-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GKp5lzs3aWtBfw3RwZRz4IhlVYhhV48dBiZOTffLh9er8he4VQ2Ks7/5Dumqo5G2 h4pmi8idco3qEAvC0zZfRw== 0000935069-05-003030.txt : 20051104 0000935069-05-003030.hdr.sgml : 20051104 20051104141420 ACCESSION NUMBER: 0000935069-05-003030 CONFORMED SUBMISSION TYPE: N-CSR PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20050831 FILED AS OF DATE: 20051104 DATE AS OF CHANGE: 20051104 EFFECTIVENESS DATE: 20051104 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HIGHLAND FLOATING RATE ADVANTAGE FUND CENTRAL INDEX KEY: 0001093062 IRS NUMBER: 000000000 FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: N-CSR SEC ACT: 1940 Act SEC FILE NUMBER: 811-09709 FILM NUMBER: 051179675 BUSINESS ADDRESS: STREET 1: TWO GALLERIA TOWER STREET 2: 13455 NOEL ROAD, SUITE 1300 CITY: DALLAS STATE: TX ZIP: 75240 BUSINESS PHONE: 9726284100 MAIL ADDRESS: STREET 1: TWO GALLERIA TOWER STREET 2: 13455 NOEL ROAD, SUITE 1300 CITY: DALLAS STATE: TX ZIP: 75240 FORMER COMPANY: FORMER CONFORMED NAME: COLUMBIA FLOATING RATE ADVANTAGE FUND DATE OF NAME CHANGE: 20031107 FORMER COMPANY: FORMER CONFORMED NAME: LIBERTY FLOATING RATE ADVANTAGE FUND DATE OF NAME CHANGE: 20001211 FORMER COMPANY: FORMER CONFORMED NAME: LIBERTY STEIN ROE ADVISOR FLOATING RATE ADVANTAGE FUND DATE OF NAME CHANGE: 20000124 N-CSR 1 advantagencsr.txt HIGHLAND ADVANTAGE NCSR 0805 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: AUGUST 31, 2005 ---------------- Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles. A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget ("OMB") control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. ss. 3507. ITEM 1. REPORTS TO STOCKHOLDERS. The Report to Shareholders is attached herewith. [GRAPHIC OMITTED] COVER PHOTO HIGHLAND FLOATING RATE ADVANTAGE FUND Annual Report August 31, 2005 [GRAPHIC OMITTED] HIGHLAND FUNDS managed by Highland Capital Management, L.P. - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND TABLE OF CONTENTS Portfolio Managers' Letter .......................................... 1 Fund Profile ........................................................ 3 Performance Information ............................................. 4 Understanding Your Expenses ......................................... 5 Financial Statements ................................................ 6 Investment Portfolio ............................................. 7 Statement of Assets and Liabilities .............................. 16 Statement of Operations .......................................... 17 Statements of Changes in Net Assets .............................. 18 Statement of Cash Flows .......................................... 20 Financial Highlights ............................................. 21 Notes to Financial Statements .................................... 25 Report of Independent Registered Public Accounting Firm ............. 31 Trustees and Officers ............................................... 32 Important Information About This Report ............................. 34 A prospectus must precede or accompany this report. Please read the prospectus carefully before you invest. PORTFOLIO MANAGERS' LETTER - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND Dear Shareholders: Highland Floating Rate Advantage Fund (the "Fund") is a non-diversified, closed-end management investment company that seeks to provide a high level of current income consistent with preservation of capital. PERFORMANCE SUMMARY For the 12-month period ended August 31, 2005, Class A shares of Highland Floating Rate Advantage Fund returned 6.56% without sales charge. That was greater than the return of the Fund's benchmark, the Credit Suisse First Boston ("CSFB") Leveraged Loan Index, which was 5.96% for the period. The Fund also did better than the Lipper Loan Participation Loan Category average, which was 5.83%. We believe the Fund was able to outperform because of favorable security selection and sector allocation, and also because of the positive effect of using leverage in a rising market. LEVERAGE LOAN MARKET OVERVIEW The year ending August 31, 2005 was another strong year for the leveraged loan market, which was fueled by improved earnings, and increased demand for floating rate loans. For the fiscal year ended August 31, 2005, total leveraged loan volume, as tracked by Standard & Poor's/Leveraged Commentary & Data, increased strongly to $279 billion, versus $215 billion in the prior year. However, during the year default rates, as tracked by Standard & Poor's/Loan Syndications & Trading Association Leveraged Loan Index, increased from a lagging 12-month default rate of 0.94% as of August 31, 2004, to 1.51% as of August 31, 2005. As tracked by the CSFB Leveraged Loan Index, spreads on leveraged loans tightened considerably during the fiscal year of the Fund from a weighted average spread of 302 basis points at August 31, 2004, to 265 basis points at August 31, 2005. This spread tightening was offset by a significant increase in LIBOR (London Interbank Offered Rate) over the fiscal year. LIBOR is the rate of interest at which banks can borrow funds from other banks, in marketable size, in the London interbank market. As you can see in the chart below, 1-month LIBOR rose from 1.67% at August 31, 2004, to 3.70% at August 31, 2005. As a result, even though spreads tightened, the weighted average coupon on leveraged loans, as tracked by the CSFB Leveraged Loan Index, increased from 4.71% at August 31, 2004, to 6.34% at August 31, 2005, a change of 1.63% over the fiscal year. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN GRAPHIC AS FOLLOWS: 3 MONTH LIBOR - 8/31/04-8/31/05* - -------------------------------------------------------------------------------- 8/31/04 1.67% 9/30/04 1.84% 10/31/04 2.00% 11/30/04 2.29% 12/31/04 2.40% 1/31/05 2.59% 2/28/05 2.72% 3/31/05 2.87% 4/30/05 3.09% 5/31/05 3.13% 6/30/05 3.34% 7/31/05 3.52% 8/31/05 3.70% - -------------------------------------------------------------------------------- * Source British Bankers Association PORTFOLIO OVERVIEW During the fiscal year the Fund initiated core positions in several new investments. Specifically, positions were taken in loans issued by Home Interiors & Gifts, Inc., a manufacturer and distributor of home decorative accessories, DS Waters Enterprises LP, a home and office delivery bottled water operator, and Kerr-McGee Corp., a global energy and chemical company. These comprise 2.3%, 1.7% and 1.7% of net assets, respectively. These percentages represent the percentages 1 PORTFOLIO MANAGERS' LETTER (CONTINUED) - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND of net assets for each holding as of August 31, 2005 and are subject to change. The Fund continues to be overweighted in the Cable & Satellite Television industry, which constituted 11.4% of net assets and performed well for the Fund. Century Cable Holdings LLC and Charter Communications Operating LLC (1.8% and 1.6% of net assets, respectively) had another strong year for the Fund. We believe the Fund remains well diversified. As of August 31, 2005, the average individual loan position represented approximately 0.3% of total assets, while the average industry sector exposure accounted for roughly 2.9%. ADDITIONAL FUND INFORMATION Effective May 23, 2005, the Fund is now able to invest up to 20% of its net assets in senior loans of foreign borrowers that are foreign currency denominated. We believe this change will be of a benefit to the Fund and allow it to invest in senior loans previously unavailable to the Fund. USE OF LEVERAGE The Fund utilizes financial leverage in an effort to increase the yield to the shareholders. As of August 31, 2005, the Fund had borrowings under its credit facility of $250 million. Total leverage, as a percentage of net assets, was 26.5% at period end. While we believe the use of leverage for investment purposes increases investment opportunity, it also increases investment risk. We thank you for your investment in the Fund. /S/MARK OKADA /S/JOE DOUGHERTY Mark Okada Joe Dougherty Portfolio Manager Portfolio Manager Mark Okada and Joe Dougherty have been portfolio managers of the Highland Floating Rate Advantage Fund since April 15, 2004. Just like any other investment, floating rate loan investments present financial risks. Defaults on the loans in the Portfolio could reduce the Fund's net asset value and its distributions, as could nonpayment of scheduled interest and principal. Prepayment of principal by a borrower could result in the Fund's managers having to replace the loan with a lower-yielding security, which could affect the valuation of the Portfolio's holdings. The Fund is a continuously offered, closed-end management investment company that provides limited liquidity through a quarterly tender offer for between 5% and 25% of outstanding shares. Each quarter, the Fund's Trustees must approve the actual tender. Please read the Fund's prospectus and statement of additional information carefully for more details. The Fund may invest a high percentage of assets in a limited number of loans, so the default of any individual holdings can have a greater impact on the Fund's net asset value than could a default in a more diversified portfolio. Floating rate loans are not covered by FDIC insurance or other guarantees relating to timely payment of principal and interest. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts will come to pass. The opinions expressed are those of the management of the Fund and are subject to change. 2 FUND PROFILE - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND OBJECTIVE To provide a high level of current income consistent with preservation of capital. TOTAL NET ASSETS (AS OF 08/31/05) $942.8 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 08/31/05 (%) - ------------------------------------ Ba 13.9 - ------------------------------------ B 59.9 - ------------------------------------ Caa 7.7 - ------------------------------------ NR 18.5 - ------------------------------------ TOP 5 SECTORS AS OF 08/31/05 (%) - ------------------------------------ Cable & Satellite Television 11.4 - ------------------------------------ Utilities 8.5 - ------------------------------------ Oil/Gas 8.2 - ------------------------------------ Lodging & Casinos 8.0 - ------------------------------------ Health Care 7.9 - ------------------------------------ TOP 10 HOLDINGS AS OF 08/31/05 (%) - ---------------------------------------------------------------------------- Home Interiors & Gifts, Inc., Initial Term Loan, 8.38%, 03/31/11 2.3 - ---------------------------------------------------------------------------- OpBiz LLC, Term Loan A, 6.50%, 08/31/10 1.9 - ---------------------------------------------------------------------------- DS Waters Enterprises LP, Term Loan, 8.17%, 11/07/09 1.7 - ---------------------------------------------------------------------------- General Growth Properties, Inc., Tranche B Term Loan, 5.67%, 11/12/08 1.6 - ---------------------------------------------------------------------------- Cricket Communications, Inc., Term Loan B, 5.99%, 01/10/11 1.6 - ---------------------------------------------------------------------------- Extended Stay America, Inc., Mezzanine Loan, 08/01/08 1.6 - ---------------------------------------------------------------------------- Century Cable Holdings LLC, Term Loan, 8.50%, 06/30/09 1.5 - ---------------------------------------------------------------------------- LNR Property Corp., Tranche B Term Loan, 6.69%, 02/03/08 1.4 - ---------------------------------------------------------------------------- SunGard Data Systems, Inc., U.S. Term Loan, 6.28%, 02/11/13 1.3 - ---------------------------------------------------------------------------- Blockbuster Entertainment Corp., Tranche B Term Loan, 7.26%, 08/20/11 1.3 - ---------------------------------------------------------------------------- Quality is calculated as a percentage of total notes and bonds. Sectors and holdings are calculated as a percentage of net assets. 3 PERFORMANCE INFORMATION - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND VALUE OF $10,000 INVESTMENT 01/13/00 (INCEPTION DATE) - 08/31/05 [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN GRAPHIC AS FOLLOWS: Class A CSFB Leveraged (with sales charge) Loan Index 01/13/2000 $9,646 $10,000 Aug-00 $10,330 $10,360 Aug-01 $10,916 $10,871 Aug-02 $10,493 $10,662 Aug-03 $12,125 $11,707 Aug-04 $13,717 $12,532 Aug-05 $14,616 $13,279 This chart compares a $10,000 investment made in the Class A Shares of the Fund to $10,000 investments made in the index, the Credit Suisse First Boston ("CSFB") Leveraged Loan Index. CSFB Leveraged Loan Index is an unmanaged index that tracks the performance of senior floating rate bank loans. Unlike mutual funds, indices are not investments, do not incur fees or expenses and are not professionally managed. It is not possible to invest directly in an index. Securities in the Fund may not match those in an index. Index performance is from December 31, 1999. PERFORMANCE OF A $10,000 INVESTMENT CLASS INCEPTION - 08/31/05 ($) - -------------------------------------------------------------------------- Sales Charge Without With - -------------------------------------------------------------------------- Class A 15,153 14,616 - -------------------------------------------------------------------------- Class B 14,866 14,866 - -------------------------------------------------------------------------- Class C 14,743 14,743 - -------------------------------------------------------------------------- Class Z 15,446 n/a - --------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS AS OF 08/31/05 (%) - ---------------------------------------------------------------------------------------------------------------------------- Share Class A B C Z - ---------------------------------------------------------------------------------------------------------------------------- Class Inception Date 01/13/00 01/13/00 01/13/00 01/13/00 - ---------------------------------------------------------------------------------------------------------------------------- Sales Charge Without With Without With Without With Without - ---------------------------------------------------------------------------------------------------------------------------- 1 - YEAR 6.56 2.81 6.19 2.94 6.03 5.03 6.93 5 - YEAR 7.40 6.63 7.06 6.91 6.90 6.90 7.79 SINCE INCEPTION 7.66 6.97 7.29 7.29 7.13 7.13 8.02
THE PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, UPON REDEMPTION, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE PERFORMANCE DATA QUOTED. FOR PERFORMANCE DATA CURRENT TO THE MOST RECENT MONTH-END, PLEASE VISIT OUR WEBSITE AT WWW.HIGHLANDFUNDS.COM. PERFORMANCE FIGURES DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR REDEMPTIONS OF FUND SHARES. ALL RESULTS SHOWN ASSUME REINVESTMENT OF DISTRIBUTIONS. RETURN FIGURES REFLECT VOLUNTARY EXPENSE REIMBURSEMENTS AND FEE WAIVERS. WITHOUT REIMBURSEMENTS OR WAIVERS, FUND RETURNS WOULD HAVE BEEN LOWER. TOTAL RETURNS "WITHOUT SALES CHARGE", DOES NOT INCLUDE SALES CHARGE OR CONTINGENT DEFERRED SALES CHARGE (CDSC). TOTAL RETURNS "WITH SALES CHARGE", REFLECT THE MAXIMUM SALES CHARGE OF 3.50% ON CLASS A SHARES; THE MAXIMUM CDSC OF 3.25% ON CLASS B SHARES SOLD WITHIN THE FIRST YEAR THEY ARE PURCHASED FOR CALCULATION OF THE 1-YEAR RETURN AND THE MAXIMUM CDSC OF 1.00% ON CLASS B SHARES SOLD WITHIN THE FIFTH YEAR THEY ARE PUR CHASED FOR CALCULATION OF THE 5-YEAR RETURN; AND THE CDSC OF 1.00% ON CLASS C SHARES SOLD WITHIN THE FIRST YEAR THEY ARE PURCHASED. 4 UNDERSTANDING YOUR EXPENSES - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND DISCLOSURE OF FUND EXPENSES: We believe it is important for you to understand the impact of fees regarding your investment. All mutual funds have operating expenses. As a shareholder of a mutual fund, you incur ongoing costs, which include costs for portfolio management, administrative services, and shareholder reports (like this one), among others. Operating expenses, which are deducted from a fund's gross income, directly reduce the investment return of the fund. A fund's expenses are expressed as a percentage of its average daily net assets. This figure is known as the expense ratio. The following examples are intended to help you understand the ongoing fees (in dollars) of investing in your Fund and to compare these costs with those of other mutual funds. The examples are based on an investment of $1,000 made at the beginning of the period shown and held for the entire period. This table illustrates your Fund's costs in two ways: ACTUAL FUND RETURN: This section helps you to estimate the actual expenses, after any applicable fee waivers, that you paid over the period. The "Ending Account Value" shown is derived from the Fund's actual return for the past six month period, the "Expense Ratio" column shows the period's annualized expense ratio, and the "Expenses Paid During Period" column shows the dollar amount that would have been paid by an investor who started with $1,000 in the Fund at the beginning of the period. You may use the information here, together with your account value, to estimate the expenses that you paid over the period. To do so, simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number given for your Fund in the first line under the heading entitled "Expenses Paid During Period." HYPOTHETICAL 5% RETURN: This section is intended to help you compare your Fund's costs with those of other mutual funds. It assumes that the Fund had an annual return of 5% before expenses, but that the expense ratio is unchanged. In this case, because the return used is not the Fund's actual return, the results do not apply to your investment. This example is useful in making comparisons to other mutual funds because the SEC requires all mutual funds to calculate expenses based on an assumed 5% annual return. You can assess your Fund's costs by comparing this hypothetical example with the hypothetical examples that appear in shareholder reports of other funds. Please note that the expenses shown in the table are meant to highlight and help you compare your ongoing costs only and do not reflect any transactional costs such as sales charges (loads) and redemption fees, which are described in the Prospectus. If these costs were applied to your account, your costs would be higher.
MARCH 1, 2005 - AUGUST 31, 2005 - --------------------------------------------------------------------------------------------------------------------------- Account Value at the Account Value at the Expenses Paid Fund's annualized beginning of the period ($) end of the period ($) during the period ($)(1) expense ratio (%)(2) - --------------------------------------------------------------------------------------------------------------------------- ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL CLASS A 1,000.00 1,000.00 1,034.90 1,014.32 11.08 10.97 2.16 CLASS B 1,000.00 1,000.00 1,033.10 1,012.55 12.86 12.73 2.51 CLASS C 1,000.00 1,000.00 1,032.20 1,011.80 13.63 13.49 2.66 CLASS Z 1,000.00 1,000.00 1,036.70 1,016.08 9.29 9.20 1.81 (1) Expenses paid during the period are equal to the Fund's annualized expense ratio, multiplied by the average account value over the period, then multiplied by the number of days in most recent fiscal half-year and divided by 365. (2) Annualized, based on the Fund's most recent fiscal half-year expenses.
5 FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- AUGUST 31, 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 This statement details the Fund's assets, LIABILITIES liabilities, net assets and share price for each share class as of the last day of the reporting period. Net assets are calculated by subtracting all the Fund's liabilities (including any unpaid expenses) from the total of the Fund's investment and non-investment assets. The share price for each class is calculated by dividing net assets for that class by the number of shares outstanding in that class as of the last day of the reporting period. STATEMENT OF OPERATIONS This statement details income earned by the Fund and the expenses accrued by the Fund during the reporting period. The Statement of Operations also shows any net gain or loss the Fund realized on the sales of its holdings during the period, as well as any unrealized gains or losses recognized over the period. The total of these results represents the Fund's net increase or decrease in net assets from operations. STATEMENTS OF CHANGES These statements demonstrate how the Fund's IN NET ASSETS net assets were affected by its operating results, distributions to shareholders and shareholder transactions (e.g., subscriptions, redemptions and dividend reinvestments) during the reporting period. The Statements of Changes in Net Assets also details changes in the number of shares outstanding. STATEMENT OF CASH FLOWS The Statement of Cash Flows reports net cash and foreign currency provided or used by operating, investing and financing activities and the net effect of those flows on cash, foreign currency and cash equivalents during the period. FINANCIAL HIGHLIGHTS The Financial Highlights demonstrate how the Fund's net asset value per share was affected by the fund's operating results. The Financial Highlights table also discloses the classes' performance and certain key ratios (e.g., class expenses and net investment income as a percentage of average net assets). NOTES TO FINANCIAL STATEMENTS These notes disclose the organizational background of the Fund, its significant accounting policies (including those surrounding security valuation, income recognition and distributions to shareholders), federal tax information, fees and compensation paid to affiliates and significant risks and contingencies. 6 INVESTMENT PORTFOLIO AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (A) - 114.9% AEROSPACE/DEFENSE - 1.0% Decrane Aircraft Holdings, Inc. 2,178,433 Term Loan B, 9.02%, 06/30/08 .............. 2,189,325 1,118,362 Term Loan D, 9.52%, 06/30/08 .............. 1,121,158 GenCorp, Inc. 2,625,000 Credit Linked Certificate of Deposit, 6.67%, 12/06/10 ........................... 2,661,146 848,750 Term Loan, 6.86%, 12/06/10 ................ 856,176 2,985,882 Vought Aircraft Industries, Inc. Term Loan, 6.17%, 12/22/11 ................ 3,038,762 ------------- 9,866,567 ------------- AIR TRANSPORT - 1.0% Continental Airlines, Inc. 857,143 Tranche A-1 Term Loan, 8.73%, 06/01/11 ........................... 860,357 2,142,857 Tranche A-2 Term Loan, 8.73%, 06/01/11 ........................... 2,150,893 2,000,000 Northwest Airlines, Inc. Tranche C Term Loan, 10.07%, 11/23/10 .......................... 1,967,500 4,456,969 United Airlines, Inc. Tranche B, 7.96%, 12/30/05 ................ 4,492,268 ------------- 9,471,018 ------------- AUTOMOTIVE - 4.2% 4,500,000 Delphi Corp. Term Loan, 10.30%, 06/14/11 ............... 4,626,173 Federal-Mogul Corp. 1,457,560 Supplemental Revolver, 7.43%, 12/09/05 ........................... 1,308,160 5,000,000 Tranche B Term Loan, 6.18%, 02/24/05 (f) ....................... 4,648,200 573,404 Tranche C Term Loan, 7.43%, 12/09/05 ........................... 574,838 Goodyear Tire & Rubber Co. 5,500,000 Second Lien Term Loan, 6.32%, 04/30/10 ........................... 5,573,370 3,500,000 Third Lien Term Loan, 7.07%, 03/01/11 ........................... 3,492,580 Hayes Lemmerz International, Inc. 4,651,097 Term Loan B, 6.85%, 06/03/09 .............. 4,708,259 1,000,000 Term Loan C, 8.92%, 06/03/10 .............. 1,015,000 Key Plastics LLC 4,538,436 Term Loan B, 6.66%, 06/29/10 .............. 4,572,474 3,495,000 Term Loan C, 9.40%, 06/25/11 .............. 3,433,837 1,331,298 Plastech, Inc. Term Loan B, 8.24%, 03/31/10 .............. 1,288,031 2,000,000 RJ Tower Corp. Tranche B DIP Term Loan, 6.63%, 02/02/07 ........................... 2,014,780 2,000,000 Tire Rack Holdings, Inc. Tranche B Term Loan, 5.82%, 06/24/12 ........................... 2,035,000 723,333 United Components, Inc. Tranche C Term Loan, 5.75%, 06/30/10 ........................... 735,312 ------------- 40,026,014 ------------- PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- BEVERAGE & TOBACCO - 3.3% 2,733,333 Caribbean Restaurant LLC Tranche B, 6.34%, 06/30/09 ................ 2,776,903 1,219,795 Commonwealth Brands, Inc. Incremental Term Loan, 7.00%, 08/28/07 ........................... 1,242,666 3,907,257 Dr. Pepper Bottling Company of Texas Tranche B Term Loan, 5.35%, 12/19/10 ........................... 3,968,796 16,024,907 DS Waters Enterprises LP Term Loan, 8.17%, 11/07/09 ................ 15,680,371 1,995,000 Intabex Netherlands BV Term Loan B, 6.73%, 05/13/10 .............. 2,024,925 3,750,000 National Distributing Co., Inc. Second Lien Term Loan, 10.15%, 06/01/10 .......................... 3,759,375 1,235,294 Sunny Delight Beverage Co. First Lien Term Loan, 7.95%, 08/20/10 ........................... 1,239,926 ------------- 30,692,962 ------------- BROADCAST RADIO & TELEVISION - 1.5% 5,500,000 HIT Entertainment PLC Second Lien Term Loan, 02/17/13 (b) .............................. 5,634,090 Spanish Broadcasting Systems, Inc. 2,992,500 First Lien Term Loan, 5.49%, 06/10/12 ........................... 3,039,273 500,000 Second Lien Term Loan, 7.51%, 06/10/13 ........................... 507,500 2,926,833 Warner Music Group Term Loan B, 5.70%, 02/28/11 .............. 2,961,311 2,000,000 Young Broadcasting, Inc. Term Loan, 5.77%, 11/03/12 ................ 2,021,680 ------------- 14,163,854 ------------- BUILDING & DEVELOPMENT - 4.9% 4,878,622 Atrium Cos., Inc. Term Loan, 6.37%, 12/28/11 ................ 4,813,541 2,717,048 CB Richard Ellis Services, Inc. Term Loan, 5.65%, 03/31/10 ................ 2,744,219 Custom Building Products, Inc. 1,995,000 First Lien Term Loan, 5.74%, 10/20/11 ........................... 2,011,199 1,500,000 Second Lien Term Loan, 8.58%, 04/20/12 ........................... 1,491,570 3,500,000 Harmon Koval Partners LLC Second Lien Term Loan, 10.55%, 06/30/07 .......................... 3,561,250 1,950,356 Lake at Las Vegas Joint Venture First Lien Term Loan, 6.31%, 11/01/09 ........................... 1,974,735 LNR Property Corp. 1,866,467 Tranche A Term Loan, 6.53%, 02/03/08 ........................... 1,867,624 13,229,595 Tranche B Term Loan, 6.69%, 02/03/08 ........................... 13,359,510 NATG Holdings LLC 131,418 Credit Linked Certificate of Deposit, 6.11%, 01/23/09 ........................... 123,533 125,466 Term Loan A, 8.20%, 01/23/09 .............. 25,093 91,747 Term Loan B1, 8.70%, 01/23/10 ............. 27,065 9,144 Term Loan B2, 8.70%, 01/23/10 ............. 8,595 990,000 Nortek Holdings, Inc. Term Loan, 5.91%, 08/27/11 ................ 1,003,405 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 7 INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) BUILDING & DEVELOPMENT (CONTINUED) 3,000,000 Palmdale Hills Property LLC First Lien Term Loan, 6.61%, 05/19/10 (b) ....................... 3,000,000 1,500,000 Pivotal Group-Promontory First Lien Term Loan, 08/31/10 (b) .............................. 1,515,000 Ply Gem Industries, Inc. 254,653 Canadian Term Loan, 6.16%, 02/12/11 ........................... 256,563 1,732,983 U S Dollar Term Loan, 6.16%, 02/12/11 ........................... 1,745,981 985,000 St. Mary's Cement, Inc. Term Loan B, 5.49%, 12/04/09 .............. 996,081 5,500,000 TE/TOUSA Mezzanine LLC Senior Mezzanine Loan, 9.06%, 08/01/09 ........................... 5,500,000 ------------- 46,024,964 ------------- BUSINESS EQUIPMENT & SERVICES - 4.6% ACI Billing Services, Inc. 975,000 First Lien Term Loan, 6.49%, 04/18/10 ........................... 979,875 997,500 Second Lien Term Loan, 11.25%, 04/18/11 .......................... 1,012,462 3,133,477 American Achievement Corp. Term Loan B, 5.85%, 03/25/11 .............. 3,178,536 3,990,000 Audio Visual Services Corp. Term Loan, 6.23%, 05/18/11 ................ 4,039,875 4,416,667 Brickman Group Holdings, Inc. Term Loan, 8.74%, 11/15/09 ................ 4,405,625 2,512,584 Carey International, Inc. Second Lien Term Loan, 12.19%, 05/10/12 .......................... 2,135,696 4,383,690 CCC Information Services Group, Inc. Term Loan, 6.42%, 08/20/10 ................ 4,449,445 2,000,000 ClientLogic Corp. Second Lien Term Loan, 12.45%, 09/03/12 .......................... 2,021,240 965,242 Data Transmissions Network Corp. Tranche B Term Loan, 6.61%, 03/17/12 ........................... 974,894 2,000,000 GXS Corp. Second Lien Term Loan, 12/20/11 (b) (c) .......................... 2,000,000 5,678,125 Hillman Group, Inc. Term Loan B, 6.69%, 03/30/11 .............. 5,781,013 2,000,000 IPC Acquisition Corp. First Lien Tranche B Term Loan, 6.31%, 08/05/11 ........................... 2,024,160 6,035,294 Knoll, Inc. Initial Term Loan, 6.52%, 09/30/11 ........ 6,088,103 1,000,000 Outsourcing Solutions, Inc. Term Loan, 7.92%, 09/30/10 ................ 1,007,500 2,000,000 Survey Sampling International LLC Second Lien Term Loan, 10.74%, 05/06/12 .......................... 2,023,760 1,000,000 WestCom Corp. Second Lien Term Facility, 10.68%, 06/17/11 .......................... 1,022,500 ------------- 43,144,684 ------------- PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- CABLE & SATELLITE TELEVISION - 11.0% 4,991,627 Adelphia Communications Corp. Tranche B DIP Term Loan, 6.31%, 03/31/06 ........................... 5,016,585 2,500,000 Atlantic Broadband Finance LLC Tranche B-1 Term Loan, 6.11%, 09/01/11 ........................... 2,528,125 6,930,000 Bragg Communications, Inc. Term Loan B, 6.36%, 08/31/11 .............. 7,012,328 3,500,000 Bresnan Communications LLC Tranche B Term Loan, 7.08%, 09/30/10 ........................... 3,563,000 6,418,750 Cebridge Connections, Inc. Second Lien Term Loan, 9.66%, 02/23/10 ........................... 6,482,937 Century Cable Holdings LLC 1,000,000 Discretionary Term Loan, 8.50%, 12/31/09 ........................... 990,000 2,500,000 Revolver, 7.25%, 03/31/09 ................. 2,463,550 13,833,333 Term Loan, 8.50%, 06/30/09 ................ 13,731,243 Charter Communications Operating LLC 4,993,791 Tranche A Term Loan, 6.68%, 04/27/10 ........................... 4,967,674 9,887,707 Tranche B Term Loan, 6.93%, 04/27/11 ........................... 9,919,348 5,506,875 Knology, Inc. Second Lien Term Loan, 13.68%, 06/29/11 .......................... 5,341,669 3,465,066 Mediacom Broadband Group LLC Term Loan B, 5.44%, 09/30/10 .............. 3,514,893 1,990,000 Mediacom Communications Corp. Term Loan B, 5.81%, 03/31/13 .............. 2,022,835 1,994,173 Millennium Digital Media Systems LLC Facility C Term Loan, 9.00%, 10/31/08 ........................... 2,009,129 Olympus Cable Holdings LLC 6,000,000 Term Loan A, 7.75%, 06/30/10 .............. 5,936,280 7,000,000 Term Loan B, 8.50%, 09/30/10 .............. 6,950,230 3,000,000 Puerto Rico Cable Acquisition Co., Inc. First Lien Term Loan, 8.75%, 07/28/11 ........................... 3,043,140 1,995,000 Rainbow National Services LLC Term Loan B, 6.44%, 03/31/12 .............. 2,011,618 997,500 Susquehanna Media Co. Term Loan B, 5.33%, 03/31/12 .............. 1,009,969 UPC Broadband Holding BV 6,965,000 Term Loan F2, 7.19%, 03/31/09 ............. 7,049,416 1,500,000 Term Loan H2, 6.25%, 09/30/12 ............. 1,516,710 6,417,431 WideOpenWest LLC Term Loan B, 6.56%, 06/22/11 .............. 6,481,606 ------------- 103,562,285 ------------- CHEMICALS/PLASTICS - 3.7% 3,000,000 Berry Plastics Corp. Term Loan, 5.60%, 12/02/11 ................ 3,053,460 3,500,000 Brenntag AG Faciltiy B2, 6.81%, 02/27/12 .............. 3,555,440 5,532,949 Celenese Dollar Term Loan B, 5.74%, 04/06/11 ........................... 5,638,075 5,375,000 Huntsman International LLC Term B Dollar Loan, 5.32%, 08/16/12 ........................... 5,449,712 8 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) CHEMICALS/PLASTICS (CONTINUED) 583,882 INVISTA Canada Co. Tranche B-2 Term Loan, 5.75%, 04/29/11 ........................... 594,100 1,345,765 INVISTA S.A.R.L. Tranche B-1 Term Loan, 5.75%, 04/29/11 ........................... 1,365,951 3,954,143 Kraton Polymers Group of Cos. Term Loan, 6.29%, 12/23/10 ................ 4,022,115 Nalco Co. 2,720,674 Tranche A-1 Term Loan, 6.06%, 11/04/09 ........................... 2,752,995 2,061,824 Tranche B Term Loan, 5.65%, 11/04/10 ........................... 2,093,864 1,870,000 Polypore, Inc. U S Term Loan, 5.92%, 11/12/11 ............ 1,880,921 4,477,500 Rockwood Specialties Group, Inc. Tranche B Term Loan, 5.93%, 07/30/12 ........................... 4,555,856 ------------- 34,962,489 ------------- CLOTHING/TEXTILES - 1.0% 2,977,273 Levi Strauss & Co. Tranche A Term Loan, 10.63%, 09/29/09 .......................... 3,118,068 6,533,333 Polymer Group, Inc. First Lien Term Loan, 6.73%, 04/27/10 ........................... 6,623,167 ------------- 9,741,235 ------------- CONGLOMERATE - 1.0% 3,346,000 Appleton Papers, Inc. Term Loan, 5.64%, 06/11/10 ................ 3,389,933 1,246,617 Jason, Inc. Term Loan B, 8.10%, 06/30/07 .............. 1,227,918 1,884,824 Mueller Group, Inc. Initial Term Loan, 6.37%, 04/23/11 ........ 1,907,216 2,781,120 Youth & Family Centered Services, Inc. Term Loan B, 7.65%, 05/28/11 .............. 2,781,120 ------------- 9,306,187 ------------- CONTAINER/GLASS PRODUCTS - 3.1% 3,465,000 Consolidated Container Co. LLC Term Loan, 6.69%, 12/15/08 ................ 3,508,312 Graham Packaging International, Inc. 1,500,000 Second Lien Term Loan, 7.75%, 04/07/12 ........................... 1,537,500 8,948,765 Term Loan B, 6.03%, 10/07/11 .............. 9,105,369 3,650,194 Graphic Packaging International, Inc. Tranche C Term Loan, 6.03%, 08/09/10 ........................... 3,713,744 1,980,000 Kranson Industries, Inc. Term Loan, 6.24%, 07/30/11 ................ 2,004,750 6,895,000 Solo Cup, Inc. Term B1 Loan, 5.68%, 02/27/11 ............. 6,971,810 1,975,000 U.S. Can Corp. Term Loan B, 7.65%, 01/10/10 .............. 1,984,875 ------------- 28,826,360 ------------- PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- COSMETICS/TOILETRIES - 0.8% 2,238,750 Marietta Intermediate Holdings First Lien Term Loan, 6.82%, 12/17/10 ........................... 2,259,749 2,000,000 MD Beauty, Inc. Second Lien Term Loan, 9.90%, 02/18/13 ........................... 2,045,000 2,875,000 Revlon Consumer Products Corp. Term Loan, 9.52%, 07/09/10 ................ 2,981,605 ------------- 7,286,354 ------------- DIVERSIFIED MANUFACTURING - 0.3% 1,000,000 GenTek, Inc. Second Lien Term Loan, 9.35%, 02/28/12 ........................... 986,660 1,962,342 Propex Fabrics, Inc. Term Loan, 5.74%, 12/31/11 ................ 1,967,248 ------------- 2,953,908 ------------- ECOLOGICAL SERVICE & EQUIPMENT - 1.0% Allied Waste North America, Inc. 2,092,951 Term Loan, 5.55%, 01/15/12 ................ 2,113,001 798,855 Tranche A Credit Linked Deposit, 2.00%, 01/15/12 ........................... 806,508 1,863,636 Envirocare of Utah LLC Term Loan, 6.11%, 04/13/10 ................ 1,900,909 4,500,000 Environmental Systems Products Holdings Second Lien, 13.70%, 12/12/10 ............. 4,590,000 ------------- 9,410,418 ------------- ELECTRONIC/ELECTRIC - 5.5% 3,500,000 Amkor Technology, Inc. Second Lien Term Loan, 8.33%, 10/27/10 ........................... 3,596,250 3,000,000 Comsys Information Technology Services, Inc. Second Lien Term Loan, 11.02%, 04/30/10 .......................... 3,007,500 Corel Corp. 987,500 First Lien Term Loan, 7.86%, 02/22/10 ........................... 987,500 2,000,000 Second Lien Term Loan, 11.73%, 08/15/10 .......................... 2,025,000 1,000,000 Datatel, Inc. Second Lien Term Loan, 8.85%, 10/05/11 ........................... 1,010,000 Infor Global Solutions European Finance S.A.R.L. 1,014,228 Euro Revolving Credit, 7.21%, 04/18/10 (h) ....................... 978,730 1,800,000 First Lien Term Loan, 6.75%, 04/18/11 ........................... 1,820,250 1,500,000 Second Lien Lux Term Loan, 10.75%, 04/18/12 .......................... 1,516,875 Magellan Holdings, Inc. 2,200,000 First Lien Term Loan, 6.75%, 04/18/11 ........................... 2,224,750 2,500,000 Second Lien U S Term Loan, 10.75%, 04/18/12 .......................... 2,528,125 6,457,500 ON Semiconductor Corp. Tranche G Term Loan, 6.50%, 12/15/11 ........................... 6,551,650 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 9 INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) ELECTRONIC/ELECTRIC (CONTINUED) 2,400,000 RedPrairie Corp. Second Lien Term Loan, 12.50%, 05/23/09 .......................... 2,406,000 12,500,000 SunGard Data Systems, Inc. U S Term Loan, 6.28%, 02/11/13 ............ 12,682,875 2,250,000 Transfirst Holdings, Inc. Second Lien Term Loan, 11.00%, 03/31/11 .......................... 2,289,375 2,836,779 UGS Corp. Term Loan, 5.67%, 05/27/11 ................ 2,881,998 4,975,000 Viasystems, Inc. Tranche B Term Loan, 7.64%, 09/30/09 ........................... 5,034,103 ------------- 51,540,981 ------------- EQUIPMENT LEASING - 1.1% NES Rentals Holdings, Inc. 1,153,333 First Lien Term Loan, 6.94%, 08/17/09 ........................... 1,159,100 28,182 Revolver, 7.00%, 08/17/09 (h) ............. 28,138 2,981,222 Second Lien Term Loan, 9.71%, 08/17/10 ........................... 3,059,479 United Rentals, Inc. 3,127,083 Initial Term Loan, 5.92%, 02/14/11 ........ 3,164,233 2,723,333 Tranche B Credit Linked Deposit, 2.25%, 02/14/11 ........................... 2,757,375 ------------- 10,168,325 ------------- FINANCIAL INTERMEDIARIES - 0.5% 3,000,000 Arias Acquisitions, Inc. Term Loan, 9.00%, 07/26/11 ................ 3,016,860 Stile Acquisition Corp. 1,493,328 Canadian Term Loan, 5.66%, 04/06/13 ........................... 1,499,241 496,672 U S Dollar Term Loan, 5.66%, 04/06/13 ........................... 498,788 ------------- 5,014,889 ------------- FOOD PRODUCTS - 2.5% 3,000,000 CTI Food Holdings Co. LLC Second Lien Secured Term Loan, 9.58%, 06/02/12 ........................... 3,060,000 1,985,000 Doane Pet Care Co. Term Loan, 7.41%, 11/05/09 ................ 2,015,609 Interstate Brands Corp. 625,000 Tranche A Term Loan, 7.75%, 07/19/06 ........................... 628,750 935,696 Tranche B Term Loan, 7.72%, 07/19/07 ........................... 942,424 2,895,340 Tranche C Term Loan, 7.77%, 07/19/07 ........................... 2,929,737 Krispy Kreme Doughnuts, Inc. 800,000 Second Lien Tranche A Credit Link Deposit, 3.58%, 04/01/10 .................. 806,000 3,192,000 Second Lien Tranche B Term Loan, 9.55%, 04/01/10 ..................... 3,215,940 3,980,893 Luigino's, Inc. Term Loan, 6.49%, 04/02/11 ................ 4,013,218 3,247,886 Merisant Co. Tranche B Term Loan, 6.93%, 01/11/10 ........................... 3,217,421 PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- FOOD PRODUCTS (CONTINUED) 3,130,151 Pinnacle Foods Holding Corp. Term Loan, 6.76%, 11/25/10 ................ 3,174,756 ------------- 24,003,855 ------------- FOOD SERVICES - 1.1% 1,000,000 AFC Enterprises, Inc. Tranche B Term Loan, 5.75%, 05/09/11 ........................... 1,012,500 Buffets, Inc. 500,000 Synthetic Letters of Credit, 5.62%, 06/28/09 ........................... 501,250 3,991,619 Term Loan, 7.16%, 06/28/09 ................ 4,031,535 Captain D's Inc., LLC 2,895,000 First Lien Term Loan, 7.42%, 12/27/10 ........................... 2,949,281 2,000,000 Second Lien Term Loan, 9.67%, 06/27/11 ........................... 2,007,500 ------------- 10,502,066 ------------- FOOD/DRUG RETAIL - 1.9% 1,000,000 Bi-Lo LLC Term Loan, 7.56%, 07/01/11 ................ 1,004,380 4,950,000 Jean Coutu Group, Inc. Term Loan B, 5.94%, 07/30/11 .............. 5,034,249 Michael Foods, Inc. 3,000,000 Floater Term Loan, 6.59%, 11/20/11 ........................... 3,083,460 4,563,758 Term Loan B, 5.15%, 11/21/10 .............. 4,637,919 2,493,750 Reliant Pharmaceuticals, Inc. First Lien Term Loan, 13.06%, 06/30/08 .......................... 2,496,867 1,995,000 Vitaquest International, Inc. First Lien Term Loan, 7.07%, 03/07/11 ........................... 1,996,237 ------------- 18,253,112 ------------- FOREST PRODUCTS - 0.3% 3,000,000 NewPage Corp. Term Loan, 6.58%, 05/02/11 ................ 3,048,750 ------------- HEALTH CARE - 7.9% 4,286,361 Alliance Imaging, Inc. Tranche C1 Term Loan, 5.94%, 12/29/11 ........................... 4,343,970 3,342,633 Alpharma Operating Corp. Term Loan B, 6.86%, 10/05/08 .............. 3,354,132 1,449,058 American HomePatient, Inc. Term Loan, 08/01/09 (b) (i) ............... 1,438,191 2,985,000 American Medical Response, Inc. Term Loan, 5.89%, 02/10/12 ................ 3,034,432 2,773,358 Ameripath, Inc. Term Loan, 6.92%, 03/27/10 ................ 2,801,092 Carl Zeiss Vision 1,000,000 Term B U S Dollar Loan, 6.24%, 05/04/13 ........................... 1,011,250 2,000,000 Term C U S Dollar Loan, 6.74%, 05/04/14 ........................... 2,015,000 3,000,000 Term D U S Dollar Loan, 8.99%, 11/04/14 ........................... 3,041,250 10 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) HEALTH CARE (CONTINUED) Cornerstone Healthcare Group Holding, Inc. 1,000,000 Senior Subordinated Unsecured Notes, 14.00%, 07/15/12 (i) ............... 1,012,500 2,000,000 Term Loan, 7.84%, 07/15/11 ................ 2,012,500 2,000,000 CRC Health Corp. Term Loan, 6.24%, 05/11/11 ................ 2,020,000 2,058,824 DaVita, Inc. Tranche B Term Loan, 05/26/12 (b) .............................. 2,091,147 1,170,970 Encore Medical IHC, Inc. Term Loan, 6.48%, 10/04/10 ................ 1,189,260 6,500,000 FHC Health Systems, Inc. Third Lien Term Loan, 12.23%, 01/14/11 .......................... 6,597,500 1,000,000 Genoa Healthcare Group LLC Second Lien Term Loan, 13.25%, 02/10/13 .......................... 1,025,000 1,974,874 Hanger Orthopedic Group, Inc. Tranche B Term Loan, 6.99%, 09/30/09 ........................... 2,011,903 HealthSouth Corp. 6,300,000 Term Loan, 6.09%, 06/14/07 ................ 6,374,813 1,700,000 Tranche B Term Loan, 3.34%, 03/08/10 ........................... 1,718,054 7,364,052 InSight Health Services Corp. Tranche B Term Loan, 7.24%, 10/17/08 ........................... 7,396,306 7,644,444 Knowledge Learning Corp. Term Loan, 5.99%, 01/07/12 ................ 7,701,778 1,977,519 Leiner Health Products Group, Inc. Tranche B Term Loan, 6.38%, 05/27/11 ........................... 1,942,912 1,000,000 LifeCare Holdings, Inc. Term Loan, 5.82%, 08/11/12 ................ 1,005,000 Rural/Metro Operating Co. LLC 720,588 Letter of Credit Term Loan, 3.42%, 03/04/11 ........................... 731,397 2,635,294 Term Loan, 6.03%, 03/04/11 ................ 2,674,824 1,066,667 Select Medical Corp. Revolver, 6.22%, 02/24/11 (h) ............. 1,061,333 Skilled Healthcare LLC 2,000,000 First Lien Term Loan, 6.42%, 06/15/12 ........................... 2,035,000 3,000,000 Second Lien Term Loan, 11.53%, 12/15/12 .......................... 3,077,520 ------------- 74,718,064 ------------- HOME FURNISHINGS - 2.7% 22,983,272 Home Interiors & Gifts, Inc. Initial Term Loan, 8.38%, 03/31/11 (b) ....................... 21,489,360 Ruby Cone I AB 2,000,000 Facility B Term Loan, 6.29%, 06/01/13 ........................... 2,002,500 1,633,901 Facility C1 Term Loan, 6.78%, 06/01/14 ........................... 1,644,113 ------------- 25,135,973 ------------- INDUSTRIAL EQUIPMENT - 1.3% 1,625,000 AIRXCEL, Inc. First Lien Term Loan, 08/31/12 (b) .............................. 1,637,188 PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- INDUSTRIAL EQUIPMENT (CONTINUED) 5,100,710 Copperweld Corp. Term Loan, 8.17%, 12/17/11 ................ 5,094,334 988,655 Dresser, Inc. Term Loan C, 5.99%, 04/10/09 .............. 999,363 1,000,000 Penn Engineering & Manufacturing Corp. Second Lien Term Loan, 9.47%, 05/25/12 ........................... 1,005,000 Terex Corp. 355,412 Incremental Term Loan, 6.18%, 12/31/09 ........................... 360,075 3,535,682 Term Loan, 5.68%, 07/03/09 ................ 3,584,297 ------------- 12,680,257 ------------- INSURANCE - 1.1% 5,000,000 American Wholesale Insurance Group, Inc. Second Lien Term Loan, 11.86%, 10/13/11 .......................... 5,000,000 1,882,192 Conseco, Inc. Term Loan, 5.57%, 06/22/10 ................ 1,903,385 2,970,000 Mitchell International, Inc. Second Lien Term Loan, 9.75%, 08/15/12 ........................... 3,021,975 ------------- 9,925,360 ------------- LEISURE GOODS/ACTIVITIES/MOVIES - 5.7% 3,200,742 AMF Bowling Worldwide, Inc. Term Loan B, 6.67%, 08/27/09 .............. 3,238,671 1,500,000 BLB Investors LLC Senior Secured Note, 07/18/12 (b) .............................. 1,531,875 12,500,000 Blockbuster Entertainment Corp. Tranche B Term Loan, 7.26%, 08/20/11 (b) ....................... 12,224,000 2,000,000 Camelbak Products, Inc. Second Lien Term Loan, 10.54%, 02/04/12 .......................... 1,992,500 5,000,000 CNL Hospitality Partners LP Mezzanine A-3 Loan, 5.83%, 09/09/06 ........................... 5,012,500 776,949 CNL Hospitality Properties LP Term Facility, 6.07%, 10/13/06 ............ 778,891 3,000,000 Fender Musical Instruments Corp. Second Lien Term Loan, 8.10%, 09/30/12 ........................... 3,060,000 9,505,000 Metro-Goldwyn-Mayer Holdings, Inc./LOC Acquisition Co. Tranche B Term Loan, 5.74%, 04/08/12 ........................... 9,623,052 2,000,000 Movie Gallery, Inc. Term Loan B, 6.49%, 04/27/11 .............. 2,012,280 4,000,000 Oriental Trading Co., Inc. Second Lien Term Loan, 8.25%, 01/08/11 ........................... 4,053,360 2,000,000 Pine Tree Holdings/Pine Tree Country Club Second Lien Tranche B Term Loan, 11.64%, 07/15/13 .......................... 2,035,000 1,980,800 Polaroid Corp. Second Lien Term Loan, 11.75%, 04/27/11 .......................... 1,985,752 6,454,992 Six Flags Theme Parks, Inc. Tranche B Term Loan, 6.36%, 06/30/09 ........................... 6,531,678 ------------- 54,079,559 ------------- SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 11 INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) LODGING & CASINOS - 8.0% 641,901 Ameristar Casinos, Inc. Term Loan B1, 5.50%, 12/20/06 ............. 648,320 2,550,000 CCM Merger, Inc./MotorCity Casino Term Loan B, 5.69%, 04/25/12 .............. 2,582,946 3,000,000 CNL Hotel Del Partners LP First Mezzanine Loan, 7.09%, 02/09/07 ........................... 3,007,500 15,000,000 Extended Stay America, Inc. Mezzanine Loan, 08/01/08 (b) (c) .......... 15,000,000 Fontainebleu Florida Hotel LLC 3,000,000 Tranche A Term Loan, 6.54%, 05/11/08 ........................... 3,000,000 2,000,000 Tranche B Term Loan, 6.54%, 05/11/08 ........................... 2,000,000 4,018,535 Global Cash Access LLC Term Loan B, 5.92%, 03/10/10 .............. 4,082,590 3,950,150 Green Valley Ranch Gaming LLC Term Loan, 5.49%, 12/22/10 ................ 4,001,976 2,200,063 Oak Hill Capital Partners Mezzanine Loan, 8.39%, 02/09/07 (c) ....................... 2,236,841 OpBiz LLC 17,918,616 Term Loan A, 6.50%, 08/31/10 .............. 18,019,498 43,693 Term Loan B, 7.50%, 08/31/10 .............. 43,893 Penn National Gaming, Inc. 1,333,333 First Lien Term Loan, 05/26/11 (b) .............................. 1,354,533 666,667 Tranche B-2 Term Loan, 05/15/12 (b) .............................. 677,500 10,500,000 Resorts International Holdings Ltd. Second Lien Term Loan, 9.42%, 04/26/13 (b) ....................... 10,542,630 1,963,583 Term Loan B, 6.20%, 04/26/12 .............. 1,991,564 1,750,000 Trump Entertainment Resorts, Inc. Term Loan B-1, 6.14%, 05/20/12 ............ 1,780,625 4,000,000 Wynn Las Vegas LLC Term Loan, 5.81%, 12/14/11 ................ 4,053,120 ------------- 75,023,536 ------------- NONFERROUS METALS/MINING - 1.7% 2,000,000 AMR Technologies Inc. Term Loan, 08/31/09 (b) (c) ............... 2,000,000 992,500 J W Aluminum Co. First Lien Term Loan, 6.92%, 10/20/10 ........................... 1,007,387 2,500,000 James River Coal Co. Credit Linked Certificate of Deposit, 3.09%, 11/30/11 ........................... 2,531,250 4,726,250 Murray Energy Corp. Tranche B Term Loan, 6.86%, 01/28/10 ........................... 4,752,812 5,985,000 Trout Coal Holdings LLC First Lien Term Loan, 6.02%, 03/23/11 ........................... 6,003,673 ------------- 16,295,122 ------------- OIL/GAS - 8.2% 6,000,000 ALON USA Term Loan, 10.30%, 01/15/09 ............... 6,180,000 9,975,000 ATP Oil & Gas Corp. Term Loan, 9.14%, 04/14/10 ................ 10,324,125 4,894,895 Basic Energy Services, Inc. Term Loan B, 6.50%, 10/03/09 .............. 4,931,607 PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- OIL/GAS (CONTINUED) 2,500,000 Carrizo Oil & Gas, Inc. Second Lien Term Loan, 9.87%, 07/21/10 ........................... 2,578,125 Coffeyville Resources LLC 600,000 First Lien Tranche B Term Loan, 6.06%, 06/24/12 ........................... 610,218 400,000 Funded Letter of Credit, 6.06%, 06/24/12 ........................... 406,876 5,000,000 Second Lien Term Loan, 10.31%, 06/24/13 .......................... 5,150,000 1,975,025 Dynegy Holdings, Inc. Term Loan, 7.49%, 05/27/10 ................ 1,986,441 El Paso Corp. 2,500,000 Deposit Accounts, 3.24%, 11/23/09 ........................... 2,534,200 8,437,839 Term Loan, 6.44%, 11/23/09 ................ 8,572,000 4,000,000 Energy Transfer Partners LP Term Loan, 6.47%, 06/16/08 ................ 4,056,480 2,791,436 Getty Petroleum Marketing, Inc. Term Loan, 6.92%, 05/19/10 ................ 2,798,415 4,000,000 Hawkeye Renewables, LLC Term Loan, 6.93%, 01/31/12 ................ 3,980,000 1,383,352 Headwaters, Inc. First Lien Term Loan B-1, 5.91%, 04/30/11 ........................... 1,404,102 Kerr-McGee Corp. 11,500,000 Tranche B Term Loan, 6.14%, 05/24/11 ........................... 11,580,845 4,000,000 Tranche X Term Loan, 5.85%, 05/24/07 ........................... 4,013,760 1,000,000 SemCrude LP U S Term Loan, 6.12%, 03/16/11 ............ 1,013,750 3,000,000 Trident Exploration Corp. Second Lien Term Loan, 10.61%, 04/26/11 .......................... 3,037,500 1,837,641 Williams Production RMT Co. Term Loan C, 5.83%, 05/30/07 .............. 1,866,749 ------------- 77,025,193 ------------- PUBLISHING - 1.8% 1,875,478 Adams Outdoor Advertising LP Term Loan, 5.64%, 10/15/11 ................ 1,901,660 4,738,125 American Lawyer Media Holdings, Inc. First Lien Term Loan, 5.99%, 03/05/10 ........................... 4,752,908 1,980,000 Herald Media, Inc. First Lien Term Loan, 5.99%, 07/22/11 ........................... 1,992,395 3,000,000 North American Membership Group, Inc. Second Lien Term Loan, 11.11%, 11/18/11 .......................... 3,015,000 1,300,533 Relizon Co. Tranche B Term Loan, 6.82%, 02/20/11 ........................... 1,307,035 3,800,000 VISANT Corp. Tranche C Term Loan, 5.94%, 12/21/11 ........................... 3,860,952 ------------- 16,829,950 ------------- REAL ESTATE INVESTMENT TRUST - 2.3% 2,500,000 BioMed Realty LP Senior Secured Term Loan, 5.76%, 05/31/10 ........................... 2,518,750 1,997,848 Crescent Real Estate Equities, LP Term Loan, 5.76%, 01/12/06 ................ 2,017,207 12 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) REAL ESTATE INVESTMENT TRUST (CONTINUED) 14,917,752 General Growth Properties, Inc. Tranche B Term Loan, 5.67%, 11/12/08 ........................... 15,107,655 2,000,000 Trustreet Properties, Inc. Term Loan, 5.51%, 04/08/10 ................ 2,018,760 ------------- 21,662,372 ------------- RETAILERS - 1.1% 2,985,000 Dollarama Group LP Term Loan B, 5.93%, 11/18/11 .............. 3,037,237 2,984,967 Harbor Freight Tools USA Term Loan, 6.27%, 07/15/10 ................ 3,020,428 1,000,000 MAPCO Express, Inc./MAPCO Family Centers, Inc. Term Loan, 6.21%, 04/28/11 ................ 1,015,620 2,957,550 Prestige Brands Holdings, Inc. Tranche B Term Loan, 6.31%, 04/06/11 ........................... 2,985,883 ------------- 10,059,168 ------------- STEEL - 0.4% 1,250,000 Euramax International, Inc. First Lien Term Loan, 6.13%, 06/29/13 ........................... 1,263,800 2,812,500 The Techs Industries, Inc. Term Loan, 6.24%, 01/14/10 ................ 2,819,531 ------------- 4,083,331 ------------- SURFACE TRANSPORT - 0.8% Quality Distribution, Inc. 1,000,000 Synthetic Letters of Credit, 6.09%, 11/13/09 ........................... 1,005,000 974,747 Term Loan, 6.59%, 11/13/09 (d) ............ 981,454 3,396,915 Term Loan, 6.67%, 11/13/09 ................ 3,420,286 2,479,234 Transport Industries LP Term Loan B, 7.50%, 06/13/10 .............. 2,488,531 ------------- 7,895,271 ------------- TELECOMMUNICATIONS/CELLULAR - 3.1% 7,875,000 Consolidated Communications, Inc. Term Loan D, 5.86%, 10/14/11 .............. 7,993,125 MetroPCS, Inc. 4,000,000 First Lien Tranche B Term Loan, 8.25%, 05/27/11 ........................... 4,122,480 6,000,000 Second Lien Term Loan, 10.75%, 05/27/12 .......................... 6,236,280 Qwest Corp. 4,000,000 Tranche A Term Loan, 8.53%, 06/30/07 ........................... 4,135,360 7,000,000 Tranche B Term Loan, 6.95%, 06/30/10 (i) ....................... 6,994,820 ------------- 29,482,065 ------------- TELECOMMUNICATIONS/COMBINATION - 3.2% 4,417,651 Centennial Cellular Operating Co. Term Loan, 5.70%, 02/09/11 ................ 4,491,867 NTELOS, Inc. 1,248,737 First Lien Term Loan B, 6.17%, 08/24/11 ........................... 1,261,812 1,500,000 Second Lien Term Loan, 8.49%, 02/24/12 ........................... 1,503,750 PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- TELECOMMUNICATIONS/COMBINATION (CONTINUED) 5,000,000 NTL, Inc. B2 Sub-Tranche, 6.41%, 04/14/12 ........................... 5,043,150 8,454,819 PanAmSat Corp. Tranche B-1 Term Loan, 5.65%, 08/20/11 ........................... 8,571,073 3,952,934 RCN Corp. Term Loan, 7.94%, 12/21/11 ................ 3,992,464 5,000,000 Woodlands Commercial Property Co. Bridge Loan, 6.86%, 11/01/05 .............. 5,037,500 ------------- 29,901,616 ------------- TELECOMMUNICATIONS/WIRELESS - 3.9% 2,000,000 CellNet Data Systems, Inc. First Lien Term Loan B, 6.68%, 04/26/12 ........................... 2,015,000 14,925,000 Cricket Communications, Inc. Term Loan B, 5.99%, 01/10/11 .............. 15,079,026 5,000,000 FairPoint Communications, Inc. Initial B Term Loan, 5.55%, 02/08/12 ........................... 5,061,250 2,000,000 Maritime Telecommunications Network, Inc. First Lien Term Loan, 6.39%, 03/29/11 ........................... 2,010,000 1,980,000 SBA Senior Finance, Inc. Tranche D Term Loan, 5.58%, 10/31/08 ........................... 1,996,078 2,992,500 Telcordia Technologies, Inc. Term Loan, 6.61%, 09/15/12 ................ 2,992,500 WilTel Communications Group, Inc. 1,989,446 First Lien Term Loan, 6.99%, 06/30/10 ........................... 2,015,547 5,959,163 Promissory Note, 7.00%, 04/01/10 (i) .............................. 5,124,880 ------------- 36,294,281 ------------- TELECOMMUNICATIONS/WIRELINE - 0.2% 1,893,878 Valor Telecommunications Enterprises LLC Tranche B Term Loan, 5.65%, 02/14/12 ........................... 1,916,187 ------------- UTILITIES - 6.2% 2,831,815 Allegheny Energy, Inc. Term Advances, 5.35%, 03/08/11 ............ 2,842,434 2,000,000 ANP Funding I, LLC Tranche A Term Loan, 7.03%, 07/29/10 ........................... 2,024,680 Boston Generating LLC 15,918 DSR Letter of Credit, 12/31/05 (b) ........ 22,603 45,275 Project Letter of Credit, 12/31/05 (b) .............................. 64,290 828,326 Project Term Loan, 12/31/05 (b) ........... 1,151,373 110,482 Working Capital Letter of Credit, 12/31/05 (b) .............................. 156,884 4,924,623 Calpine Construction Finance Co. LP First Lien Term Loan, 9.51%, 08/26/09 ........................... 5,189,322 1,613,936 Calpine Corp. Second Lien Term Loan B, 9.35%, 07/16/07 ........................... 1,315,358 6,720,614 CenterPoint Energy, Inc. Term Loan, 6.09%, 04/30/10 ................ 6,789,433 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 13 INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- SENIOR LOAN NOTES (CONTINUED) UTILITIES (CONTINUED) Covanta Energy Corp. 1,658,537 Letter of Credit Term Loan, 6.36%, 06/24/12 ........................... 1,687,561 1,341,463 Term Loan, 6.46%, 06/24/12 ................ 1,364,939 3,240,149 Infrasource, Inc. Term Loan, 6.24%, 09/30/10 ................ 3,248,249 KGen, LLC 1,995,000 Tranche A Term Loan, 6.12%, 08/05/11 ........................... 1,990,013 34,181 Tranche B Term Loan, 12.49%, 08/05/11 .......................... 33,839 1,393,218 Midwest Generations LLC Term Loan, 5.45%, 04/27/11 ................ 1,409,631 Mirant Corp. 7,000,000 Revolver, 12/31/05 (e) (f) ................ 6,125,000 2,000,000 Revolver, 07/15/08 (e) (f) ................ 1,751,000 2,500,000 Perryville Claim, 07/17/06 (e) (f) ........ 2,112,500 NRG Energy, Inc. 1,311,266 Credit Linked Certificate of Deposit, 3.39%, 12/24/07 ........................... 1,328,208 1,677,484 Term Loan, 5.26%, 12/24/11 ................ 1,698,151 4,565,367 Riverside Energy Center LLC Term Loan, 7.93%, 06/24/11 ................ 4,679,501 Rocky Mountain Energy Center LLC 361,073 Credit Linked Certificate of Deposit, 3.58%, 06/24/11 ........................... 368,295 3,159,350 Term Loan, 7.93%, 06/24/11 ................ 3,238,334 Texas Genco LLC 291,577 Delayed Draw Term Loan, 5.41%, 12/14/11 ........................... 296,405 7,005,821 Initial Term Loan, 5.42%, 12/14/11 ........ 7,119,035 ------------- 58,007,038 ------------- Total Senior Loan Notes (Cost $1,072,172,777) ................... 1,082,985,620 ------------- FOREIGN VARIABLE RATE SENIOR LOAN NOTES (A) - 7.3% FRANCE - 0.3% EUR 2,500,000 Novalis S.A.S. Second Lien Term Loan, 7.90%, 12/31/13 ........................... 3,130,327 ------------- GERMANY - 1.2% EUR 3,625,000 debitel (Netherlands) Holding BV Second Lien Term Loan, 9.10%, 06/11/14 ........................... 4,565,455 debitel Konzemfinanzierungs GmbH 1,125,000 Term Facility B, 4.85%, 06/11/13 .......... 1,389,969 803,571 Term Facility C1, 5.35%, 06/11/14 ......... 995,217 321,429 Term Facility C2, 5.35%, 06/11/14 ......... 396,790 iesy Hessen GmbH & Co. 1,500,000 Facility B, 4.88%, 02/14/13 ............... 1,850,764 1,500,000 Faciltiy C, 5.38%, 02/14/14 ............... 1,856,299 ------------- 11,054,494 ------------- PRINCIPAL AMOUNT/ COMMITMENT ($) VALUE ($) - ----------------- --------- ITALY - 0.8% EUR Pirelli Cables & Systems, Inc. 4,500,000 Second Lien Term Loan, 01/20/15 (b) .............................. 5,588,266 875,000 Euro Term Loan B, 08/01/12 (b) ............ 1,070,961 875,000 Euro Term Loan C, 08/01/12 (b) ............ 1,072,080 ------------- 7,731,307 ------------- UNITED KINGDOM - 5.0% GBP 1,000,000 Eggborough Power Ltd. Term Loan, 03/31/22 (b) (i) ............... 3,742,805 Inpower Ltd. 2,120,000 Term Loan A2, 06/30/15 (b) ................ 11,229,136 400,000 Term Loan A3, 12/30/20 (b) 0 3,125,000 PlayPower, Inc. ............................ Add On Term Loan, 12/20/09 (b) .............................. 5,690,759 Red Football Ltd. 1,250,000 Facility B Term Loan, 7.85%, 05/11/13 ........................... 2,281,924 1,250,000 Facility C Term Loan, 8.35%, 05/11/14 ........................... 2,281,924 2,000,000 Term Loan D, 11.10%, 05/11/14 ............. 3,687,050 1,402,875 SunGard UK Holdings Ltd Term Loan, 02/11/13 (b) ................... 2,557,849 4,000,000 Teesside Power Ltd. Term Loan, 04/01/08 (b) ................... 7,041,366 Trinitybrook PLC 2,500,000 Term Loan B1, 7.34%, 07/31/13 ............. 4,428,911 2,500,000 Term Loan C, 7.84%, 07/31/14 .............. 4,478,597 ------------- 47,420,321 ------------- Total Foreign Variable Rate Senior Loan Notes (Cost $67,563,269) ...................... 69,336,449 ------------- CORPORATE NOTES AND BONDS - 0.2% TELECOMMUNICATIONS/WIRELESS - 0.2% 2,000,000 Dobson Cellular Systems Floating Rate Note, 8.44%, 11/01/11 ........................... 2,090,000 ------------- Total Corporate Notes and Bonds (Cost $2,000,000) ....................... 2,090,000 ------------- SHARES ------ COMMON STOCKS (G) - 0.3% BUSINESS SERVICES - 0.0% 40,800 NATG Holdings LLC (c) ...................... 0 ------------- HEALTH CARE - 0.0% 5,500 Sun Healthcare Group, Inc. ................. 36,135 ------------- TELECOMMUNICATIONS/COMBINATION - 0.0% 2,167 Eningen Realty (c) ......................... 0 ------------- TELECOMMUNICATIONS/WIRELESS - 0.3% 76,137 Leap Wireless International, Inc. .......... 2,600,840 ------------- Total Common Stocks (Cost $772,407) ......................... 2,636,975 ------------- 14 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. INVESTMENT PORTFOLIO (CONTINUED) AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND SHARES VALUE ($) -------- --------- PREFERRED STOCK (C) - 0.0% DIVERSIFIED MANUFACTURING - 0.0% 14,382 Superior Telecom, Inc., Series A ........... 14,382 ------------- Total Preferred Stock (Cost $14,382) .......................... 14,382 ------------- FOREIGN COMMON STOCK (C) (G) - 0.0% UTILITY - 0.0% 400,000 Inpower Ltd. ............................... 0 ------------- Total Foreign Common Stock (Cost $0) ............................... 0 ------------- TOTAL INVESTMENTS - 122.7% ............................... 1,157,063,426 ------------- (cost of $1,142,522,835) (j) OTHER ASSETS & LIABILITIES, NET - (22.7)% ................ (214,258,440) ------------- NET ASSETS - 100.0% ...................................... 942,804,986 ============= - ---------------------- (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. (Unless otherwise identified by (i), all senior loans carry a variable rate interest). These base lending rates are generally (i) the prime rate offered by one or more major United States banks, (ii) the lending rate offered by one or more European banks such as the London Inter-Bank Offered Rate ("LIBOR") and (iii) the certificate of deposit rate. Rate shown represents the weighted average rate at August 31, 2005. Senior loans, while exempt from registration under the Security Act of 1933, as amended, contain certain restrictions on resale and cannot be sold publicly. Senior secured floating rate interests often require prepayments from excess cash flow or permit the borrower to repay at its election. The degree to which borrowers repay, whether as a contractual requirement or at their election, cannot be predicted with accuracy. As a result, the actual remaining maturity may be substantially less than the stated maturities shown. (b) All or a portion of this position has not settled. Contract rates do not take effect until settlement date. (c) Represents fair value as determined in good faith under the direction of the Board of Trustees. (d) Loans held on participation. (e) The issuer is in default of certain debt covenants. Income is not being accrued. (f) This issue is under the protection of the Federal bankruptcy court. (g) Non-income producing security. (h) Additional unfunded commitment. See Note 10. (i) Fixed rate senior loan. (j) Cost for Federal income tax purposes is $1,143,030,347. DIP Debtor in Possession DSR Debt Service Reserve EUR Euro GBP Great Britain Pound FOREIGN VARIABLE SENIOR LOAN NOTES INDUSTRY CONCENTRATION TABLE (% of Total Net Assets) Utilities .......................... 2.3% Leisure Goods/Activities/Movies .... 1.5% Electronic/Electric ................ 1.1% Retailers .......................... 0.9% Telecommunications/Cellular ........ 0.8% Cable & Satellite Television ....... 0.4% Clothing/Textiles .................. 0.3% ---- Total .............................. 7.3% ==== SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 15 STATEMENT OF ASSETS AND LIABILITIES - --------------------------------------------------------------------------------
AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND ($) - ---------------------------------------------------------------------------------------------------------------------- ASSETS: Investments, at value (Cost $1,142,522,835) ..................................................... 1,157,063,426 Cash and cash equivalents ....................................................................... 64,859,859 Foreign currency (Cost $31,355,771) ............................................................. 31,954,784 Receivable for: Investments sold ............................................................................. 7,834,348 Fund shares sold ............................................................................. 9,694,406 Interest and fees ............................................................................ 7,684,638 Other assets .................................................................................... 143,816 --------------- Total Assets .............................................................................. 1,279,235,277 LIABILITIES: Notes payable (Note 8) .......................................................................... 250,000,000 Deferred facility fees (Note 2) ................................................................. 36,337 Net discount and unrealized appreciation on unfunded transactions (Note 10) .................... 274,008 Payable for: Investments purchased ........................................................................ 82,343,536 Distributions ................................................................................ 1,628,160 Investment advisory fee (Note 4) ............................................................. 494,208 Administration fee (Note 4) .................................................................. 199,533 Trustees' fees (Note 4) ...................................................................... 16,667 Distribution and service fees (Note 4) ....................................................... 456,116 Interest expense (Note 8) .................................................................... 658,438 Accrued expenses and other liabilities .......................................................... 323,288 --------------- Total Liabilities ......................................................................... 336,430,291 --------------- NET ASSETS ......................................................................................... 942,804,986 =============== COMPOSITION OF NET ASSETS Paid-in capital ................................................................................. 930,949,096 Undistributed net investment income ............................................................. 285,027 Accumulated net realized loss on investments and foreign currency transactions .................. (3,325,947) Net unrealized appreciation on investments, translation of assets and liabilities denominated in foreign currency and unfunded transactions ................................................ 14,896,810 --------------- NET ASSETS ......................................................................................... 942,804,986 =============== CLASS A Net assets ...................................................................................... 351,556,649 Shares outstanding .............................................................................. 28,846,957 Net asset value per share (Net assets/Shares outstanding) ...................................... 12.19(a) Maximum offering price per share (100 / 96.50 of $12.19) ........................................ 12.63(b) CLASS B Net assets ...................................................................................... 124,499,702 Shares outstanding .............................................................................. 10,215,719 Net asset value and offering price per share (Net assets/Shares outstanding) ................... 12.19(a) CLASS C Net assets ...................................................................................... 391,455,481 Shares outstanding .............................................................................. 32,118,766 Net asset value and offering price per share (Net assets/Shares outstanding) ................... 12.19(a) CLASS Z Net assets ...................................................................................... 75,293,154 Shares outstanding .............................................................................. 6,178,337 Net asset value, offering and redemption price per share (Net assets/Shares outstanding) ........ 12.19 - ---------------------------------------------------- (a) Redemption price per share is equal to net asset value less any applicable contingent deferred sales charge. (b) On sales of $100,000 or more, the offering price is reduced.
16 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS - --------------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND ($) - --------------------------------------------------------------------------------------------------------------------------------- INVESTMENT INCOME Interest ......................................................................................... 59,275,105 Dividends ........................................................................................ 1,366 Facility and other fees .......................................................................... 1,873,193 -------------- Total Investment Income .................................................................... 61,149,664 EXPENSES Investment advisory fee (Note 4) ................................................................. 4,358,222 Administration fee (Note 4) ...................................................................... 1,945,292 Accounting services fee (Note 4) ................................................................. 341,819 Distribution fee: (Note 4) Class A ....................................................................................... 282,486 Class B ....................................................................................... 575,391 Class C ....................................................................................... 1,963,202 Service fee: (Note 4) Class A ....................................................................................... 706,216 Class B ....................................................................................... 319,662 Class C ....................................................................................... 818,001 Transfer agent fee (Note 4) ...................................................................... 646,887 Professional fees ................................................................................ 146,104 Trustees' fees (Note 4) .......................................................................... 111,925 Custody fee (Note 4) ............................................................................. 114,340 Other expenses ................................................................................... 652,134 -------------- Total Operating Expenses ................................................................... 12,981,681 Interest expense (Note 8) ........................................................................ 4,536,502 Facility expense ................................................................................. 1,217,559 -------------- Total Expenses ............................................................................. 18,735,742 Fees and expenses waived or reimbursed by Investment Adviser (Note 4) ............................ (805,040) -------------- Net Expenses ............................................................................... 17,930,702 -------------- Net Investment Income ............................................................................ 43,218,962 -------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized gain on investments ................................................................. 521,149 Net realized loss on foreign currency transactions ............................................... (73,329) Net change in unrealized appreciation on investments ............................................. 6,884,240 Net change in unrealized appreciation on unfunded transactions (Note 10) ......................... 72,486 Net change in unrealized appreciation on translation of assets and liabilities denominated in foreign currency .............................................................................. 283,733 -------------- Net Gain ......................................................................................... 7,688,279 -------------- Net Increase in Net Assets ....................................................................... 50,907,241 ==============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 17 STATEMENTS OF CHANGES IN NET ASSETS - --------------------------------------------------------------------------------
HIGHLAND FLOATING RATE ADVANTAGE FUND YEARS ENDED AUGUST 31, 2005 2004 ($) ($) ---------------- --------------- INCREASE IN NET ASSETS: OPERATIONS Net investment income ........................................................ 43,218,962 21,146,661 Net realized gain on investments and foreign currency transactions ........... 447,820 9,871,654 Net change in unrealized appreciation on investments translation of assets and liabilities denominated in foreign currency and unfunded transactions ..... 7,240,459 16,802,971 ---------------- --------------- Net Increase from Operations .............................................. 50,907,241 47,821,286 ---------------- --------------- DISTRIBUTIONS DECLARED TO SHAREHOLDERS From net investment income: Class A ................................................................... (15,863,369) (7,362,637) Class B ................................................................... (6,648,815) (4,785,071) Class C ................................................................... (16,600,896) (7,927,327) Class Z ................................................................... (4,020,231) (1,318,999) ---------------- --------------- Total Distributions Declared to Shareholders .............................. (43,133,311) (21,394,034) ---------------- --------------- SHARE TRANSACTIONS Class A: Subscriptions ............................................................. 209,578,268 155,278,295 Distributions reinvested .................................................. 10,245,197 4,387,935 Redemptions ............................................................... (83,335,719) (41,293,262) ---------------- --------------- Net Increase .............................................................. 136,487,746 118,372,968 Class B: Subscriptions ............................................................. 10,362,773 55,799,014 Distributions reinvested .................................................. 4,017,411 2,714,846 Redemptions ............................................................... (15,567,850) (17,134,851) ---------------- --------------- Net Increase (Decrease) ................................................... (1,187,666) 41,379,009 Class C: Subscriptions ............................................................. 167,261,240 208,181,539 Distributions reinvested .................................................. 11,115,461 5,151,429 Redemptions ............................................................... (68,853,512) (24,993,138) ---------------- --------------- Net Increase .............................................................. 109,523,189 188,339,830 Class Z: Subscriptions ............................................................. 40,633,785 50,799,735 Distributions reinvested .................................................. 1,870,278 465,119 Redemptions ............................................................... (20,870,623) (4,503,807) ---------------- --------------- Net Increase .............................................................. 21,633,440 46,761,047 ---------------- --------------- Net Increase from Share Transactions ...................................... 266,456,709 394,852,854 ---------------- --------------- Total Increase in Net Assets ........................................ 274,230,639 421,280,106 ---------------- --------------- NET ASSETS Beginning of period .......................................................... 668,574,347 247,294,241 End of period (including undistributed and overdistributed net investment income of $285,027 and $(215,539), respectively) .......................... 942,804,986 668,574,347 ================ ===============
18 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. STATEMENTS OF CHANGES IN NET ASSETS (CONTINUED) - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND
YEARS ENDED AUGUST 31, 2005 2004 ---------------- --------------- CHANGE IN SHAR0ES Class A: Subscriptions ............................................................... 17,322,296 13,068,545 Issued for distributions reinvested ......................................... 846,869 368,106 Redemptions ................................................................. (6,887,056) (3,460,892) ---------------- --------------- Net Increase ................................................................ 11,282,109 9,975,759 Class B: Subscriptions ............................................................... 855,878 4,712,112 Issued for distributions reinvested ......................................... 332,132 228,200 Redemptions ................................................................. (1,285,093) (1,433,835) ---------------- --------------- Net Increase (Decrease) ..................................................... (97,083) 3,506,477 Class C: Subscriptions ............................................................... 13,815,400 17,547,735 Issued for distributions reinvested ......................................... 918,787 431,547 Redemptions ................................................................. (5,686,448) (2,088,151) ---------------- --------------- Net Increase ................................................................ 9,047,739 15,891,131 Class Z: Subscriptions ............................................................... 3,359,211 4,267,378 Issued for distributions reinvested ......................................... 154,587 38,768 Redemptions ................................................................. (1,726,328) (376,712) ---------------- --------------- Net Increase ................................................................ 1,787,470 3,929,434
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 19 STATEMENT OF CASH FLOWS - --------------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND ($) - --------------------------------------------------------------------------------------------------------------------------------- INCREASE IN CASH AND FOREIGN CURRENCY CASH FLOWS USED FOR OPERATING ACTIVITIES Net investment income ........................................................................ 43,218,962 ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH USED FOR OPERATING ACTIVITIES Purchase of investments securities ........................................................... (1,290,874,899) Proceeds from disposition of investment securities and realized gain (loss) on foreign currency 851,927,901 Sale of short-term portfolio investments, net ................................................ 47,479,000 Increase in unrealized appreciation on unfunded transactions ................................. (72,486) Increase in interest and fees receivable ..................................................... (3,892,652) Decrease in receivable for expense reimbursement ............................................. 209,953 Increase in receivable for investments sold .................................................. (7,520,334) Increase in other assets ..................................................................... (138,761) Decrease in deferred facility fees ........................................................... (217,586) Increase in payable for accrued expenses ..................................................... 381,558 Net amortization of premium (discount) ....................................................... (1,081,044) Increase in payable for investments purchased ................................................ 82,343,536 Increase in mark-to-market on foreign currency and unsettled positions ....................... 283,733 Increase in other liabilities 367,026 --------------- Net cash and foreign currency flow used for operating activities ....................... (277,586,093) CASH FLOWS PROVIDED BY FINANCING ACTIVITIES Increase in notes payable .................................................................... 155,000,000 Increase in interest payable ................................................................. 524,346 Proceeds from shares sold .................................................................... 422,578,279 Payment of shares redeemed ................................................................... (188,627,704) Distributions paid in cash ................................................................... (15,074,941) --------------- Net cash flow provided by financing activities ......................................... 374,399,980 --------------- Net increase in cash and foreign currency .............................................. 96,813,887 CASH AND FOREIGN CURRENCY Beginning of the period ...................................................................... 756 --------------- End of the period ............................................................................ 96,814,643 ===============
20 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ----------------------------------------------------------------------------- CLASS A SHARES 2005 2004 2003 2002 2001 - -------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.09 - -------------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.67 0.56 0.81 0.83(b) 1.10 Net realized and unrealized gain (loss) on investments(a) 0.11 0.89 0.74 (1.26)(b) (0.32) ----------- ---------- ---------- ---------- ---------- Total from Investment Operations 0.78 1.45 1.55 (0.43) 0.78 - -------------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.67) (0.59) (0.81) (0.83) (1.13) From net realized gains -- -- -- -- --(c) ----------- ---------- ---------- ---------- ---------- Total Distributions Declared to Shareholders (0.67) (0.59) (0.81) (0.83) (1.13) - -------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74 Total return(d)(e) 6.56%(f) 13.14% 15.55% (3.88)% 6.71% - -------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Operating expenses 1.28% 1.29%(g) 1.38%(g) 1.38%(g) 1.37%(g) Interest and facility expenses 0.72% 0.40% 0.73% 0.99% 2.04% Net expenses 2.00% 1.69%(g) 2.11%(g) 2.37%(g) 3.41%(g) Net investment income 5.60% 4.73%(g) 7.67%(g) 7.25%(b)(g) 9.24%(g) Waiver/reimbursement 0.10% 0.18% 0.36% 0.32% 0.32% Portfolio turnover rate 85% 110% 90% 98% 65% Net assets, end of period (000's) $ 351,557 $ 212,205 $ 85,166 $ 69,733 $ 108,399 - ---------------------------------------------------- (a) Per share data was calculated using average shares outstanding during the period. (b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01. The impact to the ratio of net investment income to average net assets was less than 0.01%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (c) Rounds to less than $0.01. (d) Total return at net asset value assuming all distributions reinvested and no initial sales charge or contingent deferred sales charge ("CDSC"). (e) Had the Fund's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (f) Total return is calculated using the Net Asset Value used for trading at the close of business on August 31, 2005. (g) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 21 FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ----------------------------------------------------------------------------- CLASS B SHARES 2005 2004 2003 2002 2001 - -------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07 - -------------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.63 0.53 0.78 0.78(b) 1.05 Net realized and unrealized gain (loss) on investments(a) 0.11 0.88 0.73 (1.25)(b) (0.30) ----------- ---------- ---------- ---------- ---------- Total from Investment Operations 0.74 1.41 1.51 (0.47) 0.75 - -------------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.63) (0.55) (0.77) (0.79) (1.08) From net realized gains -- -- -- -- --(c) ----------- ---------- ---------- ---------- ---------- Total Distributions Declared to Shareholders (0.63) (0.55) (0.77) (0.79) (1.08) - -------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74 Total return(d)(e) 6.19%(f) 12.75% 15.16% (4.22)% 6.52% - -------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Operating expenses 1.63% 1.64%(g) 1.73%(g) 1.73%(g) 1.72%(g) Interest and facility expenses 0.72% 0.40% 0.73% 0.99% 2.04% Net expenses 2.35% 2.04%(g) 2.46%(g) 2.72%(g) 3.76%(g) Net investment income 5.25% 4.50%(g) 7.34%(g) 6.90%(b)(g) 8.89%(g) Waiver/reimbursement 0.10% 0.18% 0.36% 0.32% 0.32% Portfolio turnover rate 85% 110% 90% 98% 65% Net assets, end of period (000's) $ 124,500 $ 124,589 $ 76,379 $ 68,157 $ 80,609 - ---------------------------------------------------- (a) Per share data was calculated using average shares outstanding during the period. (b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01. The impact to the ratio of net investment income to average net assets was less than 0.01%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (c) Rounds to less than $0.01. (d) Total return at net asset value assuming all distributions reinvested and no CDSC. (e) Had the Fund's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (f) Total return is calculated using the Net Asset Value used for trading at the close of business on August 31, 2005. (g) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%.
22 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ----------------------------------------------------------------------------- CLASS C SHARES 2005 2004 2003 2002 2001 - -------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.07 - -------------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.61 0.50 0.76 0.76(b) 1.03 Net realized and unrealized gain (loss) on investments(a) 0.11 0.89 0.74 (1.25)(b) (0.30) ----------- ---------- ---------- ---------- ---------- Total from Investment Operations 0.72 1.39 1.50 (0.49) 0.73 - -------------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.61) (0.53) (0.76) (0.77) (1.06) From net realized gains -- -- -- -- --(c) ----------- ---------- ---------- ---------- ---------- Total Distributions Declared to Shareholders (0.61) (0.53) (0.76) (0.77) (1.06) - -------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74 Total return(d)(e) 6.03%(f) 12.57% 14.99% (4.36)% 6.35% - -------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Operating expenses 1.78% 1.79%(g) 1.88%(g) 1.88%(g) 1,87%(g) Interest and facility expenses 0.72% 0.40% 0.73% 0.99% 2.04% Net expenses 2.50% 2.19%(g) 2.61%(g) 2.87%(g) 3.91%(g) Net investment income 5.10% 4.19%(g) 7.14%(g) 6.75%(b)(g) 8.74%(g) Waiver/reimbursement 0.10% 0.18% 0.36% 0.32% 0.32% Portfolio turnover rate 85% 110% 90% 98% 65% Net assets, end of period (000's) $ 391,455 $ 278,731 $ 80,572 $ 61,811 $ 64,074 - ---------------------------------------------------- (a) Per share data was calculated using average shares outstanding during the period. (b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01. The impact to the ratio of net investment income to average net assets was less than 0.01%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (c) Rounds to less than $0.01. (d) Total return at net asset value assuming all distributions reinvested and no CDSC. (e) Had the Fund's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (f) Total return is calculated using the Net Asset Value used for trading at the close of business on August 31, 2005. (g) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 23 FFINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE ADVANTAGE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
YEAR ENDED AUGUST 31, ----------------------------------------------------------------------------- CLASS Z SHARES 2005 2004 2003 2002 2001 - -------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 12.08 $ 11.22 $ 10.48 $ 11.74 $ 12.08 - --------------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.71 0.59 0.78 0.86(b) 1.14 Net realized and unrealized gain (loss) on investments(a) 0.11 0.90 0.81 (1.25)(b) (0.31) ----------- ---------- ---------- ---------- ---------- Total from Investment Operations 0.82 1.49 1.59 (0.39) 0.83 - --------------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.71) (0.63) (0.85) (0.87) (1.17) From net realized gains -- -- -- -- --(c) ----------- ---------- ---------- ---------- ---------- Total Distributions Declared to Shareholders (0.71) (0.63) (0.85) (0.87) (1.17) - --------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $ 12.19 $ 12.08 $ 11.22 $ 10.48 $ 11.74 Total return(d)(e) 6.93%(f) 13.52% 15.95% (3.53)% 7.17% - --------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Operating expenses 0.93% 0.94%(g) 1.03%(g) 1.03%(g) 1.02%(g) Interest and facility expenses 0.72% 0.40% 0.73% 0.99% 2.04% Net expenses 1.65% 1.34%(g) 1.76%(g) 2.02%(g) 3.06%(g) Net investment income 5.95% 4.93%(g) 7.21%(g) 7.60%(b)(g) 9.59%(g) Waiver/reimbursement 0.10% 0.18% 0.36% 0.32% 0.32% Portfolio turnover rate 85% 110% 90% 98% 65% Net assets, end of period (000's) $ 75,293 $ 53,049 $ 5,178 $ 140 $ 2,850 - ---------------------------------------------------- (a) Per share data was calculated using average shares outstanding during the period. (b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began amortizing and accreting premium and discount on all debt securities. The effect of this change for the year ended August 31, 2002, on the net investment income and net realized and unrealized loss per share was less than $0.01. The impact to the ratio of net investment income to average net assets was less than 0.01%. Per share data and ratios for periods prior to August 31, 2002 have not been restated to reflect this change in presentation. (c) Rounds to less than $0.01. (d) Total return at net asset value assuming all distributions reinvested. (e) Had the Fund's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (f) Total return is calculated using the Net Asset Value used for trading at the close of business on August 31, 2005. (g) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%.
24 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. NOTES TO FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- AUGUST 31, 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 non-diversified, closed-end management investment company. 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 three classes of shares: Class A, Class C and Class Z. Certain share classes have their own sales charge and bear class specific expenses, which include distribution fees and service fees. On March 3, 2005, the Board of Trustees of the Fund approved the closing of the Fund's Class B shares to purchases by new and existing shareholders. The Fund discontinued selling Class B shares to new and existing investors following the close of business on May 2, 2005. Existing investors may still reinvest distributions in Class B shares. Class A shares are subject to a maximum front-end sales charge of 3.50% based on the amount of initial investment. Class A shares purchased without an initial sales charge by accounts aggregating $1 million to $25 million at the time of purchase are subject to a 1.00% contingent deferred sales charge ("CDSC") on shares sold within eighteen months. Class B shares are subject to a maximum CDSC of 3.25% based upon the holding period after purchase. Class B shares will convert to Class A shares eight years after purchase. Please read the Fund's prospectus for additional details on Class B CDSC. Class C shares are subject to a 1.00% CDSC on shares sold within one year after purchase. Class Z shares are not subject to a sales charge. There are certain restrictions on the purchase of Class Z shares, as described in the Fund's prospectus. NOTE 2. SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. The following is a summary of significant accounting policies consistently followed by the 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 by the Investment Adviser 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 and gains (losses) are determined based upon the specific identification method for both financial statement and federal income tax purposes. FOREIGN CURRENCY Foreign currencies, investments and other assets and liabilities are translated into U.S. dollars at the exchange rates using the current 4:00 p.m. London Time Spot Rate. Fluctuations in the value of the foreign currencies and other assets and liabilities resulting from changes in exchange rates, between trade and settlement dates on securities transactions and between the accrual and payment dates on dividends, interest income and foreign withholding taxes, are recorded as unrealized foreign currency gains (losses). Realized gains (losses) and unrealized appreciation (depreciation) on investment securities and income and expenses are translated on the respective dates of such transactions. The effect of changes in foreign currency exchange rates on investments in securities are not segregated in the statement of operations 25 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND from the effects of changes in market prices of those securities, but are included with the net realized and unrealized gain or loss on investment securities. REPURCHASE AGREEMENTS The Fund may engage in repurchase agreement transactions with institutions that the Fund's investment adviser has determined are creditworthy. The Fund, through its custodian, receives delivery of underlying securities collateralizing a repurchase agreement. Collateral is at least equal, at all times, to the value of the repurchase obligation including interest. A repurchase agreement transaction involves certain risks in the event of default or insolvency of the counterparty. These risks include possible delays or restrictions upon the Fund's ability to dispose of the underlying securities and a possible decline in the value of the underlying securities during the period while the Fund seeks to assert its rights. INCOME RECOGNITION Interest income is recorded on the accrual basis and includes accretion of discounts and amortization of premiums, if any. As of April 2004, facility fees received are recorded as a reduction of cost to the loan and amortized through the maturity of the loan. Prior to May 2004, facility fees received were treated as deferred revenue and amortized over two years. Unamortized facility fees are reflected as deferred fees on the Statement of Assets and Liabilities. DETERMINATION OF CLASS NET ASSET VALUES All income, expenses (other than distribution fees and service fees, which are class-specific expenses, as shown on the Statement of Operations) and realized and unrealized gains (losses) are allocated to each class of the Fund on a daily basis for purposes of determining the net asset value of each class. Income and expenses are allocated to each class based on the settled shares method, while realized and unrealized gains (losses) are allocated based on the relative net assets of each class. FEDERAL INCOME TAX STATUS The Fund intends to qualify each year as a "Regulated Investment Company" under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), and will distribute substantially all of its taxable income, if any, for its tax year, and as such will not be subject to federal income taxes. DISTRIBUTIONS TO SHAREHOLDERS Dividends from net investment income are declared daily and paid monthly. Net realized capital gains, if any, are distributed at least annually. STATEMENT OF CASH FLOWS Information on financial transactions which have been settled through the receipt or disbursement of cash are presented in the Statement of Cash Flows. The cash and foreign currency amount shown in the Statement of Cash Flows is the amount included within the Fund's Statement of Assets and Liabilities and includes cash and foreign currency on hand at its custodian bank and sub-custodian bank, respectively, and does not include any short-term investments. NOTE 3. FEDERAL TAX INFORMATION The timing and character of income and capital gain distributions are determined in accordance with Federal income tax regulations, which may differ from GAAP. As a result, net investment income (loss) and net realized gain (loss) on investment transactions for a reporting period may differ significantly from distributions during such period. Reclassifications are made to the Fund's capital accounts for permanent tax differences to reflect income and gains available for distribution (or available capital loss carryforwards) under income tax regulations. For the year ended August 31, 2005, permanent differences resulting primarily from differing treatments for discount accretion/premium amortization on debt securities and Section 988 gain (loss) were identified and reclassified among the components of the Fund's net assets as follows: - ---------------------------------------- Overdistributed Accumulated Net Investment Net Realized Income Loss - ---------------------------------------- $414,915 $(414,915) - ---------------------------------------- Net investment income and net realized gains (losses), as disclosed on the Statement of Operations, and net assets were not affected by these reclassifications. The tax character of distributions paid during the years ended August 31, 2005 and August 31, 2004 was as follows: - ---------------------------------------------------------- 2005 2004 - ---------------------------------------------------------- Distributions paid from: - ---------------------------------------------------------- Ordinary income* $43,133,311 $21,394,034 - ---------------------------------------------------------- Long-term capital gains -- -- - ---------------------------------------------------------- *For tax purposes short-term capital gains distributions, if any, are considered ordinary income distributions. 26 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND As of August 31, 2005, the components of distributable earnings on a tax basis were as follows: - ------------------------------------------------------------ Undistributed Undistributed Ordinary Long-Term Net Unrealized Income Capital Gains Appreciation* - ------------------------------------------------------------ $2,422,808 $-- $14,316,812 - ------------------------------------------------------------ *The differences between book-basis and tax-basis net unrealized appreciation (depreciation) are primarily due to deferral of losses from wash sales and accretion/amortization on debt securities. Unrealized appreciation and depreciation at August 31, 2005, based on cost of investments for federal income tax purposes, and excluding any unrealized appreciation (depreciation) from changes in the value of other assets and liabilities resulting from changes in exchange rates, was: - ------------------------------------------------------------- Unrealized appreciation $ 16,725,423 - ------------------------------------------------------------- Unrealized depreciation (2,692,344) ------------ Net unrealized appreciation $ 14,033,079 - ------------------------------------------------------------- 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 $ 3,018,341 - ------------------------------------------------------------- Under current laws, certain capital losses realized after October 31 may be deferred and treated as occurring on the first day of the following fiscal year. For the fiscal year ended August 31, 2005, the Fund has elected to defer net realized capital losses of $236,386 and net realized currency losses of $73,329 incurred from November 1, 2004 to August 31, 2005. NOTE 4. ADVISORY, ADMINISTRATION, SERVICE AND DISTRIBUTION, TRUSTEE, AND OTHER FEES INVESTMENT ADVISORY FEE Effective April 15, 2004, Highland Capital Management, L.P. ("Highland") is the investment adviser to the 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 year ended August 31, 2005, the Portfolio's effective investment advisory fee rate was 0.45%. Prior to April 15, 2004, the Fund's investment advisory agreement provided for an investment advisory fee based on the Fund's average daily managed assets, which includes assets acquired with leverage. Although the Fund's board and shareholders were informed that the new advisory agreements implemented commencing on April 15, 2004 in connection with a change in investment adviser would not change the fee structure, the text of the agreement submitted to shareholders inadvertently provides for a fee based on the Fund's average daily net assets, which would not include assets acquired with leverage. This change was inadvertent, and Highland will ask the Board of Trustees to approve an amendment reverting retroactively as of April 15, 2004 to the intended formula based on the Fund's average daily managed assets, and submit the amendment to shareholders for approval. The Fund believes that approval of this amendment is appropriate and probable. Accordingly, the Fund has not modified its financial statements to reflect the lower fee that would be in effect if the fee were based on net assets rather than managed assets. The Fund will, however, hold back the difference between the two fee levels until it receives these approvals. If the amendment is not approved, the Fund will retain the differential and the fee formula will be based on net assets. 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 August 31, 2005, Highland received $1,741,375 in administrative fees, and paid PFPC $87,069 for their services. This amount is included in the "Administration fee" on the Statement of Operations of the Fund. Prior to October 18, 2004, Columbia Management Advisors, Inc. ("Columbia Management") provided administrative and other services to the Fund for a monthly administration fee at the annual rate of 0.20% of the Fund's average daily managed net assets managed daily. 27 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND 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 August 31, 2005, PFPC received $241,658 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 August 31, 2005, PFPC received $356,714 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. 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 PFPC Distributors, Inc. (the "Distributor") serves as the principal underwriter and distributor of the Fund's shares. The Distributor is paid a CDSC on certain redemptions of Class A, Class B and Class C Shares. For the year ended August 31, 2005, the Distributor received $66,496, $250,244 and $126,898 of CDSC on Class A, Class B and Class C share redemptions, respectively. The Fund has adopted a plan pursuant to Rule 12b-1 under the 1940 Act (the "Plan"), which requires the payment of a monthly service fee to the Distributor at the annual rate not to exceed 0.25% of the average daily net assets attributable to Class A, Class B and Class C shares of the Fund. The Plan also requires the payment of a monthly distribution fee to the Distributor on an annual basis, not to exceed 0.10%, 0.45% and 0.60% of the average daily net assets attributable to Class A, Class B and Class C shares, respectively. The CDSC and the fees received from the Plan are used principally as repayment for amounts paid to dealers who sold such shares. EXPENSE LIMITS AND FEE REIMBURSEMENTS 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 expense, taxes and extraordinary expenses, if any) exceed 0.15% annually of the Fund's average daily net assets. This arrangement may be revised or discontinued by Highland at any time. CUSTODY Effective October 18, 2004, PFPC Trust Company ("PFPC Trust") is the custodian to the Fund. For the period October 18, 2004 through August 31, 2005, PFPC Trust received $118,720 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. 28 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND 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. NOTE 5. PORTFOLIO INFORMATION For the year ended August 31, 2005, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were $1,290,874,899 and $852,001,230, respectively. NOTE 6. PERIODIC REPURCHASE OFFERS The Fund has adopted a fundamental policy to offer each fiscal quarter to repurchase a specified percentage (between 5% and 25%) of the shares then outstanding at 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 trading on the NYSE on such date. The Repurchase Pricing Date will occur no later than the 14th day after the Repurchase Request Deadline, or the next business day if the 14th day is not a business day. Repurchase proceeds will be paid to shareholders no later than seven days after the Repurchase Pricing Date. For the year ended August 31, 2005, there were four Repurchase Offers. For each Repurchase Offer, the Fund offered to repurchase 10% of its shares. In the November, February, May and August Repurchase Offers 5.03%, 5.61%, 5.64% and 5.51%, 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 August 31, 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. Term Loan $974,747 $981,454 - -------------------------------------------------------------- NOTE 8. LOAN AGREEMENT Effective October 18, 2004, the Fund entered into a new $300,000,000 secured loan agreement with Citicorp North America, Inc. ("Citicorp") replacing a previous agreement. The Fund is required to maintain certain asset coverage with respect to amounts outstanding under the agreement. 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. At August 31, 2005, the Fund had one term loan outstanding with Citicorp, totaling $250,000,000 expiring on October 14, 2005. The interest rate charged on this loan at August 31, 2005 was 3.60%. The average daily loan balance was $167,273,973 at a weighted average interest rate of 2.59%. The Fund was required to maintain certain asset coverage with respect to the loan. Interest expense of $4,536,502 is included on the Statement of Operations. NOTE 9. LOAN AGREEMENT ASSET COVERAGE REQUIREMENTS - ---------------------------------------------------------------- Asset Coverage per Total Amount $1,000 of Date Outstanding Indebtedness - ---------------------------------------------------------------- 08/31/2005 $ 250,000,000 $5,129 - ---------------------------------------------------------------- 08/31/2004 95,000,000 8,038 - ---------------------------------------------------------------- 08/31/2003 59,500,000 5,156 - ---------------------------------------------------------------- 08/31/2002 74,000,000 3,701 - ---------------------------------------------------------------- 08/31/2001 88,000,000 3,908 - ---------------------------------------------------------------- 08/31/2000 19,000,000 6,739 - ---------------------------------------------------------------- 29 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND NOTE 10. UNFUNDED LOAN COMMITMENTS As of August 31, 2005, the Portfolio had unfunded loan commitments of $21,250,487, which could be extended at the option of the Borrower, pursuant to the following loan agreements: - ---------------------------------------------------------------------- Unfunded Loan Borrower Commitment - ---------------------------------------------------------------------- CCM Merger, Inc./MotorCity Casino $ 450,000 - ---------------------------------------------------------------------- Covanta Energy Corp. 1,000,000 - ---------------------------------------------------------------------- Cricket Communications, Inc. 5,000,000 - ---------------------------------------------------------------------- Dobson Cellular Systems, Inc. 625,000 - ---------------------------------------------------------------------- Federal-Mogul Corp. 117,897 - ---------------------------------------------------------------------- Infor Global Solutions European Finance S.A.R.L. 1,235,772 - ---------------------------------------------------------------------- Interstate Bakeries Corp. 7,500,000 - ---------------------------------------------------------------------- Midwest Generations LLC 2,000,000 - ---------------------------------------------------------------------- NES Rentals Holdings, Inc. 638,484 - ---------------------------------------------------------------------- Select Medical Corp. 933,334 - ---------------------------------------------------------------------- Trump Entertainment Resorts, Inc. 1,750,000 - ---------------------------------------------------------------------- $ 21,250,487 - ---------------------------------------------------------------------- NOTE 11. DISCLOSURE OF SIGNIFICANT RISKS AND CONTINGENCIES INDUSTRY FOCUS The Fund may focus its investments in certain industries, subjecting it to greater risk than a fund that is more diversified. NON-PAYMENT RISK Senior Loans, like other corporate debt obligations, are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the Fund, a reduction in the value of the Senior Loan experiencing non-payment and a potential decrease in the net asset value of the Fund. CREDIT RISK Investments rated below investment grade are commonly referred to as high-yield, high risk or "junk debt." They are regarded as predominantly speculative with respect to the issuing company's continuing ability to meet principal and/or interest payments. Investments in high yield Senior Loans may result in greater net asset value fluctuation than if the Fund did not make such investments. CURRENCY RISK A portion of the Fund's assets may be quoted or denominated in non-U.S. currencies. These securities may be adversely affected by fluctuations in relative currency exchange rates and by exchange control regulations. The Fund's investment performance may be negatively affected by a devaluation of a currency in which the Fund's investments are quoted or denominated. Further, the Fund's investment performance may be significantly affected, either positively or negatively, by currency exchange rates because the U.S. dollar value of securities quoted or denominated in another currency will increase or decrease in response to changes in the value of such currency in relation to the U.S. dollar. LEGAL PROCEEDINGS Prior to April 15, 2004, the Fund was advised by Columbia Management and was part of the Columbia Funds Complex (the "Columbia Funds"). Several Columbia Funds are defendants in civil lawsuits that have been transferred and consolidated for pretrial proceedings in the United States District Court for the District of Maryland in the Special Multi-District Litigation proceeding (Index No. 04-MO-15863) created for actions involving market timing issues against mutual fund complexes. The lawsuits have been commenced as putative class actions on behalf of investors who purchased, held or redeemed shares of the Funds during specified periods or as derivative actions on behalf of the Funds. The lawsuits seek, among other things, unspecified compensatory damages plus interest and, in some cases, punitive damages, the rescission of investment advisory contracts, the return of fees paid under those contracts, and restitution. The consolidated amended class action complaint against Columbia-affiliated defendants was filed on September 29, 2004 and does not name the Fund as a defendant or nominal defendant. The consolidated amended fund derivative complaint against Columbia-affiliated defendants was also filed on September 29, 2004 and names the Columbia Funds, collectively, as nominal defendants. On March 2, 2005, four civil revenue sharing actions alleging, among other things, that various mutual funds (including the Fund) advised by Columbia Management and Columbia Wanger Asset Management L.P. inappropriately used fund assets to pay brokers to promote the funds by directing fund brokerage transactions to such brokers and did not fully disclose such arrangements to shareholders, and charged excessive 12b-1 fees, were consolidated into a single action in the United States District Court for Massachusetts (In re Columbia Entities Litigation, Civil Action No. 04-11704-REK). On June 9, 2005, plaintiffs filed a consolidated amended class action complaint and a motion for class certification. On or about August 8, 2005, all defendants (including the Fund) filed motions to dismiss the consolidated amended complaint. The court has not decided either the class certification or dismissal motions. 30 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND TO THE TRUSTEES AND SHAREHOLDERS OF HIGHLAND FLOATING RATE ADVANTAGE FUND: In our opinion, the accompanying statement of assets and liabilities, including the investment portfolio, and the related statements of operations, changes in net assets and of cash flows and the financial highlights present fairly, in all material respects, the financial position of Highland Floating Rate Advantage Fund (the "Fund") at August 31, 2005, and the results of its operations, the changes in its net assets and cash flows and the financial highlights for periods indicated in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of investments held at August 31, 2005 by correspondence with the custodian and the banks with whom the Fund owns participations in loans, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Boston, Massachusetts October 25, 2005 31 ADDITIONAL INFORMATION (UNAUDITED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND TRUSTEES AND OFFICERS The Trustees and officers serve terms of indefinite duration. The names, addresses and ages of the Trustees and officers of the Fund, the year each was first elected or appointed to office, their principal business occupations during at least the last five years, the number of portfolios overseen by each Trustee and other directorships they hold are shown below. Each officer listed below serves as an officer of each Fund in the Highland Funds Complex.
YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS ELECTED OR OCCUPATION(S) IN HIGHLAND FUNDS OTHER NAME, ADDRESS, POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS AND AGE WITH FUND TO OFFICE FIVE YEARS BY TRUSTEE1 HELD - ------- --------- --------- ---------- ----------- ------ INDEPENDENT TRUSTEES Timothy K. Hui Trustee 2004 Associate Provost for Graduate 8 None. (Age 56) Education since July 2004 and c/o Highland Capital Assistant Provost for Educational Management, L.P. Resources from July 2001 to 13455 Noel Road, June 2004, Philadelphia Suite 1300 Biblical University. Dallas, Texas 75240 Scott F. Kavanaugh Trustee 2004 Private Investor. From February 8 None. (Age 44) 2003, to July 2003, an Executive at c/o Highland Capital Provident Funding Mortgage Management, L.P. Corporation. From January 2000 13455 Noel Road, to February 2003, Executive Vice Suite 1300 President, Director and Treasurer Dallas, Texas 75240 of Commercial Capital Bank. From April 1998 to February 2003, Managing Principal and Chief Operating Officer of Financial Institutional Partners Mortgage Company and the Managing Principal and President of Financial Institutional Partners, LLC, an investment banking firm. James F. Leary Trustee 2004 Since January 1999, a Managing 8 Capstone (Age 75) Director of Benefit Capital Series Fund, c/o Highland Capital Southwest, Inc., a financial Inc.; Stewart Management, L.P. consulting firm. Funds, Inc. 13455 Noel Road, (3 portfolios); Suite 1300 Pacesetter/ Dallas, Texas 75240 MVHC Inc. (small business investment company) Bryan A. Ward Trustee 2004 Since January 2002, Senior 8 None. (Age 50) Manager of Accenture, LLP. From c/o Highland Capital September 1998 to December Management, L.P. 2001, he was Special Projects 13455 Noel Road, Advisor to Accenture, LLP Suite 1300 with focus on the oil and Dallas, Texas 75240 gas industry.
32 ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2005 HIGHLAND FLOATING RATE ADVANTAGE FUND TRUSTEES AND OFFICERS
YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS ELECTED OR OCCUPATION(S) IN HIGHLAND FUNDS OTHER NAME, ADDRESS, POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS AND AGE WITH FUND TO OFFICE FIVE YEARS BY TRUSTEE 1 HELD - ------- --------- --------- ---------- ------------ ------ INTERESTED TRUSTEE 2 R. Joseph Dougherty Trustee 2004 Portfolio Manager of the 8 None. (Age 34) and Senior Vice Adviser. Prior to 2000, he c/o Highland Capital President was a Portfolio Analyst Management, L.P. for the Adviser. 13455 Noel Road, Suite 1300 Dallas, TX 75240 OFFICERS James D. Dondero President 2004 President and Managing N/A N/A (Age 42) Partner of the Adviser. c/o Highland Capital Director of Heritage Bank. Management, L.P. Director and Chairman of 13455 Noel Road, Heritage Bankshares, Inc. Suite 1300 Dallas, TX 75240 Mark Okada Executive 2004 Chief Investment Officer of N/A N/A (Age 44) Vice the Adviser. Director of Heritage c/o Highland Capital President Bank and Heritage Bankshares, Management, L.P. Inc. 13455 Noel Road, Suite 1300 Dallas, TX 75240 M. Jason Blackburn Secretary and 2004 Assistant Controller of the Adviser. N/A N/A (Age 29) Treasurer From September 1999 to c/o Highland Capital October 2001, he was an Management, L.P. accountant for KPMG LLP. 13455 Noel Road, Suite 1300 Dallas, TX 75240 Michael S. Minces Chief 2004 From October 2003 to August 2004, N/A N/A (Age 30) Compliance associate at Akin Gump Strauss c/o Highland Capital Officer Hauer & Feld LLP (law firm). From Management, L.P. October 2000 to March 2003, 13455 Noel Road, associate at Skadden, Arps, Slate, Suite 1300 Meagher & Flom LLP (law firm). Dallas, TX 75240 Previously, he attended The University of Texas at Austin School of Law. 1 The Highland Fund Complex consists of the following funds (the "Highland Funds"): Highland Floating Rate Limited Liability Company, Highland Floating Rate Fund, Highland Floating Rate Advantage Fund, Highland Institutional Floating Rate Income Fund, Highland Corporate Opportunities Fund, Restoration Opportunities Fund, Prospect Street(R) High Income Portfolio Inc. and Prospect Street(R) Income Shares Inc. 2 Mr. Dougherty is deemed to be an "interested person" of the Fund under the 1940 Act because of his position with the Adviser.
33 IMPORTANT INFORMATION ABOUT THIS REPORT - -------------------------------------------------------------------------------- TRANSFER AGENT The Fund mails one shareholder report to PFPC Inc. each shareholder address. If you would 101 Sabin Street like more than one report, please call Pawtucket, RI 02860 shareholder services at 1-877-665-1287 and additional reports will be sent to you. DISTRIBUTOR This report has been prepared for PFPC Distributors, Inc. shareholders of Highland Floating Rate 760 Moore Road Advantage Fund. King of Prussia, PA 19406 INVESTMENT ADVISER A description of the policies and Highland Capital Management, L.P. procedures that the Fund uses to 13455 Noel Road Suite 1300 determine how to vote proxies relating Dallas, TX 75240 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. INDEPENDENT REGISTERED PUBLIC The Fund files its complete schedule of ACCOUNTING FIRM portfolio holdings with the Securities PricewaterhouseCoopers LLP and Exchange Commission for the first 125 High Street and third quarters of each fiscal year Boston, MA 02110 on Form N-Q. The Fund's Forms N-Q are available on the Commission's website at http:/www.sec.gov and also may be reviewed and copied at the Commission's Public Reference Room in Washington, DC. Information on the Public Reference Room may be obtained by calling 1-800-SEC-0330. The Statement of Additional Information includes information about Fund Directors and is available upon request without charge by calling 1-877-665-1287. 34 THIS PAGE LEFT BLANK INTENTIONALLY. THIS PAGE LEFT BLANK INTENTIONALLY. HIGHLAND FLOATING RATE ADVANTAGE FUND Annual Report, August 31, 2005 [GRAPHIC OMITTED] HIGHLAND FUNDS managed by Highland Capital Management, L.P. HLC-FR-ADV AR-8/05 ITEM 2. CODE OF ETHICS. (a) The registrant, as of the end of the period covered by this report, has adopted a code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. (b) Not applicable. (c) There have been no amendments, during the period covered by this report, to a provision of the code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. (d) The registrant has not granted any waiver, including any implicit waiver, from a provision of the code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller. (e) Not applicable. (f) The registrant's code of ethics is incorporated by reference to Exhibit (a)(1) to the registrant's Form N-CSR filed with the Securities and Exchange Commission on November 9, 2004 (Accession No. 0001047469-04-033537). ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT. The Registrant's Board of Trustees (the "Board") has determined that James Leary, a member of the Audit Committee of the Board, is an audit committee financial expert as defined by the Securities and Exchange Commission (the "SEC"). Mr. Leary is "independent" as defined by the SEC for purposes of audit committee financial expert determinations. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. AUDIT FEES (a) The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant's annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years were $51,990 for the fiscal year ended August 31, 2004 and $54,590 for the fiscal year ended August 31, 2005. AUDIT-RELATED FEES (b) The aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant's financial statements and are not reported under paragraph (a) of this Item were $4,000 for the fiscal year ended August 31, 2004 and $5,000 for the fiscal year ended August 31, 2005. The nature of those services was agreed-upon procedures related to semi-annual financial statements. TAX FEES (c) The aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning were $4,500 for the fiscal year ended August 31, 2004 and $4,800 for the fiscal year ended August 31, 2005. The nature of those services was assistance on tax returns and excise tax calculations. ALL OTHER FEES (d) The aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant, other than the services reported in paragraphs (a) through (c) of this Item were $0 for the fiscal year ended August 31, 2004 and $0 for the fiscal year ended August 31, 2005. (e)(1) Disclose the audit committee's pre-approval policies and procedures described in paragraph (c)(7) of Rule 2-01 of Regulation S-X. The Audit Committee shall: (a) have direct responsibility for the appointment, compensation, retention and oversight of the Fund's independent auditors and, in connection therewith, to review and evaluate matters potentially affecting the independence and capabilities of the auditors; and (b) review and pre-approve (including associated fees) all audit and other services to be provided by the independent auditors to the Fund and all non-audit services to be provided by the independent auditors to the Fund's investment adviser or any entity controlling, controlled by or under common control with the investment adviser (an "Adviser Affiliate") that provides ongoing services to the Fund, if the engagement relates directly to the operations and financial reporting of the Fund; and (c) establish, to the extent permitted by law and deemed appropriate by the Audit Committee, detailed pre-approval policies and procedures for such services; and (d) consider whether the independent auditors' provision of any non-audit services to the Fund, the Fund's investment adviser or an Adviser Affiliate not pre-approved by the Audit Committee are compatible with maintaining the independence of the independent auditors. (e)(2) The percentage of services described in each of paragraphs (b) through (d) of this Item that were approved by the audit committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X are as follows: (b) 100% (c) 100% (d) Not applicable (f) The percentage of hours expended on the principal accountant's engagement to audit the registrant's financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountant's full-time, permanent employees was less than fifty percent. (g) The aggregate non-audit fees billed by the registrant's accountant for services rendered to the registrant, and rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the adviser that provides ongoing services to the registrant for each of the last two fiscal years of the registrant were $0 for the fiscal year ended August 31, 2004 and $85,252 for the fiscal year ended August 31, 2005. (h) The registrant's audit committee of the board of directors has considered whether the provision of non-audit services that were rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible with maintaining the principal accountant's independence. ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. Not applicable. ITEM 6. SCHEDULE OF INVESTMENTS. Schedule of Investments in securities of unaffiliated issuers as of the close of the reporting period is included as part of the report to shareholders filed under Item 1 of this form. ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES. The Adviser has adopted proxy voting guidelines (the "Guidelines") that provide as follows: o The Adviser votes proxies in respect of a client's securities in the client's best economic interests and without regard to the interests of the Adviser or any other client of the Adviser. o Unless the Adviser's Proxy Voting Committee (the "Committee") otherwise determines (and documents the basis for its decision) or as otherwise provided below, the Adviser votes proxies in a manner consistent with the Guidelines. o To avoid material conflicts of interest, the Adviser applies the Guidelines in an objective and consistent manner across client accounts. Where a material conflict of interest has been identified and the matter is covered by the Guidelines, the Committee votes in accordance with the Guidelines. For clients that are registered investment companies, where a conflict of interest has been identified and the matter is not covered in the Guidelines, the Adviser will disclose the conflict and the Committee's determination of the manner in which to vote to the Fund's Board. For clients that are not investment companies, where a conflict of interest has been identified and the matter is not covered in the Guidelines, the Committee will disclose the conflict to the client and advise the client that its securities will be voted only upon the client's written direction. o The Adviser also may determine not to vote proxies in respect of securities of any issuer if it determines it would be in its clients' overall best interests not to vote. The Adviser's Guidelines address how it will vote proxies on particular types of matters such as changes in corporate government structures, adoption of options plans and anti-takeover proposals. For example, the Adviser generally will: o support management in most elections for directors, unless the board gives evidence of acting contrary to the best economic interests of shareholders; o support option plans, if it believes that they provide for their administration by disinterested parties and provide incentive to directors, managers and other employees by aligning their economic interests with those of the shareholders while limiting the transfer of wealth out of the company; and o oppose anti-takeover proposals unless they are structured in such a way that they give shareholders the ultimate decision on any proposal or offer. ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES. Not yet applicable. ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT COMPANY AND AFFILIATED PURCHASERS. Not applicable. ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There have been no material changes to the procedures by which the shareholders may recommend nominees to the registrant's board of directors, where those changes were implemented after the registrant last provided disclosure in response to the requirements of Item 7(d)(2)(ii)(G) of Schedule 14A (17 CFR 240.14a-101), or this Item. ITEM 11. CONTROLS AND PROCEDURES. (a) The registrant's principal executive and principal financial officers, or persons performing similar functions, have concluded that the registrant's disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940, as amended (the "1940 Act")) are effective, as of a date within 90 days of this filing, based on their evaluation of these controls and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15(b)). (b) There were no changes in the registrant's internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act) that occurred during the registrant's last half year that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. ITEM 12. EXHIBITS. (a)(1) Not applicable. (a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto. (a)(3) Not applicable. (b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. (registrant) HIGHLAND FLOATING RATE ADVANTAGE FUND -------------------------------------------------------------------- By (Signature and Title)* /S/ JAMES D. DONDERO ------------------------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) Date NOVEMBER 3, 2005 ---------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By (Signature and Title)* /S/ JAMES D. DONDERO ------------------------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) Date NOVEMBER 3, 2005 ---------------------------------------------------------------------------- By (Signature and Title)* /S/ M. JASON BLACKBURN ------------------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) Date NOVEMBER 3, 2005 ---------------------------------------------------------------------------- * Print the name and title of each signing officer under his or her signature. EX-99.CERT 2 cert302.txt 302 CERTIFICATION CERTIFICATION PURSUANT TO RULE 30A-2(A) UNDER THE 1940 ACT AND SECTION 302 OF THE SARBANES-OXLEY ACT I, James D. Dondero, certify that: 1. I have reviewed this report on Form N-CSR of Highland Floating Rate Advantage Fund; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: NOVEMBER 3, 2005 /S/ JAMES D. DONDERO ---------------------- ----------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) CERTIFICATION PURSUANT TO RULE 30A-2(A) UNDER THE 1940 ACT AND SECTION 302 OF THE SARBANES-OXLEY ACT I, M. Jason Blackburn, certify that: 1. I have reviewed this report on Form N-CSR of Highland Floating Rate Advantage Fund; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: NOVEMBER 3, 2005 /S/ M. JASON BLACKBURN ---------------------- ------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) EX-99.906CERT 3 cert906.txt 906 CERTIFICATION CERTIFICATION PURSUANT TO RULE 30A-2(B) UNDER THE 1940 ACT AND SECTION 906 OF THE SARBANES-OXLEY ACT I, James D. Dondero, Chief Executive Officer of Highland Floating Rate Advantage Fund (the "Registrant"), certify that, to the best of my knowledge: 1. The Form N-CSR of the Registrant for the period ended August 31, 2005 (the "Report") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: NOVEMBER 3, 2005 /S/ JAMES D. DONDERO ---------------------- ----------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) I, M. Jason Blackburn, Chief Financial Officer of Highland Floating Rate Advantage Fund (the "Registrant"), certify that, to the best of my knowledge: 1. The Form N-CSR of the Registrant for the period ended August 31, 2005 (the "Report") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: NOVEMBER 3, 2005 /S/ M. JASON BLACKBURN ---------------------- ------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) -----END PRIVACY-ENHANCED MESSAGE-----