-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RFQRjVv25q6An31Hbk7Zm1P1lEm4lCSROY72ra4o6s+Q2GE10OdRpXWn1EWlhflT yBU8wvkulllfW0001VhKOw== 0000935069-05-003034.txt : 20051104 0000935069-05-003034.hdr.sgml : 20051104 20051104141809 ACCESSION NUMBER: 0000935069-05-003034 CONFORMED SUBMISSION TYPE: N-CSR PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20050831 FILED AS OF DATE: 20051104 DATE AS OF CHANGE: 20051104 EFFECTIVENESS DATE: 20051104 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HIGHLAND FLOATING RATE FUND CENTRAL INDEX KEY: 0001068200 IRS NUMBER: 364251182 STATE OF INCORPORATION: MA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: N-CSR SEC ACT: 1940 Act SEC FILE NUMBER: 811-08953 FILM NUMBER: 051179702 BUSINESS ADDRESS: STREET 1: TWO GALLERIA TOWER STREET 2: 13455 NOEL ROAD,SUITE 1300 CITY: DALLAS STATE: TX ZIP: 75240 BUSINESS PHONE: 9726284100 MAIL ADDRESS: STREET 1: TWO GALLERIA TOWER STREET 2: 13455 NOEL ROAD,SUITE 1300 CITY: DALLAS STATE: TX ZIP: 75240 FORMER COMPANY: FORMER CONFORMED NAME: COLUMBIA FLOATING RATE FUND DATE OF NAME CHANGE: 20031107 FORMER COMPANY: FORMER CONFORMED NAME: LIBERTY FLOATING RATE FUND DATE OF NAME CHANGE: 20001212 FORMER COMPANY: FORMER CONFORMED NAME: LIBERTY STEIN ROE ADVISOR FLOATING RATE FUND DATE OF NAME CHANGE: 19991025 N-CSR 1 floatingratencsr.txt HIGHLAND FLOATING RATE NCSR0805 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 811-08953 ---------------------------- HIGHLAND FLOATING RATE FUND - -------------------------------------------------------------------------------- (Exact name of registrant as specified in charter) 13455 Noel Road, Suite 1300 DALLAS, TEXAS 75240 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip code) James D. Dondero Highland Capital Management, L.P. 13455 Noel Road, Suite 1300 DALLAS, TEXAS 75240 - -------------------------------------------------------------------------------- (Name and address of agent for service) registrant's telephone number, including area code: (877) 532-2834 --------------- Date of fiscal year end: AUGUST 31 ---------- Date of reporting period: AUGUST 31, 2005 ---------------- Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles. A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget ("OMB") control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. ss. 3507. ITEM 1. REPORTS TO STOCKHOLDERS. The Report to Shareholders is attached herewith. [GRAPHIC OMITTED] COVER PHOTO HIGHLAND FLOATING RATE FUND Annual Report August 31, 2005 [GRAPHIC OMITTED] HIGHLAND FUNDS managed by Highland Capital Management, L.P. - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND TABLE OF CONTENTS Portfolio Managers' Letter ............................................... 1 Fund Profile ............................................................. 3 Performance Information .................................................. 4 Understanding Your Expenses .............................................. 5 Financial Statements ..................................................... 6 Investment Portfolio .................................................. 7 Portfolio Statement of Assets and Liabilities ......................... 16 Portfolio Statement of Operations ..................................... 17 Portfolio Statements of Changes in Net Assets ......................... 18 Portfolio Statement of Cash Flows ..................................... 19 Portfolio Financial Highlights ........................................ 20 Fund Statement of Assets and Liabilities .............................. 21 Fund Statement of Operations .......................................... 22 Fund Statements of Changes in Net Assets .............................. 23 Fund Financial Highlights ............................................. 25 Notes to Financial Statements ......................................... 29 Report of Independent Registered Public Accounting Firm .................. 36 Trustees and Officers .................................................... 37 Important Information About This Report .................................. 39 Economic and market conditions change frequently. There is no assurance that the trends described in this report will continue or commence. A prospectus must precede or accompany this report. Please read the prospectus carefully before you invest. PORTFOLIO MANAGERS' LETTER - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND Dear Shareholders: Highland Floating Rate Fund (the "Fund") is a continuously offered, non-diversified, closed-end management investment company that invests all of its investable assets in the Highland Floating Rate Limited Liability Company (the "Portfolio"). The Portfolio seeks to provide a high level of current income consistent with preservation of capital. PERFORMANCE SUMMARY For the 12-month period ended August 31, 2005, Class A shares of Highland Floating Rate Fund returned 5.93% without sales charge. That was less than the return of the fund's benchmark, the Credit Suisse First Boston ("CSFB") Leveraged Loan Index, which was 5.96% for the period. However, the Fund did better than the Lipper Loan Participation Loan Category average, which was 5.83% for the period. We are disappointed that the Fund did not outperform the CSFB Leveraged Loan Index, but we believe that the Fund is positioned to excel in the future. LEVERAGE LOAN MARKET OVERVIEW The year ending August 31, 2005 was another strong year for the leveraged loan market, which was fueled by improved earnings, and increased demand for floating rate loans. For the fiscal year ended August 31, 2005, total leveraged loan volume, as tracked by Standard & Poor's/Leveraged Commentary & Data, increased strongly to $279 billion, versus $215 billion in the prior year. However, during the year default rates, as tracked by Standard & Poor's/Loan Syndication & Trading Association Leveraged Loan Index, increased from a lagging 12 month default rate of 0.94% as of August 31, 2004, to 1.51% as of August 31, 2005. As tracked by the CSFB Leveraged Loan Index, spreads on leveraged loans tightened considerably during the fiscal year of the Fund from a weighted average spread of 302 basis points at August 31, 2004, to 265 basis points at August 31, 2005. This spread tightening was offset by a significant increase in LIBOR (London Interbank Offered Rate) over the fiscal year. LIBOR is the rate of interest at which banks can borrow funds from other banks, in marketable size, in the London interbank market. As you can see in the chart below, three month LIBOR rose from 1.67% at August 31, 2004, to 3.70% at August 31, 2005. As a result, even though spreads tightened, the weighted average coupon on leveraged loans, as tracked by the CSFB Leveraged Loan Index, increased from 4.71% at August 31, 2004, to 6.34% at August 31, 2005, a change of 1.63% over the fiscal year. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: - -------------------------------------------------------------------------------- 3 MONTH LIBOR - 8/31/04-8/31/05* 8/31/04 1.67 9/30/04 1.84 10/31/04 2 11/30/04 2.29 12/31/04 2.4 1/31/05 2.59 2/28/05 2.72 3/31/05 2.87 4/30/05 3.09 5/31/05 3.13 6/30/05 3.34 7/31/05 3.52 8/31/05 3.7 - -------------------------------------------------------------------------------- * Source British Bankers Association PORTFOLIO OVERVIEW During the fiscal year the Portfolio initiated core positions in several new investments. Specifically, positions were taken in loans issued by Home Interiors & Gifts, Inc., a manufacturer and distributor of home decorative accessories, DS Waters 1 PORTFOLIO MANAGERS' LETTER (CONTINUED) - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND Enterprises LP, a home and office delivery bottled water operator, General Growth Properties, Inc., a real estate investment trust engaged in the ownership, operation, acquisition, and development of regional mall and community shopping centers, Extended Stay America, Inc., an operator of extended stay lodging hotels, and SunGard Data Systems, Inc., a provider of integrated software and processing solutions and information availability services. These comprise 1.9%, 1.3%, 1.3%, 1.3%, and 1.3% of net assets, respectively. These percentages represent the percentages of net assets for each holding as of August 31, 2005 and are subject to change. The Portfolio continues to overweight the following industries versus the index: Cable & Satellite Television, Building & Development, and Lodging & Casinos. Cable & Satellite Television, which constituted 9.9% of net assets, performed well for the Portfolio. Specifically, Century Cable Holdings and Charter Communications Operating LLC (2.2% and 1.4% of net assets, respectively) had another strong year for the Portfolio. We believe the Portfolio remains well diversified. As of August 31, 2005, the average individual loan position represented approximately 0.03% of total assets, while the average industry sector exposure accounted for roughly 2.4%. ADDITIONAL FUND INFORMATION Effective May 23, 2005, the Portfolio is now able to invest up to 20% of its net assets in senior loans of foreign borrowers that are foreign currency denominated. We believe this change will be of benefit to the Fund and allow it to invest in senior loans previously unavailable to the Fund. We thank you for your investment in the Fund. /S/MARK OKADA /S/JOE DOUGHERTY Mark Okada Joe Dougherty Portfolio Manager Portfolio Manager Mark Okada and Joe Dougherty have been portfolio managers of the Highland Floating Rate Fund since April 15, 2004. Just like any other investment, floating rate loan investments present financial risks. Defaults on the loans in the Portfolio could reduce the Fund's net asset value and its distributions, as could nonpayment of scheduled interest and principal. Prepayment of principal by a borrower could result in the Funds' managers having to replace the loan with a lower-yielding security, which could affect the valuation of the Portfolio's holdings. The Fund is a continuously offered, closed-end management investment company that provides limited liquidity through a quarterly tender offer for between 5% and 25% of outstanding shares. Each quarter, the Fund's Trustees must approve the actual tender. Please read the Fund's prospectus and statement of additional information carefully for more details. The Fund may invest a high percentage of assets in a limited number of loans, so the default of any individual holdings can have a greater impact on the Fund's net asset value than could a default in a more diversified portfolio. Floating rate loans are not covered by FDIC insurance or other guarantees relating to timely payment of principal and interest. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts will come to pass. The opinions expressed are those of the management of the Fund and are subject to change. 2 FUND PROFILE - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND OBJECTIVE The Fund invests all of its investable assets in Highland Floating Rate Limited Liability Company (the "Portfolio"). The Portfolio seeks a high level of current income consistent with preservation of capital. TOTAL NET ASSETS (AS OF 08/31/05) $1,085.1 million The information below gives you a snapshot of your Fund at the end of the reporting period. Your Fund is actively managed and the composition of its portfolio will change over time. QUALITY BREAKDOWN AS OF 08/31/05 (%) - ----------------------------------- Ba 17.0 - ----------------------------------- B 56.1 - ----------------------------------- Caa 6.6 - ----------------------------------- NR 20.3 - ----------------------------------- TOP 5 SECTORS AS OF 08/31/05 (%) - ------------------------------------ Cable & Satellite Television 9.8 - ------------------------------------ Health Care 7.2 - ------------------------------------ Leisure Goods/Activities/Movies 6.0 - ------------------------------------ Electronic/Electric 5.7 - ------------------------------------ Building & Development 5.0 - ------------------------------------ TOP 10 HOLDINGS AS OF 08/31/05 (%) - -------------------------------------------------------------------------------- Home Interiors & Gifts, Inc., Initial Term Loan, 8.38%, 03/31/11 1.9 - -------------------------------------------------------------------------------- DS Waters Enterprises LP, Term Loan, 8.17%, 11/07/09 1.3 - -------------------------------------------------------------------------------- General Growth Properties, Inc., Tranche B Term Loan, 5.67%, 11/12/08 1.3 - -------------------------------------------------------------------------------- Cricket Communications, Inc., Term Loan B, 5.99%, 01/10/11 1.3 - -------------------------------------------------------------------------------- Extended Stay America, Inc., Mezzanine Loan, 08/01/08 1.3 - -------------------------------------------------------------------------------- Century Cable Holdings LLC, Term Loan, 8.50%, 06/30/09 1.3 - -------------------------------------------------------------------------------- OpBiz LLC, Term Loan A, 6.50%, 08/31/10 1.2 - -------------------------------------------------------------------------------- Charter Communications Operating LLC, Tranche B Term Loan, 6.93%, 04/07/11 1.2 - -------------------------------------------------------------------------------- Hilton Head Communications LP, Revolver, 6.50%, 09/30/07 1.2 - -------------------------------------------------------------------------------- SunGard Data Systems, Inc., U.S. Term Loan, 6.28%, 02/11/13 1.1 - -------------------------------------------------------------------------------- Quality is calculated as a percentage of total notes and bonds. Sectors and holdings are calculated as a percentage of net assets. 3 PERFORMANCE INFORMATION - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND VALUE OF $10,000 INVESTMENT 12/17/98 (INCEPTION DATE) - 08/31/05* [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class Z Shares -- $15,235 ] Class A (with sales charge) -- $13,527 Class B (without sales charge) -- $13,698 Class C (without sales charge) -- $13,579 CSFB Leveraged Loan Index -- $13,902 Floating cfsb Highland Highland Highland Rate leveraged Floating Floating Floating Class Z loan Rate Fund Rate Fund Rate Fund shares index - Class A - Class B - Class C 12/98 10000 10000 (with sales (without (without 8/99 10555 10370 charge) sales charge) sales charge) 11/99 10633 10331 9654 10000 10000 8/00 11423 10846 10307 10633 10618 8/01 11982 11381 10777 11077 11047 8/02 11702 11162 10489 10743 10698 8/03 13038 12256 11646 11887 11819 8/04 14346 13120 12769 12989 12895 8/05 15235 13902 13527 13698 13579 This chart compares a $10,000 investment made in each class of the Fund to $10,000 investments made in the index, the Credit Suisse First Boston ("CSFB") Leveraged Loan Index. CSFB Leveraged Loan Index is an unmanaged index that tracks the performance of senior floating rate bank loans. Unlike mutual funds, indices are not investments, do not incur fees or expenses and are not professionally managed. It is not possible to invest directly in an index. Securities in the fund may not match those in an index. * Highland Floating Rate Fund Class A, Class B, and Class C performance is from November 02, 1999. Index performance is from December 31, 1998. PERFORMANCE OF A $10,000 INVESTMENT CLASS INCEPTION - 08/31/05 ($) - -------------------------------------------------------------------------------- Sales Charge Without With - -------------------------------------------------------------------------------- Class A 14,011 13,527 - -------------------------------------------------------------------------------- Class B 13,698 13,698 - -------------------------------------------------------------------------------- Class C 13,579 13,579 - -------------------------------------------------------------------------------- Class Z 15,235 n/a - --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS AS OF 08/31/05 (%) - ------------------------------------------------------------------------------------------------------------------------------------ Share Class A B C Z - ------------------------------------------------------------------------------------------------------------------------------------ Class Inception Date 11/02/99 11/02/99 11/02/99 12/17/98 - ------------------------------------------------------------------------------------------------------------------------------------ Sales Charge Without With Without With Without With Without - ------------------------------------------------------------------------------------------------------------------------------------ 1 - YEAR 5.93 2.18 5.46 2.21 5.30 4.30 6.20 5 - YEAR 5.59 4.84 5.20 5.04 5.04 5.04 5.93 SINCE INCEPTION 5.96 5.32 5.55 5.55 5.39 5.39 6.48
THE PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, UPON REDEMPTION MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE PERFORMANCE DATA QUOTED. FOR PERFORMANCE DATA CURRENT TO THE MOST RECENT MONTH-END, PLEASE VISIT OUR WEBSITE AT WWW.HIGHLANDFUNDS.COM. PERFORMANCE FIGURES DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR REDEMPTIONS OF FUND SHARES. ALL RESULTS SHOWN ASSUME REINVESTMENT OF DISTRIBUTIONS. RETURN FIGURES REFLECT VOLUNTARY EXPENSE REIMBURSEMENTS AND FEE WAIVERS. WITHOUT REIMBURSEMENTS OR WAIVERS, FUND RETURNS WOULD HAVE BEEN LOWER. TOTAL RETURNS "WITHOUT SALES CHARGE", DOES NOT INCLUDE SALES CHARGE OR CONTINGENT DEFERRED SALES CHARGE (CDSC). TOTAL RETURNS "WITH SALES CHARGE", REFLECT THE MAXIMUM SALES CHARGE OF 3.50% ON CLASS A SHARES; THE MAXIMUM CDSC OF 3.25% ON CLASS B SHARES SUBMITTED AND ACCEPTED FOR REPURCHASE DURING THE FIRST YEAR AFTER EACH PURCHASE FOR CALCULATION OF THE 1-YEAR RETURN AND THE MAXIMUM OF 1.00% ON CLASS B SHARES SOLD WITHIN THE FIFTH YEAR THEY ARE PURCHASED FOR CALCULATION OF THE 5-YEAR RETURN; AND THE CDSC OF 1.00% ON CLASS C SHARES SOLD WITHIN THE FIRST YEAR THEY ARE PURCHASED. 4 UNDERSTANDING YOUR EXPENSES - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND DISCLOSURE OF FUND EXPENSES: We believe it is important for you to understand the impact of fees regarding your investment. All mutual funds have operating expenses. As a shareholder of a mutual fund, you incur ongoing costs, which include costs for portfolio management, administrative services, and shareholder reports (like this one), among others. Operating expenses, which are deducted from a fund's gross income, directly reduce the investment return of the fund. A fund's expenses are expressed as a percentage of its average daily net assets. This figure is known as the expense ratio. The following examples are intended to help you understand the ongoing fees (in dollars) of investing in your Fund and to compare these costs with those of other mutual funds. The examples are based on an investment of $1,000 made at the beginning of the period shown and held for the entire period. This table illustrates your Fund's costs in two ways: ACTUAL FUND RETURN: This section helps you to estimate the actual expenses, after any applicable fee waivers, that you paid over the period. The "Ending Account Value" shown is derived from the Fund's actual return for the past six month period, the "Expense Ratio" column shows the period's annualized expense ratio, and the "Expenses Paid During Period" column shows the dollar amount that would have been paid by an investor who started with $1,000 in the Fund at the beginning of the period. You may use the information here, together with your account value, to estimate the expenses that you paid over the period. To do so, simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number given for your fund in the first line under the heading entitled "Expenses Paid During Period." HYPOTHETICAL 5% RETURN: This section is intended to help you compare your Fund's costs with those of other mutual funds. It assumes that the Fund had an annual return of 5% before expenses, but that the expense ratio is unchanged. In this case, because the return used is not the Fund's actual return, the results do not apply to your investment. This example is useful in making comparisons to other mutual funds because the SEC requires all mutual funds to calculate expenses based on an assumed 5% annual return. You can assess your Fund's costs by comparing this hypothetical example with the hypothetical examples that appear in shareholder reports of other funds. Please note that the expenses shown in the table reflect the expenses of both the Fund and the allocated amount of the Portfolio and are meant to highlight and help you compare your ongoing costs only and do not reflect any transactional costs such as sales charges (loads) and redemption fees, which are described in the Prospectus. If these costs were applied to your account, your costs would be higher.
MARCH 1, 2005 - AUGUST 31, 2005 - ------------------------------------------------------------------------------------------------------------------------------------ Account Value at the Account Value at the Expenses Paid Fund's annualized beginning of the period ($) end of the period ($) during the period ($)(1) expense ratio (%)(2) - ------------------------------------------------------------------------------------------------------------------------------------ ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL CLASS A 1,000.00 1,000.00 1,030.40 1,018.95 6.35 6.31 1.24 CLASS B 1,000.00 1,000.00 1,028.60 1,017.19 8.13 8.08 1.59 CLASS C 1,000.00 1,000.00 1,027.80 1,016.43 8.89 8.84 1.74 CLASS Z 1,000.00 1,000.00 1,032.20 1,020.72 4.56 4.53 0.89 (1) Expenses paid during the period are equal to the Fund's annualized expense ratio including those expenses allocated from the Portfolio, multiplied by the average account value over the period, then multiplied by the number of days in most recent fiscal half-year and divided by 365. (2) Annualized, based on the Fund's most recent fiscal half-year expenses.
5 FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND A GUIDE TO UNDERSTANDING YOUR FUND AND PORTFOLIO'S FINANCIAL STATEMENTS INVESTMENT PORTFOLIO The Investment Portfolio details all of the Portfolio's holdings and their market value as of the last day of the reporting period. Portfolio holdings are organized by type of asset and industry to demonstrate areas of concentration and diversification. STATEMENT OF ASSETS AND 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. STATEMENTS OF CHANGES IN NET ASSETS These statements demonstrate 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 and foreign currency provided or used by operating, investing and financing activities and the net effect of those flows on cash, foreign currency and cash equivalents during the period. FINANCIAL HIGHLIGHTS The Financial Highlights demonstrate how the Fund's net asset value per share wasb affected by the fund's operating results. The Financial Highlights table also discloses the classes' performance and certain key ratios (e.g., class expenses and net investment income as a percentage of average net assets). NOTES TO FINANCIAL STATEMENTS These notes disclose the organizational background of the Fund, its significant accounting policies (including those surrounding security valuation, income recognition and distributions to shareholders), federal tax information, fees and compensation paid to affiliates and significant risks and contingencies. 6 INVESTMENT PORTFOLIO AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (A) - 92.6% AEROSPACE/DEFENSE - 0.3% 2,985,882 Vought Aircraft Industries, Inc. Term Loan, 6.17%, 12/22/11 ...... 3,038,762 ------------ AIR TRANSPORT - 0.7% Continental Airlines, Inc. 857,143 Tranche A-1 Term Loan, 8.73%, 06/01/11 ................. 860,357 2,142,857 Tranche A-2 Term Loan, 8.73%, 06/01/11 ................. 2,150,893 2,000,000 Northwest Airlines, Inc. Tranche C Term Loan, 10.07%, 11/23/10 ................ 1,967,500 3,363,375 United Airlines, Inc., DIP Tranche B Term Loan, 7.96%, 12/30/05 ................. 3,390,013 ------------ 8,368,763 ------------ AUTOMOTIVE - 4.4% CSA Acquisition Corp. 1,144,250 Tranche B Term Loan, 5.50%, 12/23/11 ................. 1,147,592 613,583 Tranche C Term Loan, 5.50%, 12/23/11 ................. 613,583 4,500,000 Delphi Corp. Term Loan, 10.30%, 06/14/11 (b) . 4,626,173 Federal-Mogul Corp. 1,270,249 Supplemental Revolver, 7.43%, 12/09/05 ................. 1,140,049 5,000,000 Tranche B Term Loan, 6.18%, 02/24/05 (f) ............. 4,648,200 1,048,750 Tranche C Term Loan, 7.43%, 12/09/05 ................. 1,051,372 Goodyear Tire & Rubber Co. 5,500,000 Second Lien Term Loan, 6.32%, 04/30/10 ................. 5,573,370 3,500,000 Third Lien Term Loan, 7.07%, 03/01/11 ................. 3,492,580 3,263,900 Hayes Lemmerz International, Inc. Term Loan B, 6.85%, 06/03/09 .... 3,304,013 1,000,000 Insurance Auto Auctions, Inc. Term Loan, 6.45%, 05/19/12 ...... 1,011,880 1,975,025 J.L. French Automotive Castings, Inc. First Lien Term Loan, 7.87%, 07/31/11 ................. 1,886,149 Key Plastics LLC 5,274,125 Term Loan B, 6.64%, 06/29/10 .... 5,313,681 5,825,000 Term Loan C, 9.40%, 06/25/11 .... 5,723,063 830,434 Keystone Automotive Industries, Inc. Term Loan B, 5.81%, 10/30/09 .... 836,663 2,457,411 Rexnord Corp. Term Loan B, 6.13%, 12/31/11 .... 2,486,605 3,960,000 Stanadyne Corp. Term Loan, 7.08%, 08/02/10 ...... 4,009,500 Tenneco Automotive, Inc. 1,779,338 Tranche B Term Loan, 6.08%, 12/12/10 ................. 1,805,476 781,632 Tranche B-1 Credit Linked Deposit, 5.59%, 12/12/10 ........ 797,264 ------------ 49,467,213 ------------ PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- BEVERAGE & TOBACCO - 2.7% 2,733,333 Caribbean Restaurant LLC Tranche B, 6.34%, 06/30/09 ...... 2,776,903 581,925 Commonwealth Brands, Inc. Incremental Term Loan, 7.00%, 08/28/07 592,836 5,154,000 Dr. Pepper Bottling Company of Texas Tranche B Term Loan, 5.35%, 12/19/10 ................. 5,235,175 15,525,680 DS Waters Enterprises LP Term Loan, 8.17%, 11/07/09 ...... 15,191,878 1,995,000 Intabex Netherlands BV Term Loan B, 6.73%, 05/13/10 .... 2,024,925 3,750,000 National Distributing Co., Inc. Second Lien Term Loan, 10.15%, 06/01/10 ................ 3,759,375 1,235,294 Sunny Delight Beverage Co. First Lien Term Loan, 7.95%, 08/20/10 ................. 1,239,926 ------------ 30,821,018 ------------ BROADCAST RADIO & TELEVISION - 1.6% 5,500,000 HIT Entertainment PLC Second Lien Term Loan, 02/17/13 (b) .................... 5,634,090 1,043,977 NEP Supershooters LP Second Lien Term Loan, 11.48%, 08/03/11 ................ 1,038,757 Spanish Broadcasting Systems, Inc. 2,992,500 First Lien Term Loan, 5.49%, 06/10/12 ................. 3,039,273 1,000,000 Second Lien Term Loan, 7.51%, 06/10/13 ................. 1,015,000 4,946,681 Warner Music Group Term Loan B, 5.70%, 02/28/11 .... 5,004,952 3,000,000 Young Broadcasting, Inc. Term Loan, 5.77%, 11/03/12 (b) .. 3,032,520 ------------ 18,764,592 ------------ BUILDING & DEVELOPMENT - 5.0% 5,030,218 Atrium Cos., Inc. Term Loan, 6.37%, 12/28/11 (b) .. 4,963,114 Custom Building Products, Inc. 1,995,000 First Lien Term Loan, 5.74%, 10/20/11 ................. 2,011,199 1,000,000 Second Lien Term Loan, 8.58%, 04/20/12 ................. 994,380 1,985,000 DESA LLC Term Loan, 8.59%, 11/26/11 ...... 1,950,263 3,500,000 Harmon Koval Partners LLC Second Lien Term Loan, 10.55%, 06/30/07 ................ 3,561,250 4,302,086 Lake at Las Vegas Joint Venture First Lien Term Loan, 6.31%, 11/01/09 ................. 4,355,862 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 7 INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) BUILDING & DEVELOPMENT (CONTINUED) LNR Property Corp. 1,000,000 Tier A Mezzanine, 7.71%, 02/03/08 ................. 1,007,500 1,866,467 Tranche A Term Loan, 6.53%, 02/03/08 ................. 1,867,624 12,249,625 Tranche B Term Loan, 6.69%, 02/03/08 ................. 12,369,916 NATG Holdings LLC 1,039,745 Credit Linked Certificate of Deposit, 6.11%, 01/23/09 ................. 977,361 992,938 Term Loan A, 8.20%, 01/23/09 .... 198,588 726,089 Term Loan B1, 8.70%, 01/23/10 ... 214,196 72,363 Term Loan B2, 8.70%, 01/23/10 ... 68,021 1,970,050 Nortek Holdings, Inc. Term Loan, 5.91%, 08/27/11 ...... 1,996,725 4,000,000 Palmdale Hills Property LLC First Lien Term Loan, 6.61%, 05/19/10 (b) ............. 4,000,000 1,500,000 Pivotal Group-Promontory First Lien Term Loan, 08/31/10 (b) .................... 1,515,000 5,500,000 TE/TOUSA Mezzanine LLC Senior Mezzanine Loan, 9.06%, 08/01/09 ................. 5,500,000 5,000,000 TWLDC Holdings LP Mezzanine Loan, 7.76%, 11/30/07 . 5,040,600 4,000,000 Woodlands Commercial Property Co. Bridge Loan, 6.27%, 11/01/05 .... 4,030,000 ------------ 56,621,599 ------------ BUSINESS EQUIPMENT & SERVICES - 3.6% 997,500 ACI Billing Services, Inc. Second Lien Term Loan, 11.25%, 04/18/11 ................ 1,012,463 700,000 American Reprographics Co. Second Lien Term Loan, 10.24%, 12/18/09 ................ 728,000 3,990,000 Audio Visual Services Corp. Term Loan, 6.23%, 05/18/11 ...... 4,039,875 4,416,667 Brickman Group Holdings, Inc. Term Loan, 8.74%, 11/15/09 ...... 4,405,625 2,512,584 Carey International, Inc. Second Lien Term Loan, 12.19%, 05/10/12 ................ 2,135,697 2,000,000 ClientLogic Corp. Second Lien Term Loan, 12.45%, 09/03/12 ................ 2,021,240 965,242 Data Transmissions Network Corp. Tranche B Term Loan, 6.61%, 03/17/12 ................. 974,894 3,250,882 Ferrell Cos., Inc. Term Loan, 6.94%, 12/17/11 ...... 3,328,091 2,425,000 Fidelity National Information Services, Inc. Term Loan B, 5.32%, 03/09/13 .... 2,431,329 1,000,000 FleetCor Technologies, Inc. Term Loan, 6.99%, 06/30/11 ...... 1,005,000 2,000,000 GXS Corp. Second Lien Term Loan, 12/20/11 (b) (c) ................ 2,000,000 1,728,125 Hillman Group, Inc. Term Loan B, 6.69%, 03/30/11 .... 1,759,439 PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- BUSINESS EQUIPMENT & SERVICES (CONTINUED) 2,000,000 IPC Acquisition Corp. First Lien Tranche B Term Loan, 6.31%, 08/05/11 ................. 2,024,160 2,816,471 Knoll, Inc. Initial Term Loan, 6.52%, 09/30/11 2,841,115 2,000,000 Survey Sampling International LLC Second Lien Term Loan, 10.74%, 05/06/12 ................ 2,023,760 8,000,000 Washington Group International Tranche B Term Loan, 3.30%, 10/03/07 ................. 8,040,000 ------------ 40,770,688 ------------ CABLE & SATELLITE TELEVISION - 9.5% 4,991,627 Adelphia Communications Corp. Tranche B DIP Term Loan, 6.31%, 03/31/06 ................. 5,016,585 Century Cable Holdings LLC 7,500,000 Discretionary Term Loan, 8.50%, 12/31/09 ................. 7,425,000 2,500,000 Revolver, 7.25%, 03/31/09 ....... 2,463,550 15,000,000 Term Loan, 8.50%, 06/30/09 ...... 14,889,300 Charter Communications Operating LLC 1,997,517 Tranche A Term Loan, 6.68%, 04/27/10 ................. 1,987,070 13,852,727 Tranche B Term Loan, 6.93%, 04/07/11 ................. 13,897,056 14,087,500 Hilton Head Communications LP Revolver, 6.50%, 09/30/07 ....... 13,770,531 5,006,250 Knology, Inc. Second Lien Term Loan, 13.68%, 06/29/11 ................ 4,856,063 Mediacom Communications Corp. 3,720,000 Term Loan A, 4.72%, 03/31/10 .... 3,713,006 995,000 Term Loan B, 5.81%, 03/31/13 .... 1,011,418 1,980,038 Term Loan C, 5.44%, 09/30/10 .... 2,008,510 Millennium Digital Media Systems LLC 972,725 Facility A Revolver, 8.72%, 10/31/08 ................. 980,020 3,087,013 Facility B Term Loan, 9.02%, 10/31/08 ................. 3,110,166 3,440,262 Facility C Term Loan, 9.00%, 10/31/08 ................. 3,466,064 Olympus Cable Holdings LLC 9,500,000 Term Loan A, 7.75%, 06/30/10 .... 9,399,110 1,000,000 Term Loan B, 8.50%, 09/30/10 .... 992,890 3,000,000 Puerto Rico Cable Acquisition Co., Inc. First Lien Term Loan, 8.75%, 07/28/11 ................. 3,043,140 11,442,500 UPC Broadband Holding BV Term Loan F2, 7.19%, 03/31/09 ... 11,581,183 WideOpenWest LLC 2,970,000 Incremental Term Loan B, 6.49%, 06/22/11 ................. 2,992,275 1,974,963 Term Loan B, 6.56%, 06/22/11 .... 1,994,712 ------------ 108,597,649 ------------ CHEMICALS/PLASTICS - 3.6% 2,500,000 Brenntag AG Faciltiy B2, 6.81%, 02/27/12 .... 2,539,600 7,472,824 Celenese Dollar Term Loan B, 5.74%, 04/06/11 ................. 7,614,807 8 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) CHEMICALS/PLASTICS (CONTINUED) 7,375,000 Huntsman International LLC Term B Dollar Loan, 5.32%, 08/16/12 ................. 7,477,513 1,900,000 Innophos, Inc. Tranche B Term Loan, 5.78%, 08/13/10 ................. 1,922,173 1,386,721 INVISTA Canada Co. Tranche B2 Term Loan, 5.75%, 04/29/11 ................. 1,410,988 3,196,191 INVISTA S.A.R.L. Tranche B1 Term Loan, 5.75%, 04/29/11 ................. 3,244,134 4,033,377 Kraton Polymers Group of Cos. Term Loan, 6.29%, 12/23/10 ...... 4,102,711 Nalco Co. 1,813,782 Tranche A-1 Term Loan, 6.06%, 11/04/09 ................. 1,835,330 1,997,656 Tranche B Term Loan, 5.65%, 11/04/10 ................. 2,028,699 1,870,000 Polypore, Inc. U S Term Loan, 5.92%, 11/12/11 .. 1,880,921 1,990,000 Rockwood Specialties Group, Inc. Tranche B Term Loan, 5.93%, 07/30/12 ................. 2,024,825 4,959,950 Supresta U.S. LLC Term Loan, 6.49%, 07/20/11 ...... 5,046,749 ------------ 41,128,450 ------------ CLOTHING/TEXTILES - 0.8% 1,910,354 Levi Strauss & Co. Tranche A Term Loan, 10.63%, 09/29/09 ................ 2,000,695 Polymer Group, Inc. 3,500,000 First Lien Term Loan, 6.73%, 04/27/10 ................. 3,548,125 3,000,000 Second Lien Term Loan, 9.73%, 04/27/11 ................. 3,075,000 ------------ 8,623,820 ------------ CONGLOMERATE - 1.0% 3,346,000 Appleton Papers, Inc. Term Loan, 5.64%, 06/11/10 ...... 3,389,933 2,054,572 Jason, Inc. Term Loan B, 8.10%, 06/30/07 .... 2,023,754 2,638,412 Mueller Group, Inc. Initial Term Loan, 6.37%, 04/23/11 2,669,756 2,781,120 Youth & Family Centered Services, Inc. Term Loan B, 7.65%, 05/28/11 .... 2,781,120 ------------ 10,864,563 ------------ CONTAINER/GLASS PRODUCTS - 2.3% 4,805,341 Berry Plastics Corp. Term Loan, 5.60%, 12/02/11 ...... 4,890,972 3,465,000 Consolidated Container Co. LLC Term Loan, 6.69%, 12/15/08 ...... 3,508,313 7,462,500 Graham Packaging International, Inc. Term Loan B, 6.03%, 10/07/11 .... 7,593,094 2,737,646 Graphic Packaging International, Inc. Tranche C Term Loan, 6.03%, 08/09/10 ................. 2,785,308 PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- CONTAINER/GLASS PRODUCTS (CONTINUED) 1,802,100 Precise Technology, Inc. First Lien Term Loan, 6.50%, 03/31/11 ................. 1,822,374 5,910,000 Solo Cup, Inc. Term B1 Loan, 5.68%, 02/27/11 ... 5,975,837 ------------ 26,575,898 ------------ COSMETICS/TOILETRIES - 0.4% 1,000,000 MD Beauty, Inc. Second Lien Term Loan, 9.90%, 02/18/13 ................. 1,022,500 2,875,000 Revlon Consumer Products Corp. Term Loan, 9.53%, 07/09/10 ...... 2,981,605 ------------ 4,004,105 ------------ DIVERSIFIED MANUFACTURING - 0.1% 1,000,000 GenTek, Inc. Second Lien Term Loan, 9.35%, 02/28/12 ................. 986,660 ------------ ECOLOGICAL SERVICE & EQUIPMENT - 0.6% Allied Waste North America, Inc. 1,447,504 Term Loan, 01/15/12 (b) ......... 1,461,371 552,496 Tranche A Credit Linked Deposit, 01/15/12 (b) ........... 557,789 4,500,000 Environmental Systems Products Holdings Second Lien, 13.70%, 12/12/10 ... 4,590,000 ------------ 6,609,160 ------------ ELECTRONIC/ELECTRIC - 4.7% 997,500 AIS Acquisition Corp. / Sensor Systems, Inc. Term Loan, 6.23%, 04/01/11 ...... 1,010,288 2,437,500 Alliance Laundry Systems LLC Term Loan, 5.80%, 01/27/12 ...... 2,477,865 3,500,000 Amkor Technology, Inc. Second Lien Term Loan, 8.33%, 10/27/10 ................. 3,596,250 484,353 Bridge Information Systems, Inc. Multidraw Term Loan, 07/07/13 (d) (e) ................ 7,265 3,000,000 Comsys Information Technology Services, Inc. Second Lien Term Loan, 11.02%, 04/30/10 ................ 3,007,500 Corel Corp. 987,500 First Lien Term Loan, 7.86%, 02/22/10 ................. 987,500 2,000,000 Second Lien Term Loan, 11.73%, 08/15/10 ................ 2,025,000 Infor Global Solutions European Finance S.A.R.L. 1,014,228 Euro Revolving Credit, 7.21%, 04/18/10 (i) ............. 978,730 1,875,000 Second Lien Lux Term Loan, 10.75%, 04/18/12 ................ 1,896,094 3,125,000 Magellan Holdings, Inc. Second Lien U S Term Loan, 10.75%, 04/18/12 ................ 3,160,156 6,975,000 On Semiconductor Corp. Tranche G Term Loan, 6.50%, 12/15/11 (b) ............. 7,076,696 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 9 INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) ELECTRONIC/ELECTRIC (CONTINUED) 2,400,000 RedPrairie Corp. Second Lien Term Loan, 12.50%, 05/23/09 ................ 2,406,000 3,880,000 Seagate Technology Holdings, Inc. Term Loan B, 4.26%, 05/13/07 .... 3,940,605 12,500,000 SunGard Data Systems, Inc. U S Term Loan, 6.28%, 02/11/13 .. 12,682,875 2,250,000 Transfirst Holdings, Inc. Second Lien Term Loan, 11.00%, 03/31/11 ................ 2,289,375 1,418,390 UGS Corp. Term Loan, 5.67%, 05/27/11 ...... 1,440,999 4,975,000 Viasystems, Inc. Tranche B Term Loan, 7.64%, 09/30/09 ................. 5,034,103 ------------ 54,017,301 ------------ EQUIPMENT LEASING - 1.1% 4,466,222 NES Rentals Holdings, Inc. Second Lien Term Loan, 9.71%, 08/17/10 ................. 4,583,460 United Rentals, Inc. 1,666,667 Initial Term Loan, 02/14/11 (b) . 1,686,466 5,760,417 Initial Term Loan, 5.92%, 02/14/11 5,828,850 333,333 Tranche B-1 Credit Linked Deposit, 02/14/11 (b) ........... 337,500 ------------ 12,436,276 ------------ FINANCIAL INTERMEDIARIES - 0.4% 3,000,000 Arias Acquisitions, Inc. Term Loan, 9.00%, 07/26/11 ...... 3,016,860 Stile Acquisition Corp. 997,500 Canadian Term Loan, 5.66%, 04/06/13 ................. 1,001,450 997,500 U S Dollar Term Loan, 5.66%, 04/06/13 ................. 1,001,749 ------------ 5,020,059 ------------ FOOD PRODUCTS - 2.0% 2,954,201 American Seafoods Group LLC Tranche B Term Loan, 6.74%, 03/31/09 ................. 2,987,465 4,000,000 CTI Food Holdings Co. LLC Second Lien Secured Term Loan, 9.58%, 06/02/12 ................. 4,095,000 1,985,000 Doane Pet Care Co. Term Loan, 7.41%, 11/05/09 ...... 2,015,609 Interstate Brands Corp. 1,875,000 Tranche A Term Loan, 7.75%, 07/19/06 ................. 1,886,250 1,959,596 Tranche C Term Loan, 7.77%, 07/19/07 ................. 1,982,876 3,980,893 Luigino's, Inc. Term Loan, 6.49%, 04/02/11 ...... 4,013,218 905,527 Merisant Co. Tranche B Term Loan, 6.93%, 01/11/10 ................. 897,033 1,721,667 Pierre Foods, Inc. Term Loan B, 9.47%, 06/30/10 .... 1,749,110 3,130,151 Pinnacle Foods Holding Corp. Term Loan, 6.76%, 11/25/10 ...... 3,174,756 ------------ 22,801,317 ------------ PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- FOOD SERVICES - 0.4% 1,000,000 AFC Enterprises, Inc. Tranche B Term Loan, 5.75%, 05/09/11 ................. 1,012,500 2,935,303 Buffets, Inc. Term Loan, 7.16%, 06/28/09 ...... 2,964,656 965,000 Captain D's Inc., LLC First Lien Term Loan, 7.42%, 12/27/10 ................. 983,094 ------------ 4,960,250 ------------ FOOD/DRUG RETAIL - 2.3% 1,000,000 Bi-Lo LLC Term Loan, 7.56%, 07/01/11 ...... 1,004,380 7,429,962 Jean Coutu Group, Inc. Term Loan B, 5.94%, 07/30/11 .... 7,556,420 Michael Foods, Inc. 3,000,000 Floater Term Loan, 6.59%, 11/20/11 ................. 3,083,460 4,563,758 Term Loan B, 5.15%, 11/21/10 .... 4,637,919 3,000,000 Nellson Nutraceutical, Inc. Second Lien Term Loan, 13.00%, 04/02/10 ................ 1,883,700 2,493,750 Reliant Pharmaceuticals, Inc. First Lien Term Loan, 13.06%, 06/30/08 ................ 2,496,867 Sturm Foods, Inc. 1,000,000 First Lien Term Loan, 6.25%, 05/26/11 ................. 1,007,500 2,000,000 Second Lien Term Loan, 10.94%, 05/26/12 ................ 2,030,000 1,995,000 Vitaquest International, Inc. First Lien Term Loan, 7.07%, 03/07/11 ................. 1,996,237 ------------ 25,696,483 ------------ FOREST PRODUCTS - 0.3% 3,000,000 NewPage Corp. Term Loan, 6.58%, 05/02/11 ...... 3,048,750 SP Newsprint Co. 513,096 Tranche B-1 Credit Linked Deposit, 3.43%, 01/09/10 ................. 521,111 218,066 Tranche B-1 Term Loan, 6.00%, 01/09/10 ................. 221,472 ------------ 3,791,333 ------------ HEALTH CARE - 7.2% 3,566,195 Alliance Imaging, Inc. Tranche C1 Term Loan, 5.94%, 12/29/11 ................. 3,614,125 3,298,630 Alpharma Operating Corp. Term Loan B, 6.86%, 10/05/08 .... 3,309,978 1,449,058 American HomePatient, Inc. Term Loan, 08/01/09 (b) (j) ..... 1,438,191 3,051,333 American Medical Response, Inc. Term Loan, 5.89%, 02/10/12 ...... 3,101,863 2,773,358 Ameripath, Inc. Term Loan, 6.92%, 03/27/10 ...... 2,801,092 Carl Zeiss Vision 1,000,000 Term B U S Dollar Loan, 6.24%, 05/04/13 ................. 1,011,250 1,000,000 Term C U S Dollar Loan, 6.74%, 05/04/14 ................. 1,007,500 2,500,000 Term D U S Dollar Loan, 8.99%, 11/04/14 ................. 2,534,375 10 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) HEALTH CARE (CONTINUED) 1,995,000 Chemed Corp. Term Loan, 5.45%, 08/24/10 ...... 2,014,950 Cornerstone Healthcare Group Holding, Inc. 1,000,000 Senior Subordinated Unsecured Notes, 14.00%, 07/15/12 (j) ..... 1,012,500 2,000,000 Term Loan, 7.84%, 07/15/11 ...... 2,012,500 2,000,000 CRC Health Corp. Term Loan, 6.24%, 05/11/11 ...... 2,020,000 4,000,000 DaVita, Inc. Tranche B Term Loan, 05/26/12 (b) .................... 4,062,800 1,170,970 Encore Medical IHC, Inc. Term Loan, 6.48%, 10/04/10 ...... 1,189,260 FHC Health Systems, Inc. 1,300,000 Delayed Draw Term Loan, 11.33%, 10/31/06 ................ 1,332,500 1,857,143 Initial Term Loan, 9.33%, 10/31/06 1,875,714 6,500,000 Third Lien Term Loan, 12.23%, 02/09/11 ................ 6,597,500 1,000,000 Genoa Healthcare Group LLC Second Lien Term Loan, 13.25%, 02/10/13 ................ 1,025,000 2,537,050 Hanger Orthopedic Group, Inc. Tranche B Term Loan, 6.99%, 09/30/09 ................. 2,584,620 HealthSouth Corp. 2,600,000 Fixed Rate Loan, 10.38%, 01/16/11 (j) .................... 2,708,316 3,937,500 Term Loan, 6.15%, 06/14/07 ...... 3,984,258 1,062,500 Tranche B Term Loan, 3.34%, 03/08/10 ................. 1,073,784 7,174,326 Insight Health Services Corp. Tranche B Term Loan, 7.24%, 10/17/08 ................. 7,205,750 577,881 Kinetic Concepts, Inc. Tranche B2 Term Loan, 5.24%, 08/11/10 ................. 586,006 6,652,137 Knowledge Learning Corp. Term Loan, 5.99%, 01/07/12 ...... 6,702,028 1,000,000 LifeCare Holdings, Inc. Term Loan, 5.82%, 08/11/12 ...... 1,005,000 3,000,000 Medical Devise Group, Inc. Tranche C Term Loan, 5.74%, 06/30/10 ................. 3,028,140 3,125,000 MultiPlan, Inc. Term Loan, 6.24%, 03/04/09 ...... 3,136,719 1,066,667 Select Medical Corp. Revolver, 6.22%, 02/24/11 (i) ... 1,061,333 Skilled Healthcare LLC 2,000,000 First Lien Term Loan, 6.42%, 06/15/12 ................. 2,035,000 3,000,000 Second Lien Term Loan, 11.53%, 12/15/12 ................ 3,077,520 474,603 Sunrise Medical Holdings, Inc. Term Loan B-1, 6.95%, 05/13/10 .. 475,196 915,333 VWR International, Inc. Tranche B Dollar Term Loan, 6.14%, 04/07/11 ................. 928,258 ------------ 81,553,026 ------------ HOME FURNISHINGS - 1.9% 23,222,442 Home Interiors & Gifts, Inc. Initial Term Loan, 8.38%, 03/31/11 (b) .................... 21,712,983 ------------ PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- INDUSTRIAL EQUIPMENT - 1.0% 1,625,000 AIRXCEL, Inc. First Lien Term Loan, 08/31/12 (b) 1,637,188 1,756,475 Blount International, Inc. U S Term Loan B, 6.16%, 08/09/10 1,782,822 4,518,407 Copperweld Corp. Term Loan, 8.17%, 12/17/11 ...... 4,512,759 1,098,325 Dresser, Inc. Term Loan C, 5.99%, 04/10/09 .... 1,110,220 1,000,000 Penn Engineering & Manufacturing Corp. Second Lien Term Loan, 9.47%, 05/25/12 ................. 1,005,000 1,276,231 Terex Corp. Term Loan, 5.68%, 07/03/09 ...... 1,293,779 ------------ 11,341,768 ------------ INSURANCE - 1.0% 5,000,000 American Wholesale Insurance Group, Inc. Second Lien Term Loan, 11.86%, 10/13/11 ................ 5,000,000 1,882,192 Conseco, Inc. Term Loan, 5.57%, 06/22/10 ...... 1,903,385 2,970,000 Mitchell International, Inc. Second Lien Term Loan, 9.75%, 08/15/12 ................. 3,021,975 1,980,000 WellCare Health Plans, Inc. Term Loan, 7.62%, 05/13/09 ...... 1,994,018 ------------ 11,919,378 ------------ LEISURE GOODS/ACTIVITIES/MOVIES - 4.7% 3,200,742 AMF Bowling Worldwide, Inc. Term Loan B, 6.67%, 08/27/09 .... 3,238,671 2,970,000 Amscan Holdings, Inc. Term Loan B, 6.13%, 04/30/12 .... 3,003,413 1,500,000 BLB Investors LLC Senior Secured Note, 07/18/12 (b) .................... 1,531,875 11,750,000 Blockbuster Entertainment Corp. Tranche B Term Loan, 7.24%, 08/20/11 (b) ............. 11,490,560 2,000,000 Camelbak Products, Inc. Second Lien Term Loan, 10.54%, 02/04/12 ................ 1,992,500 CNL Hospitality Properties LP 5,000,000 First Mezzanine Loan, 5.83%, 09/09/06 ................. 5,012,500 873,331 Term Facility, 6.07%, 10/13/06 .. 875,515 3,000,000 Fender Musical Instruments Corp. Second Lien Term Loan, 8.10%, 09/30/12 ................. 3,060,000 9,505,000 Metro-Goldwyn-Mayer Holdings, Inc./LOC Acquisition Co. Tranche B Term Loan, 5.74%, 04/08/12 ................. 9,623,052 3,000,000 Movie Gallery, Inc. Term Loan B, 6.49%, 04/27/11 .... 3,018,420 4,500,000 Oriental Trading Co., Inc. Second Lien Term Loan, 8.25%, 01/08/11 ................. 4,560,030 1,000,000 Pine Tree Holdings/Pine Tree Country Club Second Lien Tranche B Term Loan, 11.64%, 07/15/13 ................ 1,017,500 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 11 INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) LEISURE GOODS/ACTIVITIES/MOVIES (CONTINUED) 1,980,800 Polaroid Corp. Second Lien Term Loan, 11.75%, 04/27/11 ................ 1,985,752 1,568,679 Six Flags Theme Parks, Inc. Tranche B Term Loan, 6.36%, 06/30/09 ................. 1,587,315 1,980,000 Wallace Theaters First Lien Term Loan, 6.74%, 07/31/09 ................. 1,999,800 ------------ 53,996,903 ------------ LODGING & CASINOS - 5.4% 641,902 Ameristar Casinos, Inc. Term Loan B1, 5.50%, 12/20/06 ... 648,321 2,550,000 CCM Merger, Inc./MotorCity Casino Term Loan B, 5.69%, 04/25/12 .... 2,582,946 3,000,000 CNL Hotel Del Partners LP First Mezzanine Loan, 7.09%, 02/09/07 ................. 3,007,500 15,000,000 Extended Stay America, Inc. Mezzanine Loan, 08/01/08 (b) (c) ................ 15,000,000 Fontainebleu Florida Hotel LLC 3,000,000 Tranche A Term Loan, 6.54%, 05/11/08 ................. 3,000,000 2,000,000 Tranche B Term Loan, 6.54%, 05/11/08 ................. 2,000,000 3,950,150 Green Valley Ranch Gaming LLC Term Loan, 5.49%, 12/22/10 ...... 4,001,976 OpBiz LLC 13,921,569 Term Loan A, 6.50%, 08/31/10 .... 13,999,947 33,987 Term Loan B, 7.50%, 08/31/10 .... 34,142 Penn National Gaming, Inc. 1,333,333 Second Lien Term Loan, 05/26/12 (b) .................... 1,354,533 666,667 Tranche B-2 Term Loan, 05/15/12 (b) .................... 677,500 Resorts International Holdings Ltd. 11,000,000 Second Lien Term Loan, 9.42%, 04/26/13 ................. 11,044,660 1,995,000 Term Loan B, 6.20%, 04/26/12 .... 2,023,429 1,750,000 Trump Entertainment Resorts, Inc. Term Loan B-1, 6.14%, 05/20/12 .. 1,780,625 ------------ 61,155,579 ------------ NONFERROUS METALS/MINING - 1.4% 2,000,000 CII Carbon LLC Term Loan B, 07/13/12 (b) ....... 2,020,000 992,500 J W Aluminum Co. First Lien Term Loan, 6.92%, 10/20/10 ................. 1,007,387 4,726,250 Murray Energy Corp. Tranche B Term Loan, 6.86%, 01/28/10 ................. 4,752,811 Novelis, Inc. 904,352 Canadian Term Loan, 5.46%, 01/07/12 ................. 917,809 1,570,715 U S Term Loan, 5.46%, 01/07/12 ................. 1,593,491 Trout Coal Holdings LLC 2,992,500 First Lien Term Loan, 6.02%, 03/23/11 ................. 3,001,837 PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- NONFERROUS METALS/MINING (CONTINUED) 2,210,000 Second Lien Term Loan, 8.50%, 03/23/12 ................. 2,227,282 ------------ 15,520,617 ------------ OIL/GAS - 4.3% 5,000,000 ALON USA Term Loan, 10.30%, 01/15/09 ..... 5,150,000 3,311,252 Basic Energy Services, Inc. Term Loan B, 6.50%, 10/03/09 .... 3,336,087 2,500,000 Carrizo Oil & Gas, Inc. Second Lien Term Loan, 9.87%, 07/21/10 ................. 2,578,125 Coffeyville Resources LLC 600,000 First Lien Tranche B Term Loan, 6.06%, 06/24/12 ................. 610,218 400,000 Funded Letter of Credit, 6.06%, 06/24/12 ................. 406,876 5,000,000 Second Lien Term Loan, 10.31%, 06/24/13 ................ 5,150,000 El Paso Corp. 2,500,000 Deposit Accounts, 3.24%, 11/23/09 2,534,200 4,951,952 Term Loan, 6.44%, 11/23/09 ...... 5,030,687 4,000,000 Energy Transfer Partners LP Term Loan, 6.47%, 06/16/08 ...... 4,056,480 Kerr-McGee Corp. 11,500,000 Tranche B Term Loan, 6.14%, 05/24/11 ................. 11,580,845 4,000,000 Tranche X Term Loan, 5.85%, 05/24/07 ................. 4,013,760 1,000,000 Primary Energy Holdings LLC Term Loan, 8.25%, 08/24/09 ...... 1,007,820 1,000,000 SemCrude LP U S Term Loan, 6.12%, 03/16/11 .. 1,013,750 3,000,000 Trident Exploration Corp. Second Lien Term Loan, 10.61%, 04/26/11 ................ 3,037,500 ------------ 49,506,348 ------------ PUBLISHING - 1.8% 3,047,652 Adams Outdoor Advertising LP Term Loan, 5.64%, 10/15/11 ...... 3,090,197 7,950,000 American Lawyer Media Holdings, Inc. First Lien Term Loan, 5.99%, 03/05/10 (b) ............. 7,974,804 North American Membership Group, Inc. 997,500 First Lien Tranche B Term Loan, 6.86%, 05/19/11 ................. 1,002,488 3,000,000 Second Lien Term Loan, 11.11%, 11/18/11 ................ 3,015,000 1,756,706 PRIMEDIA, Inc. Term Loan B, 6.44%, 06/30/09 .... 1,761,098 1,300,533 Relizon Co. Tranche B Term Loan, 6.82%, 02/20/11 ................. 1,307,035 2,850,000 VISANT Corp. Tranche C Term Loan, 5.94%, 12/21/11 ................. 2,895,714 ------------ 21,046,336 ------------ REAL ESTATE INVESTMENT TRUST - 1.8% 14,917,752 General Growth Properties, Inc. Tranche B Term Loan, 5.67%, 11/12/08 ................. 15,107,656 12 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) REAL ESTATE INVESTMENT TRUST (CONTINUED) 5,000,000 Strategic Hotel Capital, Inc. B2 Participation Interest Notes, 6.39%, 07/09/06 ................. 4,976,200 ------------ 20,083,856 ------------ RETAILERS - 0.8% 2,985,000 Dollarama Group LP Term Loan B, 5.93%, 11/18/11 .... 3,037,238 4,022,194 Harbor Freight Tools USA Term Loan, 6.27%, 07/15/10 ...... 4,069,978 Prestige Brands Holdings, Inc. 107,620 Term Loan B Add-On, 5.19%, 04/06/11 ................. 108,607 1,975,000 Tranche B Term Loan, 6.32%, 04/06/11 ................. 1,993,921 ------------ 9,209,744 ------------ STEEL - 0.4% 1,250,000 Euramax International, Inc. First Lien Term Loan, 6.13%, 06/29/13 ................. 1,263,800 2,812,500 The Techs Industries, Inc. Term Loan, 6.24%, 01/14/10 ...... 2,819,531 ------------ 4,083,331 ------------ SURFACE TRANSPORT - 0.6% Quality Distribution, Inc. 2,147,512 Term Loan, 6.59%, 11/13/09 (e) .. 2,162,287 2,731,151 Term Loan, 6.67%, 11/13/09 ...... 2,749,941 2,479,234 Transport Industries LP Term Loan B, 7.50%, 06/13/10 .... 2,488,531 ------------ 7,400,759 ------------ TELECOMMUNICATIONS/CELLULAR - 2.0% 2,970,000 Cellular South, Inc. Term Loan, 5.33%, 05/04/11 ...... 3,012,709 MetroPCS, Inc. 4,000,000 First Lien Tranche B Term Loan, 8.25%, 05/27/11 ................. 4,122,480 6,000,000 Second Lien Term Loan, 10.75%, 05/27/12 ................ 6,236,280 10,000,000 Qwest Corp. Term Loan B, 6.95%, 06/30/10 (j) 9,992,600 ------------ 23,364,069 ------------ TELECOMMUNICATIONS/COMBINATION - 2.0% 2,000,000 Alaska Communications Systems Holdings, Inc. Term Loan, 5.49%, 02/01/12 ...... 2,025,840 4,107,450 Centennial Cellular Operating Co. Term Loan, 5.70%, 02/09/11 ...... 4,176,455 NTELOS, Inc. 1,248,737 First Lien Term Loan B, 6.17%, 08/24/11 ................. 1,261,812 1,500,000 Second Lien Term Loan, 8.49%, 02/24/12 ................. 1,503,750 5,000,000 NTL, Inc. B2 Sub-Tranche, 6.41%, 04/14/12 ................. 5,043,150 PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- TELECOMMUNICATIONS/COMBINATION (CONTINUED) 4,962,349 PanAmSat Corp. Tranche B-1 Term Loan, 5.65%, 08/20/11 ................. 5,030,582 3,952,934 RCN Corp. Term Loan, 7.94%, 12/21/11 ...... 3,992,464 ------------ 23,034,053 ------------ TELECOMMUNICATIONS/WIRELESS - 3.9% 2,150,000 Bresnan Communications LLC Tranche B Term Loan, 7.08%, 09/30/10 ................. 2,188,700 4,937,500 Consolidated Communications, Inc. Term Loan D, 5.93%, 10/14/11 .... 5,011,563 14,925,000 Cricket Communications, Inc. Term Loan B, 5.99%, 01/10/11 .... 15,079,026 5,000,000 FairPoint Communications, Inc. Initial B Term Loan, 5.55%, 02/08/12 ................. 5,061,250 2,000,000 Maritime Telecommunications Network, Inc. First Lien Term Loan, 04/07/11 (b) .................... 2,010,000 2,000,000 Nextel Partners Operating Corp. Tranche D Term Loan, 4.83%, 05/31/12 ................. 2,019,780 4,455,000 SBA Senior Finance, Inc. Tranche D Term Loan, 5.58%, 10/31/08 ................. 4,491,174 2,992,500 Telcordia Technologies, Inc. Term Loan, 6.61%, 09/15/12 ...... 2,992,500 5,959,163 WilTel Communications Group, Inc. Promissory Note, 7.00%, 04/01/10 (j) .................... 5,124,880 ------------ 43,978,873 ------------ TELECOMMUNICATIONS/WIRELINE - 0.2% 1,933,333 Valor Telecommunications Enterprises LLC Tranche B Term Loan, 5.49%, 02/14/12 ................. 1,956,108 ------------ UTILITIES - 4.4% 2,862,685 Allegheny Energy, Inc. Term Advances, 5.35%, 03/08/11 .. 2,873,420 1,960,000 Calpine Construction Finance Co. First Lien Term Loan, 9.51%, 08/26/09 ................. 2,065,350 234,347 Calpine Corp. Second Lien Term Loan B, 9.35%, 07/16/07 ................. 190,992 7,219,361 CenterPoint Energy, Inc. Term Loan, 6.08%, 04/30/10 ...... 7,293,287 1,944,089 Infrasource, Inc. Term Loan, 6.24%, 09/30/10 ...... 1,948,949 KGen, LLC 1,995,000 Tranche A Term Loan, 6.12%, 08/05/11 ................. 1,990,013 34,181 Tranche B Term Loan, 12.49%, 08/05/11 ................ 33,839 2,000,000 La Paloma Generating Co. LLC Second Lien Term Loan, 7.21%, 08/16/13 ................. 2,045,000 1,393,217 Midwest Generations LLC Term Loan, 5.45%, 04/27/11 ...... 1,409,629 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 13 INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) UTILITIES (CONTINUED) Mirant Corp. 2,000,000 Revolver, 12/31/05 (d) (f) ...... 1,750,000 6,000,000 Revolver, 07/15/08 (d) (f) ...... 5,253,000 2,500,000 Perryville Claim, 07/17/06 (d) (f) 2,112,500 1,000,000 Primary Energy Holdings LLC Term Loan, 07/15/09 (b) ......... 1,007,820 4,565,367 Riverside Energy Center LLC Term Loan, 7.93%, 06/24/11 ...... 4,679,501 Rocky Mountain Energy Center LLC 361,073 Credit Linked Certificate of Deposit, 3.58%, 06/24/11 ................. 368,295 3,159,350 Term Loan, 7.93%, 06/24/11 ...... 3,238,334 Texas Genco LLC 1,457,885 Delayed Draw Term Loan, 5.41%, 12/14/11 ................. 1,482,027 9,822,436 Initial Term Loan, 5.42%, 12/14/11 9,981,166 ------------- 49,723,122 ------------- Total Senior Loan Notes (Cost $1,048,300,987) ......... 1,054,552,812 ------------- FOREIGN VARIABLE RATE SENIOR LOAN NOTES (A) - 5.2% FRANCE - 0.3% EUR 2,500,000 Novalis S.A.S. Second Lien Term Loan, 7.90%, 12/31/13 ................. 3,130,327 ------------- GERMANY - 1.0% EUR 3,625,000 debitel (Netherlands) Holding BV Second Lien Term Loan, 9.10%, 06/11/14 ................. 4,565,455 debitel Konzemfinanzierungs GmbH 1,125,000 Term Facility B, 4.85%, 06/11/13 1,389,969 803,571 Term Facility C1, 5.35%, 06/11/14 995,217 321,429 Term Facility C2, 5.35%, 06/11/14 396,790 iesy Hessen GmbH & Co. 1,500,000 Facility B, 4.88%, 02/14/13 ..... 1,850,764 1,500,000 Faciltiy C, 5.38%, 02/14/14 ..... 1,856,299 ------------- 11,054,494 ------------- ITALY - 0.7% EUR Pirelli Cables & Systems, Inc. 4,500,000 Second Lien Term Loan, 01/20/15 (b) 5,588,266 875,000 Euro Term Loan B, 08/01/12 (b) .. 1,070,961 875,000 Euro Term Loan C, 08/01/12 (b) .. 1,072,080 ------------- 7,731,307 ------------- PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- NETHERLANDS - 0.4% EUR YBR Acquisition BV 1,250,000 Facility B Term Loan, 06/30/13 (b) .................... 1,560,367 1,250,000 Facility C Term Loan, 06/30/14 (b) .................... 1,559,414 1,250,000 Facility D Term Loan, 12/30/14 (b) .................... 1,573,818 ------------- 4,693,599 ------------- UNITED KINGDOM - 2.8% GBP 3,125,000 PlayPower, Inc. Add On Term Loan, 12/20/09 (b) .................... 5,690,759 Red Football Ltd. 1,250,000 Facility B Term Loan, 7.85%, 05/11/13 ................. 2,281,924 1,250,000 Facility C Term Loan, 8.35%, 05/11/14 ................. 2,281,924 2,000,000 Term Loan D, 11.10%, 05/11/14 ... 3,687,050 1,402,875 SunGard UK Holdings Ltd Term Loan, 02/11/13 (b) ......... 2,557,849 4,000,000 Teesside Power Ltd. Term Loan, 04/01/08 (b) ......... 7,041,366 Trinitybrook PLC 2,500,000 Term Loan B1, 7.34%, 07/31/13 ... 4,428,911 2,500,000 Term Loan C, 7.84%, 07/31/14 .... 4,478,597 ------------- 32,448,380 ------------- Total Foreign Variable Rate Senior Loan Notes (Cost $57,753,978) ............ 59,058,107 ------------- CORPORATE NOTES AND BONDS - 0.4% AUTOMOTIVE - 0.0% Key Plastics Holdings, Inc. 63,642 Junior Secured Subordinated Notes, 18.32%, 04/26/07 (c) ..... 52,186 101,433 Senior Secured Subordinated Notes, 7.00%, 04/26/07 (c) ...... 91,289 ------------- 143,475 ------------- BEVERAGE & TOBACCO - 0.2% 2,000,000 Commonwealth Brands, Inc Floating Rate Note, 10.91%, 04/15/08 (g) ............ 2,095,000 ------------- TELECOMMUNICATIONS/WIRELESS - 0.2% 2,000,000 Dobson Cellular Systems Floating Rate Note, 8.44%, 11/01/11 ................. 2,090,000 ------------- Total Corporate Notes and Bonds (Cost $4,216,224) ............. 4,328,475 ------------- SHARES ------- COMMON STOCKS (H) - 0.2% AUTOMOTIVE - 0.0% 13 Key Plastics Holdings, Inc. (c) .. 0 ------------- 14 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY SHARES VALUE ($) ------ --------- COMMON STOCKS (CONTINUED) BUSINESS SERVICES - 0.0% 322,876 NATG Holdings LLC (c) ............ 0 ------------- DIVERSIFIED MANUFACTURING - 0.0% 4,021 GenTek, Inc., B Shares ........... 57,179 ------------- ECOLOGICAL SERVICE & EQUIPMENT - 0.0% 3,445 Environmental Systems Products Holdings (c) .................... 0 ------------- HEALTH CARE - 0.0% 22,500 Sun Healthcare Group, Inc. ....... 147,825 ------------- TELECOMMUNICATIONS/COMBINATION - 0.0% 1,756 Eningen Realty (c) ............... 0 92,473 SAVVIS Communications Corp. ...... 89,699 ------------- 89,699 ------------- TELECOMMUNICATIONS/WIRELESS - 0.2% 76,137 Leap Wireless International, Inc. 2,600,840 ------------- Total Common Stocks (Cost $2,612,831) ............. 2,895,543 ------------- PREFERRED STOCK (C) - 0.0% DIVERSIFIED MANUFACTURING - 0.0% 14,382 Superior Telecom, Inc., Series A . 14,382 ------------- Total Preferred Stock (Cost $14,382) ................ 14,382 ------------- UNITS ------- WARRANTS - 0.0% DIVERSIFIED MANUFACTURING - 0.0% 4 GenTek, Inc., Class A expires 10/31/06 ........................ 12 ------------- LODGING & CASINOS - 0.0% 4,023 OpBiz LLC, expires 08/11/09 (c) .. 0 9 OpBiz LLC, expires 08/11/09 (c) .. 0 ------------- 0 ------------- UTILITIES - 0.0% 12,470 Reliant Energy, Inc., expires 08/15/08 (c) .................... 0 ------------- Total Warrants (Cost $20) .................... 12 ------------- TOTAL INVESTMENTS - 98.4% ...................... 1,120,849,331 ------------- (cost of $1,112,898,422) (k) OTHER ASSETS & LIABILITIES, NET - 1.6% ......... 18,568,551 ------------- NET ASSETS - 100.0% ............................ 1,139,417,882 ============= - ------------- (a) Senior loans in which the Portfolio invests generally pay interest at rates which are periodically predetermined by reference to a base lending rate plus a premium. (Unless otherwise identified by (j), all senior loans carry a variable rate interest). These base lending rates are generally (i) the prime rate offered by one or more major United States banks, (ii) the lending rate offered by one or more European banks such as the London Inter-Bank Offered Rate ("LIBOR") and (iii) the certificate of deposit rate. Rate shown represents the weighted average rate at August 31, 2005. Senior loans, while exempt from registration under the Security Act of 1933, as amended, contain certain restrictions on resale and cannot be sold publicly. Senior secured floating rate interests often require prepayments from excess cash flow or permit the borrower to repay at its election. The degree to which borrowers repay, whether as a contractual requirement or at their election, cannot be predicted with accuracy. As a result, the actual remaining maturity may be substantially less than the stated maturities shown. (b) All or a portion of this position has not settled. Contract rates do not take effect until settlement date. (c) Represents fair value as determined in good faith under the direction of the Board of Trustees. (d) The issuer is in default of certain debt covenants. Income is not being accrued. (e) Loans held on participation. (f) This issue is under the protection of the Federal bankruptcy court. (g) Security exempt from registration under Rule 144A of the Securities Act of 1933, as amended. This security may only be resold, in transactions exempt from registration, to qualified institutional buyers. At August 31, 2005, this security amounted to $2,095,000 or 0.2% of net assets. This security has been determined by the investment adviser to be a liquid security. (h) Non-income producing security. (i) Addiitional unfunded commitment. See Note 9. (j) Fixed rate senior loan. (k) Cost for Federal income tax purposes is $1,113,279,937. DIP Debtor in Possession EUR Euro GBP Great Britain Pound FOREIGN VARIABLE SENIOR LOAN NOTES INDUSTRY CONCENTRATION TABLE (% of Total Net Assets) Leisure/Goods/Activities/Movies .... 1.2% Electronic/Electric ................ 1.0% Retailers .......................... 0.8% Telecommunications/Cellular ........ 0.6% Utilities .......................... 0.6% Publishing ......................... 0.4% Cable & Satellite Television ....... 0.3% Clothing/Textiles .................. 0.3% ---- Total .............................. 5.2% ==== SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 15 STATEMENT OF ASSETS AND LIABILITIES - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
($) - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS: Investments, at value (Cost $1,112,898,422) ...................................................... 1,120,849,331 Cash and cash equivalents ........................................................................ 70,284,580 Foreign currency (Cost $26,503,681) .............................................................. 26,934,128 Receivable for: Investments sold .............................................................................. 7,147,881 Interest and fees ............................................................................. 7,856,548 Other assets ..................................................................................... 4,185 --------------- Total Assets ............................................................................... 1,233,076,653 LIABILITIES: Deferred facility fees (Note 2) .................................................................. 78,593 Net discount and unrealized appreciation on unfunded transactions (Note 9) ....................... 263,641 Payable for: Investments purchased ......................................................................... 92,702,416 Investment advisory fee (Note 4) .............................................................. 418,722 Trustees' fees (Note 4) ....................................................................... 3,333 Accrued expenses and other liabilities ........................................................... 192,066 --------------- Total Liabilities .......................................................................... 93,658,771 --------------- NET ASSETS .......................................................................................... 1,139,417,882 ===============
16 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
STATEMENT OF OPERATIONS - ------------------------------------------------------------------------------------------------------------------------------------ FOR THE YEAR ENDED AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY ($) - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT INCOME Interest ......................................................................................... 58,476,258 Dividends ........................................................................................ 153,936 Facility and other fees .......................................................................... 2,174,020 -------------- Total Investment Income .................................................................... 60,804,214 EXPENSES Investment advisory fee (Note 4) ................................................................. 4,369,407 Accounting services fee (Note 4) ................................................................. 305,196 Transfer agent fee (Note 4) ...................................................................... 843 Professional fees ................................................................................ 115,762 Trustees' fees (Note 4) .......................................................................... 25,935 Custody fee (Note 4) ............................................................................. 132,440 Other expenses ................................................................................... 48,799 -------------- Total Operating Expenses ................................................................... 4,998,382 Interest expense (Note 8) ........................................................................ 97,313 Facility expense (Note 8) ........................................................................ 366,077 .................................................................................................... -------------- Total Expenses ............................................................................. 5,461,772 Custody earnings credit (Note 4) ................................................................. (36) -------------- Net Expenses ............................................................................... 5,461,736 -------------- Net Investment Income ............................................................................ 55,342,478 -------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized loss on investments ................................................................. (76,108) Net realized loss on foreign currency transactions ............................................... (79,392) Net change in unrealized appreciation on investments ............................................. 7,013,479 Net change in unrealized appreciation on unfunded transactions (Note 9) .......................... 46,057 Net change in unrealized appreciation on translation of assets and liabilities denominated in foreign currency .............................................................................. 311,579 -------------- Net Gain ......................................................................................... 7,215,615 -------------- Net Increase in Net Assets ....................................................................... 62,558,093 ==============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 17 STATEMENTS OF CHANGES IN NET ASSETS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
YEARS ENDED AUGUST 31, 2005 2004 ($) ($) ---------------- --------------- INCREASE IN NET ASSETS: OPERATIONS Net investment income .......................................................... 55,342,478 32,557,033 Net realized gain (loss) on investments and foreign currency transactions ...... (155,500) 12,489,394 Net change in unrealized appreciation on investments, translation of assets and liabilities denominated in foreign currency and unfunded transactions ....... 7,371,115 20,295,744 ---------------- -------------- Net Increase from Operations ................................................ 62,558,093 65,342,171 ---------------- -------------- TRANSACTIONS IN INVESTOR'S BENEFICIAL INTEREST Contributions .................................................................. 401,269,018 453,429,815 Withdrawals .................................................................... (220,779,725) (133,062,921) ---------------- -------------- Net Increase from Transactions in Investor's Beneficial Interest ............ 180,489,293 320,366,894 ---------------- -------------- Total Increase in Net Assets .......................................... 243,047,386 385,709,065 NET ASSETS Beginning of period ............................................................ 896,370,496 510,661,431 ---------------- -------------- End of period .................................................................. 1,139,417,882 896,370,496 ================ ==============
18 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
STATEMENT OF CASH FLOWS - ------------------------------------------------------------------------------------------------------------------------------------ FOR THE YEAR ENDED AUGUST 31, 2005 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY ($) - ------------------------------------------------------------------------------------------------------------------------------------ INCREASE IN CASH AND FOREIGN CURRENCY CASH FLOWS USED FOR OPERATING ACTIVITIES Net investment income ............................................................................ 55,342,478 ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH USED FOR OPERATING ACTIVITIES Purchase of investments securities ............................................................... (1,066,823,826) Proceeds from disposition of investment securities and realized gain (loss) on foreign currency .. 713,283,129 Sale of short-term portfolio investments, net .................................................... 130,267,000 Increase in unrealized appreciation on unfunded transactions ..................................... (46,057) Increase in interest and fees receivable ......................................................... (3,784,870) Increase in receivable for investments sold ...................................................... (3,482,015) Decrease in other assets ......................................................................... 3,452 Decrease in deferred facility fees ............................................................... (366,313) Increase in payable for accrued expenses ......................................................... 38,384 Net amortization of premium (discount) ........................................................... (1,028,862) Increase in payable for investments purchased .................................................... 92,702,416 Increase in mark-to-market and realized gain (loss) on foreign currency and unsettled positions .. 232,187 Increase in other liabilities 391,850 --------------- Net cash and foreign currency flow used for operating activities ........................... (83,271,047) CASH FLOWS PROVIDED BY FINANCING ACTIVITIES Proceeds from capital contributions .............................................................. 401,269,018 Payment of capital withdrawals ................................................................... (220,779,725) --------------- Net cash flow provided by financing activities ............................................. 180,489,293 --------------- Net increase in cash and foreign currency .................................................. 97,218,246 CASH AND FOREIGN CURRENCY Beginning of the period .......................................................................... 462 --------------- End of the period ................................................................................ 97,218,708 ===============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 19 FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY SELECTED DATA FOR AN INTEREST OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ----------------------------------------------------------------------------- 2005 2004 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA Total return(a) 6.54% 10.39% 11.68%(b) (2.20)% 5.15% Operating expenses(c) 0.51% 0.52% 0.57% 0.55% 0.53% Interest expense and facility expense 0.05% --%(d) --%(d) 0.03% --% Net expenses(c) 0.56% 0.52% 0.57% 0.58% 0.53% Net investment income(c) 5.69% 4.45% 5.96% 6.42%(e) 8.94% Portfolio turnover rate 75% 97% 75% 70% 63% - ---------------------------------------------------- (a) Total return would have been lower had certain expenses not been reimbursed. (b) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Portfolio's return. (c) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%. (d) Rounds to less than 0.01%. (e) Effective September 1, 2001, the Portfolio adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on debt securities. The effect of this change for the year ended August 31, 2002, was to increase the ratio of net investment income to average net assets from 6.41% to 6.42%. Ratios and supplemental data for the periods prior to August 31, 2002 have not been restated to reflect this change in presentation.
20 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENT OF ASSETS AND LIABILITIES - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND
($) - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS: Investment in Portfolio .......................................................................... 1,080,843,087 Receivable for: Fund shares sold .............................................................................. 7,409,085 Other assets ..................................................................................... 156,853 --------------- Total Assets ............................................................................... 1,088,409,025 LIABILITIES: Payable for: Distributions ................................................................................. 2,321,363 Administration fee (Note 4) ................................................................... 360,452 Trustees' fees (Note 4) ....................................................................... 12,333 Distribution and service fees (Note 4) ........................................................ 456,933 Accrued expenses and other liabilities ........................................................... 157,236 --------------- Total Liabilities .......................................................................... 3,308,317 --------------- NET ASSETS .......................................................................................... 1,085,100,708 =============== COMPOSITION OF NET ASSETS Paid-in capital .................................................................................. 1,091,799,196 Undistributed net investment income .............................................................. 633,282 Accumulated net realized loss on investments and foreign currency transactions allocated from Portfolio ..................................................................................... (15,172,802) Net unrealized appreciation on investments, translation of assets and liabilities denominated in foreign currency and unfunded transactions allocated from Portfolio ........................... 7,841,032 --------------- NET ASSETS .......................................................................................... 1,085,100,708 =============== CLASS A Net assets ....................................................................................... 355,997,904 Shares outstanding ............................................................................... 36,042,986 Net asset value per share (Net assets/Shares outstanding) ....................................... 9.88(a) Maximum offering price per share (100 / 96.50 of $9.88) .......................................... 10.24(b) CLASS B Net assets ....................................................................................... 169,779,684 Shares outstanding ............................................................................... 17,196,142 Net asset value and offering price per share (Net assets/Shares outstanding) .................... 9.87(a) CLASS C Net assets ....................................................................................... 366,840,641 Shares outstanding ............................................................................... 37,156,359 Net asset value and offering price per share (Net assets/Shares outstanding) .................... 9.87(a) CLASS Z Net assets ....................................................................................... 192,482,479 Shares outstanding ............................................................................... 19,496,237 Net asset value, offering and redemption price per share (Net assets/Shares outstanding) ......... 9.87 - ---------------------------------------------------- (a) Redemption price per share is equal to net asset value less any applicable contingent deferred sales charge. (b) On sales of $100,000 or more, the offering price is reduced.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 21 STATEMENT OF OPERATIONS - -------------------------------------------------------------------------------- FOR THE YEAR ENDED AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND
($) - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT INCOME Interest, dividends and fees allocated from Portfolio (Note 1) ................................... 56,876,988 -------------- EXPENSES Net operating expenses allocated from Portfolio (Note 1) ......................................... 4,668,152 Administration fee (Note 4) ...................................................................... 1,820,045 Distribution fee (Note 4): Class A ....................................................................................... 260,844 Class B ....................................................................................... 803,926 Class C ....................................................................................... 1,803,596 Service fee (Note 4): Class A ....................................................................................... 658,450 Class B ....................................................................................... 446,626 Class C ....................................................................................... 751,499 Transfer agent fee (Note 4) ...................................................................... 736,422 Professional fees ................................................................................ 92,570 Accounting services fee (Note 4) ................................................................. 44,201 Trustees' fees (Note 4) .......................................................................... 83,489 Custody fee (Note 4) ............................................................................. 1,732 Other expenses ................................................................................... 610,241 -------------- Total Operating Expenses ................................................................... 12,781,793 -------------- Interest expenses allocated from Portfolio (Note 8) .............................................. 92,311 Facility expenses allocated from Portfolio (Note 8) .............................................. 345,733 -------------- Total Expenses ............................................................................. 13,219,837 Fees and expenses waived or reimbursed by Investment Adviser (Note 4) ............................ (769,363) -------------- Net Expenses ............................................................................... 12,450,474 -------------- Net Investment Income ............................................................................ 44,426,514 -------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS ALLOCATED FROM PORTFOLIO (NOTE 1) Net realized loss on investments allocated from Portfolio ........................................ (102,212) Net realized loss on foreign currency transactions allocated from Portfolio ...................... (75,323) Net change in unrealized appreciation on investments allocated from Portfolio .................... 6,665,613 Net change in unrealized appreciation on unfunded transactions allocated from Portfolio (Note 9) . 43,708 Net change in unrealized appreciation on translation of assets and liabilities denominated in foreign currency allocated from Portfolio ..................................................... 296,032 -------------- Net Gain ......................................................................................... 6,827,818 -------------- Net Increase in Net Assets ....................................................................... 51,254,332 ==============
22 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENTS OF CHANGES IN NET ASSETS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND
YEARS ENDED AUGUST 31, 2005 2004 ($) ($) ---------------- --------------- INCREASE IN NET ASSETS: OPERATIONS Net investment income ............................................................. 44,426,514 23,375,298 Net realized gain (loss) on investments and foreign currency transactions allocated from Portfolio ................................................................. (177,535) 11,716,731 Net change in unrealized appreciation on investments, translation of assets and liabilities denominated in foreign currency and unfunded transactions allocated from Portfolio ................................................................. 7,005,353 16,417,157 -------------- -------------- Net Increase from Operations ................................................... 51,254,332 51,509,186 -------------- -------------- DISTRIBUTIONS DECLARED TO SHAREHOLDERS From net investment income: Class A ........................................................................ (13,226,644) (6,051,546) Class B ........................................................................ (8,228,190) (6,346,275) Class C ........................................................................ (13,491,196) (7,124,188) Class Z ........................................................................ (8,949,145) (3,993,912) -------------- -------------- Total Distributions Declared to Shareholders ................................... (43,895,175) (23,515,921) -------------- -------------- SHARE TRANSACTIONS Class A Subscriptions .................................................................. 194,284,743 150,174,094 Distributions reinvested ....................................................... 8,414,712 4,056,148 Redemptions .................................................................... (71,078,183) (36,606,622) -------------- -------------- Net Increase ................................................................... 131,621,272 117,623,620 Class B Subscriptions .................................................................. 5,874,003 42,636,771 Distributions reinvested ....................................................... 4,892,459 3,649,856 Redemptions .................................................................... (33,620,192) (27,516,151) -------------- -------------- Net Increase (Decrease) ........................................................ (22,853,730) 18,770,476 Class C Subscriptions .................................................................. 152,460,394 166,995,336 Distributions reinvested ....................................................... 8,018,612 4,331,572 Redemptions .................................................................... (74,887,937) (34,117,656) -------------- -------------- Net Increase ................................................................... 85,591,069 137,209,252 Class Z: Subscriptions .................................................................. 97,758,278 126,869,430 Distributions reinvested ....................................................... 2,265,809 1,029,585 Redemptions .................................................................... (48,412,070) (22,807,614) -------------- -------------- Net Increase ................................................................... 51,612,017 105,091,401 -------------- -------------- Net Increase from Share Transactions ........................................... 245,970,628 378,694,749 -------------- -------------- Total Increase in Net Assets ................................................... 253,329,785 406,688,014 -------------- -------------- NET ASSETS Beginning of period ............................................................... 831,770,923 425,082,909 End of period (including undistributed and overdistributed net investment income of $633,282 and $(145,284), respectively) ......................................... 1,085,100,708 831,770,923 -------------- --------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 23 STATEMENTS OF CHANGES IN NET ASSETS (CONTINUED) - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND
YEARS ENDED AUGUST 31, 2005 2004 ---------------- --------------- CHANGE IN SHARES Class A: Subscriptions ............................................................... 19,770,029 15,464,717 Issued for distributions reinvested ......................................... 856,198 416,590 Redemptions ................................................................. (7,239,210) (3,764,250) --------------- -------------- Net Increase ................................................................ 13,387,017 12,117,057 Class B: Subscriptions ............................................................... 597,890 4,402,237 Issued for distributions reinvested ......................................... 497,995 375,744 Redemptions ................................................................. (3,425,945) (2,840,856) --------------- -------------- Net Increase (Decrease) ..................................................... (2,330,060) 1,937,125 Class C: Subscriptions ............................................................... 15,517,260 17,241,992 Issued for distributions reinvested ......................................... 816,243 445,134 Redemptions ................................................................. (7,624,801) (3,515,347) --------------- -------------- Net Increase ................................................................ 8,708,702 14,171,779 Class Z: Subscriptions ............................................................... 9,948,182 13,152,535 Issued for distributions reinvested ......................................... 230,667 105,643 Redemptions ................................................................. (4,924,398) (2,357,817) --------------- -------------- Net Increase ................................................................ 5,254,451 10,900,361
24 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ----------------------------------------------------------------------------------------------- CLASS A SHARES 2005 2004 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $ 9.80 $ 9.29 $ 8.83 $ 9.62 $ 10.00 - ------------------------------------------------------------------------------------------------------------------------------------ INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.49 0.37 0.48 0.54(b) 0.81 Net realized and unrealized gain (loss) allocated from Portfolio(a) 0.08 0.52 0.46 (0.79)(b) (0.37) ----------- ----------- ----------- ----------- ----------- Total from Investment Operations 0.57 0.89 0.94 (0.25) 0.44 - ------------------------------------------------------------------------------------------------------------------------------------ LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.49) (0.38) (0.48) (0.54) (0.82) From net realized gains -- -- -- --(c) --(c) ----------- ----------- ----------- ----------- ----------- Total Distributions Declared to Shareholders (0.49) (0.38) (0.48) (0.54) (0.82) - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF PERIOD $ 9.88 $ 9.80 $ 9.29 $ 8.83 $ 9.62 Total return(d)(e) 5.93% 9.65% 11.03%(f) (2.67)% 4.56% - ------------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 1.15% 1.15% 1.15% 1.15% 1.15% Interest expense & facility expense allocated from Portfolio 0.05% --%(g) --%(g) 0.03% --% Net expenses 1.20% 1.15% 1.15% 1.18% 1.15% Net investment income 5.05% 3.78% 5.39% 5.83%(b) 8.28% Waiver/reimbursement 0.08% 0.17% 0.28% 0.28% 0.18% Net assets, end of period (000's) $ 355,998 $ 222,032 $ 97,924 $ 108,583 $ 138,058 - ---------------------------------------------------- (a) Per share data was calculated using average shares outstanding during the period. (b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01, and increased the ratio of net investment income to average net assets from 5.82% to 5.83%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (c) Rounds to less than $0.01. (d) Had the Portfolio's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (e) Total return at net asset value assuming all distributions reinvested and no initial sales charge or CDSC. (f) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Fund's Class A Shares return. (g) Rounds to less than 0.01%.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 25 FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ----------------------------------------------------------------------------------------------- CLASS B SHARES 2005 2004 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $ 9.80 $ 9.29 $ 8.83 $ 9.62 $ 10.00 - ------------------------------------------------------------------------------------------------------------------------------------ INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.46 0.34 0.45 0.51(b) 0.77 Net realized and unrealized gain (loss) allocated from Portfolio(a) 0.06 0.51 0.46 (0.79)(b) (0.37) ----------- ----------- ----------- ----------- ----------- Total from Investment Operations 0.52 0.85 0.91 (0.28) 0.40 - ------------------------------------------------------------------------------------------------------------------------------------ LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.45) (0.34) (0.45) (0.51) (0.78) From net realized gains -- -- -- --(c) --(c) ----------- ----------- ----------- ----------- ----------- Total Distributions Declared to Shareholders (0.45) (0.34) (0.45) (0.51) (0.78) - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF PERIOD $ 9.87 $ 9.80 $ 9.29 $ 8.83 $ 9.62 Total return(d)(e) 5.46% 9.27% 10.65%(f) (3.02)% 4.19% - ------------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 1.50% 1.50% 1.50% 1.50% 1.50% Interest expense & facility expense allocated from Portfolio 0.05% --%(g) --%(g) 0.03% --% Net expenses 1.55% 1.50% 1.50% 1.53% 1.50% Net investment income 4.70% 3.51% 5.05% 5.48%(b) 7.93% Waiver/reimbursement 0.08% 0.17% 0.28% 0.28% 0.18% Net assets, end of period (000's) $ 169,780 $ 191,365 $ 163,448 $ 174,707 $ 195,891 - ---------------------------------------------------- (a) Per share data was calculated using average shares outstanding during the period. (b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01, and increased the ratio of net investment income to average net assets from 5.47% to 5.48%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (c) Rounds to less than $0.01. (d) Had the Portfolio's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (e) Total return at net asset value assuming all distributions reinvested and no CDSC. (f) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Fund's Class B Shares return. (g) Rounds to less than 0.01%.
26 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ----------------------------------------------------------------------------------------------- CLASS C SHARES 2005 2004 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $ 9.80 $ 9.29 $ 8.83 $ 9.62 $ 10.00 - ------------------------------------------------------------------------------------------------------------------------------------ INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.45 0.32 0.44 0.50(b) 0.76 Net realized and unrealized gain (loss) allocated from Portfolio(a) 0.06 0.52 0.46 (0.79)(b) (0.37) ----------- ----------- ----------- ----------- ----------- Total from Investment Operations 0.51 0.84 0.90 (0.29) 0.39 - ------------------------------------------------------------------------------------------------------------------------------------ LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.44) (0.33) (0.44) (0.50) (0.77) From net realized gains -- -- -- --(c) --(c) ----------- ----------- ----------- ----------- ----------- Total Distributions Declared to Shareholders (0.44) (0.33) (0.44) (0.50) (0.77) - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF PERIOD $ 9.87 $ 9.80 $ 9.29 $ 8.83 $ 9.62 Total return(d)(e) 5.30% 9.10% 10.48%(f) (3.16)% 4.04% - ------------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 1.65% 1.65% 1.65% 1.65% 1.65% Interest expense & facility expense allocated from Portfolio 0.05% --%(g) --%(g) 0.03% --% Net expenses 1.70% 1.65% 1.65% 1.68% 1.65% Net investment income 4.55% 3.28% 4.88% 5.33%(b) 7.78% Waiver/reimbursement 0.08% 0.17% 0.28% 0.28% 0.18% Net assets, end of period (000's) $ 366,841 $ 278,797 $ 132,656 $ 137,098 $ 184,399 - ---------------------------------------------------- (a) Per share data was calculated using average shares outstanding during the period. (b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01, and increased the ratio of net investment income to average net assets from 5.32% to 5.33%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (c) Rounds to less than $0.01. (d) Had the Portfolio's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (e) Total return at net asset value assuming all distributions reinvested and no CDSC. (f) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Fund's Class C Shares return. (g) Rounds to less than 0.01%.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 27 FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ----------------------------------------------------------------------------------------------- CLASS Z SHARES 2005 2004 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $ 9.80 $ 9.29 $ 8.83 $ 9.62 $ 10.00 - ------------------------------------------------------------------------------------------------------------------------------------ INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.53 0.40 0.50 0.57(b) 0.84 Net realized and unrealized gain (loss) allocated from Portfolio(a) 0.06 0.52 0.47 (0.78)(b) (0.37) ----------- ----------- ----------- ----------- ----------- Total from Investment Operations 0.59 0.92 0.97 (0.21) 0.47 - ------------------------------------------------------------------------------------------------------------------------------------ LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.52) (0.41) (0.51) (0.58) (0.85) From net realized gains -- -- -- --(c) --(c) ----------- ----------- ----------- ----------- ----------- Total Distributions Declared to Shareholders (0.52) (0.41) (0.51) (0.58) (0.85) - ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF PERIOD $ 9.87 $ 9.80 $ 9.29 $ 8.83 $ 9.62 Total return (d)(e) 6.20% 10.03% 11.42%(f) (2.33)% 4.89% - ------------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 0.80% 0.80% 0.80% 0.80% 0.80% Interest expense & facility expense allocated from Portfolio 0.05% --%(g) --%(g) 0.03% --% Net expenses 0.85% 0.80% 0.80% 0.83% 0.80% Net investment income 5.40% 4.12% 5.53% 6.18%(b) 8.63% Waiver/reimbursement 0.08% 0.17% 0.28% 0.28% 0.18% Net assets, end of period (000's) $ 192,482 $ 139,577 $ 31,055 $ 13,236 $ 11,662 - ---------------------------------------------------- (a) Per share data was calculated using average shares outstanding during the period. (b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01, and increased the ratio of net investment income to average net assets from 6.17% to 6.18%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (c) Rounds to less than $0.01. (d) Had the Portfolio's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (e) Total return at net asset value assuming all distributions reinvested. (f) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Fund's Class Z Shares return. (g) Rounds to less than 0.01%.
28 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. NOTES TO FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND NOTE 1. ORGANIZATION Highland Floating Rate Fund (the "Fund") is a Massachusetts business trust registered under the Investment Company Act of 1940, as amended (the "1940 Act"), as a non-diversified, closed-end management investment company. INVESTMENT GOAL The Fund invests all of its investable assets in the Highland Floating Rate Limited Liability Company (the "Portfolio"). The Portfolio seeks a high level of current income consistent with preservation of capital. THE PORTFOLIO The Portfolio is registered under the 1940 Act as a non-diversified, closed-end management investment company and is organized as a Delaware limited liability company. The Portfolio allocates income, expenses and realized and unrealized gains and losses to each investor on a daily basis, based on methods in compliance with the Internal Revenue Code of 1986, as amended (the "Code"). At August 31, 2005, the Fund and Highland Institutional Floating Rate Income Fund were the sole investors in the Portfolio and owned 94.9% and 5.1%, respectively, of the Portfolio. FUND SHARES The Fund may issue an unlimited number of shares and continuously offers three classes of shares: Class A, Class C and Class Z. Certain share classes have their own sales charge and bear class specific expenses, which include distribution fees and service fees. On March 3, 2005, the Board of Trustees of the Fund approved the closing of the Fund's Class B shares to purchases by new and existing shareholders. The Fund discontinued selling Class B shares to new and existing investors following the close of business on May 2, 2005. Existing investors may still reinvest distributions in Class B shares. Class A shares are subject to a maximum front-end sales charge of 3.50% based on the amount of initial investment. Class A shares purchased without an initial sales charge by accounts aggregating $1 million to $25 million at the time of purchase are subject to a 1.00% contingent deferred sales charge ("CDSC") on shares sold within eighteen months. Class B shares are subject to a maximum CDSC of 3.25% based upon the holding period after purchase. Class B shares will convert to Class A shares eight years after purchase. Please read the Fund's prospectus for additional details on Class B CDSC. Class C shares are subject to a 1.00% CDSC on shares sold within one year after purchase. Class Z shares are not subject to a sales charge. There are certain restrictions on the purchase of Class Z shares, as described in the Fund's prospectus. NOTE 2. SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. The following is a summary of significant accounting policies consistently followed by the Portfolio and the Fund in the preparation of their financial statements. SECURITY VALUATION The value of the Fund's assets is based on its proportionate share of the current market value of the Portfolio's net assets. For securities with readily available market quotations, the Portfolio uses those quotations for pricing. When portfolio securities are traded on the relevant day of valuation, the valuation will be the last reported sale price on that day. If there are no such sales on that day, the security will be valued at the mean between the most recently quoted bid and asked prices from principal market makers. Securities without a sale price or bid and ask quotations on the valuation day will be priced by an independent pricing service. If securities do not have readily available market quotations or pricing service prices, including circumstances under which such are determined not to be accurate or current (including when events materially affect the value of securities occurring between the time when market price is determined and calculation of the Portfolio's net asset value), such securities are valued at their fair value, as determined by the Investment Adviser in good faith in accordance with procedures established by the Portfolio's Board of Trustees. In these cases, the Portfolio's net asset value will reflect the affected portfolio securities' value as determined in the judgment of the Board of 29 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND Trustees or its designee instead of being determined by the market. Using a fair value pricing methodology to price securities may result in a value that is different from a security's most recent sale price and from the prices used by other investment companies to calculate their net asset values. There can be no assurance that the Portfolio's valuation of a security will not differ from the amount that it realizes upon the sale of such security. SECURITY TRANSACTIONS Security transactions are accounted for on the trade date. Cost and gains (losses) are determined based upon the specific identification method for both financial statement and federal income tax purposes. FOREIGN CURRENCY Foreign currencies, investments and other assets and liabilities are translated into U.S. dollars at the exchange rates using the current 4:00 p.m. London Time Spot Rate. Fluctuations in the value of the foreign currencies and other assets and liabilities resulting from changes in exchange rates, between trade and settlement dates on securities transactions and between the accrual and payment dates on dividends, interest income and foreign withholding taxes, are recorded as unrealized foreign currency gains (losses). Realized gains (losses) and unrealized appreciation (depreciation) on investment securities and income and expenses are translated on the respective dates of such transactions. The effect of changes in foreign currency exchange rates on investments in securities are not segregated in the statement of operations from the effects of changes in market prices of those securities, but are included with the net realized and unrealized gain or loss on investment securities. REPURCHASE AGREEMENTS The Portfolio may engage in repurchase agreement transactions with institutions that the Portfolio's investment adviser has determined are creditworthy. The Portfolio, 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 Portfolio's ability to dispose of the underlying securities and a possible decline in the value of the underlying securities during the period while the Portfolio seeks to assert its rights. INCOME RECOGNITION Interest income is recorded on the accrual basis and includes accretion of discounts and amortization of premiums, if any. As of April 2004, facility fees received are recorded as a reduction of cost to the loan and amortized through the maturity of the loan. Prior to May 2004, facility fees received were treated as deferred revenue and amortized over two years. Unamortized facility fees are reflected as deferred fees on the Portfolio's Statement of Assets and Liabilities. DETERMINATION OF CLASS NET ASSET VALUES All income, expenses (other than distribution fees and service fees, which are class-specific expenses, as shown on the Statement of Operations) and realized and unrealized gains (losses) are allocated to each class of the Fund on a daily basis for purposes of determining the net asset value of each class. Income and expenses are allocated to each class based on the settled shares method, while realized and unrealized gains (losses) are allocated based on the relative net assets of each class. FEDERAL INCOME TAX STATUS The Fund intends to qualify each year as a "Regulated Investment Company" under Subchapter M of the Code and will distribute substantially all of its taxable income, if any, for its tax year, and as such will not be subject to federal income taxes. In addition, the Portfolio is treated as a partnership for federal income tax purposes and all of its income is allocated to its owners based on methods in compliance with the Internal Revenue Service. Therefore, no federal income tax provision is recorded. DISTRIBUTIONS TO SHAREHOLDERS Dividends from net investment income are declared by the Fund daily and paid monthly. Net realized capital gains, if any, are distributed at least annually. STATEMENT OF CASH FLOWS Information on financial transactions which have been settled through the receipt or disbursement of cash are presented in the Statement of Cash Flows. The cash and foreign currency amount shown in the Statement of Cash Flows is the amount included within the Portfolio's Statement of Assets and Liabilities and includes cash on hand at its custodian bank and sub-custodian bank, respectively, and does not include any short-term investments. 30 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND NOTE 3. FEDERAL TAX INFORMATION The timing and character of income and capital gain distributions are determined in accordance with Federal income tax regulations, which may differ from GAAP. As a result, net investment income (loss) and net realized gain (loss) on investment transactions for a reporting period may differ significantly from distributions during such period. Reclassifications are made to the Fund's capital accounts for permanent tax differences to reflect income and gains available for distribution (or available capital loss carryforwards) under income tax regulations. For the year ended August 31, 2005, permanent differences resulting primarily from differing treatments for discount accretion/premium amortization on debt securities and Section 988 gain (loss) were identified and reclassified among the components of the Fund's net assets as follows: - -------------------------------------------------------------------------------- Overdistributed Accumulated Net Net Investment Realized Gain Paid-In Income (Loss) Capital - -------------------------------------------------------------------------------- $247,227 $(247,228) $1 - -------------------------------------------------------------------------------- Net investment income and net realized gains (losses), as disclosed on the Statement of Operations, and net assets were not affected by these reclassifications. The tax character of distributions paid during the years ended August 31, 2005 and August 31, 2004 was as follows: - -------------------------------------------------------------------------------- 2005 2004 - -------------------------------------------------------------------------------- Distributions paid from: Ordinary income* $43,895,175 $23,515,921 - -------------------------------------------------------------------------------- Long-term capital gains -- -- - -------------------------------------------------------------------------------- *For tax purposes short-term capital gains distributions, if any, are considered ordinary income distributions. As of August 31, 2005, the components of distributable earnings on a tax basis were as follows: - -------------------------------------------------------------------------------- Undistributed Undistributed Ordinary Long-Term Net Unrealized Income Capital Gains Appreciation* - -------------------------------------------------------------------------------- $3,339,596 $-- $7,475,892 - -------------------------------------------------------------------------------- *The differences between book-basis and tax-basis net unrealized appreciation (depreciation) are primarily due to deferral of losses from wash sales and accretion/amortization on debt securities. Portfolio unrealized appreciation and depreciation at August 31, 2005, based on cost of investments for federal income tax purposes, and excluding any unrealized appreciation (depreciation) from changes in the value of other assets and liabilities resulting from changes in exchange rates, was: - -------------------------------------------------------------------------------- Unrealized appreciation $14,617,239 - -------------------------------------------------------------------------------- Unrealized depreciation (7,047,845) ----------- Net unrealized appreciation $ 7,569,394 - -------------------------------------------------------------------------------- The following capital loss carryforwards may be available to reduce taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Code: - -------------------------------------------------------------------------------- Year of Capital Loss Expiration Carryforward - -------------------------------------------------------------------------------- 2010 $ 6,525,450 - -------------------------------------------------------------------------------- 2011 4,178,432 - -------------------------------------------------------------------------------- 2012 3,291,779 - -------------------------------------------------------------------------------- Total $ 13,995,661 - -------------------------------------------------------------------------------- Under current laws, certain capital losses realized after October 31 may be deferred and treated as occurring on the first day of the following fiscal year. For the fiscal year ended August 31, 2005, the Fund has elected to defer net realized capital losses of $1,166,146 and net realized currency losses of $75,323 incurred from November 1, 2004 to August 31, 2005. NOTE 4. ADVISORY, ADMINISTRATION, SERVICE AND DISTRIBUTION, TRUSTEE, AND OTHER FEES INVESTMENT ADVISORY FEE Effective April 15, 2004, Highland Capital Management, L.P. ("Highland") is the investment adviser to the Portfolio. Highland receives a monthly investment advisory fee based on the Portfolio's average daily net assets at the following annual rates: - -------------------------------------------------------------------------------- Average Daily Net Assets Annual Fee Rate - -------------------------------------------------------------------------------- First $1 billion 0.45% - -------------------------------------------------------------------------------- Next $1 billion 0.40% - -------------------------------------------------------------------------------- Over $2 billion 0.35% - -------------------------------------------------------------------------------- 31 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND For the year ended August 31, 2005, the Portfolio's effective investment advisory fee rate was 0.45%. ADMINISTRATION FEES Effective October 18, 2004, Highland provides administrative services to the Portfolio and the Fund for a monthly administration fee at the annual rate of 0.20% of the Fund's average daily net assets. The Fund, but not the Portfolio, pays Highland for these services. Under separate sub-administration agreements, Highland has delegated certain administrative functions to PFPC Inc. ("PFPC"). For the period ended August 31, 2005, Highland received $1,610,009 in administration fees and paid PFPC $80,500 for their services. This amount is included in the "Administration fee" on the Statement of Operations of the Fund. Prior to October 18, 2004, Columbia Management Advisors, Inc. ("Columbia Management") provided administrative and other services to the Fund for a monthly administration fee at the annual rate of 0.20% of the Fund's average daily net assets. For the period September 1, 2004 through October 17, 2004, Columbia Management received $210,035 in administration fees, which is included in the "Administration fee" on the Statement of Operations of the Fund. ACCOUNTING SERVICES FEES Effective October 18, 2004, the Portfolio and the Fund entered into separate accounting services agreements with PFPC. All accounting services fees are paid by the Portfolio. For the period October 18, 2004 through August 31, PFPC received $239,481 for this service. An allocated portion of the Portfolio fee is included in the "Net operating expense allocated from Portfolio" on the Statement of Operations of the Fund. Prior to October 18, 2004, Columbia Management was responsible for providing pricing and bookkeeping services to the Portfolio and the Fund under a pricing and bookkeeping agreement. Under a separate agreement (the "Outsourcing Agreement"), Columbia Management delegated those functions to State Street Bank and Trust Company ("State Street"). As a result, Columbia Management paid the total fees collected under the Outsourcing Agreement to State Street. Under its pricing and bookkeeping agreement with the Fund, Columbia Management received from the Portfolio and the Fund an annual flat fee of $10,000 and $5,000, respectively, paid monthly, and in any month that the Fund's average daily net assets exceeded $50 million, an additional monthly fee. The additional fee rate was calculated by taking into account the fees payable to State Street under the Outsourcing Agreement. This rate was applied to the average daily net assets of the Fund for that month. The Fund also paid additional fees for pricing services based on the number of securities held by the Portfolio. For the period September 1, 2004 through October 17, 2004, Columbia Management received pricing and bookkeeping fees of $27,762 from the Fund and $30,460 from the Portfolio. The Fund fee is included in the "Accounting Services fee" and an allocated portion of the Portfolio fee is included in the "Net operating expenses allocated from Portfolio" on the Statement of Operations of the Fund. TRANSFER AGENT FEE Effective October 18, 2004, PFPC provides shareholder services to the Fund. For the period October 18, 2004 through August 31, 2005, PFPC received $385,392 for this service. This fee is included in the "Transfer agent fee" on the Statement of Operations of the Fund. Prior to October 18, 2004, Columbia Funds Services, Inc. ("Columbia Services"), an affiliate of Columbia Management, provided shareholder services to the Fund. For such services, Columbia Services received a fee, paid monthly, at the annual rate of $34 per open account. Columbia Services also received reimbursement for certain out-of-pocket expenses. For the period September 1, 2004 through October 17, 2004, Columbia Services received transfer agent fees, excluding out-of-pocket expenses, of $843 from the Portfolio and $98,372 from the Fund. An allocated portion of the Portfolio fee is included in the "Net operating expenses allocated from Portfolio" and the Fund fee is included in the "Transfer agent fee" on the Statement of Operations of the Fund. SERVICE AND DISTRIBUTION FEES PFPC Distributors, Inc. (the "Distributor") serves as the principal underwriter and distributor of the Fund's shares. The Distributor is paid a CDSC on certain redemptions of Class A, Class B and Class C Shares. For the year ended August 31, 2005, the Distributor received $6,903, $233,286 and $90,996 of CDSC on Class A, Class B and Class C share redemptions, respectively. The Fund has adopted a plan pursuant to Rule 12b-1 under the 1940 Act (the "Plan"), which requires the payment of a monthly service fee to the Distributor at the annual rate not to exceed 0.25% of the average daily net assets attributable to Class A, Class B and Class C 32 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND shares of the Fund. The Plan also requires the payment of a monthly distribution fee to the Distributor on an annual basis not to exceed 0.10%, 0.45% and 0.60% of the average daily net assets attributable to Class A, Class B and Class C shares, respectively. The CDSC and the fees received from the Plan are used principally as repayment for amounts paid to dealers who sold such shares. EXPENSE LIMITS AND FEE REIMBURSEMENTS Highland has voluntarily agreed to waive fees and reimburse certain expenses to the extent that total expenses (inclusive of allocated Portfolio expenses but exclusive of distribution and service fees, brokerage commissions, interest, facility expense, taxes and extraordinary expenses, if any) exceed 0.80% annually of the Fund's average daily net assets. This arrangement may be revised or discontinued by Highland at any time. CUSTODY Effective October 18, 2004, PFPC Trust Company ("PFPC Trust") is the custodian to the Portfolio and Fund. For the period October 18, 2004 through August 31, 2005, PFPC Trust received custody fees of $112,192 from the Portfolio and $1,100 from the Fund. An allocated portion of the Portfolio fee is included in the "Net operating expenses allocated from Portfolio" and the Fund fee is included in the "Custody fee" on the Statement of Operations of the Fund. For the period September 1, 2004 through October 17, 2004, the Portfolio and Fund had an agreement with its prior custodian bank, State Street, under which custody fees could have been reduced by balance credits. The Portfolio and Fund could have invested a portion of the assets utilized in connection with the expense offset arrangement in an income-producing asset if they had not entered into such an agreement. FEES PAID TO OFFICERS AND TRUSTEES The Fund pays no compensation to its officers, all of whom are employees of Highland. Trustees who are not interested persons (as defined in the 1940 Act) of the Portfolio and Fund each receive an annual retainer fee of $25,000 for services provided as Trustees of the Portfolio and Fund. The Fund and Highland Institutional Floating Rate Income Fund pay $20,000 of this fee (allocated based on their relative net assets). The remaining $5,000 is paid by the Portfolio. NOTE 5. PORTFOLIO INFORMATION For the year ended August 31, 2005, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were $1,066,823,826 and $713,283,129, respectively. NOTE 6. PERIODIC REPURCHASE OFFERS The Fund has adopted a fundamental policy to offer each calendar quarter to repurchase a specified percentage (between 5% and 25%) of the shares then outstanding at NAV ("Repurchase Offers"). Repurchase Offers are scheduled to occur on or about the 15th day (or the next business day if the 15th is not a business day) in the months of March, June, September, and December. It is anticipated that normally the date on which the repurchase price of shares will be determined (the "Repurchase Pricing Date") will be the same date as the deadline for shareholders to provide their repurchase requests to the Distributor (the "Repurchase Request Deadline"), and if so, the Repurchase Request Deadline will be set for a time no later than the close of regular trading on the NYSE on such date. The Repurchase Pricing Date will occur no later than the 14th day after the Repurchase Request Deadline, or the next business day if the 14th day is not a business day. Repurchase proceeds will be paid to shareholders no later than seven days after the Repurchase Pricing Date. For the year ended August 31, 2005, there were four Repurchase Offers. For each Repurchase Offer, the Fund offered to repurchase 10% of its shares. In the September, December, March and June Repurchase Offers, 5.39%, 5.87%, 4.29% and 6.27%, respectively, of shares outstanding were repurchased. 33 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND NOTE 7. SENIOR LOAN PARTICIPATION COMMITMENTS The Portfolio invests at least 80% of its net assets (plus any borrowings for investment purposes) in adjustable rate senior loans ("Senior Loans") the interest rates of which float or vary periodically based upon a benchmark indicator of prevailing interest rates to domestic foreign corporations, partnerships and other entities ("Borrowers"). If the lead lender in a typical lending syndicate becomes insolvent, enters FDIC receivership or, if not FDIC insured enters into bankruptcy, the Portfolio may incur certain costs and delays in receiving payment or may suffer a loss of principal and/or interest. When the Portfolio purchases a participation of a Senior Loan interest, the Portfolio typically enters into a contractual agreement with the lender or other third party selling the participation, not with the borrower directly. As such, the Portfolio assumes the credit risk of the Borrower, selling participant or other persons interpositioned between the Portfolio and the Borrower. The ability of Borrowers to meet their obligations may be affected by economic developments in a specific industry. At August 31, 2005, the following sets forth the selling participants with respect to interests in Senior Loans purchased by the Portfolio on a participation basis. Principal Selling Participant Amount Value - -------------------------------------------------------------------------------- Goldman Sachs: Bridge Information Systems, Inc. Multidraw Term Loan $ 484,353 $ 7,265 - -------------------------------------------------------------------------------- CSFB: Quality Distributions, Inc. Term Loan $ 2,147,512 $2,162,287 - -------------------------------------------------------------------------------- NOTE 8. LINE OF CREDIT On September 13, 2004, the Portfolio entered into a $150,000,000 credit facility used for temporary or emergency purposes to facilitate portfolio liquidity. Interest is charged to the Portfolio based on its borrowings. In addition, the Portfolio has agreed to pay facility expenses on the unutilized line of credit, which are included on the Statement of Operations. For the year ended August 31, 2005, the average daily loan balance outstanding on days where borrowings existed was $59,166,667 at a weighted average interest rate of 4.93%. For the period September 1, 2004 through September 12, 2004, the Portfolio and other previously affiliated funds participated in a $350,000,000 credit facility, for temporary or emergency purposes to facilitate portfolio liquidity. Interest was charged to the Portfolio based on its borrowings. In addition, the Portfolio agreed to pay facility expenses on its pro-rata portion of the unutilized line of credit. Interest expense allocated to the Fund of $92,311 was paid for use of the line of credit and is included on the Statement of Operations. NOTE 9. UNFUNDED LOAN COMMITMENTS As of August 31, 2005, the Portfolio had unfunded loan commitments of $20,846,852, which could be extended at the option of the Borrower, pursuant to the following loan agreements: - -------------------------------------------------------------------------------- Unfunded Loan Borrower Commitment - -------------------------------------------------------------------------------- CCM Merger, Inc./MotorCity Casino $ 450,000 - -------------------------------------------------------------------------------- Centennial Cellular Operating Co. 2,250,000 - -------------------------------------------------------------------------------- Covanta Energy Corp. 1,000,000 - -------------------------------------------------------------------------------- Cricket Communications, Inc. 5,000,000 - -------------------------------------------------------------------------------- Dobson Cellular Systems, Inc. 625,000 - -------------------------------------------------------------------------------- Federal-Mogul Corp. 102,746 - -------------------------------------------------------------------------------- Infor Global Solutions European Finance S.A.R.L. 1,235,772 - -------------------------------------------------------------------------------- Interstate Bakeries Corp. 7,500,000 - -------------------------------------------------------------------------------- Select Medical Corp. 933,334 - -------------------------------------------------------------------------------- Trump Entertainment Resorts, Inc. 1,750,000 - -------------------------------------------------------------------------------- $ 20,846,852 - -------------------------------------------------------------------------------- NOTE 10. DISCLOSURE OF SIGNIFICANT RISKS AND CONTINGENCIES INDUSTRY FOCUS The Portfolio may focus its investments in certain industries, subjecting it to greater risk than a Portfolio that is more diversified. NON-PAYMENT RISK Senior Loans, like other corporate debt obligations, are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the 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. 34 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND 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/or interest payments. Investments in high-yield Senior Loans may result in greater net asset value fluctuation than if the Portfolio did not make such investments. CURRENCY RISK A portion of the Fund's assets may be quoted or denominated in non-U.S. currencies. These securities may be adversely affected by fluctuations in relative currency exchange rates and by exchange control regulations. The Fund's investment performance may be negatively affected by a devaluation of a currency in which the Fund's investments are quoted or denominated. Further, the Fund's investment performance may be significantly affected, either positively or negatively, by currency exchange rates because the U.S. dollar value of securities quoted or denominated in another currency will increase or decrease in response to changes in the value of such currency in relation to the U.S. dollar. LEGAL PROCEEDINGS Prior to April 15, 2004, the Fund was advised by Columbia Management and was part of the Columbia Funds Complex (the "Columbia Funds"). Several Columbia Funds are defendants in civil lawsuits that have been transferred and consolidated for pretrial proceedings in the United States District Court for the District of Maryland in the Special Multi-District Litigation proceeding (Index No. 04-MO-15863) created for actions involving market timing issues against mutual fund complexes. The lawsuits have been commenced as putative class actions on behalf of investors who purchased, held or redeemed shares of the Funds during specified periods or as derivative actions on behalf of the Funds. The lawsuits seek, among other things, unspecified compensatory damages plus interest and, in some cases, punitive damages, the rescission of investment advisory contracts, the return of fees paid under those contracts, and restitution. The consolidated amended class action complaint against Columbia-affiliated defendants was filed on September 29, 2004 and does not name the Fund as a defendant or nominal defendant. The consolidated amended fund derivative complaint against Columbia-affiliated defendants was also filed on September 29, 2004 and names the Columbia Funds, collectively, as nominal defendants. On March 2, 2005, four civil revenue sharing actions alleging, among other things, that various mutual funds (including the Fund) advised by Columbia Management and Columbia Wanger Asset Management L.P. inappropriately used fund assets to pay brokers to promote the funds by directing fund brokerage transactions to such brokers and did not fully disclose such arrangements to shareholders, and charged excessive 12b-1 fees, were consolidated into a single action in the United States District Court for Massachusetts (In re Columbia Entities Litigation, Civil Action No. 04-11704-REK). On June 9, 2005, plaintiffs filed a consolidated amended class action complaint and a motion for class certification. On or about August 8, 2005, all defendents (including the Fund) filed motions to dismiss the consolidated amended complaint. The court has not decided either the class certification or dismissal motions. NOTE 11. SUBSEQUENT EVENT On September 7, 2005, the Board of Directors of the Highland Institutional Floating Rate Income Fund ("Institutional Fund") (See Note 1) determined it to be in the best interest of the Institutional Fund and the Institutional Fund's shareholders that the Institutional Fund be terminated and its assets be liquidated at a date to be determined. Furthermore, that the Board of Directors of the Institutional Fund designated the officers of the Institutional Fund to take any and all action they deem necessary, to (i) cease the sale of shares of the Institutional Fund, (ii) cease the investment activity of the Institutional Fund and (iii) terminate and liquidate the Institutional Fund's portfolio investments and wind up its operations. 35 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND TO THE TRUSTEES AND SHAREHOLDERS OF HIGHLAND FLOATING RATE FUND AND THE TRUSTEES AND PARTICIPANTS OF HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY: 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 Fund (the "Fund") and Highland Floating Rate Limited Liability Company (the "Portfolio") at August 31, 2005, and the results of their operations, the changes in their net assets, the Portfolio's cash flows and their 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 and the Portfolio's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of investments held at August 31, 2005 by correspondence with the custodian and the banks with whom the Portfolio owns participations in loans, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Boston, Massachusetts October 25, 2005 36 ADDITIONAL INFORMATION (UNAUDITED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND TRUSTEES AND OFFICERS The Trustees and officers serve terms of indefinite duration. The names, addresses and ages of the Trustees and officers of the Fund, the year each was first elected or appointed to office, their principal business occupations during at least the last five years, the number of portfolios overseen by each Trustee and other directorships they hold are shown below. Each officer listed below serves as an officer of each Fund in the Highland Funds Complex.
YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS ELECTED OR OCCUPATION(S) IN HIGHLAND FUNDS OTHER NAME, ADDRESS, POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS AND AGE WITH FUND TO OFFICE FIVE YEARS BY TRUSTEE1 HELD INDEPENDENT TRUSTEES Timothy K. Hui Trustee 2004 Associate Provost for Graduate 8 None. (Age 56) Education since July 2004 and c/o Highland Capital Assistant Provost for Educational Management, L.P. Resources from July 2001 to 13455 Noel Road, June 2004, Philadelphia Suite 1300 Biblical University. Dallas, Texas 75240 Scott F. Kavanaugh Trustee 2004 Private Investor. From February 8 None. (Age 44) 2003, to July 2003, an Executive at c/o Highland Capital Provident Funding Mortgage Management, L.P. Corporation. From January 2000 13455 Noel Road, to February 2003, Executive Vice Suite 1300 President, Director and Treasurer Dallas, Texas 75240 of Commercial Capital Bank. From April 1998 to February 2003, Managing Principal and Chief Operating Officer of Financial Institutional Partners Mortgage Company and the Managing Principal and President of Financial Institutional Partners, LLC, an investment banking firm. James F. Leary Trustee 2004 Since January 1999, a Managing 8 Capstone (Age 75) Director of Benefit Capital Series Fund, c/o Highland Capital Southwest, Inc., a financial Inc.; Stewart Management, L.P. consulting firm. Funds, Inc. 13455 Noel Road, (3 portfolios); Suite 1300 Pacesetter/ Dallas, Texas 75240 MVHC Inc. (small business investment company) Bryan A. Ward Trustee 2004 Since January 2002, Senior 8 None. (Age 50) Manager of Accenture, LLP. From c/o Highland Capital September 1998 to December Management, L.P. 2001, he was Special Projects 13455 Noel Road, Advisor to Accenture, LLP Suite 1300 with focus on the oil and gas Dallas, Texas 75240 industry.
37 ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE FUND
TRUSTEES AND OFFICERS YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS ELECTED OR OCCUPATION(S) IN HIGHLAND FUNDS OTHER NAME, ADDRESS, POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS AND AGE WITH FUND TO OFFICE FIVE YEARS BY TRUSTEE1 HELD INTERESTED TRUSTEE 2 R. Joseph Dougherty Trustee 2004 Portfolio Manager of the 8 None. (Age 34) and Senior Vice Adviser. Prior to 2000, he c/o Highland Capital President was a Portfolio Analyst Management, L.P. for the Adviser. 13455 Noel Road, Suite 1300 Dallas, TX 75240 OFFICERS James D. Dondero President 2004 President and Managing N/A N/A (Age 42) Partner of the Adviser. c/o Highland Capital Director of Heritage Bank. Management, L.P. Director and Chairman of 13455 Noel Road, Heritage Bankshares, Inc. Suite 1300 Dallas, TX 75240 Mark Okada Executive 2004 Chief Investment Officer of N/A N/A (Age 44) Vice the Adviser. Director of Heritage c/o Highland Capital President Bank and Heritage Bankshares, Management, L.P. Inc. 13455 Noel Road, Suite 1300 Dallas, TX 75240 M. Jason Blackburn Secretary and 2004 Assistant Controller of the Adviser. N/A N/A (Age 29) Treasurer From September 1999 to c/o Highland Capital October 2001, he was an Management, L.P. accountant for KPMG LLP. 13455 Noel Road, Suite 1300 Dallas, TX 75240 Michael S. Minces Chief 2004 From October 2003 to August 2004, N/A N/A (Age 30) Compliance associate at Akin Gump Strauss c/o Highland Capital Officer Hauer & Feld LLP (law firm). From Management, L.P. October 2000 to March 2003, 13455 Noel Road, associate at Skadden, Arps, Slate, Suite 1300 Meagher & Flom LLP (law firm). Dallas, TX 75240 Previously, he attended The University of Texas at Austin School of Law. 1 The Highland Fund Complex consists of the following funds (the "Highland Funds"): Highland Floating Rate Limited Liability Company, Highland Floating Rate Fund, Highland Floating Rate Advantage Fund, Highland Institutional Floating Rate Income Fund, Highland Corporate Opportunities Fund, Restoration Opportunities Fund, Prospect Street(R) High Income Portfolio Inc. and Prospect Street(R) Income Shares Inc. 2 Mr. Dougherty is deemed to be an "interested person" of the Fund under the 1940 Act because of his position with the Adviser.
38 IMPORTANT INFORMATION ABOUT THIS REPORT - -------------------------------------------------------------------------------- TRANSFER AGENT PFPC Inc. 101 Sabin Street Pawtucket, RI 02860 DISTRIBUTOR PFPC Distributors, Inc. 760 Moore Road King of Prussia, PA 19406 INVESTMENT ADVISER Highland Capital Management, L.P. 13455 Noel Road Suite 1300 Dallas, TX 75240 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM PricewaterhouseCoopers LLP 125 High Street Boston, MA 02110 The Fund mails one shareholder report to each shareholder address. If you would like more than one report, please call shareholder services at 1-877-665-1287 and additional reports will be sent to you. This report has been prepared for shareholders of Highland Floating Rate Fund. A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to its portfolio securities, and the Fund's proxy voting record for the most recent 12-month period ended June 30, are available (i) without charge, upon request, by calling 1-877-665-1287 and (ii) on the Securities and Exchange Commission's website at http://www.sec.gov. The Fund files its complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q. The Fund's Forms N-Q are available on the Commission's website at http:/www.sec.gov and also may be reviewed and copied at the Commission's Public Reference Room in Washington, DC. Information on the Public Reference Room may be obtained by calling 1-800-SEC-0330. The Statement of Additional Information includes information about Fund Directors and is available upon request without charge by calling 1-877-665-1287. 39 THIS PAGE LEFT BLANK INTENTIONALLY. HIGHLAND FLOATING RATE FUND Annual Report, August 31, 2005 [GRAPHIC OMITTED] HIGHLAND FUNDS managed by Highland Capital Management, L.P. HLC-FR AR-8/05 ITEM 2. CODE OF ETHICS. (a) The registrant, as of the end of the period covered by this report, has adopted a code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. (b) Not applicable. (c) There have been no amendments, during the period covered by this report, to a provision of the code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. (d) The registrant has not granted any waiver, including any implicit waiver, from a provision of the code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller. (e) Not applicable. (f) The registrant's code of ethics is incorporated by reference to Exhibit (a)(1) to the registrant's Form N-CSR filed with the Securities and Exchange Commission on November 9, 2004 (Accession No. 0001047469-04-033535). ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT. The Registrant's Board of Trustees (the "Board") has determined that James Leary, a member of the Audit Committee of the Board, is an audit committee financial expert as defined by the Securities and Exchange Commission (the "SEC"). Mr. Leary is "independent" as defined by the SEC for purposes of audit committee financial expert determinations. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. AUDIT FEES (a) The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant's annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years were $11,250 for the fiscal year ended August 31, 2004 and $11,850 for the fiscal year ended August 31, 2005. AUDIT-RELATED FEES (b) The aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant's financial statements and are not reported under paragraph (a) of this Item were $4,000 for the fiscal year ended August 31, 2004 and $5,000 for the fiscal year ended August 31, 2005. The nature of those services was agreed-upon procedures related to semi-annual financial statements. TAX FEES (c) The aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning were $3,400 for the fiscal year ended August 31, 2004 and $3,700 for the fiscal year ended August 31, 2005. The nature of those services was assistance on tax returns and excise tax calculations. ALL OTHER FEES (d) The aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant, other than the services reported in paragraphs (a) through (c) of this Item were $0 for the fiscal year ended August 31, 2004 and $0 for the fiscal year ended August 31, 2005. (e)(1) Disclose the audit committee's pre-approval policies and procedures described in paragraph (c)(7) of Rule 2-01 of Regulation S-X. The Audit Committee shall: (a) have direct responsibility for the appointment, compensation, retention and oversight of the Fund's independent auditors and, in connection therewith, to review and evaluate matters potentially affecting the independence and capabilities of the auditors; and (b) review and pre-approve (including associated fees) all audit and other services to be provided by the independent auditors to the Fund and all non-audit services to be provided by the independent auditors to the Fund's investment adviser or any entity controlling, controlled by or under common control with the investment adviser (an "Adviser Affiliate") that provides ongoing services to the Fund, if the engagement relates directly to the operations and financial reporting of the Fund; and (c) establish, to the extent permitted by law and deemed appropriate by the Audit Committee, detailed pre-approval policies and procedures for such services; and (d) consider whether the independent auditors' provision of any non-audit services to the Fund, the Fund's investment adviser or an Adviser Affiliate not pre-approved by the Audit Committee are compatible with maintaining the independence of the independent auditors. (e)(2) The percentage of services described in each of paragraphs (b) through (d) of this Item that were approved by the audit committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X are as follows: (b) 100% (c) 100% (d) Not applicable (f) The percentage of hours expended on the principal accountant's engagement to audit the registrant's financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountant's full-time, permanent employees was less than fifty percent. (g) The aggregate non-audit fees billed by the registrant's accountant for services rendered to the registrant, and rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the adviser that provides ongoing services to the registrant for each of the last two fiscal years of the registrant were $0 for the fiscal year ended August 31, 2004 and $85,252 for the fiscal year ended August 31, 2005. (h) The registrant's audit committee of the board of directors has considered whether the provision of non-audit services that were rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible with maintaining the principal accountant's independence. ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. Not applicable. ITEM 6. SCHEDULE OF INVESTMENTS. Schedule of Investments in securities of unaffiliated issuers as of the close of the reporting period is included as part of the report to shareholders filed under Item 1 of this form. ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES. The Adviser has adopted proxy voting guidelines (the "Guidelines") that provide as follows: o The Adviser votes proxies in respect of a client's securities in the client's best economic interests and without regard to the interests of the Adviser or any other client of the Adviser. o Unless the Adviser's Proxy Voting Committee (the "Committee") otherwise determines (and documents the basis for its decision) or as otherwise provided below, the Adviser votes proxies in a manner consistent with the Guidelines. o To avoid material conflicts of interest, the Adviser applies the Guidelines in an objective and consistent manner across client accounts. Where a material conflict of interest has been identified and the matter is covered by the Guidelines, the Committee votes in accordance with the Guidelines. For clients that are registered investment companies, where a conflict of interest has been identified and the matter is not covered in the Guidelines, the Adviser will disclose the conflict and the Committee's determination of the manner in which to vote to the Fund's Board. For clients that are not investment companies, where a conflict of interest has been identified and the matter is not covered in the Guidelines, the Committee will disclose the conflict to the client and advise the client that its securities will be voted only upon the client's written direction. o The Adviser also may determine not to vote proxies in respect of securities of any issuer if it determines it would be in its clients' overall best interests not to vote. The Adviser's Guidelines address how it will vote proxies on particular types of matters such as changes in corporate government structures, adoption of options plans and anti-takeover proposals. For example, the Adviser generally will: o support management in most elections for directors, unless the board gives evidence of acting contrary to the best economic interests of shareholders; o support option plans, if it believes that they provide for their administration by disinterested parties and provide incentive to directors, managers and other employees by aligning their economic interests with those of the shareholders while limiting the transfer of wealth out of the company; and o oppose anti-takeover proposals unless they are structured in such a way that they give shareholders the ultimate decision on any proposal or offer. ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES. Not yet applicable. ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT COMPANY AND AFFILIATED PURCHASERS. Not applicable. ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There have been no material changes to the procedures by which the shareholders may recommend nominees to the registrant's board of directors, where those changes were implemented after the registrant last provided disclosure in response to the requirements of Item 7(d)(2)(ii)(G) of Schedule 14A (17 CFR 240.14a-101), or this Item. ITEM 11. CONTROLS AND PROCEDURES. (a) The registrant's principal executive and principal financial officers, or persons performing similar functions, have concluded that the registrant's disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940, as amended (the "1940 Act")) are effective, as of a date within 90 days of this filing, based on their evaluation of these controls and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15(b)). (b) There were no changes in the registrant's internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act) that occurred during the registrant's last half year that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. ITEM 12. EXHIBITS. (a)(1) Not applicable. (a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto. (a)(3) Not applicable. (b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. (registrant) HIGHLAND FLOATING RATE FUND -------------------------------------------------------------------- By (Signature and Title)* /S/ JAMES D. DONDERO ------------------------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) Date NOVEMBER 3, 2005 ---------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By (Signature and Title)* /S/ JAMES D. DONDERO ------------------------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) Date NOVEMBER 3, 2005 ---------------------------------------------------------------------------- By (Signature and Title)* /S/ M. JASON BLACKBURN ------------------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) Date NOVEMBER 3, 2005 ---------------------------------------------------------------------------- * Print the name and title of each signing officer under his or her signature. EX-99.CERT 2 cert302.txt 302 CERTIFICATION CERTIFICATION PURSUANT TO RULE 30A-2(A) UNDER THE 1940 ACT AND SECTION 302 OF THE SARBANES-OXLEY ACT I, James D. Dondero, certify that: 1. I have reviewed this report on Form N-CSR of Highland Floating Rate Fund; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: NOVEMBER 3, 2005 /S/ JAMES D. DONDERO ---------------------- ----------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) CERTIFICATION PURSUANT TO RULE 30A-2(A) UNDER THE 1940 ACT AND SECTION 302 OF THE SARBANES-OXLEY ACT I, M. Jason Blackburn, certify that: 1. I have reviewed this report on Form N-CSR of Highland Floating Rate Fund; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: NOVEMBER 3, 2005 /S/ M. JASON BLACKBURN ---------------------- ------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) EX-99.906CERT 3 cert906.txt 906 CERTIFICATION CERTIFICATION PURSUANT TO RULE 30A-2(B) UNDER THE 1940 ACT AND SECTION 906 OF THE SARBANES-OXLEY ACT I, James D. Dondero, Chief Executive Officer of Highland Floating Rate Fund (the "Registrant"), certify that, to the best of my knowledge: 1. The Form N-CSR of the Registrant for the period ended August 31, 2005 (the "Report") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. : Date: NOVEMBER 3, 2005 /S/ JAMES D. DONDERO ---------------------- ----------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) I, M. Jason Blackburn, Chief Financial Officer of Highland Floating Rate Fund (the "Registrant"), certify that, to the best of my knowledge: 1. The Form N-CSR of the Registrant for the period ended August 31, 2005 (the "Report") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: NOVEMBER 3, 2005 /S/ M. JASON BLACKBURN ---------------------- ------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) -----END PRIVACY-ENHANCED MESSAGE-----