-----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, LBB07N1ir5XLhlvpEKaLJ+WAc/9w6gu7KdUwEi/sBU3jasDP3mjYgubREB1sNGfg OOCf4Owdc1t+ETtsCJPUpg== 0000935069-07-002537.txt : 20071031 0000935069-07-002537.hdr.sgml : 20071030 20071031130027 ACCESSION NUMBER: 0000935069-07-002537 CONFORMED SUBMISSION TYPE: N-CSR PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20070831 FILED AS OF DATE: 20071031 DATE AS OF CHANGE: 20071031 EFFECTIVENESS DATE: 20071031 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HIGHLAND FLOATING RATE LTD LIABILITY CO CENTRAL INDEX KEY: 0001068201 IRS NUMBER: 364251184 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: N-CSR SEC ACT: 1940 Act SEC FILE NUMBER: 811-08957 FILM NUMBER: 071201992 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 LIMITED LIABILITY CO DATE OF NAME CHANGE: 20031107 FORMER COMPANY: FORMER CONFORMED NAME: STEIN ROE FLOATING RATE LIMITED LIABILITY CO DATE OF NAME CHANGE: 19980929 N-CSR 1 q41915_hfrllc.txt HIGHLAND LIMITED LIABILITY NCSR 0807 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 811-08957 --------- Highland Floating Rate Limited Liability Company - -------------------------------------------------------------------------------- (Exact name of registrant as specified in charter) Two Galleria Tower 13455 Noel Road, Suite 800 Dallas, Texas 75240 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip code) James D. Dondero Highland Capital Management, L.P. Two Galleria Tower 13455 Noel Road, Suite 800 Dallas, Texas 75240 - -------------------------------------------------------------------------------- (Name and address of agent for service) registrant's telephone number, including area code: (877) 665-1287 -------------- Date of fiscal year end: August 31 --------- Date of reporting period: August 31, 2007 --------------- Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles. A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget ("OMB") control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. ss. 3507. ITEM 1. REPORTS TO STOCKHOLDERS. The Report to Shareholders is attached herewith. ---------------------- HIGHLAND FLOATING RATE FUND ANNUAL REPORT AUGUST 31, 2007 ---------------------- [GRAPHIC OMITTED] [HIGHLAND FUNDS LOGO] managed by Highland Capital Management, L.P. [LOGO] HIGHLAND FLOATING RATE FUND [LOGO] - -------------------------------------------------------------------------------- TABLE OF CONTENTS Portfolio Managers' Letter ................................................ 1 Fund Profile .............................................................. 3 Financial Statements ...................................................... 4 Investment Portfolio ................................................... 5 Portfolio Statement of Assets and Liabilities .......................... 17 Portfolio Statement of Operations ...................................... 18 Portfolio Statements of Changes in Net Assets .......................... 19 Portfolio Statement of Cash Flows ...................................... 20 Portfolio Financial Highlights ......................................... 21 Fund Statement of Assets and Liabilities ............................... 22 Fund Statement of Operations ........................................... 23 Fund Statements of Changes in Net Assets ............................... 24 Fund Financial Highlights .............................................. 26 Notes to Financial Statements .......................................... 30 Report of Independent Registered Public Accounting Firm ................ 36 Additional Information ................................................. 37 Important Information About This Report ................................... 44 Economic and market conditions change frequently. There is no assurance that the trends described in this report will continue or commence. PLEASE READ THE PROSPECTUS CAREFULLY BEFORE YOU INVEST. PORTFOLIO MANAGERS' LETTER - -------------------------------------------------------------------------------- OCTOBER 24, 2007 HIGHLAND FLOATING RATE FUND DEAR SHAREHOLDERS: Q: HOW HAS THE FUND PERFORMED? A: For the 12-month period ending August 31, 2007, the Fund's Class A Shares returned 4.28%. That was greater than the return of the Fund's benchmark, the Credit Suisse ("CS") Leveraged Loan Index, which was 2.99% for the period, and the Lipper Loan Participation Loan Category average, which was 2.37% for the period. During this same time period, the Standard & Poor's ("S&P") 500 index returned 15.13% and the Lehman Aggregate Bond Index returned 5.26%. Within the portfolio there were a number of positions that performed well during the period. The Fund's strongest performers included Calpine Corporation Term Loan, Nellson Nutraceutical Second Lien Term Loan, Camelbak Products Loan Second Lien Term Loan, Reliant Pharmaceuticals First Lien Term Loan and Longyear Global Holdings Second Lien Term Loan. The weakest performers during the period included Ypso Holding SA (Numericable) B (Recap) 1 Facility, Environmental Systems Products Holdings Inc. Term Loan Second Lien, Spirit Finance Corporation Loan, IPC Systems, Inc. Tranche B-1 Term Loan and Generac Acquisition Corp. Second Lien Term Loan. Q: WHAT WAS THE INVESTMENT ENVIRONMENT LIKE FOR LEVERAGED LOANS DURING THE PERIOD? A: During most of the reporting period, loan spreads tightened while interest rates remained flat. The Credit Suisse Leveraged Loan Index's spread fell from 255 bps in October of 2006 to a low this year of 244 bps by the end of May 2007. According to Standard and Poor's Leveraged Commentary and Data ("LCD") Leveraged Lending Reviews much of the leveraged loan activity in 2007 has been driven by leveraged buy out ("LBO") transactions, which reached a volume of $248 billion in the first half of 2007, or 64% of the market.1 Inflows into collateralized loan obligation ("CLOs"), hedge funds and other non-traditional accounts more than met the market's liquidity requirements during most of the first half of the year. However, July was the worst month for loan performance on record as measured by the S&P/Loan Syndication Trading Association ("LSTA") index. Weak technical conditions drove the S&P/LSTA index down to 95.27 by the end of July. The index posted a record loss, of 3.35% in July, leaving year-to-date loan returns for the index at -.03%. During August, the market appeared to plateau with the S&P/LSTA index posting a modest gain of .23%. The leveraged loan market's performance during July and August was, in our opinion, technical in nature and impacted by the contagion from the consumer sub-prime mortgage market. For most of the year the leveraged loan market had been unaffected by the negative sentiment in the sub-prime market. However, starting in July some of the levered entities holding sub-prime assets were forced into liquidation to meet margin calls on their highly levered holdings. This caused a general repricing of other structured products and took enough liquidity out of the market to shut down the new issue CLO market, which is a major source of liquidity in the loan market. That lack of loan demand, coupled with the large new issue supply, caused a repricing of corporate loans. In our opinion market performance is being driven by the above mentioned technical factors. Further reinforcing the technical versus fundamental nature of the recent repricing is the current default rate. During this summer's repricing the lagging 12-month default rate remained near an all-time low of ..42% by principal amount, well below the index's historical average of 3.17%. These low default rates are an indication of just how strong the fundamentals remain across the credit markets. Q: HOW IS THE FUND CURRENTLY POSITIONED? A: The Fund is approximately 96.81% loans, 2.62% equities and .57% other corporate debt, as a percentage of investments. With regards to diversification, the Fund is currently invested in approximately 42 industries and 335 issuers. Q: WHAT IS YOUR OUTLOOK? A: With the large forward calendar needing to be placed and the state of the CLO market still in flux, it is difficult to see a quick snap back in spreads. - ---------- 1 S&P Leverage Loan Commentary and Data - 2nd Qtr 2007 Review p. 2. 2 S&P LCD Weekly Wrap August 16 2007 p. 16. 3 S&P LCD Loan Stats August 2007 p. 2. 4 S&P LCD Weekly Wrap September 6 2007 p. 18. 5 S&P LCD Weekly Wrap September 13 2007 p. 19. Annual Report | 1 PORTFOLIO MANAGERS' LETTER - -------------------------------------------------------------------------------- OCTOBER 24, 2007 HIGHLAND FLOATING RATE FUND Some LBO transactions are being delayed while others are offered with larger than anticipated original issue discount ("OID") and with higher spreads than initially expected in order to clear the market. We are also seeing covenants being added to deals. We believe the digestion process will take at least six months to clear the backlog of underwritten deals. By extension, loans in the secondary market traded down through August, but have shown signs of stabilization, at least temporarily, in September. Our analysts see some good buying opportunities in this price correction during the second half of the calendar year. In our opinion, repricing of the broader market was overdone from a fundamental standpoint. For example, the Credit Suisse Leveraged Loan Index traded at a monthly average of 100.09 during the first ten months of the performance year but during July and August traded down to 95.87 and 95.37, respectively. Given the fairly benign fundamental backdrop (i.e., low default rates, cash flow growth, etc.) we expect a gradual increase in pricing and tightening of spreads. However, in our opinion, this could take as long as six months due in part to the large supply of loans on the calendar. In our fundamental monitoring of our credit portfolios, we do not foresee see a material increase in default rates until after 2008, but an increase from here is probable simply due to the extraordinary low numbers today. However, the Fund holds a well diversified portfolio which should help insulate it against an increase in default rates. The inevitable market correction could be viewed as a positive for the Fund by creating some good buying opportunities. /s/ Mark Okada /s/ Joe Dougherty MARK OKADA JOE DOUGHERTY Portfolio Manager Portfolio Manager Mark Okada and Joe Dougherty have been portfolio managers of the Highland Floating Rate Fund since April 15, 2004. Just like any other investment, floating rate loan investments present financial risks. Defaults on the loans in the portfolio could reduce the Fund's net asset value and its distributions, as could nonpayment of scheduled interest and principal. Prepayment of principal by a borrower could mean the Fund's managers have to replace the loan with a lower-yielding security, which could affect the valuation of the portfolio's holdings. The Fund is a continuously offered, closed-end management investment company and provides limited liquidity through a quarterly tender offer for between 5% and 25% of outstanding shares. Each quarter, the Fund's trustees must approve the actual tender. Please read the prospectus carefully for more details. The Fund may invest a high percentage of assets in a limited number of loans, so the default of any individual 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 contributors and are subject to change. Prior investment returns are not indicative of future results. 2 | Annual Report FUND PROFILE - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND - ---------------------------------------------- Objective - ---------------------------------------------- The Highland Floating Rate Fund (the "Fund") invests all of its investable assets in Highland Floating Rate Limited Liability Company (the "Portfolio"). The Fund and the Portfolio seek a high level of current income consistent with preservation of capital. - ---------------------------------------------- Net Assets as of August 31, 2007 - ---------------------------------------------- $2,328.2 million - ---------------------------------------------- Portfolio Data as of August 31, 2007 - ---------------------------------------------- The information below provides a snapshot of the Portfolio at the end of the reporting period. The Portfolio is actively managed and the composition of its investment portfolio will change over time. ------------------------------------------------- QUALITY BREAKDOWN AS OF 08/31/07 (%)* ------------------------------------------------- A 0.2 ------------------------------------------------- Baa 0.8 ------------------------------------------------- Ba 25.0 ------------------------------------------------- B 41.0 ------------------------------------------------- Caa 3.0 ------------------------------------------------- NR 30.0 ------------------------------------------------- ------------------------------------------------- TOP 5 SECTORS AS OF 08/31/07 (%)* ------------------------------------------------- Housing -- Real Estate Development 8.2 ------------------------------------------------- Telecommunications 6.6 ------------------------------------------------- Diversified Media 6.4 ------------------------------------------------- Healthcare -- Medical Products 5.9 ------------------------------------------------- Retail 5.4 ------------------------------------------------- -------------------------------------------------------- TOP 10 HOLDINGS AS OF 08/31/07 (%)* -------------------------------------------------------- Lake at Las Vegas Joint Venture 3.2 -------------------------------------------------------- HCA, Inc. 2.4 -------------------------------------------------------- Ford Motor Co. 1.7 -------------------------------------------------------- Univision Communications, Inc. 1.7 -------------------------------------------------------- Cricket Communications, Inc. 1.6 -------------------------------------------------------- Delphi Corp. 1.6 -------------------------------------------------------- Tribune Co. 1.5 -------------------------------------------------------- Charter Communications Operating, LLC 1.5 -------------------------------------------------------- Gray Television, Inc. 1.4 -------------------------------------------------------- MetroPCS Wireless, Inc. 1.4 -------------------------------------------------------- * Quality is calculated as a percentage of total notes and bonds. Sectors and holdings are calculated as a percentage of net assets. Annual Report | 3 FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND A GUIDE TO UNDERSTANDING THE FUND'S FINANCIAL STATEMENTS INVESTMENT PORTFOLIO The Investment Portfolio details all of the Portfolio's holdings and their market value as of the last day of the reporting period. Portfolio holdings are organized by type of asset and industry to demonstrate areas of concentration and diversification. STATEMENT OF ASSETS AND LIABILITIES These statements detail the Fund's and the Portfolio's assets, liabilities, net assets and, with respect to the Fund, share price for each share class as of the last day of the reporting period. Net assets are calculated by subtracting all liabilities (including any unpaid expenses) from the total of investment and non-investment assets. The net asset value per share 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 These statements detail income earned by the Fund and the Portfolio and the expenses accrued by the Fund and the Portfolio during the reporting period. The Statement of Operations also shows any net gain or loss realized on the sales of holdings during the period, as well as any unrealized gains or losses recognized over the period. The total of these results represents net increase or decrease in net assets from operations. STATEMENTS OF CHANGES IN NET ASSETS These statements demonstrate how the Fund's and the Portfolio's net assets were affected by their 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, with respect to the Fund, also detail changes in the number of shares outstanding. STATEMENT OF CASH FLOWS This statement reports net cash and foreign currency provided or used by operating, investing and financing activities and the net effect of those flows on cash and foreign currency 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 also disclose the classes' performance and certain key ratios of the Fund and the Portfolio (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 and the Portfolio, their 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.
4 | Annual Report INVESTMENT PORTFOLIO - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- SENIOR LOANS (a) - 77.0% AEROSPACE - AEROSPACE/DEFENSE - 2.2% AWAS Capital, Inc. 13,545,859 First Lien Term Loan, 7.13%, 03/15/13 ................................ 12,936,296 6,550,321 Second Lien Term Loan, 11.38%, 03/15/13 ............................... 6,452,066 2,992,500 DeCrane Aircraft Holdings, Inc. First Lien Term Loan, 8.10%, 02/21/13 ................................ 2,902,725 1,903,900 Forgings International Holdings Term D, 9.33%, 03/22/15 ........................ 1,782,526 Forgings International Ltd. 2,349,647 Term B2, 7.61%, 09/22/14 ....................... 2,238,039 2,383,511 Term C2, 7.82%, 09/22/15 ....................... 2,270,294 1,970,000 IAP Worldwide Services, Inc. First Lien Term Loan, 9.69%, 12/30/12 ................................ 1,708,975 Travelport LLC 3,300,000 Delayed Draw Term Loan, 9.75%, 08/23/13 ................................ 3,176,250 10,000,000 Letter of Credit, 8.00%, 05/23/14 ................................ 9,625,000 357,499 Synthetic Letter of Credit, 7.61%, 08/23/13 ................................ 344,093 415,264 Synthetic Letter of Credit, 7.86%, 08/23/13 ................................ 399,691 4,340,731 Tranche B Dollar Term Loan, 7.75%, 08/23/13 ................................ 4,177,954 2,929,412 Vought Aircraft Industries, Inc. Term Loan, 7.83%, 12/22/11 ..................... 2,848,853 990,749 Wesco Aircraft Hardware Corp. First Lien Term Loan, 7.61%, 09/30/13 ................................ 964,741 ------------ 51,827,503 ------------ AEROSPACE - AIRLINES - 1.6% Continental Airlines, Inc. 1,714,286 Tranche A-1 Term Loan, 8.74%, 06/01/11 ................................ 1,690,714 4,285,714 Tranche A-2 Term Loan, 8.74%, 06/01/11 ................................ 4,226,786 Delta Air Lines, Inc. 945,000 Credit-Linked Deposit Loan, 7.36%, 04/30/12 ................................ 907,795 2,000,000 Second Lien Term Loan, 8.61%, 04/24/14 (b) ............................ 1,928,120 4,950,000 Northwest Airlines, Inc. Term Loan, DIP, 7.34%, 08/21/08 ................ 4,671,563 25,250,000 US Airways, Inc. Term Loan, 7.85%, 03/23/14 ..................... 23,890,035 ------------ 37,315,013 ------------ BROADCASTING - 3.0% 2,883,246 All3Media Intermediate Ltd. UK Term Loan B, 7.74%, 08/31/14 ................................ 2,739,084 Comcorp Broadcasting, Inc. 43,647 CCB PIK Revolver, 06/04/14 (c) (d) ............................... 47,172 196,684 CCB PIK Term Loan, 06/04/14 (c) (d) ............................... 212,569 350,503 CCB Revolver, 06/04/14 (c) (d) ................. 378,811 1,684,317 CCB Term Loan, 06/04/14 (c) (d) ................ 1,820,347 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- BROADCASTING (CONTINUED) Comcorp Broadcasting, Inc. (continued) 78,965 WK PIK Term Loan, 06/04/14 (c) (d) ............................... 85,343 677,065 WK Term Loan, 06/04/14 (c) (d) ................. 731,747 Millennium Digital Media Systems, LLC 764,478 Revolver, 9.00%, 06/30/11 (d) (e) .............. 764,478 28,068,904 Term Facility, 9.36%, 06/30/11 ................. 27,718,043 NextMedia Operating, Inc 1,185,930 Delay Draw Term Loan, 7.32%, 11/15/12 ................................ 1,126,633 2,668,341 Initial First Lien Term Loan, 7.32%, 11/15/12 ................................ 2,534,924 11,000,000 Paxson Communications Corp. First Lien Term Loan, 8.61%, 01/15/12 ................................ 10,725,000 1,500,000 Persona Communications Corp. Second Lien Term Loan, 11.32%, 04/12/14 ............................... 1,511,250 19,823,662 Young Broadcasting, Inc. Term Loan, 7.88%, 11/03/12 ..................... 18,535,124 ------------ 68,930,525 ------------ CABLE - INTERNATIONAL CABLE - 0.5% 805,000 San Juan Cable, LLC Second Lien Term Loan, 10.86%, 10/31/13 ............................... 784,875 9,442,500 UPC Financing Partnership Facility N1, 7.13%, 12/31/14 ................... 8,893,702 3,000,000 Virgin Media Inc. B4 Facility, 7.36%, 07/03/12 ................... 2,905,980 ------------ 12,584,557 ------------ CABLE - US CABLE - 4.4% 2,675,000 Bresnan Communications, LLC Additional Term Loan B, 7.36%, 06/30/13 ................................ 2,594,750 CCO Holdings, LLC 1,000,000 Incremental Loan, 7.86%, 09/06/14 .............. 966,250 2,000,000 Incremental Loan, 7.85%, 09/06/14 .............. 1,932,500 Cequel Communications LLC 250,000 Second Lien Tranche A Term Loan, 9.86%, 05/05/14 ................................ 243,125 11,720,625 Term Loan, 7.36%, 11/05/13 ..................... 11,087,711 Charter Communications Operating, LLC 16,500,000 New Term Loan, 7.35%, 03/06/14 ................. 15,675,000 36,166,667 Term Facility, 7.36%, 04/28/13 ................. 34,358,333 10,000,000 Knology, Inc. Term Loan, 7.59%, 06/30/12 ..................... 9,800,000 995,000 Mediacom Illinois, LLC Tranche C Term Loan, 7.10%, 01/31/15 ................................ 933,648 Northland Cable Television, Inc. 4,925,000 First Lien Term Loan B, 9.36%, 12/22/12 ................................ 4,912,688 4,000,000 Second Lien Term Loan, 13.36%, 06/22/13 ............................... 4,000,000 5,000,000 RCN Corp. Initial Term Loan, 7.69%, 04/25/14 ............. 4,750,000 WideOpenWest Finance, LLC 11,000,000 First Lien Term Loan, 7.85%, 06/30/14 (b) ............................ 10,367,500 1,000,000 Second Lien Term Loan, 06/29/15 (b) ................................... 910,000 ------------ 102,531,505 ------------ See accompanying Notes to Financial Statements. | 5 INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- SENIOR LOANS (CONTINUED) CHEMICALS - COMMODITY & FERTILIZER - 0.6% 6,982,500 Celanese US Holdings, LLC Term Loan, 7.11%, 04/02/14 ..................... 6,774,422 5,000,000 Cognis GMBH Facility C, 7.32%, 09/15/13 .................... 4,604,200 Ferro Corp. 500,472 Term Loan, 7.36%, 06/06/12 ..................... 495,468 1,250,000 Term Loan, 7.42%, 06/06/12 ..................... 1,237,500 267,611 Term Loan, 7.57%, 06/06/12 ..................... 264,935 ------------ 13,376,525 ------------ CHEMICALS - SPECIALTY CHEMICALS - 0.3% 997,500 Berry Plastics Holding Corp. Term C Loan, 7.36%, 04/03/15 (f) ............... 957,600 Hexion Specialty Chemicals, Inc. 2,335,641 Tranche C-1 Term Loan, 7.88%, 05/05/13 (f) ............................ 2,290,096 507,368 Tranche C-2 Term Loan, 7.88%, 05/05/13 (f) ............................ 496,713 481,479 Ineos U S Finance LLC Term Loan A4 Facility, 7.58%, 12/14/12 ................................ 460,053 1,277,273 Innophos, Inc. Tranche B Term Loan, 7.57%, 08/13/10 ................................ 1,251,727 970,284 Kraton Polymers Group of Cos. Term Loan, 7.38%, 12/23/10 ..................... 915,705 848,000 Nusil Technology LLC Tranche B Term Loan, 8.07%, 10/24/13 ................................ 852,240 1,000,000 Panda Hereford Ethanol, L.P. Tranche A Term Loan, 9.07%, 07/28/13 ................................ 977,500 ------------ 8,201,634 ------------ CONSUMER DURABLES - 0.1% 2,654,000 Rexair LLC First Lien Term Loan, 9.61%, 06/30/10 ................................ 2,627,460 ------------ CONSUMER NON-DURABLES - 1.4% 3,990,000 Amscan Holdings, Inc. Term Loan, 7.63%, 05/27/13 ..................... 3,785,513 995,556 BioTech Research Labs/Philosophy Merger Sub, Inc. First Lien Term Loan, 7.36%, 03/16/14 ................................ 910,933 1,555,556 Camelbak Products, Inc. Second Lien Term Loan, 12.91%, 02/04/12 ............................... 1,438,889 2,985,000 DS Waters of America, Inc. Term Loan, 7.61%, 10/27/12 ..................... 2,835,750 72 Eastman Kodak Co. Term B-1 Advance, 10/18/12 ..................... 72 556,429 Hanesbrands, Inc. Term B Loan, 7.10%, 09/05/13 ................... 542,240 1,693,519 Hillman Group, Inc. Term Loan B, 8.38%, 03/30/11 ................... 1,651,181 Solo Cup Co. 7,212,593 Term B1 Loan, 8.92%, 02/27/11 .................. 7,111,906 851,796 Term B1 Loan, 8.84%, 02/27/11 .................. 839,905 1,000,000 Term B1 Loan, 02/27/11 (b) ..................... 986,040 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- CONSUMER NON-DURABLES (CONTINUED) Spectrum Brands, Inc. 1,739,831 Dollar Term B II Loan, 9.32%, 03/30/13 ................................ 1,652,839 9,776,883 Dollar Term B Loan, 9.36%, 03/30/13 ................................ 9,532,461 483,286 Letter of Credit, 5.17%, 03/30/13 .............. 472,412 992,475 Yankee Candle Co., Inc. Term Loan, 7.36%, 02/06/14 ..................... 956,498 ------------ 32,716,639 ------------ DIVERSIFIED MEDIA - 5.5% 185,111 Black Press Group Ltd. Term B-2 Tranche Loan, 7.54%, 08/01/13 ................................ 181,524 304,889 Black Press U S Partnership Term B-1 Tranche Loan, 7.54%, 08/01/13 ................................ 298,980 2,921,213 Cinemark USA, Inc. Term Loan, 7.23%, 10/05/13 ..................... 2,805,300 Endurance Business Media, Inc. 2,810,126 First Lien Term Loan, 8.07%, 07/26/13 ................................ 2,683,671 2,000,000 Second Lien Term Loan, 12.57%, 01/26/14 ............................... 1,980,000 994,936 HIT Entertainment PLC Term Facility, 7.34%, 03/20/12 ................. 950,164 1,000,000 Knowledgepoint360 Group LLC Second Lien Term Loan, 12.53%, 04/26/15 ............................... 997,500 2,955,000 Merrill Communications LLC Combined Term Loan, 7.59%, 05/15/11 ................................ 2,892,206 Metro-Goldwyn-Mayer Holdings II, Inc. 13,747,475 Tranche B Term Loan, 8.61%, 04/08/12 ................................ 13,043,054 9,287,607 Tranche B Term Loan, 8.60%, 04/08/12 ................................ 8,811,710 Penton Media, Inc. 6,483,750 First Lien Term Loan, 7.60%, 02/01/13 ................................ 6,167,667 5,500,000 Second Lien Term Loan, 10.36%, 02/01/14 ............................... 5,197,500 Readers Digest Association, Inc. 972,500 Revolver, 8.63%, 02/17/13 (e) .................. 904,425 4,987,500 U.S. Term Loan, 7.36%, 03/02/14 ................ 4,650,844 Riverdeep Interactive Learning USA, Inc. 1,927,099 Bridge Facility, 12.06%, 12/21/14 .............. 1,917,464 14,442,314 Term Loan, 8.11%, 12/20/13 ..................... 14,249,798 Springer Science+Business Media S.A. 562,496 Tranche B-2, 7.75%, 09/16/11 ................... 543,000 562,496 Tranche C-2, 8.12%, 07/05/14 ................... 543,000 366,301 Tranche E-2, 8.12%, 07/05/14 ................... 353,605 338,124 USD Tranche B-2 Add On, 07/05/13 ............... 326,405 338,124 USD Tranche C-2 Add On, 07/05/14 ............... 326,405 Tribune Co. 38,000,000 Initial Tranche B Advance, 8.36%, 05/19/14 ................................ 34,437,500 20,066,667 Tranche X Advance, 7.86%, 05/18/09 ................................ 19,590,083 Valassis Communications, Inc. 213,333 Delayed Draw Term Loan, 03/02/14 (b) ................................... 199,401 718,033 Tranche B Term Loan, 7.11%, 03/02/14 ................................ 668,446 1,980,075 West Corp. Term B-2 Loan, 7.82%, 10/24/13 ................. 1,916,217 6 | See accompanying Notes to Financial Statements. INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- SENIOR LOANS (CONTINUED) DIVERSIFIED MEDIA (CONTINUED) 936,108 WMG Acquisitions Corp. Term Loan, 7.48%, 02/28/11 ..................... 911,245 ------------ 127,547,114 ------------ ENERGY - EXPLORATION & PRODUCTION - 0.4% III Exploration II LP 750,000 Delayed Draw Term Loan, 9.11%, 10/29/13 ................................ 723,750 4,239,375 Initial Draw Term Loan, 8.85%, 10/28/13 ................................ 4,090,997 Targa Resources, Inc. 771,822 Synthetic Letter of Credit, 5.23%, 10/31/12 ................................ 742,879 3,159,638 Term Loan, 7.36%, 10/31/12 ..................... 3,041,151 ------------ 8,598,777 ------------ ENERGY - OTHER ENERGY - 1.5% Coffeyville Resources, LLC 486,146 Funded Letter of Credit, 5.25%, 12/28/10 ................................ 456,977 2,499,212 Tranche D Term Loan, 8.60%, 12/30/13 ................................ 2,410,190 4,500,000 Endeavour International Holding B.V. Second Lien Term Loan, 12.36%, 11/01/11 ............................... 4,455,000 7,424,551 Helix Energy Solutions Group, Inc. Term Loan, 7.33%, 07/01/13 ..................... 7,174,047 994,962 MEG Energy Corp. Initial Term Loan, 7.36%, 04/03/13 ............. 968,437 Monitor US Finco, Inc. 3,980,000 First Lien Term Loan, 10.86%, 01/11/14 ............................... 3,980,000 3,000,000 Second Lien Term Loan, 17.36%, 12/14/14 ............................... 2,970,000 8,596,862 Value Creation, Inc. Term Loan, 12.85%, 07/01/12 .................... 8,338,956 975,000 Volnay Acquisition Co. I Term Loan B1, 7.36%, 01/12/14 .................. 947,583 4,000,000 Willbros USA, Inc. Syndicate Term Loan, 10.27%, 10/27/09 ............................... 4,020,000 ------------ 35,721,190 ------------ ENERGY - REFINING - 0.4% 846,750 Concho Resources, Inc. Second Lien Term Loan, 9.74%, 03/27/12 ................................ 834,049 3,000,000 Connacher Finance Corp. Term Loan, 8.61%, 10/20/13 ..................... 2,992,500 2,000,000 Port Barre Investments, LLC Term B Loan, 7.49%, 08/14/14 ................... 1,930,000 2,785,714 Western Refining, Inc. Term Loan, 9.00%, 05/30/14 ..................... 2,657,739 ------------ 8,414,288 ------------ FINANCIAL - 1.6% 1,741,250 AlixPartners, LLP Tranche C Term Loan, 7.61%, 10/12/13 ................................ 1,697,719 2,604,643 Arias Acquisitions, Inc. Term Loan, 10.86%, 07/26/11 .................... 2,181,388 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- FINANCIAL (CONTINUED) Checksmart Financial Co. 1,913,193 First Lien Tranche B Term Loan, 8.11%, 05/01/12 ................................ 1,831,882 2,500,000 Second Lien Term Loan, 10.87%, 05/01/13 ............................... 2,350,000 Dollar Financial Corp. 1,143,898 Canadian Borrower Term Loan, 8.11%, 10/30/12 ................................ 1,121,020 841,102 Delayed Draw Term Loan, 8.11%, 10/30/12 ................................ 824,280 Emerson Reinsurance Ltd. 3,250,000 Series A Loan, 7.11%, 12/15/11 ................. 3,152,500 1,250,000 Series B Loan, 8.36%, 12/15/11 ................. 1,212,500 992,500 First American Payment Systems, L.P. Term Loan, 8.63%, 10/06/13 ..................... 977,613 Flatiron Re Ltd. 1,619,945 Closing Date Term Loan, 9.59%, 12/29/10 ................................ 1,605,802 784,661 Delayed Draw Term Loan, 9.59%, 12/29/10 ................................ 777,811 2,078,125 FleetCor Technologies Operating Co., LLC Tranche 1 Term Loan, 7.59%, 04/30/13 ................................ 2,005,391 HUB International Holdings, Inc. 287,582 Delayed Draw Term Loan, 8.01%, 06/13/14 (e) ............................ 276,977 4,084,967 Initial Term Loan, 7.86%, 06/13/14 ............. 3,934,314 4,000,000 Kepler Holdings, Ltd. Term Loan, 10.85%, 06/30/09 .................... 3,880,000 1,000,000 Online Resources Corp. Term Loan A, 8.07%, 02/09/12 ................... 960,000 8,795,676 Wind Acquisition Holdings Finance S.A. PIK Term Loan, 12.61%, 12/21/11 ............................... 8,729,708 ------------ 37,518,905 ------------ FOOD AND DRUG - 0.4% 8,000,000 Rite Aid Corp. Senior Secured Bridge Loan, 10/23/07 (b) ................................... 7,960,000 1,492,500 Weight Watchers International, Inc. Term Loan B, 6.88%, 01/26/14 ................... 1,477,575 ------------ 9,437,575 ------------ FOOD/TOBACCO - FOOD/TOBACCO PRODUCERS - 0.5% 2,584,905 Chiquita Brands LLC Term Loan C, 8.56%, 06/28/12 ................... 2,524,573 FSB Holdings, Inc. 1,500,000 First Lien Tranche B Term Loan, 7.88%, 09/29/13 ................................ 1,455,000 1,000,000 Second Lien Term Loan, 11.13%, 03/29/14 ............................... 995,000 LJVH Holdings, Inc. 2,000,000 Second Lien Loan, 10.86%, 01/19/15 ............................... 1,940,000 880,000 Tranche B Term Loan, 7.86%, 07/19/14 ................................ 858,000 120,000 Tranche C Term Loan, 7.86%, 07/19/14 ................................ 117,000 3,826,607 Michelina's Term Loan, 8.38%, 04/02/11 ..................... 3,750,075 ------------ 11,639,648 ------------ See accompanying Notes to Financial Statements. | 7 INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- SENIOR LOANS (CONTINUED) FOOD/TOBACCO - RESTAURANTS - 1.0% 3,980,000 Aramark Canada Ltd. Canadian Term Loan, 7.35%, 01/26/14 ................................ 3,820,800 Aramark Corp. 120,394 Letter of Credit Facility, 7.36%, 01/26/14 ................................ 116,395 221 U.S. Term Loan, 7.36%, 01/26/14 ................ 214 Buffets Holdings, Inc. 583,243 PF Letter of Credit Commitments, 11/01/13 ....................................... 548,249 1,321,875 Revolver, 10.50%, 11/01/11 (e) ................. 1,201,228 4,394,583 Term Loan, 8.11%, 11/01/13 ..................... 4,130,908 1,433,089 Caribbean Restaurant LLC Tranche B Term Loan, 8.07%, 06/30/09 ................................ 1,411,593 1,951,597 El Pollo Loco, Inc. Term Loan, 7.86%, 11/18/11 ..................... 1,907,686 OSI Restaurant Partners LLC 4,644,157 Incremental Term Loan, 7.63%, 06/14/14 ................................ 4,411,949 355,843 Synthetic Revolver, 5.18%, 06/14/13 ................................ 339,830 5,000,000 Pinnacle Foods Finance LLC Term Loan, 8.11%, 04/02/14 ..................... 4,787,500 997,500 Sbarro, Inc. Term Loan B, 7.88%, 01/31/14 ................... 955,106 ------------ 23,631,458 ------------ FOREST PRODUCTS - PACKAGING - 0.3% 5,985,000 Graham Packaging Co. Term Loan B, 7.63%, 10/07/11 ................... 5,825,380 Smurfit Kappa Acquisitions 1,000,000 B1 Term Loan Facility, 7.49%, 12/01/13 ................................ 980,000 1,000,000 C1 Term Loan Facility, 8.11%, 12/01/14 ................................ 980,000 ------------ 7,785,380 ------------ FOREST PRODUCTS - PAPER - 0.1% 1,478,076 NewPage Corp. Term Loan, 7.63%, 05/02/11 ..................... 1,448,515 ------------ GAMING/LEISURE - GAMING - 0.6% 3,936,051 CCM Merger, Inc./MotorCity Casino Term Loan B, 7.36%, 04/25/12 ................... 3,827,810 1,994,811 Green Valley Ranch Gaming LLC Term Loan, 7.36%, 02/16/14 ..................... 1,905,045 1,961,759 Riverside Casino & Golf Resort, LLC Term Loan, 8.88%, 11/30/11 ..................... 1,942,141 6,000,000 VML U S Finance LLC Term B Funded Project Loan, 7.61%, 05/25/13 ................................ 5,790,000 ------------ 13,464,996 ------------ GAMING/LEISURE - OTHER LEISURE - 1.1% Alpha Topco Ltd. 1,428,571 Facility B1, 8.13%, 12/31/13 ................... 1,385,714 1,071,429 Facility B2, 8.13%, 12/31/13 ................... 1,039,286 5,000,000 Fontainebleu Florida Hotel LLC Tranche C Term Loan, 11.38%, 06/06/12 ............................... 4,668,750 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- GAMING/LEISURE - OTHER LEISURE (CONTINUED) 4,666,667 Fontainebleu Las Vegas LLC Term Loan, 8.61%, 05/17/14 ..................... 4,357,500 995,000 Greenwood Racing Inc. Term Loan, 7.57%, 11/28/11 ..................... 957,688 3,660,201 Kuilima Resort Co. First Lien Term Loan, 9.85%, 09/30/10 ................................ 3,417,713 3,000,000 Orbitz Worldwide, Inc. Term Loan, 8.34%, 07/25/14 ..................... 2,925,000 Trump Entertainment Resorts Holdings, L.P. 2,208,703 Term C-1 Facility, 7.90%, 05/20/12 ............. 2,175,572 2,208,703 Term C-2 Facility, 7.86%, 05/20/12 ............. 2,175,572 1,940,000 Wallace Theaters First Lien Term Loan, 8.60%, 07/31/09 ................................ 1,891,500 882,286 Yellowstone Mountain Club, LLC First Lien Term Loan, 7.70%, 09/30/10 ................................ 854,344 ------------ 25,848,639 ------------ HEALTHCARE - ACUTE CARE - 2.6% 1,396,862 Alliance Imaging, Inc. Tranche C1 Term Loan, 7.88%, 12/29/11 ................................ 1,373,297 HCA, Inc. 979,545 Tranche A Term Loan, 7.35%, 11/17/12 ................................ 937,601 57,240,000 Tranche B Term Loan, 7.61%, 11/17/13 (b) ............................ 55,245,758 2,977,500 ReAble Therapeutics Finance, LLC Term Loan, 7.84%, 11/04/13 ..................... 2,917,950 ------------ 60,474,606 ------------ HEALTHCARE - ALTERNATE SITE SERVICES - 1.7% 1,426,568 American HomePatient, Inc. Secured Promissory Note, 6.79%, 08/01/09 (g) ............................ 1,426,568 8,912,220 CHS/Community Health Systems, Inc. Funded Term Loan, 7.57%, 07/25/14 ................................ 8,593,162 FHC Health Systems, Inc. 513,978 Delayed Draw Term Loan, 14.07%, 12/18/09 ............................... 519,117 734,254 Initial Term Loan, 12.07%, 12/18/09 ............ 741,596 1,500,000 Third Lien Additional Term Loan, 15.11%, 02/09/11 ............................... 1,515,000 5,000,000 Third Lien Term Loan, 15.11%, 02/09/11 ............................... 5,050,000 16,335,360 LifeCare Holdings Term Loan, 8.36%, 08/11/12 ..................... 15,110,208 3,000,000 Medical Staffing Network, Inc. First Lien Term Loan, 10.75%, 07/02/13 ............................... 2,977,500 1,960,000 Skilled Healthcare LLC First Lien Term Loan, 7.57%, 06/15/12 ................................ 1,950,200 331,070 Sunrise Medical Holdings, Inc. Term Loan B-1, 9.47%, 05/13/10 ................. 316,172 1,940,000 WellCare Health Plans, Inc. Term Loan, 7.88%, 05/13/09 ..................... 1,937,575 ------------ 40,137,098 ------------ 8 | See accompanying Notes to Financial Statements. INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- SENIOR LOANS (CONTINUED) HEALTHCARE - MEDICAL PRODUCTS - 5.5% 1,786,106 American Medical Systems, Inc. Term Loan, 7.69%, 07/20/12 ..................... 1,745,918 CB Diagnostics AB 1,349,530 Facility B2, 7.46%, 01/19/15 ................... 1,298,923 3,959,790 Facility C2, 7.73%, 01/18/16 ................... 3,831,096 CCS Medical, Inc. 29,449,723 First Lien Term Loan, 8.57%, 09/30/12 ................................ 29,099,861 4,750,000 Second Lien Term Loan, 13.32%, 03/30/13 ............................... 4,785,625 1,865,625 CompBenefits Corp. Tranche B Term Loan, 8.32%, 04/12/12 ................................ 1,849,301 1,467,632 DSI Renal, Inc. Term Facility, 7.63%, 03/31/13 ................. 1,397,919 8,977,500 Fenwal, Inc. Initial First Lien Term Loan, 7.57%, 02/28/14 ................................ 8,326,631 1,000,000 Golden Gate National Senior Care LLC Second Lien Term Loan, 13.07%, 09/14/11 ............................... 990,000 Graceway Pharmaceuticals LLC 4,958,333 First Lien Term B Loan, 8.07%, 05/03/12 ................................ 4,729,010 4,500,000 Mezzanine Loan, 13.61%, 11/03/13 ............... 3,735,000 9,438,170 HealthSouth Corp. Term Loan, 7.85%, 03/10/13 ..................... 9,115,762 IM US Holdings LLC 5,000,000 First Lien Term Loan, 9.25%, 06/26/14 (b) ............................ 4,825,000 1,000,000 Second Lien Term Loan, 11.50%, 06/26/15 ............................... 985,000 Nyco Holdings 3 ApS 3,875,000 Facility B2, 7.86%, 12/29/14 ................... 3,589,258 3,875,000 Facility C2, 8.36%, 12/29/15 ................... 3,627,969 Patheon, Inc. 1,197,000 Tranche PB Loan, 7.88%, 04/27/14 ............... 1,161,090 798,000 Tranche USB Loan, 7.88%, 04/27/14 .............. 774,060 3,950,000 Pharmaceutical Holdings Corp. Term Loan, 8.76%, 01/30/12 ..................... 3,831,500 2,498,369 Psychiatric Solutions, Inc. Term Loan, 7.11%, 07/02/12 ..................... 2,404,680 Reliant Pharmaceuticals, Inc. 626,337 Delayed Draw Term Loan, 8.61%, 03/31/12 ................................ 598,152 2,366,163 Initial Term Loan, 8.59%, 03/31/12 ............. 2,259,685 Talecris Biotherapeutics Holdings Corp. 16,417,500 First Lien Term Loan, 9.08%, 12/06/13 ................................ 16,263,668 7,500,000 Second Lien Term Loan, 12.08%, 12/08/14 ............................... 7,514,100 Triumph Healthcare Second Holdings LLC 1,989,994 First Lien Term Loan, 8.83%, 07/28/13 ................................ 1,940,244 1,000,000 Second Lien Term Loan, 13.57%, 07/28/14 ............................... 962,500 4,540,493 Warner Chilcott Co., Inc. Tranche B Acquisition Date Term Loan, 7.36%, 01/18/12 ..................... 4,407,093 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- HEALTHCARE - MEDICAL PRODUCTS (CONTINUED) 1,356,959 Warner Chilcott Corp. Tranche C Acquisition Date Term Loan, 7.36%, 01/18/12 ..................... 1,317,091 ------------ 127,366,136 ------------ HOUSING - BUILDING MATERIALS - 2.6% 1,720,000 Associated Materials Inc. Term Loan, 7.89%, 08/29/10 ..................... 1,651,200 5,287,241 Atrium Cos., Inc. Closing Date Term Facility, 8.61%, 06/21/12 ................................ 4,784,953 1,866,523 Custom Building Products, Inc. First Lien Term Loan, 7.76%, 10/20/11 ................................ 1,754,532 612,171 DESA LLC Term Loan, 13.00%, 11/26/11 .................... 589,980 Jacuzzi Brands Corp. 917,095 First Lien Term Loan B, 7.62%, 02/07/14 (f) ............................ 831,117 81,081 Pre-Funded Letter of Credit, 5.25%, 02/07/14 (f) ............................ 73,784 4,465,473 Nortek, Inc. Term Loan, 7.61%, 08/27/11 ..................... 4,281,272 1,485,092 PGT Industries, Inc. First Lien Tranche A-2 Term Loan, 8.62%, 02/14/12 ................................ 1,451,678 312,297 Professional Paint, Inc. First Lien Term Loan, 7.78%, 05/31/12 ................................ 295,121 Realogy Corp. 1,969,697 Initial Term B Loan, 8.36%, 10/10/13 (f) ............................ 1,794,276 530,303 Synthetic Letter of Credit, 8.32%, 10/10/13 (f) ............................ 483,074 1,994,975 Roofing Supply Group LLC First Lien Term Loan, 9.35%, 08/31/13 ................................ 1,915,176 7,000,000 Spirit Finance Corp. Term Loan, 8.36%, 08/01/13 ..................... 6,405,000 1,000,000 Standard Pacific Corp. Term Loan B, 7.02%, 05/05/13 ................... 920,000 9,172,092 Stile Acquisition Corp. Canadian Term Loan, 7.36%, 04/06/13 ................................ 8,518,581 7,934,124 Stile U.S. Acquisition Corp. U.S. Term Loan, 7.36%, 04/06/13 ................ 7,390,637 WAICCS Las Vegas 3 LLC 11,000,000 First Lien Term Loan, 8.83%, 07/30/08 ................................ 10,890,000 5,000,000 Second Lien Term Loan, 14.33%, 07/30/08 ............................... 4,950,000 2,000,000 Withers Preserve MB-I B-Note, 9.82%, 12/14/07 ........................ 1,990,000 ------------ 60,970,381 ------------ HOUSING - REAL ESTATE DEVELOPMENT - 7.5% Ginn LA Conduit Lender, Inc. 5,676,099 First Lien Tranche A Credit-Linked Deposit, 8.86%, 06/08/11 (b) ................... 4,966,587 12,273,298 First Lien Tranche B Term Loan, 8.86%, 06/08/11 (b) ............................ 10,739,136 2,143,382 Giraffe Intermediate, LLC Mezzanine Note A-1, 7.07%, 08/09/10 ................................ 2,143,382 See accompanying Notes to Financial Statements. | 9 INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- SENIOR LOANS (CONTINUED) HOUSING - REAL ESTATE DEVELOPMENT (CONTINUED) Kyle Acquisition Group LLC 1,142,857 Facility B, 8.88%, 07/20/09 .................... 1,062,857 857,143 Facility C, 8.88%, 07/20/11 .................... 797,143 Lake at Las Vegas Joint Venture 11,074,074 Synthetic Revolver, 15.46%, 06/20/12 ............................... 10,963,333 80,925,926 Term Loan, 15.42%, 06/20/12 .................... 74,047,222 3,940,000 LBREP/L-Suncal Master I LLC First Lien Term Loan, 8.61%, 01/19/10 ................................ 3,703,600 3,000,000 LNR Property Corp. Initial Tranche B Term Loan, 8.11%, 07/12/11 ................................ 2,902,500 3,283,813 Morningside Assisted Living Senior Mortgage Loan, 8.40%, 10/12/08 ................................ 3,292,023 4,500,000 MPH Mezzanine II, LLC Mezzanine 2B, 8.85%, 02/09/08 .................. 4,488,750 2,850,000 MPH Mezzanine III, LLC Mezanine 3, 9.85%, 02/09/08 .................... 2,842,875 15,000,000 MPH Mezzanine IV, LLC Mezzanine 4, 8.57%, 02/09/08 (b) ............... 14,962,500 606,618 MPO Intermediate LLC Mezzanine Note A-1, 7.07%, 08/09/10 ................................ 606,618 1,454,555 November 2005 Land Investors, LLC First Lien Term Loan, 8.07%, 05/09/11 ................................ 1,345,463 1,985,000 Shea Capital I, LLC Facility B, 7.36%, 10/27/11 .................... 1,806,350 Tamarack Resort LLC 2,697,248 Tranche A Credit-Linked Deposit, 5.25%, 05/19/11 ................................ 2,683,761 3,995,298 Tranche B Term Loan, 8.60%, 05/19/11 ................................ 3,695,651 3,417,857 The Rhodes Cos. LLC First Lien Term Loan, 8.86%, 11/21/10 ................................ 3,195,696 17,098,651 Westgate Investments, LLC Senior Secured Loan, 13.00%, 09/25/10 PIK (g) ....................... 17,782,597 4,000,000 Weststate Land Partners LLC First Lien Term Loan, 8.61%, 05/01/08 ................................ 3,940,000 3,957,333 Woodlands Commercial Properties Co., LP Bridge Loan, 8.11%, 02/28/08 ................... 3,962,280 ------------ 175,930,324 ------------ INFORMATION TECHNOLOGY - 4.4% 3,955,000 Applied Systems, Inc. Term Loan, 7.85%, 09/26/13 ..................... 3,875,900 1,000,000 Aspect Software, Inc. Second Lien Term Loan, 12.44%, 07/11/12 ............................... 945,000 Ax Acquisition Corp. 1,000,000 First Lien Term Loan B, 8.88%, 08/15/14 ................................ 942,500 1,000,000 Second Lien Term Loan B, 9.31%, 08/15/14 ................................ 965,000 1,875,000 Billing Services Group North America, Inc. U.S. Term Loan, 7.88%, 05/05/12 ................................ 1,877,344 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- INFORMATION TECHNOLOGY (CONTINUED) 480,286 Bridge Information Systems, Inc. Multidraw Term Loan, 11.00%, 07/07/13 (c) (f) ....................... 36,021 Caritor, Inc. 7,441,860 Closing Date Term Loan, 7.61%, 06/04/13 ................................ 6,809,302 558,140 Synthetic Letter of Credit Loan, 7.61%, 06/04/13 ................................ 510,698 987,450 Deltek Systems, Inc. Term Loan, 7.59%, 04/22/11 ..................... 952,889 1,977,556 DTN, Inc. Tranche C Term Loan, 8.35%, 03/10/13 ................................ 1,947,893 19,900,000 Freescale Semiconductor, Inc. Term Loan, 7.11%, 11/29/13 ..................... 18,686,498 2,000,000 GXS Corp. Second Lien Term Loan, 14.61%, 01/29/12 ............................... 1,990,000 1,500,000 Hyland Software, Inc. First Lien Term Loan, 8.07%, 07/31/13 ................................ 1,470,000 Infor Enterprise Solutions Holdings, Inc. 3,743,996 Delayed Draw Term Loan, 9.11%, 07/28/12 ................................ 3,519,356 7,175,992 Initial U.S. Term Facility, 9.11%, 07/28/12 ................................ 6,709,552 6,165,362 Intergraph Corp. First Lien Term Loan, 7.32%, 05/29/14 (b) ............................ 5,945,751 IPC Systems, Inc. 3,000,000 Second Lien Tranche B Term Loan, 10.61%, 06/01/15 ............................... 2,628,750 17,250,000 Tranche B-1 Term Loan, 7.61%, 06/02/14 ................................ 15,223,125 4,975 MediMedia USA, Inc. Tranche B Term Loan, 7.63%, 10/05/13 ................................ 4,984 8,000,000 NameMedia, Inc. Term Loan, 11.33%, 08/31/08 .................... 7,880,000 2,683,282 Ridgefield Midco Sarl Facility A2, 13.07%, 09/30/16 PIK .............. 2,558,268 1,000,000 Serena Software, Inc. Term Loan, 7.34%, 03/10/13 ..................... 976,250 1,946,921 Sitel, LLC U.S. Term Loan, 7.85%, 01/30/14 ................ 1,854,442 5,560,866 SunGard Data Systems, Inc. Term Loan B, 7.36%, 02/28/14 ................... 5,409,722 4,738,125 Vangent, Inc. Term Loan, 7.62%, 02/14/13 ..................... 4,513,064 4,692,308 Verint Systems, Inc. Term Loan, 8.09%, 05/27/14 ..................... 4,539,808 997,500 Vertafore, Inc. Term Loan, 7.86%, 01/31/12 ..................... 957,600 ------------ 103,729,717 ------------ MANUFACTURING - 0.7% 1,760,039 Baldor Electric Co. Term Loan, 7.13%, 03/31/14 ..................... 1,731,438 1,490,921 Coinmach Corp. Tranche B-1 Term Loan, 7.88%, 12/16/12 ................................ 1,464,830 FCI International S.A.S. 127,374 Term Loan B2A, 7.76%, 03/10/14 ................. 123,659 127,374 Tranche B3C, 7.76%, 11/03/14 ................... 123,659 10 | See accompanying Notes to Financial Statements. INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- SENIOR LOANS (CONTINUED) MANUFACTURING (CONTINUED) FCI SA 122,626 Term Loan B2B, 7.76%, 03/10/14 ................. 119,049 122,626 Tranche B4B, 7.76%, 11/03/13 ................... 119,216 FCI USA, Inc. 250,000 Facility B1, 7.76%, 03/10/14 ................... 242,708 250,000 Tranche B5B, 7.76%, 11/03/13 ................... 242,708 2,992,500 FR Brand Acquisition Corp. First Lien Term Loan B, 7.63%, 02/07/14 ................................ 2,797,988 3,250,000 Generac Acquisition Corp. First Lien Term Loan, 7.85%, 11/11/13 (b) ............................ 2,897,895 1,980,000 Global Petroleum Inc. Term Loan, 9.90%, 09/18/13 ..................... 1,920,600 1,888,113 Mueller Water Products, Inc. Term Loan B, 7.10%, 05/26/14 ................... 1,846,235 2,000,000 Polypore, Inc. US Term Loan, 7.56%, 07/03/14 .................. 1,912,500 ------------ 15,542,485 ------------ METALS/MINERALS - OTHER METALS/MINERALS - 1.1% 2,155,263 Euramax International Holdings B.V. Second Lien European Loan, 13.36%, 06/29/13 (b) ........................... 2,004,394 Euramax International, Inc. 2,052,012 Domestic Term Loan, 8.38%, 06/29/12 ................................ 1,891,258 4,344,737 Second Lien Domestic Term Loan, 13.36%, 06/29/13 (b) ........................... 3,975,434 5,000,000 Kaiser Aluminum & Fabricated Products, LLC Term Loan, 9.57%, 07/06/11 ..................... 4,975,000 8,052,728 Murray Energy Corp. Tranche B Term Loan, 8.54%, 01/28/10 ................................ 8,012,465 763,307 Oglebay Norton Co. Tranche B Term Loan, 7.60%, 07/31/12 ................................ 748,041 4,388,194 Universal Buildings Products, Inc. Term Loan, 8.60%, 04/28/12 ..................... 4,366,254 ------------ 25,972,846 ------------ METALS/MINERALS - STEEL - 0.0% Standard Steel, LLC 166,667 Delayed Draw Term Loan, 7.93%, 07/02/12 ................................ 160,833 825,000 Initial Term Loan, 7.86%, 07/02/12 ............. 796,125 ------------ 956,958 ------------ RETAIL - 4.4% 20,397,938 Blockbuster Entertainment Corp. Tranche B Term Loan, 9.46%, 08/20/11 ................................ 19,830,671 31,575,741 Burlington Coat Factory Warehouse Corp. Term Loan, 7.61%, 05/28/13 ..................... 29,700,774 5,000,000 Dollar General Corp. Tranche B-1 Term Loan, 8.07%, 07/07/14 ................................ 4,657,800 945,519 Dollarama Group LP Term Loan B, 7.11%, 11/18/11 ................... 917,153 2,466,718 Eddie Bauer, Inc. Term Loan, 8.57%, 04/01/14 ..................... 2,405,050 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- RETAIL (CONTINUED) 1,496,250 General Nutrition Centers, Inc. Term Loan, 7.61%, 09/16/13 ..................... 1,410,216 Home Interiors & Gifts, Inc. 2,407,902 Initial Term Loan, 10.35%, 03/31/11 ............ 1,456,781 27,649,391 Initial Term Loan, 10.36%, 03/31/11 ............ 16,727,881 8,478,643 Michaels Stores, Inc. Replacement Loan, 7.63%, 10/31/13 .............. 8,015,879 1,995,000 Mother's Work, Inc. Term Loan, 7.86%, 03/13/13 ..................... 1,855,350 Movie Gallery, Inc. 140,000 First Lien Synthetic Letter of Credit, 10.86%, 03/08/12 (b) ........................... 117,775 3,354,000 First Lien Term Loan, 10.86%, 03/08/12 (b) ........................... 2,821,553 1,492,481 Sally Holdings, LLC Term B Loan, 7.86%, 11/18/13 ................... 1,451,438 990,000 Sports Authority, Inc., The Term Loan B, 7.61%, 05/03/13 ................... 930,600 Totes Isotoner Corp. 3,482,500 First Lien Term Loan, 7.83%, 01/31/13 ................................ 3,378,025 1,000,000 Second Lien Term Loan, 11.36%, 01/31/14 ............................... 980,000 4,000,000 Toys "R" Us Tranche B Term Loan, 9.76%, 07/19/12 ................................ 3,973,000 1,000,000 TRU 2005 Holding Co. I, Ltd Term Loan, 8.32%, 12/09/08 ..................... 985,000 ------------ 101,614,946 ------------ SERVICE - ENVIRONMENTAL SERVICES - 0.4% 997,500 Brickman Group Holdings, Inc. Tranche B Term Loan, 7.40%, 01/23/14 ................................ 950,119 591,142 Duratek, Inc. Term Loan, 7.66%, 06/07/13 ..................... 568,235 EnergySolutions, LLC 62,893 Synthetic Letter of Credit, 7.57%, 06/07/13 ................................ 60,456 1,233,178 Term Loan, 7.66%, 09/30/11 ..................... 1,185,393 Safety-Kleen Systems, Inc. 1,220,339 Synthetic Letter of Credit, 7.88%, 08/02/13 ................................ 1,195,932 4,642,881 Term Loan B, 7.88%, 08/02/13 ................... 4,550,024 ------------ 8,510,159 ------------ SERVICE - OTHER SERVICES - 1.8% 2,000,000 Audio Visual Services Group, Inc. Second Lien Loan, 10.86%, 08/28/14 ............................... 1,920,000 1,900,000 Cydcor, Inc. First Lien Tranche B Term Loan, 8.61%, 02/05/13 ................................ 1,890,500 3,482,412 Education Management LLC Tranche C Term Loan, 7.13%, 06/01/13 ................................ 3,330,509 3,451,424 NES Rentals Holdings, Inc. Second Lien Permanent Term Loan, 12.13%, 07/20/13 ............................... 3,393,164 795,841 Rental Service Corp. Second Lien Initial Term Loan, 8.86%, 11/30/13 ................................ 787,882 30,266,998 Sabre, Inc. Initial Term Loan, 7.61%, 09/30/14 ................................ 28,148,308 See accompanying Notes to Financial Statements. | 11 INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- SENIOR LOANS (CONTINUED) SERVICE - OTHER SERVICES (CONTINUED) 766,871 Survey Sampling International LLC Term Loan, 7.85%, 05/06/11 .................... 751,534 1,652,305 United Rentals, Inc. Initial Term Loan, 7.32%, 02/14/11 ............ 1,621,324 ------------- 41,843,221 ------------- TELECOMMUNICATIONS - 5.1% 8,000,000 Discovery Communications Holding LLC Term B Loan, 7.36%, 05/14/14 .................. 7,790,000 Global Tel Link Corp. 260,870 Acquisition Synthetic Deposit, 5.26%, 02/13/08 ............................... 254,348 391,304 Acquisition Term Loan, 10.75%, 02/14/13 .............................. 381,522 65,217 Synthetic Deposit, 5.26%, 02/13/08 ............................... 63,587 770,870 Term Facility, 8.86%, 02/14/08 ................ 751,598 34,750,000 Gray Television, Inc. Term Loan B, 6.86%, 12/31/14 .................. 32,838,750 3,970,000 Intelsat Corp. Tranche B-2 Term Loan, 7.36%, 01/03/14 ............................... 3,854,870 18,500,000 Level 3 Financing, Inc. Term Loan, 7.61%, 03/13/14 .................... 17,713,750 6,797,055 Sorenson Communications, Inc. Tranche C Term Loan, 7.86%, 08/16/13 ............................... 6,593,143 742,500 Stratos Global Corp./Stratos Funding LP Term B Facility, 8.11%, 02/13/12 .............. 728,578 5,471,101 Time Warner Telecom Holdings Inc. Term Loan B, 7.36%, 01/07/13 .................. 5,375,357 60,403 Univision Communications Inc Delayed Draw Term Loan 09/29/14 (b) (e) .............................. 56,062 Univision Communications, Inc. 41,577,181 Initial Term Loan, 7.61%, 09/29/14 (b) ........ 38,589,029 3,000,000 Second Lien Loan, 7.82%, 03/29/09 ............. 2,970,000 ------------- 117,960,594 ------------- TELECOMMUNICATIONS - CLEC - 0.2% 4,937,500 Consolidated Communications, Inc. Term D Loan, 7.11%, 10/14/11 .................. 4,789,375 ------------- TELECOMMUNICATIONS - DATA/INTERNET - 0.0% 1,000,000 Pine Tree Holdings/Country Road Communications, Inc. Second Lien Term Loan, 13.11%, 07/15/13 .............................. 992,500 ------------- TELECOMMUNICATIONS - FIBER/LONG DISTANCE - 0.3% 3,500,000 FairPoint Communications, Inc. Replacement B Term Loan, 7.13%, 02/08/12 ............................... 3,408,125 3,000,000 Hawaiian Telcom Communications, Inc. Tranche C Term Loan, 7.61%, 06/02/14 ............................... 2,857,500 ------------- 6,265,625 ------------- - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- TRANSPORTATION - AUTO - 5.1% 18,500,000 Dana Corp. Term Loan, 7.88%, 04/13/08 (b) ................ 18,280,405 Delphi Corp. 5,000,000 Tranche B Term Loan, 7.63%, 12/31/07 ............................... 4,920,800 37,107,500 Tranche C Term Loan, 8.13%, 12/31/07 ............................... 36,643,656 41,300,013 Ford Motor Co. Term Loan, 8.36%, 12/16/13 (b) ................ 38,860,834 10,945,000 General Motors Corp. Secured Term Loan, 7.74%, 11/29/13 ............................... 10,496,255 Key Safety Systems, Inc. 7,486,250 First Lien Term Loan, 8.64%, 03/08/14 (b) ........................... 7,111,938 2,000,000 Second Lien Term Loan, 10.32%, 09/08/14 .............................. 1,935,000 1,304,615 Stanadyne Corp. Term Loan, 8.82%, 08/06/10 .................... 1,311,138 ------------- 119,560,026 ------------- TRANSPORTATION - LAND - 0.4% Quality Distribution, Inc. 1,427,481 Synthetic Letters of Credit, 5.25%, 11/13/09 ............................... 1,420,344 6,904,646 Term Loan, 8.32%, 11/13/09 (f) ................ 6,870,124 ------------- 8,290,468 ------------- UTILITIES - 2.2% 2,915,003 Boston Generating LLC First Lien Term Loan, 7.61%, 12/20/13 ............................... 2,819,042 Boston Generating, LLC 181,483 First Lien Revolving Credit Loan, 7.61%, 12/20/13 ............................... 175,508 648,153 First Lien Synthetic Letter of Credit Loan, 5.24%, 12/20/13 .................. 626,816 969 Calpine Corp. First Priority Term Loan, 7.59%, 03/29/09 ............................... 937 Coleto Creek Power, LP 5,628,310 First Lien Term Loan, 8.11%, 06/28/13 ............................... 5,346,894 4,950,000 Second Lien Term Loan, 9.35%, 06/28/13 ............................... 4,752,000 319,857 Synthetic Letter of Credit, 8.11%, 06/28/13 ............................... 303,864 Covanta Energy Corp. 3,750 Delayed Draw Term Loan, 9.50%, 06/30/12 ............................... 3,663 659,794 Funded Letter of Credit, 5.24%, 02/09/14 ............................... 655,670 1,336,856 Term Loan, 6.88%, 02/09/14 .................... 1,305,948 3,891,020 Entegra TC, LLC Third Lien Term Loan, 11.36%, 04/19/14 .............................. 3,813,199 3,960,000 GBGH LLC First Lien Term Loan, 10.76%, 08/07/13 .............................. 3,969,900 Mach Gen, LLC 2,696,947 First Lien Term B Loan, 7.36%, 02/22/14 ............................... 2,571,081 280,397 Synthetic Letter of Credit, 7.36%, 02/22/13 ............................... 269,181 12 | See accompanying Notes to Financial Statements. INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT ($) VALUE ($) - -------------------------------------------------------------------------------- SENIOR LOANS (CONTINUED) UTILITIES (CONTINUED) 3,796,258 Mirant North America, LLC Term Loan, 7.07%, 01/03/13 .................... 3,691,861 NATG Holdings LLC 65,796 Credit-Linked Certificate of Deposit, 4.00%, 01/23/09 (c) .................. 57,242 1,001,749 Term Loan A, 11.50%, 01/23/09 (c) ............. 177,810 733,455 Term Loan B-1, 12.25%, 01/23/10 (c) ........... 128,355 NRG Energy, Inc. 2,196,836 Credit-Linked Deposit, 7.07%, 02/01/13 (b) ........................... 2,095,232 5,291,673 Term Loan, 7.07%, 02/01/13 (b) ................ 5,095,458 2,000,000 Primary Energy Operations LLC Term Loan, 8.11%, 08/24/09 .................... 1,940,000 4,426,190 Riverside Energy Center LLC Term Loan, 9.57%, 06/24/11 .................... 4,415,125 Rocky Mountain Energy Center LLC 361,073 Credit-Linked Certificate of Deposit, 5.32%, 06/24/11 ...................... 360,171 2,718,298 Term Loan, 9.57%, 06/24/11 .................... 2,711,502 TECO Panda - Union Power Partners, L.P. 353,774 Tranche A Term Loan, 06/01/12 (b) (f) .............................. 641,805 339,623 Tranche B Term Loan, 06/01/20 (b) (f) .............................. 616,133 TECO Panda Generating Co. - Gila River Power L.P. 601,415 Tranche A Term Loan, 06/01/12 (b) (f) .............................. 1,091,069 580,188 Tranche B Term Loan, 06/01/20 (b) (f) .............................. 1,052,560 ------------- 50,688,026 ------------- WIRELESS - CELLULAR/PCS - 3.5% 1,822,500 Centennial Cellular Operating Co. Term Loan, 3.57%, 02/09/11 .................... 1,786,050 38,115,000 Cricket Communications, Inc. Term B Loan, 7.36%, 06/16/13 .................. 37,114,481 Insight Midwest Holdings, LLC 3,750,000 Term Loan B, 7.35%, 04/06/14 .................. 3,661,875 6,428,302 Term Loan B, 7.36%, 04/06/14 .................. 6,277,237 1,464,844 Maritime Telecommunications Network, Inc. First Lien Term Loan, 8.11%, 05/11/12 ............................... 1,435,547 32,774,887 MetroPCS Wireless, Inc. Tranche B Term Loan, 7.63%, 11/04/13 ............................... 31,969,280 ------------- 82,244,470 ------------- Total Senior Loans (Cost $1,876,993,662) ...................... 1,795,007,807 ------------- PRINCIPAL AMOUNT - ------------------ FOREIGN DENOMINATED SENIOR LOANS (a) - 12.9% AUSTRALIA - 1.4% AUD PBL Media Finance Pty., Ltd. 5,500,000 Term Loan A, 8.78%, 02/07/13 .................. 4,282,836 15,000,000 Term Loan B, 9.03%, 02/07/13 .................. 11,898,169 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT VALUE ($) - -------------------------------------------------------------------------------- AUSTRALIA (CONTINUED) AUD 19,523,810 Seven Media Group Facility A Term Loan, 8.86%, 12/22/12 (b) ........................... 15,327,669 ------------- 31,508,674 ------------- AUSTRIA - 0.8% EUR 15,000,000 Sacher Funding Ltd. Euro Term Loan, 9.96%, 05/14/14 ............... 19,835,319 ------------- DENMARK - 0.1% EUR 2,000,000 Nyco Holdings 3 ApS Second Lien Facility D, 9.16%, 12/29/16 ............................... 2,552,690 ------------- FRANCE - 1.9% GBP Ristretto Investissements SAS 437,500 Tranche E-B2, 8.43%, 09/30/13 ............................... 859,301 437,500 Tranche E-C2, 8.84%, 09/30/14 ............................... 863,713 EUR Ypso Holding SA 221,431 Capex Term Loan, 6.23%, 12/15/12 (e) ........................... 286,739 3,452,754 Eur B Acq 1 Facility, 6.12%, 06/15/14 ............................... 4,508,246 5,633,441 Eur B Acq 2 Facility, 6.36%, 06/15/14 ............................... 7,355,559 8,946,874 Eur B Recap 1 Facility, 5.87%, 06/15/14 ............................... 11,607,737 73,323 Eur B Recap 2 Facility, 6.11%, 06/15/14 ............................... 95,737 4,690,407 Eur C Acq, 6.61%, 12/31/15 .................... 6,163,122 8,809,593 Eur C Recap, 6.61%, 12/31/15 .................. 11,575,666 ------------- 43,315,820 ------------- GERMANY - 0.5% EUR 2,500,000 Iesy Hessen/ISH NRW GMBH/ Arena Sport Euro Senior Secured Term Loan, 7.34%, 10/15/11 ............................... 3,288,846 Kabel Baden Wurttemburg GMBH & CO. KG 2,500,000 Second Lien Facility, 9.11%, 12/09/15 ............................... 3,308,204 1,826,284 Term B Facility, 6.45%, 06/09/14 .............. 2,401,775 1,826,284 Term C Facility, 6.95%, 06/09/15 .............. 2,409,393 879,378 Schieder Mobel Holding, GMBH Delayed Draw Term Loan, 9.00%, 07/20/08 (e) ........................... 869,140 ------------- 12,277,358 ------------- ITALY - 0.4% EUR 151,786 Pirelli Cables Euro Term Loan C2, 6.85%, 07/28/14 ............................... 209,380 See accompanying Notes to Financial Statements. | 13 INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT VALUE ($) - -------------------------------------------------------------------------------- FOREIGN DENOMINATED SENIOR LOANS (CONTINUED) ITALY (CONTINUED) EUR Wind Telecommunicatione S.p.A. 2,817,754 A1 Term Loan Facility, 6.14%, 05/26/12 ............................... 3,753,689 1,750,000 B1 Term Loan Facility, 6.51%, 05/26/13 ............................... 2,326,049 1,750,000 C1 Term Loan Facility, 7.26%, 05/26/14 ............................... 2,337,977 ------------- 8,627,095 ------------- NETHERLANDS - 1.6% EUR Amsterdamse Beheer- En Consultingmaatschappij B.V. 4,388,443 Casema B1 Term Loan, 6.46%, 09/12/14 ............................... 5,840,468 2,279,577 Casema B2 Term Loan, 6.46%, 09/12/14 ............................... 3,061,024 6,668,019 Casema C Term Loan, 6.96%, 09/12/15 ............................... 8,919,751 1,500,000 Casema D Term Loan Second Lien, 8.24%, 03/12/16 ............................... 2,007,171 5,150,162 Kabelcom B Term Loan, 6.11%, 09/12/14 ............................... 6,915,655 5,150,162 Kabelcom C Term Loan, 6.99%, 09/12/15 ............................... 6,915,655 1,000,000 Kabelcom D Term Loan, 6.11%, 03/12/16 ............................... 1,338,114 YBR Acquisition B.V. 806,733 Facility B2 Term Loan, 6.34%, 07/01/13 ............................... 1,076,510 1,250,000 Facility C2 Term Loan, 7.13%, 07/01/14 ............................... 1,674,040 ------------- 37,748,388 ------------- SPAIN - 0.4% EUR Gasmedi 2000 S.A. / Nattai, S.L.U. 1,666,667 Tranche B Term Loan, 6.65%, 08/11/14 ............................... 2,215,285 1,666,667 Tranche C Term Loan, 7.15%, 08/11/15 ............................... 2,215,285 1,666,667 Tranche E Second Lien Term Loan, 8.90%, 02/11/16 ............................... 2,226,645 2,061,420 Maxi PIX SARL PIK Loan, 12.11%, 05/31/16 PIK.. .............. 2,741,721 ------------- 9,398,936 ------------- SWEDEN - 0.6% EUR 3,500,000 B-FLY 2 AB Euro Term Loan B2, 6.41%, 12/30/15 ............................... 4,620,273 SEK Nordic Cable Acquisition 15,342,466 Facility A Com Hem, 5.61%, 01/31/13 ............................... 2,093,820 15,333,333 Facility B2 Com Hem Comm, 5.88%, 01/31/14 ............................... 2,103,704 9,109,589 Facility B2 Com Hem Comm, 6.11%, 01/31/14 ............................... 1,249,818 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT VALUE ($) - -------------------------------------------------------------------------------- SWEDEN (CONTINUED) SEK 14,666,667 Facility C2 Com Hem, 6.00%, 01/31/15 ............................... 2,017,562 5,513,699 Facility C2 Com Hem, 6.24%, 01/31/15 ............................... 758,470 5,000,000 Facility D Com Hem, 7.75%, 07/31/15 ............................... 695,064 6,750,000 Facility D Com Hem, 7.99%, 07/31/15 ............................... 938,337 ------------- 14,477,048 ------------- UNITED KINGDOM - 3.9% GBP 3,000,000 AA Acquistions Co., Ltd. Additional Term Loan B, 8.18%, 03/12/15 ............................... 5,986,928 4,000,000 Airport Development & Investment Ltd. Second Lien Facility, 9.70%, 04/07/11 ............................... 7,851,381 All3Media Intermediate Ltd. 714,753 Facility B, 8.20%, 08/31/14 ................... 1,358,805 2,585,073 Facility C, 8.70%, 08/31/15 ................... 4,914,439 3,000,000 Facility D, 10.57%, 02/29/16 .................. 5,824,272 3,619,829 Mezzanine Loan, 14.54%, 08/31/16 .............. 7,502,216 992,462 Ansco UK Finance CO. Ltd. Tranche B Term Loan, 8.32%, 03/08/12 ............................... 1,916,781 EUR 2,734,806 Dollar Financial UK Limited UK Borrower Euro Term Loan, 7.17%, 10/31/12 ............................... 3,653,665 GBP Forgings International Ltd. 446,537 Term B1 (GBP), 8.09%, 09/22/14 ................ 855,659 478,674 Term C1 (GBP), 8.34%, 09/22/15 ................ 922,068 Highland Acquisitions Ltd. 1,000,000 Facility B, 9.41%, 12/31/14 ................... 1,921,253 1,000,000 Facility C, 9.91%, 12/31/15 ................... 1,931,339 1,000,000 Mezzanine Facility, 16.66%, 12/31/16 .............................. 1,941,424 3,125,000 Osprey Acquisitions Ltd. Term Tranche 2, 8.21%, 02/18/12 ............... 6,177,259 Peacock Group 2,088,620 Facility B, 9.37%, 10/30/13 ................... 4,075,962 2,088,620 Facility C, 9.87%, 10/30/14 ................... 4,097,027 1,378,368 SunGard UK Holdings, Ltd. U.K. Term Loan B, 8.00%, 02/12/14 ............................... 2,696,849 Towergate Partnership Ltd. 3,125,000 Facility A, 8.44%, 10/31/12 ................... 6,161,500 3,125,000 Facility B, 8.68%, 10/31/13 ................... 6,240,292 Trinitybrook PLC 2,500,000 Term Loan B1, 9.03%, 07/31/13 .. .............. 4,939,084 2,500,000 Term Loan C1, 9.53%, 07/31/14 .. .............. 4,952,598 Virgin Media Investment Holdings Ltd. 771,045 A Facility, 6.62%, 07/10/11 ................... 1,477,485 1,750,000 C Facility, 8.48%, 03/03/13 ................... 3,406,317 ------------- 90,804,603 ------------- 14 | See accompanying Notes to Financial Statements. INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT VALUE ($) - -------------------------------------------------------------------------------- FOREIGN DENOMINATED SENIOR LOANS (CONTINUED) UNITED STATES - 1.3% GBP 1,243,750 Aramark Corp. U.K. Term Loan, 8.08%, 01/26/14 ............................... 2,408,374 1,357,813 Champion Home Builders Co. Term Loan, 9.25%, 10/31/12 .................... 2,629,243 EUR Hayes Lemmerz International, Inc. 218,182 Synthetic Letter of Credit, 6.78%, 05/30/14 ............................... 289,257 3,781,818 Term Loan Facility, 6.87%, 05/30/14 ............................... 5,013,794 GBP 2,250,000 IPC Systems, Inc. Tranche B-2 Term Loan, 8.27%, 06/02/14 ............................... 4,561,086 4,895,408 PlayPower, Inc. Tranche B Sterling Term Loan, 8.71%, 06/30/12 (b) ........................... 9,676,864 EUR 2,517,795 RD German Holdings GMBH Euro Term Loan, 6.01%, 03/02/14 ............................... 3,200,703 GBP 1,689,475 TME UK Acquisition Co. Ltd. U.K. Term Loan, 9.16%, 04/26/14 ............................... 3,399,259 ------------- 31,178,580 ------------- Total Foreign Denominated Senior Loans (Cost $296,391,522) ........................ 301,724,511 ------------- PRINCIPAL AMOUNT ($) - -------------------- ASSET-BACKED SECURITIES (h) - 0.2% 4,800,000 Acacl 2006-2A B 6.08%, 01/20/21 ............................... 4,310,203 ------------- Total Asset-Backed Securities (Cost $4,310,203) .......................... 4,310,203 ------------- CORPORATE NOTES AND BONDS (g) - 0.1% HOUSING - REAL ESTATE DEVELOPMENT - 0.0% 596,593 TOUSA, Inc. 14.75%, 07/31/15 (d) .......................... 298,297 ------------- TELECOMMUNICATIONS - 0.1% 1,438,356 American Messaging Services, Inc. Senior Secured Note, 11.63%, 09/03/08 ...................................... 1,436,558 ------------- Total Corporate Notes and Bonds (Cost $2,045,894) .......................... 1,734,855 ------------- - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT VALUE ($) - -------------------------------------------------------------------------------- CLAIMS (i) - 0.3% AEROSPACE - AIRLINES - 0.2% Delta Air Lines, Inc. 310,290 Comair ALPA Claim, 12/31/10 ................... 159,799 879,660 Delta ALPA Claim, 12/31/10 .................... 393,648 Northwest Airlines, Inc. 5,400,000 ALPA Trade Claim, 08/21/13 .................... 580,500 2,914,735 Bell Atlantic Trade Claim, 08/21/13 ........... 276,900 3,000,000 CIT Leasing Corp Trade Claim, 08/21/13 ...................................... 285,000 2,250,000 Citibank/Airbus Trade Claim, 08/21/13 ...................................... 213,750 2,500,000 EDC Trade Claims, 08/21/13 .................... 268,750 9,587,700 Flight Attendant Claim-Escrow, 08/21/13 ...................................... 910,832 1,000,000 GE Trade Claim, 08/21/13 ...................... 107,500 2,500,000 GE Trade Claim, 08/21/13 (b) .................. 268,750 5,690,250 IAM Trade Claim, 08/21/13 ..................... 611,702 6,250,000 Mesaba Trade Claim, 08/15/08 .................. 671,875 6,322,050 Retiree Claim, 08/21/13 ....................... 679,620 ------------- 5,428,626 ------------- UTILITIES - 0.1% 17,500,000 Mirant Corp. ..................................... 918,750 ------------- Total Claims (Cost $11,705,559) ......................... 6,347,376 ------------- SHARES - ------ COMMON STOCKS (j) - 2.3% AEROSPACE - AIRLINES - 0.9% 65,959 Delta Air Lines, Inc. ............................ 1,113,388 1,062,377 Northwest Airlines Corp. ......................... 19,738,969 ------------- 20,852,357 ------------- UTILITIES - 1.2% 12,470 CenterPoint Energy, Inc. ......................... 318,110 81,847 Entegra TC LLC ................................... 2,714,579 643,517 Mirant Corp. ..................................... 25,077,857 ------------- 28,110,546 ------------- WIRELESS - CELLULAR/PCS - 0.2% 73,363 Leap Wireless International, Inc. ................ 5,318,818 ------------- Total Common Stocks (Cost $42,778,478) ......................... 54,281,721 ------------- PREFERRED STOCKS - 0.1% HOUSING - REAL ESTATE DEVELOPMENT - 0.1% 4,903 TOUSA, Inc., Series A (d) ........................ 2,451,500 ------------- MANUFACTURING - 0.0% 14,382 Superior Telecom, Inc., Series A ................. 17,618 ------------- Total Preferred Stocks (Cost $4,917,632) .......................... 2,469,118 ------------- See accompanying Notes to Financial Statements. | 15 INVESTMENT PORTFOLIO (CONTINUED) - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY - -------------------------------------------------------------------------------- UNITS VALUE ($) - -------------------------------------------------------------------------------- WARRANT - 0.0% ENERGY - 0.0% 141,093 Monitor Oil (d) .................................. 0 ------------- Total Warrant (Cost $0) .................................. 0 ------------- TOTAL INVESTMENTS - 92.9% ..................................... 2,165,875,591 (cost of $2,239,142,950) (k) ------------- OTHER ASSETS & LIABILITIES, NET - 7.1% ........................ 165,233,532 ------------- NET ASSETS - 100.0% ........................................... 2,331,109,123 ============= - ---------- Forward foreign currency contracts outstanding as of August 31, 2007 were as follows: PRINCIPAL NET CONTRACTS AMOUNT UNREALIZED TO BUY OR COVERED BY APPRECIATION TO SELL CURRENCY CONTRACTS EXPIRATION (DEPRECIATION) - -------------------------------------------------------------------------------- Sell AUD 9,300,000 02/29/2008 $ (8,370) Sell AUD 6,000,000 08/28/2008 31,500 Sell EUR 55,000,000 02/04/2008 765,620 Sell GBP 26,000,000 02/07/2008 416,956 -------------- $ 1,205,706 ============== (a) Senior loans in which the Portfolio invests generally pay interest at rates which are periodically redetermined by reference to a base lending rate plus a premium. (Unless otherwise identified by footnote (g), all senior loans carry a variable rate interest.) These base lending rates are generally (i) the Prime Rate offered by one or more major U.S. banks, (ii) the lending rate offered by one or more European banks such as the London Inter-Bank Offered Rate ("LIBOR") or (iii) the certificate of deposit rate. Rate shown represents the weighted average rate at August 31, 2007. Senior loans, while exempt from registration under the Securities Act of 1933, as amended (the "1933 Act"), contain certain restrictions on resale and cannot be sold publicly. Senior secured floating rate loans often require prepayments from excess cash flow or permit the borrower to repay at its election. The degree to which borrowers repay, whether as a contractual requirement or at their election, cannot be predicted with accuracy. As a result, the actual 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) The issuer is in default of certain debt covenants. Income is not being accrued. (d) Represents fair value as determined in good faith under the direction of the Portfolio's Board of Managers. (e) Senior loans have additional unfunded loan commitments. See Note 9. (f) Loans held on participation. See Note 7 (g) Fixed rate senior loan or corporate note. (h) Variable rate security. The interest rate shown reflects the rate in effect at August 31, 2007. (i) Security represents an unsecured, unfunded claim generated against the issuer that will be converted into equity upon the completion of court proceedings. (j) Non-income producing security. (k) Cost for U.S. federal income tax purposes is $2,240,186,837. AUD Australia Dollar CLEC Competitive Local Exchange Carrier EUR Euro Currency GBP Great Britain Pound PIK Payment in Kind SEK Swedish Krona FOREIGN DENOMINATED SENIOR LOANS INDUSTRY CONCENTRATION TABLE (% of Total Net Assets) Cable - International Cable ........................... 4.0% Other ................................................. 2.1% Financial ............................................. 1.5% Telecommunications .................................... 1.4% Retail ................................................ 1.0% Broadcasting .......................................... 1.0% Diversified Media ..................................... 1.0% Housing - Real Estate Development ..................... 0.5% Aerospace - Aerospace/Defense ......................... 0.4% ----- 12.9% ===== 16 | See accompanying Notes to Financial Statements. STATEMENT OF ASSETS AND LIABILITIES - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
($) - -------------------------------------------------------------------------------------------------------------------- ASSETS: Investments, at value (cost $2,239,142,950) .................................................... 2,165,875,591 Cash ........................................................................................... 153,725,086 Foreign currency (cost $10,355,246) ............................................................ 10,465,968 Net unrealized appreciation on forward currency contracts ...................................... 1,205,706 Receivable for: Investments sold ............................................................................ 80,825,633 Dividend and interest receivable ............................................................ 20,664,278 ------------- Total assets ............................................................................. 2,432,762,262 ------------- LIABILITIES: Net discount and unrealized depreciation on unfunded transactions (Note 9) ..................... 1,058,500 Payables for: Investments purchased ....................................................................... 99,516,033 Investment advisory fee payable (Note 4) .................................................... 950,923 Trustees' fees (Note 4) ..................................................................... 200 Accrued expenses and other liabilities ......................................................... 127,483 ------------- Total liabilities ........................................................................ 101,653,139 ------------- NET ASSETS ........................................................................................ 2,331,109,123 =============
See accompanying Notes to Financial Statements. | 17 STATEMENT OF OPERATIONS - -------------------------------------------------------------------------------- FOR THE YEAR ENDED AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
($) - -------------------------------------------------------------------------------------------------------------------- INVESTMENT INCOME: Interest ....................................................................................... 166,401,817 Dividends ...................................................................................... 9,165,301 Facility and other fees ........................................................................ 9,413 ------------- Total investment income .................................................................. 175,576,531 ------------- EXPENSES: Investment advisory fees (Note 4) .............................................................. 8,664,405 Accounting service fees ........................................................................ 463,088 Professional fees .............................................................................. 120,660 Trustees' fees (Note 4) ........................................................................ 20,581 Custodian fees ................................................................................. 224,114 Reports to shareholders ........................................................................ 34,332 ------------- Net operating expenses ................................................................... 9,527,180 ------------- Interest expense (Note 8) ...................................................................... 239,479 Facility expense ............................................................................... 294,037 ------------- Net expenses ............................................................................. 10,060,696 ------------- Net investment income .................................................................... 165,515,835 ------------- NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS: Net realized gain/(loss) on investments ........................................................ 3,755,259 Net realized gain/(loss) on foreign currency transactions ...................................... (2,870,738) Net change in unrealized appreciation/(depreciation) on investments ............................ (80,761,149) Net change in unrealized appreciation/(depreciation) on unfunded transactions .................. (604,465) Net change in unrealized appreciation/(depreciation) on forward foreign currency contracts ..... 1,205,706 Net change in unrealized appreciation/(depreciation) on translation of assets and liabilities denominated in foreign currency ............................................................. 567,925 ------------- Net realized and unrealized gain/(loss) on investments ................................... (78,707,462) ------------- Net increase in net assets from operations ............................................... 86,808,373 =============
18 | See accompanying Notes to Financial Statements. STATEMENTS OF CHANGES IN NET ASSETS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
----------------------------- YEARS ENDED AUGUST 31, 2007 2006 ($) ($) ----------------------------- INCREASE IN NET ASSETS: FROM OPERATIONS Net investment income ................................................................ 165,515,835 104,530,900 Net realized gain/(loss) on investments and foreign currency transactions ............ 884,521 12,363,756 Net change in unrealized appreciation/(depreciation) on investments, unfunded transactions, forward foreign currency transactions and translation of assets and liabilities denominated in foreign currency ....................................... (79,591,983) (1,281,401) ------------- ------------- Net change in net assets from operations .......................................... 86,808,373 115,613,255 ------------- ------------- TRANSACTIONS IN INVESTOR'S BENEFICIAL INTEREST Contributions ........................................................................ 1,139,327,799 817,426,901 Withdrawals .......................................................................... (621,839,277) (345,645,810) ------------- ------------- Net increase from transactions in investor's beneficial interest .................. 517,488,522 471,781,091 ------------- ------------- Total increase in net assets ...................................................... 604,296,895 587,394,346 ------------- ------------- NET ASSETS Beginning of year .................................................................... 1,726,812,228 1,139,417,882 ------------- ------------- End of year .......................................................................... 2,331,109,123 1,726,812,228 ============= =============
See accompanying Notes to Financial Statements. | 19 STATEMENT OF CASH FLOWS - -------------------------------------------------------------------------------- FOR THE YEAR ENDED AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
($) - ------------------------------------------------------------------------------------------------------------- CASH FLOWS USED FOR OPERATING ACTIVITIES Net investment income .................................................................. 165,515,835 ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH USED FOR OPERATING ACTIVITIES Purchase of investment securities ...................................................... (2,289,064,593) Proceeds from disposition of investment securities ..................................... 1,697,856,111 Increase in dividends, interest and fees receivable .................................... (2,646,854) Increase in receivable for investments sold ............................................ (61,922,315) Decrease in other assets ............................................................... 69,969 Decrease in deferred facility fees ..................................................... (5,300) Net amortization/(accretion) of premium/(discount) ..................................... (3,826,511) Decrease in payable for investments purchased .......................................... (13,600,953) Increase in payables to related parties ................................................ 337,356 Decrease in mark-to-market on realized and unrealized gain (loss) on foreign currency .. (2,302,813) Decrease in other liabilities .......................................................... (280,321) -------------- Net cash and foreign currency flow from operating activities ........................ (509,870,389) -------------- CASH FLOWS PROVIDED BY FINANCING ACTIVITIES Proceeds from capital contributions .................................................... 1,139,327,799 Payment of capital withdrawals ......................................................... (621,839,277) -------------- Net cash flow provided by financing activities ...................................... 517,488,522 -------------- Net increase in cash and foreign currency ........................................... 7,618,133 -------------- CASH AND FOREIGN CURRENCY Beginning of the year .................................................................. 156,572,921 -------------- End of the year ........................................................................ 164,191,054 ==============
20 | See accompanying Notes to Financial Statements. FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
- ----------------------------------------------------------------------------------------- YEARS ENDED AUGUST 31, ---------------------------------------------- 2007 2006 2005 2004 2003 - ----------------------------------------------------------------------------------------- TOTAL RETURN 5.29% 8.72% 6.54% 10.39% 11.68%(a) RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA Net operating expenses 0.47% 0.52% 0.51%(b) 0.52%(b) 0.57%(b) Interest expense and facility expense 0.03% 0.04% 0.05% --(c) --(c) Net expenses 0.50% 0.56% 0.56%(b) 0.52%(b) 0.57%(b) Net investment income 8.20% 7.74% 5.69%(b) 4.45%(b) 5.96%(b) Portfolio turnover rate 86% 64% 75% 97% 75%
- ---------- (a) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Portfolio's return. (b) The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%. (c) Rounds to less than 0.01%. - -------------------------------------------------------------------------------- See accompanying Notes to Financial Statements. | 21 STATEMENT OF ASSETS AND LIABILITIES - -------------------------------------------------------------------------------- AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND
($) - -------------------------------------------------------------------------------------------------------------------------- ASSETS: Investments in Portfolio ............................................................................ 2,331,109,123 Receivable for: Fund shares sold ................................................................................. 7,764,716 Other assets ........................................................................................ 74,946 ------------- Total assets .................................................................................. 2,338,948,785 ------------- LIABILITIES: Payables for: Distributions .................................................................................... 9,184,488 Administration fee (Note 4) ...................................................................... 390,978 Trustees' fees (Note 4) .......................................................................... 800 Service and distribution fees (Note 4) ........................................................... 1,009,396 Accrued expenses and other liabilities .............................................................. 165,032 ------------- Total liabilities ............................................................................. 10,750,694 ------------- NET ASSETS ............................................................................................. 2,328,198,091 ============= COMPOSITION OF NET ASSETS: Paid-in capital ..................................................................................... 2,402,895,657 Overdistributed net investment income ............................................................... (120,308) Accumulated net realized gain/(loss) on investments and foreign currency transactions allocated from Portfolio ................................................................................... (1,975,104) Net unrealized appreciation/(depreciation) on investments, unfunded transactions, forward foreign currency contracts and assets and liabilities denominated in foreign currency allocated from Portfolio ........................................................................................ (72,602,154) ------------- NET ASSETS ............................................................................................. 2,328,198,091 ============= CLASS A Net assets .......................................................................................... 926,800,296 Shares outstanding (unlimited authorization) ........................................................ 96,087,905 Net asset value per share (Net assets/shares outstanding) ........................................... 9.65(a) Maximum offering price per share (100/96.50 of $9.65) ............................................... 10.00(b) CLASS B Net assets .......................................................................................... 123,579,751 Shares outstanding (unlimited authorization) ........................................................ 12,818,317 Net asset value and offering price per share (Net assets/shares outstanding) ........................ 9.64(a) CLASS C Net assets .......................................................................................... 931,623,462 Shares outstanding (unlimited authorization) ........................................................ 96,632,528 Net asset value and offering price per share (Net assets/shares outstanding) ........................ 9.64(a) CLASS Z Net assets .......................................................................................... 346,194,582 Shares outstanding (unlimited shares authorized) .................................................... 35,911,004 Net asset value, offering and redemption price per share (Net assets/shares outstanding) ............ 9.64
- ---------- (a) Redemption price per share is equal to net asset value less any applicable contingent deferred sales charge. (b) On sales of $100,000 or more, the offering price is reduced. 22 | See accompanying Notes to Financial Statements. STATEMENT OF OPERATIONS - -------------------------------------------------------------------------------- FOR THE YEAR ENDED AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND
($) - ------------------------------------------------------------------------------------------------------------------ INVESTMENT INCOME ALLOCATED FROM PORTFOLIO (NOTE 1): Interest ...................................................................................... 166,401,817 Dividends ..................................................................................... 9,165,301 Facility and other fees ....................................................................... 9,413 ----------- Total investment income ................................................................. 175,576,531 ----------- FUND EXPENSES: Net operating expenses allocated from Portfolio (Note 1) ...................................... 9,527,180 Administration fees (Note 4) .................................................................. 4,038,533 Accounting service fees ....................................................................... 12,500 Distribution fees: (Note 4) Class A .................................................................................... 807,915 Class B .................................................................................... 617,427 Class C .................................................................................... 4,758,821 Service fee: (Note 4) Class A .................................................................................... 2,019,787 Class B .................................................................................... 343,015 Class C .................................................................................... 1,982,842 Transfer agent fees ........................................................................... 872,342 Professional fees ............................................................................. 87,942 Trustees' fees (Note 4) ....................................................................... 82,325 Registration fees ............................................................................. 156,887 Reports to shareholders ....................................................................... 652,314 Other expenses ................................................................................ 142,798 ----------- Net operating expenses .................................................................. 26,102,628 ----------- Interest expense allocated from Portfolio (Note 8) ............................................ 239,479 Facility expense allocated from Portfolio ..................................................... 294,037 ----------- Net expenses ............................................................................ 26,636,144 ----------- Net investment income ................................................................... 148,940,387 ----------- NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS ALLOCATED FROM PORTFOLIO (NOTE 1): Net realized gain/(loss) on investments ....................................................... 3,755,259 Net realized gain/(loss) on foreign currency transactions ..................................... (2,870,738) Net change in unrealized appreciation/(depreciation) on investments ........................... (80,761,149) Net change in unrealized appreciation/(depreciation) on unfunded transactions ................. (604,465) Net change in unrealized appreciation/(depreciation) on forward foreign currency contracts .... 1,205,706 Net change in unrealized appreciation/(depreciation) on translation of assets and liabilities denominated in foreign currency ............................................................ 567,925 ----------- Net realized and unrealized gain/(loss) on investments allocated from Portfolio ......... (78,707,462) ----------- Net increase in net assets from operations .............................................. 70,232,925 ===========
See accompanying Notes to Financial Statements. | 23 STATEMENTS OF CHANGES IN NET ASSETS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND
------------------------------ YEARS ENDED AUGUST 31, 2007 2006 ($) ($) ------------------------------ INCREASE IN NET ASSETS: FROM OPERATIONS Net investment income ................................................................... 148,940,387 92,524,047 Net realized gain/(loss) on investments and foreign currency transactions allocated from Portfolio .................................................................... 884,521 12,076,962 Net change in unrealized appreciation/(depreciation) on investments, translation of assets and liabilities denominated in foreign currency unfunded transactions, forward foreign currency contracts and allocated from Portfolio ................... (79,591,983) (851,203) ------------- ------------- Net change in net assets from operations .......................................... 70,232,925 103,749,806 DISTRIBUTIONS DECLARED TO SHAREHOLDERS From net investment income: Class A .............................................................................. (60,910,569) (36,949,931) Class B .............................................................................. (9,909,902) (10,607,992) Class C .............................................................................. (55,784,748) (31,033,409) Class Z .............................................................................. (22,175,578) (14,588,702) ------------- ------------- Total distributions from net investment income .................................... (148,780,797) (93,180,034) ------------- ------------- SHARE TRANSACTIONS Class A Subscriptions ........................................................................ 505,084,021 460,060,712 Distributions reinvested ............................................................. 26,374,679 17,848,900 Redemptions .......................................................................... (306,504,923) (105,237,595) ------------- ------------- Net increase ...................................................................... 224,953,777 372,672,017 Class B Subscriptions ........................................................................ 191,510 370,397 Distributions reinvested ............................................................. 5,922,934 6,226,923 Redemptions .......................................................................... (29,756,260) (26,685,543) ------------- ------------- Net decrease ...................................................................... (23,641,816) (20,088,223) Class C Subscriptions ........................................................................ 420,897,423 307,867,391 Distributions reinvested ............................................................. 26,310,505 15,573,084 Redemptions .......................................................................... (111,844,302) (66,041,445) ------------- ------------- Net increase ...................................................................... 335,363,626 257,399,030 Class Z Subscriptions ........................................................................ 199,534,434 88,139,842 Distributions reinvested ............................................................. 7,856,463 5,020,371 Redemptions .......................................................................... (74,257,745) (61,876,293) ------------- ------------- Net Increase ...................................................................... 133,133,152 31,283,920 ------------- ------------- Net increase from share transactions .............................................. 669,808,739 641,266,744 ------------- ------------- Total increase in net assets ...................................................... 591,260,867 651,836,516 ------------- ------------- NET ASSETS Beginning of year ....................................................................... 1,736,937,224 1,085,100,708 ------------- ------------- End of year (including undistributed/(overdistributed) net investment income of $(120,308) and $2,499,928, respectively) .......................................... 2,328,198,091 1,736,937,224 ============= =============
24 | See accompanying Notes to Financial Statements. STATEMENTS OF CHANGES IN NET ASSETS (CONTINUED) - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND
------------------------------ YEARS ENDED AUGUST 31, 2007 2006 ($) ($) ------------------------------ CHANGE IN SHARES Class A Subscriptions ........................................................................ 50,366,690 46,389,131 Issued for distributions reinvested .................................................. 2,645,496 1,799,527 Redemptions .......................................................................... (30,534,216) (10,621,709) ------------- ------------- Net increase ...................................................................... 22,477,970 37,566,949 Class B Subscriptions ........................................................................ 19,199 37,376 Issued for distributions reinvested .................................................. 593,927 628,285 Redemptions .......................................................................... (2,962,542) (2,694,070) ------------- ------------- Net decrease ...................................................................... (2,349,416) (2,028,409) Class C Subscriptions ........................................................................ 42,014,317 31,050,062 Issued for distributions reinvested .................................................. 2,640,751 1,570,587 Redemptions .......................................................................... (11,131,787) (6,667,761) ------------- ------------- Net increase ...................................................................... 33,523,281 25,952,888 Class Z Subscriptions ........................................................................ 19,881,361 8,891,919 Issued for distributions reinvested .................................................. 789,106 506,341 Redemptions .......................................................................... (7,401,124) (6,252,836) ------------- ------------- Net increase ...................................................................... 13,269,343 3,145,424
See accompanying Notes to Financial Statements. | 25 FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
- ----------------------------------------------------------------------------------------------------------------- YEARS ENDED AUGUST 31, 2007 ----------------------------------------------------------------- CLASS A SHARES 2007 2006 2005 2004 2003 - ----------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF YEAR $ 9.95 $ 9.88 $ 9.80 $ 9.29 $ 8.83 - ----------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.75 0.70 0.49 0.37 0.48 Net realized and unrealized gain/(loss) allocated from Portfolio(a) (0.29) 0.07 0.08 0.52 0.46 --------- --------- --------- --------- -------- Total from investment operations 0.46 0.77 0.57 0.89 0.94 - ----------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.76) (0.70) (0.49) (0.38) (0.48) From net realized gains -- -- -- -- -- --------- --------- --------- --------- -------- Total distributions declared to shareholders (0.76) (0.70) (0.49) (0.38) (0.48) - ----------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF YEAR $ 9.65 $ 9.95 $ 9.88 $ 9.80 $ 9.29 Total return(b) 4.28%(c) 8.18% 5.93% 9.65% 11.03%(d) - ----------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 1.12% 1.17% 1.15% 1.15% 1.15% Interest expense & facility expense allocated from Portfolio 0.03% 0.04% 0.05% --(e) --(e) Net expenses(f) 1.15% 1.21% 1.20% 1.15% 1.15% Net investment income 7.55% 7.08% 5.05% 3.78% 5.39% Waiver/reimbursement -- 0.01% 0.08% 0.17% 0.28% Net assets, end of year (000's) $ 926,800 $ 732,767 $ 355,998 $ 222,032 $ 97,924 - -----------------------------------------------------------------------------------------------------------------
- ---------- (a) Per share data was calculated using average shares outstanding during the period. (b) Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or contingent deferred sales charge ("CDSC"). For periods with waivers/reimbursements, had the Portfolio's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (c) Total return is calculated using the net asset value used for trading at the close of business on August 31, 2007. (d) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Fund's Class A Shares return. (e) Rounds to less than 0.01%. (f) Net expense ratio has been calculated after applying any waiver/reimbursement, if applicable. 26 | See accompanying Notes to Financial Statements. FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
- ------------------------------------------------------------------------------------------------------------- YEARS ENDED AUGUST 31, 2007 ------------------------------------------------------------- CLASS B SHARES 2007 2006 2005 2004 2003 - ------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF YEAR $ 9.95 $ 9.87 $ 9.80 $ 9.29 $ 8.83 - ------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.72 0.67 0.46 0.34 0.45 Net realized and unrealized gain/(loss) allocated from Portfolio(a) (0.31) 0.08 0.06 0.51 0.46 --------- --------- --------- --------- --------- Total from investment operations 0.41 0.75 0.52 0.85 0.91 - ------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.72) (0.67) (0.45) (0.34) (0.45) From net realized gains -- -- -- -- -- --------- --------- --------- --------- --------- Total distributions declared to shareholders (0.72) (0.67) (0.45) (0.34) (0.45) - ------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF YEAR $ 9.64 $ 9.95 $ 9.87 $ 9.80 $ 9.29 Total return(b) 4.03% 7.82% 5.46% 9.27% 10.65%(c) - ------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 1.47% 1.52% 1.50% 1.50% 1.50% Interest expense & facility expense allocated from Portfolio 0.03% 0.04% 0.05% --(d) --(d) Net expenses(e) 1.50% 1.56% 1.55% 1.50% 1.50% Net investment income 7.20% 6.73% 4.70% 3.51% 5.05% Waiver/reimbursement -- 0.01% 0.08% 0.17% 0.28% Net assets, end of year (000's) $ 123,580 $ 150,922 $ 169,780 $ 191,365 $ 163,448 - -------------------------------------------------------------------------------------------------------------
- ---------- (a) Per share data was calculated using average shares outstanding during the period. (b) Total return is at net asset value assuming all distributions are reinvested and no CDSC. For periods with waivers/reimbursements, had the Portfolio's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (c) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Fund's Class B Shares return. (d) Rounds to less than 0.01%. (e) Net expense ratio has been calculated after applying any waiver/reimbursement, if applicable. See accompanying Notes to Financial Statements. | 27 FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
- --------------------------------------------------------------------------------------------------------------- YEARS ENDED AUGUST 31, 2007 --------------------------------------------------------------- CLASS C SHARES 2007 2006 2005 2004 2003 - --------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF YEAR $ 9.95 $ 9.87 $ 9.80 $ 9.29 $ 8.83 - --------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.70 0.65 0.45 0.32 0.44 Net realized and unrealized gain/(loss) allocated from Portfolio(a) (0.30) 0.08 0.06 0.52 0.46 --------- --------- --------- --------- --------- Total from investment operations 0.40 0.73 0.51 0.84 0.90 - --------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.71) (0.65) (0.44) (0.33) (0.44) From net realized gains -- -- -- -- -- --------- --------- --------- --------- --------- Total distributions declared to shareholders (0.71) (0.65) (0.44) (0.33) (0.44) - --------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF YEAR $ 9.64 $ 9.95 $ 9.87 $ 9.80 $ 9.29 Total return(b) 3.87% 7.65% 5.30% 9.10% 10.48%(c) - --------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 1.62% 1.67% 1.65% 1.65% 1.65% Interest expense & facility expense allocated from Portfolio 0.03% 0.04% 0.05% --(d) --(d) Net expenses(e) 1.65% 1.71% 1.70% 1.65% 1.65% Net investment income 7.05% 6.58% 4.55% 3.28% 4.88% Waiver/reimbursement -- 0.01% 0.08% 0.17% 0.28% Net assets, end of year (000's) $ 931,623 $ 627,964 $ 366,841 $ 278,797 $ 132,656 - ---------------------------------------------------------------------------------------------------------------
- ---------- (a) Per share data was calculated using average shares outstanding during the period. (b) Total return is at net asset value assuming all distributions are reinvested and no CDSC. For periods with waivers/reimbursements, had the Portfolio's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (c) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Fund's Class C Shares return. (d) Rounds to less than 0.01%. (e) Net expense ratio has been calculated after applying any waiver/reimbursement, if applicable. 28 | See accompanying Notes to Financial Statements. FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
- ------------------------------------------------------------------------------------------------------------- YEARS ENDED AUGUST 31, 2007 ------------------------------------------------------------- CLASS Z SHARES 2007 2006 2005 2004 2003 - ------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF YEAR $ 9.95 $ 9.87 $ 9.80 $ 9.29 $ 8.83 - ------------------------------------------------------------------------------------------------------------- INCOME FROM INVESTMENT OPERATIONS: Net investment income(a) 0.79 0.74 0.53 0.40 0.50 Net realized and unrealized gain/(loss) allocated from Portfolio(a) (0.31) 0.08 0.06 0.52 0.47 --------- --------- --------- --------- -------- Total from investment operations 0.48 0.82 0.59 0.92 0.97 - ------------------------------------------------------------------------------------------------------------- LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS: From net investment income (0.79) (0.74) (0.52) (0.41) (0.51) From net realized gains -- -- -- -- -- --------- --------- --------- --------- -------- Total distributions declared to shareholders (0.79) (0.74) (0.52) (0.41) (0.51) - ------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF YEAR $ 9.64 $ 9.95 $ 9.87 $ 9.80 $ 9.29 Total return (b) 4.75% 8.57% 6.20% 10.03% 11.42%(c) - ------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS/ SUPPLEMENTAL DATA: Net operating expenses 0.77% 0.82% 0.80% 0.80% 0.80% Interest expense & facility expense allocated from Portfolio 0.03% 0.04% 0.05% --(d) --(d) Net expenses(e) 0.80% 0.86% 0.85% 0.80% 0.80% Net investment income 7.90% 7.43% 5.40% 4.12% 5.53% Waiver/reimbursement -- 0.01% 0.08% 0.17% 0.28% Net assets, end of year (000's) $ 346,195 $ 225,284 $ 192,482 $ 139,577 $ 31,055 - -------------------------------------------------------------------------------------------------------------
- ---------- (a) Per share data was calculated using average shares outstanding during the period. (b) Total return is at net asset value assuming all distributions are reinvested. For periods with waivers/reimbursements, had the Portfolio's investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. (c) Total return includes a voluntary reimbursement by the Portfolio's investment adviser for a realized investment loss on an investment not meeting the Portfolio's investment restrictions. This reimbursement had an impact of less than 0.01% on the Fund's Class Z Shares return. (d) Rounds to less than 0.01%. (e) Net expense ratio has been calculated after applying any waiver/reimbursement, if applicable. See accompanying Notes to Financial Statements. | 29 NOTES TO FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND NOTE 1. ORGANIZATION Highland Floating Rate Fund (the "Fund") is a Massachusetts business trust registered under the Investment Company Act of 1940, as amended (the "1940 Act"), as a non-diversified, closed-end management investment company. The Fund invests all of its investable assets in Highland Floating Rate Limited Liability Company (the "Portfolio"). INVESTMENT OBJECTIVE The Portfolio seeks a high level of current income consistent with preservation of capital. THE PORTFOLIO The Portfolio is registered under the 1940 Act as a non-diversified, closed-end management investment company and is organized as a Delaware limited liability company. The Portfolio allocates income, expenses and realized and unrealized gains and losses to each investor on a daily basis, based on methods in compliance with the Internal Revenue Code of 1986, as amended (the "Code"). Prior to May 5, 2006, the Fund and Highland Institutional Floating Rate Income Fund (the "Institutional Fund") were the sole investors in the Portfolio. On May 5, 2006, the Institutional Fund liquidated and the Fund became the sole investor in the Portfolio. At August 31, 2007, the Fund was the sole investor in the Portfolio. FUND SHARES The Fund may issue an unlimited number of shares and continuously offers three classes of shares: Class A, Class C and Class Z. The Fund has discontinued selling Class B Shares to new and existing investors, although existing investors may still reinvest distributions in Class B Shares. Certain share classes have their own sales charge and bear class-specific expenses, which include distribution fees and service fees. Class A Shares are subject to a maximum front-end sales charge of 3.50% based on the amount of initial investment. Class A Shares purchased without an initial sales charge by accounts aggregating $1 million and greater at the time of purchase are subject to a 1.00% contingent deferred sales charge ("CDSC") on shares tendered and accepted for repurchase within eighteen months after purchase. 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 the Class B CDSC. Class C Shares are subject to a 1.00% CDSC on shares tendered and accepted for repurchase 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 Class Z Shares prospectus. NOTE 2. SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Portfolio and the Fund in the preparation of their financial statements. 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. SECURITY VALUATION The value of the Fund's assets is based on its proportionate share of the current market value of the Portfolio's net assets. For securities with readily available market quotations, the Portfolio uses those quotations for pricing. When portfolio securities are traded on the relevant day of valuation, the valuation will be the last reported sale price on that day. If there are no such sales on that day, the security will be valued at the mean between the most recently quoted bid and asked prices from principal market makers. If there is more than one such principal market maker, the value will be the average of such means. Securities without a sale price or bid and ask quotations from principal market makers on the valuation day will be valued 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 (such as when events materially affecting the value of securities occur between the time when the market price is determined and calculation of the Portfolio's net asset value), such securities are valued at their fair value, as determined in good faith by the Portfolio's investment adviser, Highland Capital Management, L.P. ("Highland" or the "Investment Adviser"), in accordance with procedures established by the Portfolio's Board of Managers. In these cases, the Portfolio's net asset value will reflect the affected portfolio securities' value as determined in the judgment of the Board of Managers or its designee instead of being 30 | Annual Report NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND determined by the market. Using a fair value pricing methodology to price securities may result in a value that is different from a security's most recent sale price and from the prices used by other investment companies to calculate their net asset values. There can be no assurance that the Portfolio's valuation of a security will not differ from the amount that it realizes upon the sale of such security. Short-term investments, that is, those with a remaining maturity of 60 days or less, are valued at amortized cost. Repurchase agreements are valued at cost plus accrued interest. Foreign price quotations are converted to U.S. dollar equivalents using the 4:00 PM London Time Spot Rate. SECURITY TRANSACTIONS Security transactions are accounted for on the trade date. Costs and gains (losses) are determined based upon the specific identification method for both financial statement and U.S. 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 PM London Time Spot Rate. Fluctuations in the value of the foreign currencies and other assets and liabilities resulting from changes in exchange rates, between trade and settlement dates on securities transactions and between the accrual and payment dates on dividends, interest income and foreign withholding taxes, are recorded as unrealized foreign currency gains (losses). Realized gains (losses) and unrealized appreciation (depreciation) on investment securities and income and expenses are translated on the respective dates of such transactions. The effect of changes in foreign currency exchange rates on investments in securities are not segregated in the Statement of Operations from the effects of changes in market prices of those securities, but are included with the net realized and unrealized gain or loss on investment securities. FORWARD FOREIGN CURRENCY CONTRACTS In order to protect against a possible loss on investments resulting from a decline or appreciation in the value of a particular foreign currency against the U.S. dollar or another foreign currency or for other reasons, the Portfolio is authorized to enter into forward currency exchange contracts. These contracts involve an obligation to purchase or sell a specified currency at a future date at a price set at the time of the contract. Forward currency contracts do not eliminate fluctuations in the values of portfolio securities but rather allow the Portfolio to establish a rate of exchange for a future point in time. INCOME RECOGNITION Interest income is recorded on the accrual basis and includes accretion of discounts and amortization of premiums, if any. Facility fees received are recorded as a reduction of cost to the loan and amortized through the maturity of the loan. Dividend income is recorded on the ex-dividend date. 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 shares 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. U.S. FEDERAL INCOME TAX STATUS The Fund intends to qualify each year as a "regulated investment company" under Subchapter M of the Code and will distribute substantially all of its taxable income and gains, if any, for its tax year, and as such will not be subject to U.S. federal income taxes. In addition, the Portfolio is treated as a partnership for U.S. federal income tax purposes and all of its income is allocated to its owners based on methods in compliance with the Internal Revenue Service. Therefore, no U.S. federal income tax provision is recorded. The Fund is the sole member of the Portfolio. For U.S. federal income tax purposes, the Portfolio is a disregarded entity. DISTRIBUTIONS TO SHAREHOLDERS Dividends from net investment income are declared by the Fund daily and paid monthly. Net realized capital gains, if any, are distributed at least annually. STATEMENT OF CASH FLOWS Information on financial transactions which have been settled through the receipt or disbursement of cash is presented in the Statement of Cash Flows. The cash and foreign currency amount shown in the Statement of Cash Flows is the amount included within the Portfolio's Statement of Assets and Liabilities and includes cash and foreign currency on hand at its custodian bank and sub-custodian bank, respectively, and does not include any short-term investments. Annual Report | 31 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND ADDITIONAL ACCOUNTING STANDARDS In July 2006, the Financial Accounting Standards Board ("FASB") released FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 provides guidance on how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. FIN 48 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Fund's tax returns to determine whether the tax positions are "more-likely-than-not" of being sustained by the applicable tax authorities. Tax positions not deemed to satisfy the "more-likely-than-not" threshold would be recorded as a tax benefit or expense in the current year. FASB required adoption of FIN 48 for fiscal years beginning after December 15, 2006, and FIN 48 is to be applied to all open tax years as of the effective date. Implementation of FIN 48 will be required beginning after August 31, 2007. In September 2006, Statement of Financial Accounting Standards No. 157 FAIR VALUE MEASUREMENTS ("SFAS 157") was issued and is effective for fiscal years beginning after November 15, 2007. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In February 2007, FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities ("SFAS 159"), which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities and to more easily understand the effect of the Fund's choice to use fair value on its earnings. SFAS 159 also requires entities to display the fair value of the selected assets and liabilities on the face of the balance sheet. SFAS 159 does not eliminate disclosure requirements of other accounting standards, including fair value measurement disclosures in SFAS 157. SFAS 159 is effective for fiscal years beginning after November 15, 2007. At this time, management is evaluating the implications of FIN 48, SFAS 157 and SFAS 159 and their impact on the Fund's financial statements, if any, has not been determined. NOTE 3. U.S. FEDERAL TAX INFORMATION The timing and character of income and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. 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, 2007, permanent differences resulting from premium amortization sold, Section 988 gain/(loss) reclass, foreign bond bifurcation and non-deductible excise tax paid were identified and reclassified among the components of the Fund's net assets as follows: - -------------------------------------------------------------------------------- Undistributed (Overdistributed) Accumulated Net Net Investment Realized Gain/ Paid-in Income (Loss) Capital - -------------------------------------------------------------------------------- $ (2,779,826) $ 2,779,965 $ (139) - -------------------------------------------------------------------------------- The tax character of distributions paid during the years ended August 31, 2007 and August 31, 2006 were as follows: - -------------------------------------------------------------------------------- 2007 2006 - -------------------------------------------------------------------------------- Distributions paid from: - -------------------------------------------------------------------------------- Ordinary income* $ 148,780,797 $ 93,180,034 - -------------------------------------------------------------------------------- Long-term capital gains -- -- - -------------------------------------------------------------------------------- * For tax purposes, short-term capital gain distributions, if any, are considered ordinary income distributions. As of August 31, 2007, the most recent tax year end, the components of distributable earnings on a tax basis were as follows: - -------------------------------------------------------------------------------- Undistributed Undistributed Ordinary Long-Term Net Unrealized Income Capital Gains Depreciation* - -------------------------------------------------------------------------------- $ 13,907,234 $ -- $ (74,814,432) - -------------------------------------------------------------------------------- * The differences between book-basis and tax-basis net unrealized appreciation/depreciation are primarily due to deferral of losses from wash sales, premium amortization and Section 732 adjustments. Portfolio unrealized appreciation and depreciation at August 31, 2007, based on cost of investments for U.S. federal income tax purposes, and excluding any unrealized appreciation and depreciation from changes in the value of other 32 | Annual Report NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND assets and liabilities resulting from changes in exchange rates, was: - -------------------------------------------------------------------------------- Unrealized appreciation $ 22,931,369 Unrealized depreciation (97,242,615) -------------- Net unrealized depreciation $ (74,311,246) ============== - -------------------------------------------------------------------------------- POST-OCTOBER LOSSES 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, 2007, the Fund intends to elect to defer net realized capital losses of $2,311,886 and currency losses of $1,975,686 incurred from November 1, 2006 through August 31, 2007. NOTE 4. ADVISORY, ADMINISTRATION, SERVICE AND DISTRIBUTION AND TRUSTEE FEES INVESTMENT ADVISORY FEE Highland Capital Management, L.P. is the investment adviser to the Portfolio. Effective August 21, 2007, Highland receives from the Portfolio a monthly advisory fee, based on the Portfolio's average daily net assets at the following annual rates: - -------------------------------------------------------------------------------- Average Daily Net Assets Annual Fee Rate - -------------------------------------------------------------------------------- First $1 billion 0.65% - -------------------------------------------------------------------------------- Next $1 billion 0.60% - -------------------------------------------------------------------------------- Over $2 billion 0.55% - -------------------------------------------------------------------------------- Prior to August 21, 2007, Highland received a monthly investment advisory fee from the Portfolio based on the Portfolio's average daily net assets at the following annual rates: - -------------------------------------------------------------------------------- Average Daily Net Assets Annual Fee Rate - -------------------------------------------------------------------------------- First $1 billion 0.45% - -------------------------------------------------------------------------------- Next $1 billion 0.40% - -------------------------------------------------------------------------------- Over $2 billion 0.35% - -------------------------------------------------------------------------------- For the year ended August 31, 2007, the Portfolio's effective investment advisory fee rate was 0.43%. ADMINISTRATION FEES Highland provides administrative services to the Portfolio and the Fund for a monthly administration fee at the annual rate of 0.20% of the Fund's average daily net assets. The Fund, but not the Portfolio, pays Highland for these services. Under separate sub-administration agreements, Highland has delegated certain administrative functions to PFPC Inc. ("PFPC"). Highland pays PFPC directly for these services. SERVICE AND DISTRIBUTION FEES PFPC Distributors, Inc. (the "Underwriter") serves as the principal underwriter and distributor of the Fund's shares. The Underwriter receives a CDSC imposed on certain redemptions of Class A, Class B and Class C Shares. For the year ended August 31, 2007, the Underwriter received $42,222, $97,693 and $110,851 of CDSCs 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 Underwriter at an annual rate of 0.25% of the average daily net assets attributable to Class A, Class B and Class C Shares of the Fund. The Plan also requires the payment of a monthly distribution fee to the Underwriter at an annual rate of 0.10%, 0.45% and 0.60% of the average daily net assets attributable to Class A, Class B and Class C Shares, respectively. The CDSC and the fees received from the Plan are used principally as repayment for amounts paid by the Underwriter to dealers who sold such shares. EXPENSE LIMITS AND FEE REIMBURSEMENTS Effective August 21, 2007, Highland voluntarily has agreed to waive advisory fees and reimburse the Fund for certain expenses (exclusive of distribution and service fees, brokerage commissions, commitment fees, interest, taxes and extraordinary expenses, if any) so that total expenses will not exceed 1.00% of the average daily net assets of the Fund. This arrangement may be modified or terminated by Highland at any time. FEES PAID TO OFFICERS AND TRUSTEES/MANAGERS The Fund and the Portfolio pay no compensation to their one interested Trustee/Manager or to any of their respective officers, all of whom are employees of Highland. Trustees/Managers who are not "interested persons" (as defined in the 1940 Act) of the Fund and the Portfolio each receive an annual retainer fee of $25,000 for services provided as Trustees of the Fund and the Portfolio. The Fund pays $20,000 of this fee and the remaining $5,000 is paid by the Portfolio. Following the Fund's conversion to a single-fund structure and the liquidation and dissolution of the Annual Report | 33 NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND Portfolio, which is expected to occur by the end of 2007, the Fund will pay the entire fee for each Trustee. NOTE 5. PORTFOLIO INFORMATION For the year ended August 31, 2007, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were $2,289,064,593 and $1,697,856,111, respectively. NOTE 6. PERIODIC REPURCHASE OFFERS The Fund has adopted a policy to offer each calendar quarter to repurchase a specified percentage (between 5% and 25%) of the shares then outstanding at the Fund's net asset value ("Repurchase Offers"). Repurchase Offers are scheduled to occur on or about the 15th day (or the next business day if the 15th is not a business day) in the months of March, June, September, and December. It is anticipated that normally the date on which the repurchase price of shares will be determined (the "Repurchase Pricing Date") will be the same date as the deadline for shareholders to provide their repurchase requests to the Distributor (the "Repurchase Request Deadline"), and if so, the Repurchase Request Deadline will be set for a time no later than the close of regular trading on the New York Stock Exchange 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. If shareholders tender for repurchase more than the Repurchase Offer amount for a given Repurchase Offer, the Fund may repurchase an additional amount of shares of up to 2% of the shares outstanding on the Repurchase Request Deadline. For the year ended August 31, 2007, there were four Repurchase Offers. For each Repurchase Offer, the Fund offered to repurchase 10% of its shares. In the September 2006, December 2006, March 2007 and June 2007 Repurchase Offers, 8.03%, 7.15%, 5.80% and 5.00%, respectively, of shares outstanding were repurchased. NOTE 7. SENIOR LOAN PARTICIPATION COMMITMENTS The Portfolio invests at least 80% of its net assets (plus any borrowings for investment purposes) in adjustable rate senior loans ("Senior Loans") the interest rates of which float or vary periodically based upon a benchmark indicator of prevailing interest rates to domestic foreign corporations, partnerships and other entities ("Borrowers"). If the lead lender in a typical lending syndicate becomes insolvent, enters FDIC receivership or, if not FDIC insured, enters into bankruptcy, the Portfolio may incur certain costs and delays in receiving payment or may suffer a loss of principal and/or interest. When the Portfolio purchases a participation of a Senior Loan interest, the Portfolio typically enters into a contractual agreement with the lender or other third party selling the participation, not with the Borrower directly. As such, the Portfolio assumes the credit risk of the Borrower, selling participant or other persons interpositioned between the Portfolio and the Borrower. The ability of Borrowers to meet their obligations may be affected by economic developments in a specific industry. At August 31, 2007, the following sets forth the selling participants with respect to interests in Senior Loans purchased by the Portfolio on a participation basis. - -------------------------------------------------------------------------------- Principal Selling Participant Amount Value - -------------------------------------------------------------------------------- Credit Suisse: Berry Plastics Holding Corp. Term C Loan $ 249,375 $ 239,400 Hexion Specialty Chemicals, Inc. Tranche C-1 Term Loan 2,335,641 2,290,096 Tranche C-2 Term Loan 507,368 496,713 Jacuzzi Brands Corp First Lien Term B Loan 917,095 831,117 Pre-Funded Letter of Credit 81,081 73,784 Quality Distributions, Inc. Term Loan 2,064,887 2,054,562 Goldman Sachs: Bridge Information Systems, Inc. Multidraw Term Loan 475,491 36,950 Morgan Stanley Senior Funding, Inc. Realogy Corp Initial Term B Loan 1,969,697 1,794,276 Synthetic Letter of Credit 530,303 483,074 - -------------------------------------------------------------------------------- NOTE 8. LINE OF CREDIT On September 13, 2004, the Portfolio entered into a $150,000,000 credit facility with the Bank of Nova Scotia, which was increased on September 12, 2005 to $200,000,000, to be used for temporary or emergency purposes to facilitate portfolio liquidity. Interest is charged to the Portfolio based on its borrowings. In addition, the Portfolio has agreed to pay facility expenses on the unutilized line of credit, which are included on the Statement of Operations. For the year ended August 31, 2007, the average daily loan balance outstanding on days where borrowings existed was $80,333,333 at a weighted average interest rate of 8.89%. 34 | Annual Report NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND Interest expense allocated to the Fund of $239,479 was paid for use of the line of credit and is included on the Statement of Operations. NOTE 9. UNFUNDED LOAN COMMITMENTS As of August 31, 2007, the Portfolio had unfunded loan commitments of $33,736,080, which could be extended at the option of the Borrower, pursuant to loan agreements with the following borrowers: - -------------------------------------------------------------------------------- Unfunded Loan Borrower Commitment - -------------------------------------------------------------------------------- American Buildings Co. $ 239,463 - -------------------------------------------------------------------------------- Autocam Corp. 38,773 - -------------------------------------------------------------------------------- Buffets Holdings, Inc. 928,125 - -------------------------------------------------------------------------------- Centennial Cellular Operating Co. 2,250,000 - -------------------------------------------------------------------------------- CHS/Community Health Systems, Inc. 587,780 - -------------------------------------------------------------------------------- Cricket Communications, Inc. 6,500,000 - -------------------------------------------------------------------------------- DeCrane Aircraft Holdings, Inc. 1,000,000 - -------------------------------------------------------------------------------- Federal-Mogul Corp. 102,746 - -------------------------------------------------------------------------------- Fenwal, Inc. 1,500,000 - -------------------------------------------------------------------------------- FleetCor Technologies Operating Co., LLC 416,667 - -------------------------------------------------------------------------------- Fontainebleu Las Vegas LLC 2,333,333 - -------------------------------------------------------------------------------- HUB International Holdings, Inc. 627,451 - -------------------------------------------------------------------------------- Interstate Bakeries Corp. 7,500,000 - -------------------------------------------------------------------------------- Millennium Digital Media Systems, LLC 3,057,912 - -------------------------------------------------------------------------------- Nordic Cable Acquisition 3,068,493 - -------------------------------------------------------------------------------- Readers Digest Association, Inc. 501,500 - -------------------------------------------------------------------------------- Schieder Mobel Holding, GMBH 24,742 - -------------------------------------------------------------------------------- Univision Communications, Inc. 2,612,416 - -------------------------------------------------------------------------------- Ypso Holding SA 446,679 - -------------------------------------------------------------------------------- $ 33,736,080 ============= - -------------------------------------------------------------------------------- NOTE 10. DISCLOSURE OF SIGNIFICANT RISKS AND CONTINGENCIES INDUSTRY FOCUS The Portfolio may focus its investments in certain industries, subjecting it to greater risk than a Portfolio that is more diversified. NON-PAYMENT RISK Senior Loans, like other corporate debt obligations, are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the Portfolio, a reduction in the value of the Senior Loan experiencing non-payment and a potential decrease in the net asset value of the Fund. CREDIT RISK Securities rated below investment grade are commonly referred to as high-yield, high risk or "junk debt." They are regarded as predominantly speculative with respect to the issuing company's continuing ability to meet principal and/or interest payments. Investments in high-yield Senior Loans may result in greater net asset value fluctuation than if the Portfolio did not make such investments. CURRENCY RISK A portion of the Portfolio'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 Portfolio's investment performance may be negatively affected by a devaluation of a currency in which the Portfolio's investments are quoted or denominated. Further, the Portfolio's investment performance may be significantly affected, either positively or negatively, by currency exchange rates because the U.S. dollar value of securities quoted or denominated in another currency will increase or decrease in response to changes in the value of such currency in relation to the U.S. dollar. FOREIGN SECURITIES Investments in foreign securities may involve special risks compared to investing in securities of U.S. issuers. These risks are more pronounced to the extent that the Portfolio invests a significant portion of its non-U.S. investment in one region or in the securities of emerging market issuers. These risks may include (i) less information about non-U.S. issuers or markets being available due to less rigorous disclosure, accounting standards or regulatory requirements; (ii) many non-U.S. markets are smaller, less liquid and more volatile and Highland may not be able to sell the Portfolio's securities at times, in amounts and at prices it considers reasonable; (iii) the economies of non-U.S. markets may grow at slower rates than expected or may experience a downturn or recession; and (iv) withholdings and other non-U.S. taxes may decrease the Fund's returns. Annual Report | 35 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - -------------------------------------------------------------------------------- TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF HIGHLAND FLOATING RATE FUND AND THE BOARD OF MANAGERS OF HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY: In our opinion, the accompanying statements of assets and liabilities, including the investment portfolios, and the related statements of operations and of changes in net assets and of cash flows and the financial highlights present fairly, in all material respects, the financial position of Highland Floating Rate Fund (the "Fund") and Highland Floating Rate Limited Liability Company (the "Portfolio") at August 31, 2007, and the results of each of their operations for the year then ended, the changes in their net assets, the Portfolio's cash flows and their financial highlights for period indicated in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's and the Portfolio's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of investments at August 31, 2007 by correspondence with the custodian and the banks with whom the Portfolio owns participations in loans, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Dallas, Texas October 25, 2007 36 | Annual Report ADDITIONAL INFORMATION (UNAUDITED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND APPROVAL OF INVESTMENT ADVISORY CONTRACTS The Portfolio has retained Highland to manage its assets pursuant to an investment advisory agreement with Highland (the "Current Portfolio Advisory Agreement"). The Current Portfolio Advisory Agreement has been approved by the Portfolio's Board of Managers and the Fund's Board of Trustees, including a majority of the Managers/Trustees who are not "interested persons" (as defined in the 1940 Act) of the Portfolio or the Fund (the "Independent Managers/Trustees"). Following an initial term of two years, the Current Portfolio Advisory Agreement continues in effect with respect to the Portfolio (unless terminated sooner) if approved at least annually by (i) a majority of the Portfolio's Independent Managers, cast in person at a meeting for the purpose of voting on such approval, and (ii) by the vote of a majority of the outstanding shares of the Fund and any other then existing feeder fund of the Portfolio, or the Portfolio's Board of Managers. At a meeting held on April 30, 2007, the Independent Managers/Trustees, assisted by their independent legal counsel, met in executive session to discuss (i) the continuation of the Current Portfolio Advisory Agreement and (ii) the approval of a new investment advisory agreement between the Portfolio and Highland (the "New Portfolio Advisory Agreement" and together with the Current Portfolio Advisory Agreement, the "Advisory Agreements") and the submission of the New Portfolio Advisory Agreement to shareholders of the Fund. The Independent Managers/Trustees discussed the fact that the New Portfolio Advisory Agreement contains substantially identical terms to the Current Portfolio Advisory Agreement except that the New Portfolio Advisory Agreement reflects an increase in advisory fees at each stated asset level of 0.20%. Prior to the meeting, the Independent Managers/ Trustees had requested detailed information from Highland which included: (1) information confirming the financial soundness of Highland; (2) information on the advisory and compliance personnel of Highland; (3) information on the internal compliance procedures of Highland; (4) comparative information showing how the Portfolio's proposed advisory fee rate schedule and anticipated operating expenses of the Fund compare to (i) other registered closed-end and private funds, in particular investment companies and funds that follow investment strategies similar to those of the Fund and investment companies that are comparable in structure and asset size, and (ii) other private and registered pooled investment vehicles or accounts managed by Highland, as well as the performance of such vehicles and accounts (in absolute and market terms); (5) information regarding brokerage and portfolio transactions; and (6) information on any legal proceedings or regulatory audits or investigations affecting Highland. The Independent Managers/Trustees reviewed various factors discussed in independent counsel's legal memorandum, the detailed information provided by Highland and other relevant information and factors, including the following: THE NATURE, EXTENT, AND QUALITY OF THE SERVICES TO BE PROVIDED BY HIGHLAND The Independent Managers/Trustees considered the portfolio management services provided by Highland and the activities related to portfolio management, including use of technology, research capabilities, and investment management staff. They discussed the experience and qualifications of the personnel who provide advisory services, including the background and experience of the members of the portfolio management team. The Independent Managers/Trustees reviewed the management structure, assets under management and investment philosophies and processes of Highland. They also reviewed and discussed Highland's compliance policies and procedures. The Independent Managers/Trustees concluded that Highland has the quality and depth of personnel and investment methods essential to performing its duties under the Advisory Agreements and that the nature of such advisory services is satisfactory. HIGHLAND'S HISTORICAL PERFORMANCE IN MANAGING THE PORTFOLIO AND THE FUND The Independent Managers/Trustees reviewed Highland's historical performance in managing the Portfolio and the Fund based on data set forth in the Lipper Analytical New Applications database. They noted that, as a result of its investment in the Portfolio, the Fund is consistently outperforming its benchmark, the Credit Suisse Leveraged Loan Index, as well as its peers that employ leverage (other than Highland Floating Rate Advantage Fund ("ADV")) and those that do not employ leverage. During the 12 months ended March 31, 2007, the Fund's Class A Shares earned a return of 9.71%, which represents a 33.01% incremental return or 241 basis points more than its benchmark. During the 12 months ended March 31, 2007, the Fund's Class B Shares earned a return of 9.34%, which represents a 27.95% incremental return or 204 basis points more than its benchmark. During the 12 months ended March 31, 2007, the Fund's Class C Shares earned a return of 9.18%, which represents a 25.75% incremental return or 188 basis points more than its benchmark. During the 12 months ended March 31, 2007, the Fund's Class Z Shares earned a return of 10.10%, which represents a 38.36% incremental return or 280 basis points more than its benchmark. Additionally, of its peer group, only ADV (which employs leverage) outperformed the Fund during the 12 months ended March 31, 2007. Additionally, in Lipper's Annualized Rate of Return Annual Report | 37 ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND APPROVAL OF INVESTMENT ADVISORY CONTRACTS (CONTINUED) categories, all of the Fund's share classes were ranked in the Top 9 for the 3-year, 5-year and since inception time frames of the Total Return set. THE INVESTMENT PERFORMANCE OF OTHER ACCOUNTS OR FUNDS MANAGED BY HIGHLAND The Independent Managers/Trustees reviewed the performance of Highland for accounts or funds that are similar to the Portfolio compared with other investment companies of similar investment objectives and size. They reviewed the performance of ADV and noted that it is consistently outperforming its benchmark, the Credit Suisse Leveraged Loan Index, as well as both its peers that employ leverage and those that do not employ leverage. During the 12 months ended March 31, 2007, ADV's Class A Shares earned a return of 10.44%, which represents a 43.01% incremental return or 314 basis points more than its benchmark. During the 12 months ended March 31, 2007, ADV's Class B Shares earned a return of 10.05%, which represents a 37.67% incremental return or 275 basis points more than its benchmark. During the 12 months ended March 31, 2007, ADV's Class C Shares earned a return of 9.89%, which represents a 35.48% incremental return or 259 basis points more than its benchmark. During the 12 months ended March 31, 2007, ADV's Class Z Shares earned a return of 10.83%, which represents a 48.36% incremental return or 353 basis points more than its benchmark. Furthermore, when compared to its peer group, all of ADV's share classes have been the top performing share classes of any peer, in the categories 1-Year Total Return, and Total Return since April 15, 2004, as well as the Annualized Total Rates of Return in 3-Year, 5-Year, since April 15, 2004 (the date on which Highland became ADV's Investment Adviser), and Since Inception time frames. The Independent Managers/Trustees were satisfied with Highland's overall performance records. The Independent Managers/Trustees also reviewed the performance of a private separate account that is the Fund's only other Highland-advised peer and noted that it is consistently outperforming its benchmark, the Credit Suisse Leveraged Loan Index. During the 12 months ended March 31, 2007, the private sector account earned a return of 8.05%, which represents a 10.27% incremental return or 75 basis points more than its benchmark. Furthermore, the private separate account outperformed its benchmark in the categories Total Return since April 15, 2004, as well as the Annualized Total Rates of Return in 3-Year, 5-Year, since April 15, 2004 and Since Inception time frames. THE COSTS OF THE SERVICES TO BE PROVIDED BY HIGHLAND AND THE PROFITS TO BE REALIZED BY HIGHLAND AND ITS AFFILIATES FROM THE RELATIONSHIP WITH THE PORTFOLIO AND THE FUND With respect to the Advisory Agreements, the Independent Managers/Trustees also gave substantial consideration to: (1) the fee rate to be paid to Highland under the Advisory Agreements as well as under the Administration Services Agreement between Highland and the Fund; (2) the anticipated expenses Highland would incur in providing advisory services; (3) so-called "fallout benefits" to Highland under the Advisory Agreements, such as any incremental increase to its reputation derived from serving as investment adviser to the Portfolio; and (4) a comparison of the fees payable to Highland under the Advisory Agreements to fees paid to Highland by other funds and to investment advisers serving other investment companies with similar investment programs to that of the Portfolio. After such review, the Independent Managers/Trustees determined that the anticipated profitability rate to Highland with respect to the Advisory Agreements was fair and reasonable. THE EXTENT TO WHICH ECONOMIES OF SCALE WOULD BE REALIZED AS THE PORTFOLIO GROWS AND WHETHER FEE LEVELS REFLECT THESE ECONOMIES OF SCALE FOR THE BENEFIT OF SHAREHOLDERS The Independent Managers/Trustees considered the effective fees under the Advisory Agreements, as a percentage of assets at different asset levels, and possible economies of scale to Highland. They considered the anticipated asset levels of the Portfolio, the information provided by Highland relating to its estimated costs, and information comparing the fee rate to be charged by Highland with fee rates charged by other unaffiliated investment advisers to their clients. They also considered Highland's willingness, if shareholders approve the New Portfolio Advisory Agreement, to voluntarily waive advisory fees and reimburse the Fund for certain expenses (exclusive of distribution and service fees, brokerage commissions, commitment fees, interest, taxes and extraordinary expenses, if any) so that total expenses would not exceed an annual rate of 1.00% of the average daily net assets of the Fund. The Independent Managers/Trustees concluded that the fee structures are reasonable and appropriately would result in a sharing of economies of scale in view of the information provided by Highland. In determining whether to approve the continuation of the Current Portfolio Advisory Agreement and to recommend the submission to shareholders of the New Portfolio 38 | Annual Report ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND APPROVAL OF INVESTMENT ADVISORY CONTRACTS (CONTINUED) Advisory Agreement, the Independent Managers/Trustees drew the following conclusions: The Independent Managers/Trustees concluded that an increase in the investment advisory fee rate would be in the best interests of shareholders because it would enable Highland to remain committed to the long-term management of the Fund and the Portfolio at a more appropriate fee level. The Independent Managers/Trustees determined that the current fee rate and the increased advisory fee rate proposal are fair and reasonable, in light of the resources that Highland has devoted to managing the Portfolio during the period Highland has served as the investment adviser to the Portfolio and in view of the fact that the current advisory fee rate for the Portfolio is substantially below the average advisory/management fee rate in the Portfolio's peer groups. The Board also noted that the proposed advisory fee rate increase would still be below the average of other funds with similar investment programs to that of the Portfolio. They also noted the Portfolio's excellent performance under Highland's management. The Fund's Board noted that at its May 19, 2006 board meeting it had approved an advisory agreement substantially identical to the New Portfolio Advisory Agreement and that the Fund had held a shareholder meeting but did not obtain the requisite shareholder approval by a very slim margin. The Board noted that only 55% of the shares entitled to vote on the proposal had been represented at the meeting and, therefore, a significant portion of the shareholders did not vote on the proposal. The Board also noted the ADV shareholder approval of a similar advisory fee rate increase and Highland's continued belief that a fee rate increase is appropriate and necessary to maintain the high level of service it provides to Fund and the Portfolio. The Board considered whether any of the factors that led to its approval at the May 19, 2006 meeting had changed. In light of the continued high level of service that Highland provides to Fund and the Portfolio, the Board determined that the New Portfolio Advisory Agreement should be submitted for shareholder approvals. SHAREHOLDER VOTING RESULTS At a Special Meeting of the Shareholders of the Fund originally scheduled for July 20, 2007 and adjourned until August 21, 2007 (the "Meeting"), the shareholders of record of the Fund as of June 4, 2007 ("Record Date") were asked to approve (i) the New Portfolio Advisory Agreement; (ii) an Agreement and Plan of Reorganization, pursuant to which the Fund would be reorganized into a newly formed Delaware statutory trust, also named Highland Floating Rate Fund; and (iii) the Fund's conversion to a single-fund structure and the liquidation and dissolution of the Portfolio (collectively, the "Proposals"). As of the Record Date, the Fund had the following shares outstanding: - -------------------------------------------------------------------------------- Class A 90,322,341.92 - -------------------------------------------------------------------------------- Class B 13,272,971.86 - -------------------------------------------------------------------------------- Class C 89,155,983.56 - -------------------------------------------------------------------------------- Class Z 30,995,064.52 - -------------------------------------------------------------------------------- On July 20, 2007, the date of the Meeting, there was not present, in person or by proxy, a majority of the outstanding shares entitled to vote at the Meeting. Therefore, the Fund's quorum requirement was not met and the Meeting was adjourned to August 21, 2007. On August 21, 2007, a majority of the total number of outstanding shares of the Fund entitled to vote was represented at the Meeting and the Fund's quorum requirement was met. On August 21, 2007, the Proposals were voted on and each was approved by the shareholders of the Fund. The shares represented at the Meeting on August 21, 2007 voted on the Proposals as follows: With respect to the approval of the New Portfolio Advisory Agreement: - -------------------------------------------------------------------------------- For: 86,523,909 - -------------------------------------------------------------------------------- Against: 20,673,537 - -------------------------------------------------------------------------------- Abstain: 5,746,557 - -------------------------------------------------------------------------------- With respect to the approval of the Agreement and Plan of Reorganization: - -------------------------------------------------------------------------------- For: 95,833,921 - -------------------------------------------------------------------------------- Against: 8,919,328 - -------------------------------------------------------------------------------- Abstain: 8,190,754 - -------------------------------------------------------------------------------- With respect to the approval of the Fund's conversion to a single-fund structure and the liquidation and dissolution of the Portfolio: - -------------------------------------------------------------------------------- For: 95,893,621 - -------------------------------------------------------------------------------- Against: 8,530,404 - -------------------------------------------------------------------------------- Abstain: 8,519,981 - -------------------------------------------------------------------------------- Annual Report | 39 ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND ADDITIONAL PORTFOLIO INFORMATION The Investment Adviser and its affiliates manage other accounts, including registered and private funds and individual accounts. Although investment decisions for the Portfolio are made independently from those of such other accounts, the Investment Adviser may, consistent with applicable law, make investment recommendations to other clients or accounts that may be the same or different from those made to the Portfolio, including investments in different levels of the capital structure of a company, such as equity versus senior loans, or that take contrary provisions in multiple levels of the capital structure. The Investment Adviser has adopted policies and procedures that address the allocation of investment opportunities, execution of portfolio transactions, personal trading by employees and other potential conflicts of interest that are designed to ensure that all client accounts are treated equitably over time. Nevertheless, this may create situations where a client could be disadvantaged because of the investment activities conducted by the Investment Adviser for other client accounts. When the Portfolio and one or more of such other accounts is prepared to invest in, or desires to dispose of, the same security, available investments or opportunities for each will be allocated in a manner believed by the Investment Adviser to be equitable to the Portfolio and such other accounts. The Investment Adviser also may aggregate orders to purchase and sell securities for the Portfolio and such other accounts. Although the Investment Adviser believes that, over time, the potential benefits of participating in volume transactions and negotiating lower transaction costs should benefit all accounts including the Portfolio, in some cases these activities may adversely affect the price paid or received by the Portfolio or the size of the position obtained or disposed of by the Portfolio. 40 | Annual Report ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND TRUSTEES AND OFFICERS The Board of Trustees of the Fund provides broad oversight over the operations and affairs of the Fund and protects the interests of shareholders. The Board has overall responsibility to manage and control the business affairs of the Fund, including the complete and exclusive authority to establish policies regarding the management, conduct and operation of the Fund's business. The names 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 the last five years, the number of funds overseen by each Trustee and other directorships they hold are shown below. The business address for each Trustee and officer of the Fund is c/o Highland Capital Management, L.P., Two Galleria Tower, 13455 Noel Road, Suite 800, Dallas, TX 75240. Each Trustee of the Fund also serves in the same role as a member of the Board of Managers of the Portfolio. Each officer of the Fund also serves in the same role as an officer of the Portfolio.
- ------------------------------------------------------------------------------------------------------------------------------------ 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 - ------------------------------------------------------------------------------------------------------------------------------------ INDEPENDENT TRUSTEES Timothy K. Hui Trustee Indefinite Dean of Educational Resources 12 None (Age 59) Term; since July 2006; Assistant Trustee Provost for Graduate Education since from July 2004 to June 2006, 2004 and Assistant Provost for Educational Resources from July 2001 to June 2004, Philadelphia Biblical University. Scott F. Kavanaugh Trustee Indefinite Private Investor since February 12 None (Age 46) Term; 2004. Sales Representative at Trustee Round Hill Securities from since March 2003 to January 2004; 2004 Executive at Provident Funding Mortgage Corporation, February 2003 to July 2003; Executive Vice President. Director and CAO, Commercial Capital Bank, January 2000 to February 2003; Managing Principal and Chief Operating Officer, Financial Institutional Partners Mortgage Company and the Managing Principal and President of Financial Institutional Partners, LLC (an investment banking firm), April 1998 to February 2003. James F. Leary Trustee Indefinite Managing Director, Benefit 12 Board Member of (Age 77) Term; Capital Southwest, Inc. (a Capstone Group Trustee financial consulting firm) since of Funds (7 since January 1999. portfolios) 2004 - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 41 ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND TRUSTEES AND OFFICERS
- ------------------------------------------------------------------------------------------------------------------------------------ YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS ELECTED OR OCCUPATION(S) IN HIGHLAND FUNDS OTHER NAME, ADDRESS, POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS AND AGE WITH FUND TO OFFICE FIVE YEARS BY TRUSTEE 1 HELD - ------------------------------------------------------------------------------------------------------------------------------------ INDEPENDENT TRUSTEES Bryan A. Ward Trustee Indefinite Senior Manager since January 12 None (Age 52) Term; 2002 and Special Projects Trustee Advisor, Accenture, LLP since (consulting firm) with focus on 2004 the oil and gas industry, from September 1998 to December 2001. INTERESTED TRUSTEE 2 R. Joseph Dougherty 2 Trustee and Indefinite Senior Portfolio Manager of the 12 None (Age 37) Chairman of the Term; Investment Adviser since 2000. Board Trustee Director and Senior Vice and President of the funds in the Chairman Highland Fund Complex. of the Board since 2004 OFFICERS James D. Dondero Chief Executive 1 year President and Director of Strand N/A N/A (Age 45) Officer and Term; Advisors, Inc. ("Strand"), the President Chief General Partner of the Executive Investment Adviser. President Officer of the funds in the Highland and Fund Complex. President since 2004 Mark Okada Executive Vice 1 year Executive Vice President of N/A N/A (Age 45) President Term; Strand and the funds in the Executive Highland Fund Complex. Vice President since 2004 R. Joseph Dougherty Senior Vice 1 year Senior Portfolio Manager of the N/A N/A (Age 37) President Term; Investment Adviser since 2000. Senior Director and Senior Vice Vice President of the funds in the President Highland Fund Complex. since 2004 - ------------------------------------------------------------------------------------------------------------------------------------
42 | Annual Report ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND TRUSTEES AND OFFICERS
- ------------------------------------------------------------------------------------------------------------------------------------ YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS ELECTED OR OCCUPATION(S) IN HIGHLAND FUNDS OTHER NAME, ADDRESS, POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS AND AGE WITH FUND TO OFFICE FIVE YEARS BY TRUSTEE 1 HELD - ------------------------------------------------------------------------------------------------------------------------------------ OFFICERS M. Jason Blackburn Chief Financial 1 year Assistant Controller of the N/A N/A (Age 31) Officer (Principal Term; Adviser since November 2001. Accounting Secretary, Treasurer and Secretary of the Officer), Treasurer Chief funds in the Highland Fund and Secretary Financial Complex. Officer and Treasurer since 2004 Michael Colvin Chief Compliance 1 year General Counsel and Chief N/A N/A (Age 38) Officer Term; Chief Compliance Officer of the Compliance Investment Adviser since June Officer 2007 and Chief Compliance since July Officer of the funds in the 2007 Highland Fund Complex since July 2007, Shareholder in the Corporate and Securities Group at Greenberg Traurig, LLP, from January 2007 to June 2007, Partner from January 2003 to January 2007 and Associate from 1995 to 2002 in the Private Equity Practice Group at Weil, Gotshal & Manges, LLP. - ------------------------------------------------------------------------------------------------------------------------------------
1 The Highland Fund Complex consists of all of the registered investment companies advised by the Investment Adviser as of the date of this report. 2 Mr. Dougherty is deemed to be an "interested person" of the Fund and the Portfolio under the 1940 Act because of his position with the Investment Adviser. Annual Report | 43 IMPORTANT INFORMATION ABOUT THIS REPORT - -------------------------------------------------------------------------------- INVESTMENT ADVISER Highland Capital Management, L.P. Two Galleria Tower 13455 Noel Road, Suite 800 Dallas, TX 75240 TRANSFER AGENT PFPC Inc. 101 Sabin Street Pawtucket, RI 02860 DISTRIBUTOR PFPC Distributors, Inc. 760 Moore Road King of Prussia, PA 19406 CUSTODIAN PFPC Trust Company 8800 Tinicum Boulevard Philadelphia, PA 19153 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM PricewaterhouseCoopers LLP 2001 Ross Avenue, Suite 1800 Dallas, TX 75201 LEGAL ADVISOR Skadden, Arps, Slate, Meagher & Flom LLP Four Times Square New York, NY 10036 This report has been prepared for shareholders of Highland Floating Rate Fund. The Fund mails one shareholder report to each shareholder address. If you would like more than one report, please call shareholder services at 1-877-665-1287 to request that additional reports be sent to you. A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to its portfolio securities, and the Fund's proxy voting record for the most recent 12-month period ended June 30, are available (i) without charge, upon request, by calling 1-877-665-1287 and (ii) on the Securities and Exchange Commission's website at http://www.sec.gov. The Fund files its complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q. The Fund's Forms N-Q are available on the Commission's website at http://www.sec.gov and also may be reviewed and copied at the Commission's Public Reference Room in Washington, DC. Information on the Public Reference Room may be obtained by calling 1-800-SEC-0330. The Statement of Additional Information includes information about Fund Trustees and is available upon request without charge by calling 1-877-665-1287. 44 | Annual Report - -------------------------------------------------------------------------------- HIGHLAND FLOATING RATE FUND Annual Report, August 31, 2007 [HIGHLAND FUNDS LOGO] managed by Highland Capital Management, L.P. www.highlandfunds.com HLC-FR AR-08/07 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 December 9, 2004 (Accession No. 0001047469-04-036597). 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 this Item 3 of Form N-CSR. 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 are $59,000 for 2006 and $40,000 for 2007. 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 are $5,500 for 2006 and $3,500 for 2007. The nature of the services related to agreed-upon procedures, performed on the Fund's 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 are $4,800 for 2006 and $2,850 for 2007. The nature of the services related to assistance on the Fund's 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 are $0 for 2006 and $0 for 2007. (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) N/A (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 was $81,000 for 2006 and $1,417,420 for 2007. (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. Highland Capital Management, L.P. (the "Company") has adopted proxy voting policies (the "Policy") that provide as follows: 1. Application; General Principles 1.1 This proxy voting policy (the "Policy") applies to securities held in Client accounts as to which the above-captioned investment adviser (the "Company") has voting authority, directly or indirectly. Indirect voting authority exists where the Company's voting authority is implied by a general delegation of investment authority without reservation of proxy voting authority. 1.2 The Company shall vote proxies in respect of securities owned by or on behalf of a Client in the Client's best economic interests and without regard to the interests of the Company or any other Client of the Company. 2. Voting; Procedures 2.1 MONITORING. A settlement designee of the Company shall have responsibility for monitoring portfolios managed by the Company for securities subject to a proxy vote. Upon the receipt of a proxy notice related to a security held in a portfolio managed by the Company, the settlement designee shall forward all relevant information to the portfolio manager(s) with responsibility for the security. 2.2 VOTING. 2.2.1. Upon receipt of notice from the settlement designee, the portfolio manager(s) with responsibility for purchasing the security subject to a proxy vote shall evaluate the subject matter of the proxy and cause the proxy to be voted on behalf of the Client. In determining how to vote a particular proxy, the portfolio manager (s) shall consider, among other things, the interests of each Client account as it relates to the subject matter of the proxy, any potential conflict of interest the Company may have in voting the proxy on behalf of the Client and the procedures set forth in this Policy. 2.2.2 If a proxy relates to a security held in a registered investment company or business development company ("Retail Fund") portfolio, the portfolio manager(s) shall notify the Compliance Department and a designee from the Retail Funds group. Proxies for securities held in the Retail Funds will be voted by the designee from the Retail Funds group in a manner consistent with the best interests of the applicable Retail Fund and a record of each vote will be reported to the Retail Fund's Board of Directors in accordance with the procedures set forth in Section 4 of this Policy. 2.3 CONFLICTS OF INTEREST. If the portfolio manager(s) determine that the Company may have a potential material conflict of interest (as defined in Section 3 of this Policy) in voting a particular proxy, the portfolio manager(s) shall contact the Company's Compliance Department prior to causing the proxy to be voted. 2.3.1. For a security held by a Retail Fund, the Company shall disclose the conflict and the determination of the manner in which it proposes to vote to the Retail Fund's Board of Directors. The Company's determination shall take into account only the interests of the Retail Fund, and the Compliance Department shall document the basis for the decision and furnish the documentation to the Board of Directors. 2.3.2. For a security held by an unregistered investment company, such as a hedge fund and structured products ("Non-Retail Funds"), where a material conflict of interest has been identified the Company may resolve the conflict by following the recommendation of a disinterested third party or by abstaining from voting. 2.4 NON-VOTES. The Company may determine not to vote proxies in respect of securities of any issuer if it determines it would be in its Client's overall best interests not to vote. Such determination may apply in respect of all Client holdings of the securities or only certain specified Clients, as the Company deems appropriate under the circumstances. As examples, the portfolio manager(s) may determine: (a) not to recall securities on loan if, in its judgment, the negative consequences to Clients of disrupting the securities lending program would outweigh the benefits of voting in the particular instance or (b) not to vote certain foreign securities positions if, in its judgment, the expense and administrative inconvenience outweighs the benefits to Clients of voting the securities. 2.5 RECORDKEEPING. Following the submission of a proxy vote, the applicable portfolio manager(s) shall submit a report of the vote to a settlement designee of the Company. Records of proxy votes by the Company shall be maintained in accordance with Section 4 of this Policy. 2.6 CERTIFICATION. On a quarterly basis, each portfolio manager shall certify to the Compliance Department that they have complied with this Policy in connection with proxy votes during the period. 3. Conflicts of Interest 3.1 Voting the securities of an issuer where the following relationships or circumstances exist are deemed to give rise to a material conflict of interest for purposes of this Policy: 3.1.1 The issuer is a Client of the Company accounting for more than 5% of the Company's annual revenues. 3.1.2 The issuer is an entity that reasonably could be expected to pay the Company more than $1 million through the end of the Company's next two full fiscal years. 3.1.3 The issuer is an entity in which a "Covered Person" (as defined in the Retail Funds' and the Company's Policies and Procedures Designed to Detect and Prevent Insider Trading and to Comply with Rule 17j-1 of the Investment Company Act of 1940, as amended (each, a "Code of Ethics")) has a beneficial interest contrary to the position held by the Company on behalf of Clients. 3.1.4 The issuer is an entity in which an officer or partner of the Company or a relative(1) of any such person is or was an officer, director or employee, or such person or relative otherwise has received more than $150,000 in fees, compensation and other payment from the issuer during the Company's last three fiscal years; PROVIDED, HOWEVER, that the Compliance Department may deem such a relationship not to be a material conflict of interest if the Company representative serves as an officer or director of the issuer at the direction of the Company for purposes of seeking control over the issuer. 3.1.5 The matter under consideration could reasonably be expected to result in a material financial benefit to the Company through the end of the Company's next two full fiscal years (for example, a vote to increase an investment advisory fee for a Retail Fund advised by the Company or an affiliate). 3.1.6 Another Client or prospective Client of the Company, directly or indirectly, conditions future engagement of the Company on voting proxies in respect of any Client's securities on a particular matter in a particular way. 3.1.7 The Company holds various classes and types of equity and debt securities of the same issuer contemporaneously in different Client portfolios. 3.1.8 Any other circumstance where the Company's duty to serve its Clients' interests, typically referred to as its "duty of loyalty," could be compromised. 3.2 Notwithstanding the foregoing, a conflict of interest described in Section 3.1 shall not be considered material for the purposes of this Policy in respect of a specific vote or circumstance if: 3.2.1 The securities in respect of which the Company has the power to vote account for less than 1% of the issuer's outstanding voting securities, but only if: (i) such securities do not represent - ------------------- (1) For the purposes of this Policy, "relative" includes the following family members: spouse, minor children or stepchildren or children or stepchildren sharing the person's home. one of the 10 largest holdings of such issuer's outstanding voting securities and (ii) such securities do not represent more than 2% of the Client's holdings with the Company. 3.2.2 The matter to be voted on relates to a restructuring of the terms of existing securities or the issuance of new securities or a similar matter arising out of the holding of securities, other than common equity, in the context of a bankruptcy or threatened bankruptcy of the issuer. 4. Recordkeeping and Retention 4.1 The Company shall retain records relating to the voting of proxies, including: 4.1.1 Copies of this Policy and any amendments thereto. 4.1.2 A copy of each proxy statement that the Company receives regarding Client securities. 4.1.3 Records of each vote cast by the Company on behalf of Clients. 4.1.4 A copy of any documents created by the Company that were material to making a decision how to vote or that memorializes the basis for that decision. 4.1.5 A copy of each written request for information on how the Company voted proxies on behalf of the Client, and a copy of any written response by the Company to any (oral or written) request for information on how the Company voted. 4.2 These records shall be maintained and preserved in an easily accessible place for a period of not less than five years from the end of the Company's fiscal year during which the last entry was made in the records, the first two years in an appropriate office of the Company. 4.3 The Company may rely on proxy statements filed on the SEC's EDGAR system or on proxy statements and records of votes cast by the Company maintained by a third party, such as a proxy voting service (provided the Company had obtained an undertaking from the third party to provide a copy of the proxy statement or record promptly on request). 4.4 Records relating to the voting of proxies for securities held by the Retail Funds will be reported periodically to the Retail Funds' Boards of Directors/Trustees/Managers and, with respect to Retail Funds other than business development companies, to the SEC on an annual basis pursuant to Form N-PX. Revised: February 21, 2007 ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES. (A)(1) IDENTIFICATION OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS AND DESCRIPTION OF ROLE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS The Fund's portfolio is managed by a portfolio management team. As of the date of this filing, the members of the team who are primarily responsible for the day-to-day management of the Fund's portfolio are R. Joseph Dougherty and Mark Okada. JOE DOUGHERTY, CFA, CPA - PARTNER, HEAD OF RETAIL PRODUCTS, SENIOR PORTFOLIO MANAGER Mr. Dougherty is Head of Retail Products at Highland Capital Management, L.P., and is a Senior Portfolio Manager. Prior to joining Highland in March 1998, Mr. Dougherty served as an Investment Analyst with Sandera Capital Management from 1997 to 1998. Formerly, he was a Business Development Manager at Akzo Nobel from 1994 to 1996 and a Senior Accountant at Deloitte & Touche, LLP from 1992 to 1994. Mr. Dougherty is a Partner, Senior Portfolio Manager, and heads Highland's retail products business unit ("Highland Funds"). He serves as Portfolio Manager, Senior Vice President and/or Director of the Firm's NYSE-listed funds and 1940 Act Registered Funds. He also serves as Portfolio Manager for the Firm's sub-advised closed-end funds. In this capacity, Mr. Dougherty oversees investment decisions for the retail funds, alongside several other Portfolio Managers, and manages the team dedicated to their day-to-day operations. Prior to his current duties, Mr. Dougherty served as Portfolio Analyst for Highland from 1998 to 1999. As a Portfolio Analyst, Mr. Dougherty helped follow companies within the chemical, retail, supermarket, wireless and restaurant sectors. He received an MBA from Southern Methodist University, and a BS in Accounting from Villanova University. Mr. Dougherty is a Certified Public Accountant, and has earned the right to use the Chartered Financial Analyst designation. MARK OKADA, CFA - MANAGING PARTNER, CHIEF INVESTMENT OFFICER Mr. Okada is a Founder and Chief Investment Officer of Highland Capital Management, L.P. He is responsible for overseeing Highland's investment activities for its various strategies, and has over 20 years of experience in the credit markets. Prior to founding Highland, Mr. Okada served as Manager of Fixed Income for Protective Life Insurance's GIC subsidiary from 1990 to 1993. He was primarily responsible for the bank loan portfolio and other risk assets. Protective was one of the first non-bank entrants into the syndicated loan market. From 1986 to 1990, he served as Vice President at Hibernia National Bank, managing a portfolio of high yield loans in excess of $1 billion. Mr. Okada is an honors graduate of the University of California Los Angeles with degrees in Economics and Psychology. He has earned the right to use the Chartered Financial Analyst designation. Mr. Okada is a Director of NexBank and Highland Financial Partners, and Chairman of the Board of Directors of Common Grace Ministries, Inc. (A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBER AND POTENTIAL CONFLICTS OF INTEREST OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBER The following tables provide information about funds and accounts, other than the Fund, for which the Fund's portfolio managers are primarily responsible for the day-to-day portfolio management as of August 31, 2007. R. JOSEPH DOUGHERTY
- -------------------------------------------------------------------------------------------------------------------------- Total # of Accounts Managed Total Assets with # of Accounts Total Assets with Performance-Based Performance-Based Type of Accounts Managed (millions) Advisory Fee Advisory Fee (millions) - -------------------------------------------------------------------------------------------------------------------------- Registered Investment 12 $6,155 -- -- Companies: - -------------------------------------------------------------------------------------------------------------------------- Other Pooled Investment 1 $357 -- -- Vehicles: - -------------------------------------------------------------------------------------------------------------------------- Other Accounts: -- -- -- -- - --------------------------------------------------------------------------------------------------------------------------
MARK OKADA
- -------------------------------------------------------------------------------------------------------------------------- Type of Accounts Total # of Accounts Managed Total Assets with # of Accounts Total Assets with Performance-Based Performance-Based Managed (millions) Advisory Fee Advisory Fee (millions) - -------------------------------------------------------------------------------------------------------------------------- Registered Investment 13 $7,091 -- -- Companies: - -------------------------------------------------------------------------------------------------------------------------- Other Pooled Investment 30 $17,536 24 $15,686 Vehicles: - -------------------------------------------------------------------------------------------------------------------------- Other Accounts: -- -- -- -- - --------------------------------------------------------------------------------------------------------------------------
POTENTIAL CONFLICTS OF INTERESTS The Adviser has built a professional working environment, a firm-wide compliance culture and compliance procedures and systems designed to protect against potential incentives that may favor one account over another. Highland has adopted policies and procedures that address the allocation of investment opportunities, execution of portfolio transactions, personal trading by employees and other potential conflicts of interest that are designed to ensure that all client accounts are treated equitably over time. Nevertheless, the Adviser furnishes advisory services to numerous clients in addition to the Fund, and the Adviser may, consistent with applicable law, make investment recommendations to other clients or accounts (including accounts that are hedge funds or have performance or higher fees paid to the Adviser or in which portfolio managers have a personal interest in the receipt of such fees) that may be the same as or different from those made to the Fund. In addition, the Adviser, its affiliates and any of their partners, directors, officers, stockholders or employees may or may not have an interest in the securities whose purchase and sale the Adviser recommends to the Fund. Actions with respect to securities of the same kind may be the same as or different from the action that the Adviser, or any of its affiliates, or any of their partners, directors, officers, stockholders or employees or any member of their families may take with respect to the same securities. Moreover, the Adviser may refrain from rendering any advice or services concerning securities of companies of which any of the Adviser's (or its affiliates') partners, directors, officers or employees are directors or officers, or companies as to which the Adviser or any of its affiliates or the partners, directors, officers and employees of any of them has any substantial economic interest or possesses material non-public information. In addition to its various policies and procedures designed to address these issues, the Adviser includes disclosure regarding these matters to its clients in both its Form ADV and investment advisory agreements. The Adviser, its affiliates or their partners, directors, officers and employees similarly serve or may similarly serve other entities that operate in the same or related lines of business. Accordingly, these individuals may have obligations to investors in those entities or funds or to other clients, the fulfillment of which might not be in the best interests of the Fund. As a result, the Adviser will face conflicts in the allocation of investment opportunities to the Fund and other funds and clients. In order to enable such affiliates to fulfill their fiduciary duties to each of the clients for which they have responsibility, the Adviser will endeavor to allocate investment opportunities in a fair and equitable manner which may, subject to applicable regulatory constraints, involve pro rata co-investment by the Fund and such other clients or may involve a rotation of opportunities among the Fund and such other clients. While the Adviser does not believe there will be frequent conflicts of interest, if any, the Adviser and its affiliates have both subjective and objective procedures and policies in place designed to manage the potential conflicts of interest between the Adviser's fiduciary obligations to the Fund and their similar fiduciary obligations to other clients so that, for example, investment opportunities are allocated in a fair and equitable manner among the Fund and such other clients. An investment opportunity that is suitable for multiple clients of the Adviser and its affiliates may not be capable of being shared among some or all of such clients due to the limited scale of the opportunity or other factors, including regulatory restrictions imposed by the 1940 Act. There can be no assurance that the Adviser's or its affiliates' efforts to allocate any particular investment opportunity fairly among all clients for whom such opportunity is appropriate will result in an allocation of all or part of such opportunity to the Fund. Not all conflicts of interest can be expected to be resolved in favor of the Fund. The Adviser expects to apply to the SEC for exemptive relief to enable the Fund and registered investment companies advised by the Adviser to co-invest with other accounts and funds managed by the Adviser and its affiliates in certain privately-placed securities and other situations. There are no assurances that the Adviser will receive the requested relief. If such relief is not obtained and until it is obtained, the Adviser may be required to allocate some investments solely to any of the Fund, a registered fund, or another account or fund advised by the Adviser or its affiliates. This restriction could preclude the Fund from investing in certain securities it would otherwise be interested in and could adversely affect the speed at which the Fund is able to invest its assets and, consequently, the performance of the Fund. (A)(3) COMPENSATION STRUCTURE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS Highland's financial arrangements with its portfolio managers, its competitive compensation and its career path emphasis at all levels reflect the value senior management places on key resources. Compensation may include a variety of components and may vary from year to year based on a number of factors including the relative performance of a portfolio managers underlying account, the combined performance of the portfolio managers underlying accounts, and the relative performance of the portfolio managers underlying accounts measured against other employees. The principal components of compensation include a base salary, a discretionary bonus, various retirement benefits and one or more of the incentive compensation programs established by Highland such as the Option It Plan and the Long-Term Incentive Plan. BASE COMPENSATION. Generally, portfolio managers receive base compensation based on their seniority and/or their position with the firm, which may include the amount of assets supervised and other management roles within the firm. DISCRETIONARY COMPENSATION. In addition to base compensation, portfolio managers may receive discretionary compensation, which can be a substantial portion of total compensation. Discretionary compensation can include a discretionary cash bonus as well as one or more of the following: OPTION IT PLAN. The purpose of the Plan is to attract and retain the highest quality employees for positions of substantial responsibility, and to provide additional incentives to a select group of management or highly compensated employees of the Fund so as to promote the success of the Fund. LONG TERM INCENTIVE PLAN. The purpose of the Plan is to create positive morale and teamwork, to attract and retain key talent, and to encourage the achievement of common goals. The Plan seeks to reward participating employees based on the increased value of Highland through the use of Long-term Incentive Units. Senior portfolio managers who perform additional management functions may receive additional compensation in these other capacities. Compensation is structured such that key professionals benefit from remaining with the firm. (A)(4) DISCLOSURE OF SECURITIES OWNERSHIP The following table sets forth the dollar range of equity securities beneficially owned by each portfolio manager in the Fund as of August 31, 2007.
- ------------------------------------------------------------------------------------------------- DOLLAR RANGES OF EQUITY SECURITIES BENEFICIALLY NAME OF PORTFOLIO MANAGER OWNED BY PORTFOLIO MANAGER - ------------------------------------------------------------------------------------------------- R. Joseph Dougherty None - ------------------------------------------------------------------------------------------------- Mark Okada None - -------------------------------------------------------------------------------------------------
(B) Not 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. ITEM 11. CONTROLS AND PROCEDURES. (a) The registrant's principal executive and principal financial officers, or persons performing similar functions, have concluded that the registrant's disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940, as amended (the "1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within 90 days of the filing date of the report that includes the disclosure required by this paragraph, based on their evaluation of these controls and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15(b)). (b) There were no changes in the registrant's internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR 270.30a-3(d)) that occurred during the registrant's second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. ITEM 12. EXHIBITS. (a)(1) Not applicable. (a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto. (a)(3) Not applicable. (b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. (Registrant) Highland Floating Rate Limited Liability Company ------------------------------------------------------------------- By (Signature and Title)* /s/ James D. Dondero ------------------------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) Date October 31, 2007 ---------------------------------------------------------------------------- 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 October 31, 2007 ---------------------------------------------------------------------------- By (Signature and Title)* /s/ M. Jason Blackburn ------------------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) Date October 31, 2007 ---------------------------------------------------------------------------- * Print the name and title of each signing officer under his or her signature. EX-99.CERT 2 cert302.txt CERT 302 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 Limited Liability Company; 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: October 31, 2007 /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 Limited Liability Company; 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: October 31, 2007 /s/ M. Jason Blackburn ---------------------------- -------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) EX-99.906CERT 3 cert906.txt CERT 906 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 Limited Liability Company (the "Registrant"), certify that: 1. The Form N-CSR of the Registrant (the "Report") fully complies with the requirements of Section 13(a) or 15(d) 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: October 31, 2007 /s/ James D. Dondero ------------------------------ ----------------------------------------- James D. Dondero, Chief Executive Officer (principal executive officer) I, M. Jason Blackburn, Chief Financial Officer of Highland Floating Rate Limited Liability Company (the "Registrant"), certify that: 1. The Form N-CSR of the Registrant (the "Report") fully complies with the requirements of Section 13(a) or 15(d) 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: October 31, 2007 /s/ M. Jason Blackburn ---------------------------- -------------------------------------------- M. Jason Blackburn, Chief Financial Officer (principal financial officer) -----END PRIVACY-ENHANCED MESSAGE-----