N-CSRS 1 advantagencsr.txt FLOATING RATE ADVANTAGE NCSRS UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number 811-09709 ---------------------------- HIGHLAND FLOATING RATE ADVANTAGE 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, 2005 ------------------ Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles. A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget ("OMB") control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. ss. 3507. ITEM 1. REPORTS TO STOCKHOLDERS. The Report to Shareholders is attached herewith. -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND TABLE OF CONTENTS Fund Profile ............................................................. 1 Financial Statements ..................................................... 2 Investment Portfolio .................................................. 3 Statement of Assets and Liabilities ................................... 10 Statement of Operations ............................................... 11 Statements of Changes in Net Assets ................................... 12 Statement of Cash Flows ............................................... 14 Financial Highlights .................................................. 15 Notes to Financial Statements ......................................... 19 Important Information About This Report .................................. 25 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 ADVANTAGE FUND OBJECTIVE To provide a high level of current income, consistent with preservation of capital. TOTAL NET ASSETS (AS OF 02/28/05) $788.8 million The information below gives you a snapshot of your Fund at the end of the reporting period. Your Fund is actively managed and the composition of its portfolio will change over time. QUALITY BREAKDOWN AS OF 02/28/05 (%) --------------------------------------------------------------------- Ba 24.3 --------------------------------------------------------------------- B 54.5 --------------------------------------------------------------------- Caa 5.6 --------------------------------------------------------------------- NR 15.4 --------------------------------------------------------------------- Other 0.2 --------------------------------------------------------------------- TOP 5 SECTORS AS OF 02/28/05 (%) --------------------------------------------------------------------- Cable & Satellite Television 12.4 --------------------------------------------------------------------- Health Care 8.5 --------------------------------------------------------------------- Utilities 7.3 --------------------------------------------------------------------- Telecommunications/Wireless 7.0 --------------------------------------------------------------------- Business Equipment & Services 6.7 --------------------------------------------------------------------- TOP 10 HOLDINGS AS OF 02/28/05 (%) --------------------------------------------------------------------- General Growth Properties, Inc., Tranche B Term Loan 2.6 --------------------------------------------------------------------- OpBiz LLC, Term Loan A 2.3 --------------------------------------------------------------------- Cricket Communications, Inc., Term Loan B 1.9 --------------------------------------------------------------------- Century Cable Holdings LLC, Discretionary Term Loan 1.7 --------------------------------------------------------------------- LNR Property Corp., Tranche B Term Loan 1.7 --------------------------------------------------------------------- Allied Waste North America, Inc.* Tranche A 1.7 --------------------------------------------------------------------- Blockbuster Entertainment Corp., Term Loan B 1.4 --------------------------------------------------------------------- Acterna Corp., Term Loan 1.3 --------------------------------------------------------------------- Consolidated Communications, Inc., Term Loan C 1.3 --------------------------------------------------------------------- Texas Genco LLC, Delayed Draw Term Loan 1.3 --------------------------------------------------------------------- Quality is calculated as a percentage of total investments. Sectors and holdings are calculated as a percentage of net assets. 1 FINANCIAL STATEMENTS -------------------------------------------------------------------------------- FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND A GUIDE TO UNDERSTANDING YOUR FUND'S FINANCIAL STATEMENTS INVESTMENT PORTFOLIO The Investment Portfolio details all of the Fund's holdings and their market value as of the last day of the reporting period. Portfolio holdings are organized by type of asset and industry to demonstrate areas of concentration and diversification. STATEMENT OF ASSETS AND 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 This statement demonstrates how the Fund's net assets were affected by its operating results, distributions to shareholders and shareholder transactions (e.g., subscriptions, redemptions and dividend reinvestments) during the reporting period. The Statements of Changes in Net Assets also details changes in the number of shares outstanding. STATEMENT OF CASH FLOWS The Statement of Cash Flows reports net cash provided or used by operating, investing and financing activities and the net effect of those flows on cash and cash equivalents during the period. NOTES TO FINANCIAL STATEMENTS These notes disclose the organizational background of the Fund, its significant accounting policies (including those surrounding security valuation, income recognition and distributions to shareholders), federal tax information, fees and compensation paid to affiliates and significant risks and contingencies. FINANCIAL HIGHLIGHTS The Financial Highlights demonstrate how the Fund's net asset value per share was affected by the fund's operating results. The Financial Highlights table also discloses the classes' performance and certain key ratios (e.g., class expenses and net investment income as a percentage of average net assets).
2 INVESTMENT PORTFOLIO (UNAUDITED) FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- VARIABLE RATE SENIOR LOAN NOTES (A) - 127.4% AEROSPACE/DEFENSE - 1.9% 4,962,500 CACI International, Inc. Term Loan, 4.59%, 05/03/11 .................... 5,036,938 Decrane Aircraft Holdings, Inc. 2,178,433 Term Loan B, 8.06%, 06/30/08 .................. 2,178,432 1,118,362 Term Loan D, 8.06%, 06/30/08 .................. 1,118,362 3,491,250 GenCorp, Inc. Credit Linked Certificate of Deposit, 5.72%, 12/06/10 ............................... 3,529,060 3,000,000 Vought Aircraft Industries, Inc. Term Loan, 5.17%, 12/22/11 .................... 3,048,750 ------------- 14,911,542 ------------- AIR TRANSPORT - 1.2% 5,000,000 American Airlines, Inc. Revolver, 12/15/05 (b) ........................ 5,007,800 4,482,788 United Airlines, Inc. Tranche B, 7.50%, 06/30/05 .................... 4,530,395 ------------- 9,538,195 ------------- AUTOMOTIVE - 4.8% Exide Technologies 2,000,000 European Borrower Dollar Term Loan, 6.11%, 05/05/10 ............................... 2,015,000 2,000,000 US Borrower Term Loan, 6.11%, 05/05/10 ............................... 2,015,000 Federal-Mogul Corp. 392,157 Letter of Credit, 12/09/05 (b) ................ 398,039 1,575,457 Supplemental Revolver, 6.15%, 12/09/05 (c) ........................... 1,548,351 3,607,843 Term Loan, 12/09/11 (b) ....................... 3,440,980 5,000,000 Tranche B Term Loan, 5.17%, 06/30/05 ............................... 4,765,000 573,404 Tranche C Term Loan, 6.42%, 12/09/05 ............................... 576,988 5,605,611 Hayes Lemmerz International, Inc. Term Loan, 6.24%, 06/03/09 .................... 5,734,092 3,750,000 Key Automotive Group Term Loan C, 8.43%, 06/25/11 .................. 3,785,175 4,755,637 Key Plastics Holdings, Inc Term Loan B, 5.70%, 06/29/10 .................. 4,844,852 1,883,408 Keystone Automotive Industries, Inc. Term Loan, 5.61%, 10/30/09 .................... 1,904,597 1,360,345 Plastech, Inc. Term Loan B, 5.31%, 03/31/10 .................. 1,357,515 2,000,000 RJ Tower Corp. Tranche B Dip Term Loan, 02/07/12 (b) .................................. 2,051,240 Tenneco Automotive, Inc. 1,779,338 Tranche B Term Loan, 12/12/10 (b) .................................. 1,779,338 907,701 Tranche B-1 Credit Linked Deposit, 12/12/10 (b) .................................. 907,701 773,333 United Components, Inc. Tranche C, 5.29%, 06/30/10 .................... 785,413 ------------- 37,909,281 ------------- BEVERAGE & TOBACCO - 2.9% 2,887,500 Caribbean Restaurant LLC Tranche B, 5.34%, 06/30/09 .................... 2,935,317 1,788,364 Commonwealth Brands, Inc. Term Loan, 5.94%, 08/28/07 .................... 1,826,367 PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- BEVERAGE & TOBACCO (CONTINUED) 2,180,694 Constellation Brands, Inc. Tranche B Term Loan, 4.40%, 11/30/11 ............................... 2,214,190 4,078,328 Dr. Pepper Bottling Company of Texas Term Loan B, 4.48%, 12/19/10 .................. 4,155,817 3,278,521 DS Waters Enterprises LP Term Loan, 6.85%, 11/07/09 .................... 3,049,025 3,753,270 Keystone Foods Holdings LLC Term Loan, 4.76%, 06/16/11 .................... 3,795,495 Sunny Delight Beverage Co. 2,000,000 First Lien Term Loan, 6.79%, 08/20/10 ............................... 1,995,000 3,000,000 Second Lien Term Loan, 10.04%, 08/20/10 .............................. 2,865,000 ------------- 22,836,211 ------------- BROADCAST RADIO & TELEVISION - 2.0% 6,000,000 Freedom Communications, Inc. Tranche B Term Loan, 4.29%, 05/18/12 ............................... 6,096,600 1,896,307 GT Brands LLC Term Loan, 10.50%, 09/30/07 ................... 512,003 4,331,250 Spanish Broadcasting Systems, Inc. Term Loan B, 5.92%, 10/30/09 .................. 4,412,461 4,950,000 Warner Music Group Term Loan B, 5.34%, 02/28/11 .................. 5,035,041 ------------- 16,056,105 ------------- BUILDING & DEVELOPMENT PRODUCTS - 3.4% 4,000,000 Atrium Cos., Inc. Term Loan, 5.28%, 12/28/11 .................... 4,061,680 2,776,169 CB Richard Ellis Services, Inc. Term Loan, 4.54%, 03/31/10 .................... 2,803,931 2,000,153 Lake at Las Vegas Joint Venture First Lien Term Loan, 5.32%, 11/01/09 ............................... 2,029,955 LNR Property Corp. 2,000,000 Tranche A Term Loan, 0.50%, 02/03/08 (c) ........................... 1,961,360 13,500,000 Tranche B Term Loan, 5.59%, 02/03/08 ............................... 13,698,315 NATG Holdings LLC 131,418 Credit Linked Certificate of Deposit, 0.85%, 01/23/09 ............................... 110,390 121,350 Term Loan A, 7.09%, 01/23/09 .................. 22,450 88,538 Term Loan B1, 7.69%, 01/23/10 ................. 23,020 9,144 Term Loan B2, 7.69%, 01/23/10 ................. 7,681 995,000 Nortek Holdings, Inc. Term Loan, 4.78%, 08/27/11 .................... 1,011,666 990,000 St. Mary's Cement, Inc. Term Loan B, 4.56%, 12/04/09 .................. 1,002,375 ------------- 26,732,823 ------------- BUSINESS EQUIPMENT & SERVICES - 6.7% 10,009,865 Acterna Corp. Term Loan, 09/30/07 (b) ....................... 10,109,964 Acterna LLC 2,145,110 Pre-petition Term Loan, 09/30/07 (b) .................................. 2,016,404 354,890 Term Loan, 03/31/06 (b) ....................... 354,890 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 3 INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- VARIABLE RATE SENIOR LOAN NOTES (CONTINUED) BUSINESS EQUIPMENT & SERVICES (CONTINUED) 3,262,286 American Achievement Corp. Term Loan B, 5.31%, 03/25/11 .................. 3,315,331 4,666,667 Brickman Group Holdings, Inc. Term Loan, 7.97%, 11/15/09 .................... 4,655,000 CCC Information Services Group, Inc. 1,994,781 Term Loan, 5.67%, 08/20/10 .................... 2,019,716 2,388,908 Term Loan B, 5.67%, 08/20/10 .................. 2,418,770 3,930,250 Global Imaging Systems, Inc. First Additional Term Loan, 4.70%, 05/10/10 ............................... 3,980,636 5,706,875 Hillman Group, Inc. Term Loan B, 5.50%, 03/30/11 .................. 5,792,364 6,917,647 Knoll, Inc. Initial Term Loan, 5.59%, 09/30/11 ............................... 6,986,824 2,694,716 OfficeMax, Inc. Tranche B Term Loan, 4.94%, 10/28/11 ............................... 2,744,245 2,026,011 Outsourcing Solutions Inc. Term Loan, 7.59%, 12/03/08 .................... 2,026,011 5,000,000 Rural/Metro Corp. Term Loan, 9.63%, 12/31/06 .................... 5,000,000 727,451 URS Corp. Term Loan B, 4.71%, 08/22/08 .................. 731,772 1,000,000 WestCom Corp. Term Loan C2, 9.66%, 06/17/11 ............................... 1,040,000 ------------- 53,191,927 ------------- CABLE & SATELLITE TELEVISION - 12.4% 5,000,000 Adelphia Communications Corp. Tranche B DIP Term Loan, 03/31/06 (b) .................................. 5,025,000 4,000,000 Atlantic Broadband Finance LLC Term Loan B, 5.19%, 09/01/11 .................. 4,068,720 6,965,000 Bragg Communications, Inc. Term Loan B, 5.39%, 08/31/11 .................. 7,060,769 3,500,000 Bresnan Communications LLC Term Loan B, 6.04%, 09/30/10 .................. 3,552,080 6,451,250 Cebridge Connections, Inc. Second Lien Term Loan, 8.76%, 02/23/10 ............................... 6,398,866 Century Cable Holdings LLC 13,833,333 Discretionary Term Loan, 7.50%, 06/30/09 ............................... 13,784,591 1,000,000 Discretionary Term Loan, 7.50%, 12/31/09 ............................... 996,250 Charter Communications Operating LLC 2,000,000 Tranche A Term Loan, 04/27/10 (b) ............. 1,998,280 3,000,000 Tranche A Term Loan, 5.73%, 04/27/10 ............................... 2,997,420 9,950,000 Tranche B Term Loan, 5.98%, 04/27/11 ............................... 9,993,880 3,000,169 DirecTV Holdings LLC Term Loan B, 4.59%, 03/06/10 .................. 3,042,831 3,482,500 Mediacom Broadband Group LLC Term Loan B, 5.17%, 09/30/10 .................. 3,542,747 2,000,000 Mediacom Communications Corp. Term Loan B, 4.88%, 03/31/13 .................. 2,035,000 1,000,000 Millennium Digital Media Capital Corp. Term Loan C, 10/31/08 (b) ..................... 997,500 Olympus Cable Holdings LLC 6,000,000 Term Loan A, 6.75%, 06/30/10 .................. 5,921,760 PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- CABLE & SATELLITE TELEVISION (CONTINUED) 7,000,000 Term Loan B, 7.50%, 09/30/10 .................. 6,967,170 2,000,000 Rainbow National Services LLC Term Loan B, 5.69%, 03/31/12 .................. 2,021,000 4,000,000 Susquehanna Media Co. Term Loan B, 4.19%, 03/31/12 .................. 4,067,520 6,965,000 UPC Financing Partnership Term Loan C2, 5.98%, 03/31/09 ................. 7,073,793 6,449,924 WideOpenWest LLC Term Loan B, 7.11%, 06/22/11 ............... 6,490,237 ------------- 98,035,414 ------------- CHEMICALS/PLASTICS - 5.3% 3,500,000 Brenntag AG Term Loan B2, 5.88%, 02/27/12 ................. 3,564,190 Celenese 958,035 Delayed Draw Term Loan C, 0.75%, 04/06/11 (c) ........................... 974,801 5,541,965 Dollar Term Loan B, 5.10%, 04/06/11 ............................... 5,662,004 4,987,437 Coffeyville, Inc. Term Loan, 7.56%, 05/10/10 .................... 5,062,249 7,000,000 Huntsman Co. LLC Term Loan B, 6.15%, 03/31/10 .................. 7,092,960 3,974,215 Kraton Polymers Group of Cos. Term Loan, 5.34%, 12/23/10 .................... 4,040,028 Nalco Co. 2,945,674 Term Loan A, 5.18%, 11/04/09 .................. 2,987,656 2,061,824 Term Loan B, 4.67%, 11/04/10 .................. 2,091,209 1,870,000 Polypore, Inc. Term Loan, 4.92%, 11/12/11 .................... 1,893,375 4,500,000 Rockwood Specialties Group, Inc. Tranche B Term Loan, 07/30/12 (b) ............. 4,564,215 4,365,000 Waddington North America, Inc. Term Loan B, 5.32%, 04/07/11 .................. 4,232,697 ------------- 42,165,384 ------------- CLOTHING/TEXTILES - 1.2% 2,992,424 Levi Strauss & Co. Tranche A, 9.64%, 09/29/09 .................... 3,199,650 6,568,333 Polymer Group, Inc. First Lien Term Loan, 5.78%, 04/27/10 ............................... 6,643,278 ------------- 9,842,928 ------------- CONGLOMERATE - 1.2% 3,482,500 Appleton Papers, Inc. Term Loan, 4.56%, 06/11/10 .................... 3,526,588 1,253,178 Jason, Inc. Term Loan B, 7.14%, 06/30/07 .................. 1,262,828 1,890,154 Mueller Group, Inc. New Term Loan, 6.04%, 04/23/11 ............................... 1,912,609 2,985,000 Youth & Family Centered Services, Inc. Term Loan B, 6.77%, 05/28/11 .................. 2,992,463 ------------- 9,694,488 ------------- CONTAINER/GLASS PRODUCTS - 4.3% 3,482,500 Consolidated Container Co. LLC Term Loan, 5.13%, 12/15/08 .................... 3,526,031 7,500,000 Graham Packaging International, Inc. Term Loan B, 5.09%, 10/07/11 .................. 7,635,300 4 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- VARIABLE RATE SENIOR LOAN NOTES (CONTINUED) CONTAINER/GLASS PRODUCTS (CONTINUED) 3,650,194 Graphic Packaging International, Inc. Term Loan C, 5.14%, 08/09/10 .................. 3,716,336 1,990,000 Kranson Industries, Inc. Term Loan, 5.31%, 07/30/11 .................... 2,002,438 740,625 Reddy Ice Group, Inc. Supplemental Term Loan, 5.17%, 08/14/09 ............................... 746,179 Smurfit-Stone Container Corp. 654,975 Credit Linked Certificate of Deposit, 2.49%, 11/01/10 ............................... 665,206 5,234,431 Tranche B, 4.60%, 11/01/11 .................... 5,315,146 1,610,594 Tranche C, 4.50%, 11/01/11 .................... 1,631,725 1,203,125 Sola International, Inc. Term Loan, 5.17%, 12/11/09 .................... 1,218,164 6,930,000 Solo Cup, Inc. Term Loan, 5.06%, 02/27/11 .................... 7,053,008 ------------- 33,509,533 ------------- COSMETICS/TOILETRIES - 1.5% 2,381,165 Church & Dwight Co., Inc Tranche B, 4.40%, 05/30/11 .................... 2,415,406 3,825,666 Johnson Diversey, Inc. Term Loan B, 4.99%, 11/03/09 .................. 3,890,244 2,250,000 Marietta Intermediate Holdings First Lien Term Loan B, 7.75%, 12/17/10 ............................... 2,266,875 1,000,000 MD Beauty, Inc. Second Lien Term Loan, 02/18/13 (b) .................................. 1,015,000 2,000,000 Revlon Consumer Products Corp. Term Loan, 8.59%, 07/09/10 .................... 2,090,000 ------------- 11,677,525 ------------- DIVERSIFIED MANUFACTURING - 0.1% 1,000,000 GenTek, Inc. Second Lien Term Loan, 02/01/12 (b) .................................. 1,025,000 ------------- ECOLOGICAL SERVICE & EQUIPMENT - 2.7% Allied Waste North America, Inc. 12,933,700 Tranche A, 5.43%, 01/15/10 .................... 13,076,488 3,732,609 Tranche C, 5.26%, 01/15/10 .................... 3,751,010 4,500,000 Environmental Systems Products Holdings Second Lien, 12.72%, 12/12/10 ................. 4,651,875 ------------- 21,479,373 ------------- ELECTRONIC/ELECTRIC - 4.3% 987,500 AMI Semiconductor, Inc. Term Loan, 5.17%, 09/26/08 .................... 999,843 2,500,000 Amkor Technology, Inc. Second Lien Term Loan, 7.37%, 10/27/10 ............................... 2,618,750 1,000,000 Camp Acquisition Co. Second Lien Term Loan B, 8.63%, 06/30/12 ............................... 1,002,500 3,000,000 Comsys Information Technology Services, Inc. Second Lien Term Loan, 10.00%, 04/30/10 .............................. 3,000,000 PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- ELECTRONIC/ELECTRIC (CONTINUED) 3,000,000 Corel Corp. Second Lien Term Loan, 10.59%, 08/15/10 .............................. 3,015,000 8,500,000 ON Semiconductor Corp. Tranche G Term Loan, 5.56%, 12/15/11 ............................... 8,515,980 3,138,464 Transaction Network Services, Inc. Term Loan, 4.41%, 12/31/08 .................... 3,130,617 2,250,000 Transfirst Holdings, Inc. Second Lien Term Loan, 10.06%, 03/31/11 .............................. 2,300,625 2,985,000 UGS Corp. Term Loan B, 6.50%, 05/27/11 .................. 3,037,238 1,000,000 Verifone, Inc. Second Lien Term Loan, 8.73%, 12/31/11 ............................... 1,031,880 5,000,000 Viasystems, Inc. Tranche B Term Loan, 6.49%, 09/30/09 ............................... 5,057,800 ------------- 33,710,233 ------------- EQUIPMENT LEASING - 1.5% National Equipment Service, Inc. 1,160,000 First Lien Term Loan, 5.48%, 08/17/09 ............................... 1,165,800 666,667 Revolver, 0.38%, 08/17/09 (c) ................. 665,608 4,500,000 Neff Rental, Inc. Initial Term Loan, 7.25%, 05/01/08 ............ 4,455,000 United Rentals, Inc. 3,142,917 Delayed Draw Term Loan B, 4.92%, 02/14/11 ............................... 3,199,866 2,723,333 Term Loan C2, 2.25%, 02/14/11 ................. 2,680,223 ------------- 12,166,497 ------------- FARMING/AGRICULTURE - 0.8% 6,427,167 AGCO Corp. Term Loan, 4.48%, 01/31/06 .................... 6,545,683 ------------- FINANCIAL INTERMEDIARIES - 0.9% 4,000,000 Marina District Finance Co., Inc. Term Loan, 3.93%, 10/20/11 .................... 4,042,480 3,000,000 Metris Cos., Inc. Term Loan, 12.09%, 05/06/07 ................... 3,168,750 ------------- 7,211,230 ------------- FOOD PRODUCTS - 3.3% 1,995,000 Doane Pet Care Co. Term Loan, 6.43%, 11/05/09 .................... 2,031,149 7,500,000 Interstate Bakeries Corp. Revolver, 0.50%, 09/22/06 (c) ................. 7,448,475 Interstate Brands Corp. 935,696 Term Loan B, 6.73%, 07/19/07 .................. 923,027 2,895,340 Term Loan C, 6.77%, 07/19/07 .................. 2,836,217 625,000 Tranche A, 6.80%, 07/19/06 .................... 616,662 4,183,393 Luigino's, Inc. Term Loan B, 5.53%, 04/02/11 .................. 4,195,190 703,764 Merisant Co. Term Loan B, 5.48%, 01/11/10 .................. 705,088 7,146,000 Pinnacle Foods Holding Corp. Delayed Draw Term Loan, 5.81%, 11/25/10 ............................... 7,195,164 ------------- 25,950,972 ------------- SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 5 INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- VARIABLE RATE SENIOR LOAN NOTES (CONTINUED) FOOD SERVICES - 1.3% 332,798 AFC Enterprises, Inc. Term Loan A, 7.25%, 09/23/08 .................. 336,125 3,246,603 Buffets, Inc. Term Loan, 6.27%, 06/28/09 .................... 3,273,680 3,000,000 Captain D's Inc., LLC First Lien Term Loan, 6.42%, 12/27/10 ............................... 3,022,500 2,000,000 Captain D's LLC Second Lien Term Loan, 8.67%, 06/27/11 ............................... 1,990,000 782,961 Domino's, Inc. New Term Loan, 4.31%, 06/25/10 ................ 793,562 1,000,000 Landry's Restaurants, Inc. Term Loan, 4.53%, 12/28/10 .................... 1,015,620 ------------- 10,431,487 ------------- FOOD/DRUG RETAIL - 1.6% 4,980,000 Jean Coutu Group, Inc. Term Loan B, 5.00%, 07/30/11 .................. 5,071,532 Michael Foods, Inc. 3,000,000 Floater Term Loan, 6.59%, 11/20/11 ............................... 3,090,000 4,596,465 Term Loan, 5.07%, 11/21/10 .................... 4,674,605 ------------- 12,836,137 ------------- FOREST PRODUCTS - 0.1% SP Newsprint Co. 345,556 Term Loan, 5.67%, 01/08/10 .................... 351,388 644,444 Term Loan B Letter of Credit, 2.59%, 01/09/08 ............................... 655,322 ------------- 1,006,710 ------------- HEALTH CARE - 8.3% 3,687,500 Alliance Imaging, Inc. Tranche C Term Loan, 4.97%, 12/29/11 ............................... 3,737,060 6,964,103 Alpharma Operating Corp. Term Loan B, 5.81%, 10/05/08 .................. 7,003,241 3,000,000 American Medical Response, Inc. Term Loan, 02/10/12 (b) ....................... 3,058,140 3,211,600 Ameripath, Inc. Term Loan, 5.92%, 03/27/10 .................... 3,239,702 1,995,000 Ardent Health Services Term Loan, 4.80%, 08/12/11 .................... 2,022,431 2,938,229 Davita, Inc. Term Loan B, 4.58%, 03/31/09 .................. 2,953,126 712,500 dj Orthopedics LLC Term Loan, 4.88%, 05/15/09 .................... 724,969 2,056,876 Eye Care Centers of America Term Loan A, 8.75%, 12/23/05 .................. 2,062,018 FHC Health Systems, Inc. 1,500,000 Third Lien Term Loan, 02/07/11 (b) ............ 1,530,000 5,000,000 Third Lien Term Loan, 11.77%, 01/14/11 .............................. 5,100,000 1,984,924 Hanger Orthopedic Group, Inc. Term Loan B, 6.06%, 09/30/09 .................. 1,994,848 4,000,000 InSight Health Services Corp. Tranche B, 6.31%, 10/17/08 .................... 4,022,480 1,350,921 Kinetic Concepts, Inc. Term Loan B1, 4.31%, 08/11/10 ................. 1,360,216 7,703,704 Knowledge Learning Corp. Term Loan, 5.15%, 01/07/12 .................... 7,771,188 PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- HEALTH CARE (CONTINUED) 1,987,506 Leiner Health Products Group, Inc. Term Loan B, 5.56%, 05/27/11 .................. 2,017,319 MedAssets, Inc. 500,000 Second Lien Term Loan, 12.56%, 06/16/08 .............................. 510,000 727,968 Senior Term Loan, 7.31%, 03/16/09 ............................... 737,977 1,970,000 Medex, Inc. Term Loan, 5.60%, 05/30/09 .................... 1,987,237 1,221,023 Orthofix International N.V. Term Loan B, 4.55%, 12/30/08 .................. 1,238,581 1,517,564 PerkinElmer, Inc. Term Loan B, 4.59%, 12/26/08 .................. 1,537,778 Select Medical Corp. 2,000,000 Revolver, 02/24/11 (b) ........................ 1,998,760 3,000,000 Tranche B Term Loan, 02/24/12 (b) ............. 3,039,390 3,235,623 Skilled Healthcare LLC First Lien Term Loan, 5.34%, 07/31/10 ............................... 3,272,024 2,481,250 VCA Antech, Inc. Term Loan E, 4.44%, 06/30/09 .................. 2,512,265 ------------- 65,430,750 ------------- HOME FURNISHINGS - 1.2% 4,369,419 Holmes Group, Inc. First Lien Term Loan, 5.91%, 11/08/10 ............................... 4,418,575 2,630,455 Juno Lighting, Inc. First Lien Term Loan, 5.20%, 11/21/10 ............................... 2,683,064 2,491,071 Sealy Mattress Co. Term Loan C, 4.80%, 08/06/12 .................. 2,533,121 ------------- 9,634,760 ------------- INDUSTRIAL EQUIPMENT - 0.9% 1,758,662 Copperweld Corp. Term Loan, 7.17%, 12/17/11 .................... 1,763,058 988,655 Dresser, Inc. Term Loan C, 5.17%, 04/10/09 .................. 1,002,872 Terex Corp. 605,193 Incremental Term Loan, 5.39%, 12/31/09 ............................... 612,002 3,535,682 Term Loan, 4.89%, 07/03/09 .................... 3,579,877 ------------- 6,957,809 ------------- INSURANCE - 1.5% 8,640,000 Conseco, Inc. Term Loan, 6.17%, 06/22/10 .................... 8,820,922 2,985,000 Mitchell International, Inc. Second Lien Term Loan, 8.80%, 08/15/12 ............................... 3,003,656 ------------- 11,824,578 ------------- LEISURE GOODS/ACTIVITIES/MOVIES - 5.4% 3,216,949 AMF Bowling Worldwide, Inc. Term Loan B, 5.39%, 08/27/09 .................. 3,240,046 1,990,000 Amscan Holdings, Inc. Term Loan B, 5.60%, 04/30/12 .................. 1,997,463 10,750,000 Blockbuster Entertainment Corp. Term Loan B, 5.32%, 08/20/11 .................. 10,817,188 2,483,759 Boyd Gaming Corp. Term Loan B, 4.23%, 06/30/11 .................. 2,520,618 6 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- VARIABLE RATE SENIOR LOAN NOTES (CONTINUED) LEISURE GOODS/ACTIVITIES/MOVIES (CONTINUED) 1,989,975 Cinemark USA, Inc. Term Loan, 4.35%, 03/31/11 .................... 2,014,850 CNL Hospitality Partners LP 5,000,000 First Lien Term Loan, 5.23%, 09/09/06 ............................... 5,000,000 4,000,000 Term Loan, 5.09%, 10/13/06 .................... 4,080,000 4,987,500 Metro-Goldwyn-Mayer Studios, Inc. Term Loan B, 5.06%, 04/30/11 .................. 5,007,749 2,386,979 MTS, Inc. Term Loan, 15.25%, 04/01/05 ................... 2,291,499 2,887,047 Regal Cinemas, Inc. Term Loan, 4.56%, 11/10/10 .................... 2,932,893 2,477,518 Six Flags Theme Parks, Inc. Term Loan B, 5.09%, 06/30/09 .................. 2,506,406 ------------- 42,408,712 ------------- LODGING & CASINOS - 6.6% 692,600 Ameristar Casinos, Inc. Term Loan B1, 4.63%, 12/20/06 ................. 704,720 4,677,885 Global Cash Access LLC Term Loan, 5.42%, 03/10/10 .................... 4,712,969 3,970,000 Green Valley Ranch Gaming LLC Term Loan B, 4.50%, 12/22/10 .................. 4,024,588 2,500,000 Mississippi Band of Chocktaw Indians Term Loan, 5.02%, 11/04/11 .................... 2,540,625 OpBiz LLC 17,918,616 Term Loan A, 5.56%, 08/31/10 .................. 17,836,549 42,127 Term Loan B, 6.56%, 08/31/10 .................. 41,934 Venetian Casino Resort LLC 341,880 Delayed DrawTerm Loan B, 06/15/11 (b) .................................. 346,369 1,658,120 Term Loan B, 06/15/11 (b) ..................... 1,686,623 Wyndham International, Inc. 9,860,000 IRL Tranche II, 06/30/06 (b) .................. 9,914,230 6,237,208 Term Loan I, 7.38%, 06/30/06 .................. 6,263,404 4,000,000 Wynn Las Vegas LLC Delayed Draw Term Loan, 2.88%, 12/14/11 (c) ........................... 4,070,000 ------------- 52,142,011 ------------- NONFERROUS METALS/MINING - 2.0% 2,486,702 CII Carbon LLC Term Loan, 4.76%, 06/25/08 .................... 2,463,377 2,000,000 Consol Energy, Inc. Tranche B, 5.09%, 06/30/10 .................... 2,003,120 997,500 J W Aluminum Co. First Lien Term Loan, 5.89%, 10/20/10 ............................... 1,013,709 Murray Energy Corp. 1,000,000 Tranche B Term Loan, 01/28/10 (b) ............. 1,017,500 3,750,000 Tranche B Term Loan, 5.94%, 01/28/10 ............................... 3,815,625 Novelis, Inc. 1,826,923 Canadian Term Loan, 4.50%, 01/07/12 ............................... 1,855,935 3,173,077 United States Term Loan, 4.50%, 01/07/12 ............................... 3,225,433 ------------- 15,394,699 ------------- PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- OIL/GAS - 5.9% 6,000,000 ALON USA Term Loan, 10.00%, 01/15/09 ................... 6,150,000 ATP Oil & Gas Corp. 3,958,786 First Lien Term Loan, 8.58%, 03/29/09 ............................... 4,037,961 4,962,500 Second Lien Term Loan, 12.62%, 03/31/09 .............................. 4,987,312 5,000,000 Basic Energy Services, Inc. Term Loan B, 5.55%, 10/03/09 .................. 5,050,000 4,027,500 Belden & Blake Corp. Term Loan, 5.69%, 07/07/11 .................... 4,085,416 2,985,000 Dynegy Holdings, Inc. Term Loan, 6.59%, 05/27/10 .................... 3,040,969 El Paso Corp. 2,500,000 Deposit Accounts, 2.40%, 11/23/09 ............. 2,540,250 3,486,000 Term Loan, 5.44%, 11/23/09 .................... 3,552,234 2,900,000 Getty Petroleum Marketing, Inc. Term Loan, 5.80%, 05/19/10 .................... 2,958,000 1,843,750 Headwaters, Inc. Term Loan B, 6.31%, 04/30/11 .................. 1,869,673 1,000,000 Premcor Refining Group Synthetic Tranche Facility, 4.34%, 04/13/09 ............................... 1,012,080 2,385,000 Pride Offshore, Inc. Term Advances, 4.34%, 07/07/11 ................ 2,423,756 967,419 Tesoro Petroleum Corp. Initial Term Loan, 7.99%, 04/15/08 ............ 997,873 1,760,000 Western Refining Co. LP Term Loan, 6.17%, 08/28/08 .................... 1,786,400 1,846,969 Williams Production RMT Co. Term Loan C, 4.99%, 05/30/07 .................. 1,878,145 ------------- 46,370,069 ------------- PUBLISHING - 3.3% 1,990,000 Adams Outdoor Advertising LP First Lien Term Loan, 4.92%, 10/15/11 ............................... 2,023,153 5,055,390 Dex Media East LLC Term Loan A, 4.52%, 11/08/08 .................. 5,125,760 3,900,943 Dex Media West LLC Term Loan A, 4.72%, 09/09/09 .................. 3,957,741 1,990,000 Herald Media, Inc. First Lien Term Loan, 5.03%, 07/22/11 ............................... 2,026,696 3,244,014 R.H. Donnelley Corp. Term Loan D, 4.28%, 06/30/11 .................. 3,294,102 1,300,533 Relizon Co. Term Loan, 5.78%, 02/20/11 .................... 1,303,784 4,412,500 Transwestern Publishing Co. First Lien Term Loan, 4.20%, 02/25/11 ............................... 4,439,416 3,880,000 VISANT Corp. Tranche B, 4.81%, 12/06/11 .................... 3,940,140 ------------- 26,110,792 ------------- REAL ESTATE INVESTMENT TRUST - 3.2% 2,000,000 AIMCO Properties, L.P. Term Loan, 4.75%, 11/02/09 .................... 2,040,000 771,429 Central Parking Corp. Term Loan B, 4.56%, 03/31/10 .................. 785,176 2,130,585 Crescent Real Estate Equities LP Term Loan, 4.84%, 01/12/06 .................... 2,149,888 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 7 INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- VARIABLE RATE SENIOR LOAN NOTES (CONTINUED) REAL ESTATE INVESTMENT TRUST (CONTINUED) 20,000,000 General Growth Properties, Inc. Tranche B Term Loan, 4.84%, 11/12/08 ............................... 20,302,000 ------------- 25,277,064 ------------- RETAILERS - 1.2% 2,000,000 Dollarama Term Loan B, 5.02%, 11/18/11 .................. 2,030,000 4,000,000 Harbor Freight Tools USA Term Loan, 4.83%, 07/15/10 .................... 4,031,240 2,972,525 Prestige Brands Holdings, Inc. Tranche B, 5.39%, 04/06/11 .................... 3,011,079 ------------- 9,072,319 ------------- STEEL - 0.4% 2,887,500 The Techs Industries, Inc. Term Loan, 4.81%, 01/14/10 .................... 2,901,938 ------------- SURFACE TRANSPORT - 1.1% 603,922 Pacer International, Inc. New Term Loan, 4.68%, 06/10/10 ................ 616,755 Quality Distribution, Inc. 1,000,000 PF Letters of Credit, 3.10%, 11/13/09 ............................... 970,000 3,432,117 Term Loan, 5.64%, 11/13/09 .................... 3,345,250 984,848 Term Loan, 5.64%, 11/13/09 (e) ................ 959,921 2,595,963 Transport Industries LP Term Loan B, 6.56%, 06/13/10 .................. 2,600,844 ------------- 8,492,770 ------------- TELECOMMUNICATIONS/CELLULAR - 3.1% 4,975,000 American Tower LP Term Loan B, 4.23%, 08/31/11 .................. 5,049,227 625,000 Dobson Cellular Systems, Inc. Revolver, 0.63%, 10/21/09 (c) ................. 599,219 Qwest Corp. 5,000,000 Term Loan A, 7.39%, 06/30/07 .................. 5,209,350 7,000,000 Term Loan B, 6.95%, 06/30/10 .................. 7,275,830 5,970,000 Western Wireless Corp. Term Loan B, 5.61%, 05/31/11 .................. 6,026,476 ------------- 24,160,102 ------------- TELECOMMUNICATIONS/COMBINATION - 3.7% 4,440,075 Centennial Cellular Operating Co. Term Loan B, 4.46%, 02/09/11 .................. 4,508,897 5,000,000 NTL, Inc. Tranche B Term Loan B, 5.20%, 04/14/12 ............................... 5,068,750 PanAmSat Corp. 2,500,000 08/20/11 (b) .................................. 2,538,350 1,140,813 Term Loan A-1, 5.09%, 08/20/09 ................ 1,147,942 546,818 Term Loan A-2, 5.09%, 08/20/09 ................ 550,235 4,954,819 Term Loan B, 5.34%, 08/20/11 .................. 5,030,826 1,000,000 Tranche B, 5.34%, 08/20/11 .................... 1,015,340 4,000,000 RCN Corp. Term Loan, 7.06%, 12/21/11 .................... 4,023,360 5,000,000 Woodlands Commercial Property Co. Bridge Loan, 4.84%, 08/30/05 .................. 5,037,500 ------------- 28,921,200 ------------- PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- TELECOMMUNICATIONS/WIRELESS - 6.7% 9,933,333 Consolidated Communications, Inc Term Loan C, 5.18%, 10/14/11 .................. 10,074,858 Cricket Communications, Inc. 5,000,000 Revolver, 0.75%, 01/10/10 (c) ................. 4,925,000 15,000,000 Term Loan B, 5.09%, 01/10/11 .................. 15,182,850 FairPoint Communications, Inc. 2,500,000 Initial B Term Loan, 02/08/12 (b) ............. 2,541,025 2,500,000 Initial B Term Loan, 4.75%, 02/08/12 ............................... 2,541,025 6,800,000 Nextel Partners Operating Corp. Term Loan C, 4.94%, 05/31/11 .................. 6,899,824 1,000,000 Primus Telecommunications Group, Inc. Term Loan, 9.61%, 02/18/11 .................... 1,005,000 1,990,000 SBA Senior Finance, Inc. Term Loan, 4.86%, 10/31/08 .................... 2,024,825 2,000,000 Triton PCS Holdings, Inc. Term Loan, 5.87%, 11/18/09 .................... 2,032,920 5,994,105 WilTel Communications Group, Inc. Term Loan, 7.00%, 04/01/10 .................... 5,814,282 ------------- 53,041,609 ------------- TELECOMMUNICATIONS/WIRELINE - 0.5% 4,000,000 Valor Telecommunications Enterprises LLC Tranche B Term Loan, 5.99%, 02/14/12 ............................... 4,061,000 ------------- UTILITIES - 7.0% 2,605,732 Allegheny Energy, Inc. Term Advances, 4.80%, 03/08/11 ................ 2,663,371 4,949,749 Calpine Construction Finance Co. LP Term Loan, 8.58%, 08/26/09 .................... 5,331,820 1,622,170 Calpine Corp. Second Lien Term Loan B, 8.41%, 07/16/07 ............................... 1,439,676 3,256,555 Infrasource, Inc. Term Loan, 5.56%, 09/30/10 .................... 3,289,120 Midwest Generations LLC 2,000,000 Term Loan, 0.50%, 04/27/09 (c) ................ 1,965,000 2,801,674 Term Loan, 5.65%, 04/27/11 .................... 2,848,602 Mirant Corp. 5,000,000 Revolver, 07/17/05 (b) ........................ 3,654,200 2,000,000 Revolver, 07/15/08 (b) ........................ 1,466,260 NRG Energy, Inc. 1,750,000 Credit Linked Certificate of Deposit, 4.33%, 12/24/07 ...................... 1,776,250 2,250,000 Term Loan, 4.52%, 12/24/11 .................... 2,279,520 5,000,000 Reliant Energy, Inc. Term Loan, 5.06%, 04/30/10 .................... 5,088,400 4,626,288 Riverside Energy Center LLC Term Loan, 6.98%, 06/24/11 .................... 4,741,945 Rocky Mountain Energy Center LLC 361,073 Credit Linked Certificate of Deposit, 2.63%, 06/24/11 ...................... 368,295 3,286,536 Term Loan, 6.98%, 06/24/11 .................... 3,368,699 Texas Genco LLC 1,461,538 Delayed Draw Term Loan, 1.25%, 12/14/11 (c) ........................... 1,485,741 9,871,795 Initial Term Loan, 4.48%, 12/14/11 ............ 10,043,762 2,955,000 TNP Enterprises, Inc. Term Loan, 7.72%, 12/31/06 .................... 2,995,631 ------------- 54,806,292 ------------- Total Variable Rate Senior Loan Notes (Cost $973,592,701) ......................... 1,005,473,152 ------------- 8 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (UNAUDITED) (CONTINUED) FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PAR/ COMMITMENT ($) VALUE ($) ---------------- ------------- CORPORATE NOTES AND BONDS (F) - 2.2% CONTAINER/GLASS PRODUCTS - 0.3% 2,500,000 Constar International, Inc. Floating Rate Note, 6.15%, 02/15/12 ............................... 2,550,000 ------------- FOOD/DRUG RETAIL - 0.5% 4,000,000 Duane Reade, Inc. Floating Rate Note, 7.01%, 12/15/10 ............................... 4,020,000 ------------- HEALTH CARE - 0.2% 2,000,000 Elan Finance Floating Rate Note, 6.49%, 11/15/11 ............................... 1,750,000 ------------- OIL & GAS - 0.6% 4,500,000 Secunda International Ltd. Floating Rate Note, 10.66%, 09/01/12 .............................. 4,500,000 ------------- TELECOMMUNICATIONS/CELLULAR - 0.3% 2,000,000 Dobson Cellular Systems, Inc. Floating Rate Note, 7.49%, 11/01/11 ............................... 2,120,000 ------------- UTILITIES - 0.3% 2,000,000 Calpine Construction Finance Co. LP Floating Rate Note, 11.63%, 08/26/11 .............................. 2,240,000 ------------- Total Corporate Notes and Bonds (Cost $17,214,311) .......................... 17,180,000 ------------- SHARES ---------------- COMMON STOCKS (G) - 0.3% BUSINESS SERVICES - 0.0% 40,800 NATG Holdings LLC (d) ........................... 0 ------------- HEALTH CARE - 0.0% 43,117 Sun Healthcare Group, Inc. ...................... 294,058 ------------- TELECOMMUNICATIONS/WIRELESS - 0.3% 76,137 Leap Wireless International, Inc. ............... 2,040,471 ------------- Total Common Stocks (Cost $1,600,216) ........................... 2,334,529 ------------- SHARES VALUE ($) ---------------- ------------- PREFERRED STOCKS (D) - 0.0% DIVERSIFIED MANUFACTURING - 0.0% 14,382 Superior Essex, Inc., Series A .................. 14,382 ------------- Total Preferred Stocks (Cost $14,382) .............................. 14,382 ------------- UNFUNDED LOAN COMMITMENTS - (2.8)% .............................. (22,336,758) ------------- TOTAL INVESTMENTS - 127.1% ...................................... 1,002,665,305 ------------- (cost of $992,421,610) (h) OTHER ASSETS & LIABILITIES, NET - (27.1)% ....................... (213,857,016) ------------- NET ASSETS - 100.0% ............................................. 788,808,289 ============= __________________ (a) Senior loans in which the Fund invests generally pay interest at rates which are periodically predetermined by reference to a base lending rate plus a premium. These base lending rates are generally (i) the prime rate offered by one or more major United States banks, (ii) the lending rate offered by one or more European banks such as the London Inter-Bank Offered Rate ("LIBOR") and (iii) the certificate of deposit rate. Rate shown represents the weighted average rate at February 28, 2005. Senior loans are generally considered to be restricted in that the Fund ordinarily is contractually obligated to receive approval from the agent bank and/or borrower prior to the disposition of a senior loan. (b) Unsettled loan. Interest rate cannot be determined at this time. (c) Unfunded commitment. As of February 28, 2005, the Portfolio had unfunded loan commitments of $22,336,758, which could be extended at the option of the Borrower, pursuant to the following loan agreements: UNFUNDED LOAN BORROWER COMMITMENT -------- ------------- Celenese $ 958,035 Cricket Communications, Inc. 5,000,000 Dobson Cellular Systems, Inc. 625,000 Federal-Mogul Corp. 125,779 Interstate Bakeries Corp. 7,500,000 LNR Property Corp. 2,000,000 Midwest Generations LLC 2,000,000 National Equipment Service, Inc. 666,406 Texas Genco LLC 1,461,538 Wynn Las Vegas LLC 2,000,000 ------------- $ 22,336,758 ============= (d) Represents fair value as determined in good faith under the direction of the Board of Trustees. (e) Loans held on participation. (f) Securities exempt from registration under Rule 144A of the Securities Act of 1933, as amended. These securities may only be resold, in transactions exempt from registration, to qualified institutional buyers. At February 28, 2005, these securities amounted to $17,180,000 or 2.2% of net assets. These securities have been determined by the Fund's investment adviser to be liquid securities. (g) Non-income producing security. (h) Cost for Federal income tax purposes is $992,869,593. DIP Debtor in Possession IRL Increasing Rate Loan SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 9 STATEMENT OF ASSETS AND LIABILITIES -------------------------------------------------------------------------------- FEBRUARY 28, 2005 (UNAUDITED) HIGHLAND FLOATING RATE ADVANTAGE FUND
($) ------------------------------------------------------------------------------------------------------------- ASSETS: Investments, at cost .................................................................... 992,421,610 --------------- Investments, at value ................................................................... 1,002,665,305 Cash and cash equivalents ............................................................... 26,589,655 Receivable for: Investments sold ..................................................................... 19,334,435 Fund shares sold ..................................................................... 7,660,150 Interest and fees .................................................................... 6,577,823 Expense reimbursement due from Investment Adviser ....................................... 36,427 Deferred Trustees' compensation plan (Note 4) ........................................... 5,055 Other assets ............................................................................ 106,225 --------------- Total Assets ...................................................................... 1,062,975,075 LIABILITIES: Notes payable ........................................................................... 200,000,000 Deferred facility fees .................................................................. 126,935 Payable for: Investments purchased ................................................................ 71,552,957 Distributions ........................................................................ 1,083,795 Investment advisory fee (Note 4) ..................................................... 327,635 Administration fee (Note 4) .......................................................... 145,616 Trustees' fees (Note 4) .............................................................. 16,667 Distribution and service fees (Note 4) ............................................... 350,721 Interest expense (Note 8) ............................................................ 312,611 Deferred Trustees' fees (Note 4) ........................................................ 5,055 Accrued expenses and other liabilities .................................................. 244,794 --------------- Total Liabilities ................................................................. 274,166,786 --------------- NET ASSETS ................................................................................ 788,808,289 =============== COMPOSITION OF NET ASSETS Paid-in capital ......................................................................... 781,811,749 Overdistributed net investment income ................................................... (630,311) Accumulated net realized loss ........................................................... (2,616,844) Net unrealized appreciation on investments .............................................. 10,243,695 --------------- NET ASSETS ................................................................................ 788,808,289 =============== CLASS A Net assets .............................................................................. 272,818,084 Shares outstanding ...................................................................... 22,498,968 Net asset value per share (Net assets/Shares outstanding) .............................. 12.13(a) Maximum offering price per share ($12.13 / 0.9650) ...................................... 12.57(b) CLASS B Net assets .............................................................................. 128,072,109 Shares outstanding ...................................................................... 10,561,876 Net asset value and offering price per share (Net assets/Shares outstanding) ........... 12.13(a) CLASS C Net assets .............................................................................. 318,228,941 Shares outstanding ...................................................................... 26,242,727 Net asset value and offering price per share (Net assets/Shares outstanding) ........... 12.13(a) CLASS Z Net assets .............................................................................. 69,689,155 Shares outstanding ...................................................................... 5,747,122 Net asset value, offering and redemption price per share (Net assets/Shares outstanding) 12.13
____________________________________________________ (a) Redemption price per share is equal to the net asset value per share less any applicable contingent deferred sales charge. (b) On sales of $100,000 or more, the offering price is reduced. 10 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND FOR THE SIX MONTHS ENDED FEBRUARY 28, 2005 (UNAUDITED)
($) ------------------------------------------------------------------------------------------------------------- INVESTMENT INCOME Interest ................................................................................ 23,913,192 Facility and other fees ................................................................. 856,634 --------------- Total investment income ........................................................... 24,769,826 EXPENSES Investment advisory fee (Note 4) ........................................................ 1,947,574 Administration fee (Note 4) ............................................................. 865,902 Distribution fee: (Note 4) Class A .............................................................................. 124,081 Class B .............................................................................. 284,271 Class C .............................................................................. 885,659 Service fee: (Note 4) Class A .............................................................................. 310,203 Class B .............................................................................. 157,929 Class C .............................................................................. 369,025 Transfer agent fee (Note 4) ............................................................. 259,750 Professional fees ....................................................................... 203,072 Accounting services fee (Note 4) ........................................................ 178,469 Trustees' fees (Note 4) ................................................................. 61,230 Custody fee (Note 4) .................................................................... 45,493 Other expenses .......................................................................... 609,793 --------------- Total Operating Expenses .......................................................... 6,302,451 Interest expense ........................................................................ 1,453,993 Commitment fee .......................................................................... 206,324 --------------- Total Expenses (Note 8) ........................................................... 7,962,768 Fees and expenses waived or reimbursed by Investment Adviser (Note 4) ................... (531,201) Custody earnings credit (Note 4) ........................................................ -- --------------- Net Expenses ...................................................................... 7,431,567 --------------- Net Investment Income ................................................................... 17,338,259 --------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized gain on investments ........................................................ 742,008 Net change in unrealized appreciation on investments .................................... 2,587,344 --------------- Net Gain ................................................................................ 3,329,352 --------------- Net Increase in Net Assets .............................................................. 20,667,611 ===============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 11 STATEMENTS OF CHANGES IN NET ASSETS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND
SIX MONTHS ENDED FEBRUARY 28, YEAR ENDED 2005 AUGUST 31, (UNAUDITED) 2004 ($) ($) ------------- ------------- INCREASE IN NET ASSETS: OPERATIONS Net investment income ............................................ 17,338,259 21,146,661 Net realized gain on investments ................................. 742,008 9,871,654 Net change in unrealized appreciation on investments ............. 2,587,344 16,802,971 ------------- ------------- Net Increase from Operations ................................... 20,667,611 47,821,286 ------------- ------------- DISTRIBUTIONS DECLARED TO SHAREHOLDERS From net investment income: Class A ........................................................ (6,374,553) (7,362,637) Class B ........................................................ (2,995,887) (4,785,071) Class C ........................................................ (6,737,575) (7,927,327) Class Z ........................................................ (1,645,016) (1,318,999) ------------- ------------- Total Distributions Declared to Shareholders ................... (17,753,031) (21,394,034) ------------- ------------- SHARE TRANSACTIONS Class A: Subscriptions .................................................. 92,724,876 155,278,295 Distributions reinvested ....................................... 4,020,897 4,387,935 Redemptions .................................................... (37,163,899) (41,293,262) ------------- ------------- Net Increase ................................................... 59,581,874 118,372,968 Class B: Subscriptions .................................................. 7,781,201 55,799,014 Distributions reinvested ....................................... 1,798,764 2,714,846 Redemptions .................................................... (6,576,550) (17,134,851) ------------- ------------- Net Increase ................................................... 3,003,415 41,379,009 Class C: Subscriptions .................................................. 64,294,246 208,181,539 Distributions reinvested ....................................... 3,867,254 5,151,429 Redemptions .................................................... (29,819,521) (24,993,138) ------------- ------------- Net Increase ................................................... 38,341,979 188,339,830 Class Z: Subscriptions .................................................. 26,024,674 50,799,735 Distributions reinvested ....................................... 692,827 465,119 Redemptions .................................................... (10,325,407) (4,503,807) ------------- ------------- Net Increase ................................................... 16,392,094 46,761,047 ------------- ------------- Net Increase from Share Transactions ........................... 117,319,362 394,852,854 ------------- ------------- Total Increase in Net Assets ............................ 120,233,942 421,280,106 ------------- ------------- NET ASSETS Beginning of period .............................................. 668,574,347 247,294,241 End of period (including overdistributed net investment income of $(630,311) and $(215,539), respectively) ....................... 788,808,289 668,574,347 ============= =============
12 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENTS OF CHANGES IN NET ASSETS (CONTINUED) -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND
SIX MONTHS ENDED FEBRUARY 28, YEAR ENDED 2005 AUGUST 31, (UNAUDITED) 2004 ------------- ------------- CHANGES IN SHARES Class A: Subscriptions .................................................. 7,672,476 13,068,545 Issued for distributions reinvested ............................ 332,550 368,106 Redemptions .................................................... (3,070,906) (3,460,892) ------------- ------------- Net Increase ................................................... 4,934,120 9,975,759 Class B: Subscriptions .................................................. 643,789 4,712,112 Issued for distributions reinvested ............................ 148,779 228,200 Redemptions .................................................... (543,494) (1,433,835) ------------- ------------- Net Increase ................................................... 249,074 3,506,477 Class C: Subscriptions .................................................. 5,316,024 17,547,735 Issued for distributions reinvested ............................ 370,950 431,547 Redemptions .................................................... (2,515,274) (2,088,151) ------------- ------------- Net Increase ................................................... 3,171,700 15,891,131 Class Z: Subscriptions .................................................. 2,152,720 4,267,378 Issued for distributions reinvested ............................ 57,287 38,768 Redemptions .................................................... (853,752) (376,712) ------------- ------------- Net Increase ................................................... 1,356,255 3,929,434
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 13 STATEMENT OF CASH FLOWS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND FOR THE SIX MONTHS ENDED FEBRUARY 28, 2005 (UNAUDITED)
($) ------------------------------------------------------------------------------------------------------------- INCREASE IN CASH CASH FLOWS USED FOR OPERATING ACTIVITIES Net investment income ................................................................... 17,338,259 ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH USED FOR OPERATING ACTIVITIES Purchase of investment securities ....................................................... (661,839,724) Proceeds from disposition of investment securities ...................................... 372,736,411 Sale of short-term portfolio investments, net ........................................... 47,479,000 Increase in interest and fees receivable ................................................ (2,070,475) Decrease in receivable for expense reimbursement ........................................ 173,526 Increase in receivable for investments sold ............................................. (19,735,784) Increase in other assets ................................................................ (106,225) Decrease in deferred facility fees ...................................................... (126,988) Increase in payable for accrued expenses ................................................ 30,954 Net amortization of premium (discount) .................................................. (601,801) Increase in payable for investments purchased ........................................... 71,552,957 Decrease in other liabilities ........................................................... (28,188) --------------- Net cash flow used for operating activities ....................................... (175,198,078) CASH FLOWS PROVIDED BY FINANCING ACTIVITIES Increase in notes payable ............................................................... 105,000,000 Increase in interest payable ............................................................ 178,519 Proceeds from shares sold ............................................................... 187,601,466 Payment of shares redeemed .............................................................. (83,885,377) Distributions paid in cash .............................................................. (7,107,631) --------------- Net cash flow provided by financing activities .................................... 201,786,977 --------------- Net increase in cash .............................................................. 26,588,899 CASH Cash at beginning of the period ......................................................... 756 --------------- Cash at end of the period ............................................................... 26,589,655 ===============
14 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, --------------------------------------------------------- SIX MONTHS ENDED PERIOD ENDED FEBRUARY 28, 2005 AUGUST 31, CLASS A SHARES (UNAUDITED) 2004 2003 2002 2001 2000 (a) ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.09 $ 12.00 ------------------------------------------------------------------------------------------------------------------------------------ INCOME FROM INVESTMENT OPERATIONS: Net investment income 0.30(b) 0.56(b) 0.81(b) 0.83(b)(c) 1.10(b) 0.64 Net realized and unrealized gain (loss) on investments 0.05 0.89 0.74 (1.26)(c) (0.32) 0.07 ============= ========= ======== ========= ========= ======== Total from Investment Operations 0.35 1.45 1.55 (0.43) 0.78 0.71 ------------------------------------------------------------------------------------------------------------------------------------ LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.30) (0.59) (0.81) (0.83) (1.13) (0.62) From net realized gains -- -- -- -- --(d) -- ============= ========= ======== ========= ========= ======== Total Distributions Declared to Shareholders (0.30) (0.59) (0.81) (0.83) (1.13) (0.62) ==================================================================================================================================== NET ASSET VALUE, END OF PERIOD $ 12.13 $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.09 Total return (e)(f) 2.97%(g) 13.14% 15.55% (3.88)% 6.71% 6.04%(g) ------------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Operating expenses 1.40%(i) 1.29%(h) 1.38%(h) 1.38%(h) 1.37%(h) 1.01%(h)(i) Interest and commitment fee expenses 0.40%(i) 0.40% 0.73% 0.99% 2.04% 1.91%(i) Net expenses 1.80%(i) 1.69%(h) 2.11%(h) 2.37%(h) 3.41%(h) 2.92%(h)(i) Net investment income 4.98%(i) 4.73%(h) 7.67%(h) 7.25%(c)(h) 9.24%(h) 9.49%(h)(i) Waiver/reimbursement 0.15%(i) 0.18% 0.36% 0.32% 0.32% 1.41%(i) Portfolio turnover rate 42%(g) 110% 90% 98% 65% 8%(g) Net assets, end of period (000's) $ 272,818 $ 212,205 $ 85,166 $ 69,733 $ 108,399 $ 54,402
________________________________________________ (a) The Fund commenced investment operations on January 13, 2000. (b) Per share data was calculated using average shares outstanding during the period. (c) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01. The impact to the ratio of net investment income to average net assets was less than 0.01%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (d) Rounds to less than $0.01. (e) Total return at net asset value assuming all distributions reinvested and no initial sales charge or contingent deferred sales charge ("CDSC"). (f) Had the Fund's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (g) Not annualized. (h) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%. (i) Annualized. SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 15 FINANCIAL HIGHLIGHTS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ---------------------------------------------------- SIX MONTHS ENDED PERIOD ENDED FEBRUARY 28, 2005 AUGUST 31, CLASS B SHARES (UNAUDITED) 2004 2003 2002 2001 2000 (a) ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07 $ 12.00 ------------------------------------------------------------------------------------------------------------------------------------ INCOME FROM INVESTMENT OPERATIONS: Net investment income 0.28(b) 0.53(b) 0.78(b) 0.78(b)(c) 1.05(b) 0.62 Net realized and unrealized gain (loss) on investments 0.05 0.88 0.73 (1.25)(c) (0.30) 0.05 ============= ========= ======== ========= ========= ======== Total from Investment Operations 0.33 1.41 1.51 (0.47) 0.75 0.67 ------------------------------------------------------------------------------------------------------------------------------------ LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.28) (0.55) (0.77) (0.79) (1.08) (0.60) From net realized gains -- -- -- -- --(d) -- ============= ========= ======== ========= ========= ======== Total Distributions Declared to Shareholders (0.28) (0.55) (0.77) (0.79) (1.08) (0.60) ==================================================================================================================================== NET ASSET VALUE, END OF PERIOD $ 12.13 $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07 Total return (e)(f) 2.79%(g) 12.75% 15.16% (4.22)% 6.52% 5.69%(g) ------------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Operating expenses 1.75%(i) 1.64%(h) 1.73%(h) 1.73%(h) 1.72%(h) 1.36%(h)(i) Interest and commitment fee expenses 0.40%(i) 0.40% 0.73% 0.99% 2.04% 1.91%(i) Net expenses 2.15%(i) 2.04%(h) 2.46%(h) 2.72%(h) 3.76%(h) 3.27%(h)(i) Net investment income 4.63%(i) 4.50%(h) 7.34%(h) 6.90%(c)(h) 8.89%(h) 9.14%(h)(i) Waiver/reimbursement 0.15%(i) 0.18% 0.36% 0.32% 0.32% 1.41%(i) Portfolio turnover rate 42%(g) 110% 90% 98% 65% 8%(g) Net assets, end of period (000's) $ 128,072 $ 124,589 $ 76,379 $ 68,157 $ 80,609 $ 19,964
____________________________________________________ (a) The Fund commenced investment operations on January 13, 2000. (b) Per share data was calculated using average shares outstanding during the period. (c) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01. The impact to the ratio of net investment income to average net assets was less than 0.01%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (d) Rounds to less than $0.01. (e) Total return at net asset value assuming all distributions reinvested and no CDSC. (f) Had the Fund's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (g) Not annualized. (h) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%. (i) Annualized. 16 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ---------------------------------------------------- SIX MONTHS ENDED PERIOD ENDED FEBRUARY 28, 2005 AUGUST 31, CLASS C SHARES (UNAUDITED) 2004 2003 2002 2001 2000 (a) ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07 $ 12.00 ------------------------------------------------------------------------------------------------------------------------------------ INCOME FROM INVESTMENT OPERATIONS: Net investment income 0.27(b) 0.50(b) 0.76(b) 0.76(b)(c) 1.03(b) 0.61 Net realized and unrealized gain (loss) on investments 0.05 0.89 0.74 (1.25)(c) (0.30) 0.05 ============= ========= ======== ========= ========= ======== Total from Investment Operations 0.32 1.39 1.50 (0.49) 0.73 0.66 ------------------------------------------------------------------------------------------------------------------------------------ LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.27) (0.53) (0.76) (0.77) (1.06) (0.59) From net realized gains -- -- -- -- --(d) -- ============= ========= ======== ========= ========= ======== Total Distributions Declared to Shareholders (0.27) (0.53) (0.76) (0.77) (1.06) (0.59) ==================================================================================================================================== NET ASSET VALUE, END OF PERIOD $ 12.13 $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07 Total return (e)(f) 2.71%(g) 12.57% 14.99% (4.36)% 6.35% 5.62%(g) ------------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Operating expenses 1.90%(i) 1.79%(h) 1.88%(h) 1.88%(h) 1,87%(h) 1.51%(h)(i) Interest and commitment fee expenses 0.40%(i) 0.40% 0.73% 0.99% 2.04% 1.91%(i) Net expenses 2.30%(i) 2.19%(h) 2.61%(h) 2.87%(h) 3.91%(h) 3.42%(h)(i) Net investment income 4.48%(i) 4.19%(h) 7.14%(h) 6.75%(c)(h) 8.74%(h) 8.99%(h)(i) Waiver/reimbursement 0.15%(i) 0.18% 0.36% 0.32% 0.32% 1.41%(i) Portfolio turnover rate 42%(g) 110% 90% 98% 65% 8%(i) Net assets, end of period (000's) $ 318,229 $ 278,731 $ 80,572 $ 61,811 $ 64,074 $ 13,013
_________________________________________________ (a) The Fund commenced investment operations on January 13, 2000. (b) Per share data was calculated using average shares outstanding during the period. (c) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01. The impact to the ratio of net investment income to average net assets was less than 0.01%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (d) Rounds to less than $0.01. (e) Total return at net asset value assuming all distributions reinvested and no CDSC. (f) Had the Fund's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (g) Not annualized. (h) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%. (i) Annualized. SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 17 FINANCIAL HIGHLIGHTS -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ---------------------------------------------------- SIX MONTHS ENDED PERIOD ENDED FEBRUARY 28, 2005 AUGUST 31, CLASS Z SHARES (UNAUDITED) 2004 2003 2002 2001 2000 (a) ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.08 $ 12.00 ------------------------------------------------------------------------------------------------------------------------------------ INCOME FROM INVESTMENT OPERATIONS: Net investment income 0.32(b) 0.59(b) 0.78(b) 0.86(b)(c) 1.14(b) 0.67 Net realized and unrealized gain (loss) on investments 0.06 0.90 0.81 (1.25)(c) (0.31) 0.05 ============= ========= ======== ========= ========= ======== Total from Investment Operations 0.38 1.49 1.59 (0.39) 0.83 0.72 ------------------------------------------------------------------------------------------------------------------------------------ LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.33) (0.63) (0.85) (0.87) (1.17) (0.64) From net realized gains -- -- -- -- --(d) -- ============= ========= ======== ========= ========= ======== Total Distributions Declared to Shareholders (0.33) (0.63) (0.85) (0.87) (1.17) (0.64) ==================================================================================================================================== NET ASSET VALUE, END OF PERIOD $ 12.13 $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.08 Total return (e)(f) 3.14%(g) 13.52% 15.95% (3.53)% 7.17% 6.11%(g) ------------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Operating expenses 1.05%(i) 0.94%(h) 1.03%(h) 1.03%(h) 1.02%(h) 0.66%(h)(i) Interest and commitment fee expenses 0.40%(i) 0.40% 0.73% 0.99% 2.04% 1.91%(i) Net expenses 1.45%(i) 1.34%(h) 1.76%(h) 2.02%(h) 3.06%(h) 2.57%(h)(i) Net investment income 5.33%(i) 4.93%(h) 7.21%(h) 7.60%(c)(h) 9.59%(h) 9.84%(h)(i) Waiver/reimbursement 0.15%(i) 0.18% 0.36% 0.32% 0.32% 1.41%(i) Portfolio turnover rate 42%(g) 110% 90% 98% 65% 8%(g) Net assets, end of period (000's) $ 69,689 $ 53,049 $ 5,178 $ 140 $ 2,850 $ 2,656
____________________________________________________ (a) The Fund commenced investment operations on January 13, 2000. (b) Per share data was calculated using average shares outstanding during the period. (c) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01. The impact to the ratio of net investment income to average net assets was less than 0.01%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (d) Rounds to less than $0.01. (e) Total return at net asset value assuming all distributions reinvested. (f) Had the Fund's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (g) Not annualized. (h) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%. (i) Annualized. 18 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -------------------------------------------------------------------------------- FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND NOTE 1. ORGANIZATION Highland Floating Rate Advantage Fund (the "Fund") is a Massachusetts business trust registered under the Investment Company Act of 1940, as amended (the "1940 Act"), as a nondiversified, closed-end management investment company. Effective October 18, 2004, Columbia Floating Rate Advantage Fund was renamed Highland Floating Rate Advantage Fund. INVESTMENT GOAL The Fund seeks to provide a high level of current income consistent with preservation of capital. FUND SHARES The Fund may issue an unlimited number of shares and continuously offers four classes of shares: Class A, Class B, 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. 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 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. 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 CDSC. There are certain restrictions on the purchase of Class Z shares, as described in the Fund's prospectus. NOTE 2. SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements. SECURITY VALUATION The value of the Fund's assets is based on the current market value of its investments. For securities with readily available market quotations, the Fund uses those quotations for pricing. When portfolio securities are traded on the relevant day of valuation, the valuation will be the last reported sale price on that day. If there are no such sales on that day, the security will be valued at the mean between the most recently quoted bid and asked prices from principal market makers. Securities without a sale price or bid and ask quotations on the valuation day will be priced by an independent pricing service. If securities do not have readily available market quotations or pricing service prices, including circumstances under which such are determined not to be accurate or current (including when events materially affect the value of securities occurring between the time when market price is determined and calculation of the Fund's net asset value), such securities are valued at their fair value, as determined in good faith in accordance with procedures approved by the Fund's Board of Trustees. Using a fair value pricing methodology to price securities may result in a value that is different from a security's most recent sale price and from the prices used by other investment companies to calculate their net asset values. There can be no assurance that the Fund's valuation of a security will not differ from the amount that it realizes upon the sale of such security. SECURITY TRANSACTIONS Security transactions are accounted for on the trade date. Cost is determined and gains (losses) are based upon the specific identification method for both financial statement and federal income tax purposes. REPURCHASE AGREEMENTS The Fund may engage in repurchase agreement transactions with institutions that the Fund's investment adviser has determined are creditworthy. The Fund, through its custodian, receives delivery of underlying securities collateralizing a repurchase agreement. Collateral is at least equal, at all times, to the value of the repurchase obligation including interest. A repurchase agreement transaction involves certain risks in the event of default or insolvency of the counterparty. These risks include possible delays or restrictions upon the Fund's ability to dispose of the underlying securities and a possible decline in the value of the underlying securities during the period while the Fund seeks to assert its rights. 19 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND INCOME RECOGNITION Interest income is recorded on the accrual basis and includes accretion of discounts and amortization of premiums. Facility fees received are treated as market discounts. Unamortized facility fees are reflected as deferred fees on the Statement of Assets and Liabilities. DETERMINATION OF CLASS NET ASSET VALUES All income, expenses (other than class-specific expenses of distribution fees and service fees, as shown on the Statement of Operations) and realized and unrealized gains (losses) are allocated to each class of the Fund on a daily basis for purposes of determining the net asset value of each class. Income and expenses are allocated to each class based on the settled shares method, while realized and unrealized gains (losses) are allocated based on the relative net assets of each class. FEDERAL INCOME TAX STATUS The Fund intends to qualify each year as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), and will distribute substantially all of its taxable income, if any, for its tax year, and as such will not be subject to federal income taxes. DISTRIBUTIONS TO SHAREHOLDERS Dividends from net investment income are declared daily and paid monthly. Net realized capital gains, if any, are distributed at least annually. STATEMENT OF CASH FLOWS Information on financial transactions which have been settled through the receipt or disbursement of cash is presented in the Statement of Cash Flows. The cash amount shown in the Statement of Cash Flows is the amount included within the Fund's Statement of Assets and Liabilities and includes cash on hand at its custodian bank and does not include any short-term investments. NOTE 3. FEDERAL TAX INFORMATION The timing and character of income and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. Reclassifications are made to the Fund's capital accounts for permanent tax differences to reflect income and gains available for distribution (or available capital loss carryforwards) under income tax regulations. The tax character of distributions paid during the years ended August 31, 2004 and August 31, 2003 was as follows: -------------------------------------------------------------------------------- 2004 2003 -------------------------------------------------------------------------------- Distributions paid from: -------------------------------------------------------------------------------- Ordinary income* $21,394,034 $14,189,172 -------------------------------------------------------------------------------- Long-term capital gains -- -- -------------------------------------------------------------------------------- * For tax purposes short-term capital gains distributions, if any, are considered ordinary income distributions. As of August 31, 2004, the components of distributable earnings on a tax basis were as follows: -------------------------------------------------------------------------------- Undistributed Undistributed Ordinary Long-Term Net Unrealized Income Capital Gains Appreciation* -------------------------------------------------------------------------------- $843,934 $-- $7,295,223 -------------------------------------------------------------------------------- * The differences between book-basis and tax-basis net unrealized appreciation/depreciation are primarily due to deferral of losses from wash sales. These amounts are as of the most recent tax year end. Unrealized appreciation and depreciation at February 28, 2005, based on cost of investments for federal income tax purposes was: -------------------------------------------------------------------------------- Unrealized appreciation $ 14,307,791 -------------------------------------------------------------------------------- Unrealized depreciation $ (4,512,079) ------------ Net unrealized appreciation $ 9,795,712 -------------------------------------------------------------------------------- The following capital loss carryforwards may be available to reduce taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Code: -------------------------------------------------------------------------------- Year of Capital Loss Expiration Carryforward -------------------------------------------------------------------------------- 2011 $ 3,234,575 -------------------------------------------------------------------------------- Capital loss carryforwards of $2,420,026 were utilized during the Fund's fiscal year ended August 31, 2004. 20 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND NOTE 4. ADVISORY, ADMINISTRATION, SERVICE AND DISTRIBUTION, TRUSTEE, AND OTHER FEES INVESTMENT ADVISORY FEE Effective April 15, 2004, Highland Capital Management, L.P. ("Highland") is the investment adviser to the Fund. Highland receives a monthly investment advisory fee based on the Fund's average daily managed net assets at the following annual rates: -------------------------------------------------------------------------------- Average Daily Managed Net Assets Annual Fee Rate -------------------------------------------------------------------------------- First $1billion 0.45% -------------------------------------------------------------------------------- Next $1billion 0.40% -------------------------------------------------------------------------------- Over $2 billion 0.35% -------------------------------------------------------------------------------- Average daily managed net assets of the Fund means the average daily value of the total assets of the Fund less all accrued liabilities of the Fund (other than the aggregate amount of any outstanding borrowing constituting financial leverage). For the six months ended February 28, 2005, the Portfolio's effective investment advisory fee rate was 0.45%. Prior to April 15, 2004, Columbia Management Advisors, Inc. ("Columbia Management") was the investment adviser to the Fund. Columbia Management was an indirect, wholly owned subsidiary of FleetBoston Financial Corporation ("FleetBoston"). Effective April 1, 2004, FleetBoston, including Columbia Management and the Fund's transfer agent and distributor, was acquired by Bank of America Corporation. ADMINISTRATION FEES Effective October 18, 2004, Highland provides administrative services to the Fund for a monthly administration fee at the annual rate of 0.20% of the Fund's average daily managed net assets. Under a separate sub-administration agreement, Highland has delegated certain administrative functions to PFPC Inc. ("PFPC"). For the period ended February 28, 2005, Highland received $661,985 in administrative fees, and paid PFPC $33,099 for their services. This amount is included in the "Administration fees" on the Statement of Operations of the Fund. Prior to October 18, 2004, Columbia Management provided administrative and other services to the Fund for a monthly administration fee at the annual rate of 0.20% of the Fund's average daily managed net assets managed daily. For the period September 1, 2004 through October 17, 2004, Columbia Management received $203,917 in administration fees, which are included in the "Administration fee" on the Statement of Operations of the Fund. ACCOUNTING SERVICES FEES Effective October 18, 2004, the Fund entered into an accounting services agreement with PFPC. For the period October 18, 2004 through February 28, 2005, PFPC received $94,651 for this service. This fee is included in the "Accounting services fee" on the Statement of Operations. Prior to October 18, 2004, Columbia Management was responsible for providing pricing and bookkeeping services to the Fund under a pricing and bookkeeping agreement. Under a separate agreement (the "Outsourcing Agreement"), Columbia Management delegated those functions to State Street Bank and Trust Company ("State Street"). As a result, Columbia Management paid the total fees collected under the Outsourcing Agreement to State Street. Under its pricing and bookkeeping agreement with the Fund, Columbia Management received from the Fund an annual flat fee of $10,000 paid monthly, and in any month that the Fund's average daily net assets exceeded $50 million, an additional monthly fee. The additional fee rate was calculated by taking into account the fees payable to State Street under the Outsourcing Agreement. This rate was applied to the average daily net assets of the Fund for that month. The Fund also paid additional fees for pricing services based on the number of securities held by the Fund. For the period September 1, 2004 through October 17, 2004, Columbia Management received $24,100 of pricing and bookkeeping fees. This fee is included in the "Accounting services fee" on the Statement of Operations of the Fund. TRANSFER AGENT FEE Effective October 18, 2004, PFPC provides shareholder services to the Fund. For the period October 18, 2004 through February 28, 2005, PFPC received $135,156 for this service. This fee is included in the "Transfer agent fee" on the Statement of Operations. Prior to October 18, 2004, Columbia Funds Services, Inc. ("Columbia Services"), an affiliate of Columbia Management, provided shareholder services to the Fund. For such services, Columbia Services received a fee, paid monthly, at the annual rate of $34 per open account. 21 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND Columbia Services also received reimbursement for certain out-of-pocket expenses. For the period September 1, 2004 through October 17, 2004, Columbia Services received $86,380 for transfer agent services, excluding out-of-pocket expenses. This amount is included in the "Transfer agent fee" on the Statement of Operations of the Fund. SERVICE AND DISTRIBUTION FEES Effective April 15, 2004, PFPC Distributors, Inc. (the "Distributor") serves as the principal underwriter and distributor of the Fund's shares. Prior to April 15, 2004, Columbia Funds Distributor, Inc., an affiliate of Columbia Management, served as the principal underwriter of the Fund. 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, 2005, the Distributor received $27,020, $120,354 and $76,324 of CDSC on Class A, Class B and Class C share redemptions, respectively. The Fund has adopted a plan pursuant to Rule 12b-1 under the 1940 Act (the "Plan"), which requires the payment of a monthly service fee to the Distributor at the annual rate of 0.25% of the average daily net assets attributable to Class A, Class B and Class C shares of the Fund. The Plan also requires the payment of a monthly distribution fee to the Distributor not exceeding, on an annual basis, 0.10% for Class A shares and 0.75% for Class B and Class C shares. As of February 28, 2005 the distribution fees paid to the Distributor, on an annual basis, were 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 usedprincipally as repayment for amounts paid to dealers who sold such shares. EXPENSE LIMITS AND FEE REIMBURSEMENTS Highland has voluntarily agreed to waive fees and reimburse certain expenses to the extent that total expenses (exclusive of investment advisory fees, administration fees, distribution and service fees, brokerage commissions, interest, facility fees, taxes and extraordinary expenses, if any) exceed 0.15% annually of the Fund's average daily managed net assets. This arrangement may be revised or discontinued by Highland at any time. CUSTODY Effective October 18, 2004, PFPC Trust Company ("PFPC Trust") is the custodian to the Fund. For the period October 18, 2004 through February 28, 2005, PFPC Trust received $41,078 for this service. This fee is included in the "Custody fee" on the Statement of Operations. For the period September 1, 2004 through October 17, 2004, the Fund had an agreement with its prior custodian bank, State Street, under which custody fees could have been reduced by balance credits. The Fund could have invested a portion of the assets utilized in connection with the expense offset arrangement in an income-producing asset if it had not entered into such an agreement. FEES PAID TO OFFICERS AND TRUSTEES The Fund pays no compensation to its officers, all of whom are employees of Highland. The Fund pays Trustees who are not interested persons (as defined in the 1940 Act) each an annual retainer of $25,000 for services provided as Trustees of the Fund. Prior to July 30, 2004, the previous Trustees of the Fund participated in a deferred compensation plan. Any continuing obligations of the plan will be paid solely out of the Fund's assets. NOTE 5. PORTFOLIO INFORMATION For the six months ended February 28, 2005, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were $661,839,724 and $372,736,411, 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 February, May, August, and November. It is anticipated that normally the date on which the repurchase price of shares will be determined (the "Repurchase Pricing Date") will be the same date as the deadline for shareholders to provide their repurchase requests to the Distributor (the "Repurchase Request Deadline"), and if so, the Repurchase Request Deadline will be set for a time no later than the close of regular 22 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND 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, 2005, there were two Repurchase Offers. For each Repurchase Offer, the Fund offered to repurchase 10% of its shares. In the November and February Repurchase Offers 5.03% and 5.61%, respectively, of shares outstanding were repurchased. NOTE 7. SENIOR LOAN PARTICIPATION COMMITMENTS The Fund invests at least 80% of its net assets (plus any borrowings for investment purposes) in adjustable rate senior loans ("Senior Loans"), the interest rates of which float or vary periodically based upon a benchmark indicator of prevailing interest rates to domestic foreign corporations, partnerships and other entities ("Borrowers"). If the lead lender in a typical lending syndicate becomes insolvent, enters FDIC receivership or, if not FDIC insured enters into bankruptcy, the Fund may incur certain costs and delays in receiving payment or may suffer a loss of principal and/or interest. When the Fund purchases a participation of a Senior Loan interest, the Fund typically enters into a contractual agreement with the lender or other third party selling the participation, not with the borrower directly. As such, the Fund assumes the credit risk of the Borrower, selling participant or other persons interpositioned between the Fund and the Borrower. The ability of Borrowers to meet their obligations may be affected by economic developments in a specific industry. At February 28, 2005, the following sets forth the selling participants with respect to interests in Senior Loans purchased by the Fund on a participation basis. -------------------------------------------------------------------------------- Principal Selling Participant Amount Value -------------------------------------------------------------------------------- CSFB: Quality Distributions, Inc. PFLetters of Credit $984,848 $959,921 -------------------------------------------------------------------------------- NOTE 8. LOAN AGREEMENT Effective October 18, 2004, the Fund entered into a new $300,000,000 secured loan agreement replacing a previous agreement. The Fund is required to maintain certain asset coverage with respect to amounts outstanding under the agreement. At February 28, 2005, the Fund had one term loan outstanding with Citicorp North America, Inc. ("Citicorp"), totaling $200,000,000, which bears interest at 2.60% per annum, expiring on October 14, 2005. The average daily loan balance was $136,602,210 at a weighted average interest rate of 2.09%. The Fund was required to maintain certain asset coverage with respect to the loan. For the period September 1, 2004 through October 17, 2004, the Fund had a loan agreement with Citicorp, under which the Fund could borrow up to $150,000,000. NOTE 9. LOAN AGREEMENT ASSET COVERAGE REQUIREMENTS -------------------------------------------------------------------------------- Asset Coverage per Total Amount $1,000 of Date Outstanding Indebtedness -------------------------------------------------------------------------------- 02/28/2005 $200,000,000 $5,302 -------------------------------------------------------------------------------- 08/31/2004 95,000,000 8,038 -------------------------------------------------------------------------------- 08/31/2003 59,500,000 5,156 -------------------------------------------------------------------------------- 08/31/2002 74,000,000 3,701 -------------------------------------------------------------------------------- 08/31/2001 88,000,000 3,908 -------------------------------------------------------------------------------- 08/31/2000 19,000,000 6,739 -------------------------------------------------------------------------------- NOTE 10. DISCLOSURE OF SIGNIFICANT RISKS AND CONTINGENCIES INDUSTRY FOCUS The Fund may focus its investments in the financial services industry, subjecting it to greater risk than a fund that is more diversified. NON-PAYMENT RISK Senior Loans, like other corporate debt obligations, are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the Fund, a reduction in the value of the Senior Loan experiencing non-payment and a potential decrease in the net asset value of the Fund. 23 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FEBRUARY 28, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND CREDIT RISK Investments rated below investment grade are commonly referred to as high-yield, high risk or "junk debt." They are regarded as predominantly speculative with respect to the issuing company's continuing ability to meet principal and/or interest payments. Investments in high yield Senior Loans may result in greater net asset value fluctuation than if the Fund did not make such investments. LEGAL PROCEEDINGS Prior to April 15, 2004, the Fund was advised by Columbia Management and was part of the Columbia funds complex (the "Columbia Funds"). Several Columbia Funds are defendants in civil lawsuits that have been transferred and consolidated for pretrial proceedings in the United States District Court for the District of Maryland in the Special Multi-District Litigation proceeding (Index No. 04-MO-15863) created for actions involving market timing issues against mutual fund complexes. The lawsuits have been commenced as putative class actions on behalf of investors who purchased, held or redeemed shares of the Funds during specified periods or as derivative actions on behalf of the Funds. The lawsuits seek, among other things, unspecified compensatory damages plus interest and, in some cases, punitive damages, the rescission of investment advisory contracts, the return of fees paid under those contracts, and restitution. The consolidated amended class action complaint against Columbia-affiliated defendants was filed on September 29, 2004 and does not name the Fund as a defendant or nominal defendant. The consolidated amended fund derivative complaint against Columbia-affiliated defendants was also filed on September 29, 2004 and names the Columbia Funds, collectively, as nominal defendants. On March 2, 2005, four civil revenue sharing actions alleging, among other things, that various mutual funds advised by Columbia Management and Columbia Wanger Asset Management L.P. inappropriately used fund assets to pay brokers to promote the funds by directing fund brokerage transactions to such brokers and did not fully disclose such arrangements to shareholders, and charged excessive 12b-1 fees, were consolidated into a single action in the United States District Court for Massachusetts (IN RE COLUMBIA ENTITIES LITIGATION, Civil Action No. 04-11704-REK). The consolidated complaint has not yet been filed. The Fund was named as a nominal defendant in each of the four revenue sharing actions. NOTE 11. SUBSEQUENT EVENT On March 4, 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's Class B shares will not accept purchases by new and existing investors after the close of business on May 2, 2005. Existing investors may still reinvest distributions in Class B shares. 24 IMPORTANT INFORMATION ABOUT THIS REPORT -------------------------------------------------------------------------------- TRANSFER AGENT PFPC Inc. 760 Moore Road King of Prussia, PA 19406 877.665.1287 DISTRIBUTOR PFPC Distributors, Inc. 760 Moore Road King of Prussia, PA 19406 INVESTMENT ADVISER Highland Capital Management, L.P. 13455 Noel Rd. 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 Advantage Fund. A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to its portfolio securities, and the Fund's proxy voting record for the most recent 12-month period ended June 30, are available (i) without charge, upon request, by calling 1-877-665-1287 and (ii) on the Securities and Exchange Commission's website at http://www.sec.gov. The Fund files its complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q, beginning with the fiscal quarter ending November 30, 2004. The Fund's Forms N-Q are available on the Commission's website at http:/www.sec.gov and also may be reviewed and copied at the Commission's Public Reference Room in Washington, DC. Information on the Public Reference Room may be obtained by calling 1-800-SEC-0330. The Statement of Additional Information includes information about Fund Directors and is available upon request without charge by calling 1-877-665-1287. 25 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 ADVANTAGE FUND -------------------------------------------------------------------- By (Signature and Title)* /S/ JAMES D. DONDERO ------------------------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) Date MAY 9, 2005 ---------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By (Signature and Title)* /S/ JAMES D. DONDERO ------------------------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) Date MAY 9, 2005 ---------------------------------------------------------------------------- By (Signature and Title)* /S/ M. JASON BLACKBURN ------------------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) Date MAY 9, 2005 ---------------------------------------------------------------------------- * Print the name and title of each signing officer under his or her signature.