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 800
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 800
DALLAS, TEXAS 75240
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(Name and address of agent for service)
registrant's telephone number, including area code: (877) 665-1287
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Date of fiscal year end: AUGUST 31
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Date of reporting period: AUGUST 31, 2006
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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, 100 F Street, NE,
Washington, DC 20549. 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.
FLOATING RATE
ADVANTAGE
FRONT
COVER
[GRAPHIC OMITTED]
HIGHLAND SHIELD
HIGHLAND FLOATING RATE ADVANTAGE FUND
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TABLE OF CONTENTS
Portfolio Managers' Letter ............................................. 1
Fund Profile ........................................................... 3
Financial Statements ................................................... 4
Investment Portfolio ................................................ 5
Statement of Assets and Liabilities ................................. 18
Statement of Operations ............................................. 19
Statements of Changes in Net Assets ................................. 20
Statement of Cash Flows ............................................. 22
Financial Highlights ................................................ 23
Notes to Financial Statements ....................................... 27
Report of Independent Registered Public Accounting Firm ................ 33
Additional Information ................................................. 34
Important Information About This Report ................................ 38
Economic and market conditions change frequently.
There is no assurance that the trends described in this
report will continue or commence.
A PROSPECTUS MUST PRECEDE OR ACCOMPANY THIS REPORT.
PLEASE READ THE PROSPECTUS CAREFULLY BEFORE YOU INVEST.
PORTFOLIO MANAGERS' LETTER
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OCTOBER 27, 2006 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. This annual report for
the Fund covers the twelve-month period ended August 31, 2006. In the report,
portfolio managers Mark Okada and Joseph Dougherty of Highland Capital
Management, L.P. ("Highland") discuss performance, investment process strategy,
and outlook.
Q: HOW HAS THE FUND PERFORMED?
A: For the 12-month period ending August 31, 2006, the Fund (Z share) returned
10.47%. That was greater than the return of the Fund's benchmark, the Credit
Suisse ("CS") Leveraged Loan Index, which was 6.36% for the period, and the
Lipper Loan Participation Loan Category average, which was 6.46% for the period.
During this same time period, the Standard & Poor's 500 Index returned 8.88% and
the Lehman Aggregate Bond Index returned 1.71%. So the Fund has done very well
relative to both its own benchmark and other traditional asset classes.
Within the portfolio there were a number of positions that performed well during
the period. The Fund's strongest performers include Mirant Corp. common stock,
which was received through the company's bankruptcy in exchange for the loans
the Fund had held; Blockbuster Entertainment Corp. Tranche B Term Loan, which is
a core position in the Fund; Calpine Corp. Second Lien Term Loan; DS Waters
Enterprises, LP Term Loan; and Movie Gallery, Inc. Term B Loan. The weakest
performers during the period include CamelBak Products, LLC Second Lien Term
Loan, American Homepatient, Inc. Secured Promissory Note, Covanta Energy Corp.
First Lien Revolver, Cornerstone Healthcare Group Senior Subordinated Unsecured
Notes, and Bragg Communications, Inc. Term Loan B.
Q: WHAT WAS THE INVESTMENT ENVIRONMENT LIKE FOR LEVERAGED LOANS DURING THE
PERIOD?
A: The investment environment during the twelve months ending August 31, 2006,
has generally been beneficial for the leveraged loan markets. As measured by the
CS Leveraged Loan Index, the leveraged loan market was up 6.36% over the past
twelve months.
The credit environment continued to be favorable for the loan markets as the
default environment was relatively benign. Default rates have decreased slightly
from 1.51% in August, 2005 (by number of loans on a trailing 12-month basis) to
1.36% at the end of August 2006, according to Standard & Poor's Leveraged
Commentary & Data ("LCD"). Solid earnings growth and strong liquidity have kept
default rates low during the period. Spreads narrowed from 265 basis points at
the end of August 2005 to 253 basis points at the end of August 2006, as tracked
by the CS Leveraged Loan Index. However, the tightening in spreads was more than
offset by an increase in interest rates. Three-month LIBOR increased
approximately 150 basis points during the same time period. As a result, the
weighted average coupon for leveraged loans increased from 6.34% to 7.98% during
the same period, as tracked by the CS Leveraged Loan Index. New issue bank loan
volume growth has been dramatic in 2006, totaling $397 billion during the first
eight months, which is up from $241 billion during the comparable time period in
2005, according to Prospect News Bank Loan Daily.
[GRAPHIC OMITTED]
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS:
8/31/05 3.87
9/30/05 4.07
10/31/05 4.26
11/30/05 4.42
12/31/05 4.54
1/31/06 4.68
2/28/06 4.82
3/31/06 5
4/30/06 5.13
5/31/06 5.24
6/30/06 5.48
7/31/06 5.47
8/31/06 5.4
Source: British Bankers' Association
Annual Report | 1
PORTFOLIO MANAGERS' LETTER
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OCTOBER 27, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
Q: HOW IS THE FUND CURRENTLY POSITIONED?
A: The Fund is approximately 98.8% loans, 0.0% bonds, and 1.2% equities, as a
percentage of investments. With regards to diversification, the Fund is
currently invested in approximately 44 industries and 410 borrowers. Some of the
Fund's core positions include Cricket Communications, Inc., a wireless
communications service; Movie Gallery, Inc., a home entertainment specialty
retailer; Georgia Pacific Corp., a manufacturer of tissue, packaging, paper,
building products, and related chemicals; Blockbuster Entertainment Corp., a
company providing rentable home entertainment; and Millennium Digital Media
Systems, LLC, a broadband services company. The U.S. cable television, retail,
and utility industries are among the largest exposures in the portfolio.
Q: HOW DOES THE FUND'S USE OF LEVERAGE IMPACT PERFORMANCE?
A: The Fund utilizes financial leverage in an effort to increase the yield to
the shareholders. As of August 31, 2006, the Fund had borrowings under its
credit facility of $400 million. Total leverage, as a percentage of total
assets, was 13.7% at period end. We believe the use of leverage for investment
purposes increases investment opportunity and it also increases investment risk.
Q: WHAT IS YOUR OUTLOOK?
A: We expect the leveraged loan market to perform well during the remainder of
2006. We believe defaults should continue to move up slightly during the
remainder of the year, although they should continue to remain below the
historical average of 3.09% for the 10-year period ended 2005, as tracked by the
CS Leveraged Loan Index. New issue bank loan volume is expected to remain strong
for the foreseeable future, driven by jumbo deals. Demand from new
collateralized loan obligations will continue to provide ample liquidity in the
loan market. The Fed raised rates to 5.25% in June and left rates at that level
during the August and September meetings, and we anticipate a stable rate
environment in the coming year. Overall, our view is that the economy is
healthy, but slowing, and do not expect any material decreases in the credit
quality of the portfolio.
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 mean the Fund's managers
have 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 and
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 prospectus 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 contributor and are
subject to change.
Prior investment returns are not indicative of future results.
2 | Annual Report
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 August 31, 2006
$1,824.2 million
Portfolio Data as of August 31, 2006
The information below provides a snapshot of the Fund at the end of the
reporting period. The Fund is actively managed and the composition of its
portfolio will change over time.
QUALITY BREAKDOWN AS OF 08/31/06 (%)
- --------------------------------------
Baa 0.2
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Ba 17.1
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B 58.6
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Caa 8.4
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NR 15.7
TOP 5 SECTORS AS OF 08/31/06 (%)
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Retail 9.1
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Cable: US Cable 8.6
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Utility 8.0
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Transportation -- Auto 6.0
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Housing -- Real Estate
Development 5.8
TOP 10 HOLDINGS AS OF 08/31/06 (%)
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Movie Gallery, Inc. 2.2
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Cricket Communications, Inc. 2.1
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Georgia-Pacific Corp. 2.1
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Blockbuster Entertainment Corp. 1.7
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Millennium Digital Media Systems, LLC 1.5
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Resorts International Holdings Ltd. 1.4
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Charter Communications Operating LLC 1.3
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United Air Lines, Inc. 1.2
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Edge Star Partners LLC 1.2
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Calpine Generating Co., LLC 1.1
Quality is calculated as a percentage of total notes and bonds.
Sectors and holdings are calculated as a percentage of net assets.
Annual Report | 3
FINANCIAL STATEMENTS
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AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
A GUIDE TO UNDERSTANDING THE 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 This statement details the Fund's assets, liabilities,
AND 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 net assets
IN 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.
4 | Annual Report
INVESTMENT PORTFOLIO
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AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (A) - 117.4%
AEROSPACE - AEROSPACE/DEFENSE - 2.2%
AWAS Capital, Inc.
14,360,119 First Priority Term Loan,
7.25%, 03/15/13 ................................. 14,072,917
7,840,430 Second Priority Term Loan,
11.50%, 03/15/13 ................................ 7,879,631
3,000,000 BE Aerospace, Inc.
Tranche B Term Loan,
08/01/12 (b) .................................... 3,008,460
7,939,983 DeCrane Aircraft Holdings, Inc.
First Lien Term Loan,
9.76%, 03/31/08 ................................. 7,964,755
IAP Worldwide Services, Inc.
1,990,000 First Lien Term Loan,
8.50%, 12/30/12 ................................. 2,003,691
1,500,000 Second Lien Term Loan,
13.50%, 06/20/13 ................................ 1,535,625
2,957,647 Vought Aircraft Industries, Inc.
Term Loan, 8.00%, 12/22/11 ...................... 2,981,663
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39,446,742
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AEROSPACE - AIRLINES - 4.0%
992,475 American Airlines, Inc.
Term Facility, 8.34%, 12/17/10 .................. 1,007,153
Continental Airlines, Inc.
1,714,286 Tranche A-1 Term Loan,
8.61%, 06/01/11 ................................. 1,735,714
4,285,714 Tranche A-2 Term Loan,
8.61%, 06/01/11 ................................. 4,339,286
Delta Airlines, Inc.
5,000,000 DIP, Term Loan A,
8.02%, 03/16/08 ................................. 5,071,400
6,000,000 Term Loan Equipment Notes,
08/25/12 (b) .................................... 6,007,500
1,133,408 ILC Industries, Inc.
First Lien Term Loan,
8.00%, 02/24/12 ................................. 1,137,658
10,000,000 Northwest Airlines Inc.
Term Loan DIP, 08/21/08 (b) ..................... 10,018,800
14,500,000 U S Airways, Inc.
Term Loan, 9.00%, 03/31/11 ...................... 14,599,760
United Air Lines, Inc.
3,482,500 Delayed Draw Tranche B
Term Loan, 9.08%, 02/01/12 ...................... 3,539,091
24,377,500 Tranche B Term Loan,
9.25%, 02/01/12 ................................. 24,761,446
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72,217,808
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BROADCASTING - 4.2%
2,500,000 Barrington Broadcasting Group
Term Loan, 08/11/13 (b) ......................... 2,516,800
5,382,142 CMP Susquehanna Corp.
Term Loan, 7.31%, 05/05/13 ...................... 5,397,145
Millennium Digital Media Systems, LLC
30,464,347 Facility B Term Loan,
9.49%, 10/31/08 ................................. 30,464,347
141,685 Revolver, 10/31/08 (b) (c) ...................... 141,685
1,037,839 Term Facility, 10/31/08 (b) ..................... 1,037,839
NextMedia Operating, Inc.
705,446 Delay Draw Term Loan,
7.41%, 11/15/12 ................................. 702,801
1,587,254 Initial Term Loan (1st Lien),
7.33%, 11/15/12 ................................. 1,581,968
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
BROADCASTING (CONTINUED)
NextMedia Operating, Inc. (continued)
1,000,000 Second Lien Term Loan,
9.83%, 11/15/13 ................................. 1,008,750
11,000,000 Paxson Communications Corp.
First Lien Term Loan,
8.76%, 01/15/12 ................................. 11,178,750
21,839,680 Young Broadcasting, Inc.
Term Loan, 8.00%, 11/03/12 ...................... 21,734,849
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75,764,934
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CABLE - INTERNATIONAL CABLE - 1.9%
Kabel Baden-Wurttemburg GmbH & Co.
(Germany)
750,000 Term B Facility, 06/30/14 (b) ................... 751,875
750,000 Term C Facility, 06/30/15 (b) ................... 755,625
2,992,500 Liberty Cablevision of Puerto Rico, Ltd.
(Puerto Rico)
Term Loan, 7.48%, 02/13/13 ...................... 2,998,126
8,000,000 NTL Inc. (United Kingdom)
B4 Facility, 01/10/13 (b) ....................... 8,040,000
2,887,500 Puerto Rico Cable Acquisition Co., Inc.
(Puerto Rico)
First Lien Term Loan,
8.50%, 07/28/11 ................................. 2,901,938
San Juan Cable, LLC (Puerto Rico)
2,487,500 First Lien Term Loan,
7.27%, 10/31/12 ................................. 2,492,674
2,500,000 Second Lien Term Loan,
10.77%, 10/31/13 ................................ 2,543,750
UPC Broadband Holding BV
(Netherlands)
6,965,000 Facility F2, 7.64%, 03/31/09 .................... 6,969,876
1,500,000 Facility H2, 7.64%, 09/30/12 .................... 1,500,480
1,000,000 Facility J2, 03/31/13 (b) ....................... 1,000,700
1,000,000 Facility K2, 03/31/13 (b) ....................... 1,000,320
UPC Financing Partnership
(Netherlands)
1,000,000 Facility J2, 7.64%, 03/31/13 .................... 1,000,700
2,000,000 Facility K2, 7.64%, 12/31/13 .................... 2,000,640
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33,956,704
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CABLE - US CABLE - 8.6%
2,493,750 Atlantic Broadband Finance LLC
Tranche B-1 Term Loan,
7.99%, 09/01/11 ................................. 2,517,141
Bresnan Communications LLC
2,000,000 Second Lien Term Loan,
9.92%, 03/29/14 ................................. 2,041,260
7,825,000 Tranche B Term Loan,
7.17%, 09/29/13 ................................. 7,825,939
Century Cable Holdings LLC
1,000,000 Discretionary Term Loan,
10.25%, 12/31/09 ................................ 969,760
2,500,000 Revolver, 9.25%, 03/31/09 ....................... 2,404,700
15,833,333 Term Loan, 10.25%, 06/30/09 ..................... 15,457,292
Cequel Communications LLC
5,000,000 Bridge Term Loan,
10.49%, 10/30/07 ................................ 5,018,750
4,500,000 First Lien Term Loan B,
7.74%, 11/05/13 ................................. 4,454,055
2,000,000 Second Lien Tranche A Term Loan,
9.99%, 05/04/14 ................................. 1,940,000
29,768,944 Charter Communications
Operating LLC
Term Loan, 8.13%, 04/28/13 ...................... 29,880,875
See accompanying Notes to Financial Statements. | 5
INVESTMENT PORTFOLIO (CONTINUED)
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AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
CABLE - US CABLE (CONTINUED)
24,937,500 CSC Holdings, Inc.
Incremental Term Loan,
7.13%, 03/29/13 ................................. 24,828,274
Knology, Inc.
2,991,990 New Term Loan, 7.99%, 06/29/10 .................. 3,009,463
5,591,568 Second Lien Term Loan,
15.49%, 06/29/11 ................................ 6,542,135
Mediacom Broadband Group
2,297,338 Tranche C Term Loan,
7.23%, 01/31/15 ................................. 2,295,684
2,202,662 Tranche D-2 Term Loan,
7.38%, 01/31/15 ................................. 2,183,852
1,000,000 Mediacom Illiniois, LLC
Tranche B Term Loan,
7.22%, 03/31/13 ................................. 999,500
Northland Cable Television, Inc.
4,975,000 First Lien Term Loan B,
9.47%, 12/22/12 ................................. 4,987,438
6,000,000 Second Lien Term Loan,
13.49%, 06/22/13 ................................ 6,000,000
Olympus Cable Holdings LLC
11,000,000 Term Loan A, 9.50%, 06/30/10 (b) ................ 10,585,300
11,350,000 Term Loan B, 10.25%, 09/30/10 (b) ............... 11,011,770
WideOpenWest Finance LLC
10,085,009 First Lien Term Loan,
7.71%, 05/01/13 ................................. 10,098,523
1,000,000 Second Lien Term Loan,
10.23%, 05/01/14 ................................ 1,009,620
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156,061,331
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CHEMICALS - COMMODITY & FERTILIZER - 0.9%
5,142,728 Celanese
Dollar Term Loan B,
7.50%, 04/06/11 ................................. 5,173,791
1,533,694 Cognis Corp.
Dollar Facility B, 8.17%, 03/31/12 .............. 1,544,890
4,722,223 Ferro Corp.
Term Loan, 8.66%, 06/06/12 (c) .................. 4,710,417
4,871,245 Huntsman International LLC
Term B Dollar Loan,
7.08%, 08/16/12 ................................. 4,865,984
-------------
16,295,082
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CHEMICALS - SPECIALTY CHEMICALS - 3.7%
1,995,000 AGY Holding Corp.
First Lien Term Loan,
8.25%, 04/07/12 ................................. 2,008,726
2,000,000 Almatis Holdings 4 B.V. (Netherlands)
Facility A2, 7.87%, 12/31/12 .................... 2,012,500
Almatis U S Holding Inc.
1,500,000 Facility B3, 8.12%, 12/31/13 .................... 1,523,205
1,500,000 Facility C3, 8.12%, 12/31/14 .................... 1,525,785
Basell BV (Netherlands)
791,160 Facility B4 USD, 5.34%, 08/01/13 ................ 802,286
791,160 Facility C4 USD, 5.34%, 08/01/14 ................ 802,286
Basell USA, Inc.
6,455,803 Facility B2, 5.34%, 08/01/13 (b) ................ 6,546,572
6,455,802 Facility C2, 5.34%, 08/01/14 (b) ................ 6,545,991
Brenntag Holding GMBH & Co.
(Germany)
589,091 Acquisition Facility,
8.08%, 01/17/14 ................................. 593,509
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
CHEMICALS - SPECIALTY CHEMICALS (CONTINUED)
Brenntag Holding GMBH & Co. (continued)
2,410,909 Facility B2 Term Loan,
8.08%, 01/17/14 ................................. 2,438,032
1,000,000 Second Lien Dollar Facility,
11.87%, 06/22/15 ................................ 1,033,120
Ineos U S Finance LLC
2,000,000 Term Loan A4, 7.34%, 12/14/12 ................... 1,998,280
7,500,000 Term Loan B2, 7.84%, 12/14/13 ................... 7,575,000
7,500,000 Term Loan C2, 7.84%, 12/14/14 ................... 7,589,100
4,488,750 ISP Chemco, Inc.
Term Loan, 7.24%, 02/16/13 ...................... 4,493,149
3,914,226 Kraton Polymers Group of Cos.
Term Loan, 7.38%, 12/23/10 ...................... 3,919,158
5,000,000 Panda Hereford Ethanol, L.P.
Tranche A Term Loan,
9.14%, 07/28/13 ................................. 4,987,500
6,422,399 Rockwood Specialties Group, Inc.
Tranche E Term Loan,
7.49%, 07/30/12 ................................. 6,471,466
4,500,000 Solutia, Inc.
New Term Loan B DIP,
8.96%, 03/31/07 ................................. 4,528,125
-------------
67,393,790
-------------
CONSUMER DURABLES - 0.7%
1,000,000 Berkline/Benchcraft LLC.
Term Loan, 11/03/11 (b) ......................... 852,500
4,000,000 Bombardier Recreational Products Inc.
(Canada)
Term Loan, 8.24%, 06/28/13 ...................... 3,997,520
1,000,000 Fender Musical Instruments Corp.
Second Lien Term Loan,
11.12%, 09/30/12 ................................ 1,015,000
4,000,000 Rexair LLC
Additional Term Facility,
9.78%, 06/30/10 ................................. 4,010,000
Ruby Cone I AB (Sweden)
1,687,216 Facility B1 Term Loan,
7.77%, 06/01/13 ................................. 1,682,998
1,623,681 Facility C1 Term Loan,
8.27%, 06/01/14 ................................. 1,625,044
-------------
13,183,062
-------------
CONSUMER NON-DURABLES - 4.7%
2,398,923 American Achievement Corp.
Tranche B Term Loan,
7.99%, 09/27/12 ................................. 2,416,915
2,992,500 Amscan Holdings
Term Loan B, 8.64%, 12/23/12 .................... 3,009,318
1,481,250 Bare Escentuals Beauty, Inc.
(MD Beauty)
1st Lien Term Loan (Add on),
8.19%, 02/18/12 ................................. 1,485,872
2,000,000 Camelbak Products, Inc.
Second Lien Term Loan,
12.96%, 02/04/12 ................................ 1,610,000
19,813,261 DS Waters Enterprises LP
Term Loan, 9.39%, 11/07/09 (b) .................. 19,701,911
Eastman Kodak Co.
13,485,916 Term B-1 Advance,
7.71%, 10/18/12 ................................. 13,496,225
2,411,765 Term B-2 Advance Delayed Draw,
7.71%, 10/18/12 ................................. 2,412,536
Hanesbrands, Inc.
2,000,000 Second Lien Facility, 03/05/14 (b) .............. 2,036,240
4,000,000 Term Loan B, 09/05/13 (b) ....................... 4,036,480
6 | See accompanying Notes to Financial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
CONSUMER NON-DURABLES (CONTINUED)
5,620,625 Hillman Group, Inc.
Term Loan B, 8.50%, 03/31/11 .................... 5,666,264
Jarden Corp.
952,915 Term Loan B1, 7.25%, 01/24/12 ................... 954,707
952,938 Term Loan B2, 7.25%, 01/24/12 ................... 951,547
2,000,000 MD Beauty, Inc.
Second Lien Term Loan,
12.33%, 02/18/13 ................................ 2,015,000
5,000,000 Owens-Brockway Glass Container Inc.
Tranche B Term Loan,
7.08%, 06/14/13 ................................. 5,007,050
860,080 Polaroid Corp.
Term Loan, 14.00%, 04/27/11 ..................... 862,231
2,927,600 Prestige Brands Holdings, Inc.
Tranche B Term Loan,
7.71%, 04/06/11 ................................. 2,942,238
2,875,000 Revlon Consumer Products Corp.
Term Loan, 11.49%, 07/09/10 ..................... 2,957,656
Solo Cup Co.
1,000,000 Second Lien Term Loan,
9.66%, 03/31/12 ................................. 1,006,880
4,845,305 Term B1 Loan, 7.84%, 02/27/11 ................... 4,860,034
1,977,440 Spectrum Brands
U. S. Dollar Term Loan B,
8.40%, 02/07/12 ................................. 1,981,157
Technical Concepts, LLC
913,690 U. S. Dollar Term Loan A,
8.58%, 02/15/11 ................................. 915,975
858,780 U. S. Dollar Term Loan B,
8.83%, 02/15/13 860,927
3,750,000 VJCS Acquisition, Inc.
Term B Facility, 7.80%, 07/19/13 ................ 3,750,000
-------------
84,937,163
-------------
DIVERSIFIED MEDIA - 5.1%
12,841,578 American Lawyer Media Holdings, Inc.
First Lien Term Loan,
8.00%, 03/05/10 (b) ............................. 12,837,468
377,778 Black Press Group Ltd. (Canada)
Term B-2 Tranche Loan,
7.71%, 08/01/13 ................................. 380,139
622,222 Black Press U S Partnership
Term B-1 Tranche Loan,
7.50%, 08/01/13 ................................. 626,111
1,363,334 Day International, Inc.
First Lien U S Term Loan,
8.12%, 12/05/12 ................................. 1,376,967
2,458,333 Deluxe Canada Holdings, Inc.
(Canada)
First Lien Tranche C Term Loan,
9.25%, 01/28/11 ................................. 2,482,917
2,000,000 Endurance Business Media, Inc.
First Lien Term Loan,
8.08%, 07/24/13 ................................. 2,009,380
HIT Entertainment PLC
(United Kingdom)
2,980,000 First Lien Term Advance,
7.70%, 03/20/12 (b) ............................. 3,000,860
5,500,000 Second Lien Term Loan,
10.95%, 02/26/13 ................................ 5,551,590
3,980,000 Merrill Communications LLC
Combined Term Loan,
7.65%, 05/15/11 ................................. 4,004,875
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
DIVERSIFIED MEDIA (CONTINUED)
Metro-Goldwyn-Mayer Holdings II,
Inc./LOC Acquisition Co.
976,190 Tranche A Term Loan,
8.75%, 04/08/11 ................................. 973,086
14,276,738 Tranche B Term Loan,
7.75%, 04/08/12 (b) ............................. 14,231,052
North American Membership
Group, Inc.
994,962 First Lien Tranche B Term Loan,
8.75%, 05/19/11 ................................. 992,475
3,000,000 Second Lien Term Loan,
13.00%, 11/18/11 ................................ 2,985,000
Panavision, Inc.
1,995,000 First Lien Term Loan,
8.40%, 03/30/11 ................................. 2,012,476
3,500,000 Second Lien Term Loan,
12.49%, 03/30/12 ................................ 3,563,420
2,500,000 PBI Media, Inc.
Second Lien Term Loan,
11.49%, 09/30/13 ................................ 2,498,450
7,882,195 Six Flags Theme Parks, Inc.
Tranche B, 8.48%, 06/30/09 (b) .................. 8,002,084
Springer Science+Business Media S.A.
(Germany)
562,496 Tranche B-2, 07/05/13 (b) ....................... 570,332
562,496 Tranche C-2, 07/05/14 (b) ....................... 570,349
338,124 USD Tranche B-2 Add On,
07/05/13 (b) .................................... 342,493
1,014,373 USD Tranche C-2 Add On,
07/05/14 (b) .................................... 1,030,856
366,301 USD Tranche E-2 Add On,
07/05/14 (b) .................................... 372,254
6,518,043 VISANT Corp.
Tranche C Term Loan,
7.07%, 10/04/11 ................................. 6,559,563
10,000,000 VNU Inc./Nielsen Finance LLC
Dollar Term Loan, 08/09/13 (b) .................. 9,965,600
2,892,271 Warner Music Group
Term Loan, 7.39%, 02/28/11 ...................... 2,906,530
4,000,000 Yell Group Plc (United Kingdom)
Facility B1 (USD), 10/27/12 (b) ................. 4,019,160
-------------
93,865,487
-------------
ENERGY - EXPLORATION & PRODUCTION - 1.6%
11,150,000 ATP Oil & Gas Corp.
Term Loan, 8.72%, 04/14/10 ...................... 11,303,312
4,466,250 Cheniere LNG Holdings LLC
Term Loan, 8.25%, 08/31/12 ...................... 4,502,516
Targa Resources, Inc.
2,000,000 Asset Bridge Term Loan,
7.58%, 10/31/07 ................................. 2,002,920
1,161,290 Synthetic Term Loan,
5.37%, 10/31/12 ................................. 1,162,742
4,802,419 Term Loan, 7.65%, 10/31/12 ...................... 4,821,197
6,000,000 TARH E&P Holdings, LP
Second Lien Term Loan,
11.68%, 11/15/10 ................................ 6,045,000
-------------
29,837,687
-------------
ENERGY - OTHER ENERGY - 1.9%
7,111,111 Alon USA Energy, Inc.
Paramount Facility,
7.91%, 06/22/13 ................................. 7,186,631
See accompanying Notes to Financial Statements. | 7
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
ENERGY - OTHER ENERGY (CONTINUED)
2,475,000 Carrizo Oil & Gas, Inc.
Second Lien Term Loan,
11.50%, 07/21/10 ................................ 2,530,687
7,500,000 Coffeyville Resources LLC
Second Lien Term Loan,
12.13%, 06/24/13 ................................ 7,750,050
5,000,000 Global Petroleum, Inc.
(SPI Petroleum)
Term Loan, 07/26/13 (b) ......................... 5,012,500
8,000,000 Helix Energy Solutions Group, Inc.
Term Loan, 7.51%, 07/01/13 ...................... 8,010,000
251,986 MarkWest Energy Operating, LLC
Term Loan, 7.66%, 12/29/10 ...................... 251,986
2,992,500 MEG Energy Corp. (Canada)
Initial Term Loan,
7.50%, 04/03/13 ................................. 2,999,054
1,638,794 SemCrude LP
U S Term Loan,
7.62%, 03/16/11 ................................. 1,645,972
-------------
35,386,880
-------------
ENERGY - REFINING - 1.0%
3,000,000 Energy Transfer Equity, L.P.
Term Loan, 7.50%, 02/08/12 ...................... 3,011,250
4,000,000 Hawkeye Renewables, LLC
First Lien Term Loan,
9.33%, 06/30/12 ................................. 3,972,480
6,500,000 J Ray McDermott SA (Panama)
Synthetic Facility,
7.77%, 06/06/12 ................................. 6,516,250
Northeast Biofuels, LLC
1,365,854 Construction Term Loan,
11.50%, 06/30/13 ................................ 1,376,098
634,146 Synthetic Letter of Credit,
5.50%, 06/30/13 ................................. 638,902
OPTI Canada, Inc. (Canada)
311,111 Term Loan, 7.26%, 05/17/13 ...................... 311,242
688,889 Term Loan, 7.18%, 05/17/13 ...................... 689,178
1,714,286 Resolute Aneth, LLC
Second Lien Tern Loan,
10.47%, 04/13/12 ................................ 1,731,429
-------------
18,246,829
-------------
ENERGY - SERVICE & EQUIPMENT - 0.6%
4,962,500 Complete Production Services
Term B Facility,
7.66%, 09/12/12 ................................. 4,985,724
3,005,294 Petroleum Geo-Services ASA/PGS
Finance, Inc. (Norway)
Term Loan, 7.75%, 12/16/12 ...................... 3,035,347
2,500,000 Vetco International Holdings, Inc. (DE)
(United Kingdom)
Second Lien Term D Loan,
10.50%, 01/12/14 (b) ............................ 2,553,126
-------------
10,574,197
-------------
FINANCIAL - 2.7%
American Wholesale Insurance
Group, Inc.
992,500 First Lien Term Loan A,
8.50%, 10/27/11 ................................. 996,222
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
FINANCIAL (CONTINUED)
American Wholesale Insurance
Group, Inc. (continued)
2,000,000 Second Lien Term Loan B,
12.75%, 04/27/12 ................................ 2,005,000
2,887,500 Arias Acquisitions, Inc.
Term Loan, 9.25%, 07/26/11 ...................... 2,800,875
1,000,000 Arrowhead General Insurance Agency
First LeinTerm Loan,
8.33%, 08/08/12 ................................. 1,010,620
1,500,000 Bay Point Re Limited (Bermuda)
Term Loan, 9.81%, 12/31/10 ...................... 1,516,875
Checksmart Financial Co.
1,995,000 First Lien Tranche B Term Loan,
8.06%, 05/01/12 ................................. 1,995,000
2,500,000 Second Lien Term Loan,
10.89%, 05/01/13 ................................ 2,531,250
5,000,000 Concord Re Ltd. (Bermuda)
Term Loan, 02/29/12 (b) ......................... 5,050,000
4,326,562 Conseco, Inc.
Term Loan, 7.08%, 06/22/10 ...................... 4,330,196
4,666,667 Crump Group, Inc.
Tranche B Term Loan,
8.11%, 12/19/12 ................................. 4,672,500
Flatiron Re Ltd. (Bermuda)
4,378,947 Closing Date Term Loan,
9.76%, 12/20/10 ................................. 4,378,947
2,121,053 Delayed Draw Term Loan,
9.75%, 12/20/10 ................................. 2,121,053
2,992,500 IPayment, Inc.
Term Facility, 7.72%, 05/10/13 .................. 2,994,355
1,990,000 LPL Holdings, Inc.
Tranche B Term Loan,
8.67%, 06/28/13 ................................. 2,014,557
1,896,557 Mitchell International, Inc.
Term Loan, 7.50%, 08/15/11 ...................... 1,904,257
NASDAQ Stock Market, Inc.
1,869,720 Tranche B Term Loan,
6.97%, 04/18/12 ................................. 1,870,599
1,083,833 Tranche C Term Loan,
7.07%, 04/18/12 ................................. 1,084,516
809,352 Outsourcing Solutions, Inc.
Term Loan, 9.83%, 09/30/10 ...................... 811,375
5,000,000 Starbound Reinsurance Ltd.
(Bermuda)
Term Loan, 9.40%, 03/01/08 ...................... 5,009,400
-------------
49,097,597
-------------
FOOD AND DRUG - 1.7%
1,445,652 Bi-Lo LLC
Term Loan, 9.43%, 07/01/11 ...................... 1,464,619
3,000,000 CTI Food Holdings Co. LLC
Second Lien Secured Term Loan,
11.50%, 06/02/12 ................................ 3,048,750
2,728,798 Duloxetine Royalty Sub
(Cayman Islands)
Term Loan, 10.01%, 10/18/13 ..................... 2,749,264
9,152,170 Jean Coutu Group, Inc.
Term Loan B, 8.00%, 07/30/11 ................... 9,184,751
1,957,544 Leiner Health Products Group, Inc.
Tranche B Term Loan,
8.61%, 05/27/11 ................................. 1,967,958
4,552,348 Michael Foods, Inc.
Term Loan B-1, 7.51%, 11/21/10 .................. 4,587,037
971,429 Nash Finch Co.
Initial Term Loan,
7.63%, 11/12/10 ................................. 975,071
8 | See accompanying Notes to Financial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
FOOD AND DRUG (CONTINUED)
6,831,127 Nellson Nutraceutical, Inc.
First Lien Term Loan,
12.25%, 10/04/09 ................................ 6,409,920
1,496,250 Supervalu Inc.
Term Loan B, 7.06%, 06/02/12 .................... 1,496,250
-------------
31,883,620
-------------
FOOD/TOBACCO - BEVERAGES & BOTTLING - 1.0%
769,635 AFC Enterprises, Inc.
Tranche B Term Loan,
7.75%, 05/09/11 ................................. 772,036
3,411,944 Commonwealth Brands, Inc.
Term Loan, 7.75%, 12/22/12 ...................... 3,436,681
3,300,000 National Distributing Co., Inc.
Second Lien Term Loan,
11.83%, 06/01/10 ................................ 3,308,250
1,995,000 Nutro Products, Inc.
Term Facility, 7.27%, 04/26/13 .................. 1,998,751
7,000,000 Reynolds American, Inc.
Term Loan, 7.26%, 05/31/12 ...................... 7,038,780
1,209,011 Sunny Delight Beverages Co.
First Lien Term Loan,
11.47%, 08/20/10 ................................ 1,207,875
-------------
17,762,373
-------------
FOOD/TOBACCO - FOOD/TOBACCO PRODUCERS - 2.0%
Chiquita Brands, LLC
97,857 Term Loan B, 06/28/12 (b) ....................... 97,979
6,098,700 Term Loan C, 7.58%, 06/28/12 (b) ................ 6,129,193
Dole Food Co., Inc.
186,258 Credit Linked Deposit,
5.37%, 04/12/13 ................................. 183,289
418,033 Tranche B Term Loan,
7.52%, 04/12/13 ................................. 412,138
1,393,442 Tranche C Term Loan,
7.54%, 04/04/13 ................................. 1,371,231
Gate Gourmet Borrower LLC
2,660,022 Dollar Term Loan First Lien,
8.25%, 03/09/12 ................................. 2,666,672
333,311 First Lien Letter of Credit,
8.25%, 12/31/10 ................................. 337,061
Krispy Kreme Doughnuts, Inc.
800,000 Second Lien Tranche A Credit Link
Deposit, 5.39%, 04/01/10 ........................ 828,000
3,160,000 Second Lien Tranche B Term Loan,
12.74%, 04/01/10 ................................ 3,270,600
12,989,634 Merisant Co.
Tranche B Term Loan,
8.74%, 01/11/10 ................................. 12,924,685
5,711,252 Michelina's
Term Loan, 8.31%, 04/02/11 ...................... 5,757,628
3,357,998 Pinnacle Foods Group Inc.
New Term Loan,
7.48%, 11/25/10 ................................. 3,362,195
-------------
37,340,671
-------------
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
FOOD/TOBACCO - RESTAURANTS - 1.0%
Buffets, Inc.
500,000 Synthetic Letters of Credit,
5.40%, 06/28/09 ................................. 503,750
3,650,330 Term Loan, 8.99%, 06/28/09 ...................... 3,677,708
2,633,333 Caribbean Restaurant LLC
Tranche B Term Loan,
8.08%, 06/30/09 ................................. 2,662,958
El Pollo Loco, Inc.
4,000,000 Term Loan, 06/01/13 (b) ......................... 4,011,680
3,980,000 Term Loan, 8.40%, 11/18/11 ...................... 3,991,622
1,481,250 Garden Fresh Restaurant Corp.
First Lien Term Loan B,
8.76%, 06/22/11 ................................. 1,484,953
994,063 New World Restaurant Group, Inc.
First Lien Term Loan,
10.25%, 03/31/11 ................................ 999,033
1,375,000 NPC International, Inc.
Term Loan, 7.14%, 05/03/13 ...................... 1,368,978
-------------
18,700,682
-------------
FOREST PRODUCTS - PACKAGING - 3.8%
5,886,775 Berry Plastics Corp.
Term Loan, 7.08%, 12/02/11 ...................... 5,888,011
2,853,165 Consolidated Container Co. LLC
Term Loan, 8.38%, 12/15/08 ...................... 2,867,430
Georgia-Pacific Corp.
27,362,500 First Lien Term B,
7.35%, 02/14/13 ................................. 27,417,225
20,000,000 Second Lien Term Loan,
8.30%, 02/14/14 ................................. 20,208,800
11,321,328 Graham Packaging Co.
Term Loan B, 7.75%, 10/07/11 .................... 11,361,858
2,000,000 JSG Acquisitions (Smurfit Kappa)
(Ireland)
B1 Term Loan Facility,
8.38%, 12/01/13 ................................. 2,010,640
-------------
69,753,964
-------------
FOREST PRODUCTS - PAPER - 0.5%
2,934,147 Appleton Papers, Inc.
Term Loan, 7.67%, 06/11/10 ...................... 2,946,998
3,495,833 Graphic Packaging International, Inc.
Tranche C Term Loan,
7.92%, 08/09/10 ................................. 3,531,106
2,322,346 NewPage Corp.
Term Loan, 8.50%, 05/02/11 ...................... 2,338,324
1,000,000 Verso Paper Holdings LLC
Term Loan B Facility,
7.25%, 07/28/13 ................................. 1,002,500
-------------
9,818,928
-------------
GAMING/LEISURE - GAMING - 5.0%
2,971,125 CCM Merger, Inc./MotorCity Casino
Term Loan B, 7.45%, 04/25/12 .................... 2,967,857
2,500,000 Century California Subsidiary, Inc.
Term Loan B, 7.11%, 03/01/13 .................... 2,505,625
5,000,000 Copa Casino of Mississippi, LLC
Term Loan, 10.42%, 06/14/12 ..................... 5,012,500
1,819,439 DHM Holdings Company, Inc.
Multi Draw Term Loan,
7.03%, 03/03/08 (c) ............................. 1,814,890
3,154,632 Global Cash Access LLC
Term Loan B, 7.08%, 03/10/10 .................... 3,154,632
3,910,450 Green Valley Ranch Gaming LLC
Term Loan, 7.50%, 12/22/10 ...................... 3,915,338
See accompanying Notes to Financial Statements. | 9
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
GAMING/LEISURE - GAMING (CONTINUED)
8,000,000 Lakes Gaming and Resorts, LLC
Term Loan, 11.69%, 06/21/10 ..................... 7,960,000
1,496,250 London Arena & Waterfront
Finance LLC
Tranche A Term Loan,
8.78%, 03/08/12 ................................. 1,511,213
OpBiz LLC
18,318,616 Term Loan A, 8.51%, 08/31/10 (b) ................ 17,761,363
103,821 Term Loan B, 08/31/10 (b) ....................... 100,837
1,985,000 Penn National Gaming, Inc.
Term Loan B, 7.20%, 10/03/12 .................... 1,994,369
1,500,000 Pinnacle Entertainment, Inc.
Term Loan B, 7.33%, 12/15/11 .................... 1,504,065
Resorts International Holdings Ltd.
16,102,206 Second Lien Term Loan,
16.50%, 04/26/13 ................................ 16,796,695
16,126,257 Term Loan B, 9.50%, 04/26/12 .................... 16,234,625
6,000,000 VML U S Finance LLC
Term B Funded Project Loan,
8.20%, 05/25/13 ................................. 6,027,480
2,000,000 Wynn Las Vegas LLC
Term Loan B, 7.21%, 08/15/13 .................... 2,007,080
-------------
91,268,569
-------------
GAMING/LEISURE - OTHER LEISURE - 1.9%
3,162,010 AMF Bowling Worldwide, Inc.
Term Loan B, 8.31%, 08/27/09 .................... 3,191,670
2,325,000 BRE/ESA MEZZ 5 LLC
Mezzanine D Loan,
8.33%, 07/11/08 ................................. 2,325,000
12,675,000 BRE/Homestead MEZZ 4 LLC
Mezzanine D Loan,
8.33%, 07/11/08 ................................. 12,675,000
Fontainebleu Florida Hotel LLC
3,000,000 Tranche A Term Loan,
8.15%, 05/11/08 ................................. 3,000,000
2,000,000 Tranche B Term Loan,
8.15%, 05/11/08 ................................. 2,000,000
4,463,763 Kuilima Resort Co.
First Lien Term Loan,
8.08%, 09/30/10 ................................. 4,430,284
2,200,063 Oak Hill Capital Partners
Mezzanine Loan,
10.37%, 02/09/07 ................................ 2,200,063
Trump Entertainment Resorts, Inc.
1,000,000 Delayed Draw Term Loan B,
05/01/12 (b) (c) ................................ 1,002,500
3,228,722 Term Loan B-1,
8.03%, 05/20/12 (c) ............................. 3,248,901
-------------
34,073,418
-------------
HEALTHCARE - ACUTE CARE - 0.8%
4,256,570 Alliance Imaging, Inc.
Tranche C1 Term Loan,
7.98%, 12/29/11 ................................. 4,273,426
1,995,000 Ameripath, Inc.
Tranche B Term Loan,
7.39%, 10/31/12 ................................. 1,996,237
1,990,000 Capella Healthcare, Inc.
First Lien Term Loan,
8.24%, 11/30/12 ................................. 2,003,691
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
HEALTHCARE - ACUTE CARE (CONTINUED)
Cornerstone Healthcare Group
Holding, Inc.
1,019,361 Senior Subordinated Unsecured
Notes, 14.00%, 07/15/12 (d) ..................... 815,489
1,886,129 Term Loan, 9.47%, 07/15/11 ...................... 1,848,405
2,725,052 DaVita, Inc.
Tranche B Term Loan,
7.43%, 10/05/12 ................................. 2,736,606
National Mentor Holdings, Inc.
56,000 Institutional Letter of Credit Facility,
7.84%, 06/29/13 ................................. 56,210
944,000 Tranche B Term Loan,
7.86%, 06/29/13 ................................. 948,720
-------------
14,678,784
-------------
HEALTHCARE - ALTERNATE SITE SERVICES - 1.8%
1,442,482 American HomePatient, Inc.
Secured Promissory Note,
6.79%, 08/01/09 (d) ............................. 1,442,482
1,946,129 American Medical Response, Inc.
Term Loan, 7.28%, 02/10/12 ...................... 1,950,391
1,995,000 CRC Health Corp.
New Term Loan,
7.75%, 02/06/13 ................................. 1,997,494
FHC Health Systems, Inc.
5,000,000 Third Lien Term Loan,
14.23%, 01/14/11 ................................ 5,200,000
1,500,000 Third Lien Term Loan,
14.23%, 02/09/11 ................................ 1,560,000
696,310 Matria Healthcare, Inc.
First Lien Tranche B Term Loan,
01/19/12 (b) .................................... 695,330
4,466,250 Renal Advantage, Inc.
Tranche B Term Loan,
7.84%, 10/06/12 ................................. 4,491,350
Rural/Metro Operating Co. LLC
720,588 Letter of Credit Term Loan,
5.26%, 03/04/11 ................................. 723,744
2,202,941 Term Loan, 7.52%, 03/04/11 ...................... 2,212,590
9,875,000 Select Medical Corp.
Tranche B Term Loan,
02/24/12 (b) .................................... 9,749,291
1,980,000 Skilled Healthcare LLC
First Lien Term Loan,
7.78%, 06/15/12 ................................. 2,002,275
-------------
32,024,947
-------------
HEALTHCARE - MEDICAL PRODUCTS - 4.2%
7,000,000 American Medical Systems, Inc.
Term Loan, 7.81%, 07/20/12 ...................... 7,026,250
1,850,000 Bradley Pharmaceuticals, Inc.
Term Loan, 9.43%, 11/14/10 ...................... 1,870,813
Carl Zeiss TopCo GmbH/US Newco
375,000 Term B U S Dollar Loan,
7.86%, 05/04/13 ................................. 376,406
1,375,000 Term C U S Dollar Loan,
8.36%, 05/04/14 ................................. 1,380,156
CCS Medical, Inc.
6,482,500 First Lien Term Loan,
8.75%, 09/30/12 (b) ............................. 6,296,128
2,250,000 Second Lien Term Loan,
13.50%, 03/30/13 ................................ 2,109,375
1,975,000 CompBenefits Corp.
Tranche B Term Loan,
8.52%, 04/12/12 ................................. 1,988,588
10 | See accompanying Notes to Financial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
HEALTHCARE - MEDICAL PRODUCTS (CONTINUED)
1,110,920 Encore Medical IHC, Inc.
Term Loan, 8.34%, 10/04/10 ...................... 1,115,086
Golden Gate National Senior
Care LLC
4,987,500 First Lien Term Loan,
7.96%, 03/14/11 ................................. 5,012,438
1,000,000 Second Lien Term Loan,
12.96%, 09/14/11 ................................ 1,017,500
3,500,000 Hanger Orthopedic Group, Inc.
Tranche B Term Loan,
8.00%, 05/26/13 ................................. 3,517,500
17,500,000 HealthSouth Corp.
Term Loan B, 8.52%, 03/10/13 .................... 17,585,400
MMM Holding, Inc./NAMM
Holdings, Inc. (Puerto Rico)
1,486,835 PHMC Acquisition Term Loan,
7.75%, 08/10/11 ................................. 1,490,552
2,513,165 Term Loan, 7.75%, 08/22/11 ...................... 2,519,448
8,500,000 National Renal Institutes, Inc.
Term Facility, 7.63%, 03/31/13 .................. 8,518,615
2,411,831 Reliant Pharmaceuticals, Inc.
First Lien Term Loan,
15.00%, 06/30/08 ................................ 2,435,949
Warner Chilcott Co., Inc. (Puerto Rico)
198,037 Dovobet Delayed Draw Term Loan,
7.83%, 01/18/12 (b) ............................. 199,068
990,406 Dovonex Delayed Draw Term Loan,
7.83%, 01/18/12 (b) ............................. 992,882
6,829,120 Tranche B Acquisition Date
Term Loan, 7.79%, 01/18/12 (b) .................. 6,850,427
432,286 Tranche C Acquisition Date
Term Loan, 01/18/12 (b) ......................... 435,122
199,704 Tranche D Acquisition Date
Term Loan, 01/18/12 (b) ......................... 201,014
2,398,207 Warner Chilcott Corp.
Tranche C Acquisition Date
Term Loan, 7.61%, 01/18/12 ...................... 2,413,940
956,659 Warner Chilcott Holdings Co. III, Ltd.
(Bermuda)
Tranche D Acquisition Date Term
Loan, 7.61%, 01/18/12 ........................... 962,935
-------------
76,315,592
-------------
HOUSING - BUILDING MATERIALS - 2.5%
4,452,941 Atrium Cos., Inc.
Closing Date Term Facility,
8.22%, 05/31/12 ................................. 4,319,353
995,556 Contech Construction Products
New Term Loan,
7.44%, 01/31/13 ................................. 998,662
1,890,397 Custom Building Products, Inc.
First Lien Term Loan,
7.75%, 10/20/11 ................................. 1,902,609
11,000,000 Edge Las Vegas Development LLC
Second Lien Term Loan,
14.40%, 06/01/07 ................................ 11,055,000
1,989,611 NCI Building Systems, Inc.
Tranche B Term Loan,
6.71%, 06/18/10 ................................. 1,990,844
9,812,405 Nortek Holdings, Inc.
Term Loan, 7.36%, 08/27/11 ...................... 9,842,039
807,256 PGT Industries, Inc.
First Lien Tranche A-2 Term Loan,
8.41%, 02/14/12 ................................. 810,283
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
HOUSING - BUILDING MATERIALS (CONTINUED)
2,481,250 Pivotal Group Promotory
First Lien Term Loan,
8.08%, 08/31/10 ................................. 2,453,336
Ply Gem Industries, Inc.
311,719 Canadian Term Loan,
7.65%, 08/15/11 ................................. 309,574
4,675,781 U S Term Loan, 7.58%, 08/15/11 .................. 4,643,612
3,000,000 Roofing Supply Group, LLC
First Lien Term Loan,
08/31/13 (b) .................................... 2,977,500
975,000 St. Mary's Cement, Inc.
Tranche B Term Loan,
7.50%, 12/04/09 ................................. 977,438
1,000,000 Standard Pacific Corp.
Term Loan B, 6.93%, 05/05/13 .................... 986,250
1,478,357 Stile Acquisition Corp. (Canada)
Canadian Term Loan,
7.49%, 04/06/13 ................................. 1,452,486
491,693 Stile U S Acquisition Corp.
U S Term Loan, 7.49%, 04/06/13 .................. 484,288
-------------
45,203,274
-------------
HOUSING - REAL ESTATE DEVELOPMENT - 5.8%
2,500,000 BioMed Realty LP
Senior Secured Term Loan,
7.65%, 05/31/10 ................................. 2,500,000
Edge Star Partners LLC
10,000,000 First Lien Term Loan,
8.65%, 11/18/06 ................................. 10,043,800
6,000,000 Second Lien Term Loan,
14.90%, 11/18/06 ................................ 6,030,000
2,143,382 Giraffe Intermediate, LLC
Mezzanine Note A-1,
7.11%, 08/09/07 ................................. 2,143,382
2,965,230 Lake at Las Vegas Joint Venture
First Lien Term Loan,
8.25%, 11/01/09 ................................. 2,967,454
4,980,000 LBREP/L-Suncal Master I LLC
First Lien, 8.74%, 01/18/10 (b) ................. 5,014,262
389,474 Lion Gables Realty LP
Term Loan, 7.78%, 09/30/06 ...................... 390,136
11,000,000 LNR Property Corp.
Initial Tranche B Term Loan,
8.22%, 07/12/11 ................................. 11,091,740
Morningside Assisted Living
1,996,280 Mezzanine Loan,
12.63%, 10/12/08 ................................ 1,996,280
1,497,210 Senior Mortgage Loan,
8.38%, 10/12/08 ................................. 1,497,210
606,618 MPO Intermediate LLC
Mezzanine Note A-1,
7.12%, 08/09/07 ................................. 606,618
2,493,750 November 2005 Land Investors, LLC
First Lien Term Loan,
8.25%, 05/09/11 ................................. 2,499,984
2,970,000 Palmdale Hills Property LLC
First Lien Term Loan,
8.26%, 05/19/10 ................................. 2,940,300
7,500,000 Rubicon GSA II, LLC (Australia)
Term Loan, 08/30/08 (b) ......................... 7,537,500
Spanish Peaks Holdings LLC
1,061,772 Tranche A Credit-Linked Deposit,
5.40%, 08/10/11 ................................. 1,048,499
2,280,661 Tranche B Term Loan,
7.82%, 08/10/11 ................................. 2,255,004
See accompanying Notes to Financial Statements. | 11
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
HOUSING - REAL ESTATE DEVELOPMENT (CONTINUED)
Tamarack Resort LLC
1,400,000 Tranche A Credit-Linked Deposit,
8.75%, 05/19/11 ................................. 1,400,000
2,094,750 Tranche B Term Loan,
8.75%, 05/19/11 ................................. 2,094,750
5,500,000 TE/TOUSA Mezzanine LLC
Senior Mezzanine Loan,
10.75%, 08/01/09 ................................ 5,513,750
2,000,000 Trustreet Properties, Inc.
Term Loan, 7.40%, 04/08/10 ...................... 2,011,240
Westgate Investments, LLC
16,350,000 Second Lien Term Loan,
07/15/10 (b) .................................... 16,350,000
6,150,000 Senior Secured Loan,
08/03/12 (b) (d) ................................ 6,150,000
4,000,000 Weststate Land Partners LLC
First Lien Term Loan,
8.65%, 05/01/07 ................................. 4,010,000
5,000,000 Woodlands Commercial Properties
Co. LP
Bridge Loan, 8.26%, 02/28/08 .................... 5,006,250
400,000 Woodlands Commercial Property Co.
Secured Term Loan,
7.35%, 08/29/09 ................................. 400,500
1,600,000 Woodlands Land Devolopment Co., LP
Secured Term Loan,
7.35%, 08/29/09 ................................. 1,602,000
950,933 Yellowstone Mountain Club, LLC
Loan, 7.71%, 09/30/10 ........................... 946,578
-------------
106,047,237
-------------
INFORMATION TECHNOLOGY - 4.3%
1,000,000 Aspect Software, Inc.
Second Lien Term Loan,
12.56%, 07/05/12 ................................ 997,500
1,975,000 Billing Services Group North
America, Inc.
U S Term Loan, 8.12%, 05/05/12 .................. 1,977,469
6,000,000 Comsys Information Services
Second Lien Term Loan,
13.04%, 10/31/10 ................................ 6,015,000
1,995,000 Corel Corp. (Canada)
First Lien Term Loan,
8.64%, 02/16/10 ................................. 1,995,000
Data Transmissions Network Corp.
997,500 First Lein Tranche B Term Loan,
8.43%, 03/10/13 ................................. 1,002,487
3,000,000 Second Lien Term Loan,
13.30%, 08/15/13 ................................ 3,015,000
997,490 Deltek Systems, Inc.
Term Loan, 7.75%, 04/22/11 ...................... 1,004,971
GXS Corp.
2,000,000 First Lien Term Loan,
10.41%, 06/20/11 ................................ 1,985,000
2,000,000 Second Lien Term Loan,
10.41%, 12/20/11 ................................ 2,010,000
Infor Enterprise Solutions
Holdings, Inc. (Luxemborg)
3,428,571 Delayed Draw Term Loan,
9.08%, 07/28/12 ................................. 3,456,411
6,571,429 Initial U S Term Facility,
9.08%, 07/28/12 ................................. 6,604,286
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
INFORMATION TECHNOLOGY (CONTINUED)
892,562 Infor Global Solutions European
Finance S.A.R.L. First Lien LUX
Term Loan, 04/18/11 (b) ......................... 903,719
198,347 Infor Global Solutions U S (Magellan
Holdings) First Lien Delayed Draw
Term Loan, 06/30/11 (b) ......................... 199,958
4,364,265 IPC Acquisition Corp.
First Lien Tranche B Term Loan,
8.03%, 08/05/11 ................................. 4,386,086
409,091 Magellan Holdings, Inc.
Second Lien U S Term Loan,
04/18/12 (b) .................................... 410,114
6,392,918 ON Semiconductor Corp.
Term Loan H, 7.75%, 12/15/11 .................... 6,428,846
4,000,000 Open Solutions Inc.
First Lien Term Loan,
7.78%, 09/03/11 ................................. 4,027,520
3,097,701 Per-Se Technologies, Inc.
Term Loan, 7.73%, 01/06/13 ...................... 3,109,318
2,500,000 Secure Computing Corp.
Term Loan, 08/31/13 (b) ......................... 2,500,000
3,875,000 Serena Software, Inc.
Term Loan, 03/11/13 (b) ......................... 3,874,225
15,366,692 SunGard Data Systems, Inc.
U S Term Loan,
8.00%, 02/11/13 (b) ............................. 15,487,013
2,000,000 Transfirst Holdings, Inc.
Second Lien Term Loan,
11.57%, 03/31/13 ................................ 2,020,000
2,541,573 UGS Corp.
Replacement Term Loan,
7.47%, 05/27/11 ................................. 2,544,750
X-Rite, Inc.
1,000,000 First Lien Initial Term Loan,
7.64%, 06/30/12 ................................. 1,007,500
1,000,000 Second Lien Term Loan,
10.39%, 06/30/13 ................................ 1,005,000
-------------
77,967,173
-------------
MANUFACTURING - 2.2%
2,493,750 Aearo Co. (Pacer Holding Co.)
First Lien Term Loan B,
7.96%, 03/24/13 ................................. 2,520,234
1,412,101 AIRXCEL, Inc.
First Lien Term Loan,
8.38%, 08/31/12 ................................. 1,419,162
2,000,000 Brand Services, Inc.
Term Loan, 07/15/12 (b) ......................... 2,002,500
1,333,333 CI Acquisition, Inc.
Term Loan B, 7.56%, 10/17/12 .................... 1,341,667
1,496,974 Coinmach Corp.
Tranche B-1 Term Loan,
7.91%, 12/16/12 ................................. 1,508,680
1,500,000 Dundee Holdco Ltd. (United Kingdom)
U S Term Loan B1,
8.08%, 02/17/14 ................................. 1,503,750
828,947 Euramax International Holdings B.V.
Second Lien European
Term Loan, 12.49%, 06/29/13 ..................... 822,730
Euramax International, Inc.
3,112,360 First Lien Domestic Term Loan,
8.06%, 06/28/12 ................................. 3,136,481
1,671,053 Second Lien Domestic Term Loan,
12.49%, 06/29/13 ................................ 1,682,549
2,000,000 Georgia Gulf Corp.
Term Loan, 09/01/13 (b) ......................... 2,010,500
12 | See accompanying Notes to Financial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
MANUFACTURING (CONTINUED)
Matinvest 2 SAS (Deutsche Connector)
2,250,000 B-2 Facility, 06/22/14 (b) ...................... 2,275,313
2,250,000 C-2 Facility, 06/22/15 (b) ...................... 2,279,520
6,824,475 Mueller Group LLC
Term Loan, 7.51%, 10/03/12 ...................... 6,874,840
3,547,568 Polypore, Inc.
U S Term Loan, 8.33%, 11/12/11 .................. 3,578,609
3,000,000 Quantum Corp.
First Lien Term Loan,
10.40%, 08/22/12 ................................ 3,003,750
3,000,000 Sensata Technology BV/Sensata
Technology Finance Co.
(Netherlands)
U S Term Loan, 7.24%, 04/27/13 .................. 2,984,220
1,000,000 Wire Rope Corp. of America, Inc.
Secured Term Loan, 06/17/11 (b) ................. 1,025,000
-------------
39,969,505
-------------
METALS/MINERALS - OTHER METALS/MINERALS - 1.7%
2,000,000 Aleris International, Inc. (Germany)
U S Loan, 7.88%, 08/01/11 ....................... 2,009,380
2,487,500 Alpha Natural Resources LLC
Tranche B Term Loan,
7.25%, 10/26/12 ................................. 2,485,958
7,500,000 James River Coal Co.
Credit Linked Deposit,
5.35%, 11/30/11 (b) ............................. 7,528,125
5,000,000 Kaiser Aluminum & Chemical
Second Lien Term Loan,
9.70%, 04/24/11 ................................. 5,025,000
9,133,524 Murray Energy Corp.
Tranche B Term Loan,
8.40%, 01/28/10 ................................. 9,224,859
1,345,000 Neo Material Technologies, Inc.
Term Loan, 9.00%, 08/31/09 ...................... 1,350,044
800,000 Oglebay Norton Co.
Tranche B Term Loan,
7.90%, 07/31/12 ................................. 806,000
2,992,500 Universal Buildings Products, Inc.
Term Loan, 8.96%, 04/28/12 ...................... 3,022,425
-------------
31,451,791
-------------
METALS/MINERALS - STEEL - 0.0%
833,333 Standard Steel, LLC
Initial Term Loan,
8.09%, 06/30/12 ................................. 839,583
-------------
RETAIL - 8.1%
Blockbuster Entertainment Corp.
2,059,649 Tranche A Term Loan,
8.64%, 08/20/09 ................................. 2,057,981
37,179,973 Tranche B Term Loan,
9.10%, 08/20/11 ................................. 37,289,281
13,949,975 Burlington Coat Factory
Warehouse Corp.
Term Loan, 7.53%, 05/28/13 (b) .................. 13,641,541
2,955,094 Dollarama Group LP (Canada)
Term Loan B, 7.49%, 11/18/11 .................... 2,964,314
2,493,225 Eddie Bauer, Inc.
Term Loan, 9.58%, 06/21/11 ...................... 2,495,095
26,276,708 Home Interiors & Gifts, Inc.
Initial Term Loan,
10.39%, 03/31/11 ................................ 22,729,352
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
RETAIL (CONTINUED)
1,000,000 HVHC Inc.
Term Loan B, 7.70%, 08/01/13 .................... 1,004,380
895,959 MAPCO Express, Inc./MAPCO
Family Centers, Inc.
Term Loan, 8.20%, 04/28/11 ...................... 903,234
Movie Gallery, Inc.
3,753,135 Term Loan A, 10.50%, 04/27/11 (b) ............... 3,577,226
49,194,625 Term Loan B, 10.75%, 04/27/11 (b) ............... 46,759,491
8,781,646 Neiman Marcus Group, Inc. (The)
Term Loan, 7.77%, 04/06/13 ...................... 8,861,032
1,500,000 Sports Authority, Inc., (The)
Term Loan B, 05/03/13 (b) ....................... 1,499,070
4,000,000 Toys "R" Us
Tranche B Term Loan,
9.64%, 07/19/12 ................................. 4,070,800
-------------
147,852,797
-------------
SERVICE - ENVIRONMENTAL SERVICES - 1.0%
Allied Waste North America, Inc.
2,979,781 Term Loan, 7.23%, 01/15/12 ...................... 2,977,100
380,556 Tranche A Credit Linked Deposit,
5.37%, 01/15/12 ................................. 380,320
3,353,100 Audio Visual Services Corp.
Term Loan, 8.00%, 05/18/11 ...................... 3,369,865
1,509,434 Duratek, Inc.
Term Loan B, 7.76%, 06/07/13 .................... 1,521,691
EnergySolutions, LLC
157,233 Synthetic Letter of Credit,
7.58%, 06/07/13 ................................. 158,509
3,333,333 Term Loan, 7.76%, 09/30/11 ...................... 3,363,200
Safety-Kleen Systems, Inc.
1,322,034 Synthetic Letter of Credit,
08/02/13 (b) .................................... 1,326,159
4,677,966 Term Loan B, 08/02/13 (b) ....................... 4,692,561
-------------
17,789,405
-------------
SERVICE - OTHER SERVICES - 1.9%
2,000,000 Ashtead Group PLC
Term Loan, 08/31/11 (b) ......................... 2,001,240
3,833,333 Brickman Group Holdings, Inc.
Term Loan, 10.52%, 11/15/09 ..................... 3,823,750
10,000,000 Education Management LLC
Tranche B Term Loan,
8.06%, 06/01/13 ................................. 10,059,400
1,297,872 Headwaters, Inc.
First Lien Term Loan B-1,
7.48%, 04/30/11 ................................. 1,304,088
Koosharem Corp.
3,000,000 First Lien Term Loan,
9.83%, 06/30/12 ................................. 2,992,500
1,000,000 Second Lien Term Loan,
15.75%, 06/30/13 ................................ 987,500
La Petite Academy, Inc.
2,631,818 Closing Date Term Loan,
8.33%, 08/16/12 (b) ............................. 2,644,978
1,684,091 Delayed Draw Term Loan,
09/18/06 (b) (c) ................................ 1,692,511
1,000,000 NES Rentals
Second Lien Term Loan,
08/17/10 (b) .................................... 1,010,000
United Rentals, Inc.
5,563,900 Initial Term Loan,
7.33%, 02/14/11 ................................. 5,583,597
3,229,596 Tranche B Credit Linked Deposit,
4.86%, 02/14/11 ................................. 3,229,596
-------------
35,329,160
-------------
See accompanying Notes to Financial Statements. | 13
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
TELECOMMUNICATIONS - 3.4%
10,000,000 Crown Castle Operating Co.
Term Loan, 7.65%, 06/01/14 ...................... 10,066,200
1,000,000 Gabriel Communications Finance Co.
Term Loan B, 10.34%, 05/12/12 ................... 1,005,620
12,000,000 Intelsat Corp.
Tranche B-2 Term Loan,
8.01%, 01/03/14 ................................. 12,091,920
9,000,000 Level 3 Financing, Inc.
Term Loan, 8.41%, 12/01/11 ...................... 9,061,920
1,500,000 Maritime Telecommunications
Network, Inc.
First Lien Term Loan,
8.19%, 04/07/11 ................................. 1,507,500
1,000,000 Millennium New Jersey Holdco, LLC
First Lien B Term Loan, 08/23/12 (b) ............ 1,000,000
PaeTec Communications, Inc.
3,000,000 First Lien Initial Term Loan,
8.88%, 06/12/12 ................................. 3,013,140
1,000,000 Second Lien Term Loan,
12.88%, 06/12/13 ................................ 1,020,000
RCN Corp.
3,500,000 Initial Term Loan,
7.28%, 05/30/13 ................................. 3,500,000
1,060,703 Term Loan, 05/30/13 (b) ......................... 1,060,703
Sorenson Communications, Inc.
2,000,000 Revolver, 08/16/12 (b) .......................... 1,992,360
1,000,000 Second Lien Term Loan,
12.33%, 02/16/14 ................................ 1,011,250
5,000,000 Tranche B Term Loan,
8.33%, 08/16/13 ................................. 5,021,900
3,750,000 Stratos Global Corp./Stratos
Funding LP (Canada)
Term B Facility, 8.25%, 02/13/12 ................ 3,742,950
7,000,000 Windstream Corp.
Tranche B Term Loan,
7.26%, 07/17/13 (b) ............................. 7,039,340
-------------
62,134,803
-------------
TELECOMMUNICATIONS - CLEC - 0.4%
7,875,000 Consolidated Communications, Inc.
Term Loan D, 7.44%, 10/14/11 .................... 7,865,156
-------------
TELECOMMUNICATIONS - DATA/INTERNET - 0.1%
2,000,000 Pine Tree Holdings/Country Road
Communications, Inc.
Second Lien Tranche B
Term Loan, 13.30%, 07/15/13 ..................... 2,030,000
-------------
TELECOMMUNICATIONS - FIBER/LONG DISTANCE - 1.5%
6,500,000 FairPoint Communications, Inc.
Replacement B Term Loan,
7.25%, 02/08/12 (b) ............................. 6,461,390
997,778 Hawaiian Telcom Communications
Tranche B Term Loan,
7.75%, 10/31/12 ................................. 1,001,250
Qwest Corp.
3,000,000 Term Loan B, 6.95%, 06/30/10 .................... 3,041,730
7,000,000 Tranche B Term Loan,
6.95%, 06/30/10 (b) (d) ......................... 7,044,590
WestCom Corp.
8,500,000 Second Lien Term Loan, 12.54%, 06/17/11 ......... 8,558,480
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
TELECOMMUNICATIONS - FIBER/LONG DISTANCE (CONTINUED)
WestCom Corp. (continued)
357,473 Tranche B Term Loan,
8.28%, 12/17/10 ................................. 357,920
-------------
26,465,360
-------------
TRANSPORTATION - AUTO - 6.0%
2,000,000 Avon Automotive
U S Term Loan, 11.25%, 08/11/11 ................. 2,000,000
3,891,897 Carey International, Inc.
Second Lien Term Loan,
17.20%, 05/10/12 ................................ 3,882,167
375,854 Cooper-Standard Automotive (Canada)
Canada Limited
Tranche B Term Loan, 12/23/11 (b) ............... 376,794
Cooper-Standard Automotive Inc.
627,281 Term Loan D, 12/23/11 (b) ....................... 629,890
604,635 Tranche C Term Loan , 12/23/11 (b) .............. 606,146
20,000,000 Dana Corp.
DIP Term Loan, 7.65%, 04/13/08 (b) .............. 20,020,800
Dayco Products LLC - (Mark IV)
1,000,000 Replacement Term B Loan,
8.03%, 06/21/11 ................................. 1,009,790
1,000,000 Second Lien Term Loan,
8.03%, 12/31/11 ................................. 1,025,630
Delphi Corp.
21,903,133 Term Loan, 13.75%, 06/14/11 (b) ................. 22,714,205
1,500,000 Tranche B DIP Term Loan,
8.13%, 10/08/07 ................................. 1,528,740
4,500,000 Environmental Systems Products
Holdings
Second Lien Term Loan,
15.41%, 12/12/10 ................................ 4,590,000
Federal-Mogul Corp.
1,500,000 DIP Term Loan, 7.50%, 12/09/06 .................. 1,505,625
1,457,560 Supplemental Revolver,
9.08%, 12/09/06 (c) ............................. 1,463,025
573,404 Tranche C Term Loan,
9.08%, 12/09/06 ................................. 574,838
2,000,000 Gleason Works (The)
Second Lien Term Loan,
10.97%, 12/30/13 ................................ 2,030,000
4,500,000 Goodyear Tire & Rubber Co.
Third Lien Term Loan,
8.70%, 03/01/11 ................................. 4,556,250
Hayes Lemmerz International, Inc.
3,154,379 Term Loan B, 8.91%, 06/03/09 .................... 3,191,853
1,000,000 Term Loan C, 06/03/10 (b) ....................... 1,012,250
Hertz Corp. (The)
369,899 Delayed Draw Term Loan,
7.70%, 08/15/07 ................................. 372,096
444,444 Letter of Credit, 5.42%, 12/21/12 ............... 447,502
3,170,125 Tranche B Term Loan, 7.68%, 12/21/12 ............ 3,193,647
4,239,130 Insurance Auto Auctions, Inc.
Term Loan, 7.90%, 05/19/12 (c) .................. 4,262,954
Key Plastics LLC
4,409,879 Term Loan B, 8.86%, 06/29/10 .................... 4,451,244
3,263,409 Term Loan C, 11.59%, 06/24/11 (b) ............... 3,240,957
4,000,000 Lear Corp.
First Lien Term Loan B,
7.97%, 04/25/12 ................................. 3,961,760
1,869,981 Navistar International Corp.
Delay Draw Term Loan,
10.49%, 02/22/09 (c) ............................ 1,876,994
1,255,367 Plastech, Inc.
Term Loan B, 10.25%, 03/31/10 ................... 1,230,259
14 | See accompanying Notes to Financial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
TRANSPORTATION - AUTO (CONTINUED)
4,702,887 Tire Rack Holdings, Inc.
Tranche B Term Loan,
7.24%, 06/24/12 ................................. 4,676,457
647,438 United Components, Inc.
Tranche C Term Loan,
7.70%, 06/30/10 ................................. 651,491
8,000,000 Vanguard Car Rental USA Holding, Inc.
Term Loan, 8.32%, 06/14/13 ...................... 8,019,040
-------------
109,102,404
-------------
TRANSPORTATION - LAND - 1.2%
568,435 Ozburn-Hessey Holding Co., LLC
Term Loan, 8.78%, 08/10/12 ...................... 568,435
Quality Distribution, Inc.
2,427,481 Synthetic Letters of Credit,
5.40%, 11/13/09 ................................. 2,439,618
5,626,988 Term Loan, 8.33%, 11/13/09 ...................... 5,655,123
930,457 Term Loan, 8.33%, 11/13/09 (e) .................. 935,109
4,720,848 SIRVA Worldwide, Inc.
Tranche B Term Loan,
11.46%, 12/01/10 ................................ 4,524,178
7,638,246 Transport Industries, LP
Term Loan B, 8.00%, 09/30/11 .................... 7,671,701
-------------
21,794,164
-------------
UTILITIES - 6.0%
2,000,000 ANP Funding I ,LLC
Tranche A Term Loan,
8.98%, 07/29/10 ................................. 2,015,840
Astoria Generating Co.
Acquisitions LLC
751,289 First Lien Term Loan B,
7.45%, 02/23/12 ................................. 754,813
4,500,000 Second Lien Term Loan C,
9.20%, 08/23/13 ................................. 4,554,540
177,665 Term Letter of Credit,
7.45%, 02/23/12 ................................. 178,589
Boston Generating LLC
1,678,891 First Lien Series A Term Advance,
8.75%, 12/15/10 ................................. 1,712,468
95,893 First Lien Series B Term Advance,
8.75%, 09/30/10 ................................. 97,547
234,297 Second Lien Term Loan,
11.80%, 09/30/10 ................................ 246,158
4,874,372 Calpine Construction Finance Co. LP
First Lien Term Loan,
11.40%, 08/26/09 ................................ 5,158,694
Calpine Corp.
3,431,729 First Lien DIP Revolver,
7.75%, 12/20/07 ................................. 3,452,319
14,359,818 Second Lien Term Loan,
07/16/07 (f) .................................... 14,584,119
2,000,000 Calpine Generating Co., LLC
First Priority Term Loan,
04/01/09 (b) .................................... 2,054,640
CenterPoint Energy, Inc.
3,970,000 Term Loan, 7.66%, 04/30/10 ...................... 3,975,399
1,763,585 Term Loan, 7.71%, 04/30/10 ...................... 1,765,983
Coleto Creek Power, LP
6,000,000 Second Lein Term Loan,
06/28/13 (b) .................................... 5,640,000
318,471 Synthetic Facility, 8.26%, 06/28/13 ............. 316,879
4,681,529 Term Loan, 8.20%, 06/28/13 ...................... 4,658,121
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
UTILITIES (CONTINUED)
Covanta Energy Corp.
1,500,000 Delayed Draw Term Loan,
7.75%, 06/30/12 ................................. 1,511,250
1,560,976 Letter of Credit Term Loan,
5.46%, 06/24/12 ................................. 1,514,146
1,118,598 Term Loan, 7.70%, 06/24/12 ...................... 1,126,987
2,000,000 Dynegy Holdings Inc
Term Loan, 7.08%, 01/31/12 ...................... 1,998,760
2,000,000 El Paso Corp.
Deposit Loan, 07/31/11 (b) ...................... 2,011,240
4,000,000 GBGH, LLC (U S Energy)
First Lien Term Loan,
10.94%, 08/07/13 ................................ 4,010,000
KGen, LLC
1,975,000 Tranche A Term Loan,
8.12%, 08/05/11 ................................. 1,975,000
36,217 Tranche B Term Loan,
14.50%, 08/05/11 ................................ 37,213
LSP General Finance Co. LLC
119,545 First Lien Delayed Draw Term Loan,
7.08%, 05/04/13 (c) ............................. 120,143
2,878,788 First Lien Term Loan B,
7.25%, 05/04/13 ................................. 2,875,218
NATG Holdings LLC
72,073 Credit Linked Certificate of Deposit,
01/23/09 (f) .................................... 62,703
126,579 Term Loan A, 01/23/09 (f) ....................... 22,468
92,678 Term Loan B1, 01/23/10 (f) ...................... 16,682
9,144 Term Loan B2, 01/23/10 (f) ...................... 7,955
NRG Energy, Inc.
3,898,925 Credit Linked Certificate of Deposit,
7.50%, 02/02/13 ................................. 3,914,442
17,058,323 Term Loan, 7.33%, 02/01/13 ...................... 17,155,214
4,470,594 Plum Point Energy Associates, LLC
Second Lien Term Loan,
10.75%, 09/14/14 ................................ 4,431,476
4,518,016 Riverside Energy Center LLC
Term Loan, 9.74%, 06/24/11 ...................... 4,642,262
Rocky Mountain Energy Center LLC
361,073 Credit Linked Certificate of Deposit,
5.39%, 06/24/11 ................................. 371,906
3,121,434 Term Loan, 9.74%, 06/24/11 ...................... 3,207,273
TECO Panda Generating Co. -
Gila River Power Station
485,932 Project Letter of Credit, 06/01/12 (b) .......... 561,252
1,332,396 Tranche A Term Loan, 06/01/12 (b) ............... 1,525,593
1,285,370 Tranche B Term Loan, 06/01/20 (b) ............... 1,497,456
31,350 Working Capital, 06/01/12 (b) ................... 36,523
TECO Panda- Union Power Partners, L.P.
141,077 Project Letter of Credit, 06/01/12 (b) .......... 164,355
783,762 Tranche A Term Loan, 06/01/12 (b) ............... 897,408
752,412 Tranche B Term Loan, 06/01/20 (b) ............... 876,559
62,701 Working Capital, 06/01/12 (b) ................... 73,047
Thermal North America, Inc.
500,000 Credit Linked Certificate of Deposit,
7.16%, 10/12/13 ................................. 498,750
1,369,433 Term Loan, 7.25%, 10/12/13 ...................... 1,367,721
-------------
109,677,111
-------------
WIRELESS - CELLULAR/PCS - 3.6%
4,111,181 Centennial Cellular Operating Co.
(Puerto Rico)
Term Loan, 7.69%, 02/09/11 ...................... 4,136,876
38,500,000 Cricket Communications, Inc.
Term B Facility, 8.25%, 06/16/13 ................ 38,856,125
See accompanying Notes to Financial Statements. | 15
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
WIRELESS - CELLULAR/PCS (CONTINUED)
MetroPCS, Inc.
10,850,000 First Lien Tranche B Term Loan,
10.19%, 05/27/11 ................................ 11,121,250
10,800,000 Second Lien Term Loan,
12.94%, 05/27/12 ................................ 11,385,036
-------------
65,499,287
-------------
WIRELESS - WIRELESS INFRASTRUCTURE - 0.2%
1,909,176 CellNet Data Systems, Inc.
First Lien Term Loan B,
8.50%, 04/26/12 ................................. 1,928,268
1,985,000 DPI Holdings, LLC
Term Loan, 7.45%, 09/30/10 ...................... 1,982,519
-------------
3,910,787
-------------
Total Senior Loan Notes
(Cost $2,131,137,213) ......................... 2,140,815,838
-------------
FOREIGN DENOMINATED SENIOR LOAN NOTES (A) - 6.9%
DENMARK - 0.5%
EUR
Nordic Telephone Co. Holdings APS
3,750,000 Euro Facility B2, 5.54%, 04/10/14 ............... 4,853,562
3,750,000 Euro Facility C2, 5.54%, 04/10/15 ............... 4,859,611
-------------
9,713,173
-------------
FRANCE - 0.8%
EUR
Ypso Holding SA
2,106,147 Eur B (Acq) 1 Facility,
5.61%, 06/15/14 ................................. 2,674,080
3,436,345 Eur B (Acq) 2 Facility,
5.61%, 06/15/14 ................................. 4,362,973
5,457,508 Eur B (Recap) 1 Facility,
5.61%, 06/15/14 ................................. 6,929,153
-------------
13,966,206
-------------
GERMANY - 1.2%
EUR
16,900,000 P7S1 Holding II S.a.r.L - GMP
Facility B, 7.07%, 07/08/11 ..................... 21,599,083
-------------
ITALY - 0.9%
EUR
Prysmian Cables & Systems, Inc.
3,461,538 Second Lien Term Loan,
9.94%, 01/20/15 ................................. 4,547,252
875,000 Euro Term Loan B,
5.57%, 08/04/12 ................................. 1,127,458
875,000 Euro Term Loan C2,
5.57%, 08/04/12 ................................. 1,128,679
1,038,462 Second Lien Tranche C Term Loan,
9.94%, 01/20/15 ................................. 1,364,175
Wind Telecomunicazione S.p.A.
3,500,000 A1 Term Loan Facility,
5.38%, 05/26/12 ................................. 4,476,140
1,750,000 B1 Term Loan Facility,
5.63%, 05/26/13 ................................. 2,250,122
1,750,000 C1 Term Loan Facility,
5.63%, 05/26/14 ................................. 2,254,781
-------------
17,148,607
-------------
SWITZERLAND - 0.1%
EUR
1,262,063 Merisant Co.
Tranche A (Euro) Term Loan,
6.40%, 01/11/09 ................................. 1,565,018
-------------
UNITED KINGDOM - 3.4%
GBP
1,275,000 Eggborough Power Ltd.
Term Loan, 03/31/22 (b) (d) ..................... 8,112,445
926,518 Invensys International Holdings Ltd.
GBP Bonding Facility B,
7.04%, 12/15/10 ................................. 1,777,799
NTL Inc.
3,000,000 A Facility, 03/03/11 (b) ........................ 5,625,998
1,383,227 B1 Facility, 01/10/13 (b) ....................... 2,627,847
1,616,773 B2 Facility, 09/03/12 (b) ....................... 3,071,552
1,750,000 NTL Investment Holdings Ltd.
GBP Tranche C Term Loan,
7.64%, 03/03/13 ................................. 3,349,573
Peacock Group (The)
2,250,000 Facility B, 7.33%, 10/30/13 ..................... 4,306,593
2,250,000 Facility C, 7.33%, 10/30/14 ..................... 4,306,593
3,022,959 PlayPower, Inc.
Add-on Term Loan,
7.75%, 12/18/09 ................................. 5,750,131
Safety-Kleen JPMP SK Holdings Ltd.
1,350,000 GBP Term Loan B1,
7.32%, 12/14/12 ................................. 2,577,536
1,817,400 Euro Term Loan C,
6.23%, 12/20/14 ................................. 2,364,165
1,392,327 SunGard U K Holdings Ltd.
U K Term Loan, 7.22%, 02/11/13 .................. 2,674,903
2,824,639 Teesside Power Ltd.
Term Loan, 5.51%, 04/01/08 ...................... 5,446,773
Trinitybrook PLC
2,500,000 Term Loan B1, 7.66%, 07/31/13 ................... 4,766,986
2,500,000 Term Loan C1, 7.66%, 07/31/14 ................... 4,785,817
-------------
61,544,711
-------------
Total Foreign Denominated
Senior Loan Notes
(Cost $121,444,606) ........................... 125,536,798
-------------
SHARES
-------
COMMON STOCKS (G) - 1.5%
TELECOMMUNICATIONS - 0.0%
2,167 Eningen Realty (h) ............................... 0
-------------
UTILITIES - 1.3%
4,569 EBG Holding LLC .................................. 1,258,760
780,934 Mirant Corp. ..................................... 22,623,650
40,800 NATG Holdings LLC (h) ............................ 0
-------------
23,882,410
-------------
WIRELESS - CELLULAR/PCS - 0.2%
76,137 Leap Wireless International, Inc. ................ 3,522,098
-------------
Total Common Stocks
(Cost $23,076,316) .............................. 27,404,508
-------------
16 | See accompanying Notes to Financial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
PRINCIPAL AMOUNT ($) VALUE ($)
- ------------------- ---------
PREFERRED STOCK - 0.0%
MANUFACTURING - 0.0%
14,382 Superior Telecom, Inc., Series A ................. 11,506
-------------
Total Preferred Stock
(Cost $14,382) ................................ 11,506
-------------
UNITS
-------
WARRANTS (G) (H) - 0.0%
GAMING/LEISURE - GAMING - 0.0%
10 OpBiz LLC, expires 08/31/10 (h) .................. 0
32,173 OpBiz LLC, expires 08/31/10 (h) .................. 0
-------------
0
-------------
Total Warrants
(Cost $0) ..................................... 0
-------------
CLAIMS (I) - 0.0%
UTILITIES - 0.0%
18,500,000 Mirant Corp. ..................................... 231,250
-------------
Total Claims
(Cost $2) ....................................... 231,250
-------------
TOTAL INVESTMENTS - 125.8% ..................................... 2,293,999,900
-------------
(cost of $2,275,672,519) (j)
OTHER ASSETS & LIABILITIES, NET - (25.8)% ...................... (469,787,410)
-------------
NET ASSETS - 100.0% ............................................ 1,824,212,490
==============
- ------------------
(a) Senior loans in which the Portfolio invests generally pay interest at
rates which are periodically predetermined by reference to a base lending
rate plus a premium. (Unless otherwise identified by footnote (d), 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") or (iii) the certificate of
deposit rate. Rate shown represents the weighted average rate at August
31, 2006. 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 loans 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 actua
(b) All or a portion of these positions have not settled. Contract rates do
not take effect until settlement date.
(c) Senior Loan Notes have additional unfunded loan commitments. See Note 9.
(d) Fixed rate senior loans or corporate notes.
(e) Loan held on participation.
(f) These issuers are in default of certain debt covenants. Income is not
being accrued.
(g) Non-income producing security.
(h) Represents fair value as determined in good faith under the direction of
the Board of Trustees.
(i) Security is the result of company restructuring that will be converted
into equity upon the completion of court proceedings.
(j) Cost for Federal income tax purposes is $2,276,511,533.
CLEC Competitive Local Exchange Carrier
DIP Debtor in Possession
EUR Euro Currency
GBP Great Britain Pound
FOREIGN DENOMINATED SENIOR LOAN NOTES
INDUSTRY CONCENTRATION TABLE
(% of Total Net Assets)
Cable - International Cable ......... 1.6%
Broadcasting ........................ 1.2%
Retail .............................. 1.0%
Telecommunications .................. 1.0%
Manufacturing ....................... 0.9%
Utilities ........................... 0.7%
Service ............................. 0.3%
Food/Tobacco - Beverages & Bottling . 0.1%
Information Technology .............. 0.1%
-----
Total ............................... 6.9%
=====
See accompanying Notes to Financial Statements. | 17
STATEMENT OF ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
($)
- ------------------------------------------------------------------------------------------------------------------------
ASSETS:
Investments:
Investments, at value (Cost $2,275,672,519) ...................................................... 2,293,999,900
Cash ............................................................................................. 79,760,757
Foreign currency (Cost $16,356,042) .............................................................. 16,615,318
Receivable for:
Investments sold .............................................................................. 17,539,213
Fund shares sold .............................................................................. 16,299,206
Dividend, interest and fees ................................................................... 22,544,719
Other assets ..................................................................................... 79,017
---------------
Total assets 2,446,838,130
LIABILITIES:
Notes payable .................................................................................... 335,000,000
Deferred facility fees (Note 2) ............................................................... 6,038
Net discount and unrealized appreciation on unfunded transactions (Note 9) ....................... 379,952
Payable for:
Investments purchased ......................................................................... 283,665,091
Distributions ................................................................................. 8,108
Investment advisory fee (Note 4) .............................................................. 644,940
Administration fee (Note 4) ................................................................... 329,980
Trustees' fees (Note 4) ....................................................................... 16,667
Distribution and service fees (Note 4) ........................................................ 850,593
Interest expense (Note 8) ..................................................................... 1,260,333
Accrued expenses and other liabilities ........................................................... 463,938
---------------
Total liabilities .......................................................................... 622,625,640
---------------
NET ASSETS .......................................................................................... 1,824,212,490
===============
COMPOSITION OF NET ASSETS
Paid-in capital .................................................................................. 1,788,387,980
Undistributed net investment income .............................................................. 6,424,519
Accumulated net realized gain on investments and foreign currency transactions ................... 11,343,655
Net unrealized appreciation on investments, unfunded transactions and translation of assets
and liabilities denominated in foreign currency ............................................... 18,056,336
---------------
NET ASSETS .......................................................................................... 1,824,212,490
===============
CLASS A
Net assets ....................................................................................... 729,844,934
Shares outstanding (unlimited authorization) ..................................................... 58,702,842
Net asset value per share (Net assets/Shares outstanding) ....................................... 12.43(a)
Maximum offering price per share (100 / 96.50 of $12.43) ......................................... 12.88(b)
CLASS B
Net assets ....................................................................................... 115,651,389
Shares outstanding (unlimited authorization) ..................................................... 9,301,911
Net asset value and offering price per share (Net assets/Shares outstanding) .................... 12.43(a)
CLASS C
Net assets ....................................................................................... 816,720,050
Shares outstanding (unlimited authorization) ..................................................... 65,681,591
Net asset value and offering price per share (Net assets/Shares outstanding) .................... 12.43(a)
CLASS Z
Net assets ....................................................................................... 161,996,117
Shares outstanding (unlimited shares authorized) ................................................. 13,030,548
Net asset value, offering and redemption price per share (Net assets/Shares outstanding) ......... 12.43
<FN>
- ----------------------------------------------------
(a) Redemption price per share is equal to net asset value less any applicable contingent deferred sales charge.
(b) On sales of $100,000 or more, the offering price is reduced.
</FN>
18 | See accompanying Notes to Financial Statements.
STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
($)
- ------------------------------------------------------------------------------------------------------------------------
INVESTMENT INCOME
Interest ......................................................................................... 129,133,988
Dividends ........................................................................................ 1,366
Facility and other fees .......................................................................... 41,980
--------------
Total investment income .................................................................... 129,177,334
EXPENSES
Investment advisory fee (Note 4) ................................................................. 4,837,673
Administration fee (Note 4) ...................................................................... 3,094,941
Accounting services fee .......................................................................... 435,915
Distribution fee: (Note 4)
Class A ....................................................................................... 515,422
Class B ....................................................................................... 548,452
Class C ....................................................................................... 3,373,835
Service fee: (Note 4)
Class A ....................................................................................... 1,288,555
Class B ....................................................................................... 304,696
Class C ....................................................................................... 1,405,764
Transfer agent fee ............................................................................... 810,648
Professional fees ................................................................................ 168,680
Trustees' fees (Note 4) .......................................................................... 109,808
Custody fee ...................................................................................... 190,504
Registration fees ................................................................................ 166,163
Reports to shareholders .......................................................................... 262,546
Other expenses ................................................................................... 452,853
--------------
Total operating expenses ................................................................... 17,966,455
Interest expense (Note 8) ........................................................................ 12,039,609
Facility expense ................................................................................. 1,449,370
--------------
Total expenses ............................................................................. 31,455,434
Fees and expenses waived or reimbursed by Investment Adviser (Note 4) ............................ (540,214)
--------------
Net expenses ............................................................................... 30,915,220
--------------
Net investment income ............................................................................ 98,262,114
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS
Net realized gain on investments ................................................................. 15,433,323
Net realized gain on foreign currency transactions ............................................... 4,094,515
Net change in unrealized appreciation on investments ............................................. 3,786,790
Net change in unrealized depreciation on unfunded transactions (Note 9) .......................... (129,185)
Net change in unrealized depreciation on translation of assets and liabilities denominated
in foreign currency ............................................................................ (498,079)
--------------
Net realized and unrealized gain ................................................................. 22,687,364
--------------
Net increase in net assets from operations ....................................................... 120,949,478
==============
See accompanying Notes to Financial Statements. | 19
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
HIGHLAND FLOATING RATE ADVANTAGE FUND
YEARS ENDED AUGUST 31,
2006 2005
($) ($)
----------------- --------------
INCREASE IN NET ASSETS:
OPERATIONS
Net investment income ......................................................... 98,262,114 43,218,962
Net realized gain on investments and foreign currency transactions ............ 19,527,838 447,820
Net change in unrealized appreciation (depreciation) on investments, unfunded
transactions and translation of assets and liabilities denominated in
foreign currency ........................................................... 3,159,526 7,240,459
----------------- ----------------
Net increase from operations ............................................... 120,949,478 50,907,241
----------------- ----------------
TRANSACTIONS IN INVESTOR'S BENEFICIAL INTEREST
DISTRIBUTIONS DECLARED TO SHAREHOLDERS From net investment income:
Class A .................................................................... (39,595,036) (15,863,369)
Class B .................................................................... (8,837,518) (6,648,815)
Class C .................................................................... (40,413,435) (16,600,896)
Class Z .................................................................... (8,134,869) (4,020,231)
----------------- ----------------
Total distributions from net investment income ............................. (96,980,858) (43,133,311)
----------------- ----------------
SHARE TRANSACTIONS
Class A
Subscriptions .............................................................. 509,092,824 209,578,268
Distributions reinvested ................................................... 26,150,996 10,245,197
Redemptions ................................................................ (166,364,386) (83,335,719)
----------------- ----------------
Net increase ............................................................... 368,879,434 136,487,746
Class B
Subscriptions .............................................................. 789 10,362,773
Distributions reinvested ................................................... 5,382,976 4,017,411
Redemptions ................................................................ (16,695,298) (15,567,850)
----------------- --------------
Net decrease ............................................................... (11,311,533) (1,187,666)
Class C
Subscriptions .............................................................. 471,122,036 167,261,240
Distributions reinvested ................................................... 27,967,790 11,115,461
Redemptions ................................................................ (84,176,434) (68,853,512)
----------------- ----------------
Net increase ............................................................... 414,913,392 109,523,189
Class Z
Subscriptions .............................................................. 115,875,101 40,633,785
Distributions reinvested ................................................... 4,884,669 1,870,278
Redemptions ................................................................ (35,802,179) (20,870,623)
----------------- ----------------
Net increase ............................................................... 84,957,591 21,633,440
----------------- ----------------
Net increase from share transactions ....................................... 857,438,884 266,456,709
----------------- ----------------
Total increase in net assets ............................................... 881,407,504 274,230,639
NET ASSETS
Beginning of period ........................................................... 942,804,986 668,574,347
End of period (including undistributed net investment income of $6,424,519 and
$285,027, respectively) ................................................ 1,824,212,490 942,804,986
================= ================
20 | See accompanying Notes to Financial Statements.
STATEMENTS OF CHANGES IN NET ASSETS (CONTINUED)
- --------------------------------------------------------------------------------
HIGHLAND FLOATING RATE ADVANTAGE FUND
YEARS ENDED AUGUST 31,
2006 2005
($) ($)
----------------- --------------
CHANGE IN SHARES
Class A
Subscriptions .............................................................. 41,216,188 17,322,296
Issued for distributions reinvested ........................................ 2,115,861 846,869
Redemptions ................................................................ (13,476,164) (6,887,056)
----------------- ----------------
Net increase ............................................................... 29,855,885 11,282,109
Class B
Subscriptions .............................................................. 63 855,878
Issued for distributions reinvested ........................................ 436,133 332,132
Redemptions ................................................................ (1,350,004) (1,285,093)
----------------- ----------------
Net decrease ............................................................... (913,808) (97,083)
Class C
Subscriptions .............................................................. 38,110,054 13,815,400
Issued for distributions reinvested ........................................ 2,261,974 918,787
Redemptions ................................................................ (6,809,203) (5,686,448)
----------------- ----------------
Net increase ............................................................... 33,562,825 9,047,739
Class Z
Subscriptions .............................................................. 9,364,415 3,359,211
Issued for distributions reinvested ........................................ 395,086 154,587
Redemptions ................................................................ (2,907,290) (1,726,328)
----------------- ----------------
Net increase ............................................................... 6,852,211 1,787,470
See accompanying Notes to Financial Statements. | 21
STATMENT OF CASH FLOWS
- --------------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
($)
- ------------------------------------------------------------------------------------------------------------------------
CASH FLOWS USED FOR OPERATING ACTIVITIES
Net investment income ............................................................................ 98,262,113
ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TONET CASH USED FOR OPERATING ACTIVITIES
Purchase of investments securities ............................................................... (2,053,386,509)
Proceeds from disposition of investment securities ............................................... 937,171,158
Increase in dividends, interest and fees receivable .............................................. (14,854,043)
Increase in receivable for investments sold ...................................................... (9,704,865)
Decrease in other assets ......................................................................... 64,799
Decrease in deferred facility fees ............................................................... (36,337)
Net amortization of premium (discount) ........................................................... (1,501,009)
Increase in payable for investments purchased .................................................... 201,321,555
Increase in payables to related parties .......................................................... 675,656
Increase in mark-to-market on realized and unrealized gain (loss) on foreign currency ............ 3,596,436
Increase in other liabilities .................................................................... 1,377,742
---------------
Net cash and foreign currency flow from operating activities ............................... (837,013,304)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Increase in notes payable ........................................................................ 85,000,000
Decrease in interest payable ..................................................................... (658,438)
Proceeds from shares sold ........................................................................ 1,089,485,950
Payment of shares redeemed ....................................................................... (303,038,297)
Distributions paid in cash ....................................................................... (34,214,479)
---------------
Net cash flow provided by financing activities ............................................. 836,574,736
---------------
Net decrease in cash and foreign currency .................................................. (438,568)
CASH AND FOREIGN CURRENCY
Beginning of the period .......................................................................... 96,814,643
---------------
End of the period ................................................................................ 96,376,075
===============
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 A SHARES 2006 2005 2004 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING
OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.96 0.67 0.56 0.81 0.83(b)
Net realized and unrealized gain (loss)
on investments(a) 0.22 0.11 0.89 0.74 (1.26)(b)
-------- -------- -------- -------- --------
Total from investment operations 1.18 0.78 1.45 1.55 (0.43)
- -----------------------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.94) (0.67) (0.59) (0.81) (0.83)
From net realized gains -- -- -- -- --
-------- -------- -------- -------- --------
Total distributions declared to shareholders (0.94) (0.67) (0.59) (0.81) (0.83)
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 12.43 $ 12.19 $ 12.08 $ 11.22 $ 10.48
Total return(c) 10.08% 6.56%(d) 13.14% 15.55% 3.88)%
- -----------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Operating expenses 1.12% 1.28% 1.29%(e) 1.38%(e) 1.38%(e)
Interest and facility expenses 1.04% 0.72% 0.40% 0.73% 0.99%
Net expenses(f) 2.16% 2.00% 1.69%(e) 2.11%(e) 2.37%(e)
Net investment income 7.78% 5.60% 4.73%(e) 7.67%(e) 7.25%(b)(e)
Waiver/reimbursement 0.04% 0.10% 0.18% 0.36% 0.32%
Portfolio turnover rate 61% 85% 110% 90% 98%
Net assets, end of period (000's) $729,845 $351,557 $212,205 $ 85,166 $ 69,733
<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) Total return is at net asset value assuming all distributions reinvested
and no initial sales charge or CDSC. Had the Fund's investment adviser not
waived or reimbursed a portion of expenses, total return would have been
reduced.
(d) Total return is calculated using the Net Asset Value used for trading at
the close of business on August 31, 2005.
(e) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
(f) Net expense ratio has been calculated after applying any
waiver/reimbursement.
</FN>
See accompanying Notes to Financial Statements. | 23
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 2006 2005 2004 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING
OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.92 0.63 0.53 0.78 0.78(b)
Net realized and unrealized gain (loss)
on investments(a) 0.22 0.11 0.88 0.73 (1.25)(b)
-------- -------- -------- -------- --------
Total from investment operations 1.14 0.74 1.41 1.51 (0.47)
- ------------------------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.90) (0.63) (0.55) (0.77) (0.79)
From net realized gains -- -- -- -- --
-------- -------- -------- -------- --------
Total distributions declared to
shareholders (0.90) (0.63) (0.55) (0.77) (0.79)
- ------------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 12.43 $ 12.19 $ 12.08 $ 11.22 $ 10.48
Total return(c) 9.70% 6.19%(d) 12.75% 15.16% (4.22)%
- ------------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Operating expenses 1.47% 1.63% 1.64%(e) 1.73%(e) 1.73%(e)
Interest and facility expenses 1.04% 0.72% 0.40% 0.73% 0.99%
Net expenses(f) 2.51% 2.35% 2.04%(e) 2.46%(e) 2.72%(e)
Net investment income 7.43% 5.25% 4.50%(e) 7.34%(e) 6.90%(b)(e)
Waiver/reimbursement 0.04% 0.10% 0.18% 0.36% 0.32%
Portfolio turnover rate 61% 85% 110% 90% 98%
Net assets, end of period (000's) $115,651 $124,500 $124,589 $ 76,379 $ 68,157
<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) Total return is at net asset value assuming all distributions reinvested
and no CDSC. Had the Fund's investment adviser not waived or reimbursed a
portion of expenses, total return would have been reduced.
(d) Total return is calculated using the Net Asset Value used for trading at
the close of business on August 31, 2005.
(e) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
(f) Net expense ratio has been calculated after applying any
waiver/reimbursement.
</FN>
24 | 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 2006 2005 2004 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING
F PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.90 0.61 0.50 0.76 0.76(b)
Net realized and unrealized gain (loss)
on investments(a) 0.22 0.11 0.89 0.74 (1.25)(b)
-------- -------- -------- -------- --------
Total from investment operations 1.12 0.72 1.39 1.50 (0.49)
- ------------------------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.88) (0.61) (0.53) (0.76) (0.77)
From net realized gains -- -- -- -- --
-------- -------- -------- -------- --------
Total distributions declared to
shareholders (0.88) (0.61) (0.53) (0.76) (0.77)
- ------------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 12.43 $ 12.19 $ 12.08 $ 11.22 $ 10.48
Total return(c) 9.62% 6.03%(d) 12.57% 14.99% (4.36)%
- ------------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Operating expenses 1.62% 1.78% 1.79%(e) 1.88%(e) 1.88%(e)
Interest and facility expenses 1.04% 0.72% 0.40% 0.73% 0.99%
Net expenses(f) 2.66% 2.50% 2.19%(e) 2.61%(e) 2.87%(e)
Net investment income 7.28% 5.10% 4.19%(e) 7.14%(e) 6.75%(b)(e)
Waiver/reimbursement 0.04% 0.10% 0.18% 0.36% 0.32%
Portfolio turnover rate 61% 85% 110% 90% 98%
Net assets, end of period (000's) $816,720 $391,455 $278,731 $ 80,572 $ 61,811
<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) Total return is at net asset value assuming all distributions reinvested
and no CDSC. Had the Fund's investment adviser not waived or reimbursed a
portion of expenses, total return would have been reduced.
(d) Total return is calculated using the Net Asset Value used for trading at
the close of business on August 31, 2005.
(e) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
(f) Net expense ratio has been calculated after applying any
waiver/reimbursement.
</FN>
See accompanying Notes to Financial Statements. | 25
FINANCIAL 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 2006 2005 2004 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING
OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 1.00 0.71 0.59 0.78 0.86(b)
Net realized and unrealized gain (loss)
on investments(a) 0.22 0.11 0.90 0.81 (1.25)(b)
-------- -------- -------- -------- --------
Total from investment operations 1.22 0.82 1.49 1.59 (0.39)
- ------------------------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.98) (0.71) (0.63) (0.85) (0.87)
From net realized gains -- -- -- -- --
-------- -------- -------- -------- --------
Total distributions declared
to shareholders (0.98) (0.71) (0.63) (0.85) (0.87)
- ------------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 12.43 $ 12.19 $ 12.08 $ 11.22 $ 10.48
Total return(c) 10.47% 6.93%(d) 13.52% 15.95% (3.53)%
- ------------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Operating expenses 0.77% 0.93% 0.94%(e) 1.03%(e) 1.03%(e)
Interest and facility expenses 1.04% 0.72% 0.40% 0.73% 0.99%
Net expenses(f) 1.81% 1.65% 1.34%(e) 1.76%(e) 2.02%(e)
Net investment income 8.13% 5.95% 4.93%(e) 7.21%(e) 7.60%(b)(e)
Waiver/reimbursement 0.04% 0.10% 0.18% 0.36% 0.32%
Portfolio turnover rate 61% 85% 110% 90% 98%
Net assets, end of period (000's) $161,996 $ 75,293 $ 53,049 $ 5,178 $ 140
<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) Total return is at net asset value assuming all distributions reinvested.
Had the Fund's investment adviser not waived or reimbursed a portion of
expenses, total return would have been reduced.
(d) Total return is calculated using the Net Asset Value used for trading at
the close of business on August 31, 2005.
(e) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
(f) Net expense ratio has been calculated after applying any
waiver/reimbursement.
</FN>
26 | See accompanying Notes toFinancial Statements.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
AUGUST 31, 2006 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 OBJECTIVE
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, although 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 and greater 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 the 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. Securities without a sale price or bid and
ask quotations on the valuation day will be priced by an independent pricing
service. 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 be-tween the
most recently quoted bid and asked prices from principal market makers. 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 in good faith by the Investment Adviser in accordance
with procedures established by the Fund's Board of Trustees. In these cases, the
Fund's net asset value will reflect the affected portfolio securities' value as
determined in the judgment of the Board of Trustees or its designee instead of
being determined by the market. 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. Costs 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 from the effects of changes in
market prices of those securities, but are included with the net real-
Annual Report | 27
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
ized 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 April 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 and gains, 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.
ADDITIONAL ACCOUNTING STANDARDS
On July 13, 2006, the Financial Accounting Standards Board (FASB) released FASB
Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" ("FIN 48").
FIN 48 provides guidance for how uncertain tax positions should be recognized,
measured, presented and disclosed in the financial statements. FIN 48 requires
the evaluation of tax positions taken in the course of preparing the Fund's tax
returns to determine whether the tax positions are "more-likely-than-not" of
being sustained by the applicable tax authority. Tax benefits of positions not
deemed to meet the more-likely-than-not threshold would be booked as a tax
expense in the current year and recognized as: a liability for unrecognized tax
benefits; a reduction of an income tax refund receivable; a reduction of
deferred tax asset; an increase in deferred tax liability; or a combination
thereof. Adoption of FIN 48 is required for fiscal years beginning after
December 15, 2006. At this time, management is evaluating the implications of
FIN 48 and its impact in the financial statements has not been determined.
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, 2006, permanent differences resulting primarily
from differing treatments for discount accretion/premium amortization on debt
securities, bond bifurcation, and Section 988 gain (loss) were identified and
reclassified among the components of the Fund's net assets as follows:
- --------------------------------------------------------------------------------
Overdistributed Accumulated Net
Net Investment Realized Gain
Income (Loss)
- --------------------------------------------------------------------------------
$4,858,236 $(4,858,236)
- --------------------------------------------------------------------------------
The tax character of distributions paid during the years ended August 31, 2006
and August 31, 2005 was as follows:
28 | Annual Report
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
2006 2005
- ------------------------------------------------------------
Distributions paid from:
Ordinary income* $96,980,858 $43,133,311
- ------------------------------------------------------------
Long-term capital gains -- --
*For tax purposes, short-term capital gains distributions, if any, are
considered ordinary income distributions.
As of August 31, 2006, the most recent tax year end, the components of
distributable earnings on a tax basis were as follows:
- -----------------------------------------------------------
Undistributed Undistributed
Ordinary Long-Term Net Unrealized
Income Capital Gains Appreciation*
- -----------------------------------------------------------
$22,490,899 $193,580 $17,274,021
- -----------------------------------------------------------
*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, 2006, 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 $20,981,728
Unrealized depreciation (3,493,361)
------------
Net unrealized appreciation $17,488,367
============
- --------------------------------------------------------------
NOTE 4. ADVISORY, ADMINISTRATION, SERVICE AND
DISTRIBUTION, TRUSTEE, AND OTHER FEES
INVESTMENT ADVISORY FEE
Highland Capital Management, L.P. ("Highland" or the "Investment Adviser") is
the investment adviser to the Fund. The Fund is accruing a monthly investment
advisory fee based on the Fund's average daily net assets at the following
annual rates:
- ---------------------------------------------------------
Average Daily Net Assets Annual Fee Rate
First $1billion 0.45%
- ---------------------------------------------------------
Next $1 billion 0.40%
- ---------------------------------------------------------
Over $2 billion 0.35%
- ---------------------------------------------------------
For the year ended August 31, 2006, the Portfolio's effective investment
advisory fee rate was 0.37%.
On July 28, 2006, the excess Investment Advisory Fees held in escrow as a result
of the differing calculation methodologies (discussed below) was released to the
Fund in the amount of $1,572,491. Of this amount, $708,952 and $863,539
pertained to the pertained to the current and prior fiscal years, respectively.
The impact of the current year release to the investment advisory fee for the
year ended August 31, 2006 was as follows:
Calculated Investment Advisory Fee $ 6,410,164
Release of Escrow, Current Year Advisory Fee 708,952
-------------
Net Investment Advisory Fee $ 5,701,212
=============
Without the impact of the release of the escrowed amounts attributable to the
prior fiscal year, the Fund's effective advisory fee, for the year ended August
31, 2006 was 0.44%.
On April 9, 2004, Columbia Management Advisors, Inc. ("Columbia") and Highland
entered into an agreement to sell certain of the assets of Columbia's bank loan
asset management group to Highland. Upon completion of the sale on April 15,
2004, the advisory agreement between Columbia and the Fund terminated because
such sale effected an "assignment" (as defined in the1940 Act), and an interim
advisory agreement between Highland and the Fund took effect. At a meeting held
on March 29, 2004, the prior board of trustees of the Fund, approved by an
unanimous vote of the Trustees present, (i) the interim advisory agreement to
take effect on April 15, 2004 and (ii) the agreement that is currently in effect
between the Fund and Highland (the "Current Advisory Agreement"), subject to
shareholder approval. On July 30, 2004 the shareholders of the Fund approved the
Current Advisory Agreement with Highland and it became effective immediately
after such approval. Due to a drafting error, the detailed description of the
advisory fee in the proxy statement and the form of the Current Advisory
Agreement submitted to shareholders in 2004 and signed by the parties described
an advisory fee calculation methodology based on average daily net rather than
managed assets that would result in Highland's receiving a lower advisory fee
than that believed approved by the prior trustees and actually calculated and
paid to Highland since the adoption of the Current Advisory Agreement. The only
difference between the two methodologies is that the intended advisory fee would
have been charged against managed assets rather than net assets. Because the
Fund borrows to seek to enhance its returns, Highland's fee computed on the
basis of average daily managed assets would be higher than the fee computed on
the basis of average daily net assets and thus Highland may have an economic
incentive to incur more leverage in order to maximize its compensation.
In view of the time and resources it would take to obtain a judicial ruling
regarding retroactive approval of the correction under the 1940 Act, Highland
resolved to release the fee differential to the Fund and recommend that the
Board approve and submit to shareholders a new advisory agreement that would
make certain changes to the way that the advisory fee is calculated. Inasmuch as
the proxy disclosure presented to shareholders in 2004 as to the precise rate of
the advisory fee to be paid by the Fund was inconsistent with the intention of
the prior board, Highland proposed
Annual Report | 29
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
that the current Board approve a correction to the advisory fee calculation
methodology to indicate that advisory fees are calculated based on average daily
managed assets rather than average daily net assets. Additionally, in light of
the excellent performance of the Fund during the period Highland has served as
the investment adviser and in view of the fact that the advisory/management fee
for the Fund is substantially below the average of the Fund's Lipper peer group,
Highland also proposed that the Board approve an increase in the advisory fee.
At an in-person Board meeting held on May 19, 2006, the current Board, including
the members of the Board who are not "interested persons" (as defined in the
1940 Act) of the Fund (the "Independent Trustees"), unanimously approved both
the continuation of the Current Advisory Agreement and a new advisory agreement
between the Fund and Highland that would include the terms that Highland
proposed (the "New Advisory Agreement") to be submitted to shareholders.
ADMINISTRATION FEES
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"). Highland pays
PFPC directly for these fees.
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, 2006, the Distributor received $252,263, $184,683 and $113,445 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
Prior to June 12, 2006, Highland had 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) exceeded 0.15% annually of the Fund's average daily net
assets. This arrangement may be reinstated by Highland at any time.
FEES PAID TO OFFICERS AND TRUSTEES
The Fund pays no compensation to its one "Interested Trustee" or any of its
other officers, all of whom are employees of Highland.
The Fund pays the Independent Trustees 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, 2006, the cost of purchases and proceeds from
sales of securities, excluding short-term obligations, were $2,053,386,509 and
$937,171,158, 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 the Fund's net asset value ("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 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 New York Stock Exchange 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, 2006, there were four Repurchase Offers. For each
Repurchase Offer, the Fund offered to repurchase 10% of its shares. In the
November 2005, February 2006, May 2006 and August 2006 Repurchase Offers, 8.38%,
5.00%, 4.24% and 3.79%, 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
30 | Annual Report
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE FUND
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, 2006, 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
- ------------------------------------------------------------
CS:
Quality Distributions, Inc.
Term Loan $930,457 $935,109
NOTE 8. LOAN AGREEMENT
Effective October 18, 2004, and amended on November 14, 2005, the Fund entered
into a $400,000,000 secured loan agreement with Citicorp North America, Inc.
("Citicorp") replacing a previous agreement.
At August 31, 2006, the Fund had one term loan outstanding with Citicorp,
totaling $335,000,000. The interest rate charged on this loan at August 31, 2006
was 5.40%. The average daily loan balance was $255,383,562 at weighted average
interest rate of 4.57%. The Fund was required to maintain certain asset coverage
with respect to the loan. Interest expense of $12,039,609 is included on the
Statement of Operations.
The Fund is required to maintain 300% asset coverage with respect to amounts
outstanding under the agreement. The loan agreement asset coverage is calculated
by subtracting the Fund's total liabilities, not including any bank loans and
senior securities, from the Fund's total net assets and dividing such amount by
the principal amount of the debt outstanding and is as follows:
- --------------------------------------------------------------------------
Asset
Coverage per
$1,000 of
Total Amount Outstanding
Date Indebtedness
- --------------------------------------------------------------------------
08/31/2006 $335,000,000 $7,292
- --------------------------------------------------------------------------
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
9. UNFUNDED LOAN COMMITMENTS
As of August 31, 2006, the Portfolio had unfunded loan commitments of
$40,783,562, which could be extended at the option of the Borrower, pursuant to
the following loan agreements:
- --------------------------------------------------------------
Unfunded
Loan
Borrower Commitment
- --------------------------------------------------------------
Alon USA Energy, Inc. $ 888,889
- --------------------------------------------------------------
Atrium Co. Inc. 547,059
- --------------------------------------------------------------
Covanta Energy Corp. 1,000,000
- --------------------------------------------------------------
Cricket Communications, Inc. 6,500,000
- --------------------------------------------------------------
Decrane Aircraft Holdings, Inc. 2,000,000
- --------------------------------------------------------------
DHM Holdings Co. Inc. 180,561
- --------------------------------------------------------------
Federal-Mogul Corp. 117,897
- --------------------------------------------------------------
Ferro Corp. 3,777,778
- --------------------------------------------------------------
Infor Global Solutions S.A.R.L. 2,250,000
- --------------------------------------------------------------
Insurance Auto Auctions, Inc. 217,391
- --------------------------------------------------------------
Interstate Bakeries Corp. 4,117,132
- --------------------------------------------------------------
La Petite Academy, Inc. 5,684,091
- --------------------------------------------------------------
LSP General Finance Co. LLC 1,666
- --------------------------------------------------------------
MEG Energy Corp. 3,000,000
- --------------------------------------------------------------
Millennium Digital Media Systems, LLC 4,109,024
- --------------------------------------------------------------
Navistar International Co. 130,019
- --------------------------------------------------------------
NES Rentals Holdings, Inc. 666,667
- --------------------------------------------------------------
Oglebay Norton Co. 200,000
- --------------------------------------------------------------
Standard Steel, LLC 166,667
- --------------------------------------------------------------
Trump Entertainment Resorts, Inc. 3,228,721
- --------------------------------------------------------------
VML US Finance LLC 2,000,000
- --------------------------------------------------------------
$ 40,783,562
===================
The net discount in unrealized gain (loss) on the unfunded commitments is
recorded as a liability on the Statement of Assets and Liabilities. The change
in unrealized gain (loss) is recorded on the Statement of Operations.
NOTE 10. 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.
Annual Report | 31
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 HIGHLAND FLOATING RATE ADVANTAGE 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.
FOREIGN SECURITIES
Investments in foreign securities may involve special risks compared to
investing in securities of U.S. issuers. These risks are more pronounced to the
extent that the Fund invests a significant portion of its non-U.S. investment in
one region or in the securities of emerging market issuers. These risk may
include (i) less information about non-U.S. issuers or markets being available
due to less rigorous disclosure, accounting standards or regulatory
requirements; (ii) many non-U.S. markets are smaller, less liquid and more
volatile and the Adviser may not be able to sell the Fund's securities at times,
in amounts and at prices it considers reasonable; (iii) the economies of
non-U.S. markets may grow at slower rates than expected or may experience a
downturn or recession; and (iv) withholdings and other non-U.S. taxes may
decrease the Fund's returns.
NOTE 12. SUBSEQUENT EVENT
At a meeting held on September 8, 2006, the Board of Trustees approved The Bank
of Nova Scotia ("Scotia") as the Credit Facility Provider for the Fund, on
substantially similar terms to those of the Fund's existing credit facility with
Citicorp, with such modifications as approved by the Trustees.
After negotiation of documentation and approval by the Board of Trustees, on
October 12, 2006, the Fund entered into a revolving credit and security
agreement with Liberty Street Funding Corp. and Bay Street Funding Trust, as the
conduit lenders, and Scotia, as agent for the secured parties. The total
commitment under the Scotia facility is $500 million in aggregate principal
amount. Proceeds of the Scotia facility were used to repay all outstanding
obligations and terminate the Citicorp facility at closing.
32 | Annual Report
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
- --------------------------------------------------------------------------------
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 and of
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, 2006, and the results of its
operations for the year then ended, the changes in its net assets and cash flows
and the financial highlights for each of the 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 at August 31, 2006 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
Dallas, Texas
October 27, 2006
Annual Report | 33
ADDITIONAL INFORMATION (UNAUDITED)
- --------------------------------------------------------------------------------
APPROVAL OF INVESTMENT ADVISORY CONTRACTS HIGHLAND FLOATING RATE ADVANTAGE FUND
To assist the Board with its consideration of Highland's proposal, the Board
requested, through Fund counsel and its independent legal counsel, and received
from Highland, various written materials, including: (1) information confirming
the financial soundness of Highland; (2) information on the advisory and
marketing personnel of Highland, including compensation arrangements; (3)
information on the internal compliance procedures of Highland; (4) comparative
information showing how the Fund's proposed fee schedule and anticipated
operating expenses compare to (i) other registered investment companies that
follow investment strategies similar to those of the Fund, and (ii) other
private and registered pooled investment vehicles or accounts managed by
Highland, as well as the performance of such vehicles and accounts; (5)
information regarding brokerage and portfolio transactions; and (6) information
on any legal proceedings or regulatory audits or investigations affecting
Highland.
The Independent Trustees, assisted by their independent legal counsel, met in
executive session to discuss the terms of the Current Advisory Agreement and the
New Advisory Agreement (together, the "Agreements"). The Independent Trustees
reviewed various factors discussed in independent counsel's legal memorandum,
detailed information provided by Highland and other relevant information and
factors including the following:
THE NATURE, EXTENT, AND QUALITY OF THE SERVICES TO BE
PROVIDED BY HIGHLAND
The Independent Trustees considered the portfolio management services provided
by Highland and the activities related to portfolio management, including use of
technology, research capabilities, and investment management staff. They
discussed the experience and qualifications of the personnel who provide
advisory services, including the background and experience of the members of the
portfolio management team. The Independent Trustees reviewed the management
structure, assets under management and investment philosophies and processes of
Highland. They also reviewed and discussed Highland's compliance policies and
procedures. The Independent Trustees concluded that Highland had the quality and
depth of personnel and investment methods essential to performing its duties
under the Agreements and that the nature of such advisory services is
satisfactory.
HIGHLAND'S HISTORICAL PERFORMANCE IN MANAGING THE
FUND
The Independent Trustees reviewed Highland's historical performance in managing
the Fund as provided by Lipper. They noted that since Highland has become the
Fund's investment adviser, the Fund outperformed its benchmark, the Credit
Suisse Leveraged Loan Index, by 231 basis points per year on an annualized
basis. Furthermore, when compared to its peer group, all of the Fund's share
classes have been the top performing share classes of any peer, in the
categories Year-to-Date Total Return, 1-year Total Return, Total Return since
4/15/04, as well as the Annualized Total Rates of Return in 3-Year, 5-Year,
since 4/15/04, and since Inception time frames. Moreover, during the 12 months
ended March 31, 2006, the Fund's Class Z Shares earned a return of 9.37%, which
represents outperformance of 51.37% or 318 basis points compared to its
benchmark, which returned 6.19%. The Independent Trustees were satisfied with
Highland's historical performance in managing the Fund.
THE INVESTMENT PERFORMANCE OF OTHER ACCOUNTS OR
FUNDS MANAGED BY HIGHLAND
The Independent Trustees reviewed the performance of Highland for accounts or
funds that are similar to the Fund compared with other investment companies of
similar investment objectives and size. They reviewed Highland's historical
performance in managing Highland Floating Rate Limited Liability Company
("FRLLC"). Highland Floating Rate Fund ("FRF") invests substantially all of its
assets in FRLLC, which then invests such assets in securities and other assets
in accordance with the investment objectives of FRF and FRLLC. The Independent
Trustees noted that as a result of its investment in FRLLC, FRF is consistently
outperforming its benchmark, the Credit Suisse Leveraged Loan Index, as well as
both its peers that employ leverage and those that do not employ leverage.
During the 12 months ended March 31, 2006, FRF's Class Z Shares earned a return
of 7.61%, which represents a 22.94% incremental return or 142 basis points more
than its benchmark. Additionally, in Lipper's Annualized Rate of Return
categories, all of FRF's share classes were ranked in the Top 5 for the 5-Year
and Since Inception Total Return sets, and the top 6 for the 3-Year Total Return
set. The Independent Trustees were satisfied with Highland's overall performance
records.
THE COSTS OF THE SERVICES TO BE PROVIDED BY HIGHLAND
AND THE PROFITS TO BE REALIZED BY HIGHLAND AND ITS
AFFILIATES FROM THE RELATIONSHIP WITH THE FUND
The Independent Trustees also gave substantial consideration to the fees payable
under the New Advisory Agreement, including: (i) the basis points to be paid to
Highland; (ii) the anticipated expenses Highland would incur in providing
advisory services; and (iii) a comparison of the fees payable to Highland under
the Agreements to fees paid to Highland by other trusts and to investment
advisers serving other investment companies with similar investment programs to
that of the Fund. After such review, the Independent Trustees determined that
the anticipated profitability rates to Highland with respect to the Agreements
were fair and reasonable.
34 | Annual Report
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
APPROVAL OF INVESTMENT ADVISORY CONTRACTS HIGHLAND FLOATING RATE ADVANTAGE FUND
THE EXTENT TO WHICH ECONOMIES OF SCALE WOULD BE
REALIZED AS THE FUND GROWS AND WHETHER FEE LEVELS
REFLECT THESE ECONOMIES OF SCALE FOR THE BENEFIT OF
SHAREHOLDERS
The Independent Trustees considered the effective fees under the Agreements, as
a percentage of assets at different asset levels, and possible economies of
scale to Highland. They considered the anticipated asset levels of the Fund, the
information provided by Highland relating to its estimated costs, and
information comparing the fee rate to be charged by Highland with fee rates
charged by other unaffiliated investment advisers to their clients. They also
considered Highland's willingness to reinstate its voluntary "other expenses"
cap if shareholders approve the New Advisory Agreement. The Independent Trustees
concluded that the fee structures are reasonable and appropriately would result
in a sharing of economies of scale in the current environment in view of the
information provided by Highland.
In determining whether to approve the Agreements, the Independent Trustees
concluded that, based on the materials presented to them and the conversations
the Board had with representatives of Highland, the Fund's auditors, the Fund's
counsel and counsel to the Independent Trustees, continuation of the Current
Advisory Agreement and submission of the New Advisory Agreement to shareholders
would be in the best interests of shareholders. The Independent Trustees
determined that the advisory fee rates under the Agreements are fair and
reasonable, in light of the excellent performance of the Fund during the period
Highland has served as the investment adviser and in view of the fact that the
advisory fee rates for the Fund are substantially below the average
advisory/management fee rate in the Fund's Lipper peer groups.
Annual Report | 35
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 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 TRUSTEE 1 HELD
INDEPENDENT TRUSTEES
Timothy K. Hui Trustee 2004 Assistant Provost for Graduate 8 None
(Age 58) Education since July 2004;
c/o Highland Capital Assistant
Management, L.P. Provost for Educational
13455 Noel Road, Resources, July 2001 to June
Suite 800 2004, Philadelphia Biblical
Dallas, TX 75240 University
Scott F. Kavanaugh Trustee 2004 Private Investor; Executive at 8 None
(Age 45) Provident Funding Mortgage
c/o Highland Capital Corporation, February 2003 to
Management, L.P. July 2003; Executive Vice
13455 Noel Road, President, Director and
Suite 800 Treasurer, Commercial Capital
Dallas, TX 75240 Bank, January 2000 to February
2003; Managing Principal and
Chief Operating Officer,
Financial Institutional Partners
Mortgage Company and the
Managing Principal and
President of Financial
Institutional Partners, LLC, (an
investment banking firm), April
1998 to February 2003.
James F. Leary Trustee 2004 Managing Director, Benefit 8 Board Member of
(Age 76) Capital Southwest, Inc., Capstone Asset
c/o Highland Capital (a financial consulting firm) Management
Management, L.P. since January 1999. Group of Mutual
13455 Noel Road, Funds.
Suite 800
Dallas, TX 75240
Bryan A. Ward Trustee 2004 Senior Manager, Accenture, 8 None
(Age 51) LLP since January 2002;
c/o Highland Capital Special Projects Advisor,
Management, L.P. Accenture, LLP with focus on
13455 Noel Road, the oil and gas industry,
Suite 800 September 1998 to December
Dallas, TX 75240 2001.
36 | Annual Report
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
AUGUST 31, 2006 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 and 2004 Portfolio Manager of 8 N/A
(Age 36) Senior Vice Highland since 2000.
c/o Highland Capital President
Management, L.P.
13455 Noel Road,
Suite 800
Dallas, TX 75240
OFFICERS (3)
James D. Dondero President 2004 President and Managing N/A N/A
(Age 44) Partner of Highland; President
c/o Highland Capital and Director of Strand Advisors,
Management, L.P. Inc., the general partner of the
13455 Noel Road, Adviser.
Suite 800
Dallas, TX 75240
Mark Okada Executive Vice 2004 Chief Investment Officer of N/A N/A
(Age 44) President Highland since March 1993;
c/o Highland Capital Officer of Strand Advisors,
Management, L.P. Inc., the general partner of the
13455 Noel Road, Adviser.
Suite 800
Dallas, TX 75240
M. Jason Blackburn Secretary and 2004 Assistant Controller of N/A N/A
(Age 30) Treasurer Highland since November
c/o Highland Capital 2001; Accountant, KPMG LLP,
Management, L.P. September 1999 to October
13455 Noel Road, 2001.
Suite 800
Dallas, TX 75240
Michael S. Minces Chief Compliance 2004 Associate, Akin Gump N/A N/A
(Age 32) Officer Strauss Hauer & Feld LLP
c/o Highland Capital (law firm), October 2003 to
Management, L.P. August 2004; Associate,
13455 Noel Road, Skadden, Arps, Slate,
Suite 800 Meagher & Flom LLP (law
Dallas, TX 75240 firm), October 2000 to March
2003. Previously, he attended
The University of Texas at
Austin School of Law.
<FN>
1 The Highland Fund Complex consists of the following Funds: Highland Floating Rate Limited Liability Company, Highland Floating
Rate Fund, Highland Floating Rate Advantage Fund, Highland Corporate Opportunities Fund, Restoration Opportunities Fund, Highland
Credit Strategies Fund, Prospect Street(R) High Income Portfolio Inc., Prospect Street(R) Income Shares Inc. and Highland Equity
Opportunities Fund.
2 Mr. Dougherty is deemed to be an "interested person" of the Fund under the 1940 Act because of his position with Highland.
3 Each officer also serves in the same capacity for each Fund in the Highland Fund Complex.
</FN>
Annual Report | 37
IMPORTANT INFORMATION ABOUT THIS REPORT
- --------------------------------------------------------------------------------
TRANSFER AGENT
PFPC Inc.
101 Sabin Street
Pawtucket, RI 02860
DISTRIBUTOR
PFPC Distributors, Inc.
760 Moore Road
King of Prussia, PA 19406
INVESTMENT ADVISER
Highland Capital Management, L.P.
13455 Noel Road, Suite 800
Dallas, TX 75240
INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
PricewaterhouseCoopers LLP
2001 Ross Avenue, Suite 1800
Dallas, TX 75201
The Fund mails one shareholder report to each shareholder address. If you would
like more than one report, please call shareholder services at 1-877-665-1287
and additional reports will be sent to you.
This report has been prepared for shareholders of Highland Floating Rate
Advantage Fund.
A description of the policies and procedures that the Fund uses to determine how
to vote proxies relating 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.
The Fund files its complete schedule of portfolio holdings with the
Securities and Exchange Commission for the first and third quarters of each
fiscal year 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 Trustees
and is available upon request without charge by calling 1-877-665-1287.
38 | Annual Report
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THIS PAGE LEFT BLANK INTENTIONALLY.
FLOATING RATE
ADVANTAGE
BACK
COVER
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 are
$59,000 for 2006 and $54,590 for 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 are $5,500 for 2006 and $5,000 for 2005. The nature of the
services related to agreed-upon procedures, performed on the Fund's
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 are $4,800 for 2006 and $4,800
for 2005. The nature of the services related to assistance on the
Fund's 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 are $0
for 2006 and $0 for 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) N/A
(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 was $81,000 for 2006 and $85,252 for 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.
The Fund's portfolio is managed by a portfolio management team. The
members of the team who are primarily responsible for the day-to-day management
of the Fund's portfolio are R. Joseph Dougherty and Mark Okada.
Mr. Dougherty is a Portfolio Manager at Highland and heads Highland's
retail funds effort. In this capacity, Mr. Dougherty oversees investment
decisions for the retail funds, alongside several other portfolio managers, and
manages the team dedicated to their day-to-day administration. He also serves as
a Director, Chairman and Senior Vice President of Prospect Street(R) High Income
Portfolio Inc. ("PHY") and Prospect Street(R) Income Shares Inc. ("CNN"). Prior
to his current duties, Mr. Dougherty served as Portfolio Analyst for Highland
from 1998 to 1999. As a Portfolio Analyst, Mr. Dougherty also helped follow
companies within the chemical, retail, supermarket and restaurant sectors. Prior
to joining Highland, Mr. Dougherty served as an Investment Analyst with Sandera
Capital Management from 1997
to 1998. Formerly, he was a Business Development Manager at Akzo Nobel from
1994 to 1996 and a Senior Accountant at Deloitte and Touche, LLP from 1992 to
1994. He received a BS in Accounting from Villanova University and an MBA from
Southern Methodist University. Mr. Dougherty is a Chartered Financial Analyst
and a Certified Public Accountant.
Mr. Okada has been Executive Vice President of Highland since March
1993 and is Executive Vice President of PHY and CNN. From July 1990 to March
1993, Mr. Okada was Manager-Fixed Income for Protective Asset Management
Company, where his responsibilities included management and administration of
approximately $1.3 billion in bank loan purchases, credit evaluation of
fixed-income assets and quantitative analysis for special projects. Prior to
July 1990, Mr. Okada was employed by Hibernia National Bank, where he most
recently served as Vice President and Section Head of the Capital Markets Group
and was responsible for a portfolio of $1 billion in highly leveraged
transactions. Prior thereto, he was a management trainee for Mitsui
Manufacturers Bank. Mr. Okada graduated with honors from UCLA with a B.S. in
Economics and a B.S. in Psychology in 1984. Mr. Okada is a Chartered Financial
Analyst, and is a member of the Dallas Society of Security Analysts.
The following tables provide information about funds and accounts,
other than the Fund, for which the Fund's portfolio managers are primarily
responsible for the day-to-day portfolio management as of August 31, 2006.
R. JOSEPH DOUGHERTY
- ----------------------------------------------------------------------------------------------------------------------
Total Assets with
Total # of Accounts Managed Performance-Based
# of Accounts Total Assets with Performance-Based Advisory Fee
TYPE OF ACCOUNTS MANAGED (MILLIONS) ADVISORY FEE (MILLIONS)
---------------- ------- ---------- ------------ ----------
- ----------------------------------------------------------------------------------------------------------------------
Registered Investment 7 $3,263 - -
Companies:
- ----------------------------------------------------------------------------------------------------------------------
Other Pooled Investment 1 $276 - -
Vehicles:
- ----------------------------------------------------------------------------------------------------------------------
Other Accounts: - - - -
- ----------------------------------------------------------------------------------------------------------------------
MARK OKADA
- ----------------------------------------------------------------------------------------------------------------------
Total Assets with
Total # of Accounts Managed Performance-Based
# of Accounts Total Assets with Performance-Based Advisory Fee
TYPE OF ACCOUNTS MANAGED (MILLIONS) ADVISORY FEE (MILLIONS)
---------------- ------- ---------- ------------ ----------
- ----------------------------------------------------------------------------------------------------------------------
Registered Investment 8 $4,173 - -
Companies:
- ----------------------------------------------------------------------------------------------------------------------
Other Pooled Investment 37 $18,538 31 $16,578
Vehicles:
- ----------------------------------------------------------------------------------------------------------------------
Other Accounts: - - - -
- ----------------------------------------------------------------------------------------------------------------------
CONFLICTS OF INTERESTS. The Adviser has built a professional working
environment, a firm-wide compliance culture and compliance procedures and
systems designed to protect against potential incentives that may favor one
account over another. Highland has adopted policies and procedures that address
the allocation of investment opportunities, execution of portfolio transactions,
personal trading by employees and other potential conflicts of interest that are
designed to ensure that all client accounts are treated equitably over time.
Nevertheless, the Adviser furnishes advisory services to numerous clients in
addition to the Fund, and the Adviser may, consistent with applicable law, make
investment recommendations to other clients or accounts (including accounts that
are hedge funds or have performance or higher fees paid to the Adviser or in
which portfolio managers have a personal interest in the receipt of such fees)
that may be the same as or different from those made to the Fund. In addition,
the Adviser, its affiliates and any of their partners, directors, officers,
stockholders or employees may or may not have an interest in the securities
whose purchase and sale the Adviser recommends to the Fund. Actions with respect
to securities of the same kind may be the same as or different from the action
that the Adviser, or any of its affiliates, or any of their partners, directors,
officers, stockholders or employees or any member of their families may take
with respect to the same securities. Moreover, the Adviser may refrain from
rendering any advice or services concerning securities of companies of which any
of the Adviser's (or its affiliates') partners, directors, officers or employees
are directors or officers, or companies as to which the Adviser or any of its
affiliates or the partners, directors, officers and employees of any of them has
any substantial economic interest or possesses material non-public information.
In addition to its various policies and procedures designed to address these
issues, the Adviser includes disclosure regarding these matters to its clients
in both its Form ADV and investment advisory agreements.
The Adviser, its affiliates or their partners, directors, officers and
employees similarly serve or may similarly serve other entities that operate in
the same or related lines of business. Accordingly, these individuals may have
obligations to investors in those entities or funds or to other clients, the
fulfillment of which might not be in the best interests of the Fund. As a
result, the Adviser will face conflicts in the allocation of investment
opportunities to the Fund and other funds and clients. In order to enable such
affiliates to fulfill their fiduciary duties to each of the clients for which
they have responsibility, the Adviser will endeavor to allocate investment
opportunities in a fair and equitable manner which may, subject to applicable
regulatory constraints, involve pro rata co-investment by the Fund and such
other clients or may involve a rotation of opportunities among the Fund and such
other clients.
While the Adviser does not believe there will be frequent conflicts of
interest, if any, the Adviser and its affiliates have both subjective and
objective procedures and policies in place designed to manage the potential
conflicts of interest between the Adviser's fiduciary obligations to the Fund
and their similar fiduciary obligations to other clients so that, for example,
investment opportunities are allocated in a fair and equitable manner among the
Fund and such other clients. An investment opportunity that is suitable for
multiple clients of the Adviser and its affiliates may not be capable of being
shared among some or all of such clients due to the limited scale of the
opportunity or other factors, including regulatory restrictions imposed by the
1940 Act. There can be no assurance that the Adviser's or its affiliates'
efforts to allocate any particular investment opportunity fairly among all
clients for whom such opportunity is appropriate will result in an allocation of
all or part of such opportunity to the Fund. Not all conflicts of interest can
be expected to be resolved in favor of the Fund.
The Adviser expects to apply to the SEC for exemptive relief to enable
the Fund and registered investment companies advised by the Adviser to co-invest
with other accounts and funds managed by the Adviser and its affiliates in
certain privately-placed securities and other situations. There are no
assurances that the Adviser will receive the requested relief. If such relief is
not obtained and until it is obtained, the Adviser may be required to allocate
some investments solely to any of the Fund, a registered fund, or another
account or fund advised by the Adviser or its affiliates. This restriction could
preclude the Fund from investing in certain securities it would otherwise be
interested in and could adversely affect the speed at which the Fund is able to
invest its assets and, consequently, the performance of the Fund.
DESCRIPTION OF COMPENSATION. Highland's financial arrangements with
its portfolio managers, its competitive compensation and its career path
emphasis at all levels reflect the value senior management places on key
resources. Compensation may include a variety of components and may vary from
year to year based on a number of factors including the relative performance of
a portfolio managers underlying account, the combined performance of the
portfolio managers underlying accounts, and the relative performance of the
portfolio managers underlying accounts measured against other employees. The
principal components of compensation include a base salary, a discretionary
bonus, various retirement benefits and one or more of the incentive compensation
programs established by Highland such as the Option It Plan and the Long-Term
Incentive Plan.
Base compensation. Generally, portfolio managers receive base
compensation based on their seniority and/or their position with the firm, which
may include the amount of assets supervised and other management roles within
the firm.
Discretionary compensation. In addition to base compensation, portfolio
managers may receive discretionary compensation, which can be a substantial
portion of total compensation. Discretionary compensation can include a
discretionary cash bonus as well as one or more of the following:
Option It Plan. The purpose of the Plan is to attract and
retain the highest quality employees for positions of
substantial responsibility, and to provide additional
incentives to a select group of management or highly
compensated employees of the Fund so as to promote the success
of the Fund.
Long Term Incentive Plan. The purpose of the Plan is to create
positive morale and teamwork, to attract and retain key
talent, and to encourage the achievement of common goals. The
Plan seeks to reward participating employees based on the
increased value of Highland through the use of Long-term
Incentive Units.
Senior portfolio managers who perform additional management functions
may receive additional compensation in these other capacities. Compensation is
structured such that key professionals benefit from remaining with the firm.
OWNERSHIP OF SECURITIES. The following table sets forth the dollar
range of equity securities beneficially owned by each portfolio manager in the
Fund as of August 31, 2006.
- --------------------------------------------------------------------------------
NAME OF PORTFOLIO MANAGER DOLLAR RANGES OF EQUITY SECURITIES BENEFICIALLY
OWNED BY PORTFOLIO MANAGER
- --------------------------------------------------------------------------------
R. Joseph Dougherty None
- --------------------------------------------------------------------------------
Mark Okada $500,001 - $1,000,000
- --------------------------------------------------------------------------------
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") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, 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 (17
CFR 270.30a-3(d)) that occurred during the registrant's second fiscal
quarter of the period covered by this report 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
By (Signature and Title)* /S/ JAMES D. DONDERO
-------------------------------------------------------
James D. Dondero, Chief Executive Officer
(principal executive officer)
Date NOVEMBER 6, 2006
----------------------------------------------------------------------------
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 6, 2006
----------------------------------------------------------------------------
By (Signature and Title)* /S/ M. JASON BLACKBURN
-------------------------------------------------------
M. Jason Blackburn, Chief Financial Officer
(principal financial officer)
Date NOVEMBER 6, 2006
----------------------------------------------------------------------------
* Print the name and title of each signing officer under his or her signature.