabilities, including
the investment portfolio, and the related statements of operations, changes in
net assets and of cash flows and the financial highlights present fairly, in all
material respects, the financial position of Highland Floating Rate Advantage
Fund (the "Fund") at August 31, 2005, and the results of its operations, the
changes in its net assets and cash flows and the financial highlights for
periods indicated in conformity with accounting principles generally accepted in
the United States of America. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of investments held at August 31, 2005 by correspondence with the
custodian and the banks with whom the Fund owns participations in loans, provide
a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
October 25, 2005
31
ADDITIONAL INFORMATION (UNAUDITED)
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
TRUSTEES AND OFFICERS
The Trustees and officers serve terms of indefinite duration. The names,
addresses and ages of the Trustees and officers of the Fund, the year each was
first elected or appointed to office, their principal business occupations
during at least the last five years, the number of portfolios overseen by each
Trustee and other directorships they hold are shown below. Each officer listed
below serves as an officer of each Fund in the Highland Funds Complex.
YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS
ELECTED OR OCCUPATION(S) IN HIGHLAND FUNDS OTHER
NAME, ADDRESS, POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS
AND AGE WITH FUND TO OFFICE FIVE YEARS BY TRUSTEE1 HELD
- ------- --------- --------- ---------- ----------- ------
INDEPENDENT TRUSTEES
Timothy K. Hui Trustee 2004 Associate Provost for Graduate 8 None.
(Age 56) Education since July 2004 and
c/o Highland Capital Assistant Provost for Educational
Management, L.P. Resources from July 2001 to
13455 Noel Road, June 2004, Philadelphia
Suite 1300 Biblical University.
Dallas, Texas 75240
Scott F. Kavanaugh Trustee 2004 Private Investor. From February 8 None.
(Age 44) 2003, to July 2003, an Executive at
c/o Highland Capital Provident Funding Mortgage
Management, L.P. Corporation. From January 2000
13455 Noel Road, to February 2003, Executive Vice
Suite 1300 President, Director and Treasurer
Dallas, Texas 75240 of Commercial Capital Bank. From
April 1998 to February
2003, Managing Principal
and Chief Operating
Officer of Financial
Institutional Partners
Mortgage Company and the
Managing Principal and
President of Financial
Institutional Partners,
LLC, an investment
banking firm.
James F. Leary Trustee 2004 Since January 1999, a Managing 8 Capstone
(Age 75) Director of Benefit Capital Series Fund,
c/o Highland Capital Southwest, Inc., a financial Inc.; Stewart
Management, L.P. consulting firm. Funds, Inc.
13455 Noel Road, (3 portfolios);
Suite 1300 Pacesetter/
Dallas, Texas 75240 MVHC Inc.
(small business
investment
company)
Bryan A. Ward Trustee 2004 Since January 2002, Senior 8 None.
(Age 50) Manager of Accenture, LLP. From
c/o Highland Capital September 1998 to December
Management, L.P. 2001, he was Special Projects
13455 Noel Road, Advisor to Accenture, LLP
Suite 1300 with focus on the oil and
Dallas, Texas 75240 gas industry.
32
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND
TRUSTEES AND OFFICERS
YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS
ELECTED OR OCCUPATION(S) IN HIGHLAND FUNDS OTHER
NAME, ADDRESS, POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS
AND AGE WITH FUND TO OFFICE FIVE YEARS BY TRUSTEE 1 HELD
- ------- --------- --------- ---------- ------------ ------
INTERESTED TRUSTEE 2
R. Joseph Dougherty Trustee 2004 Portfolio Manager of the 8 None.
(Age 34) and Senior Vice Adviser. Prior to 2000, he
c/o Highland Capital President was a Portfolio Analyst
Management, L.P. for the Adviser.
13455 Noel Road,
Suite 1300
Dallas, TX 75240
OFFICERS
James D. Dondero President 2004 President and Managing N/A N/A
(Age 42) Partner of the Adviser.
c/o Highland Capital Director of Heritage Bank.
Management, L.P. Director and Chairman of
13455 Noel Road, Heritage Bankshares, Inc.
Suite 1300
Dallas, TX 75240
Mark Okada Executive 2004 Chief Investment Officer of N/A N/A
(Age 44) Vice the Adviser. Director of Heritage
c/o Highland Capital President Bank and Heritage Bankshares,
Management, L.P. Inc.
13455 Noel Road,
Suite 1300
Dallas, TX 75240
M. Jason Blackburn Secretary and 2004 Assistant Controller of the Adviser. N/A N/A
(Age 29) Treasurer From September 1999 to
c/o Highland Capital October 2001, he was an
Management, L.P. accountant for KPMG LLP.
13455 Noel Road,
Suite 1300
Dallas, TX 75240
Michael S. Minces Chief 2004 From October 2003 to August 2004, N/A N/A
(Age 30) Compliance associate at Akin Gump Strauss
c/o Highland Capital Officer Hauer & Feld LLP (law firm). From
Management, L.P. October 2000 to March 2003,
13455 Noel Road, associate at Skadden, Arps, Slate,
Suite 1300 Meagher & Flom LLP (law firm).
Dallas, TX 75240 Previously, he attended The University
of Texas at Austin School of Law.
<FN>
1 The Highland Fund Complex consists of the following funds (the "Highland
Funds"): Highland Floating Rate Limited Liability Company, Highland Floating
Rate Fund, Highland Floating Rate Advantage Fund, Highland Institutional
Floating Rate Income Fund, Highland Corporate Opportunities Fund, Restoration
Opportunities Fund, Prospect Street(R) High Income Portfolio Inc. and Prospect
Street(R) Income Shares Inc.
2 Mr. Dougherty is deemed to be an "interested person" of the Fund under the
1940 Act because of his position with the Adviser.
</FN>
33
IMPORTANT INFORMATION ABOUT THIS REPORT
- --------------------------------------------------------------------------------
TRANSFER AGENT The Fund mails one shareholder report to
PFPC Inc. each shareholder address. If you would
101 Sabin Street like more than one report, please call
Pawtucket, RI 02860 shareholder services at 1-877-665-1287
and additional reports will be sent to
you.
DISTRIBUTOR This report has been prepared for
PFPC Distributors, Inc. shareholders of Highland Floating Rate
760 Moore Road Advantage Fund.
King of Prussia, PA 19406
INVESTMENT ADVISER A description of the policies and
Highland Capital Management, L.P. procedures that the Fund uses to
13455 Noel Road Suite 1300 determine how to vote proxies relating
Dallas, TX 75240 to its portfolio securities, and the
Fund's proxy voting record for the most
recent 12-month period ended June 30,
are available (i) without charge, upon
request, by calling 1-877-665-1287 and
(ii) on the Securities and Exchange
Commission's website at
http://www.sec.gov.
INDEPENDENT REGISTERED PUBLIC The Fund files its complete schedule of
ACCOUNTING FIRM portfolio holdings with the Securities
PricewaterhouseCoopers LLP and Exchange Commission for the first
125 High Street and third quarters of each fiscal year
Boston, MA 02110 on Form N-Q. The Fund's Forms N-Q are
available on the Commission's website at
http:/www.sec.gov and also may be
reviewed and copied at the Commission's
Public Reference Room in Washington, DC.
Information on the Public Reference Room
may be obtained by calling
1-800-SEC-0330.
The Statement of Additional Information
includes information about Fund
Directors and is available upon request
without charge by calling
1-877-665-1287.
34
THIS PAGE LEFT BLANK INTENTIONALLY.
THIS PAGE LEFT BLANK INTENTIONALLY.
HIGHLAND FLOATING RATE ADVANTAGE FUND Annual Report, August 31, 2005
[GRAPHIC OMITTED] HIGHLAND FUNDS
managed by Highland Capital Management, L.P.
HLC-FR-ADV AR-8/05
ITEM 2. CODE OF ETHICS.
(a) The registrant, as of the end of the period covered by this report, has
adopted a code of ethics that applies to the registrant's principal
executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions.
(b) Not applicable.
(c) There have been no amendments, during the period covered by this
report, to a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions.
(d) The registrant has not granted any waiver, including any implicit
waiver, from a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller.
(e) Not applicable.
(f) The registrant's code of ethics is incorporated by reference to Exhibit
(a)(1) to the registrant's Form N-CSR filed with the Securities and
Exchange Commission on November 9, 2004 (Accession No.
0001047469-04-033537).
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
The Registrant's Board of Trustees (the "Board") has determined that James
Leary, a member of the Audit Committee of the Board, is an audit committee
financial expert as defined by the Securities and Exchange Commission (the
"SEC"). Mr. Leary is "independent" as defined by the SEC for purposes of audit
committee financial expert determinations.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
AUDIT FEES
(a) The aggregate fees billed for each of the last two fiscal years for
professional services rendered by the principal accountant for the
audit of the registrant's annual financial statements or services that
are normally provided by the accountant in connection with statutory
and regulatory filings or engagements for those fiscal years were
$51,990 for the fiscal year ended August 31, 2004 and $54,590 for the
fiscal year ended August 31, 2005.
AUDIT-RELATED FEES
(b) The aggregate fees billed in each of the last two fiscal years for
assurance and related services by the principal accountant that are
reasonably related to the performance of the audit of the registrant's
financial statements and are not reported under paragraph (a) of this
Item were $4,000 for the fiscal year ended August 31, 2004 and $5,000
for the fiscal year ended August 31, 2005. The nature of those services
was agreed-upon procedures related to semi-annual financial statements.
TAX FEES
(c) The aggregate fees billed in each of the last two fiscal years for
professional services rendered by the principal accountant for tax
compliance, tax advice, and tax planning were $4,500 for the fiscal
year ended August 31, 2004 and $4,800 for the fiscal year ended August
31, 2005. The nature of those services was assistance on tax returns
and excise tax calculations.
ALL OTHER FEES
(d) The aggregate fees billed in each of the last two fiscal years for
products and services provided by the principal accountant, other than
the services reported in paragraphs (a) through (c) of this Item were
$0 for the fiscal year ended August 31, 2004 and $0 for the fiscal year
ended August 31, 2005.
(e)(1) Disclose the audit committee's pre-approval policies and procedures
described in paragraph (c)(7) of Rule 2-01 of Regulation S-X.
The Audit Committee shall:
(a) have direct responsibility for the appointment, compensation,
retention and oversight of the Fund's independent auditors and, in
connection therewith, to review and evaluate matters potentially
affecting the independence and capabilities of the auditors; and
(b) review and pre-approve (including associated fees) all audit and
other services to be provided by the independent auditors to the
Fund and all non-audit services to be provided by the independent
auditors to the Fund's investment adviser or any entity
controlling, controlled by or under common control with the
investment adviser (an "Adviser Affiliate") that provides ongoing
services to the Fund, if the engagement relates directly to the
operations and financial reporting of the Fund; and
(c) establish, to the extent permitted by law and deemed appropriate
by the Audit Committee, detailed pre-approval policies and
procedures for such services; and
(d) consider whether the independent auditors' provision of any
non-audit services to the Fund, the Fund's investment adviser or
an Adviser Affiliate not pre-approved by the Audit Committee are
compatible with maintaining the independence of the independent
auditors.
(e)(2) The percentage of services described in each of paragraphs (b) through
(d) of this Item that were approved by the audit committee pursuant to
paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X are as follows:
(b) 100%
(c) 100%
(d) Not applicable
(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most
recent fiscal year that were attributed to work performed by persons
other than the principal accountant's full-time, permanent employees
was less than fifty percent.
(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's
investment adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or overseen by
another investment adviser), and any entity controlling, controlled by,
or under common control with the adviser that provides ongoing services
to the registrant for each of the last two fiscal years of the
registrant were $0 for the fiscal year ended August 31, 2004 and
$85,252 for the fiscal year ended August 31, 2005.
(h) The registrant's audit committee of the board of directors has
considered whether the provision of non-audit services that were
rendered to the registrant's investment adviser (not including any
sub-adviser whose role is primarily portfolio management and is
subcontracted with or overseen by another investment adviser), and any
entity controlling, controlled by, or under common control with the
investment adviser that provides ongoing services to the registrant
that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X is compatible with maintaining the principal
accountant's independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
ITEM 6. SCHEDULE OF INVESTMENTS.
Schedule of Investments in securities of unaffiliated issuers as of the close of
the reporting period is included as part of the report to shareholders filed
under Item 1 of this form.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Adviser has adopted proxy voting guidelines (the "Guidelines") that
provide as follows:
o The Adviser votes proxies in respect of a client's securities in the
client's best economic interests and without regard to the interests
of the Adviser or any other client of the Adviser.
o Unless the Adviser's Proxy Voting Committee (the "Committee")
otherwise determines (and documents the basis for its decision) or as
otherwise provided below, the Adviser votes proxies in a manner
consistent with the Guidelines.
o To avoid material conflicts of interest, the Adviser applies the
Guidelines in an objective and consistent manner across client
accounts. Where a material conflict of interest has been identified
and the matter is covered by the Guidelines, the Committee votes in
accordance with the Guidelines. For clients that are registered
investment companies, where a conflict of interest has been identified
and the matter is not covered in the Guidelines, the Adviser will
disclose the conflict and the Committee's determination of the manner
in which to vote to the Fund's Board. For clients that are not
investment companies, where a conflict of interest has been identified
and the matter is not covered in the Guidelines, the Committee will
disclose the conflict to the client and advise the client that its
securities will be voted only upon the client's written direction.
o The Adviser also may determine not to vote proxies in respect of
securities of any issuer if it determines it would be in its clients'
overall best interests not to vote.
The Adviser's Guidelines address how it will vote proxies on particular types of
matters such as changes in corporate government structures, adoption of options
plans and anti-takeover proposals. For example, the Adviser generally will:
o support management in most elections for directors, unless the board
gives evidence of acting contrary to the best economic interests of
shareholders;
o support option plans, if it believes that they provide for their
administration by disinterested parties and provide incentive to
directors, managers and other employees by aligning their economic
interests with those of the shareholders while limiting the transfer
of wealth out of the company; and
o oppose anti-takeover proposals unless they are structured in such a
way that they give shareholders the ultimate decision on any proposal
or offer.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
Not yet applicable.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 7(d)(2)(ii)(G) of Schedule 14A (17 CFR
240.14a-101), or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act")) are effective, as of a date within 90 days of this filing,
based on their evaluation of these controls and procedures required by
Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and Rules
13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as
amended (17 CFR 240.13a-15(b) or 240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act)
that occurred during the registrant's last half year that has
materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Not applicable.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) HIGHLAND FLOATING RATE ADVANTAGE FUND
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By (Signature and Title)* /S/ JAMES D. DONDERO
-------------------------------------------------------
James D. Dondero, Chief Executive Officer
(principal executive officer)
Date NOVEMBER 3, 2005
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Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /S/ JAMES D. DONDERO
-------------------------------------------------------
James D. Dondero, Chief Executive Officer
(principal executive officer)
Date NOVEMBER 3, 2005
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By (Signature and Title)* /S/ M. JASON BLACKBURN
-------------------------------------------------------
M. Jason Blackburn, Chief Financial Officer
(principal financial officer)
Date NOVEMBER 3, 2005
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* Print the name and title of each signing officer under his or her signature.