<Page>
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 811-9709
--------
HIGHLAND FLOATING RATE ADVANGE FUND
(Exact name of Registrant as specified in charter)
13455 Noel Road, Suite 1300
Dallas, Texas 75240
(Address of principal executive offices)
James D. Dondero
Highland Capital Management, L.P.
13455 Noel Road, Suite 1300
Dallas, Texas 75240
COPIES TO:
Stuart H. Coleman, Esq.
Stroock & Stroock & Lavan LLP
180 Maiden Lane
New York, New York 10038
(Name and address of agent for service)
Registrant's telephone number, including area code: (877) 532-2834
Date of fiscal year end: 8/31
----
Date of reporting period: 8/31/2004
---------
<Page>
FORM N-CSR
ITEM 1. REPORTS TO STOCKHOLDERS.
<Page>
[GRAPHIC]
HIGHLAND FLOATING RATE ADVANTAGE FUND
ANNUAL REPORT
AUGUST 31, 2004
[HIGHLAND FUNDS LOGO]
MANAGED BY
HIGHLAND CAPITAL MANAGEMENT, L.P.
<Page>
TABLE OF CONTENTS
<Table>
Fund Profile 1
Performance Information 2
Understanding Your Expenses 3
Economic Update 4
Portfolio Managers' Report 5
Financial Statements 7
Investment Portfolio 8
Statement of Assets and Liabilities 27
Statement of Operations 28
Statement of Changes in Net Assets 29
Statement of Cash Flows 31
Notes to Financial Statements 32
Financial Highlights 38
Report of Independent Registered Public Accounting Firm 43
Unaudited Information 44
Trustees 45
Officers 46
Important Information About This Report 47
</Table>
Economic and market conditions change frequently. There is no assurance that the
trends described in this report will continue or commence.
NOT FDIC MAY LOSE VALUE
INSURED -----------------
NO BANK GUARANTEE
TO OUR FELLOW SHAREHOLDERS
HIGHLAND FLOATING RATE ADVANTAGE FUND
DEAR SHAREHOLDER:
I am pleased to submit this annual report for the period ended August 31, 2004.
I am also pleased to have announced on April 15, 2004 that Highland Capital
Management, L.P. ("Highland") entered into a new investment advisory agreement
with the Highland Floating Rate Advantage Fund, formerly Columbia Floating Rate
Advantage Fund. The agreement was approved at a special meeting of the Fund's
shareholders held on July 30, 2004. As you may know, since April 15, 2004, when
the investment management of the Fund was transferred to Highland and the
distribution of the Fund to PFPC Distributors, Inc., Highland acted as advisor
to the Fund under an interim agreement pending final shareholder approval.
At the shareholder meeting, five new Trustees were elected to the Fund's Board
of Trustees. The Fund's Board of Trustees now consists of: Timothy K. Hui, Scott
F. Kavanaugh, James F. Leary, Bryan A. Ward and R. Joseph Dougherty. Mr.
Dougherty is the only Trustee affiliated with Highland. Biographical information
for each Trustee can be found in the report that follows.
Effective October 18, 2004, PFPC Inc. ("PFPC") replaced Columbia Funds Services,
Inc. as the Fund's transfer agent. As of that date, PFPC assumed all account
servicing responsibilities for the Fund.
Some changes that will affect shareholders of the Highland Floating Rate
Advantage Fund include the following:
Effective October 18, 2004, the name of the Fund changed from Columbia Floating
Rate Advantage Fund to Highland Floating Rate Advantage Fund and you should
anticipate new fund CUSIP numbers. (A CUSIP is a unique identification number
assigned to each class of a fund by the Committee on Uniform Security
Identification Procedures.) Ticker symbols for the Fund will remain the same. A
list of the new CUSIP numbers and other information related to these changes are
available online at www.highlandfunds.com, our new website.
Please don't hesitate to contact your financial advisor or call Shareholder
Services at 877-665-1287 for more information.
In the report that follows, your portfolio manager talks in depth about
investment strategies and other factors that affected your Fund's performance
during the period. I encourage you to read the report carefully.
I thank you for your business and I look forward to continuing to serve your
investment needs.
Sincerely,
/s/ James D. Dondero
James D. Dondero
President
<Page>
FUND PROFILE
HIGHLAND FLOATING RATE ADVANTAGE FUND
The information below gives you a snapshot of your fund at the end of the
reporting period. Your fund is actively managed and the composition of its
portfolio will change over time.
QUALITY BREAKDOWN AS OF 08/31/04 (%)
<Table>
Aa 0.7
Baa 0.1
Ba 28.6
B 46.3
Caa 3.7
Ca 0.1
NR 20.3
Other 0.2
</Table>
TOP 5 SECTORS AS OF 08/31/04 (%)
<Table>
Utilities 9.5
Cable & Satellite Television 7.9
Oil & Gas 5.8
Lodging & Casinos 5.5
Telecommunication/Cellular 5.5
</Table>
TOP 10 ISSUERS AS OF 08/31/04 (%)
<Table>
Allied Waste North America 2.6
Olympus Cable Holdings 1.9
Century Cable Holdings 1.7
Mission Energy Holdings 1.4
Conseco 1.4
Airgates PCS 1.3
NUI 1.3
RLC Industries 1.3
Opbiz 1.2
Michael Foods 1.2
</Table>
Quality is calculated as a percentage of total investments. Sectors and issuers
are calculated as a percentage of net assets.
[SIDENOTE]
SUMMARY
- - FOR THE ONE-YEAR PERIOD THAT ENDED AUGUST 31, 2004, THE FUND'S CLASS A
SHARES RETURNED 13.14% WITHOUT A SALES CHARGE.
OBJECTIVE
To provide a high level of current
income, consistent with
preservation of capital
TOTAL NET ASSETS
$668.6 million
1
<Page>
PERFORMANCE INFORMATION
HIGHLAND FLOATING RATE ADVANTAGE FUND
[CHART]
VALUE OF $10,000 INVESTMENT 01/13/00 - 08/31/04
<Table>
<Caption>
CLASS A SHARES CLASS A SHARES CSFB LEVERAGED
WITHOUT SALES CHARGE WITH SALES CHARGE LOAN INDEX
1/13/2000 $ 10,000 $ 9,650 $ 10,000
1/31/2000 $ 10,050 $ 9,698 $ 10,097
2/29/2000 $ 10,141 $ 9,787 $ 10,130
3/31/2000 $ 10,151 $ 9,795 $ 10,050
4/30/2000 $ 10,210 $ 9,853 $ 10,086
5/31/2000 $ 10,316 $ 9,955 $ 10,171
6/30/2000 $ 10,420 $ 10,055 $ 10,233
7/31/2000 $ 10,521 $ 10,153 $ 10,307
8/31/2000 $ 10,604 $ 10,233 $ 10,359
9/30/2000 $ 10,696 $ 10,322 $ 10,393
10/31/2000 $ 10,778 $ 10,400 $ 10,398
11/30/2000 $ 10,821 $ 10,442 $ 10,421
12/31/2000 $ 10,895 $ 10,514 $ 10,494
1/31/2001 $ 10,998 $ 10,613 $ 10,557
2/28/2001 $ 11,049 $ 10,663 $ 10,647
3/31/2001 $ 11,020 $ 10,634 $ 10,660
4/30/2001 $ 10,915 $ 10,533 $ 10,615
5/31/2001 $ 11,027 $ 10,641 $ 10,742
6/30/2001 $ 11,041 $ 10,654 $ 10,755
7/31/2001 $ 11,176 $ 10,785 $ 10,782
8/31/2001 $ 11,316 $ 10,920 $ 10,868
9/30/2001 $ 11,128 $ 10,739 $ 10,660
10/31/2001 $ 10,873 $ 10,493 $ 10,494
11/30/2001 $ 11,007 $ 10,622 $ 10,659
12/31/2001 $ 11,176 $ 10,784 $ 10,769
1/31/2002 $ 11,344 $ 10,947 $ 10,829
2/28/2002 $ 11,274 $ 10,879 $ 10,788
3/31/2002 $ 11,493 $ 11,090 $ 10,913
4/30/2002 $ 11,652 $ 11,245 $ 11,029
5/31/2002 $ 11,683 $ 11,274 $ 11,022
6/30/2002 $ 11,455 $ 11,054 $ 10,855
7/31/2002 $ 11,051 $ 10,664 $ 10,690
8/31/2002 $ 10,878 $ 10,497 $ 10,659
9/30/2002 $ 10,723 $ 10,347 $ 10,683
10/31/2002 $ 10,621 $ 10,249 $ 10,540
11/30/2002 $ 10,806 $ 10,427 $ 10,721
12/31/2002 $ 11,067 $ 10,680 $ 10,889
1/31/2003 $ 11,232 $ 10,839 $ 11,036
2/28/2003 $ 11,249 $ 10,855 $ 11,094
3/31/2003 $ 11,398 $ 10,999 $ 11,130
4/30/2003 $ 11,778 $ 11,366 $ 11,287
5/31/2003 $ 12,143 $ 11,718 $ 11,438
6/30/2003 $ 12,421 $ 11,986 $ 11,600
7/31/2003 $ 12,494 $ 12,057 $ 11,679
8/31/2003 $ 12,572 $ 12,132 $ 11,704
9/30/2003 $ 12,810 $ 12,361 $ 11,821
10/31/2003 $ 13,040 $ 12,584 $ 11,928
11/30/2003 $ 13,283 $ 12,818 $ 12,015
12/31/2003 $ 13,473 $ 13,001 $ 12,089
1/31/2004 $ 13,777 $ 13,295 $ 12,215
2/29/2004 $ 13,794 $ 13,311 $ 12,253
3/31/2004 $ 13,874 $ 13,388 $ 12,303
4/30/2004 $ 13,967 $ 13,478 $ 12,360
5/31/2004 $ 13,974 $ 13,484 $ 12,388
6/30/2004 $ 14,090 $ 13,596 $ 12,467
7/31/2004 $ 14,170 $ 13,674 $ 12,511
8/31/2004 $ 14,220 $ 13,723 $ 12,533
</Table>
The graph and table do not reflect a deduction of the taxes that a shareholder
would pay on fund distributions or the redemption of fund shares. The Credit
Suisse First Boston (CSFB) Leveraged Loan Index is an unmanaged index that
tracks the performance of senior floating rate bank loans. Unlike mutual funds,
indices are not investments, do not incur fees or expenses and are not
professionally managed. It is not possible to invest directly in an index.
Securities in the fund may not match those in an index. Index performance is
from December 31, 1999.
AVERAGE ANNUAL TOTAL RETURN AS OF 08/31/04 (%)
<Table>
<Caption>
SHARE CLASS A B C Z
- -----------------------------------------------------------------------------------
INCEPTION 01/13/00 01/13/00 01/13/00 01/13/00
- -----------------------------------------------------------------------------------
SALES CHARGE WITHOUT WITH WITHOUT WITH WITHOUT WITH WITHOUT
- -----------------------------------------------------------------------------------
1-year 13.14 9.18 12.75 9.50 12.57 11.57 13.52
Life 7.90 7.07 7.53 7.37 7.38 7.38 8.26
</Table>
AVERAGE ANNUAL TOTAL RETURN AS OF 06/30/04 (%)
<Table>
<Caption>
SHARE CLASS A B C Z
- -----------------------------------------------------------------------------------
SALES CHARGE WITHOUT WITH WITHOUT WITH WITHOUT WITH WITHOUT
- -----------------------------------------------------------------------------------
1-year 13.46 9.49 13.07 9.82 12.89 11.89 13.85
Life 7.99 7.13 7.62 7.45 7.47 7.47 8.35
</Table>
Investors should consider the investment objectives, risks, charges and expenses
of the Highland Funds carefully before investing. A prospectus with this and
other information about the Fund maybe obtained at 1-877-665-1287 or
www.highlandfunds.com. Prospectus should be read carefully before investing.
Average annual total return "without sales charge", does not include sales
charges or contingent deferred sales charges. Average annual total return "with
sales charge" reflect the maximum sales charge of 3.50% on class A shares. The
maximum early withdrawal charge (EWC) on class B shares is 3.25% for shares
submitted and accepted for repurchase during the first year after each purchase.
The EWC on class C shares is 1% within the first year from each purchase. There
is no EWC on class C shares thereafter. All results shown assume reinvestment of
distributions. Performance results reflect voluntary waivers or reimbursement
arrangements, performance results would have been lower.
The fund commenced operations on 1/13/00. Class A, B and C share (newer share
classes) performance information includes returns of the Fund's class Z shares
(the oldest existing share class) for periods prior to the inception dates of
the newer share classes. These returns are not restated to reflect any expense
differential (e.g., Rule 12b-1 fees) between class Z shares and the newer share
classes. Had the expense differential been reflected, the returns for periods
prior to the inception date of the newer share classes would have been lower.
The fund is available with no transaction fee on all major platforms. The sales
charge typically applied to class A shares, which carry a 12b-1 fee, is waived
for purchases of the fund through registered investment advisors (RIAs) and
defined contribution (DC) plans. Class Z shares, also offered to RIAs and DC
plans, are sold without a 12b-1 fee at NAV.
[SIDENOTE]
PERFORMANCE OF A $10,000 INVESTMENT
01/13/00 - 08/31/04 ($)
<Table>
<Caption>
SALES CHARGE: WITHOUT WITH
- --------------------------------------
Class A 14,220 13,723
Class B 14,001 13,901
Class C 13,906 13,906
Class Z 14,445 n/a
</Table>
Performance data quoted represents past performance and current performance may
be lower or higher. Past performance is no guarantee of future results. The
investment return and principal value will fluctuate so that shares, when
redeemed, may be worth more or less than the original cost. Please visit
www.highlandfunds.com for daily net asset value and most recent month-end
performance updates.
2
<Page>
UNDERSTANDING YOUR EXPENSES
HIGHLAND FLOATING RATE ADVANTAGE FUND
As a fund shareholder, you incur two types of costs. There are transaction
costs, which generally include sales charges on purchases and may include
redemption or exchange fees. There are also continuing costs, which generally
include investment advisory and/or Rule 12b-1 fees, and other fund expenses. The
information on this page is intended to help you understand your ongoing costs
of investing in the fund and to compare this cost with the continuing costs of
investing in other funds.
ANALYZING YOUR FUND'S EXPENSES BY SHARE CLASS
To illustrate these ongoing costs, we have provided an example and calculated
the expenses paid by investors in each share class during the reporting period.
The information in the following table is based on an initial investment of
$1,000, which is invested at the beginning of the reporting period and held for
the entire period. Expense information is calculated two ways and each method
provides you with different information. The amount listed in the "actual"
column is calculated using the fund's actual operating expenses and total return
for the period. The amount listed in the "hypothetical" column for each share
class assumes that the return each year is 5% before expenses and includes the
fund's actual expense ratio. You should not use the hypothetical account values
and expenses to estimate either your actual account balance at the end of the
period or the expenses you paid during this reporting period.
MARCH 1, 2004 - AUGUST 31, 2004
<Table>
<Caption>
ACCOUNT VALUE AT THE ACCOUNT VALUE AT THE EXPENSES PAID FUND'S ANNUALIZED
BEGINNING OF THE PERIOD ($) END OF THE PERIOD ($) DURING THE PERIOD ($) EXPENSE RATIO (%)
ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL
Class A 1,000.00 1,000.00 1,034.64 1,017.29 7.98 7.91 1.56
Class B 1,000.00 1,000.00 1,032.93 1,015.53 9.76 9.68 1.91
Class C 1,000.00 1,000.00 1,032.12 1,014.78 10.52 10.43 2.06
Class Z 1,000.00 1,000.00 1,036.35 1,019.05 6.19 6.14 1.21
</Table>
Expenses paid during the period are equal to the fund's annualized expense
ratio, multiplied by the average account value over the period, then multiplied
by the number of days in most recent fiscal half-year and divided by 366.
Had the advisor or its affiliates not waived or reimbursed a portion of
expenses, total return would have been reduced.
It is important to note that the expense amounts shown in the table are meant to
highlight only continuing costs of investing in the fund and do not reflect any
transactional costs, such as sales charges, redemption or exchange fees.
Therefore, the hypothetical examples provided will not help you determine the
relative total costs of owning different funds. If these transactional costs
were included, your costs would have been higher.
COMPARE WITH OTHER FUNDS
Since all funds are required to include the same hypothetical calculations about
expenses in shareholder reports, you can use this information to compare the
ongoing cost of investing in the fund with other funds. To do so, compare the 5%
hypothetical example with the 5% hypothetical examples that appear in the
shareholder reports of other funds. As you compare hypothetical examples of
other fund companies, it is important to note that hypothetical examples are
meant to highlight the continuing cost of investing in a fund and do not reflect
any transactional costs, such as sales charges or redemption or exchange fees.
[SIDENOTE]
ESTIMATING YOUR ACTUAL EXPENSES
To estimate the expenses that you paid over the period, first you will need your
account balance at the end of the period:
- - FOR SHAREHOLDERS WHO RECEIVE THEIR ACCOUNT STATEMENTS FROM PFPC INC., YOUR
ACCOUNT BALANCE IS AVAILABLE ONLINE AT www.highlandfunds.com OR BY CALLING
SHAREHOLDER SERVICES AT 877-665-1287
- - FOR SHAREHOLDERS WHO RECEIVE THEIR ACCOUNT STATEMENTS FROM THEIR BROKERAGE
FIRM, CONTACT YOUR BROKERAGE FIRM TO OBTAIN YOUR ACCOUNT BALANCE
1. DIVIDE YOUR ENDING ACCOUNT BALANCE BY $1,000. FOR EXAMPLE, IF AN ACCOUNT
BALANCE WAS $8,600 AT THE END OF THE PERIOD, THE RESULT WOULD BE 8.6
2. IN THE SECTION OF THE TABLE BELOW TITLED "EXPENSES PAID DURING THE PERIOD,"
LOCATE THE AMOUNT FOR YOUR SHARE CLASS. YOU WILL FIND THIS NUMBER IS IN THE
COLUMN LABELED "ACTUAL." MULTIPLY THIS NUMBER BY THE RESULT FROM STEP 1.
YOUR ANSWER IS AN ESTIMATE OF THE EXPENSES YOU PAID ON YOUR ACCOUNT DURING
THE PERIOD
3
<Page>
ECONOMIC UPDATE
HIGHLAND FLOATING RATE ADVANTAGE FUND
Despite occasional uncertainty about jobs and consumer spending, the US economy
grew at a pace of more than 4.5% during the 12-month period that began September
1, 2003 and ended August 31, 2004. Growth slowed in the final months of the
period, and many economists lowered their expectations for the balance of 2004.
Nevertheless, the US economy remained on solid ground.
Consumer confidence seesawed, mostly in reaction to changing job data, which
dominated much of the economic news during the year. The Conference Board
reported that confidence declined on weak job figures early in 2004. Confidence
rose after the US labor markets added more than 1.2 million new jobs between
March and May. However, disappointing job creation in June and July curbed
consumer enthusiasm again in August.
Consumers expressed their confidence in the economy by spending on retail goods,
autos and housing. Low mortgage rates continued to fuel a red-hot housing
market. However, consumer spending declined in two of the last three months of
the period, the first such pullback in a year. Businesses stepped into the gap
and helped fuel the economy during the period. Industrial production rose and
factories utilized more of their capacity. Spending on technology and capital
equipment picked up, and outlays for office and warehouse construction turned
the corner after a three-year downturn.
BONDS DELIVER RESPECTABLE RETURNS
Despite periods of interest rate volatility, the US bond market delivered
respectable gains. The yield on the 10-year US Treasury bond drifted generally
lower for the first eight months of the period. Then it rose sharply as the
economy strengthened, the employment picture brightened and investors began to
anticipate a shift in the Federal Reserve Board's policy on short-term interest
rates. The Fed delivered on these expectations and raised the federal funds
rate, a key short-term rate, twice during the period--from 1.0% to 1.25% in June
and to 1.50% in August.(1)
A shaky stock market, higher energy prices and some weak economic data gave the
bond market a boost in July and August as the 10-year Treasury yield fell to
4.1%, ending the period lower than where it started. As a result, the Lehman
Brothers Aggregate Bond Index, a broad measure of investment grade bond market
performance, returned 6.13%. Municipals were the best performers among
investment-grade bonds, returning 7.11% as measured by the Lehman Municipal Bond
Index. However, the high-yield sector outdistanced all other sectors. The
Merrill Lynch US High Yield, Cash Pay Index returned 13.64%.
US STOCKS OUTPERFORMED BONDS
Buoyed by strong gains at the beginning of the period, the S&P 500 Index
returned 11.46% during this 12-month reporting period. However, concerns about
new terror threats and higher interest rates and energy prices sidelined
investors as the period wore on. Late in the period, leadership passed from
small-cap stocks, which were strong performers early in the period, to mid- and
large-cap stocks. Value stocks continued to lead growth stocks. Energy stocks
and real estate investment trusts were the best-performing sectors for the
period.
(1) The federal funds rate was raised to 1.75% in September.
[SIDENOTE]
SUMMARY
FOR THE ONE-YEAR PERIOD ENDED AUGUST 31, 2004
- - PERFORMANCE IN THE FIXED INCOME UNIVERSE WAS LED BY HIGH YIELD BONDS. AS
MEASURED BY THE MERRILL LYNCH US HIGH YIELD, CASH PAY INDEX, THIS SECTOR
POSTED A RETURN MORE THAN SEVEN PERCENTAGE POINTS HIGHER THAN THE RETURN
FOR INVESTMENT-GRADE BONDS, AS MEASURED BY THE LEHMAN BROTHERS AGGREGATE
BOND INDEX.
- - THE US STOCK MARKET ROSE AS THE ECONOMY STRENGTHENED. BOTH THE RUSSELL 3000
INDEX, WHICH TRACKS APPROXIMATELY 98% OF THE US STOCK MARKET, AND THE S&P
500 INDEX POSTED DOUBLE-DIGIT RETURNS THIS PERIOD.
[CHART]
<Table>
LEHMAN BROTHERS AGGREGATE BOND INDEX 6.13
MERRILL LYNCH US HIGH YIELD, CASH PAY INDEX 13.64
</Table>
[CHART]
<Table>
RUSSELL 3000 INDEX 11.31
S&P 500 INDEX 11.46
</Table>
4
<Page>
PORTFOLIO MANAGERS' REPORT
HIGHLAND FLOATING RATE ADVANTAGE FUND
For the 12-month period ended August 31, 2004, class A shares of Highland
Floating Rate Advantage Fund returned 13.14% without sales charge. That was
greater than the return of the fund's benchmark, the CSFB Leveraged Loan Index,
which was 7.05% for the period. The fund also did better than the Lipper Loan
Participation Funds Category average, which was 8.82%(1). These high returns
reflect an advantageous environment for all types of credit instruments. We
believe the fund was able to outperform because of favorable security selection
and sector allocation, and also because of the positive effect of using leverage
in a rising market.
A STRONG CREDIT ENVIRONMENT
The period ended August 31, 2004 was another strong year for the credit markets,
fueled by improved earnings, strong job growth and increased demand for
floating-rate loans. However, financial markets faced pressure from the
political instability in the Middle East, high oil prices and increased interest
rates. During both its June 30 and August 10 meetings, the Federal Reserve
increased the fed funds rate 25 basis points, bringing the fed funds rate to
1.50%. Leveraged loan default rates continued to drop as corporate balance
sheets improved.
As always, the use of leverage tends to exaggerate the trends of the underlying
market. When the market was declining in 2001, the decline was magnified by
leverage. Since November 2002, however, the fund's one-fifth to one-third
leverage position added several percentage points to the fund's return.
CABLE AND TELECOM - RESPECTABLE GAINS
Cable and satellite television, which constituted 7.9% of the Fund's net assets,
performed well for the fund. Century Cable and Olympus Cable (1.7% and 1.9% of
net assets, respectively) had another strong year for the fund. Both of these
holdings are wholly-owned subsidiaries of Adelphia, a cable industry bellwether.
The fund's position in telecommunications contributed significantly to its
strong performance. Telecommunications, which accounted for 8.1% of the fund's
net assets, showed continued strength for the second year. Cricket
Communications was a very solid performer for the fund. After trading well above
par, the bank loans converted to Cricket Communications notes and equity in Leap
Wireless during the year. Both the notes and equity had strong performance
through the end of the period. Cricket Communications and Leap Wireless were
0.1% and 0.3% of net assets, respectively.
(1) Lipper, Inc., a widely respected data provider in the industry, calculates
an average total return for mutual funds with similar investment objectives
as the fund. This Fund falls under the Lipper Loan Participation Category
average.
[SIDENOTE]
NET ASSET VALUE PER SHARE
AS OF 08/31/04 ($)
<Table>
Class A 12.08
Class B 12.08
Class C 12.08
Class Z 12.08
</Table>
DISTRIBUTIONS DECLARED PER SHARE
09/01/03 - 08/31/04 ($)
<Table>
Class A 0.59
Class B 0.55
Class C 0.53
Class Z 0.63
</Table>
SEC YIELDS AS OF 08/31/04 (%)
<Table>
Class A 3.91
Class B 3.75
Class C 3.56
Class Z 4.39
</Table>
The 30-day SEC yields reflect the fund's earning power net of expenses,
expressed as an annualized percentage of the public offering price at the end of
the period. If the advisor or its affiliates had not waived certain fund
expenses, the SEC yields would have been lower.
HOLDINGS DISCUSSED IN THIS REPORT
AS OF 08/31/04 (%)
<Table>
Century Cable 1.7
Olympus Cable 1.9
Cricket Communications 0.1
Leap Wireless 0.3
</Table>
Your fund is actively managed and the composition of its portfolio will change
over time. Information provided is calculated as a percentage of net assets.
5
<Page>
The fund did not experience any major defaults during the period. Many lower
rated companies have improved their financial condition via newfound access to
the high yield bond market. As a result, lower quality credits performed well
again this year.
/s/ Mark Okada
/s/ Joe Dougherty
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 that the fund
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 amount. 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 holding 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.
6
<Page>
FINANCIAL STATEMENTS
AUGUST 31, 2004 HIGHLAND FLOATING RATE ADVANTAGE FUND
A GUIDE TO UNDERSTANDING YOUR FUND'S FINANCIAL STATEMENTS
INVESTMENT PORTFOLIO
The investment portfolio details all of the fund's holdings and their market
value as of the last day of the reporting period. Portfolio holdings are
organized by type of asset, industry, country or geographic region (if
applicable) to demonstrate areas of concentration and diversification.
STATEMENT OF ASSETS AND LIABILITIES
This statement details the fund's assets, 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.
STATEMENT OF CHANGES IN NET ASSETS
This statement demonstrates how the fund's 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 Statement 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 provided or used by operating,
investing and financing activities and the net effect of those flows on cash and
cash equivalents during the period.
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.
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).
7
<Page>
INVESTMENT PORTFOLIO
AUGUST 31, 2004 HIGHLAND FLOATING RATE ADVANTAGE FUND
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- 105.6%
AEROSPACE/DEFENSE - 0.6%
DECRANE AIRCRAFT HOLDINGS, INC. Term Loan B
7.110% 06/30/08 1,657,759 1,646,361
VOUGHT AIRCRAFT INDUSTRIES, INC. Term Loan B
5.14% 06/30/07 (b) 216,435 218,599
Term Loan C
5.39% 06/30/08 (b) 1,334,577 1,347,923
Term Lsoan X
4.89% 12/31/06 (b) 847,637 855,054
----------------------------------------------------------------------------
AEROSPACE/DEFENSE TOTAL 4,067,937
AIR TRANSPORT - 0.2%
UNITED AIRLINES, INC. Term Loan B
9.000% 09/30/04 1,486,779 1,503,505
----------------------------------------------------------------------------
AIR TRANSPORT TOTAL 1,503,505
AUTOMOTIVE - 5.0%
EXIDE TECHNOLOGIES European Borrower Dollar Term Loan
5.250% 05/05/10 2,500,000 2,510,938
US Borrower Term Loan
5.250% 05/05/10 2,500,000 2,512,500
FEDERAL-MOGUL CORP. Supplemental Revolver
5.390% 02/06/05 (b) 1,449,678 1,446,053
Term Loan B
4.140% 02/24/05 5,000,000 4,673,440
Term Loan C
5.390% 02/05/05 573,404 577,705
HLI OPERATING CO., INC. Term Loan
4.910% 09/28/04 110,405 112,682
5.390% 09/30/04 571,058 582,836
5.120% 10/29/04 376,423 384,187
5.420% 10/29/04 14,752 15,056
5.330% 11/29/04 380,706 388,558
5.730% 01/26/05 181,787 185,537
KEY AUTOMOTIVE GROUP Term Loan B
4.490% 09/01/04 1,227,273 1,242,614
4.610% 09/29/04 1,295,454 1,311,647
4.780% 11/30/04 1,227,273 1,242,614
Term Loan C
7.270% 09/03/04 1,200,000 1,214,250
7.360% 09/29/04 1,350,000 1,366,031
7.530% 11/30/04 1,200,000 1,214,250
PLASTECH, INC. Term loan B
4.340% 02/12/10 1,484,483 1,506,750
SHILOH INDUSTRIES, INC. Term Loan B
5.640% 01/14/09 3,482,500 3,499,912
</Table>
See accompanying Notes to Financial Statements.
8
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
AUTOMOTIVE - (CONTINUED)
TRW AUTOMOTIVE ACQUISITIONS CORP. Term Loan D1
4.125% 02/28/11 6,765,652 6,888,280
UNITED COMPONENTS, INC. Tranche C
4.420% 06/30/10 856,667 868,981
----------------------------------------------------------------------------
AUTOMOTIVE TOTAL 33,744,821
BEVERAGE & TOBACCO - 3.8%
BUFFETS, INC. Term Loan
4.980% 09/01/04 853,696 863,300
4.590% 09/30/04 2,513,043 2,541,315
Synthetic Letters of Credit
4.610% 06/28/09 466,700 471,950
CARIBBEAN RESTAURANTS LLC Tranche B
4.850% 06/30/09 3,000,000 3,041,250
COMMONWEALTH BRANDS, INC. Term Loan
5.688% 08/28/07 2,135,002 2,160,356
DEL MONTE CORP. Term Loan B
3.836% 09/30/04 759,622 771,847
3.930% 10/29/04 2,950,981 2,998,475
DR. PEPPER BOTTLING COMPANY OF TEXAS Term Loan
3.400% 09/22/04 4,265,258 4,313,907
3.400% 09/30/04 11,371 11,501
DS WATERS ENTERPRISES LP Term Loan
4.336% 09/30/04 1,687,500 1,610,508
4.620% 12/30/04 750,000 715,781
KEYSTONE FOODS HOLDINGS LLC Term Loan
3.938% 06/16/11 4,000,000 4,053,124
SUNNY DELIGHT BEVERAGE CO. First Lien Term Loan
5.980% 08/20/10 2,000,000 2,020,000
----------------------------------------------------------------------------
BEVERAGE & TOBACCO TOTAL 25,573,314
BROADCASTING RADIO & TELEVISION - 2.6%
DIRECTV HOLDINGS LLC Term Loan B2
3.760% 09/15/04 1,517,506 1,539,320
3.880% 10/12/04 1,482,663 1,503,976
FREEDOM COMMUNICATIONS, INC. Term Loan
3.340% 09/01/04 4,061,538 4,124,366
3.750% 11/29/04 1,938,462 1,968,448
GRAY TELEVISION, INC. Incremental Term Loan
3.360% 10/01/04 1,802,483 1,817,128
3.450% 11/03/04 277,305 279,558
</Table>
See accompanying Notes to Financial Statements.
9
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
BROADCASTING RADIO & TELEVISION
- (CONTINUED)
GT BRANDS LLC Term Loan
9.500% 09/30/07 1,896,307 1,706,676
SPANISH BROADCASTING SYSTEMS, INC. Term Loan
4.840% 10/30/09 4,353,125 4,423,863
----------------------------------------------------------------------------
BROADCASTING RADIO &
TELEVISION TOTAL 17,363,335
BUILDING & DEVELOPMENT - 1.1%
AIMCO PROPERTIES LP Term Loan
4.700% 05/30/08 2,000,000 2,018,750
CB RICHARD ELLIS SERVICES, INC. Term Loan
4.060% 09/15/04 1,002,046 1,008,622
4.419% 12/15/04 1,473,008 1,482,675
4.420% 02/16/05 330,675 332,846
NATG HOLDINGS LLC Credit Linked Certificate of Deposit
0.850% 01/23/05 131,418 101,849
Term Loan A
6.130% 01/23/09 121,791 25,843
Term Loan B1
6.630% 01/23/10 86,522 18,359
Term Loan B2
6.630% 01/23/10 9,144 7,406
ST. MARY'S CEMENT, INC. Term Loan B
4.086% 12/04/09 995,000 1,003,706
TAPCO INTERNATIONAL CORP. Term Loan B
4.330% 09/29/04 243,353 244,570
4.340% 09/30/04 602,297 605,309
Term Loan C
4.580% 09/29/04 243,353 244,570
4.590% 09/30/04 361,378 363,185
----------------------------------------------------------------------------
BUILDING & DEVELOPMENT
TOTAL 7,457,690
BUSINESS EQUIPMENT & SERVICES - 4.2%
AMERICAN ACHIEVEMENT CORP. Term Loan B
4.086% 09/28/04 3,251,613 3,280,065
4.290% 11/29/04 225,806 227,782
6.000% 11/30/04 5,081 5,125
BRICKMAN GROUP HOLDINGS, INC. Term Loan
6.775% 11/15/09 4,888,889 4,876,667
GLOBAL IMAGING SYSTEMS, INC. First Additional Term Loan
3.590% 09/30/04 348,357 352,276
3.680% 11/12/04 378,081 382,334
3.720% 11/16/04 3,213,687 3,249,841
HILLMAN GROUP, INC. Term Loan B
6.750% 09/30/04 14,375 14,537
4.625% 10/26/04 5,721,250 5,785,614
</Table>
See accompanying Notes to Financial Statements.
10
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
BUSINESS EQUIPMENT & SERVICES
- (CONTINUED)
INFOUSA , INC. Term Loan
4.000% 03/25/09 3,833,333 3,881,250
TRANSCORE HOLDINGS, INC. Term Loan B
4.827% 09/30/04 1,128,000 1,142,100
6.250% 11/30/04 2,981 3,018
Term Loan C
4.828% 09/30/04 3,952,941 4,002,353
6.250% 11/30/04 17,059 17,272
URS CORP. Term Loan B
3.630% 08/22/08 727,451 731,316
----------------------------------------------------------------------------
BUSINESS EQUIPMENT &
SERVICES TOTAL 27,951,550
CABLE & SATELLITE TELEVISION - 7.9%
ATLANTIC BROADBAND FINANCE LLC Term Loan B
4.610% 09/01/11 4,000,000 4,055,000
BRESNAN COMMUNICATIONS LLC Term Loan B
4.830% 09/07/04 1,244,444 1,262,722
4.860% 09/07/04 311,111 315,681
5.090% 09/30/04 311,111 315,681
5.110% 10/15/04 1,633,334 1,657,324
CENTURY CABLE HOLDINGS LLC Discretionary Term Loan
6.500% 12/31/09 1,000,000 975,208
Term Loan
6.500% 06/30/09 10,500,000 10,259,067
CHARTER COMMUNICATIONS OPERATING LLC Tranche A Term Loan
4.670% 04/27/10 3,000,000 2,930,556
Tranche B Term Loan
4.920% 04/27/11 5,000,000 4,941,145
CSC HOLDINGS, INC. (b) Revolver
2.563% 09/01/04 731,250 723,024
2.813% 09/01/04 43,750 43,258
2.750% 09/07/04 718,750 710,664
5.250% 09/30/04 7,500 7,416
3.063% 10/08/04 175,000 173,031
3.413% 11/08/04 730,000 721,787
OLYMPUS CABLE HOLDINGS LLC Term Loan A
5.750% 06/30/10 6,000,000 5,826,426
Term Loan B
6.500% 09/30/10 7,000,000 6,842,500
SUSQUEHANNA MEDIA CO. Term Loan B
3.150% 03/31/12 4,000,000 4,056,252
UPC FINANCING PARTNERSHIP Term Loan C2
7.381% 12/30/04 35,000 35,361
7.325% 01/07/05 6,930,000 7,001,469
----------------------------------------------------------------------------
CABLE & SATELLITE
TELEVISION TOTAL 52,853,572
</Table>
See accompanying Notes to Financial Statements.
11
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
CHEMICALS/PLASTICS - 4.2%
BCP CAYLUX HOLDINGS LUXEMBOURG Bridge Term C
5.730% 02/19/05 4,000,000 4,054,376
BRENNTAG AG Term Loan B2
4.730% 02/27/12 3,500,000 3,545,937
HUNTSMAN LLC Term Loan A
5.625% 03/31/07 5,372,299 5,400,122
Term Loan B
11.438% 09/16/04 832,978 837,292
11.438% 09/23/04 18,948 19,046
KRATON POLYMERS LLC Term Loan
4.063% 09/24/04 259,259 259,583
4.375% 12/23/04 1,996,946 1,999,442
4.500% 01/04/05 32,408 32,449
NALCO CO. Term Loan A
4.070% 09/23/04 1,350,000 1,365,862
4.080% 09/23/04 1,145,674 1,159,136
4.430% 01/24/05 787,500 796,753
Term Loan B
4.080% 09/23/04 926,905 942,216
4.110% 09/23/04 648,525 659,237
4.430% 01/24/05 572,228 581,680
POLYPORE, INC. Term Loan
4.840% 11/12/11 2,000,000 2,016,250
4.840% 11/12/11 2,000,000 2,016,250
WADDINGTON NORTH AMERICA, INC. Term Loan B
4.570% 04/07/11 4,455,000 4,445,257
----------------------------------------------------------------------------
CHEMICALS/PLASTICS
TOTAL 28,114,638
CLOTHING/TEXTILES - 1.8%
MAIDENFORM, INC. Term Loan
4.850% 05/11/10 3,000,000 3,022,500
POLYMER GROUP, INC. First Lien Term Loan
3.890% 04/27/10 3,000,000 3,021,876
SPRINGS INDUSTRIES, INC. Term Loan A
4.875% 03/05/07 666,379 669,919
Term Loan B
5.586% 09/05/08 4,986,010 5,049,372
----------------------------------------------------------------------------
CLOTHING/TEXTILES TOTAL 11,763,667
CONGLOMERATE - 1.4%
APPLETON PAPERS, INC. Term Loan
3.790% 09/20/04 1,750,000 1,770,781
3.980% 11/19/04 1,750,000 1,770,782
</Table>
See accompanying Notes to Financial Statements.
12
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
CONGLOMERATE - (CONTINUED)
JASON, INC. Term Loan B
5.890% 09/29/04 3,281 3,248
6.031% 11/29/04 1,256,458 1,243,894
MUELLER GROUP, INC. Term Loan
4.400% 09/30/04 1,523,133 1,530,748
4.930% 10/29/04 183,511 184,428
4.540% 11/30/04 183,510 184,428
YOUTH & FAMILY CENTERED SERVICES, INC. Term Loan B
7.250% 05/28/11 3,000,000 3,000,000
----------------------------------------------------------------------------
CONGLOMERATE TOTAL 9,688,309
CONTAINERS/GLASS PRODUCTS - 1.4%
CONSOLIDATED CONTAINERS CO. LLC Term Loan
4.688% 09/30/04 8,750 8,804
3.250% 12/31/04 8,750 8,805
5.125% 03/03/05 3,482,500 3,504,266
GRAPHIC PACKAGING INTERNATIONAL, INC. Term Loan B
4.350% 08/09/10 3,960,000 4,019,400
REDDY ICE GROUP, INC. Supplemental Term Loan
4.150% 08/14/09 744,375 752,439
SOLA INTERNATIONAL, INC. Term Loan
4.090% 12/11/09 1,234,375 1,251,348
----------------------------------------------------------------------------
CONTAINERS/GLASS
PRODUCTS TOTAL 9,545,062
COSMETICS/TOILETRIES - 1.7%
AMERICAN SAFETY RAZOR CO. Tranche B
4.950% 10/29/04 20,000 20,250
4.840% 11/29/04 1,137,255 1,151,470
5.020% 11/29/04 837,745 848,217
CHURCH & DWIGHT CO., INC. Tranche B
3.270% 05/30/11 3,000,000 3,039,843
JOHNSON DIVERSEY, INC. Term Loan B
3.754% 09/03/04 117,204 119,211
3.950% 11/03/04 3,814,425 3,879,747
REVLON CONSUMER PRODUCTS CORP. Term Loan
7.600% 10/13/04 1,000,000 1,017,500
7.860% 01/11/05 1,000,000 1,017,500
----------------------------------------------------------------------------
COSMETICS/TOILETRIES
TOTAL 11,093,738
ECOLOGICAL SERVICES & EQUIPMENT - 3.3%
ALLIED WASTE NORTH AMERICA, INC. Tranche A
3.860% 01/15/10 13,064,343 13,263,574
Tranche C
4.270% 09/15/04 760,569 773,166
4.300% 09/22/04 3,042,274 3,092,664
</Table>
See accompanying Notes to Financial Statements.
13
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
ECOLOGICAL SERVICES & EQUIPMENT
- (CONTINUED)
ENVIRONMENTAL SYSTEMS PRODUCTS HOLDINGS Second Lien
11.586% 09/30/04 2,083,333 2,151,041
11.680% 10/29/04 1,861,111 1,921,597
11.781% 11/30/04 555,556 573,612
----------------------------------------------------------------------------
ECOLOGICAL SERVICES &
EQUIPMENT TOTAL 21,775,654
ELECTRONICS/ELECTRIC - 3.5%
AMI SEMICONDUCTOR, INC. Term Loan
4.140% 09/26/08 992,500 1,003,666
CACI INTERNATIONAL, INC. Term Loan
3.630% 09/30/04 12,500 12,570
3.710% 11/09/04 12,500 12,571
3.950% 02/09/05 4,962,500 4,990,414
SEMICONDUCTORS COMPONENTS INDUSTRIES LLC Term Loan F
4.375% 08/04/09 3,064,619 3,092,071
TRANSACTION NETWORK SERVICES, INC. Term Loan
3.875% 12/31/08 3,661,541 3,652,387
TRANSFIRST HOLDINGS, INC. Term Loan C
9.200% 03/31/11 2,250,000 2,255,625
UGS CORP. Term Loan B
3.850% 05/27/11 3,000,000 3,022,500
VERIFONE, INC. Second Lien Term Loan
7.680% 12/31/11 1,000,000 1,020,000
VIASYSTEMS, INC. Term Loan B
7.150% 09/30/08 4,289,988 4,331,099
----------------------------------------------------------------------------
ELECTRONICS/ELECTRIC
TOTAL 23,392,903
EQUIPMENT LEASING - 1.1%
NATIONAL EQUIPMENT SERVICES Revolver
7.000% 08/17/09 (b) 80,000 80,400
First Lien Term Loan
9.500% 08/17/09 1,333,333 1,340,000
UNITED RENTALS (NORTH AMERICA), INC. Credit Linked Deposit
3.611% 02/14/11 2,723,333 2,765,319
Delayed Draw Term Loan B
3.890% 09/30/04 2,533,333 2,562,783
4.030% 11/30/04 625,417 632,687
----------------------------------------------------------------------------
EQUIPMENT LEASING TOTAL 7,381,189
FARMING/AGRICULTURE - 1.0%
AGCO CORP. Term Loan
3.586% 09/30/04 1,165,500 1,173,149
3.590% 10/13/04 5,296,667 5,331,429
----------------------------------------------------------------------------
FARMING/AGRICULTURE
TOTAL 6,504,578
</Table>
See accompanying Notes to Financial Statements.
14
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
FINANCIAL INTERMEDIARIES - 2.4%
CONSECO, INC. Term Loan
5.110% 06/22/10 9,000,000 9,136,872
MARINA DISTRICT FINANCE CO., INC. Term Loan A
3.410% 09/30/04 293,551 295,263
3.840% 09/30/04 267,516 269,076
3.890% 09/30/04 1,400,637 1,408,807
3.850% 10/04/04 735,669 739,960
3.900% 10/13/04 189,067 190,170
METRIS COMPANIES., INC. Term Loan
10.992% 5/6/07 4,000,000 4,150,000
----------------------------------------------------------------------------
FINANCIAL INTERMEDIARIES
TOTAL 16,190,148
FOOD/DRUG RETAIL - 1.2%
MICHAEL FOODS, INC. Floater Term Loan
5.214% 11/20/11 3,000,000 3,088,125
Term Loan
3.964% 11/22/04 4,191,920 4,256,765
4.230% 11/22/04 353,535 359,004
4.240% 11/22/04 13,005 13,206
4.090% 11/26/04 404,040 410,290
----------------------------------------------------------------------------
FOOD/DRUG RETAIL TOTAL 8,127,390
FOOD PRODUCTS - 3.5%
BURNS PHILP, INC. Delayed Drraw Term Loan B
4.828% 02/20/09 6,559,332 6,649,523
INTERSTATE BRANDS CORP. Term Loan B
5.350% 09/24/04 389,873 363,557
3.336% 09/30/04 155,949 145,423
5.480% 11/22/04 389,874 363,557
Term Loan C
5.086% 09/30/04 238,791 222,673
4.920% 02/14/05 2,656,549 2,477,232
Tranche A
5.230% 11/19/04 166,667 155,417
5.420% 02/25/05 458,333 427,395
LUIGINO'S, INC. Term Loan B
4.313% 09/01/04 2,571,429 2,597,144
4.688% 09/30/04 1,917,321 1,936,494
MERISANT CO. Term Loan B
4.430% 01/11/10 791,995 796,252
PINNACLE FOODS CORP. Delayed Draw Term Loan
4.030% 09/30/04 18,000 18,225
4.200% 12/31/04 18,000 18,225
4.260% 01/04/05 7,146,000 7,235,325
----------------------------------------------------------------------------
FOOD PRODUCTS TOTAL 23,406,442
</Table>
See accompanying Notes to Financial Statements.
15
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
FOOD SERVICES - 0.4%
AFC ENTERPRISES, INC. Term Loan A
3.938% 09/13/04 295,039 291,351
4.250% 09/14/04 295,039 291,350
4.375% 09/30/04 225,494 222,675
DOMINO'S, INC. Term Loan
3.875% 06/25/10 2,115,161 2,151,185
----------------------------------------------------------------------------
FOOD SERVICES TOTAL 2,956,561
FOREST PRODUCTS - 2.5%
RLC INDUSTRIES CO. Term Loan B
3.640% 02/26/10 8,469,969 8,554,668
SOLO CUP, INC. Term Loan
4.086% 09/30/04 2,980,385 3,014,534
4.210% 11/01/04 3,984,615 4,030,271
SP NEWSPRINT CO. Term Loan
4.610% 01/08/10 350,556 355,376
Term Loan B
1.579% 01/09/08 644,444 654,111
----------------------------------------------------------------------------
FOREST PRODUCTS TOTAL 16,608,960
HEALTHCARE - 5.4%
AMERIPATH, INC. Term Loan
4.360% 03/27/10 3,220,000 3,244,150
COLGATE MEDICAL LTD. Term Loan B
4.340% 09/30/04 867,045 876,529
4.340% 09/28/04 795,455 804,155
CONCENTRA OPERATING CORP. Term Loan
4.120% 09/30/04 5,774 5,774
4.260% 11/26/04 2,303,896 2,303,896
DAVITA, INC. Term Loan B
3.160% 09/30/04 650,232 656,792
3.586% 09/30/04 650,232 656,792
3.600% 10/15/04 387,112 391,017
3.740% 11/23/04 387,111 391,017
3.870% 12/31/04 650,231 656,792
3.980% 01/31/05 229,400 231,714
DJ ORTHOPEDICS LLC Term Loan
3.875% 09/30/04 9,375 9,482
3.938% 10/29/04 196,875 199,092
4.250% 01/31/05 525,000 530,903
HANGER ORTHOPEDIC Term Loan B
4.340% 09/30/09 1,994,975 1,997,469
KINETIC CONCEPTS, INC. Term Loan B1
3.590% 08/11/10 1,664,992 1,687,885
</Table>
See accompanying Notes to Financial Statements.
16
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
HEALTHCARE - (CONTINUED)
KNOWLEDGE LEARNING CORP. Term Loan B
4.780% 09/03/04 106,383 107,181
4.880% 09/27/04 808,511 814,575
4.890% 09/30/04 42,220 42,536
6.500% 09/30/04 3,936,170 3,965,692
LEINER HEALTH PRODUCTS GROUP, INC. Term Loan B
4.590% 09/30/04 7,500 7,594
4.890% 12/31/04 2,992,500 3,029,906
MEDASSETS, INC. Second Lien Term Loan
11.150% 06/16/08 500,000 507,500
Senior Term Loan
5.900% 09/30/04 832,015 838,255
6.350% 09/30/04 107,143 107,947
MEDEX, INC. Term Loan
4.600% 05/30/09 1,980,000 2,002,687
MEDPOINTE, INC. Term Loan B
6.850% 09/30/04 7,079 7,108
6.950% 11/05/04 2,746,800 2,757,960
PACIFICARE HEALTH SYSTEMS, INC. Term Loan
4.100% 09/13/04 323,333 327,913
4.143% 10/13/04 333,333 338,056
4.210% 11/15/04 333,334 338,056
PERKINELMER, INC. Term Loan B
3.600% 09/24/04 3,912,088 3,949,578
5.750% 09/30/04 98,504 99,448
VICAR OPERATING, INC. Term Loan E
3.938% 06/30/09 2,493,750 2,531,156
----------------------------------------------------------------------------
HEALTHCARE TOTAL 36,416,607
HOME FURNISHINGS - 1.3%
HOLMES GROUP, INC. First Lien Term Loan
4.719% 09/13/04 693,182 689,716
4.850% 09/17/04 3,466 3,449
4.961% 11/19/04 689,716 686,267
JARDEN CORP. Term Loan B
3.836% 04/24/08 1,240,625 1,249,154
JUNO LIGHTING, INC. First Lien Term Loan
4.340% 10/01/04 1,927,273 1,956,182
4.620% 10/01/04 909,090 922,727
6.250% 11/30/04 10,682 10,842
SEALY MATTRESS CO. Term Loan C
4.063% 08/06/12 2,866,071 2,898,911
----------------------------------------------------------------------------
HOME FURNISHINGS TOTAL 8,417,248
</Table>
See accompanying Notes to Financial Statements.
17
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
INDUSTRIAL EQUIPMENT - 1.0%
AXIA, INC. Term Loan B
5.680% 09/13/04 250,000 252,969
5.890% 09/30/04 16,667 16,865
5.930% 11/12/04 233,333 236,104
5.990% 12/13/04 458,333 463,776
DRESSER, INC. Term Loan C
4.150% 04/10/09 1,014,673 1,030,051
TEREX CORP. Incremental Term Loan
3.890% 11/08/04 303,149 307,791
4.160% 12/07/04 359,629 365,136
Term Loan
3.160% 09/30/04 1,625,230 1,647,577
3.340% 10/29/04 1,625,230 1,647,577
3.781% 11/30/04 621,644 630,191
----------------------------------------------------------------------------
INDUSTRIAL EQUIPMENT TOTAL 6,598,037
LEISURE GOODS/ACTIVITIES/MOVIES - 4.0%
AMF BOWLING WORLDWIDE, INC. Term Loan B
4.150% 09/29/04 1,425,926 1,438,849
4.580% 09/30/04 2,037,037 2,055,499
6.500% 09/30/04 122,222 123,330
4.670% 10/29/04 1,208,472 1,219,424
4.760% 11/26/04 692,593 698,870
AMSCAN HOLDINGS, INC. Term Loan
4.350% 09/14/04 907,317 918,658
4.350% 10/14/04 195,122 197,561
4.591% 01/14/05 897,561 908,781
CNL HOSPITALITY PARTNERS LP Term Loan
4.313% 01/03/05 2,640,845 2,640,845
METRO-GOLDWYN-MAYER STUDIOS, INC. Term Loan B
4.140% 04/30/11 5,000,000 5,024,375
REGAL CINEMAS, INC. Term Loan
3.881% 11/10/10 2,901,591 2,937,861
SIX FLAGS THEME PARKS, INC. Term Loan B
4.040% 06/30/09 1,584,525 1,592,943
TRUE TEMPER SPORTS, INC. Term Loan
3.860% 09/07/04 995,000 985,050
4.210% 11/09/04 1,000,000 990,000
WARNER MUSIC GROUP Term Loan B
4.025% 10/22/04 1,250,000 1,267,858
4.319% 11/30/04 2,487,500 2,523,036
4.531% 11/24/04 1,237,500 1,255,179
----------------------------------------------------------------------------
LEISURE GOODS/ACTIVITIES/MOVIES
TOTAL 26,778,119
</Table>
See accompanying Notes to Financial Statements.
18
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
LODGING & CASINOS - 5.5%
OPBIZ Term Loan A
4.800% 08/31/10 (c) 8,239,367 8,113,498
Term Loan B
5.975% 08/31/10 (c) 19,057 18,766
ALLIANCE GAMING CORP. Term Loan B
3.788% 09/04/09 3,320,269 3,364,539
AMERISTAR CASINOS, INC. Term Loan B1
3.563% 12/20/06 787,505 798,087
BORA BORA LLC Term Loan
7.070% 12/31/05 5,000,000 5,087,500
BOYD GAMING CORP. Term Loan B
3.350% 09/30/04 2,000,000 2,022,188
3.690% 12/31/04 2,000,000 2,022,188
GLOBAL CASH ACCESS LLC Term Loan
4.390% 03/10/10 4,937,500 5,011,562
GREEN VALLEY RANCH GAMING LLC Term Loan B
4.336% 12/22/10 3,980,000 4,039,700
WYNDHAM INTERNATIONAL, INC. Term Loan I
6.375% 06/30/06 6,639,342 6,505,174
----------------------------------------------------------------------------
LODGING & CASINOS TOTAL 36,983,202
NONFERROUS METALS/MINERALS - 0.7%
CONSOL ENERGY, INC. Tranche B
3.990% 06/30/10 2,000,000 2,023,750
FAIRMOUNT MINERALS, LTD. First Lien Term Loan
4.850% 04/07/10 2,459,375 2,471,672
----------------------------------------------------------------------------
NONFERROUS METALS/MINERALS TOTAL 4,495,422
OIL & GAS - 5.8%
ALON USA, INC. Term Loan
10.000% 12/12/08 6,000,000 6,180,000
ATP OIL & GAS CORP. First Lien Term loan
10.500% 09/15/04 661,667 678,209
10.500% 09/30/04 666,667 683,334
10.500% 10/29/04 333,333 341,666
10.500% 01/31/05 333,333 341,666
Second Lien Term Loan
12.000% 09/15/04 701,786 819,335
12.000% 01/31/05 4,285,714 5,003,571
BELDEN & BLAKE CORP. Term Loan
6.000% 06/30/11 2,500,000 2,523,437
</Table>
See accompanying Notes to Financial Statements.
19
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
OIL & GAS - (CONTINUED)
DYNEGY HOLDINGS, INC. Term Loan
5.530% 05/27/10 3,000,000 3,057,189
GETTY PETROLEUM MARKETING, INC. Term Loan
4.840% 05/19/10 3,000,000 3,049,689
LA GRANGE ACQUISITION LP Term Loan
4.480% 09/03/04 551,724 560,000
4.640% 09/30/04 448,276 455,000
MAGELLAN MIDSTREAM HOLDINGS LP Tranche B
4.650% 06/17/08 507,766 515,382
PREMCOR REFINING GROUP Synthetic Tranche Facility
3.495% 04/13/09 1,000,000 1,010,625
PRIDE OFFSHORE, INC. Term Advances
3.340% 07/07/11 3,000,000 3,038,124
SECUNDA INTERNATIONAL LTD. Floating Rate Note
9.780% 09/01/12 4,500,000 4,432,500
TESORO PETROLEUM CORP. Fixed Asset Term Loan
7.100% 04/15/08 1,979,950 2,041,206
WESTERN REFINING CO. LP Term Loan B
5.140% 08/28/08 1,920,000 1,948,800
WILLIAMS PRODUCTION RMT CO. Term Loan C
4.100% 05/30/07 1,856,297 1,884,915
----------------------------------------------------------------------------
OIL & GAS TOTAL 38,564,648
PUBLISHING - 3.6%
ADAMS OUTDOOR ADVERTISING LP First Lien Term Loan
3.880% 10/15/11 1,500,000 1,518,124
DEX MEDIA EAST LLC Term Loan A
3.570% 09/09/04 895,476 906,296
3.580% 09/13/04 660,749 668,733
3.600% 09/20/04 615,421 622,857
3.590% 09/30/04 895,476 906,296
3.710% 11/08/04 1,119,345 1,132,870
3.760% 11/26/04 727,355 736,144
3.790% 11/30/04 911,894 922,912
DEX MEDIA WEST LLC Term Loan A
3.570% 09/09/04 780,274 790,677
3.580% 09/13/04 361,765 366,588
3.540% 09/20/04 478,804 485,188
3.590% 09/30/04 997,509 1,010,809
3.580% 10/08/04 580,772 588,515
3.700% 10/26/04 1,644,781 1,666,711
3.680% 11/12/04 319,203 323,459
3.730% 11/19/04 545,305 552,576
3.790% 11/30/04 987,755 1,000,925
</Table>
See accompanying Notes to Financial Statements.
20
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
PUBLISHING - (CONTINUED)
R.H. DONNELLY, INC. New Term B-2
3.630% 09/08/04 724,059 733,152
3.840% 09/08/04 160,960 162,981
3.800% 09/21/04 160,960 162,981
3.810% 09/23/04 160,960 162,981
3.840% 09/30/04 1,104,997 1,118,885
3.860% 10/04/04 160,961 162,981
3.840% 10/12/04 482,881 488,950
RELIZON CO. Term Loan
4.730% 02/20/11 1,793,333 1,803,421
TRANSWESTERN PUBLISHING CO. First Lien Term Loan
3.375% 09/30/04 1,625,000 1,638,712
3.875% 09/30/04 650,000 655,485
3.938% 04/26/05 2,500,000 2,521,094
----------------------------------------------------------------------------
PUBLISHING TOTAL 23,811,303
REAL ESTATE INVESTMENT TRUSTS - 0.7%
CENTRAL PARKING CORP. Term Loan B
4.336% 03/31/10 1,626,300 1,647,138
CRESCENT REAL ESTATE EQUITIES LP Term Loan
3.742% 09/01/04 519,822 525,833
3.850% 09/15/04 2,038,802 2,062,377
3.850% 09/20/04 318,182 321,861
----------------------------------------------------------------------------
REAL ESTATE INVESTMENTS TRUSTS TOTAL 4,557,209
RETAILERS - 1.3%
ADVANCE STORES CO., INC. Term Loan D
3.563% 09/07/04 131,333 133,016
3.750% 11/04/04 601,944 609,657
Term Loan E
3.375% 09/07/04 1,432,536 1,452,233
3.563% 09/07/04 531,341 538,647
3.750% 11/04/04 1,002,776 1,016,564
CH OPERATING LLC Term Loan
6.188% 09/30/04 206,897 207,414
6.188% 10/29/04 1,137,931 1,140,776
KEYSTONE AUTOMOTIVE INDUSTRIES, INC. Term Loan
6.000% 09/30/04 35,875 36,351
4.669% 12/17/04 995,516 1,008,738
4.671% 02/17/05 932,735 945,122
RAYOVAC CORP. Term Loan C
4.110% 09/23/04 548,896 555,185
4.100% 10/12/04 441,640 446,701
4.211% 11/15/04 630,915 638,144
----------------------------------------------------------------------------
RETAILERS TOTAL 8,728,548
</Table>
See accompanying Notes to Financial Statements.
21
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
STEEL - 0.9%
AMSTED INDUSTRIES, INC. Term Loan
5.590% 09/30/04 534,706 546,403
5.600% 09/30/04 141,176 144,264
5.710% 11/01/04 2,294,118 2,344,302
THE TECHS INDUSTRIES, INC. Term Loan
3.890% 01/14/10 2,962,500 2,969,906
----------------------------------------------------------------------------
STEEL TOTAL 6,004,875
SURFACE TRANSPORT - 3.3%
COMCAR INDUSTRIES, INC. Term Loan B
6.610% 09/20/04 2,850,000 2,835,750
6.615% 09/24/04 120,000 119,400
8.000% 11/01/04 15,000 14,925
LAIDLAW INVESTMENTS LTD. Term Loan B
5.500% 06/19/09 6,198,750 6,303,354
PACER INTERNATIONAL, INC. Term Loan
4.063% 09/15/04 39,216 39,780
4.188% 09/16/04 47,059 47,735
4.063% 11/12/04 286,216 290,330
4.438% 12/15/04 113,784 115,420
4.063% 04/14/05 215,686 218,786
QUALITY DISTRIBUTIONS, INC. PF Letters of Credit
1.000% 11/13/09 1,000,000 995,000
Term Loan
4.640% 09/30/04 154,343 153,571
4.600% 10/15/04 4,833,094 4,808,929
TRANSPORT INDUSTRIES LP Term Loan B
5.563% 06/13/10 3,000,000 3,005,625
TTI, INC. Term Loan
5.400% 09/30/04 42,957 43,315
4.985% 10/18/04 1,267,217 1,277,777
5.360% 10/18/04 1,153,651 1,163,264
YELLOW ROADWAY CORP. Credit Linked Certificate of Deposit
1.499% 06/11/08 545,455 550,398
Initial Term Loan
5.250% 06/11/08 194,805 196,571
----------------------------------------------------------------------------
SURFACE TRANSPORT TOTAL 22,179,930
TELECOMMUNICATIONS/CELLULAR - 5.5%
AIRGATES PCS, INC. Tranche 1
5.375% 09/30/04 545,045 543,683
5.438% 11/30/04 19,089 19,041
Tranche 2
5.438% 09/30/04 195,612 195,123
5.125% 10/25/04 333,623 332,789
</Table>
See accompanying Notes to Financial Statements.
22
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- -------------------------------------------- ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
TELECOMMUNICATIONS/CELLULAR - (CONTINUED)
5.625% 12/15/04 200,174 199,673
5.625% 12/31/04 200,174 199,673
5.750% 01/04/05 1,000,870 998,368
5.750% 02/09/05 600,521 599,020
5.750% 02/28/05 5,488,848 5,475,126
AMERICAN TOWER LP Term Loan B
3.880% 08/31/11 2,000,000 2,030,312
CONSOLIDATED COMMUNICATIONS, INC. Term Loan B
4.336% 09/30/04 1,666,667 1,689,584
4.350% 09/30/04 2,261,905 2,293,006
4.480% 11/19/04 3,571,428 3,620,535
NEXTEL PARTNERS OPERATING CORP. Term Loan C
4.313% 05/31/11 6,800,000 6,896,050
QWEST CORP. Term Loan A
6.500% 06/30/07 5,000,000 5,173,750
WESTERN WIRELESS CORP. Term Loan B
4.530% 09/07/04 3,538,461 3,592,171
4.600% 10/05/04 1,230,769 1,249,451
4.630% 10/21/04 615,385 624,726
4.670% 10/28/04 615,385 624,726
----------------------------------------------------------------------------
TELECOMMUNICATIONS/CELLULAR TOTAL 36,667,659
TELECOMMUNICATIONS/COMBINATION - 1.4%
ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC. Term Loan
4.875% 02/14/09 1,741,250 1,759,025
CENTENNIAL CELLULAR OPERATING CO. Tranche B
3.910% 09/30/04 6,875,000 6,899,172
4.338% 11/30/04 312,500 313,599
4.531% 11/30/04 275,000 275,967
----------------------------------------------------------------------------
TELECOMMUNICATIONS/COMBINATION TOTAL 9,247,763
TELECOMMUNICATIONS/WIRELESS - 0.2%
DOBSON CELLULAR SYSTEMS, INC. Revolver
5.100% 10/21/09 233,333 223,417
SPECTRASITE COMMUNICATIONS, INC. Incremental Term Loan
3.930% 12/31/07 1,118,866 1,135,649
----------------------------------------------------------------------------
TELECOMMUNICATIONS/WIRELESS TOTAL 1,359,066
TELECOMMUNICATIONS/WIRELINE - 0.7%
VALOR TELECOMMUNICATIONS ENTERPRISES II LLC Term Loan A
4.080% 09/10/04 1,471,927 1,476,527
4.140% 09/30/04 639,971 641,971
Term Loan B
5.330% 09/10/04 1,097,905 1,104,767
5.390% 09/30/04 1,232,793 1,240,498
----------------------------------------------------------------------------
TELECOMMUNICATIONS/WIRELINE TOTAL 4,463,763
</Table>
See accompanying Notes to Financial Statements.
23
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- -------------------------------------------- ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
UTILITIES - 9.5%
ALLEGHENY ENERGY SUPPLY CO. Term Loan C
5.830% 09/30/04 109,375 111,278
5.640% 11/10/04 5,500,000 5,595,677
6.190% 02/07/05 625,000 635,873
CALPINE CONSTRUCTION FINANCE CO., LP Term Loan
7.625% 08/26/09 4,974,874 5,328,090
CALPINE CORP. Second Lien
7.350% 07/16/07 6,633,000 5,638,050
CENTERPOINT ENERGY, INC. Term Loan
4.723% 10/07/06 4,959,459 4,983,637
INFRASOURCE, INC. Term Loan
4.590% 09/30/10 3,272,961 3,248,413
MIDWEST GENERATION LLC Term Loan
4.850% 10/01/04 742,500 752,709
4.890% 10/01/04 750,000 760,313
4.570% 10/27/04 1,500,000 1,520,625
MISSION ENERGY HOLDING CO. Term Loan
7.000% 09/01/04 875,000 879,375
7.000% 12/10/04 875,000 879,375
Term Loan B
9.110% 07/02/06 7,032,467 7,401,672
NORTHWESTERN CORP. Term Loan
7.100% 12/01/06 2,462,500 2,493,282
NRG ENERGY, INC. Credit Linked Deposit
5.500% 06/23/10 416,667 430,729
Term Loan
5.559% 06/23/10 738,363 763,467
NUI CORP. Closing Date Term Loan
6.559% 11/23/04 1,438,424 1,443,818
Term Loan
8.000% 11/23/04 7,335,963 7,363,473
ORION POWER MIDWEST LP Term Loan
4.610% 09/07/04 1,823,283 1,824,423
4.780% 09/07/04 97,242 97,303
4.890% 09/30/04 3,047,136 3,049,040
RIVERSIDE ENERGY CENTER LLC Term Loan
6.020% 06/24/11 2,785,336 2,813,190
ROCKY MOUNTAIN ENERGY CENTER LLC Credit-Linked Deposit
6.020% 06/24/11 212,396 214,520
Term Loan
6.020% 06/24/11 2,002,268 2,022,290
</Table>
See accompanying Notes to Financial Statements.
24
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- -------------------------------------------- ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a)
- (CONTINUED)
UTILITIES - (CONTINUED)
TNP ENTERPRISES, INC. Term Loan
6.725% 12/31/06 2,970,000 3,025,688
----------------------------------------------------------------------------
UTILITIES TOTAL 63,276,310
TOTAL VARIABLE RATE SENIOR
LOAN INTERESTS
(COST OF $697,958,321) 705,614,672
SENIOR NOTES - 0.1%
TELECOMMUNICATIONS/WIRELESS - 0.1%
CRICKET COMMUNICATIONS, INC. Senior Secured Note
1.000% 08/16/10 460,200 542,461
----------------------------------------------------------------------------
TELECOMMUNICATIONS/WIRELESS TOTAL 542,461
TOTAL SENIOR NOTES
(COST OF $0) 542,461
<Caption>
SHARES
----------------------------------------------------------------------------
COMMON STOCKS ( D) - 0.5%
BUSINESS SERVICES - 0.0%
NATG HOLDINGS LLC (c) 40,800 --
----------------------------------------------------------------------------
BUSINESS SERVICES TOTAL --
DIVERSIFIED MANUFACTURING - 0.1%
SUPERIOR TELECOM, INC. 47,459 630,730
----------------------------------------------------------------------------
DIVERSIFIED MANUFACTURING TOTAL 630,730
HEALTHCARE - 0.1%
SUN HEALTHCARE GROUP, INC. 84,117 723,406
----------------------------------------------------------------------------
HEALTHCARE TOTAL 723,406
TELECOMMUNICATIONS/WIRELESS - 0.3%
LEAP WIRELESS INTERNATIONAL, INC. 76,137 2,105,188
----------------------------------------------------------------------------
TELECOMMUNICATIONS/WIRELESS TOTAL 2,105,188
TOTAL COMMON STOCKS
(COST OF $4,001,785) 3,459,324
</Table>
See accompanying Notes to Financial Statements.
25
<Page>
<Table>
<Caption>
SHARES VALUE ($)
- -------------------------------------------- ----------------------------------------------------------------------------
PREFERRED STOCKS - 0.0%
DIVERSIFIED MANUFACTURING - 0.0%
SUPERIOR TELECOM, INC. (c) 14,382 14,382
----------------------------------------------------------------------------
DIVERSIFIED MANUFACTURING TOTAL 14,382
TOTAL PREFERRED STOCKS
(COST OF $14,382) 14,382
<Caption>
PAR($)
- -------------------------------------------- ----------------------------------------------------------------------------
SHORT-TERM OBLIGATION - 7.1%
Repurchase agreement with
State Street Bank & Trust
Co., dated 08/31/04 due
09/01/04 at 1.490%,
collateralized by a U.S.
Treasury Note maturing
08/15/05, market value of
$48,430,525 (repurchase
proceeds $47,480,965)
(cost of $47,479,000) 47,479,000 47,479,000
TOTAL INVESTMENTS - 113.3%
(COST OF $749,453,488)(e) 757,109,839
OTHER ASSETS & LIABILITIES, NET - (13.3)% (88,535,492)
NET ASSETS - 100.0% 668,574,347
</Table>
NOTES TO INVESTMENT PORTFOLIO:
(a) Senior Loans in which the Fund invests generally pay interest at rates
which are periodically redetermined by reference to a base lending rate
plus a premium. These base lending rates are generally (i) the prime rate
offered by one or more major United States banks, (ii) the lending rate
offered by one or more European banks such as the London Inter-Bank Offered
Rate ("LIBOR") and (iii) the certificate of deposit rate. Senior loans are
generally considered to be restricted in that the Fund ordinarily is
contractually obligated to receive approval from the Agent Bank and/or
borrower prior to the disposition of a Senior Loan.
(b) Additional unfunded commitment, see note 8.
(c) Represents fair value as determined in good faith under the direction of
the Board of Trustees.
(d) Non-income producing security.
(e) Cost for federal income tax purposes is $749,814,616.
See accompanying Notes to Financial Statements.
26
<Page>
STATEMENT OF ASSETS AND LIABILITIES
AUGUST 31, 2004 HIGHLAND FLOATING RATE ADVANTAGE FUND
<Table>
<Caption>
($)
- ----------------------------------- ------------------------------------------------------------------------------------
ASSETS Investments, at cost 749,453,488
--------------
Investments, at value 757,109,839
Cash 756
Receivable for:
Investments sold 314,013
Fund shares sold 4,436,619
Interest and fees 3,791,986
Expense reimbursement due from Investment Advisor 209,953
Deferred Trustees' compensation plan 5,055
--------------
Total Assets 765,868,221
LIABILITIES Deferred facility fees 253,923
Payable for:
Distributions 818,137
Investment advisory fee 283,452
Administration fee 126,297
Transfer agent fee 81,579
Pricing and bookkeeping fees 66,927
Trustees' fees 108
Custody fee 7,717
Distribution and service fees 332,901
Interest expense 134,092
Deferred Trustees' fees 5,055
Other liabilities 183,686
Notes payable 95,000,000
--------------
Total Liabilities 97,293,874
NET ASSETS 668,574,347
COMPOSITION OF NET ASSETS Paid-in capital 664,492,387
Overdistributed net investment income (215,539)
Accumulated net realized loss (3,358,852)
Net unrealized appreciation on investments 7,656,351
--------------
NET ASSETS 668,574,347
CLASS A Net assets 212,204,568
Shares outstanding 17,564,848
Net asset value per share 12.08(a)
Maximum offering price per share ($12.08/0.9650) 12.52(b)
CLASS B Net assets 124,589,114
Shares outstanding 10,312,802
Net asset value and offering price per share 12.08(a)
CLASS C Net assets 278,731,246
Shares outstanding 23,071,027
Net asset value and offering price per share 12.08(a)
CLASS Z Net assets 53,049,419
Shares outstanding 4,390,867
Net asset value, offering and redemption price per share 12.08
</Table>
(a) Redemption price per share is equal to net asset value less any applicable
contingent deferred sales charge.
(b) On sales of $100,000 or more the offering price is reduced.
See accompanying Notes to Financial Statements.
27
<Page>
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED AUGUST 31, 2004
<Table>
<Caption>
($)
- --------------------------------------- -------------------------------------------------------------------------------
INVESTMENT INCOME Interest 28,141,699
Dividends 44,246
Facility and other fees 2,135,656
--------------
Total Investment Income 30,321,601
EXPENSES Investment advisory fee 2,582,639
Administration fee 1,149,451
Distribution fee:
Class A 153,121
Class B 473,453
Class C 1,116,380
Service fee:
Class A 382,802
Class B 263,030
Class C 465,158
Transfer agent fee 670,412
Pricing and bookkeeping fees 294,159
Trustees' fees 16,417
Custody fee 30,582
Other expenses 523,679
--------------
Total Operating Expenses 8,121,283
Interest expense 1,219,796
Commitment fee 664,440
--------------
Total Expenses 10,005,519
Fees and expenses waived or reimbursed by
Investment Advisor (830,065)
Custody earnings credit (514)
--------------
Net Expenses 9,174,940
--------------
Net Investment Income 21,146,661
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS Net realized gain on investments 9,871,654
Net change in unrealized
appreciation/depreciation
on investments 16,802,971
--------------
Net Gain 26,674,625
--------------
Net Increase in Net Assets
from Operations 47,821,286
</Table>
See accompanying Notes to Financial Statements.
28
<Page>
STATEMENT OF CHANGES IN NET ASSETS
<Table>
<Caption>
YEAR ENDED AUGUST 31 2004 ($) 2003 ($)
- -------------------------------------- ------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS:
OPERATIONS Net investment income 21,146,661 14,268,045
Net realized gain (loss) on investments 9,871,654 (4,458,140)
Net change in unrealized appreciation/depreciation
on investments 16,802,971 16,553,299
-------------------------------
Net Increase from Operations 47,821,286 26,363,204
DISTRIBUTIONS DECLARED TO SHAREHOLDERS From net investment income:
Class A (7,362,637) (4,987,877)
Class B (4,785,071) (4,852,868)
Class C (7,927,327) (4,288,202)
Class Z (1,318,999) (60,225)
-------------------------------
Total Distributions Declared to Shareholders (21,394,034) (14,189,172)
SHARE TRANSACTIONS Class A:
Subscriptions 155,278,295 26,844,332
Distributions reinvested 4,387,935 3,108,790
Redemptions (41,293,262) (18,545,181)
-------------------------------
Net Increase 118,372,968 11,407,941
Class B:
Subscriptions 55,799,014 15,460,982
Distributions reinvested 2,714,846 2,841,144
Redemptions (17,134,851) (14,388,694)
-------------------------------
Net Increase 41,379,009 3,913,432
Class C:
Subscriptions 208,181,539 31,262,179
Distributions reinvested 5,151,429 2,853,491
Redemptions (24,993,138) (19,111,456)
-------------------------------
Net Increase 188,339,830 15,004,214
Class Z:
Subscriptions 50,799,735 4,975,535
Distributions reinvested 465,119 2,309
Redemptions (4,503,807) (23,102)
-------------------------------
Net Increase 46,761,047 4,954,742
Net Increase from Share
Transactions 394,852,854 35,280,329
-------------------------------
Total Increase in Net Assets 421,280,106 47,454,361
NET ASSETS Beginning of period 247,294,241 199,839,880
End of period (including overdistributed net
investment income of $(215,539) and $(59,212),
respectively) 668,574,347 247,294,241
</Table>
See accompanying Notes to Financial Statements.
29
<Page>
<Table>
<Caption>
YEAR ENDED AUGUST 31 2004 ($) 2003 ($)
- -------------------------------------- ------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS:
CHANGES IN SHARES Class A:
Subscriptions 13,068,545 2,421,540
Issued for distributions reinvested 368,106 294,027
Redemptions (3,460,892) (1,778,375)
-------------------------------
Net Increase 9,975,759 937,192
Class B:
Subscriptions 4,712,112 1,412,670
Issued for distributions reinvested 228,200 268,398
Redemptions (1,433,835) (1,376,098)
-------------------------------
Net Increase 3,506,477 304,970
Class C:
Subscriptions 17,547,735 2,837,998
Issued for distributions reinvested 431,547 269,627
Redemptions (2,088,151) (1,823,827)
-------------------------------
Net Increase 15,891,131 1,283,798
Class Z:
Subscriptions 4,267,378 449,963
Issued for distributions reinvested 38,768 210
Redemptions (376,712) (2,073)
-------------------------------
Net Increase 3,929,434 448,100
</Table>
See accompanying Notes to Financial Statements.
30
<Page>
STATEMENT OF CASH FLOWS
HIGHLAND FLOATING RATE ADVANTAGE FUND
<Table>
<Caption>
YEAR ENDED
AUGUST 31, 2004 ($)
- ---------------------------------------------- -------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH
CASH FLOWS USED FOR OPERATING ACTIVITIES Net investment income 21,146,661
ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME Purchase of investment securities (968,665,713)
TO NET CASH USED FOR OPERATING ACTIVITIES Proceeds from disposition of investment securities 568,377,752
Purchase of short-term portfolio investments, net (27,716,000)
Increase in interest and fees receivable (2,062,289)
Increase in receivable for expense reimbursement (209,953)
Decrease in receivable for investments sold 780,365
Decrease in other assets 2,196
Decrease in deferred facility fees (69,713)
Increase in payable for accrued expenses 456,921
Net amortization of premium (discount) (2,066,647)
Decrease in payable for investments purchased (60,571)
Decrease in payable for expense reimbursement (37,094)
Increase in other liabilities 75,014
-------------------
Net cash used for operating activities (410,049,071)
CASH FLOWS FROM FINANCING ACTIVITIES Increase in notes payable 35,500,000
Increase in interest payable 60,654
Proceeds from shares sold 470,741,466
Payment of shares redeemed (87,925,058)
Distributions paid in cash (8,327,728)
-------------------
Net cash flows from financing activities 410,049,334
-------------------
Net increase in cash 263
-------------------
CASH Cash at beginning of the year 493
-------------------
Cash at end of the year 756
</Table>
See accompanying Notes to Financial Statements.
31
<Page>
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2004 HIGHLAND FLOATING RATE ADVANTAGE FUND
NOTE 1. ORGANIZATION
Highland Floating Rate Advantage Fund (the "Fund"), formerly Columbia Floating
Rate Advantage Fund, is a Massachusetts business trust registered under the
Investment Company Act of 1940, as amended, as a non-diversified, closed-end
management investment company.
Effective October 13, 2003, the Fund changed its name from Liberty Floating Rate
Advantage Fund to Columbia Floating Rate Advantage Fund.
Effective October 18, 2004, Columbia Floating Rate Advantage Fund was renamed
Highland Floating Rate Advantage Fund.
INVESTMENT GOAL
The Fund seeks to provide a high level of current income consistent with
preservation of capital.
FUND SHARES
The Fund may issue an unlimited number of shares and offers four classes of
shares: Class A, Class B, Class C and Class Z. Each share class has its own
sales charge and expense structure.
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 are subject to a 1.00% early withdrawal charge on shares sold
within eighteen months on an original purchase of $1 million to $25 million.
Class B shares are subject to a maximum early withdrawal charge of 3.25% based
upon the holding period after purchase. Class B shares will convert to Class A
shares eight years after purchase. Class C shares are subject to a 1.00% early
withdrawal charge on shares sold within one year after purchase. Class Z shares
are offered continuously at net asset value. 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 Portfolio is determined in accordance with guidelines
established and periodically reviewed by the Board of Trustees. Senior loans are
generally valued using market prices or quotations provided by banks, dealers or
pricing services with respect to secondary market transactions. The prices
provided by these principal market makers may differ from the value that would
be realized if the loans were sold and the difference could be material to the
financial statements. In the absence of actual market values, the senior loans
will be valued at fair value, which is intended to approximate market value,
pursuant to procedures approved by the Board of Trustees. In determining fair
value, the following factors, among others, will be considered on an on-going
basis: (i) the creditworthiness of the Borrower; (ii) the current interest rate,
the interest rate redetermination period and maturity of such senior loan
interests; and (iii) recent prices in the market for instruments of similar
quality, rate and interest rate redeterminiation period and maturity. Because of
uncertainty inherent in the valuation process, the estimated value of a senior
loan may differ significantly from the value that would have been used had there
been market activity for that senior loan interest.
Equity securities are valued at the last sale price on the principal exchange on
which they trade, except for securities traded on the NASDAQ, which are valued
at the NASDAQ official close price. Unlisted securities or listed securities for
which there were no sales during the day are valued at the closing bid price on
such exchanges or over-the-counter markets.
Short-term debt obligations maturing within 60 days are valued at amortized
cost, which approximates market value.
Investments for which market quotations are not readily available, or quotations
which management believes are not appropriate, are valued at fair value as
determined in good faith under consistently applied procedures established by
and under the general supervision of the Board of Trustees.
32
<Page>
SECURITY TRANSACTIONS
Security transactions are accounted for on the trade date. Cost is determined
and gains (losses) are based upon the specific identification method for both
financial statement and federal income tax purposes.
REPURCHASE AGREEMENTS
The Fund may engage in repurchase agreement transactions with institutions that
the Fund's investment advisor 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. Facility fees received are treated as
market discounts. 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 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, as amended, and will distribute
substantially all of its taxable income, if any, for its tax year, and as such
will not be subject to federal income taxes.
DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income are declared daily and paid monthly. Net
realized capital gains, if any, are distributed at least annually.
STATEMENT OF CASH FLOWS
Information on financial transactions which have been settled through the
receipt or disbursement of cash is presented in the Statement of Cash Flows. The
cash amount shown in the Statement of Cash Flows is the amount included within
the Fund's Statement of Assets and Liabilities and includes cash on hand at its
custodian bank and does not include any short-term investments.
NOTE 3. FEDERAL TAX INFORMATION
The timing and character of income and capital gain distributions are determined
in accordance with income tax regulations, which may differ from GAAP.
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, 2004, permanent differences resulting primarily
from differing treatments for discount accretion/premium amortization on debt
securities were identified and reclassified among the components of the Fund's
net assets as follows:
<Table>
<Caption>
OVERDISTRIBUTED ACCUMULATED
NET INVESTMENT NET REALIZED PAID-IN
INCOME LOSS CAPITAL
- ----------------------------------------------------------------------
$ 91,046 $ (91,045) $ (1)
</Table>
Net investment income and net realized gains (losses), as disclosed on the
Statement of Operations, and net assets were not affected by this
reclassification.
The tax character of distributions paid during the years ended August 31, 2004
and August 31, 2003 was as follows:
<Table>
<Caption>
AUGUST 31, AUGUST 31,
2004 2003
- ------------------------------------------------------------------------
Distributions paid from:
Ordinary Income* $ 21,394,034 $ 14,189,172
Long-Term Capital Gains -- --
</Table>
*For tax purposes short-term capital gains distributions, if any, are considered
ordinary income distributions.
33
<Page>
As of August 31, 2004, the components of distributable earnings on a tax basis
were as follows:
<Table>
<Caption>
UNDISTRIBUTED UNDISTRIBUTED
ORDINARY LONG-TERM NET UNREALIZED
INCOME CAPITAL GAINS APPRECIATION*
- --------------------------------------------------------------------------
$ 843,934 $ -- $ 7,295,223
</Table>
*The differences between book-basis and tax-basis net unrealized
appreciation/depreciation are primarily due to deferral of losses from wash
sales.
Unrealized appreciation and depreciation at August 31, 2004, based on cost of
investments for federal income tax purposes and excluding any unrealized
appreciation and depreciation from changes in the value of other assets and
liabilities resulting from changes in exchange rates, was:
<Table>
Unrealized appreciation $ 45,460,523
Unrealized depreciation (38,165,300)
-------------
Net unrealized appreciation $ 7,295,223
</Table>
The following capital loss carryforwards may be available to reduce taxable
income arising from future net realized gains on investments, if any, to the
extent permitted by the Internal Revenue Code:
<Table>
<Caption>
YEAR OF CAPITAL LOSS
EXPIRATION CARRYFORWARD
- --------------------------------------------------------------------------------
2011 $ 3,234,575
</Table>
Capital loss carryforwards of $2,420,026 were utilized during the year ended
August 31, 2004 for the Fund.
NOTE 4. FEES AND COMPENSATION PAID TO AFFILIATES
Effective April 15, 2004, Highland Capital Management, L.P. ("Highland") is the
investment advisor to the Fund. Prior to April 15, 2004, Columbia Management
Advisors, Inc. ("Columbia") was the investment advisor to the Fund. Columbia was
an indirect, wholly owned subsidiary of FleetBoston Financial Corporation
("FleetBoston"), however effective April 1, 2004, FleetBoston, including the
Funds' investment advisor, transfer agent and distributor, was acquired by Bank
of America Corporation ("BOA"). The change in investment advisor will not impact
the Fund's investment strategy.
INVESTMENT ADVISORY FEE
Highland receives a monthly investment advisory fee based on the Portfolio's
average daily managed net assets at the following annual rates:
<Table>
<Caption>
AVERAGE DAILY NET ASSETS ANNUAL FEE RATE
- --------------------------------------------------------------------------------
First $1 billion 0.45%
Next $1 billion 0.40%
Over $2 billion 0.35%
</Table>
For the period November 1, 2003 through April 14, 2004, Columbia received a
monthly investment advisory fee based on the same fee schedule. Prior to
November 1, 2003, Columbia was entitled to receive a monthly investment advisory
fee at the annual rate of 0.45% of the Fund's average daily managed net assets.
For the year ended August 31, 2004, the Fund's effective investment advisory fee
rate was 0.45%.
ADMINISTRATION FEES
During the year ended August 31, 2004, Columbia provided administrative and
other services to the Fund for a monthly administration fee at the annual rate
of 0.20% of the Fund's average daily managed net assets.
Effective October 18, 2004, Highland replaced Columbia to provide administrative
services to the Fund for a monthly administration fee at the annual rate of
0.20% of the Fund's average daily managed assets. Also effective October 18,
2004, under a separate agreement, Highland has delegated certain administrative
functions to PFPC, Inc. ("PFPC"). PFPC receives from Highland a fee at the
annual rate of 0.01% of the Fund's average daily managed assets.
PRICING AND BOOKKEEPING FEES
During the year ended August 31, 2004, Columbia was responsible for providing
pricing and bookkeeping services to the Fund under a pricing and bookkeeping
agreement. Under a separate agreement (the "Outsourcing Agreement"), Columbia
delegated those functions to State Street Corporation ("State Street"). As a
result, Columbia paid the total fees collected to State Street under the
Outsourcing Agreement.
Under its pricing and bookkeeping agreement with the Fund, Columbia received
from the Fund an annual flat fee of $10,000 paid monthly, and in any month that
the Fund's average daily net assets exceeded $50 million, an additional monthly
fee. The additional fee rate was
34
<Page>
calculated by taking into account the fees payable to State Street under the
Outsourcing Agreement. This rate is applied to the average daily net assets of
the Fund for that month. The Fund also paid additional fees for pricing services
based on the number of securities held by the Fund. For the year ended August
31, 2004, the Fund's effective pricing and bookkeeping fee rates, inclusive of
out-of-pocket expenses, was 0.062%
Effective October 18, 2004, the pricing and bookkeeping agreement with Columbia
was terminated, and the Fund entered into a new agreement with PFPC to provide
accounting services.
TRANSFER AGENT FEE
During the year ended August 31, 2004, Columbia Funds Services, Inc. (the
"Transfer Agent"), an affiliate of Columbia, provided shareholder services to
the Fund. For such services, the Transfer Agent received a fee, paid monthly, at
the annual rate of $34.00 per open account. The Transfer Agent also received
reimbursement for certain out-of-pocket expenses.
Prior to November 1, 2003, the Transfer Agent was entitled to receive a monthly
transfer agent fee, in addition to reimbursement for certain out-of-pocket
expenses, at the annual rate of 0.06% of the Fund's average daily net assets
plus flat-rate charges based on the number of shareholder accounts and
transactions. For the year ended August 31, 2004, the Fund's effective transfer
agent fee rate, inclusive of out-of-pocket expenses, was 0.14%.
Effective October 18, 2004, PFPC replaced Columbia Funds Services, Inc., to
provide shareholder services to the Fund.
UNDERWRITING DISCOUNTS, SERVICE AND DISTRIBUTION FEES
Effective April 15, 2004, PFPC Distributors, Inc. replaced Columbia Funds
Distributor, Inc. ("CFDI"), an affiliate of Columbia, as the principal
underwriter of the Fund, in connection with the change in investment advisor.
For the period September 1, 2003 to April 15, 2004, CFDI retained net
underwriting discounts of $71,053 on sales of the Fund's Class A shares and
received early withdrawal charges ("EWC") of $61,419, $218,781 and $78,661 on
Class A, Class B and Class C share redemptions, respectively.
The Fund has adopted a 12b-1 plan (the "Plan") which requires the payment of a
monthly service fee to the Distributor at the annual rate of 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 at the annual rates of 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 EWC and the fees received from the Plan are used principally as repayment to
the Distributor for amounts paid by the Distributor to dealers who sold such
shares.
EXPENSE LIMITS AND FEE REIMBURSEMENTS
Highland has voluntarily agreed to waive fees and reimburse certain expenses to
the extent that total expenses (exclusive of investment advisory fees,
administration fees, distribution and service fees, brokerage commissions,
interest, facility fees, taxes and extraordinary expenses, if any) exceed 0.15%
annually of the Fund's average daily managed net assets. This arrangement may be
revised or discontinued by Highland at any time. Prior to April 15, 2004,
Columbia voluntarily waived fees and reimbursed certain expenses of the Fund
based on the same fee structure.
CUSTODY CREDITS
During the year ended August 31, 2004, the Fund had an agreement with its
custodian bank under which custody fees may be reduced by balance credits. The
Fund could have invested a portion of the assets utilized in connection with the
expense offset arrangement in an income-producing asset if it had not entered
into such an agreement.
Effective October 18, 2004, the agreement with its former custodian bank was
terminated.
FEES PAID TO OFFICERS AND TRUSTEES
Effective August 5, 2004, new officers of the Fund were elected. The Fund pays
no compensation to these officers, all of whom are employees of Highland. Prior
to this date, all of the Fund's officers were employees of Columbia or its
affiliates. The Fund's previous officers also received no compensation from the
Fund.
Effective July 30, 2004, the shareholders of the Fund voted to elect a new Board
of Trustees in connection with the change in Investment Advisor. Each Trustee of
the Fund is paid a flat rate fee of $20,000 per year for services provided as a
Board member of the Fund.
35
<Page>
Prior to July 30, 2004, the previous Trustees of the Fund participated in a
deferred compensation plan. Any continuing obligations of the plan will be paid
solely out of the Fund's assets.
OTHER
Columbia provided certain services to the Fund related to Sarbanes-Oxley
compliance. For the year ended August 31, 2004, the Fund paid $1,704 to Columbia
for such services. This amount is included in "Other expenses" on the Statement
of Operations.
NOTE 5. PORTFOLIO INFORMATION
For the year ended August 31, 2004, the cost of purchases and proceeds from
sales of securities, excluding short-term obligations, were $968,665,713 and
$568,377,752, respectively.
NOTE 6. TENDER OF SHARES
The Board of Trustees has adopted a policy of making tender offers on a
quarterly basis. The Board has designated the 15th day of February, May, August
and November of each year, or the next business day if the 15th is not a
business day, as the Repurchase Request Deadline. Tender offers are made for a
portion of the Fund's outstanding shares at the net asset value of the shares as
of the Repurchase Pricing Date. The tender amount, which is determined by the
Board of Trustees, will be at least 5% and no more than 25% of the total number
of shares outstanding on the Repurchase Request Deadline. The Fund may
repurchase an additional amount of shares up to 2% of the shares outstanding on
the Repurchase Request Deadline if the shareholders' offer for repurchase
exceeds the Repurchase Offer Amount. For the year ended August 31, 2004, there
were four tender offers in November, February, May and August. For each tender,
the Fund offered to repurchase 10%, 25%, 15% and 25%, respectively, of its
shares, and 4.59%, 3.03%, 4.13% and 4.98%, respectively, of shares outstanding
were tendered.
NOTE 7. SENIOR LOAN PARTICIPATION COMMITMENTS
The Fund invests primarily in participations and assignments, or acts as a party
to the primary lending syndicate of Variable Rate Senior Loan interests to
United States corporations, partnerships, and other entities. If the lead lender
in a typical lending syndicate becomes insolvent, enters FDIC receivership or,
if not FDIC insured enters into bankruptcy, the Fund may incur certain costs and
delays in receiving payment or may suffer a loss of principal and/or interest.
When the Fund purchases a participation of a senior loan interest, the Fund
typically enters into a contractual agreement with the lender or other third
party selling the participation, not with the borrower directly. As such, the
Fund assumes the credit risk of the Borrower, Selling Participant or other
persons interpositioned between the Fund and the Borrower. The ability of
Borrowers to meet their obligations may be affected by economic developments in
a specific industry.
At August 31, 2004, the following sets forth the selling participants with
respect to interests in senior loans purchased by the Fund on a participation
basis.
<Table>
<Caption>
PRINCIPAL
SELLING PARTICIPANT AMOUNT VALUE
- --------------------------------------------------------------------------------
Citibank:
CSC Holdings, Inc.
Revolver $ 2,337,500 $ 2,379,180
CSFB:
Quality Distributions, Inc.
PF Letters of Credit 1,000,000 995,000
</Table>
NOTE 8. UNFUNDED LOAN COMMITMENTS
As of August 31, 2004, the Fund had unfunded loan commitments of $6,822,849,
which could be extended at the option of the Borrower, pursuant to the following
loan agreements:
<Table>
<Caption>
UNFUNDED
BORROWER COMMITMENT
- --------------------------------------------------------------------------------
CSC Holdings, Inc. $ 593,750
Dobson Cellular Systems, Inc. 1,016,667
Federal-Mogul Corp. 125,765
National Equipment Service - Revolver 586,667
Vought Aircraft Industries, Inc. - Revolver 4,500,000
------------
$ 6,822,849
</Table>
NOTE 9. LOAN AGREEMENT
At August 31, 2004, the Fund had one term loan outstanding with Citicorp North
America, Inc., totaling $95,000,000, which bore interest at 1.67% per annum, due
October 18, 2004. The Fund could borrow up to $150,000,000. The average daily
loan balance was $104,195,915 at a weighted average interest rate of 1.19%. The
Fund was required to maintain certain asset coverage with respect to the loan.
36
<Page>
Effective October 18, 2004, the Fund entered into a new $300,000,000 loan
agreement replacing the previous agreement. The Fund is required to maintain
certain asset coverage with respect to amounts outstanding under the agreement.
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 or principal. Non-payment would result in a
reduction of income to the Portfolio, a reduction in the value of the Senior
Loan experiencing non-payment and a potential decrease in the net asset value of
the Fund/Portfolio.
CREDIT RISK
Securities 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
interest payments. Investments in high-yield Senior Loans may result in greater
net asset value fluctuation than if the Fund/Portfolio did not make such
investments.
LEGAL PROCEEDINGS
Columbia, CFDI, certain of their affiliates and the Fund (collectively, "the
Columbia Group"), have received information requests and subpoenas from various
regulatory and law enforcement authorities in connection with their
investigations of late trading and market timing in mutual funds as well as
other industry wide issues.
On February 24, 2004, the Securities and Exchange Commission ("SEC") filed a
civil complaint in the United States District Court for the District of
Massachusetts against Columbia and CFDI, alleging that they had violated certain
provisions of the federal securities laws in connection with trading activity in
mutual fund shares. Also on February 24, 2004, the New York Attorney General
("NYAG") filed a civil complaint in New York Supreme Court, County of New York
against Columbia and CFDI alleging that Columbia and CFDI had violated certain
New York anti-fraud statutes. On March 15, 2004, Columbia and CFDI entered into
agreements in principle with the SEC Division of Enforcement and NYAG in
settlement of the charges. In a separate agreement with the NYAG, the Columbia
Group and its affiliate Bank of America Capital Management, LLC have agreed to
collectively reduce mutual fund fees by $160 million over a five-year period.
As a result of these matters or any adverse publicity or other developments
resulting from them, there may be increased redemptions or reduced sales of Fund
shares, which could increase transaction costs or operating expenses, or have
other adverse consequences for the Fund.
In connection with the events described in detail above, various parties have
filed suit against certain funds (including the Fund), their Boards and/or
FleetBoston (and affiliated entities). More than 300 cases (including those
filed against entities unaffiliated with the funds, their Boards and/or
FleetBoston and its affiliated entities) have been consolidated in a
multi-district proceeding and transferred to the Federal District Court in
Maryland. Recently, certain Columbia fund and affiliated entities and the Fund
have been named as defendants in several derivative actions under various
sections of the Investment Company Act of 1940, as amended, alleging, among
other things, that the fees and expenses paid by those funds are excessive. The
funds and the other defendants to these actions, including Columbia and various
affiliates, certain other mutual funds advised by Columbia and its affiliates,
and various directors of such funds and the Fund have denied these allegations
and are contesting the plaintiffs' claims. These suits and certain regulatory
investigations are ongoing, however, based on currently available information,
Columbia believes that these lawsuits are without merit, and that the likelihood
they will have a material adverse impact on any fund is remote.
37
<Page>
FINANCIAL HIGHLIGHTS
HIGHLAND FLOATING RATE ADVANTAGE FUND
SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
<Table>
<Caption>
PERIOD ENDED
YEAR ENDED AUGUST 31, AUGUST 31,
CLASS A SHARES 2004 2003 2002 2001 2000(a)
- -----------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 11.22 $ 10.48 $ 11.74 $ 12.09 $ 12.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment income 0.56(b) 0.81(b) 0.83(b)(c) 1.10(b) 0.64
Net realized and unrealized gain (loss)
on investments 0.89 0.74 (1.26)(c) (0.32) 0.07
--------- --------- --------- --------- ---------
Total from Investment Operations 1.45 1.55 (0.43) 0.78 0.71
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.59) (0.81) (0.83) (1.13) (0.62)
From net realized gains -- -- -- --(d) --
--------- --------- --------- --------- ---------
Total Distributions Declared
to Shareholders (0.59) (0.81) (0.83) (1.13) (0.62)
NET ASSET VALUE, END OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.09
Total return (e) (f) 13.14% 15.55% (3.88)% 6.71% 6.04%(g)
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL
DATA:
Operating expenses (h) 1.29% 1.38% 1.38% 1.37% 1.01%(i)
Interest and commitment fees expenses 0.40% 0.73% 0.99% 2.04% 1.91%(i)
Net expenses (h) 1.69% 2.11% 2.37% 3.41% 2.92%(i)
Net investment income (h) 4.73% 7.67% 7.25%(c) 9.24% 9.49%(i)
Waiver/reimbursement 0.18% 0.36% 0.32% 0.32% 1.41%(i)
Portfolio turnover rate 110% 90% 98% 65% 8%(g)
Net assets, end of period (000's) $ 212,205 $ 85,166 $ 69,733 $ 108,399 $ 54,402
</Table>
(a) The Fund commenced investment operations on January 13, 2000.
(b) Per share data was calculated using average shares outstanding during the
period.
(c) 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, to 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.
(d) Rounds to less than $0.01.
(e) Total return at net asset value assuming all distributions reinvested and
no initial sales charge or early withdrawal charge.
(f) Had the Investment Advisor not waived or reimbursed a portion of expenses,
total return would have been reduced.
(g) Not annualized.
(h) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
(i) Annualized.
38
<Page>
<Table>
<Caption>
PERIOD ENDED
YEAR ENDED AUGUST 31, AUGUST 31,
CLASS B SHARES 2004 2003 2002 2001 2000(a)
- -----------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 11.22 $ 10.48 $ 11.74 $ 12.07 $ 12.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment income 0.53(b) 0.78(b) 0.78(b)(c) 1.05(b) 0.62
Net realized and unrealized gain (loss)
on investments 0.88 0.73 (1.25)(c) (0.30) 0.05
--------- --------- --------- --------- ---------
Total from Investment Operations 1.41 1.51 (0.47) 0.75 0.67
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.55) (0.77) (0.79) (1.08) (0.60)
From net realized gains -- -- -- --(d) --
--------- --------- --------- --------- ---------
Total Distributions Declared
to Shareholders (0.55) (0.77) (0.79) (1.08) (0.60)
NET ASSET VALUE, END OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07
Total return (e) (f) 12.75% 15.16% (4.22)% 6.52% 5.69%(g)
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL
DATA:
Operating expenses (h) 1.64% 1.73% 1.73% 1.72% 1.36%(i)
Interest and commitment fees expenses 0.40% 0.73% 0.99% 2.04% 1.91%(i)
Net expenses (h) 2.04% 2.46% 2.72% 3.76% 3.27%(i)
Net investment income (h) 4.50% 7.34% 6.90%(c) 8.89% 9.14%(i)
Waiver/reimbursement 0.18% 0.36% 0.32% 0.32% 1.41%(i)
Portfolio turnover rate 110% 90% 98% 65% 8%(g)
Net assets, end of period (000's) $ 124,589 $ 76,379 $ 68,157 $ 80,609 $ 19,964
</Table>
(a) The Fund commenced investment operations on January 13, 2000.
(b) Per share data was calculated using average shares outstanding during the
period.
(c) 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, to 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.
(d) Rounds to less than $0.01.
(e) Total return at net asset value assuming all distributions reinvested and
no early withdrawal charge.
(f) Had the Investment Advisor not waived or reimbursed a portion of expenses,
total return would have been reduced.
(g) Not annualized.
(h) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01.
(i) Annualized.
39
<Page>
<Table>
<Caption>
PERIOD ENDED
YEAR ENDED AUGUST 31, AUGUST 31,
CLASS C SHARES 2004 2003 2002 2001 2000(a)
- -----------------------------------------------------------------------------------------------------------------------------
$ 11.22 $ 10.48 $ 11.74 $ 12.07 $ 12.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment income 0.50(b) 0.76(b) 0.76(b)(c) 1.03(b) 0.61
Net realized and unrealized gain (loss)
on investments 0.89 0.74 (1.25)(c) (0.30) 0.05
--------- --------- --------- --------- ---------
Total from Investment Operations 1.39 1.50 (0.49) 0.73 0.66
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.53) (0.76) (0.77) (1.06) (0.59)
From net realized gains -- -- -- --(d) --
--------- --------- --------- --------- ---------
Total Distributions Declared
to Shareholders (0.53) (0.76) (0.77) (1.06) (0.59)
NET ASSET VALUE, END OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07
Total return (e) (f) 12.57% 14.99% (4.36)% 6.35% 5.62%(g)
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL
DATA:
Operating expenses (h) 1.79% 1.88% 1.88% 1.87% 1.51%(i)
Interest and commitment fees expenses 0.40% 0.73% 0.99% 2.04% 1.91%(i)
Net expenses (h) 2.19% 2.61% 2.87% 3.91% 3.42%(i)
Net investment income (h) 4.19% 7.14% 6.75%(c) 8.74% 8.99%(i)
Waiver/reimbursement 0.18% 0.36% 0.32% 0.32% 1.41%(i)
Portfolio turnover rate 110% 90% 98% 65% 8%(g)
Net assets, end of period (000's) $ 278,731 $ 80,572 $ 61,811 $ 64,074 $ 13,013
</Table>
(a) The Fund commenced investment operations on January 13, 2000.
(b) Per share data was calculated using average shares outstanding during the
period.
(c) 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, to 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.
(d) Rounds to less than $0.01.
(e) Total return at net asset value assuming all distributions reinvested and
no early withdrawal charge.
(f) Had the Investment Advisor not waived or reimbursed a portion of expenses,
total return would have been reduced.
(g) Not annualized.
(h) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
(i) Annualized.
40
<Page>
<Table>
<Caption>
PERIOD ENDED
YEAR ENDED AUGUST 31, AUGUST 31,
CLASS Z SHARES 2004 2003 2002 2001 2000(a)
- -----------------------------------------------------------------------------------------------------------------------------
$ 11.22 $ 10.48 $ 11.74 $ 12.08 $ 12.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment income 0.59(b) 0.78(b) 0.86(b)(c) 1.14(b) 0.67
Net realized and unrealized gain (loss)
on investments 0.90 0.81 (1.25)(c) (0.31) 0.05
--------- --------- --------- --------- ---------
Total from Investment Operations 1.49 1.59 (0.39) 0.83 0.72
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.63) (0.85) (0.87) (1.17) (0.64)
From net realized gains -- -- -- --(d) --
--------- --------- --------- --------- ---------
Total Distributions Declared
to Shareholders (0.63) (0.85) (0.87) (1.17) (0.64)
NET ASSET VALUE, END OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.08
Total return (e) (f) 13.52% 15.95% (3.53)% 7.17% 6.11%(g)
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL
DATA:
Operating expenses (h) 0.94% 1.03% 1.03% 1.02% 0.66%(i)
Interest and commitment fees expenses 0.40% 0.73% 0.99% 2.04% 1.91%(i)
Net expenses (h) 1.34% 1.76% 2.02% 3.06% 2.57%(i)
Net investment income (h) 4.93% 7.21% 7.60%(c) 9.59% 9.84%(i)
Waiver/reimbursement 0.18% 0.36% 0.32% 0.32% 1.41%(i)
Portfolio turnover rate 110% 90% 98% 65% 8%(g)
Net assets, end of period (000's) $ 53,049 $ 5,178 $ 140 $ 2,850 $ 2,656
</Table>
(a) The Fund commenced investment operations on January 13, 2000.
(b) Per share data was calculated using average shares outstanding during the
period.
(c) 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, to 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.
(d) Rounds to less than $0.01.
(e) Total return at net asset value assuming all distributions reinvested.
(f) Had the Investment Advisor not waived or reimbursed a portion of expenses,
total return would have been reduced.
(g) Not annualized.
(h) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.
(i) Annualized.
41
<Page>
LOAN AGREEMENT ASSET COVERAGE REQUIREMENTS
HIGHLAND FLOATING RATE ADVANTAGE FUND
<Table>
<Caption>
TOTAL AMOUNT ASSET COVERAGE PER $1,000
DATE OUTSTANDING OF INDEBTNEDNESS
- --------------------------------------------------------------------------------
08/31/2004 $ 95,000,000 $ 8,062
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
</Table>
42
<Page>
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE TRUSTEES AND THE SHAREHOLDERS OF HIGHLAND FLOATING RATE ADVANTAGE FUND
In our opinion, the accompanying statements of assets and liabilities, including
the investment portfolio, and the related statements of operations, changes in
net assets and of cash flows and the financial highlights present fairly, in all
material respects, the financial position of Highland Floating Rate Advantage
Fund (the "Fund") (formerly Columbia Floating Rate Advantage Fund), at August
31, 2004, and the results of its operations, the changes in its net assets and
cash flows and the financial highlights for 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), which require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of investments held at August 31, 2004 by
correspondence with the custodian and the banks with whom the Fund owns
participations in loans, provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
October 27, 2004
43
<Page>
UNAUDITED INFORMATION
HIGHLAND FLOATING RATE ADVANTAGE FUND
On July 30, 2004, a Special Meeting of the Shareholders of the Fund was held to
elect five Trustees and to approve a new advisory agreement between Highland
Capital Management, L.P. and the Fund. On June 1, 2004, the record date for the
Meeting, the Fund had outstanding 49,657,731.2010 shares of beneficial interest.
The votes cast at the Meeting were as follows:
1. ELECTION OF FIVE (5) TRUSTEES:
<Table>
<Caption>
FOR WITHHELD BROKER NON-VOTES
--- -------- ----------------
Timothy K. Hui 43,234,867.7470 225,824.4410 0
Scott F. Kavanaugh 43,236,164.8890 224,527.2990 0
James F. Leary 43,235,125.1550 225,567.0330 0
Brian A. Ward 43,235,967.1550 224,725.0330 0
R. Joseph Dougherty 43,235,277.5140 225,414.6740 0
</Table>
2. TO APPROVE THE FUND'S ADVISORY AGREEMENT BETWEEN HIGHLAND CAPITAL MANAGEMENT,
L.P. AND THE FUND:
<Table>
For: 42,907,000.4160 shares of beneficial interest
being a majority of the shares
represented at the Meeting
Against: 204,387.8130 shares of beneficial interest
Abstain: 349,303.9560 shares of beneficial interest
Broker Non-Votes: 0
</Table>
44
<Page>
TRUSTEES
HIGHLAND FLOATING RATE ADVANTAGE FUND
The Trustees 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 trustee and officer listed below
serves in the same capacity for the other three Highland Funds and for the two
Prospect Street Funds (Prospect Street(R) High Income Portfolio, Inc. and
Prospect Street(R) Income Shares, Inc. (two closed-end funds advised by
Highland). The Statement of Additional Information (SAI) contains additional
information about the Trustees and is available without charge upon request by
calling the Fund's distributor at 877-665-1287.
<Table>
<Caption>
NAME, ADDRESS AND AGE, POSITION WITH THE FUND, YEAR
FIRST ELECTED OR APPOINTED TO OFFICE PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS, OTHER DIRECTORSHIPS HELD
DISINTERESTED TRUSTEES
TIMOTHY K. HUI (age 55) Assistant Provost for and, since September 1998, Director of Learning
48 Willow Greene Drive Resources of the Philadelphia Biblical University.
Churchville, PA 18966
Trustee (since 2004)
SCOTT F. KAVANAUGH (age 43) Since March 2003, Sales Representative at Round Hill Securities. From
9 Old Ranch Road February 2003 to July 2003, Executive at Provident Funding Mortgage
Laguna Niguel, CA 92677 Corporation. From January 2000 to February 2003, Executive Vice President,
Trustee (since 2004) Director and Treasurer of Commercial Capital Bank. From April 1998 to
February 2003, Managing Principal and Chief Operating Officer of Financial
Institutional Partners Mortgage Company and Managing Principal and
President of Financial Institutional Partners, LLC, an investment banking firm.
JAMES F. LEARY (age 73) Since January 1999, Managing Director of Benefit Capital Sourthwest, Inc, a
15851 N. Dallas Parkway financial consulting firm. Director for Capstone Asset Management Group of
Suite 500 Mutual Funds (nine portfolios)
Addison, Texas 75001
Trustee (since 2004)
BRYAN A. WARD (age 49) Since January 2002, Senior Manager of Accenture, LLP, a consulting firm. From
901 Main Street September 1998 to December 2001, Special Projects Advisor, Contractor and
Dallas, Texas 75202 Information Technology consultant to Accenture, LLP.
Trustee (since 2004)
INTERESTED TRUSTEE
R. JOSEPH DOUGHERTY (age 34) Since January 2003, Senior Portfolio Manager of Highland. From January 1999 to
13455 Noel Road Suite 1300 January 2003, Portfolio Manager of Highland. Prior to January 1999, Portfolio
Dallas, TX 75240 Analyst for Highland.
Trustee (since 2004)
</Table>
45
<Page>
OFFICERS
HIGHLAND FLOATING RATE ADVANTAGE FUND
<Table>
<Caption>
NAME, ADDRESS AND AGE, POSITION WITH THE FUND,
YEAR FIRST ELECTED OR APPOINTED TO OFFICE PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
JAMES D. DONDERO (42) President and Managing Partner of the Highland.
13455 Noel Road Suite 1300
Dallas, TX 75240
President (Since August 5, 2004)
MARK K. OKADA (43) Chief Investment Officer of the Adviser.
13455 Noel Road Suite 1300
Dallas, TX 75240
Executive Vice President (Since August 5, 2004)
R. JOSEPH DOUGHERTY (34) Since January 2003, Senior Portfolio Manager of Highland. From January 1999 to
13455 Noel Road Suite 1300 January 2003, Portfolio Manager of Highland. Prior to January 1999, Portfolio
Dallas, TX 75240 Analyst for Highland.
Senior Vice President (Since August 5, 2004)
M. JASON BLACKBURN (28) Assistant Controller of the Highland. From September 1999 to October 2001, an
13455 Noel Road Suite 1300 accountant for KPMG LLP.
Dallas, TX 75240
Secretary and Treasurer (Since August 5, 2004)
</Table>
46
<Page>
IMPORTANT INFORMATION ABOUT THIS REPORT
HIGHLAND FLOATING RATE ADVANTAGE FUND
TRANSFER AGENT The fund mails one shareholder report to
PFPC Inc. each shareholder address. If you would like
400 Bellevue more than one report, please call
Wilmington, DE 19809 shareholder services at 877-665-1287 and
877.665.1287 additional reports will be sent to you.
This report has been prepared for
DISTRIBUTOR shareholders of Highland Floating Rate
PFPC Distributors, Inc. Advantage Fund.
760 Moore Road
King of Prussia, PA 19406 A description of the policies and procedures
that the fund uses to determine how to vote
INVESTMENT ADVISOR proxies relating to its portfolio
Highland Capital Management, L.P. securities, and the Fund's proxy voting
13455 Noel Rd., Suite 1300 record for the most recent 12-month period
Dallas, TX 75240 ended June 30, are available (i) without
charge, upon request, by calling
INDEPENDENT REGISTERED PUBLIC 877-665-1287 and (ii) on the Securities and
ACCOUNTING FIRM Exchange Commission's website at
PricewaterhouseCoopers LLP http://www.sec.gov.
125 High Street
Boston, MA 02110 The Fund will file 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,
beginning with the fiscal quarter ending
November 30, 2004. 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.
47
<Page>
THIS PAGE INTENTIONALLY LEFT BLANK.
<Page>
HIGHLAND FLOATING RATE ADVANTAGE FUND PRSRT STD
ANNUAL REPORT, AUGUST 31, 2004 U.S. POSTAGE
PAID
HOLLISTON, MA
PERMIT NO. 20
[HIGHLAND FUNDS LOGO]
MANAGED BY
HIGHLAND CAPITAL MANAGEMENT, L.P.
(C) 2004 PFPC DISTRIBUTORS, INC.
760 MOORE ROAD
KING OF PRUSSIA, PA 19406
www.highlandfunds.com
762-02/777S-0904 (10/04) 04/2929
<Page>
ITEM 2. CODE OF ETHICS.
The Registrant 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.
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.
(a) AUDIT FEES. The aggregate fees billed for each of the last two
fiscal years (the "Reporting Periods") for professional services rendered by the
Registrant's principal accountant (the "Auditor") for the audit of the
Registrant's annual financial statements, or services that are normally provided
by the Auditor in connection with the statutory and regulatory filings or
engagements for the Reporting Periods, were $49,510 in 2003 and $48,680 in 2004.
(b) AUDIT-RELATED FEES. The aggregate fees billed in the Reporting
Periods for assurance and related services by the Auditor 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 4 were $7,000 in 2003 and
$6,500 in 2004. These services consisted of the review of the semi-annual
financial statements, and agreed-upon procedures required by lending
organizations.
The aggregate fees billed in the Reporting Periods for non-audit
assurance and related services by the Auditor to the Registrant's investment
adviser (not including any sub-investment 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
("Service Affiliates") which required pre-approval by the Audit Committee were
$0 in 2003 and $0 in 2004 that were reasonably related to the performance of the
annual audit of the Service Affiliate.
2
<Page>
(c) TAX FEES. The aggregate fees billed in the Reporting Periods for
professional services rendered by the Auditor for tax compliance, tax advice and
tax planning ("Tax Services") were $1,900 in 2003 and $2,612 in 2004 These
services consisted of (i) review or preparation of U.S. federal, state, local
and excise tax returns; and (ii) U.S. federal, state and local tax planning,
advice and assistance regarding statutory, regulatory or administrative
developments.
The aggregate fees billed in the Reporting Periods for Tax Services by
the Auditor to Service Affiliates which required pre-approval by the Audit
Committee were $0 in 2003 and $0 in 2004.
(d) ALL OTHER FEES. The aggregate fees billed in the Reporting Periods
for products and services provided by the Auditor, other than the services
reported in paragraphs (a) through (c) of this Item, were $0 in 2003 and $0 in
2004.
The aggregate fees billed in the Reporting Periods for Non-Audit
Services by the Auditor to Service Affiliates, other than the services reported
in paragraphs (b) through (d) of this Item, which required pre-approval by the
Audit Committee were $95,000 in 2003 and $95,000 in 2004.
NON-AUDIT FEES. The aggregate non-audit fees billed by the Auditor for
services rendered to the Registrant, and rendered to Service Affiliates, for the
Reporting Periods were $0 in 2003 and $0 in 2004.
AUDITOR INDEPENDENCE. The Registrant's Audit Committee has considered
whether the provision of non-audit services that were rendered to Service
Affiliates which were not pre-approved (not requiring pre-approval) is
compatible with maintaining the Auditor's independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
ITEM 6. SCHEDULE OF INVESTMENTS.
Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Registrant has delegated voting of proxies in respect of portfolio
holdings to its investment adviser, Highland Capital Management, L.P. ("HCMLP"),
to vote the Registrant's proxies in accordance with HCMLP's proxy voting
guidelines and procedures. HCMLP has adopted proxy voting guidelines (the
"Guidelines") that provide as follows:
- HCMLP votes proxies in respect of the Registrant's securities in the
Registrant's best interests and without regard to the interests of HCMLP or
any client of HCMLP.
3
<Page>
- Unless HCMLP's Proxy Voting Committee (the "Committee") otherwise
determines (and documents the basis for its decisions) or as otherwise
provided below, HCMLP votes proxies in a manner consistent with the
Guidelines.
- To avoid material conflicts of interest, HCMLP applies the Guidelines in an
objective and consistent manner across the Registrant's 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 the Registrant, where a conflict of interest has been identified and
the matter is not covered in the Guidelines, HCMLP will disclose the
conflict and the Committee's determination of the matter in which to vote
to the Registrant's Board.
- HCMLP also may determine not to vote proxies in respect of securities of
the Registrant if it determines it would be in the Registrant's best
interests not to vote.
HCMLP's Guidelines also address how it will vote proxies on particular
types of matters such as corporate governance matters, disclosure of executive
compensation and share repurchase programs. For example, HCMLP generally will:
- Support management in most elections for directors, unless the board gives
evidence of acting contrary to the best economic interests of shareholders;
- Support proposals seeking increased disclosure of executive compensation;
and
- Support management proposals to institute share repurchase plans in which
all shareholders may participate on equal terms.
ITEM 8. PURCHASE OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANIES AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 9. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Registrant has a Nominating Committee (the "Committee") of the
Board responsible for selecting and nominating persons as members of the Board
for election or appointment by the Board and for election by stockholders. The
Committee has adopted a Nominating Committee Charter (the "Charter"), pursuant
to which the Committee will consider recommendations for nominees from
stockholders submitted to the Secretary of the Registrant, Two Galleria Tower,
13455 Noel Road, Dallas, Texas 75240. In evaluating potential nominees,
including any nominees recommended by stockholders, the Committee takes into
consideration various factors including character and integrity, business and
professional experience, and whether the Committee believes the person has the
ability to apply sound and independent business judgment and would act in the
interest of the Registrant and its stockholders. Submissions must include all
information relating to the recommended nominee that is required to be disclosed
in solicitations or proxy statements for the election of Board members, as well
as information sufficient to evaluate the factors to be considered by the
Committee. Submissions must be accompanied by a written consent of the
individual to stand for election if nominated by the Board and to serve if
elected by the stockholders, and such additional information must be provided
regarding the recommended nominee as reasonably requested by the Committee.
ITEM 10. CONTROLS AND PROCEDURES.
(a) The Registrant's principal executive and principal financial
officers have concluded, based on their evaluation of the Registrant's
disclosure controls and procedures as of a date within 90 days of
4
<Page>
the filing date of this report, that the Registrant's disclosure controls and
procedures are reasonably designed to ensure that information required to be
disclosed by the Registrant on Form N-CSR is recorded, processed, summarized and
reported within the required time periods and that information required to be
disclosed by the Registrant in the reports that it files or submits on Form
N-CSR is accumulated and communicated to the Registrant's management, including
its principal executive and principal financial officers, as appropriate to
allow timely decisions regarding required disclosure.
(b) There were no changes to the Registrant's internal control over
financial reporting that occurred during the Registrant's most recently ended
fiscal half-year that have materially affected, or are reasonably likely to
materially affect, the Registrant's internal control over financial reporting.
ITEM 11. EXHIBITS.
(a)(1) Code of ethics referred to in Item 2.
(a)(2) Certifications of principal executive and principal financial
officers as required by Rule 30a-2(a) under the Investment Company Act of 1940.
(a)(3) Not applicable.
(b) Certification of principal executive and principal financial
officers as required by Rule 30a-2(b) under the Investment Company Act of 1940.
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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.
HIGHLAND FLOATING RATE ADVANGTAGE FUND
By: /s/ James D. Dondero
-----------------------
James D. Dondero
Chief Executive Officer
Date: November 09, 2004
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: /s/ James D. Dondero
-----------------------
James D. Dondero
Chief Executive Officer
Date: November 09, 2004
By: /s/ M. Jason Blackburn
-----------------------
M. Jason Blackburn
Chief Financial Officer
Date: November 09, 2004
EXHIBIT INDEX
(a)(1) Code of ethics referred to in Item 2.
(a)(2) Certifications of principal executive and principal financial
officers as required by Rule 30a-2(a) under the Investment Company Act
of 1940. (EX-99.CERT)
(b) Certification of principal executive and principal financial
officers as required by Rule 30a-2(b) under the Investment Company Act
of 1940. (EX-99.906CERT)
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