N-CSRS 1 highfloatrate.txt HIGHLAND FLOATING RATE NCSRS 0206 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: FEBRUARY 28, 2006 ------------------ Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles. A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget ("OMB") control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. ss. 3507. ITEM 1. REPORTS TO STOCKHOLDERS. The Report to Shareholders is attached herewith. [HIGHLAND FUNDS LOGO] HIGHLAND FLOATING RATE FUND SEMI-ANNUAL REPORT FEBRUARY 28, 2006 -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND TABLE OF CONTENTS Fund Profile ............................................................. 1 Financial Statements ..................................................... 2 Investment Portfolio .................................................. 3 Portfolio Statement of Assets and Liabilities ......................... 13 Portfolio Statement of Operations ..................................... 14 Portfolio Statements of Changes in Net Assets ......................... 15 Portfolio Statement of Cash Flows ..................................... 16 Portfolio Financial Highlights ........................................ 17 Fund Statement of Assets and Liabilities .............................. 18 Fund Statement of Operations .......................................... 19 Fund Statements of Changes in Net Assets .............................. 20 Fund Financial Highlights ............................................. 22 Notes to Financial Statements ......................................... 26 Important Information About This Report .................................. 32 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. FUND PROFILE -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND OBJECTIVE The Highland Floating Rate Fund (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 02/28/06) $1,328.2 million The information below gives you a snapshot of the Portfolio at the end of the reporting period. The Portfolio is actively managed and the composition of its portfolio will change over time. QUALITY BREAKDOWN IN THE PORTFOLIO AS OF 02/28/06 (%) -------------------------------------------------------------------------- Ba 16.6 -------------------------------------------------------------------------- B 62.0 -------------------------------------------------------------------------- Caa 6.5 -------------------------------------------------------------------------- NR 14.9 -------------------------------------------------------------------------- TOP 5 SECTORS IN THE PORTFOLIO AS OF 02/28/06 (%) -------------------------------------------------------------------------- Cable 10.2 -------------------------------------------------------------------------- Retail 7.4 -------------------------------------------------------------------------- Utilities 6.8 -------------------------------------------------------------------------- Gaming/Leisure 6.1 -------------------------------------------------------------------------- Telecommunications 5.6 -------------------------------------------------------------------------- TOP 10 HOLDINGS IN THE PORTFOLIO AS OF 02/28/06 (%) ------------------------------------------------------------------------------------ Georgia-Pacific Corp., First Lien Term Loan, 02/14/13 1.9 ------------------------------------------------------------------------------------ United Air Lines, Inc., Tranche B Term Loan, 8.63%, 02/01/12 1.9 ------------------------------------------------------------------------------------ Home Interiors & Gifts, Inc., Initial Term Loan, 9.81%, 03/31/11 1.9 ------------------------------------------------------------------------------------ DS Waters Enterprises LP, Term Loan, 9.03%, 11/07/09 1.7 ------------------------------------------------------------------------------------ Charter Communications Operating LLC, Tranche B Term Loan, 7.92%, 04/07/11 1.7 ------------------------------------------------------------------------------------ Georgia-Pacific Corp., Second Lien Term Loan, 7.56%, 02/14/14 1.5 ------------------------------------------------------------------------------------ Blockbuster Entertainment Corp., Tranche B Term Loan, 8.73%, 08/20/11 1.4 ------------------------------------------------------------------------------------ Resorts International Holdings Ltd., Second Lien Term Loan, 12.03%, 04/26/13 1.2 ------------------------------------------------------------------------------------ Movie Gallery, Inc., Term Loan B, 8.28%, 04/27/11 1.1 ------------------------------------------------------------------------------------ Cricket Communications, Inc., Term Loan B, 7.03%, 01/10/11 1.1 ------------------------------------------------------------------------------------
Quality is calculated as a percentage of total notes and bonds. Sectors and holdings are calculated as a percentage of net assets. 1 FINANCIAL STATEMENTS -------------------------------------------------------------------------------- FEBRUARY 28, 2006 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 was affected by the fund's operating results. The Financial Highlights table also discloses the classes' performance and certain key ratios (e.g., class expenses and net investment income as a percentage of average net assets). NOTES TO FINANCIAL STATEMENTS These notes disclose the organizational background of the Fund, its significant accounting policies (including those surrounding security valuation, income recognition and distributions to shareholders), federal tax information, fees and compensation paid to affiliates and significant risks and contingencies. 2 INVESTMENT PORTFOLIO (UNAUDITED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- SENIOR LOAN NOTES (a) - 93.6% AEROSPACE - AEROSPACE/DEFENSE - 1.0% 7,980,000 DeCrane Aircraft Holdings, Inc. First Lien Term Loan, 8.78%, 03/31/08 .............................. 8,009,925 2,000,000 IAP Worldwide Services, Inc. First Lien Term Loan, 7.63%, 12/30/12 .............................. 2,027,500 2,971,765 Vought Aircraft Industries, Inc. Term Loan, 7.11%, 12/22/11 ................... 2,999,254 ----------- 13,036,679 ----------- AEROSPACE - AIRLINES - 2.3% Continental Airlines, Inc. 857,143 Tranche A-1 Term Loan, 9.79%, 06/01/11 .............................. 872,143 2,142,857 Tranche A-2 Term Loan, 9.79%, 06/01/11 .............................. 2,180,357 2,000,000 Northwest Airlines, Inc. Tranche C Term Loan, 10.82%, 11/23/10 ............................. 2,035,000 24,500,000 United Airlines, Inc. Tranche B Term Loan, 8.63%, 02/01/12 .............................. 24,949,330 ----------- 30,036,830 ----------- BROADCASTING - 2.6% 1,000,000 Enterprise NewsMedia LLC Term Loan, 7.53%, 06/30/12 ................... 1,012,500 NEP Supershooters LP 1,423,769 First Lien Term A Loan, 8.60%, 02/03/11 .............................. 1,446,008 1,043,977 Second Lien Term Loan, 12.53%, 08/03/11 ............................. 1,038,757 NextMedia Operating, Inc 1,227,692 Delay Draw Term Loan, 6.57%, 11/15/12 .............................. 1,238,815 2,762,308 Initial First Lien Term Loan, 6.57%, 11/15/12 .............................. 2,786,892 11,000,000 Paxson Communications Corp. First Lien Term Loan, 7.78%, 01/15/12 .............................. 11,043,340 2,977,500 Spanish Broadcasting Systems, Inc. First Lien Term Loan, 6.28%, 06/10/12 .............................. 3,015,969 13,003,592 Young Broadcasting, Inc. Term Loan, 6.81%, 11/03/12 (b) ............... 13,052,486 ----------- 34,634,767 ----------- CABLE - INTERNATIONAL CABLE - 2.4% 4,991,626 Adelphia Communications Corp. Tranche B DIP Term Loan, 6.88%, 03/31/06 .............................. 5,016,585 1,870,505 Bragg Communications, Inc. Term Loan B, 6.81%, 08/31/11 ................. 1,891,548 5,000,000 NTL, Inc. B2 Sub-Tranche, 7.57%, 04/14/12 .............................. 5,028,100 2,962,500 Puerto Rico Cable Acquisition Co., Inc. First Lien Term Loan, 7.25%, 07/28/11 .............................. 2,997,695 San Juan Cable, LLC 2,500,000 First Lien Term Loan, 9.94%, 10/31/12 .............................. 2,531,250 PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- CABLE - INTERNATIONAL CABLE (CONTINUED) San Juan Cable, LLC (continued) 2,500,000 Second Lien Term Loan, 6.44%, 10/31/13 .............................. 2,515,100 11,442,500 UPC Broadband Holding BV Facility F2, 8.03%, 03/31/09 ................. 11,591,252 ----------- 31,571,530 ----------- CABLE - US CABLE - 7.5% 1,150,000 Bresnan Communications LLC Tranche B Term Loan, 8.07%, 09/30/10 .............................. 1,163,938 Century Cable Holdings LLC 7,500,000 Discretionary Term Loan, 9.50%, 12/31/09 .............................. 7,387,500 2,500,000 Revolver, 8.50%, 03/31/09 .................... 2,433,600 15,000,000 Term Loan, 9.50%, 06/30/09 ................... 14,733,750 Charter Communications Operating LLC 1,997,517 Tranche A Term Loan, 7.67%, 04/27/10 .............................. 2,008,303 21,770,446 Tranche B Term Loan, 7.92%, 04/07/11 (b) .......................... 22,011,683 14,087,500 Hilton Head Communications LP Revolver, 7.50%, 09/30/07 .................... 13,721,225 5,044,914 Knology, Inc. Second Lien Term Loan, 14.66%, 06/29/11 ............................. 5,498,956 Mediacom Broadband Group 3,520,000 Tranche A Term Loan, 5.94%, 03/31/10 .............................. 3,520,000 1,970,113 Tranche C Term Loan, 6.69%, 09/30/10 .............................. 1,996,118 990,000 Mediacom Illiniois, LLC Tranche B Term Loan, 6.79%, 03/31/13 .............................. 1,003,613 Northland Cable Television, Inc. 5,000,000 First Lien Term Loan B, 10.50%, 12/22/12 ............................. 5,012,500 4,000,000 Second Lien Term Loan, 14.00%, 06/22/13 ............................. 4,000,000 Olympus Cable Holdings LLC 9,500,000 Term Loan A, 8.75%, 06/30/10 ................. 9,321,020 1,000,000 Term Loan B, 9.50%, 09/30/10 ................. 984,690 WideOpenWest LLC 2,955,000 Incremental Term Loan B, 7.53%, 06/22/11 .............................. 2,962,388 1,964,988 Term Loan B, 7.55%, 06/22/11 ................. 1,971,119 ----------- 99,730,403 ----------- CHEMICALS - COMMODITY & FERTILIZER - 0.6% 7,454,142 Celenese Dollar Term Loan B, 6.53%, 04/06/11 .............................. 7,546,647 78,772 Huntsman International LLC Term B Dollar Loan, 6.32%, 08/16/12 .............................. 79,292 ----------- 7,625,939 ----------- CHEMICALS - SPECIALTY CHEMICALS - 2.5% Brenntag Holding GMBH & Co. 589,091 Acquisition Facility, 7.07%, 01/17/14 .............................. 598,664 2,410,909 Facility B2 Term Loan, 7.07%, 01/17/14 .............................. 2,457,922 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 3 INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- SENIOR LOAN NOTES (CONTINUED) CHEMICALS - SPECIALTY CHEMICALS (CONTINUED) Ineos US Finance LLC 2,000,000 Term Loan A4, 6.83%, 12/14/12 ................ 1,998,440 5,750,000 Term Loan B2, 6.83%, 12/14/13 (b) ............ 5,829,120 5,750,000 Term Loan C2, 7.33%, 12/14/14 (b) ............ 5,808,478 1,890,000 Innophos, Inc. Tranche B Term Loan, 6.82%, 08/13/10 .............................. 1,916,762 443,136 INVISTA Canada Co. Tranche B-2 Term Loan, 6.38%, 04/29/11 .............................. 448,121 886,272 INVISTA S.A.R.L. Tranche B-1 Term Loan, 6.38%, 04/29/11 .............................. 896,243 4,500,000 ISP Chemco, Inc. Term Loan, 02/16/13 (b) ...................... 4,542,210 4,012,903 Kraton Polymers Group of Cos. Term Loan, 7.02%, 12/23/10 ................... 4,073,097 Nalco Co. 478,782 Tranche A-1 Term Loan, 7.07%, 11/04/09 .............................. 482,373 1,997,656 Tranche B Term Loan, 6.34%, 11/04/10 .............................. 2,022,486 1,980,000 Rockwood Specialties Group, Inc. Tranche E Term Loan, 6.67%, 07/30/12 .............................. 2,007,225 ----------- 33,081,141 ----------- CONSUMER DURABLES - 0.2% 3,000,000 Rexair LLC Second Lien Term Loan, 11.69%, 06/30/11 ............................. 3,000,000 ----------- CONSUMER NON-DURABLES - OTHER NON-DURABLES - 3.9% 2,000,000 Amscan Holdings Term Loan B, 7.77%, 12/23/12 ................. 1,982,500 23,757,927 DS Waters Enterprises LP Term Loan, 9.03%, 11/07/09 (b) ............... 23,045,189 10,561,765 Eastman Kodak Co. Term B-1 Advance, 6.72%, 10/18/12 .............................. 10,681,218 1,719,375 Hillman Group, Inc. Term Loan B, 7.69%, 03/31/11 ................. 1,748,398 1,000,000 Jarden Corp Term Loan B1, 01/24/12 (b) ................... 1,011,150 1,000,000 MD Beauty, Inc. Second Lien Term Loan, 11.67%, 02/18/13 ............................. 1,011,880 1,970,800 Polaroid Corp. Term Loan, 11.63%, 04/27/11 .................. 1,975,727 Prestige Brands Holdings, Inc. 107,078 Term Loan B Add-On, 6.89%, 04/06/11 .............................. 108,350 1,965,000 Tranche B Term Loan, 7.24%, 04/06/11 .............................. 1,988,344 2,875,000 Revlon Consumer Products Corp. Term Loan, 10.50%, 07/09/10 .................. 2,962,458 875,533 Solo Cup, Inc. Term B1 Loan, 7.03%, 02/27/11 ................ 884,446 UCG Paper Crafts 400,000 First Lien Synthetic Facility, 02/17/13 (b) ................................. 401,000 1,600,000 First Lien Term Loan, 02/17/13 (b) ........... 1,604,000 PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- CONSUMER NON-DURABLES - OTHER NON-DURABLES (CONTINUED) UCG Paper Crafts (continued) 2,000,000 Second Lien Term Loan, 08/17/13 (b) .......... 2,007,500 ----------- 51,412,160 ----------- CONSUMER NON-DURABLES - TEXTILES - 0.3% 2,000,000 Camelbak Products, Inc. Second Lien Term Loan, 6.50%, 02/04/12 .............................. 1,920,000 1,900,632 Levi Strauss & Co. Tranche A Term Loan, 11.52%, 09/29/09 ............................. 1,958,126 ----------- 3,878,126 ----------- DIVERSIFIED MEDIA - 4.1% 2,881,037 Adams Outdoor Advertising LP Term Loan, 6.62%, 10/15/11 ................... 2,923,042 8,308,145 American Lawyer Media Holdings, Inc. First Lien Term Loan, 7.03%, 03/05/10 .............................. 8,328,916 2,992,424 Cygnus Business Media Term Loan B, 9.10%, 07/13/09 ................. 2,977,462 1,480,152 Day International, Inc. First Lien U S Term Loan, 7.03%, 12/05/12 .............................. 1,499,128 2,500,000 Deluxe Canada Holdings, Inc. First Lien Tranche C Term Loan, 8.33%, 01/28/11 .............................. 2,525,000 5,500,000 HIT Entertainment PLC Second Lien Term Loan, 9.97%, 02/26/13 .............................. 5,552,140 3,000,000 Merrill Communications LLC Combined Term Loan, 6.86%, 05/15/11 .............................. 3,030,480 9,505,000 Metro-Goldwyn-Mayer Holdings, Inc./ LOC Acquisition Co. Tranche B Term Loan, 6.78%, 04/08/12 .............................. 9,614,498 North American Membership Group, Inc. 992,500 First Lien Tranche B Term Loan, 7.78%, 05/19/11 .............................. 987,538 3,000,000 Second Lien Term Loan, 12.03%, 11/18/11 ............................. 2,985,000 1,995,000 PBI Media, Inc. First Lien Term Loan, 6.91%, 09/30/12 .............................. 1,999,150 3,000,000 PRIMEDIA, Inc. Term Loan B, 09/30/13 (b) .................... 2,971,500 1,560,757 Six Flags Theme Parks, Inc. Tranche B Term Loan, 7.11%, 06/30/09 .............................. 1,581,234 2,815,517 VISANT Corp. Tranche C Term Loan, 6.78%, 10/04/11 .............................. 2,856,004 4,917,474 Warner Music Group Term Loan, 6.66%, 02/28/11 ................... 4,975,107 ----------- 54,806,199 ----------- ENERGY - EXPLORATION & PRODUCTION - 1.5% 4,488,750 Cheniere LNG Holdings LLC Term Loan, 6.95%, 08/30/12 .................... 4,546,251 2,000,000 Primary Energy Operations LLC Term Loan, 7.56%, 08/24/09 .................... 2,021,240 4 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- SENIOR LOAN NOTES (CONTINUED) ENERGY - EXPLORATION & PRODUCTION (CONTINUED) Targa Resources, Inc. 2,000,000 Asset Bridge Term Loan, 6.83%, 10/31/07 .............................. 2,007,500 967,742 Synthetic Term Loan, 4.40%, 10/31/12 .............................. 979,839 4,022,177 Term Loan, 6.74%, 10/31/12 ................... 4,075,833 6,000,000 TARH E&P Holdings, LP Second Lien Term Loan, 10.25%, 11/15/10 ............................. 6,015,000 ----------- 19,645,663 ----------- ENERGY - OTHER ENERGY - 1.6% 4,477,500 Carrizo Oil & Gas, Inc. Second Lien Term Loan, 10.53%, 07/21/10 ............................. 4,606,228 Coffeyville Resources LLC 597,004 First Lien Tranche B Term Loan, 7.07%, 06/24/12 .............................. 605,774 400,000 Funded Letter of Credit, 4.46%, 06/24/12 .............................. 406,000 8,000,000 Second Lien Term Loan, 11.31%, 06/24/13 ............................. 8,267,520 2,771,906 Ferrell Cos., Inc. Term Loan, 8.00%, 12/17/11 ................... 2,820,414 1,430,336 Magellan MIdstream Holdings Term Loan, 12/15/10 (b) ...................... 1,448,215 3,000,000 Nordic Biofuels of Ravenna, LLC First Lien Term Loan, 8.92%, 04/30/13 .............................. 3,022,500 369,409 SemCrude LP U S Term Loan, 6.75%, 03/16/11 374,721 ----------- 21,551,372 ----------- ENERGY - SERVICE & EQUIPMENT - 0.1% 361,291 Dresser, Inc. Term Loan C, 7.11%, 04/10/09 ................. 367,314 1,250,000 Vetco International Holdings, Inc. (DE) Second Lien Term D Loan, 9.70%, 01/12/14 .............................. 1,272,925 ----------- 1,640,239 ----------- FINANCIAL - 1.6% 2,000,000 American Wholesale Insurance Group, Inc. Second Lien Term Loan B, 11.99%, 04/27/12 ............................. 2,005,000 2,962,500 Arias Acquisitions, Inc. Term Loan, 8.28%, 07/26/11 ................... 2,958,797 4,872,782 Conseco, Inc. Term Loan, 6.57%, 06/22/10 ................... 4,915,468 5,000,000 Crump Group, Inc. Tranche B Term Loan, 7.55%, 12/19/12 .............................. 5,037,500 3,705,263 Flatiron Re Ltd. Closing Date Term Loan, 8.81%, 12/29/10 .............................. 3,742,316 961,538 FleetCor Technologies, Inc. Term Loan, 8.08%, 06/30/11 ................... 961,538 2,000,000 LPL Holdings, Inc. Tranche B Term Loan, 7.88%, 06/28/13 .............................. 2,007,080 ----------- 21,627,699 ----------- PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- FOOD AND DRUG - 1.8% 985,507 Bi-Lo LLC Term Loan, 8.54%, 06/30/11 ................... 987,971 4,000,000 CTI Food Holdings Co. LLC Second Lien Secured Term Loan, 10.31%, 06/02/12 ............................. 4,080,000 1,824,620 Duloxetine Royalty Sub Term Loan, 9.10%, 10/18/13 ................... 1,833,743 8,461,196 Jean Coutu Group, Inc. Term Loan B, 6.94%, 07/30/11 ................. 8,574,068 4,563,758 Michael Foods, Inc. Term Loan B-1, 6.66%, 11/21/10 ............... 4,627,651 4,879,919 Nellson Nutraceutical, Inc. Second Lien Term Loan, 14.00%, 04/04/10 ............................. 1,415,177 995,000 Sturm Foods, Inc. First Lien Term Loan, 7.25%, 05/26/11 .............................. 1,010,542 1,962,314 Vitaquest International, Inc. First Lien Term Loan, 7.94%, 03/07/11 .............................. 1,957,409 ----------- 24,486,561 ----------- FOOD/TOBACCO - BEVERAGES & BOTTLING - 0.8% 942,368 AFC Enterprises, Inc. Tranche B Term Loan, 6.81%, 05/09/11 .............................. 954,148 4,973,178 Dr. Pepper/Seven Up Bottling Group, Inc. Tranche B Term Loan, 6.57%, 12/19/10 .............................. 5,048,372 3,750,000 National Distributing Co., Inc. Second Lien Term Loan, 11.11%, 06/01/10 ............................. 3,759,375 1,235,294 Sunny Delight Beverages Co. First Lien Term Loan, 8.61%, 08/20/10 .............................. 1,226,029 ----------- 10,987,924 ----------- FOOD/TOBACCO - FOOD/TOBACCO PRODUCERS - 1.2% 7,865,193 Merisant Co. Tranche B Term Loan, 7.92%, 01/11/10 .............................. 7,552,237 3,958,393 Michelina's Term Loan, 7.50%, 04/02/11 ................... 4,012,821 1,588,333 Pierre Foods, Inc. Term Loan B, 6.56%, 06/30/10 ................. 1,609,681 2,839,346 Pinnacle Foods Holding Corp. Term Loan, 7.78%, 11/25/10 ................... 2,882,646 ----------- 16,057,385 ----------- FOOD/TOBACCO - RESTAURANTS - 0.8% 2,698,663 Buffets, Inc. Term Loan, 8.19%, 06/28/09 ................... 2,725,650 930,000 Captain D's Inc., LLC First Lien Term Loan, 8.36%, 12/27/10 .............................. 939,300 2,658,333 Caribbean Restaurant LLC Tranche B Term Loan, 7.32%, 06/30/09 .............................. 2,685,475 2,000,000 El Pollo Loco, Inc. Term Loan, 7.56%, 11/18/11 ................... 2,027,500 1,500,000 Garden Fresh Restaurant Corp. First Lien Term Loan B, 7.82%, 06/22/11 .............................. 1,503,750 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 5 INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- SENIOR LOAN NOTES (CONTINUED) FOOD/TOBACCO - RESTAURANTS (CONTINUED) 1,000,000 New World Restaurant Group, Inc. First Lien Term Loan, 9.50%, 03/31/11 .............................. 1,007,500 ----------- 10,889,175 ----------- FOREST PRODUCTS - PACKAGING - 4.5% 4,781,314 Berry Plastics Corp. Term Loan, 6.45%, 12/02/11 ................... 4,850,069 Georgia-Pacific Corp. 25,000,000 First Lien Term Loan, 02/14/13 (b) ........... 25,216,000 20,000,000 Second Lien Term Loan, 7.56%, 02/14/14 .............................. 20,430,500 7,425,000 Graham Packaging Co. Term Loan B, 6.84%, 10/07/11 ................. 7,527,094 JSG Acquisitions (Smurfit Kappa) 1,000,000 B1 Term Loan Facility, 12/01/13 (b) .......... 1,015,000 1,000,000 C1 Term Loan Facility, 12/01/13 (b) .......... 1,015,000 ----------- 60,053,663 ----------- FOREST PRODUCTS - PAPER - 0.7% 3,238,331 Appleton Papers, Inc. Term Loan, 6.58%, 06/11/10 ................... 3,276,803 2,621,875 Graphic Packaging International, Inc. Tranche C Term Loan, 6.98%, 08/09/10 .............................. 2,667,233 2,985,000 NewPage Corp. Term Loan, 7.56%, 05/02/11 ................... 3,029,775 SP Newsprint Co. 513,096 Tranche B-1 Credit Linked Deposit, 4.61%, 01/09/10 .............................. 520,793 198,382 Tranche B-1 Term Loan, 6.86%, 01/09/10 .............................. 201,358 ----------- 9,695,962 ----------- GAMING/LEISURE - GAMING - 3.2% 2,986,125 CCM Merger, Inc./MotorCity Casino Term Loan B, 6.57%, 04/25/12 ................. 3,009,656 3,930,300 Green Valley Ranch Gaming LLC Term Loan, 6.53%, 12/22/10 ................... 3,984,342 OpBiz LLC 11,439,157 Term Loan A, 7.53%, 08/31/10 ................. 11,215,178 10,505 Term Loan B, 8.53%, 08/31/10 ................. 10,321 1,995,000 Penn National Gaming, Inc. Term Loan B, 6.38%, 10/03/12 ................. 2,023,489 Resorts International Holdings Ltd. 17,333,264 Second Lien Term Loan, 12.03%, 04/26/13 ............................. 16,249,935 2,833,143 Term Loan B, 7.53%, 04/26/12 ................. 2,826,967 3,000,000 Washington County Casino & Golf Resort Tranche B Term Loan, 11/01/11 (b) ............ 3,000,000 ----------- 42,319,888 ----------- GAMING/LEISURE - OTHER LEISURE - 2.6% 3,178,184 AMF Bowling Worldwide, Inc. Term Loan B, 7.61%, 08/27/09 ................. 3,215,941 PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- GAMING/LEISURE - OTHER LEISURE (CONTINUED) 2,325,000 BRE/ESA Mezz5 LLC Mezzanine D Loan, 8.00%, 07/11/08 .............................. 2,330,812 12,675,000 BRE/Homestead MEZZ 4 LLC Mezzanine D Loan, 8.00%, 07/11/08 .............................. 12,706,687 3,000,000 Fender Musical Instruments Corp. Second Lien Term Loan, 8.72%, 09/30/12 .............................. 3,018,750 Fontainebleu Florida Hotel LLC 3,000,000 Tranche A Term Loan, 7.49%, 05/11/08 .............................. 3,000,000 2,000,000 Tranche B Term Loan, 7.49%, 05/11/08 .............................. 2,000,000 997,500 Kuilima Resort Co. First Lien Term Loan, 7.36%, 09/30/10 .............................. 1,006,228 2,000,000 Riverside Casino & Golf Resort LLC Term Loan, 8.88%, 11/30/11 ................... 2,000,000 2,000,000 Southwest Sports Group LLC Term Loan, 7.07%, 12/22/10 ................... 2,025,000 1,741,250 Trump Entertainment Resorts, Inc. Term Loan B-1, 7.17%, 05/20/12 ............... 1,760,856 1,970,000 Wallace Theaters First Lien Term Loan, 7.77%, 07/31/09 .............................. 1,987,237 ----------- 35,051,511 ----------- HEALTHCARE - ACUTE CARE - 1.1% 3,566,195 Alliance Imaging, Inc. Tranche C1 Term Loan, 7.18%, 12/29/11 .............................. 3,569,904 2,000,000 Ameripath, Inc. Tranche B Term Loan, 6.57%, 10/31/12 .............................. 2,025,940 2,000,000 Capella Healthcare, Inc. First Lien Term Loan, 7.45%, 11/30/12 .............................. 2,018,760 Cornerstone Healthcare Group Holding, Inc. 1,008,629 Senior Subordinated Unsecured Notes, 14.00%, 07/15/12 (c) ......................... 988,457 1,977,119 Term Loan, 8.64%, 07/15/11 ................... 1,962,290 4,029,118 DaVita, Inc. Tranche B Term Loan, 6.79%, 10/05/12 .............................. 4,092,778 ----------- 14,658,129 ----------- HEALTHCARE - ALTERNATE SITE SERVICES - 3.2% 1,442,482 American HomePatient, Inc. Secured Promissory Note, 6.79%, 08/01/09 (c) .......................... 1,442,482 2,175,143 American Medical Response, Inc. Term Loan, 5.25%, 02/10/12 ................... 2,202,332 1,985,000 Chemed Corp. Term Loan, 6.53%, 08/24/10 ................... 2,004,850 2,000,000 CRC Health Corp. New Term Loan, 6.81%, 02/06/13 ............... 2,025,000 FHC Health Systems, Inc. 1,300,000 Delayed Draw Term Loan, 12.41%, 10/31/06 ............................. 1,345,500 1,857,143 Initial Term Loan, 10.41%, 10/31/06 ............................. 1,922,143 1,500,000 Third Lien Additional Term Loan, 13.41%, 02/09/11 ............................. 1,530,000 6 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- SENIOR LOAN NOTES (CONTINUED) HEALTHCARE - ALTERNATE SITE SERVICES (CONTINUED) FHC Health Systems, Inc. (continued) 5,000,000 Third Lien Term Loan, 13.41%, 02/09/11 ............................. 5,112,500 2,524,139 Hanger Orthopedic Group, Inc. Tranche B Term Loan, 8.27%, 09/30/09 .............................. 2,562,001 HealthSouth Corp. 3,917,813 Term Loan, 7.11%, 06/14/07 ................... 4,032,918 1,062,500 Tranche B Term Loan, 4.12%, 03/21/10 .............................. 1,065,156 546,631 Kinetic Concepts, Inc. Tranche B2 Term Loan, 6.28%, 08/11/10 .............................. 552,781 2,750,000 MultiPlan, Inc. Term Loan, 7.03%, 03/04/09 ................... 2,765,455 4,488,750 Renal Advantage, Inc. Tranche B Term Loan, 7.07%, 10/06/12 .............................. 4,533,638 1,990,000 Skilled Healthcare LLC First Lien Term Loan, 7.25%, 06/15/12 .............................. 2,011,134 474,603 Sunrise Medical Holdings, Inc. Term Loan B-1, 7.89%, 05/13/10 ............... 475,196 2,000,000 Triumph Healthcare Second Holdings, LLC Second Lien Term Loan, 13.06%, 08/31/12 ............................. 1,903,320 915,333 VWR International, Inc. Tranche B Dollar Term Loan, 7.12%, 04/07/11 .............................. 928,606 1,970,000 WellCare Health Plans, Inc. Term Loan, 7.06%, 05/13/09 ................... 1,986,016 2,669,346 Youth & Family Centered Services, Inc. Term Loan B, 8.69%, 05/28/11 ................. 2,662,672 ----------- 43,063,700 ----------- HEALTHCARE - MEDICAL PRODUCTS - 1.6% Carl Zeiss TopCo GmbH/US Newco 1,000,000 Term B U S Dollar Loan, 6.95%, 05/04/13 .............................. 1,003,750 1,000,000 Term C U S Dollar Loan, 7.45%, 05/04/14 .............................. 1,007,500 CCS Medical, Inc. 3,500,000 First Lien Term Loan, 7.78%, 09/30/12 .............................. 3,476,690 1,250,000 Second Lien Term Loan, 12.53%, 03/30/13 ............................. 1,156,250 1,140,945 Encore Medical IHC, Inc. Term Loan, 7.54%, 10/04/10 ................... 1,153,780 Matria Healthcare, Inc. 2,021,136 First Lien Tranche B Term Loan, 6.90%, 01/19/12 (b) .......................... 2,043,874 978,864 First Lien Tranche C Term Loan, 7.02%, 01/19/07 (b) .......................... 981,917 2,481,250 Reliant Pharmaceuticals, Inc. First Lien Term Loan, 14.08%, 06/30/08 ............................. 2,506,062 Warner Chilcott Co., Inc. 165,046 Dovobet Delayed Draw Term Loan, 7.44%, 01/18/12 .............................. 165,973 825,155 Dovonex Delayed Draw Term Loan, 7.36%, 01/18/12 .............................. 829,792 4,038,967 Tranche B Acquisition Date Term Loan, 7.36%, 01/18/12 .............................. 4,068,008 PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ----------- HEALTHCARE - MEDICAL PRODUCTS (CONTINUED) 1,627,507 Warner Chilcott Corp. Tranche C Acquisition Date Term Loan, 7.28%, 01/18/12 ................... 1,640,234 751,862 Warner Chilcott Holdings Co. III, Ltd. Tranche D Acquisition Date Term Loan, 7.28%, 01/18/12 ................... 757,742 ----------- 20,791,572 ----------- HOUSING - BUILDING MATERIALS - 2.1% 9,004,934 Atrium Cos., Inc. Term Loan, 7.84%, 12/28/11 ................... 9,004,934 1,000,000 Contech Construction Products New Term Loan, 6.69%, 01/31/13 ............... 1,013,750 1,899,968 Custom Building Products, Inc. First Lien Term Loan, 6.78%, 10/20/11 .............................. 1,910,646 4,130,079 Lake at Las Vegas Joint Venture First Lien Term Loan, 7.45%, 11/01/09 .............................. 4,141,271 1,960,101 Nortek Holdings, Inc. Term Loan, 6.94%, 08/27/11 ................... 1,980,192 1,000,000 PGT Industries, Inc. First Lien Tranche A-2 Term Loan, 7.75%, 02/14/12 .............................. 1,015,000 1,496,250 Pivotal Group Promotory First Lien Term Loan, 7.36%, 08/31/10 .............................. 1,491,582 2,250,000 Ply Gem Industries, Inc. U S Term Loan, 02/24/13 (b) .................. 2,272,500 3,000,000 Propex Fabrics Tranche B Term Loan, 07/31/12 (b) ............ 3,030,000 Stile Acquisition Corp. 992,500 Canadian Term Loan, 6.63%, 04/06/13 .............................. 975,131 992,500 U S Term Loan, 6.63%, 04/06/13 ............... 976,441 ----------- 27,811,447 ----------- HOUSING - REAL ESTATE DEVELOPMENT - 3.8% 1,975,000 DESA LLC Term Loan, 9.50%, 11/26/11 ................... 1,954,026 6,000,000 Edge Star Partners LLC First Lien Term Loan, 8.02%, 11/18/06 .............................. 6,075,000 2,143,382 Giraffe Intermediate, LLC Mezzanine Note A-1, 6.32%, 08/09/07 .............................. 2,143,382 LNR Property Corp. 907,200 Tier A Mezzanine, 7.26%, 02/03/08 ............ 914,566 1,370,467 Tranche A Term Loan, 7.57%, 02/03/08 .............................. 1,379,032 11,317,958 Tranche B Term Loan, 7.57%, 02/03/08 .............................. 11,427,516 Morningside Assisted Living 1,998,622 Mezzanine Loan, 11.75%, 10/12/08 ............. 1,998,622 1,498,967 Senior Mortgage Loan, 7.50%, 10/12/08 .............................. 1,498,967 606,618 MPO Intermediate LLC Mezzanine Note A-1, 6.32%, 08/09/07 .............................. 606,618 3,980,000 Palmdale Hills Property LLC First Lien Term Loan, 7.61%, 05/19/10 .............................. 3,980,000 2,000,000 Shea Capital I, LLC Facility B, 6.69%, 10/27/11 .................. 2,002,500 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 7 INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ------------- SENIOR LOAN NOTES (CONTINUED) HOUSING - REAL ESTATE DEVELOPMENT (CONTINUED) Spanish Peaks Holdings LLC 751,997 Tranche A Credit-Linked Deposit, 4.43%, 08/10/11 ............................ 759,517 1,703,670 Tranche B Term Loan, 6.90%, 08/10/11 ............................ 1,716,447 5,500,000 TE/TOUSA Mezzanine LLC Senior Mezzanine Loan, 10.25%, 08/01/09 ........................... 5,513,750 5,000,000 TWLDC Holdings LP Mezzanine Loan, 8.78%, 11/30/07 5,043,750 4,000,000 Woodlands Commercial Property Co. Bridge Loan, 7.36%, 02/28/08 ............... 4,030,000 ------------- 51,043,693 ------------- INFORMATION TECHNOLOGY - 4.0% 205,526 Avago Technologies Tranche B-1 Term Loan, 7.07%, 12/01/12 ............................ 206,168 484,353 Bridge Information Systems, Inc. Multidraw Term Loan, 07/07/13 (d) (e) ........................... 7,265 6,000,000 Comsys Information Services Second Lien Term Loan, 12.16%, 10/31/10 ........................... 6,015,000 Corel Corp. 962,500 First Lien Term Loan, 8.82%, 02/16/10 ............................ 967,313 2,000,000 Second Lien Term Loan, 12.57%, 08/15/10 ........................... 2,010,000 960,323 Data Transmissions Network Corp. Tranche B Term Loan, 7.62%, 03/17/12 ............................ 969,926 416,965 Fidelity National Information Services, Inc. Term Loan B, 6.32%, 03/09/13 ............... 420,426 2,000,000 GXS Corp. Second Lien Term Loan, 13.68%, 12/20/11 ........................... 2,010,000 Infor Global Solutions European Finance S.A.R.L. 1,080,000 Euro Revolving Credit, 7.86%, 04/18/10 (f) ........................ 1,066,500 1,875,000 Second Lien Lux Term Loan, 11.82%, 04/18/12 ........................... 1,919,531 1,922,561 IPC Acquisition Corp. First Lien Tranche B Term Loan, 7.21%, 08/05/11 ............................ 1,947,785 3,125,000 Magellan Holdings, Inc. Second Lien U S Term Loan, 11.82%, 04/18/12 ........................... 3,199,219 6,939,950 On Semiconductor Corp. Term Loan H, 7.14%, 12/15/11 ............... 7,016,567 992,500 Overwatch Systems Term Loan, 7.28%, 04/01/11 ................. 1,003,676 2,431,034 Per-Se Technologies, Inc. Term Loan, 6.79%, 01/06/13 (b) ............. 2,467,500 12,437,500 SunGard Data Systems, Inc. U S Term Loan, 7.22%, 02/11/13 ............. 12,623,441 483,781 Telcordia Technologies, Inc. Term Loan, 7.31%, 09/15/12 ................. 478,034 2,250,000 Transfirst Holdings, Inc. Second Lien Term Loan, 12.06%, 03/31/11 ........................... 2,283,750 PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ------------- INFORMATION TECHNOLOGY (CONTINUED) 1,346,956 UGS Corp. Replacement Term Loan, 6.61%, 05/27/11 ............................ 1,364,910 4,950,000 Viasystems, Inc. Replacement Tranche B Term Loan, 8.83%, 09/30/09 ............................ 4,996,431 ------------- 52,973,442 ------------- MANUFACTURING - 1.3% 1,440,156 AIRXCEL, Inc. First Lien Term Loan, 7.63%, 08/31/12 ............................ 1,458,158 1,443,641 Blount International, Inc. U S Term Loan B, 7.06%, 08/09/10 ........... 1,458,828 1,500,000 Coinmach Corp. Tranche B-1 Term Loan, 7.13%, 12/16/12 ............................ 1,525,005 828,947 Euramax International Holdings B.V. Second Lien European Term Loan, 11.54%, 06/29/13 ........................... 815,477 Euramax International, Inc. 2,062,482 First Lien Domestic Term Loan, 7.25%, 06/29/13 (b) ........................ 2,061,616 1,671,053 Second Lien Domestic Term Loan, 11.54%, 06/29/13 ........................... 1,625,099 4,490,000 Mueller Group LLC Term Loan, 6.84%, 10/03/12 (b) ............. 4,551,154 1,773,784 Polypore, Inc. U S Term Loan, 7.53%, 11/12/11 ............. 1,784,320 1,272,933 Terex Corp. Term Loan, 6.84%, 07/03/09 ................. 1,290,436 ------------- 16,570,093 ------------- METALS/MINERALS - OTHER METALS/MINERALS - 1.1% 2,500,000 Alpha Natural Resources LLC Tranche B Term Loan, 6.32%, 10/26/12 ............................ 2,513,800 8,176,616 Murray Energy Corp. Tranche B Term Loan, 7.61%, 01/28/10 ............................ 8,202,127 3,977,500 Trout Coal Holdings LLC First Lien Term Loan, 7.73%, 03/23/11 ............................ 3,957,613 ------------- 14,673,540 ------------- METALS/MINERALS - STEEL - 0.5% 1,990,000 CII Carbon LLC Term Loan B, 6.56%, 08/23/12 ............... 2,013,641 Novelis, Inc. 751,617 Canadian Term Loan, 6.44%, 01/07/12 ............................ 761,478 1,305,439 U S Term Loan, 6.44%, 01/07/12 ............. 1,322,671 2,737,500 Techs Industries, Inc. (The) Term Loan, 7.61%, 01/14/10 ................. 2,740,922 ------------- 6,838,712 ------------- RETAIL - 5.7% 19,606,375 Blockbuster Entertainment Corp. Tranche B Term Loan, 8.73%, 08/20/11 (b) ........................ 19,091,903 2,970,000 Dollarama Group LP Term Loan B, 6.92%, 11/18/11 ............... 2,999,700 8 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ------------- SENIOR LOAN NOTES (CONTINUED) RETAIL (CONTINUED) 3,615,910 Harbor Freight Tools USA Term Loan, 6.82%, 07/15/10 ................. 3,652,647 26,199,071 Home Interiors & Gifts, Inc. Initial Term Loan, 9.81%, 03/31/11 ......... 24,578,134 Movie Gallery, Inc. 395,263 Term Loan A, 8.03%, 04/27/11 ............... 371,547 16,170,687 Term Loan B, 8.28%, 04/27/11 ............... 15,175,220 4,984,177 Neiman Marcus Group, Inc. (The) Term Loan, 6.95%, 04/06/13 ................. 5,060,734 3,000,000 Oriental Trading Co., Inc. Second Lien Term Loan, 9.31%, 01/08/11 ............................ 3,039,360 1,000,000 TRU 2005 Holding Co. I, Ltd Term Loan, 7.57%, 12/09/08 ................. 995,620 ------------- 74,964,865 ------------- SERVICE - ENVIRONMENTAL SERVICES - 1.3% 2,212,500 Alliance Laundry Systems LLC Term Loan, 6.73%, 01/27/12 ................. 2,244,316 Allied Waste North America, Inc. 2,849,497 Term Loan, 6.44%, 01/15/12 ................. 2,881,925 1,106,303 Tranche A Credit Linked Deposit, 6.39%, 01/15/12 ............................ 1,119,612 3,370,000 Audio Visual Services Corp. Term Loan, 7.28%, 05/18/11 ................. 3,403,700 8,000,000 Washington Group International Tranche B Term Loan, 6.18%, 10/03/07 ............................ 8,040,000 ------------- 17,689,553 ------------- SERVICE - OTHER SERVICES - 1.4% 4,138,889 Brickman Group Holdings, Inc. Term Loan, 9.81%, 11/15/09 ................. 4,128,542 2,443,665 NES Rentals Holdings, Inc. Second Lien Term Loan, 10.47%, 08/17/10 ........................... 2,480,320 3,000,000 Penhall International Corp. Second Lien Term Loan, 11.21%, 11/01/10 ........................... 3,037,500 1,000,000 Survey Sampling International LLC Second Lien Term Loan, 11.78%, 05/06/12 ........................... 1,010,620 United Rentals, Inc. 7,385,987 Initial Term Loan, 6.86%, 02/14/11 ......... 7,481,414 336,842 Tranche B Credit-Linked Deposit, 6.64%, 02/14/11 ............................ 341,053 ------------- 18,479,449 ------------- TELECOMMUNICATIONS - 3.4% 2,000,000 Alaska Communications Systems Holdings, Inc. Term Loan, 6.28%, 02/01/12 ................. 2,016,680 1,500,000 IWL Communications, Inc. First Lien Tranche B Term Loan, 8.07%, 01/31/12 ............................ 1,496,250 1,995,000 Maritime Telecommunications Network, Inc. First Lien Term Loan, 7.48%, 04/07/11 ............................ 2,004,975 Millennium Digital Media Systems LLC 2,382,473 Facility A Revolver, 9.32%, 10/31/08 (b) ........................ 2,400,341 PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ------------- TELECOMMUNICATIONS (CONTINUED) Millennium Digital Media Systems LLC (continued) 10,108,137 Facility B Term Loan, 9.19%, 10/31/08 (b) ........................ 10,201,468 11,577,379 Facility C Term Loan, 8.74%, 10/31/08 (b) ........................ 11,684,516 2,000,000 Nextel Partners Operating Corp. Tranche D Term Loan, 5.91%, 05/31/12 ............................ 2,006,440 NTELOS, Inc. 1,242,462 First Lien Term B Advance, 7.11%, 08/24/11 ............................ 1,257,223 1,500,000 Second Lien Term Loan, 9.61%, 02/24/12 ............................ 1,518,510 4,937,500 PanAmSat Corp. Tranche B-1 Term Loan, 6.49%, 08/20/11 ............................ 5,000,700 5,500,000 Sorenson Communications, Inc. First Lien Term Loan B, 7.49%, 11/15/12 ............................ 5,584,260 ------------- 45,171,363 ------------- TELECOMMUNICATIONS - CLEC - 0.7% 4,937,500 Consolidated Communications, Inc. Term Loan D, 6.34%, 10/14/11 ............... 4,988,455 3,933,070 RCN Corp. Term Loan, 8.81%, 12/21/11 ................. 4,001,899 ------------- 8,990,354 ------------- TELECOMMUNICATIONS - DATA/INTERNET - 0.1% 1,000,000 Pine Tree Holdings/Country Road Communications, Inc. Second Lien Tranche B Term Loan, 12.55%, 07/15/13 ........................... 1,017,500 ----------- TELECOMMUNICATIONS - FIBER/LONG DISTANCE - 1.4% 5,000,000 FairPoint Communications, Inc. Replacement B Term Loan, 6.31%, 02/08/12 ............................ 5,034,400 1,000,000 Hawaiian Telcom Communications Tranche B Term Loan, 6.78%, 10/31/12 ............................ 1,009,550 10,000,000 Qwest Corp. Tranche B Term Loan, 6.95%, 06/30/10 (g) ........................ 10,191,700 1,950,820 WestCom Corp. Tranche B Term Loan, 7.53%, 12/17/10 ............................ 1,954,487 ------------- 18,190,137 ------------- TRANSPORTATION - AUTO - 3.7% 3,757,551 Carey International, Inc. Second Lien Term Loan, 16.53%, 05/10/12 ........................... 3,452,250 Delphi Corp. 1,000,000 Revolver, 06/18/09 (b) ..................... 1,039,160 8,403,133 Term Loan, 13.00%, 06/14/11 ................ 8,886,313 1,500,000 Tranche B DIP Term Loan, 7.38%, 10/08/07 ............................ 1,526,250 4,500,000 Environmental Systems Products Holdings Second Lien Term Loan, 14.71%, 12/12/10 ........................... 4,590,000 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 9 INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ------------- SENIOR LOAN NOTES (CONTINUED) TRANSPORTATION - AUTO (CONTINUED) Federal-Mogul Corp. 4,500,000 DIP Term Loan, 6.56%, 12/09/06 ............. 4,525,290 1,270,249 Supplemental Revolver, 8.35%, 03/31/06 (f) ........................ 1,273,425 1,048,750 Tranche C Term Loan, 8.35%, 03/31/06 ............................ 1,053,994 3,500,000 Goodyear Tire & Rubber Co. Third Lien Term Loan, 7.81%, 03/01/11 ............................ 3,518,970 Hertz Corp. (The) 444,444 Letter of Credit, 4.50%, 12/21/12 .......... 452,000 3,034,667 Tranche B Term Loan, 6.89%, 12/21/12 ............................ 3,084,799 991,644 Insurance Auto Auctions, Inc. Term Loan, 7.40%, 05/19/12 ................. 1,004,040 5,138,310 Key Plastics LLC Term Loan B, 7.65%, 06/29/10 ............... 5,138,310 2,312,606 Rexnord Corp. Term Loan B, 6.89%, 12/31/11 ............... 2,342,971 3,940,000 Stanadyne Corp. Term Loan, 8.07%, 08/02/10 ................. 3,959,700 Tenneco Automotive, Inc. 1,779,338 Tranche B Term Loan, 7.02%, 12/12/10 ............................ 1,808,270 781,632 Tranche B-1 Credit Linked Deposit, 6.82%, 12/12/10 ............................ 795,310 ------------- 48,451,052 ------------- TRANSPORTATION - LAND - 0.7% Quality Distribution, Inc. 1,427,481 Synthetic Letters of Credit, 4.43%, 11/13/09 ............................ 1,434,618 2,716,252 Term Loan, 7.57%, 11/13/09 (e) ............. 2,729,833 4,412,330 Term Loan, 7.57%, 11/13/09 ................. 4,434,391 ------------- 8,598,842 ------------- UTILITIES - 5.4% 3,652,727 Allegheny Energy, Inc. Term Advances, 5.63%, 03/08/11 ............. 3,682,131 Boston Generating LLC 1,418,919 First Lien Series A Term Advance, 09/30/10 (b) ............................... 1,453,796 81,081 First Lien Series B Term Advance, 09/30/10 (b) ............................... 83,074 1,950,000 Calpine Construction Finance Co., LP First Lien Term Loan, 10.57%, 08/26/09 ........................... 2,074,313 Calpine Corp. 2,000,000 First Lien Revolver, 12/20/07 (b) .......... 1,980,000 3,446,809 First Lien Term Loan, 12/20/07 (b) ......... 3,502,819 9,983,749 Second Lien Term Loan B, 10.35%, 07/16/07 (b) (d) ................... 9,190,041 CenterPoint Energy, Inc. 2,700,554 Term Loan, 6.09%, 04/30/10 ................. 2,702,228 5,985,000 Term Loan, 6.92%, 04/30/10 ................. 5,988,711 El Paso Corp. 2,500,000 Deposit Accounts, 4.11%, 11/23/09 .......... 2,526,400 7,611,855 Term Loan, 7.31%, 11/23/09 (b) ............. 7,706,394 1,934,246 Infrasource, Inc. Term Loan, 7.53%, 09/30/10 ................. 1,943,917 KGen, LLC 1,985,000 Tranche A Term Loan, 7.15%, 08/05/11 ............................ 1,985,000 PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ------------- UTILITIES (CONTINUED) KGen, LLC (continued) 35,187 Tranche B Term Loan, 13.53%, 08/05/11 ........................... 35,363 500,000 La Paloma Generating Co. LLC Second Lien Term Loan, 8.03%, 08/16/13 ............................ 508,440 1,357,921 Midwest Generation LLC Term Loan, 6.38%, 04/27/11 ................. 1,376,090 NATG Holdings LLC 570,221 Credit Linked Certificate of Deposit, 6.81%, 01/23/09 ............................ 536,008 1,001,749 Term Loan A, 11.00%, 01/23/09 (d) .......... 235,411 733,455 Term Loan B1, 11.50%, 01/23/10 ............. 172,362 72,363 Term Loan B2, 11.50%, 01/23/10 ............. 68,021 NRG Energy, Inc. 2,413,620 Credit Linked Certificate of Deposit, 6.62%, 02/02/13 ............................ 2,435,584 10,586,380 Term Loan, 6.57%, 02/01/13 ................. 10,704,312 4,541,692 Riverside Energy Center LLC Term Loan, 8.92%, 06/24/11 ................. 4,609,817 Rocky Mountain Energy Center LLC 361,073 Credit Linked Certificate of Deposit, 8.92%, 06/24/11 ............................ 366,489 3,142,331 Term Loan, 8.92%, 06/24/11 ................. 3,189,466 Thermal North America, Inc. 1,000,000 Credit Linked Certificate of Deposit, 6.32%, 10/12/13 ........................... 1,006,880 997,976 Term Loan, 6.28%, 10/12/13 ................ 1,004,842 ------------- 71,067,909 ------------- WIRELESS - CELLULAR/PCS - 3.3% 2,955,000 Cellular South, Inc. Term Loan, 6.37%, 05/04/11 ................. 2,995,631 3,822,500 Centennial Cellular Operating Co. Term Loan, 6.64%, 02/09/11 ................. 3,878,385 14,850,000 Cricket Communications, Inc. Term Loan B, 7.03%, 01/10/11 ............... 15,063,543 MetroPCS, Inc. 9,850,000 First Lien Tranche B Term Loan, 9.50%, 05/27/11 ............................ 10,165,988 10,800,000 Second Lien Term Loan, 12.00%, 05/27/12 ........................... 11,394,000 ------------- 43,497,547 ------------- Total Senior Loan Notes (Cost $1,236,371,363) ................... 1,241,363,715 ------------- FOREIGN VARIABLE RATE SENIOR LOAN NOTES (a) - 4.7% GERMANY - 0.8% EUR 3,625,000 debitel (Netherlands) Holding BV Second Lien Facility, 9.49%, 06/11/14 ............................ 4,449,404 debitel Konzernfinanzierungs GmbH 1,125,000 Term Facility B, 5.24%, 06/11/13 ........... 1,352,186 803,571 Term Facility C1, 5.74%, 06/11/14 .......... 968,041 321,429 Term Facility C2, 5.74%, 06/11/14 .......... 389,363 iesy Hessen GmbH & Co. 1,500,000 Facility B, 5.39%, 02/14/13 ................ 1,801,574 1,500,000 Facility C, 5.89%, 02/14/14 ................ 1,804,167 ------------- 10,764,735 ------------- 10 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ------------- FOREIGN VARIABLE RATE SENIOR LOAN NOTES (CONTINUED) ITALY - 0.4% EUR Prysmian Cables & Systems, Inc. 1,923,077 Second Lien Term Loan, 9.44%, 01/20/15 ............................ 2,355,566 875,000 Euro Term Loan B, 5.07%, 08/04/12 ............................ 1,048,560 875,000 Euro Term Loan C2, 4.75%, 08/04/12 ............................ 1,048,435 576,923 Second Lien Tranche C Term Loan, 9.44%, 01/20/15 ............................ 706,670 ------------- 5,159,231 ------------- NETHERLANDS - 0.2% EUR YBR Acquisition B.V. 1,250,000 Facility B2 Term Loan, 5.14%, 06/30/13 ............................ 1,514,173 1,250,000 Facility C2 Term Loan, 5.64%, 06/30/14 ............................ 1,516,006 ------------- 3,030,179 ------------- SWITZERLAND - 0.2% EUR 2,077,716 Merisant Co. Tranche A (Euro) Term Loan, 5.79%, 01/11/09 ............................ 2,399,746 ------------- UNITED KINGDOM - 3.1% GBP Debenhams Finance Holdings PLC 1,500,000 Sterling Tranche B, 7.34%, 04/25/13 ............................ 2,612,798 1,500,000 Sterling Tranche C, 7.84%, 04/25/14 ............................ 2,618,367 Peacock Group (The) 2,250,000 Facility B, 7.33%, 10/30/13 ................ 3,974,795 2,250,000 Facility C, 7.83%, 10/30/14 ................ 3,974,795 3,125,000 PlayPower, Inc. Add-on Term Loan, 7.63%, 12/18/09 ............................ 5,547,912 Red Football Ltd. 1,250,000 Facility B Term Loan, 7.85%, 05/11/13 ............................ 2,220,544 1,250,000 Facility C Term Loan, 8.35%, 05/11/14 ............................ 2,226,016 1,399,359 SunGard U K Holdings Ltd. U K Term Loan, 7.13%, 02/11/13 2,464,402 3,938,551 Teesside Power Ltd. Term Loan, 5.44%, 04/01/08 ................. 6,880,151 Trinitybrook PLC 2,500,000 Term Loan B1, 7.32%, 07/31/13 .............. 4,392,490 2,500,000 Term Loan C1, 7.32%, 07/31/14 .............. 4,402,691 ------------- 41,314,961 ------------- Total Foreign Variable Rate Senior Loan Notes (Cost $62,214,205) ...................... 62,668,852 ------------- PRINCIPAL AMOUNT ($) VALUE ($) -------------------- ------------- CORPORATE NOTES AND BONDS (g) - 0.0% TRANSPORTATION - AUTO - 0.0% Key Plastics Holdings, Inc. 63,642 Junior Secured Subordinated Notes, 18.32%, 04/26/07 .................... 52,186 101,432 Senior Secured Subordinated Notes, 7.00%, 04/26/07 ..................... 93,825 ------------- Total Corporate Notes and Bonds (Cost $156,225) ......................... 146,011 ------------- SHARES -------- COMMON STOCKS (h) - 1.1% TELECOMMUNICATIONS - 0.0% 1,756 Eningen Realty (g) ............................ 0 33,727 SAVVIS Communications Corp. ................... 23,946 ------------- 23,946 ------------- TRANSPORTATION - AUTO - 0.0% 3,445 Environmental Systems Products Holdings (g) ............................... 0 ------------- UTILITIES - 0.8% 12,470 CenterPoint Energy, Inc. (g) .................. 126,695 439,003 Mirant Corp. .................................. 10,799,485 322,876 NATG Holdings LLC (g) ......................... 0 ------------- 10,926,180 ------------- WIRELESS - CELLULAR/PCS - 0.3% 76,137 Leap Wireless International, Inc. ............. 3,206,129 ------------- Total Common Stocks (Cost $8,943,166) ....................... 14,156,255 ------------- PREFERRED STOCK - 0.0% MANUFACTURING - 0.0% 14,382 Superior Telecom, Inc., Series A .............. 12,225 ------------- AUTOMOTIVE - 0.0% 13 Key Plastics Holdings, Inc. (g) (h) ........... 0 ------------- Total Preferred Stock (Cost $14,382) .......................... 12,225 ------------- UNITS ------------- WARRANTS (h) - 0.0% GAMING/LEISURE - GAMING (g) - 0.0% 26,091 OpBiz LLC, expires 08/11/09 ................... 0 28 OpBiz LLC, expires 08/11/09 ................... 0 ------------- 0 ------------- SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 11 INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2006 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY UNITS VALUE ($) ------------- ------------- WARRANTS (CONTINUED) MANUFACTURING - 0.0% 4 GenTek, Inc., Class A expires 10/31/06 .................................. 31 ------------- Total Warrants (Cost $20) ............................. 31 ------------- CLAIMS (I) - 0.1% UTILITIES - 0.1% 28,000,000 Mirant Corp. .................................. 1,586,760 ------------- Total Claims (Cost $0) ............................... 1,586,760 ------------- TOTAL INVESTMENTS - 99.5% ..................................... 1,319,933,849 (Cost of $1,307,699,361) (j) ------------- OTHER ASSETS & LIABILITIES, NET - 0.5% ........................ 7,249,258 ------------- NET ASSETS - 100.0% ........................................... 1,327,183,107 ============= ---------- (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 (g), all senior loans carry a variable rate interest). These base lending rates are generally (i) the prime rate offered by one or more major United States banks, (ii) the lending rate offered by one or more European banks such as the London Inter-Bank Offered Rate ("LIBOR") or (iii) the certificate of deposit rate. Rate shown represents the weighted average rate at February 28, 2006. Senior loans, while exempt from registration under the Security Act of 1933, as amended, contain certain restrictions on resale and cannot be sold publicly. Senior secured floating rate loans often require prepayments from excess cash flow or permit the borrower to repay at its election. The degree to which borrowers repay, whether as a contractual requirement or at their election, cannot be predicted with accuracy. As a result, the 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) Fixed rate senior loan (d) The issuer is in default of certain debt covenants. Income is not being accrued. (e) Loans held on participation. (f) Senior Loan Notes have additional unfunded loan commitments. See Note 9. (g) Represents fair value as determined in good faith under the direction of the Board of Trustees. (h) Non-income producing security. (i) Security is the result of company restructuring that will be converted to equity upon the conclusion of court proceedings. (j) Cost for Federal income tax purposes is $1,308,046,346. CLEC Competitive Local Exchange Carrier DE Delaware DIP Debtor in Possession EUR Euro Currency GBP Great Britain Pound FOREIGN VARIABLE SENIOR LOAN NOTES INDUSTRY CONCENTRATION TABLE (% of Total Net Assets) Retail ................................ 1.7% Manufacturing ......................... 0.8% Wireless - Cellular/PCS ............... 0.5% Utilities ............................. 0.5% Gaming/Leisure - Other Leisure ........ 0.3% Cable - International Cable ........... 0.3% Diversified Media ..................... 0.2% Information Technology ................ 0.2% Food/Tobacco - Food/Tobacco Producers ........................... 0.2% --- 4.7% === 12 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENT OF ASSETS AND LIABILITIES -------------------------------------------------------------------------------- FEBRUARY 28, 2006 (UNAUDITED) HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY ($) -------------------------------------------------------------------------------- ASSETS: Investments, at value (Cost $1,307,699,361) ................ 1,319,933,849 Cash ....................................................... 78,849,328 Foreign currency (Cost $11,912,817) ........................ 11,917,439 Receivable for: Investments sold ........................................ 30,731,723 Interest and fees ....................................... 12,421,192 Other assets ............................................... 1,056 ------------- Total assets ......................................... 1,453,854,587 LIABILITIES: Net discount and unrealized appreciation on unfunded transactions (Note 9) .................................... 160,964 Payable for: Investments purchased ................................... 125,982,485 Investment advisory fee (Note 4) ........................ 432,829 Trustees' fees (Note 4) ................................. 3,333 Accrued expenses and other liabilities ..................... 91,869 ------------- Total liabilities .................................... 126,671,480 ------------- NET ASSETS .................................................... 1,327,183,107 ============= SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 13 STATEMENT OF OPERATIONS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY FOR THE SIX MONTHS ENDED FEBRUARY 28, 2006 (UNAUDITED)
($) ------------------------------------------------------------------------------------------------------------ INVESTMENT INCOME Interest ................................................................................. 46,100,032 Dividends ................................................................................ 683 Facility and other fees .................................................................. 77,503 ---------- Total investment income ............................................................... 46,178,218 EXPENSES Investment advisory fee (Note 4) ......................................................... 2,625,484 Accounting services fee .................................................................. 179,207 Professional fees ........................................................................ 47,611 Trustees' fees (Note 4) .................................................................. 10,631 Custody fee .............................................................................. 52,032 Reports to shareholders .................................................................. 5,800 Texas franchise expense .................................................................. 126,081 Other expenses ........................................................................... 12,375 ---------- Total operating expenses .............................................................. 3,059,221 Interest expense (Note 8) ................................................................ 114,563 Facility expense (Note 8) ................................................................ 148,128 ---------- Net expenses .......................................................................... 3,321,912 ---------- Net investment income .................................................................... 42,856,306 ---------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized gain on investments ......................................................... 3,302,503 Net realized loss on foreign currency transactions ....................................... (379,134) Net change in unrealized appreciation on investments ..................................... 4,283,579 Net change in unrealized appreciation on unfunded transactions (Note 9) .................. 101,072 Net change in unrealized depreciation on translation of assets and liabilities denominated in foreign currency .................................................................... (336,454) ---------- Net gain ................................................................................. 6,971,566 ---------- Net increase in net assets from operations ............................................... 49,827,872 ==========
14 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENTS OF CHANGES IN NET ASSETS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
SIX MONTHS ENDED FEBRUARY 28, 2006 YEAR ENDED (UNAUDITED) AUGUST 31, 2005 ($) ($) ------------------ --------------- INCREASE IN NET ASSETS: OPERATIONS Net investment income ......................................................... 42,856,306 55,342,478 Net realized gain (loss) on investments and foreign currency transactions ..... 2,923,369 (155,500) Net change in unrealized appreciation on investments, translation of assets and liabilities denominated in foreign currency and unfunded transactions ...... 4,048,197 7,371,115 ------------------ --------------- Net increase from operations ............................................... 49,827,872 62,558,093 ------------------ --------------- TRANSACTIONS IN INVESTOR'S BENEFICIAL INTEREST Contributions ................................................................. 337,884,585 401,269,018 Withdrawals ................................................................... (199,947,232) (220,779,725) ------------------ --------------- Net increase from transactions in investor's beneficial interest ........... 137,937,353 180,489,293 ------------------ --------------- Total increase in net assets ............................................... 187,765,225 243,047,386 NET ASSETS Beginning of period ........................................................... 1,139,417,882 896,370,496 ------------------ --------------- End of period ................................................................. 1,327,183,107 1,139,417,882 ================== ===============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 15 STATEMENT OF CASH FLOWS -------------------------------------------------------------------------------- FOR THE SIX MONTHS ENDED FEBRUARY 28, 2006 (UNAUDITED) HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
($) ----------------------------------------------------------------------------------------------------------- INCREASE IN CASH AND FOREIGN CURRENCY CASH FLOWS USED FOR OPERATING ACTIVITIES Net investment income ............................................................... 42,856,306 ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH USED FOR OPERATING ACTIVITIES Purchase of investments securities ..................................................... (589,351,285) Proceeds from disposition of investment securites ...................................... 398,502,964 Increase in interest and fees receivable ............................................... (4,564,644) Increase in receivable for investments sold ............................................ (23,583,842) Decrease in other assets ............................................................... 3,129 Decrease in deferred facility fees ..................................................... (78,593) Net amortization of premium (discount) ................................................. (650,115) Increase in payable for investments purchased ......................................... 33,280,069 Decrease in mark-to-market on realized and unrealized gain (loss) on foreign currency .. (715,588) Increase in payable for accrued affiliated expenses ................................... 14,107 Decrease in other expenses and liabilities ............................................. (101,802) ------------ Net cash and foreign currency flow used for operating activities .................... (144,389,294) CASH FLOWS PROVIDED BY FINANCING ACTIVITIES Proceeds from capital contributions .................................................... 337,884,585 Payment of capital withdrawals ......................................................... (199,947,232) ------------ Net cash flow provided by financing activities ...................................... 137,937,353 ------------ Net decrease in cash and foreign currency ........................................... (6,451,941) CASH AND FOREIGN CURRENCY Beginning of the period ................................................................ 97,218,708 End of the period ...................................................................... 90,766,767 ============
16 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY SELECTED DATA FOR AN INTEREST OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ------------------------------------------------------ SIX MONTHS ENDED FEBRUARY 28, 2006 (UNAUDITED) 2005 2004 2003 2002 2001 ------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA Total return 4.22%(e) 6.54% 10.39% 11.68%(a) (2.20)% 5.15% Operating expenses 0.52%(f) 0.51%(b) 0.52%(b) 0.57%(b) 0.55%(b) 0.53%(b) Interest expense and facility expense 0.04%(f) 0.05% --%(c) --%(c) 0.03% --% Net expenses 0.56%(f) 0.56%(b) 0.52%(b) 0.57%(b) 0.58%(b) 0.53%(b) Net investment income 7.21%(f) 5.69%(b) 4.45%(b) 5.96%(b) 6.42%(b(d) 8.94%(b) Portfolio turnover rate 33%(e) 75% 97% 75% 70% 63%
---------- (a) 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. (b) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%. (c) Rounds to less than 0.01%. (d) 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. (e) Not annualized. (f) Annualized. SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 17 STATEMENT OF ASSETS AND LIABILITIES -------------------------------------------------------------------------------- FEBRUARY 28, 2006 (UNAUDITED) HIGHLAND FLOATING RATE FUND
($) ----------------------------------------------------------------------------------------------------------------------- ASSETS: Investment in Portfolio ........................................................................... 1,324,768,752 Receivable for Fund shares sold ................................................................... 7,560,060 Other assets ...................................................................................... 70,887 ------------- Total assets ................................................................................ 1,332,399,699 LIABILITIES: Payable for: Distributions .................................................................................. 3,309,473 Administration fee (Note 4) .................................................................... 111,427 Trustees' fees (Note 4) ........................................................................ 12,833 Distribution and service fees (Note 4) ......................................................... 510,247 Accrued expenses and other liabilities ............................................................ 207,451 ------------- Total liabilities ........................................................................... 4,151,431 ------------- NET ASSETS ........................................................................................... 1,328,248,268 ============= COMPOSITION OF NET ASSETS Paid-in capital ................................................................................... 1,328,892,589 Overdistributed net investment income ............................................................. (252,657) Accumulated net realized loss on investments and foreign currency transactions allocated from Portolio ....................................................................................... (12,400,261) Net unrealized appreciation on investments, translation of assets and liabilities denominated in foreign currency and unfunded transactions allocated from Portfolio ............................ 12,008,597 ------------- NET ASSETS ........................................................................................... 1,328,248,268 ============= CLASS A Net assets ........................................................................................ 507,372,329 Shares outstanding (unlimited shares authorized) .................................................. 51,126,846 Net asset value per share (Net assets/Shares outstanding) ......................................... 9.92(a) Maximum offering price per share (100 / 96.50 of $9.92) ........................................... 10.28(b) CLASS B Net assets ........................................................................................ 160,157,754 Shares outstanding (unlimited shares authorized) .................................................. 16,145,690 Net asset value and offering price per share (Net assets/Shares outstanding) ...................... 9.92(a) CLASS C Net assets ........................................................................................ 466,590,208 Shares outstanding (unlimited shares authorized) .................................................. 47,036,688 Net asset value and offering price per share (Net assets/Shares outstanding) ...................... 9.92(a) CLASS Z Net assets ........................................................................................ 194,127,977 Shares outstanding (unlimited shares authorized) .................................................. 19,570,575 Net asset value, offering and redemption price per share (Net assets/Shares outstanding) .......... 9.92
---------- (a) Redemption price per share is equal to net asset value less any applicable contingent deferred sales charge. (b) On sales of $100,000 or more, the offering price is reduced. 18 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS -------------------------------------------------------------------------------- FOR THE SIX MONTHS ENDED FEBRUARY 28, 2006 (UNAUDITED) HIGHLAND FLOATING RATE FUND
($) --------------------------------------------------------------------------------------------------------------------- INVESTMENT INCOME ALLOCATED FROM PORTFOLIO (NOTE 1) Interest .......................................................................................... 45,066,276 Dividends ......................................................................................... 658 Facility and other fees ........................................................................... 74,958 ----------- Total investment income allocated from Portfolio ............................................ 45,141,892 EXPENSES Net operating expense allocated from Portfolio (Note 1) ........................................... 2,865,064 Administration fee (Note 4) ....................................................................... 1,162,313 Distribution fee (Note 4): Class A ........................................................................................ 207,956 Class B ........................................................................................ 361,563 Class C ........................................................................................ 1,196,057 Service fee (Note 4): Class A ........................................................................................ 519,890 Class B ........................................................................................ 200,868 Class C ........................................................................................ 498,357 Transfer agent fee ................................................................................ 366,834 Professional fees ................................................................................. 41,012 Accounting services fee ........................................................................... 7,326 Trustees' fees (Note 4) ........................................................................... 38,250 Custody fee ....................................................................................... 700 Registration fees ................................................................................. 33,000 Reports to shareholders ........................................................................... 162,119 Texas franchise expense allocated from Portfolio (Note 1) ......................................... 121,540 Other expenses .................................................................................... 218,662 ----------- Total operating expenses .................................................................... 8,001,511 ----------- Interest expense allocated from Portfolio (Note 8) ................................................ 110,273 Facility expense allocated from Portfolio (Note 8) ................................................ 144,915 ----------- Total expenses .............................................................................. 8,256,699 Fees and expenses waived or reimbursed by Investment Adviser (Note 4) ............................. (246,026) ----------- Net expenses ................................................................................ 8,010,673 ----------- Net investment income ............................................................................. 37,131,219 ----------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS ALLOCATED FROM PORTFOLIO (NOTE 1) Net realized gain on investments .................................................................. 3,147,384 Net realized loss on foreign currency transactions ................................................ (374,843) Net change in unrealized appreciation on investments .............................................. 4,384,949 Net change in unrealized appreciation on unfunded transactions .................................... 103,180 Net change in unrealized depreciation on translation of assets and liabilities denominated in foreign currency ............................................................................... (320,564) ----------- Net gain .......................................................................................... 6,940,106 ----------- Net increase in net assets from operations ........................................................ 44,071,325 ===========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 19 STATEMENTS OF CHANGES IN NET ASSETS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND
SIX MONTHS ENDED FEBRUARY 28, 2006 YEAR ENDED (UNAUDITED) AUGUST 31, 2005 ($) ($) ----------------- --------------- INCREASE IN NET ASSETS: OPERATIONS Net investment income ............................................................... 37,131,219 44,426,514 Net realized gain (loss) on investments and foreign currency transactions allocated from Portfolio ................................................................... 2,772,541 (177,535) Net change in unrealized appreciation on investments, translation of assets and liabilities denominated in foreign currency and unfunded transactions allocated from Portfolio ................................................................... 4,167,565 7,005,353 ----------------- --------------- Net increase from operations ..................................................... 44,071,325 51,254,332 ----------------- --------------- DISTRIBUTIONS DECLARED TO SHAREHOLDERS From net investment income: Class A .......................................................................... (13,951,773) (13,226,644) Class B .......................................................................... (5,108,998) (8,228,190) Class C .......................................................................... (12,364,301) (13,491,196) Class Z .......................................................................... (6,592,086) (8,949,145) ----------------- --------------- Total distributions declared to Shareholders ..................................... (38,017,158) (43,895,175) ----------------- --------------- SHARE TRANSACTIONS Class A Subscriptions .................................................................... 187,632,361 194,284,743 Distributions reinvested ......................................................... 7,180,190 8,414,712 Redemptions ...................................................................... (45,727,909) (71,078,183) ----------------- --------------- Net increase ..................................................................... 149,084,642 131,621,272 Class B Subscriptions .................................................................... 120,787 5,874,003 Distributions reinvested ......................................................... 2,997,338 4,892,459 Redemptions ...................................................................... (13,503,632) (33,620,192) ----------------- --------------- Net decrease ..................................................................... (10,385,507) (22,853,730) Class C Subscriptions .................................................................... 121,509,924 152,460,394 Distributions reinvested ......................................................... 6,402,112 8,018,612 Redemptions ...................................................................... (30,255,810) (74,887,937) ----------------- --------------- Net increase ..................................................................... 97,656,226 85,591,069 Class Z Subscriptions .................................................................... 39,228,149 97,758,278 Distributions reinvested ......................................................... 2,087,977 2,265,809 Redemptions ...................................................................... (40,578,094) (48,412,070) ----------------- --------------- Net increase ..................................................................... 738,032 51,612,017 ----------------- --------------- Net increase from share transactions ............................................. 237,093,393 245,970,628 ----------------- --------------- Total increase in net assets ..................................................... 243,147,560 253,329,785 ----------------- --------------- NET ASSETS Beginning of period ................................................................. 1,085,100,708 831,770,923 End of period (including undistributed and (overdistributed) net investment income of $(252,657) and $633,282, respectively) ........................................ 1,328,248,268 1,085,100,708 ================= ===============
20 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENTS OF CHANGES IN NET ASSETS (CONTINUED) -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND
SIX MONTHS ENDED FEBRUARY 28, 2006 YEAR ENDED (UNAUDITED) AUGUST 31, 2005 ----------------- --------------- CHANGE IN SHARES Class A Subscriptions .................................................................... 18,983,957 19,770,029 Issued for distributions reinvested .............................................. 726,301 856,198 Redemptions ...................................................................... (4,626,398) (7,239,210) ----------------- --------------- Net increase ..................................................................... 15,083,860 13,387,017 Class B Subscriptions .................................................................... 12,224 597,890 Issued for distributions reinvested .............................................. 303,326 497,995 Redemptions ...................................................................... (1,366,002) (3,425,945) ----------------- --------------- Net decrease ..................................................................... (1,050,452) (2,330,060) Class C Subscriptions .................................................................... 12,294,824 15,517,260 Issued for distributions reinvested .............................................. 647,835 816,243 Redemptions ...................................................................... (3,062,330) (7,624,801) ----------------- --------------- Net increase ..................................................................... 9,880,329 8,708,702 Class Z Subscriptions .................................................................... 3,970,142 9,948,182 Issued for distributions reinvested .............................................. 211,291 230,667 Redemptions ...................................................................... (4,107,095) (4,924,398) ----------------- --------------- Net increase ..................................................................... 74,338 5,254,451
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 21 FINANCIAL HIGHLIGHTS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ---------------------------------------------------------------------- SIX MONTHS ENDED FEBRUARY 28, 2006 CLASS A SHARES (UNAUDITED) 2005 2004 2003 2002 2001 ----------------------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 9.88 $ 9.80 $ 9.29 $ 8.83 $ 9.62 $ 10.00 ----------------------------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.32 0.49 0.37 0.48 0.54(b) 0.81 Net realized and unrealized gain (loss) allocated from Portfolio(a) 0.05 0.08 0.52 0.46 (0.79)(b) (0.37) ========== ========= ========= ========== ========= ========= Total from investment operations 0.37 0.57 0.89 0.94 (0.25) 0.44 ----------------------------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.33) (0.49) (0.38) (0.48) (0.54) (0.82) From net realized gains -- -- -- -- --(c) --(c) ========== ========= ========= ========== ========= ========= Total distributions declared to shareholders (0.33) (0.49) (0.38) (0.48) (0.54) (0.82) =================================================================================================================================== NET ASSET VALUE, END OF PERIOD $ 9.92 $ 9.88 $ 9.80 $ 9.29 $ 8.83 $ 9.62 Total return(d)(e) 3.79%(f) 5.93% 9.65% 11.03%(h) (2.67)% 4.56% ----------------------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 1.17%(g) 1.15% 1.15% 1.15% 1.15% 1.15% Interest expense & facility expense allocated from Portfolio 0.04%(g) 0.05% --%(i) --%(i) 0.03% --% Net expenses(j) 1.21%(g) 1.20% 1.15% 1.15% 1.18% 1.15% Net investment income 6.55%(g) 5.05% 3.78% 5.39% 5.83%(b) 8.28% Waiver/reimbursement 0.04%(g) 0.08% 0.17% 0.28% 0.28% 0.18% Net assets, end of period (000's) $ 507,372 $ 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) Not annualized. (g) Annualized. (h) 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. (i) Rounds to less than 0.01%. (j) Net expense ratio has been calculated after applying any waiver/reimbursement. 22 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, ---------------------------------------------------------------------- SIX MONTHS ENDED FEBRUARY 28, 2006 CLASS B SHARES (UNAUDITED) 2005 2004 2003 2002 2001 ----------------------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 9.87 $ 9.80 $ 9.29 $ 8.83 $ 9.62 $ 10.00 ----------------------------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.30 0.46 0.34 0.45 0.51(b) 0.77 Net realized and unrealized gain (loss) allocated from Portfolio(a) 0.06 0.06 0.51 0.46 (0.79)(b) (0.37) ========== ========= ========= ========== ========= ========= Total from investment operations 0.36 0.52 0.85 0.91 (0.28) 0.40 ----------------------------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.31) (0.45) (0.34) (0.45) (0.51) (0.78) From net realized gains -- -- -- -- --(c) --(c) ========== ========= ========= ========== ========= ========= Total distributions declared to (0.31) (0.45) (0.34) (0.45) (0.51) (0.78) shareholders =================================================================================================================================== NET ASSET VALUE, END OF PERIOD $ 9.92 $ 9.87 $ 9.80 $ 9.29 $ 8.83 $ 9.62 Total return(d)(e) 3.72%(f) 5.46% 9.27% 10.65%(h) (3.02)% 4.19% ----------------------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 1.52%(g) 1.50% 1.50% 1.50% 1.50% 1.50% Interest expense & facility expense allocated from Portfolio 0.04%(g) 0.05% --%(i) --%(i) 0.03% --% Net expenses(j) 1.56%(g) 1.55% 1.50% 1.50% 1.53% 1.50% Net investment income 6.20%(g) 4.70% 3.51% 5.05% 5.48%(b) 7.93% Waiver/reimbursement 0.04%(g) 0.08% 0.17% 0.28% 0.28% 0.18% Net assets, end of period (000's) $ 160,158 $ 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) Not annualized. (g) Annualized. (h) 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. (i) Rounds to less than 0.01%. (j) Net expense ratio has been calculated after applying any waiver/reimbursement. SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 23 FINANCIAL HIGHLIGHTS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ---------------------------------------------------------------------- SIX MONTHS ENDED FEBRUARY 28, 2006 CLASS C SHARES (UNAUDITED) 2005 2004 2003 2002 2001 ----------------------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 9.87 $ 9.80 $ 9.29 $ 8.83 $ 9.62 $ 10.00 ----------------------------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.30 0.45 0.32 0.44 0.50(b) 0.76 Net realized and unrealized gain (loss) allocated from Portfolio(a) 0.05 0.06 0.52 0.46 (0.79)(b) (0.37) ========== ========= ========= ========== ========= ========= Total from investment operations 0.35 0.51 0.84 0.90 (0.29) 0.39 ----------------------------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.30) (0.44) (0.33) (0.44) (0.50) (0.77) From net realized gains -- -- -- -- --(c) --(c) ========== ========= ========= ========== ========= ========= Total distributions declared to (0.30) (0.44) (0.33) (0.44) (0.50) (0.77) shareholders =================================================================================================================================== NET ASSET VALUE, END OF PERIOD $ 9.92 $ 9.87 $ 9.80 $ 9.29 $ 8.83 $ 9.62 Total return(d)(e) 3.64%(f) 5.30% 9.10% 10.48%(h) (3.16)% 4.04% ----------------------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 1.67%(g) 1.65% 1.65% 1.65% 1.65% 1.65% Interest expense & facility expense allocated from Portfolio 0.04%(g) 0.05% --%(i) --%(i) 0.03% --% Net expenses(j) 1.71%(g) 1.70% 1.65% 1.65% 1.68% 1.65% Net investment income 6.05%(g) 4.55% 3.28% 4.88% 5.33%(b) 7.78% Waiver/reimbursement 0.04%(g) 0.08% 0.17% 0.28% 0.28% 0.18% Net assets, end of period (000's) $ 466,590 $ 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) Not annualized. (g) Annualized. (h) 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. (i) Rounds to less than 0.01%. (j) Net expense ratio has been calculated after applying any waiver/reimbursement. 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, ---------------------------------------------------------------------- SIX MONTHS ENDED FEBRUARY 28, 2006 CLASS Z SHARES (UNAUDITED) 2005 2004 2003 2002 2001 ----------------------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 9.87 $ 9.80 $ 9.29 $ 8.83 $ 9.62 $ 10.00 ----------------------------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.34 0.53 0.40 0.50 0.57(b) 0.84 Net realized and unrealized gain (loss) allocated from Portfolio(a) 0.06 0.06 0.52 0.47 (0.78)(b) (0.37) ========== ========= ========= ========== ========= ========= Total from investment operations 0.40 0.59 0.92 0.97 (0.21) 0.47 ----------------------------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.35) (0.52) (0.41) (0.51) (0.58) (0.85) From net realized gains -- -- -- -- --(c) --(c) ========== ========= ========= ========== ========= ========= Total distributions declared to (0.35) (0.52) (0.41) (0.51) (0.58) (0.85) shareholders =================================================================================================================================== NET ASSET VALUE, END OF PERIOD $ 9.92 $ 9.87 $ 9.80 $ 9.29 $ 8.83 $ 9.62 Total return (d)(e) 4.08%(f) 6.20% 10.03% 11.42%(h) (2.33)% 4.89% ----------------------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 0.82%(g) 0.80% 0.80% 0.80% 0.80% 0.80% Interest expense & facility expense allocated from Portfolio 0.04%(g) 0.05% --%(i) --%(i) 0.03% --% Net expenses(j) 0.86%(g) 0.85% 0.80% 0.80% 0.83% 0.80% Net investment income 6.90%(g) 5.40% 4.12% 5.53% 6.18%(b) 8.63% Waiver/reimbursement 0.04%(g) 0.08% 0.17% 0.28% 0.28% 0.18% Net assets, end of period (000's) $ 194,128 $ 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) Not annualized. (g) Annualized. (h) 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. (i) Rounds to less than 0.01%. (j) Net expense ratio has been calculated after applying any waiver/reimbursement. SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 25 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -------------------------------------------------------------------------------- FEBRUARY 28, 2006 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 February 28, 2006, the Fund and Highland Institutional Floating Rate Income Fund were the sole investors in the Portfolio and owned 99.8% and 0.2%, 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 26 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2006 HIGHLAND FLOATING RATE FUND the judgment of the Board of Trustees or its designee instead of being determined by the market. Using a fair value pricing methodology to price securities may result in a value that is different from a security's most recent sale price and from the prices used by other investment companies to calculate their net asset values. There can be no assurance that the 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. 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 and gains, 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. 27 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2006 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. 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 most recent tax year end, the components of distributable earnings on a tax basis were as follows: -------------------------------------------------------------------------------- Undistributed Undistributed Ordinary Long-Term Net Unrealized Income Capital Gains Appreciation* -------------------------------------------------------------------------------- $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. Portfolio unrealized appreciation and depreciation at February 28, 2006, based on cost of investments for federal income tax purposes, and excluding any unrealized appreciation and depreciation from changes in the value of other assets and liabilities resulting from changes in exchange rates, was: -------------------------------------------------------------------------------- Unrealized appreciation $ 22,550,123 Unrealized depreciation (10,662,620) ------------ Net unrealized appreciation $ 11,887,503 ============ -------------------------------------------------------------------------------- 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 -------------------------------------------------------------------------------- NOTE 4. ADVISORY, ADMINISTRATION, SERVICE AND DISTRIBUTION, AND TRUSTEE FEES INVESTMENT ADVISORY FEE 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% -------------------------------------------------------------------------------- For the six months ended February 28, 2006, the Portfolio's effective investment advisory fee rate was 0.44%. ADMINISTRATION FEES 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"). Highland pays PFPC directly for these services. 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 six months ended February 28, 2006, the Distributor received $21,736, $86,390 and $28,816 of CDSC on Class A, Class B and Class C share redemptions, respectively. 28 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2006 HIGHLAND FLOATING RATE FUND The Fund has adopted a plan pursuant to Rule 12b-1 under the 1940 Act (the "Plan"), which requires the payment of a monthly service fee to the Distributor at the annual rate not to exceed 0.25% of the average daily net assets attributable to Class A, Class B and Class C shares of the Fund. The Plan also requires the payment of a monthly distribution fee to the Distributor on an annual basis not to exceed 0.10%, 0.45% and 0.60% of the average daily net assets attributable to Class A, Class B and Class C shares, respectively. The CDSC and the fees received from the Plan are used principally as repayment for amounts paid to dealers who sold such shares. EXPENSE LIMITS AND FEE REIMBURSEMENTS Highland has voluntarily agreed to waive fees and reimburse certain expenses to the extent that total expenses (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. FEES PAID TO OFFICERS AND TRUSTEES The Fund pays no compensation to its one interested Trustee or to any of its other 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 six months ended February 28, 2006, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were $589,351,285 and $398,502,964, 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 six months ended February 28, 2006, there were two Repurchase Offers. For each Repurchase Offer, the Fund offered to repurchase 10% of its shares. In the September and December Repurchase Offers, 4.65% and 6.38%, respectively, of shares outstanding were repurchased. 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 February 28, 2006, the following sets forth the selling participants with respect to interests in Senior Loans purchased by the Portfolio on a participation basis. 29 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2006 HIGHLAND FLOATING RATE FUND Principal Selling Participant Amount Value -------------------------------------------------------------------------------- Goldman Sachs: Bridge Information Systems, Inc. Multidraw Term Loan $ 484,353 $ 7,265 -------------------------------------------------------------------------------- CSFB: Quality Distribution, Inc. Term Loan 2,716,252 2,729,833 -------------------------------------------------------------------------------- NOTE 8. LINE OF CREDIT On September 13, 2004, the Portfolio entered into a $150,000,000 credit facility, which was amended on September 12, 2005 to $200,000,000, 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 six months ended February 28, 2006, the average daily loan balance outstanding on days where borrowings existed was $34,000,000 at a weighted average interest rate of 6.74%. Interest expense allocated to the Fund of $110,273 was paid for use of the line of credit and is included on the Statement of Operations. NOTE 9. UNFUNDED LOAN COMMITMENTS As of February 28, 2006, the Portfolio had unfunded loan commitments of $28,616,386, which could be extended at the option of the Borrower, pursuant to the following loan agreements: -------------------------------------------------------------------------------- Unfunded Loan Borrower Commitment -------------------------------------------------------------------------------- Centennial Cellular Operating Co. $ 2,250,000 -------------------------------------------------------------------------------- Covanta Energy Corp. 1,000,000 -------------------------------------------------------------------------------- Cricket Communications, Inc. 5,000,000 -------------------------------------------------------------------------------- DeCrane Aircraft Holdings, Inc. 1,000,000 -------------------------------------------------------------------------------- Dobson Cellular Systems, Inc. 625,000 -------------------------------------------------------------------------------- Eastman Kodak Co. 2,411,764 -------------------------------------------------------------------------------- Federal-Mogul Corp. 102,746 -------------------------------------------------------------------------------- Flatiron Re Ltd. 1,794,737 -------------------------------------------------------------------------------- Hertz Corp. 520,889 -------------------------------------------------------------------------------- Infor Global Solutions European Finance S.A.R.L. 1,170,000 -------------------------------------------------------------------------------- Interstate Bakeries Corp. 7,500,000 -------------------------------------------------------------------------------- Trump Entertainment Resorts, Inc. 1,741,250 -------------------------------------------------------------------------------- United Airlines, Inc. 3,500,000 -------------------------------------------------------------------------------- $ 28,616,386 ============= -------------------------------------------------------------------------------- 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. 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. FOREIGN SECURITIES Investments in foreign securities may involve special risks compared to investing in securities of U.S. issuers. These risks are more pronounced to the extent that the Portfolio invests a significant portion of its non-U.S. investment in one region or in the securities of emerging market issuers. These risk may include (i) less information about non-U.S. issuers or markets being available due to less rigorous disclosure, accounting standards or 30 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2006 HIGHLAND FLOATING RATE FUND regulatory requirements; (ii) many non-U.S. markets are smaller, less liquid and more volitile and the Adviser may not be able to sell the Portfolio's securities at times, in amounts and at prices it considers reasonable; (iii) the ecomomies of non-U.S. markets may grow at slower rates than expected or may experience a downturn or recession; and (iv) witholdings and other non-U.S. taxes may decrease the Fund's returns. 31 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. 32 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND Semi-Annual Report, February 28, 2006 [HIGHLAND FUNDS LOGO] www.highlandfunds.com SEMIFRF ITEM 2. CODE OF ETHICS. Not applicable. ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT. Not applicable. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. Not applicable. 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. Not applicable. 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") (17 CFR 270.30a-3(c))) are effective, as of a date within 90 days of the filing date of the report that includes the disclosure required by this paragraph, based on their evaluation of these controls and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15(b)). (b) There were no changes in the registrant's internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR 270.30a-3(d)) that occurred during the registrant's second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. ITEM 12. EXHIBITS. (a)(1) Not applicable. (a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto. (a)(3) Not applicable. (b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. (registrant) HIGHLAND FLOATING RATE FUND -------------------------------------------------------------------- By (Signature and Title)* /S/ JAMES D. DONDERO ------------------------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) Date APRIL 26, 2006 ---------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By (Signature and Title)* /S/ JAMES D. DONDERO ------------------------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) Date APRIL 26, 2006 ---------------------------------------------------------------------------- By (Signature and Title)* /S/ M. JASON BLACKBURN ------------------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) Date APRIL 26, 2006 ---------------------------------------------------------------------------- * Print the name and title of each signing officer under his or her signature.