<PAGE>
HIGHLANDER
INCOME FUND
* * *
ANNUAL REPORT
1996
<PAGE>
TABLE OF CONTENTS
HIGHLANDER INCOME FUND
Highlander Income Fund is a diversified, closed-end fund. The
fund's investment objective is to provide high current income. To
achieve this objective, the fund invests primarily in a
combination of high-grade, mortgage-backed securities and lower-
rated fixed income securities, which include securities commonly
referred to as "junk bonds." The mortgage-backed securities may
include certain derivative securities, such as inverse floating
rate securities and Z-bonds. High-yield, or junk bond, securities
generally have greater volatility of price and greater risks to
principal and income than securities in the higher-rated
categories. Each of these asset classes must comprise at least
30%, and no more than 70%, of the portfolio. Fund shares trade on
the American Stock Exchange under the symbol HLA.
AVERAGE ANNUAL TOTAL RETURNS . . .1
LETTER TO SHAREHOLDERS . . . . . .2
FINANCIAL STATEMENTS AND NOTES . .7
INVESTMENTS IN SECURITIES. . . . 17
INDEPENDENT AUDITORS' REPORT . . 28
FEDERAL TAX INFORMATION. . . . . 29
SHAREHOLDER UPDATE . . . . . . . 30
CALL TO RECEIVE QUARTERLY UPDATES
If you would like to be put on our mailing list to receive
quarterly fund summaries for Highlander Income Fund (HLA), call
our Shareholder Services Department at 1 800 866-7778.
<PAGE>
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED FEBRUARY 29, 1996
[GRAPH]
Average annual total return figures are through February 29, 1996, are based on
the change in net asset value (NAV), and reflect the reinvestment of all
distributions but do not reflect sales charges. NAV-based performance is used to
measure investment management results.
Average annual total return figures based on the change in market price for the
one-year and since inception periods ended February 29, 1996, were 15.91% and
0.62%, respectively. These figures also assume reinvested distributions and do
not reflect sales charges.
* This blended index is comprised of 50% Lehman Brothers U.S. Mortgage Index and
50% Lehman Brothers High-Yield Single B Securities Index, which had individual
one-year returns of 11.42% and 14.73% and since inception returns of 8.80% and
11.01%, respectively.
The Lehman Brothers U.S. Mortgage Index is comprised of U.S. government agency
mortgage-backed securities with 5 to 30 years to maturity. The Lehman Brothers
High-Yield Single B Securities Index is comprised of fixed rate, public non-
convertible issues that are rated B by Moody's Investor Service. Developed by
Lehman Brothers, the indexes are unmanaged, reflect the reinvestment of all
distributions and do not include any fees or expenses in total returns.
Past performance does not guarantee future results. The investment return and
market value of an investment will fluctuate so that fund shares, when sold, may
be worth more or less than their original cost.
1
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HIGHLANDER INCOME FUND
[PHOTOS]
Brad Stone, CFA, Piper Capital Management,
shares primary responsibility for the management of Highlander Income Fund. He
has eight years of financial experience.
Wan-Chong Kung, Piper Capital Management,
assists with the management of Highlander Income Fund. She has four years of
financial experience.
April 17, 1996
Dear Shareholders:
HIGHLANDER INCOME FUND HAD A NET ASSET VALUE TOTAL RETURN OF 15.84%* FOR THE
ONE-YEAR PERIOD ENDED FEBRUARY 29, 1996. This assumes distributions were
reinvested and does not include sales charges. In comparison, a 50%/50% blend of
the Lehman Brothers U.S. Mortgage Index and the Lehman Brothers High-Yield
Single B Securities Index had a return of 13.08%. The fund's return based on
market price was 15.91%* for this same one-year period.
THE FUND'S PERFORMANCE WAS ENHANCED BY ITS APPROXIMATELY EQUAL WEIGHTING OF
HIGH-YIELD AND MORTGAGE-BACKED SECURITIES AS BOTH SECTORS PERFORMED WELL. The
fund's mortgage-backed portion maintained a relatively long effective duration
during most of 1995, and this enabled the fund to benefit from the declining
interest rate environment which occurred throughout much of 1995. As interest
rates declined, the prices of the mortgage-backed securities increased -
particularly those with longer effective durations. In addition, the fund's
high-yield portion contributed to the fund's performance because in early 1995
we increased its allocation to companies with higher credit quality. Within the
high-yield market, higher-rated securities typically perform better than lower-
rated securities in periods of declining interest rates, as these higher-rated
securities are less affected by economic slowdowns because of their stronger
financial positions and more stable operating profiles.
* PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. THE INVESTMENT RETURN AND
MARKET VALUE OF AN INVESTMENT WILL FLUCTUATE SO THAT FUND SHARES, WHEN SOLD, MAY
BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
2
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HIGHLANDER INCOME FUND
[PHOTO]
Mark Durbiano, CFA, Federated Advisers,
shares primary responsibility for the management of Highlander Income Fund. He
has 14 years of financial experience.
THE MORTGAGE-BACKED PORTION OF THE FUND CONTINUES TO EMPHASIZE U.S. AGENCY
MORTGAGE-BACKED PASS-THROUGH SECURITIES. AS OF FEBRUARY 29, 41% OF THE FUND'S
TOTAL ASSETS WERE INVESTED IN THESE SECURITIES. In late 1995, we began to
increase the fund's exposure to 15-year mortgage-backed securities while
decreasing its focus on 30-year mortgage-backed securities. We increased our
exposure to these shorter duration securities because we felt we were able to
purchase them at relatively attractive prices. Typically, as interest rates
decline, as they did through much of 1995, investors tend to move toward longer
duration securities, such as 30-year mortgage-backed securities. Therefore, as
the demand for shorter duration securities decreased throughout the year, the
15-year securities provided superior relative value. By the end of February
1996, 13% of the fund's total assets consisted of 15-year mortgage-backed
securities and 25% was invested in 30-year mortgage-backed securities.
(On February 28, 1995, the fund had no investments in 15-year mortgage
securities while nearly 45% of the fund was allocated to 30-year mortgage
securities.)
TO LESSEN THE IMPACT OF FAST MORTGAGE PREPAYMENT RATES BROUGHT ON BY 1995'S
DECLINING INTEREST RATES, WE FOCUSED ON DISCOUNT AND SEASONED PREMIUM MORTGAGE
SECURITIES IN THE MORTGAGE-BACKED PORTION OF THE FUND. As rates decline,
borrowers may prepay or refinance their mortgage loans at faster rates. These
fast prepayment rates could cause the fund to amortize premiums paid for the
mortgage securities more quickly which reduces the fund's income levels. The
fund's allocation to premium mortgages is primarily made up of seasoned, or
older, mortgage loans. Seasoned premium mortgage loans are backed by underlying
loans that have older origination dates. For a variety of reasons, borrowers are
not as likely to prepay these
3
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HIGHLANDER INCOME FUND
seasoned loans. As a result, they typically exhibit greater prepayment stability
even when rates are declining. Also, the prepayment rates on discount mortgages,
which have lower coupons, generally remain close to expected levels because
there is relatively less incentive to prepay these loans.
PORTFOLIO COMPOSITION
February 29, 1996
[GRAPH]
IN EARLY 1995, WE INCREASED THE ALLOCATION TO HIGHER-RATED SECURITIES IN THE
HIGH-YIELD PORTION OF THE FUND. This proved beneficial as lower-rated securities
suffered due to declining interest rates and market expectations of an economic
slowdown. As interest rates began to rise in early 1996 - creating the
perception that the economy was bouncing back - we slightly downgraded the
quality in the high-yield portion to a level comparable to the blended Lehman
index. While these rising rates caused bond prices in general to fall, the
prices of high-yield bonds remained relatively strong due to the more positive
economic outlook.
THE HIGH-YIELD PORTION OF THE FUND CONTINUES TO OVERWEIGHT NONCYCLICAL
INDUSTRIES WHILE IT UNDERWEIGHTS CYCLICAL INDUSTRIES. During the year, we
increased our exposure to noncyclical industries because they tend to be less
affected by economic changes than cyclical industries. In particular, we felt
the cable television, broadcast television and telecommunications sectors
offered attractive opportunities. While cyclical bonds, which generally rise
quickly when the economy picks up
4
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HIGHLANDER INCOME FUND
and fall quickly when the economy slows, have become more attractive in recent
months, they still appear overpriced and we can't justify substantial new
investments at this time.
THE FUND'S INCREASED EMPHASIS ON 15-YEAR MORTGAGE-BACKED SECURITIES BEGINNING IN
LATE 1995 SERVED TO SHORTEN THE FUND'S EFFECTIVE DURATION.
As interest rates began to rise in early 1996, this shorter duration benefited
the fund because shorter duration securities perform better than long duration
securities in a rising interest rate environment. We also sold the fund's long
duration inverse floating rate security in November. However, we still own two
long duration Z-bonds, representing 5% of total assets. As of February 29, the
fund's effective duration was 5.1 years.
THE FUND'S PARTICIPATION IN THE SALE-FORWARD (DOLLAR-ROLL) PROGRAM REPRESENTED
12% OF TOTAL ASSETS ON FEBRUARY 29, 1996. This compares to a 22% investment in
the program in February 1995. The sale-forward program allows the fund to
generate fee income by committing to pay for securities in the future at today's
prices. Keep in mind that these commitments also increase the number of assets
exposed to market and interest rate risk. In the next few months, we will look
for opportunities to invest more actively in this program.
EFFECTIVE DURATION
Effective duration estimates the interest rate risk of a security, in other
words how much the value of the security is expected to change with a given
change in interest rates. The longer a security's effective duration, the more
sensitive its price is to changes in interest rates. For example, if interest
rates were to increase by 1%, the market value of a bond with an effective
duration of five years would decrease by about 5%, with all other factors being
constant.
It is important to understand that, while a valuable measure, effective duration
is based on certain assumptions and has several limitations. It is most
effective as a measure of interest rate risk when interest rate changes are
small, rapid and occur equally across all the different points of the yield
curve.
In addition, effective duration is difficult to calculate precisely for bonds
with prepayment options, such as mortgage-backed securities, because the
calculation requires assumptions about prepayment rates. For example, when
interest rates go down, homeowners may prepay their mortgages at a higher rate
than assumed in the initial effective duration calculation, thereby shortening
the effective duration of the fund's mortgage-backed securities. Conversely, if
rates increase, prepayments may decrease to a greater extent than assumed,
extending the effective duration of such securities. For these reasons, the
effective durations of funds that invest a significant portion of their assets
in mortgage-backed securities can be greatly affected by changes in interest
rates.
5
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HIGHLANDER INCOME FUND
LOOKING AHEAD, WE BELIEVE THE INTEREST RATE ENVIRONMENT WILL REMAIN FAIRLY
STABLE FOR THE NEXT FEW MONTHS, AND WE DON'T EXPECT TO MAKE ANY MAJOR CHANGES TO
THE PORTFOLIO. Within the mortgage-backed portion of the fund, we will maintain
the emphasis on discount and seasoned premium mortgage-backed pass-through
securities. In the fund's high-yield portion, we expect to maintain a neutral
credit quality position given our belief that a recession is not imminent. In
addition, we may begin increasing our exposure to cyclical industries if
attractive opportunities arise.
Thank you for your investment in Highlander Income Fund. We remain committed to
providing you with high-quality management service and look forward to helping
you reach your financial goals.
Sincerely,
/s/ J. Bradley Stone
J. Bradley Stone
Portfolio Manager
/s/ Mark E. Durbiano
Mark E. Durbiano
Portfolio Manager
/s/ Wan-Chong Kung
Wan-Chong Kung
Assistant Portfolio Manager
6
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FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
FEBRUARY 29, 1996
<TABLE>
<S> <C>
ASSETS:
Investments in securities at market value* (note 2)
(including a repurchase agreement of $4,000) ........... $ 33,595,126
Cash in bank on demand deposit ........................... 55,886
Receivable for investment securities sold ................ 986,227
Accrued interest receivable .............................. 439,318
----------------
Total assets ......................................... 35,076,557
----------------
LIABILITIES:
Payable for securities purchased ......................... 48,888
Payable for investment securities purchased on a
when-issued basis (note 2) ............................. 7,111,875
Accrued investment management fee ........................ 13,359
Accrued administrative fee ............................... 4,453
----------------
Total liabilities .................................... 7,178,575
----------------
Net assets applicable to outstanding capital stock ....... $ 27,897,982
----------------
----------------
REPRESENTED BY:
Capital stock - authorized 200 million shares of $0.01 par
value; outstanding, 1,989,467 shares ................. $ 19,895
Additional paid-in capital ............................... 27,687,450
Accumulated net realized loss on investments ............. (316,186)
Unrealized appreciation of investments ................... 506,823
----------------
Total - representing net assets applicable to
outstanding capital stock ........................ $ 27,897,982
----------------
----------------
Net asset value per share of outstanding capital stock ... $ 14.02
----------------
----------------
* Investments in securities at identified cost ........... $ 33,088,303
----------------
----------------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
6
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FINANCIAL STATEMENTS
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED FEBRUARY 29, 1996
<TABLE>
<S> <C>
INCOME:
Interest ............................................... $ 2,657,007
Fee income (note 2) ...................................... 105,967
----------------
Total investment income .............................. 2,762,974
----------------
EXPENSES (NOTE 3):
Investment management fee ................................ 164,520
Administrative fee ....................................... 54,840
Custodian, accounting and transfer agent fees ............ 77,215
Reports to shareholders .................................. 29,768
Directors' fees .......................................... 11,954
Audit and legal fees ..................................... 29,902
Other expenses ........................................... 27,969
----------------
Total expenses ....................................... 396,168
Less expenses paid indirectly ............................ (404)
----------------
Total net expenses ................................... 395,764
----------------
Net investment income ................................ 2,367,210
----------------
NET REALIZED AND UNREALIZED GAINS (LOSSES) ON INVESTMENTS:
Net realized gain on investments (note 4) ................ 491,786
Net realized loss on closed futures contracts ............ (44,596)
----------------
Net realized gain on investments ....................... 447,190
Net change in unrealized appreciation or depreciation of
investments ............................................ 1,205,735
----------------
Net gain on investments ................................ 1,652,925
----------------
Net increase in net assets resulting from
operations ....................................... $ 4,020,135
----------------
----------------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
7
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FINANCIAL STATEMENTS
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Period from
Year Ended 3/31/94*
2/29/96 to 2/28/95
---------------- ----------------
<S> <C> <C>
OPERATIONS:
Net investment income .................................. $ 2,367,210 2,275,942
Net realized gain (loss) on investments .................. 447,190 (763,376)
Net change in unrealized appreciation or depreciation of
investments ............................................ 1,205,735 (698,912)
---------------- ----------------
Net increase in net assets resulting from operations ... 4,020,135 813,654
---------------- ----------------
DISTRIBUTIONS TO SHAREHOLDERS:
From net investment income ............................... (2,367,210) (2,275,942)
In excess of net investment income ....................... (3,049) (27,712)
Tax return of capital .................................... (26,682) --
---------------- ----------------
Total distributions .................................... (2,396,941) (2,303,654)
---------------- ----------------
CAPITAL SHARE TRANSACTIONS:
Proceeds from initial public offering of 2,000,000 shares,
net of underwriting discount and offering expenses of
$2,123,482 ............................................. -- 27,876,518
Payments for retirement of 17,200 shares (note 6) ........ (211,735) --
---------------- ----------------
Increase (decrease) in net assets from capital share
transactions ......................................... (211,735) 27,876,518
---------------- ----------------
Total increase in net assets ......................... 1,411,459 26,386,518
Net assets at beginning of period (note 1) ................. 26,486,523 100,005
---------------- ----------------
Net assets at end of period .............................. $ 27,897,982 26,486,523
---------------- ----------------
---------------- ----------------
Distributions in excess of net investment income ......... $ -- (27,712)
---------------- ----------------
---------------- ----------------
</TABLE>
* COMMENCEMENT OF OPERATIONS.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
8
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NOTES TO FINANCIAL STATEMENTS
(1) ORGANIZATION
Highlander Income Fund Inc. (the fund) is registered under the
Investment Company Act of 1940 (as amended) as a diversified,
closed-end management investment company. The fund commenced
operations on March 31, 1994, upon completion of its initial
public offering of common stock. The only transaction of the
fund prior to March 31, 1994, was the sale to Piper Jaffray
Companies Inc. of 6,667 shares of capital stock for $100,005 on
March 24, 1994. The fund invests primarily in a combination of
high-grade, mortgage-backed securities, and lower-rated fixed
income securities including securities commonly referred to as
"junk bonds." Shares of the fund are listed on the American
Stock Exchange under the symbol HLA.
(2) SIGNIFICANT
ACCOUNTING
POLICIES
INVESTMENTS IN SECURITIES
The values of fixed income securities are determined using
pricing services or prices quoted by independent brokers.
Exchange-listed options are valued at the last sale price and
open financial futures are valued at the last settlement price.
When market quotations are not readily available, or in certain
other circumstances, securities are valued at fair value
according to methods selected in good faith by the board of
directors. Short-term securities with maturities of 60 days or
less are valued at amortized cost which approximates market
value.
Securities transactions are accounted for on the date the
securities are purchased or sold. Realized gains and losses are
calculated on the identified-cost basis. Interest income,
including amortization of bond discount and premium computed on
a level-yield basis, is accrued daily.
HIGH-YIELD DEBT SECURITIES
Although the fund has a diversified portfolio, the fund has
60.9% of total net assets invested in non-investment grade
(high-yield) and comparable quality unrated high-yield
securities. Investments in high-yield securities are accompanied
by a greater degree of credit risk and such securities tend to
be more sensitive to economic conditions than higher-rated
securities. The risk of loss due to default by the issuer may be
significantly greater for the holders of high-yield securities,
because such securities are generally unsecured and are
9
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NOTES TO FINANCIAL STATEMENTS
often subordinated to other creditors of the issuer. The fund
held one security, representing 0.7% of total net assets, which
was in default at February 29, 1996.
OPTIONS TRANSACTIONS
For hedging purposes, the fund may buy and sell put and call
options, write covered call options on portfolio securities,
write cash-secured puts and write call options that are not
covered for cross-hedging purposes. The risk in writing a call
option is the fund gives up the opportunity of profit if the
market price of the security increases. The risk in writing a
put option is the fund may incur a loss if the market price of
the security decreases and the option is exercised. The risk in
buying an option is that the fund pays a premium whether or not
the option is exercised. The fund also has the additional risk
of not being able to enter into a closing transaction if a
liquid secondary market does not exist. The fund also may write
over-the-counter options where the completion of the obligation
is dependent upon the credit standing of the other party.
Option contracts are valued daily at the closing prices on their
primary exchanges and unrealized appreciation or depreciation is
recorded. The fund will realize a gain or loss upon expiration
or closing of the option transaction. When an option is
exercised, the proceeds from sales for a written call option,
the purchase cost of a written put option or the cost of a
security for a purchased put or call option is adjusted by the
amount of premium received or paid.
FUTURES TRANSACTIONS
For hedging purposes, the fund may buy and sell interest rate
futures contracts. Risks of entering into futures contracts and
related options include the possibility there may be an illiquid
market and that a change in the value of the contract or option
may not correlate with changes in the value of the underlying
securities.
Upon entering into a futures contract, the fund is required to
deposit either cash or securities in an amount (initial margin)
equal to a certain percentage of the contract value. Subsequent
payments (variation margin) are made or received by the fund
each day. The variation margin payments are equal to the daily
changes in the
10
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NOTES TO FINANCIAL STATEMENTS
contract value and are recorded as unrealized gains and losses.
The fund recognizes a realized gain or loss when the contract is
closed
or expires.
SECURITIES PURCHASED ON A WHEN-ISSUED BASIS
Delivery and payment for securities that have been purchased by
the fund on a forward-commitment or when-issued basis can take
place a month or more after the transaction date. During this
period, such securities do not earn interest, are subject to
market fluctuations and may increase or decrease in value prior
to their delivery. The fund maintains, in a segregated account
with its custodian, assets with a market value equal to the
amount of its purchase commitments. The purchase of securities
on a when-issued or forward-commitment basis may increase the
volatility of the fund's net asset value to the extent the fund
makes such purchases while remaining substantially fully
invested. As of February 29, 1996, the fund had entered into
outstanding when-issued or forward commitments of $7,111,875.
In connection with its ability to purchase securities on a
when-issued or forward-commitment basis, the fund may enter into
mortgage "dollar rolls" in which the fund sells securities for
delivery in the current month and simultaneously contracts with
the same counterparty to repurchase similar (same type, coupon,
and maturity) but not identical securities on a specified future
date. As an inducement to "roll over" its purchase commitments,
the fund receives negotiated fees. For the year ended February
29, 1996, such fees earned by the fund amounted to $105,967.
FEDERAL TAXES
The fund's policy is to comply with the requirements of the
Internal Revenue Code applicable to regulated investment
companies and to distribute all taxable income to shareholders.
Therefore, no income tax provision is required.
Net investment income and net realized gains (losses) may differ
for financial statement and tax purposes primarily because of
losses deferred due to "wash sale" transactions and the timing
of income recognition for certain defaulted securities and
collateralized mortgage obligations. The character of
distributions made during the year from net investment income or
net realized gains may differ
11
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NOTES TO FINANCIAL STATEMENTS
from their ultimate characterization for federal income tax
purposes. The effect on dividend distributions of certain
book-to-tax differences is presented as an "excess distribution"
in the statement of changes in net assets and the financial
highlights. Also, due to the timing of dividend distributions,
the fiscal year in which amounts are distributed may differ from
the year that the income or realized gains (losses) were
recorded by the fund.
On the statement of assets and liabilities, as a result of
permanent book-to-tax differences, a reclassification adjustment
has been made to increase undistributed net investment income
and decrease additional paid-in capital by $30,761.
DISTRIBUTIONS
The fund pays monthly distributions from net investment income.
Realized capital gains, if any, will be distributed on an annual
basis. These distributions are recorded as of the close of
business on the ex-dividend date. Such distributions are payable
in cash, or pursuant to the fund's dividend reinvestment plan,
reinvested in additional shares of the fund's capital stock.
Under the plan, fund shares will be purchased in the open market
unless the market price plus commission exceeds the net asset
value by 10% or more. If, at the close of business on the
dividend payment date, the shares purchased in the open market
are insufficient to satisfy the dividend reinvestment
requirement, the fund will issue new shares at a discount of up
to 5% from the current market price.
REPURCHASE AGREEMENTS
For repurchase agreements entered into with certain
broker-dealers, the fund, along with other affiliated registered
investment companies, may transfer uninvested cash balances into
a joint trading account, the daily aggregate of which is
invested in repurchase agreements secured by U.S. government and
agency obligations. Securities pledged as collateral for all
individual and joint repurchase agreements are held by the
fund's custodian bank until maturity of the repurchase
agreement. Provisions for all agreements ensure that the daily
market value of the collateral is in excess of the repurchase
amount in the event of default.
12
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NOTES TO FINANCIAL STATEMENTS
USE OF ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported results of operations for the reporting period. Actual
results could differ from those estimates.
(3) FEES AND
EXPENSES
The fund has entered into the following agreements with Piper
Capital Management Incorporated (the adviser and the
administrator):
The investment management agreement provides the adviser with a
monthly management fee computed at the per annum rate of 0.60%
of the fund's average weekly net assets. For its fee, the
adviser will provide investment advice and, in general, will
conduct the management and investment activities of the fund.
Federated Advisers has been retained by the adviser as a
subadviser and is paid a monthly fee by the adviser equal to 50%
of the investment management fee.
The administration agreement provides the administrator with a
monthly fee computed at the per annum rate of 0.20%. For its
fee, the administrator will provide reporting, regulatory, and
record-keeping services for the fund.
In addition to investment management and administrative fees,
the fund is responsible for paying most other operating
expenses, including outside directors' fees and expenses,
custodian fees, registration fees, printing and shareholder
reports, transfer agent fees and expenses, legal, auditing and
accounting services, insurance, interest, taxes, and other
miscellaneous expenses.
Expenses paid indirectly represent a reduction of custodian fees
for earnings on cash balances maintained with the custodian by
the fund.
13
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NOTES TO FINANCIAL STATEMENTS
(4) SECURITIES
TRANSACTIONS
Cost of purchases and proceeds from sales of securities (other
than short-term securities) aggregated $29,125,228 and
$30,311,792, respectively, for the year ended February 29, 1996.
During the year ended February 29, 1996, the fund paid no
brokerage commissions to affiliated brokers.
(5) CAPITAL LOSS
CARRYOVER
For federal income tax purposes, the fund had a capital loss
carryover of $316,186 on February 29, 1996, which, if not offset
by subsequent capital gains, will expire in 2003 and 2004. It is
unlikely the board of directors will authorize a distribution of
any net realized capital gains until the available capital loss
carryover has been offset or expires.
(6) RETIREMENT OF
FUND SHARES
The fund's board of directors voted to discontinue the share
repurchase program effective February 6, 1996. Pursuant to the
plan, the fund had cumulatively repurchased and retired 17,200
shares as of January 13, 1996, which represents 0.86% of the
shares originally issued.
14
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NOTES TO FINANCIAL STATEMENTS
(7) FINANCIAL
HIGHLIGHTS
Per-share data for a share of capital stock outstanding
throughout each period and selected information for each period
are as follows:
<TABLE>
<CAPTION>
Year Ended Period Ended
2/29/96 2/28/95(a)
----------- ------------
<S> <C> <C>
PER-SHARE DATA
Net asset value, beginning of period .................... $ 13.20 13.95
----------- ------
Operations:
Net investment income ................................... 1.19 1.13
Net realized and unrealized gain (loss) on
investments ........................................... 0.83 (0.73)
----------- ------
Total from operations ................................. 2.02 0.40
----------- ------
Distributions to shareholders:
From net investment income .............................. (1.19) (1.14)
In excess of net investment income ...................... -- (0.01)
Tax return of capital ................................... (0.01) --
----------- ------
Total distributions ................................... (1.20) (1.15)
----------- ------
Net asset value, end of period .......................... $ 14.02 13.20
----------- ------
----------- ------
Per-share market value, end of period ................... $ 12.63 12.00
----------- ------
----------- ------
SELECTED INFORMATION
Total return, net asset value (b) ......................... 15.84% 3.23%
Total return, market value (c) ............................ 15.91% (12.69%)
Net assets at end of period (in millions) ............... $ 28 26
Ratio of expenses to average weekly net assets (d) ........ 1.44% 1.18%(e)
Ratio of net investment income to average weekly net
assets .................................................. 8.63% 9.37%(e)
Portfolio turnover rate (excluding short-term
securities) ............................................. 90% 69%
</TABLE>
(A) COMMENCEMENT OF OPERATIONS WAS MARCH 31, 1994.
(B) TOTAL RETURN, NET ASSET VALUE, IS BASED ON THE CHANGE IN NET ASSET VALUE OF
A SHARE DURING THE PERIOD AND ASSUMES REINVESTMENT OF DISTRIBUTIONS AT NET
ASSET VALUE.
(C) TOTAL RETURN, MARKET VALUE, IS BASED ON THE CHANGE IN MARKET PRICE OF A
SHARE DURING THE PERIOD AND ASSUMES REINVESTMENT OF DISTRIBUTIONS AT ACTUAL
PRICES PURSUANT TO THE FUND'S DIVIDEND REINVESTMENT PLAN.
(D) BEGINNING IN FISCAL 1996, THE EXPENSE RATIO REFLECTS THE EFFECT OF GROSS
EXPENSES PAID INDIRECTLY BY THE FUND. PRIOR PERIOD EXPENSE RATIOS HAVE NOT
BEEN ADJUSTED.
(E) ADJUSTED TO AN ANNUAL BASIS.
15
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
FEBRUARY 29, 1996
<TABLE>
<CAPTION>
Principal Market
Name of Issuer Amount Value (a)
- ------------------------------------------------------------------- --------- ----------
<S> <C> <C>
(PERCENTAGES OF EACH INVESTMENT CATEGORY RELATE TO TOTAL NET ASSETS)
MORTGAGE-BACKED SECURITIES (58.5%):
COLLATERALIZED MORTGAGE OBLIGATIONS (D) (6.6%):
U.S. AGENCY Z-TRANCHE (6.6%):
6.50%, FHLMC, Series 1694, Class Z, 3/15/24 .................. $ 1,138,429 900,623
7.00%, FNMA, Series 1994 - 55, Class Z, 3/25/24 ................ 1,107,418 941,305
----------
1,841,928
----------
U.S. AGENCY FIXED RATE MORTGAGES (51.9%):
7.50%, FHLMC, 4/1/24 ........................................... 731,499 738,806
7.50%, FHLMC, 10/16/25 ......................................... 2,000,000(b) 2,019,980
6.50%, FHLMC, 8/23/00 .......................................... 2,000,000(b) 2,018,720
11.00%, FNMA, 10/1/20 .......................................... 365,158 409,086
9.00%, FNMA, 7/1/24 ............................................ 1,000,000(b) 1,051,860
8.00%, FNMA, 7/1/24 ............................................ 902,353 925,183
10.00%, FNMA, 10/1/17 .......................................... 577,816 635,771
9.50%, FNMA, 5/1/25 ............................................ 941,275 1,012,445
6.50%, FNMA, 9/1/25 ............................................ 734,304 707,216
8.00%, FNMA, 3/1/08 ............................................ 1,268,802 1,311,611
7.00%, FNMA, 1/1/08 ............................................ 2,000,000(b) 2,013,720
6.00%, FNMA, 3/18/11 ........................................... 1,000,000(b) 970,610
7.50%, GNMA, 9/15/23 ........................................... 65,665 66,362
7.50%, GNMA, 7/15/23 ........................................... 351,017 354,745
9.00%, GNMA, 6/15/16 ........................................... 225,237 239,596
----------
14,475,711
----------
Total Mortgage-Backed Securities
(cost: $16,364,251) ......................................... 16,317,639
----------
</TABLE>
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES.
16
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
(CONTINUED)
<TABLE>
<CAPTION>
S&P Principal Market
Name of Issuer Rating (g) Amount Value (a)
- --------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
HIGH-YIELD CORPORATE BONDS (60.9%):
AEROSPACE AND DEFENSE (0.9%):
Tracor Inc., Senior Subordinated Note, 10.88%,
8/15/01 ............................................. B $ 250,000 263,750
----------
AUTOMOTIVE (2.3%):
Aftermarket Technology, Senior Subordinated Note,
12.00%, 8/1/04 ...................................... B- 250,000 273,125
Lear Seat Corp., Subordinated Note, 8.25%, 2/1/02 .... B 100,000 99,000
Motor Wheel Corp., Senior Note, 11.50%, 3/1/00 ....... B- 300,000 270,000
----------
642,125
----------
BANKING (0.5%):
First Nationwide Holdings, Senior Note, 12.25%,
5/15/01 ............................................. BB- 100,000 114,000
First Nationwide Holdings, Senior Subordinated Note,
9.13%, 1/15/03 ...................................... B 50,000(e) 51,000
----------
165,000
----------
BEVERAGE AND TOBACCO (0.3%):
Dr Pepper Bottling Holdings, Delayed Interest, 10.67%,
2/15/03 ............................................. N-R 100,000(f) 86,500
----------
BROADCAST RADIO AND TELEVISION (5.4%):
ACT III Broadcasting, Senior Subordinated Note,
10.25%, 12/15/05 .................................... B- 50,000 50,875
Allbritton Communications Co., Senior Subordinated
Debenture, 11.50%, 8/15/04 .......................... B- 250,000 265,625
Australis Media LTD, Note, Delayed Interest, 14.38%,
5/15/03 ............................................. CCC 150,000(f) 108,375
Chancellor Broadcasting, Senior Subordinated Note,
12.50%, 10/1/04 ..................................... B- 100,000 113,000
Chancellor Broadcasting, Senior Subordinated Note,
9.38%, 10/1/04 ...................................... B- 50,000 49,000
Granite Broadcasting Corp., Senior Subordinated Note,
10.38%, 5/15/05 ..................................... B- 250,000 257,500
Heritage Media Corp., Senior Subordinated Note, 8.75%,
2/15/06 ............................................. B 25,000 24,625
</TABLE>
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES.
17
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
(CONTINUED)
<TABLE>
<CAPTION>
S&P Principal Market
Name of Issuer Rating (g) Amount Value (a)
- --------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Pegasus Media & Communications, Note, 12.50%,
7/1/05 .............................................. N-R $ 100,000 102,500
SCI Television Inc., Senior Note, 11.00%, 6/30/05 .... BB- 250,000 265,000
Sinclair Broadcast Group Inc., Senior Subordinated
Note, 10.00%, 12/15/03 .............................. B+ 250,000 256,875
Sullivan Broadcasting Holdings, Debenture, 13.25%,
12/15/06 ............................................ B- 25,000 25,625
----------
1,519,000
----------
BUSINESS SERVICES (0.8%):
Knoll Inc., Senior Subordinated Note, 10.88%,
3/15/06 ............................................. B- 100,000(e) 102,250
United Stationery Supply, Senior Subordinated Note,
12.75%, 5/1/05 ...................................... B- 100,000 113,750
----------
216,000
----------
CABLE TELEVISION (6.1%):
Bell Cablemedia Plc, Delayed Interest, 12.98%,
7/15/04 ............................................. BB- 50,000(f) 36,750
Cablevision System Corp., Senior Subordinated
Debenture, 9.88%, 2/15/13 ........................... B 125,000 135,312
Comcast UK Cable, Debenture, Delayed Interest, 11.07%,
11/15/07 ............................................ B 125,000(f) 74,375
Continental Cablevision Inc., Debenture, 9.50%,
8/1/13 .............................................. BB 250,000 289,375
CS Wireless Systems Inc., Delayed Interest, 11.26%,
3/1/06 .............................................. CCC+ 200,000(f)(e) 113,000
Groupe Videotron, 10.63%, 2/15/05 .................... BB+ 100,000 109,500
International Cabletel Inc., Senior Note, Delayed
Interest, 10.84%, 10/15/03 .......................... N-R 250,000(f) 187,812
International Cabletel Inc., Senior Note, Delayed
Interest, 11.67%, 4/15/05 ........................... B 75,000(f) 49,687
International Cabletel Inc., Senior Note, Delayed
Interest, 11.77%, 2/1/06 ............................ N-R 100,000(f)(e) 60,000
People's Choice TV Corp., Delayed Interest, 13.37%,
6/1/04 .............................................. CCC+ 150,000(f) 98,250
Rifkin Acquisition Partners, Senior Subordinated Note,
11.13%, 1/15/06 ..................................... B- 75,000(e) 77,250
Rogers Cablesystems, Senior Note, 10.00%, 3/15/05 .... BB+ 150,000 161,250
</TABLE>
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES.
18
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
(CONTINUED)
<TABLE>
<CAPTION>
S&P Principal Market
Name of Issuer Rating (g) Amount Value (a)
- --------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Telewest Plc, Senior Note, Delayed Interest, 10.77%,
10/1/07 ............................................. BB $ 425,000(f) 260,312
Wireless One Inc., 13.00%, 10/15/03 .................. B- 50,000 54,000
----------
1,706,873
----------
CHEMICALS AND PLASTICS (4.0%):
Crain Industries, Senior Subordinated Note, 13.50%,
8/15/05 ............................................. N-R 125,000 130,625
Foamex LP, Senior Note, 11.25%, 10/1/02 .............. B 100,000 97,000
Foamex LP, Senior Subordinated Note, 11.88%,
10/1/04 ............................................. B- 50,000 47,000
G-I Holdings Inc., Senior Note, 10.50%, 10/1/98 ...... N-R 228,000(c)(e) 182,400
G-I Holdings Inc., Senior Note, 10.00%, 2/15/06 ...... B+ 216,000(e) 223,020
Harris Chemical North American, Senior Note, 10.25%,
7/15/01 ............................................. B+ 100,000 101,750
Polymer Group, Senior Note, 12.25%, 7/15/02 . B- 125,000 129,375
RBX Corp., Senior Subordinated Note, 11.25%,
10/15/05 ............................................ N-R 75,000(e) 74,062
Uniroyal Technology Corp., Senior Note, 11.75%,
6/1/03 .............................................. B 125,000 120,625
----------
1,105,857
----------
CONGLOMERATE (0.7%):
Sherritt Gordon Limited, Note, 9.75%, 4/1/03 ......... BB- 175,000 185,937
----------
CONSUMER NON-DURABLES (1.4%):
Curtice/Burns Foods Inc., Senior Subordinated Note,
12.25%, 2/1/05 ...................................... B 250,000 246,250
Playtex Family Products Corp., Senior Subordinated
Note, 9.00%, 12/15/03 ............................... B 150,000 138,563
----------
384,813
----------
CONTAINER AND GLASS PRODUCTS (1.3%):
Owens Illinois Inc., Senior Subordinated Note, 10.50%,
6/15/02 ............................................. B+ 250,000 265,313
Portola Packaging Inc., Senior Note, 10.75%,
10/1/05 ............................................. B 100,000 105,500
----------
370,813
----------
</TABLE>
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES.
19
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
(CONTINUED)
<TABLE>
<CAPTION>
S&P Principal Market
Name of Issuer Rating (g) Amount Value (a)
- --------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
COSMETICS AND TOILETRIES (0.9%):
Revlon Consumer Products Corp., Senior Note, 9.38%,
4/1/01 .............................................. B $ 250,000 254,375
----------
ECOLOGICAL SERVICES AND EQUIPMENT (1.8%):
Allied Waste Industries Inc., Senior Subordinated
Note, 12.00%, 2/1/04 ................................ B 250,000 272,500
ICF Kaiser International, Senior Subordinated Note,
12.00%, 12/31/03 .................................... B- 50,000 47,750
Mid-American Waste System Inc., Senior Subordinated
Note, 12.25%, 2/15/03 ............................... D 250,000 192,500
----------
512,750
----------
ELECTRICAL UTILITIES (0.6%):
El Paso Electric Co., 9.40%, 5/1/11 .................. BB- 150,000 154,125
----------
FINANCE (0.3%):
Trizec Finance Limited, Senior Note, 10.88%,
10/15/05 ............................................ BB- 75,000 77,906
----------
FOOD MANUFACTURER (0.3%):
Spreckles Industries Inc., Senior Note, 11.50%,
9/1/00 .............................................. B 75,000 76,125
----------
FOOD PRODUCTS (2.7%):
Carr-Gottstein Foods Co., Senior Subordinated Note,
12.00%, 11/15/05 .................................... B- 50,000(e) 51,875
Doskocil Companies Inc., Senior Subordinated Note,
9.75%, 7/15/00 ...................................... B 125,000 123,125
PMI Acquisition Corp., Senior Subordinated Note,
10.25%, 9/1/03 ...................................... B 250,000 260,000
Specialty Foods Corp., Senior Subordinated Note,
11.25%, 8/15/03 ..................................... B- 250,000 208,750
Van De Kamps Inc., Senior Subordinated Note, 12.00%,
9/15/05 ............................................. B- 100,000 106,500
----------
750,250
----------
FOOD SERVICES (1.3%):
Flagstar Corp., Senior Note, 10.88%, 12/1/02 ......... B- 400,000 364,000
----------
</TABLE>
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES.
20
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
(CONTINUED)
<TABLE>
<CAPTION>
S&P Principal Market
Name of Issuer Rating (g) Amount Value (a)
- --------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
FOOD AND DRUG RETAILING (1.2%):
Pathmark Stores Inc., Senior Subordinated Note, 9.63%,
5/1/03 .............................................. B- $ 100,000 96,500
Penn Traffic Co., Senior Subordinated Note, 9.63%,
4/15/05 ............................................. B 75,000 63,563
Ralphs Grocery Co., Senior Note, 10.45%, 6/15/04 ..... B 100,000 97,250
Ralphs Grocery Co., Senior Subordinated Note, 11.00%,
6/15/05 ............................................. B- 75,000 70,125
----------
327,438
----------
FOREST PRODUCTS (2.2%):
Container Corporation of America, Senior Note, 9.75%,
4/1/03 .............................................. B+ 125,000 123,438
Riverwood International Corp., Senior Subordinated
Note, 11.25%, 6/15/02 ............................... B 100,000 110,750
SD Warren Co., Senior Subordinated Note, 12.00%,
12/15/04 ............................................ B+ 200,000 215,000
Stone Container, Senior Note, 11.50%, 10/1/04 B+ 150,000 150,750
----------
599,938
----------
HEALTH CARE SERVICES (1.3%):
Amerisource Distribution, Payment-in-Kind Debenture,
11.25%, 7/15/05 ..................................... B 139,458 154,101
Tenet Healthcare, Senior Subordinated Notes, 10.13%,
3/1/05 .............................................. B+ 200,000 221,500
----------
375,601
----------
HEAVY ELECTRICAL MACHINERY (0.5%):
Alvey Systems Inc., Senior Subordinated Note, 11.38%,
1/31/03 ............................................. B- 125,000 130,313
----------
HOTELS AND LEISURE (0.8%):
Courtyard By Marriott, Senior Note, 10.75%, 2/1/08 ... B- 100,000(e) 101,250
Motels of America Inc., Senior Subordinated Note,
12.00%, 4/15/04 ..................................... B- 125,000 124,375
----------
225,625
----------
</TABLE>
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES.
21
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
(CONTINUED)
<TABLE>
<CAPTION>
S&P Principal Market
Name of Issuer Rating (g) Amount Value (a)
- --------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
INDUSTRIAL PRODUCTS AND EQUIPMENT (2.7%):
Cabot Safety Corp., Senior Subordinated Note, 12.50%,
7/15/05 ............................................. B $ 150,000 166,500
CAI Wireless Systems Inc., Senior Note, 12.25%,
9/15/02 ............................................. BB- 75,000 81,188
Coinmach Corp., 11.75%, 11/15/05 ..................... B+ 100,000(e) 102,500
Exide Corp, 10.00%, 4/15/05 .......................... BB- 125,000 134,375
Fairfield Manufacturing, Senior Subordinated Note,
11.38%, 7/1/01 ...................................... CCC+ 100,000 101,500
Pace Industries, Senior Note, 10.63%, 12/1/02 ........ B- 50,000 46,000
Panamsat LP, Senior Subordinated Note, Delayed
Interest, 11.82%, 8/1/03 ............................ B 150,000(f) 126,750
----------
758,813
----------
INDUSTRIAL PROPERTY (0.6%):
Monarch Marking Systems, Senior Note, 12.50%,
7/1/03 .............................................. B+ 150,000 162,750
----------
LEISURE AND ENTERTAINMENT (2.8%):
Affinity Group Incorporated, Senior Subordinated Note,
11.50%, 10/15/03 .................................... B 250,000 256,250
Alliance Entertainment, Senior Subordinated Note,
11.25%, 7/15/05 ..................................... B- 100,000 101,000
Premier Parks, Senior Note, 12.00%, 8/15/03 .......... B+ 150,000 159,750
Six Flags Theme Parks, Senior Subordinated Note,
Delayed Interest, 12.53%, 6/15/05 ................... B 300,000(f) 253,500
----------
770,500
----------
MACHINE TOOL MANUFACTURER (1.1%):
Primeco Inc., Senior Subordinated Note, 12.75%,
3/1/05 .............................................. B 125,000 133,750
Waters Technologies Corp., Senior Subordinated Note,
12.75%, 9/30/04 ..................................... B 150,000 171,750
----------
305,500
----------
OIL AND GAS (3.2%):
California Energy Inc., Senior Note, Delayed Interest,
10.70%, 1/15/04 ..................................... BB- 400,000(f) 386,000
Clark USA Inc., Senior Note, 10.88%, 12/1/05 . B+ 100,000(e) 105,250
Falcon Drilling Inc., Senior Note, 9.75%, 1/15/01 .... B+ 100,000 105,000
</TABLE>
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES.
22
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
(CONTINUED)
<TABLE>
<CAPTION>
S&P Principal Market
Name of Issuer Rating (g) Amount Value (a)
- --------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Giant Industries Inc., Senior Subordinated Note,
9.75%, 11/15/03 ..................................... B+ $ 250,000 255,000
United Meridian Corp., Senior Subordinated Note,
10.38%, 10/15/05 .................................... B 50,000 53,500
----------
904,750
----------
PRINTING AND PUBLISHING (1.4%):
Affiliated Newspaper Investments, Senior Discount
Note, Delayed Interest, 12.79%, 7/1/06 .............. B+ 500,000(f) 340,000
Hollinger International Publishing, Senior
Subordinated Note, 9.25%, 2/1/06 .................... BB- 50,000 50,000
----------
390,000
----------
RETAIL STORES (3.0%):
Brylane LP/Brylane Capital Corp., Senior Subordinated
Note, 10.00%, 9/1/03 ................................ B+ 375,000 337,500
Herff Jones Inc., Senior Subordinated Note, 11.00%,
8/15/05 ............................................. B 200,000 218,000
Hosiery Corp Of America Inc., Senior Subordinated
Note, 13.75%, 8/1/02 ................................ B- 100,000 107,750
Icon Health and Fitness, Senior Subordinated Note,
13.00%, 7/15/02 ..................................... B- 150,000(e) 168,000
----------
831,250
----------
STEEL MANUFACTURER (2.3%):
Bayou Steel Corp., 10.25%, 3/1/01 .................... B 75,000 68,625
Envirosource Inc., Senior Note, 9.75%, 6/15/03 B 250,000 230,000
Geneva Steel Corp., Senior Note, 11.13%, 3/15/01 ..... B 100,000 86,250
GS Technologies, Senior Note, 12.00%, 9/1/04 ......... B 250,000 250,625
----------
635,500
----------
SURFACE TRANSPORTATION (2.0%):
Gearbulk Holding LTD, Senior Note, 11.25%, 12/1/04 ... BB 125,000 136,875
Great Dane Holdings, Senior Subordinated Note, 12.75%,
8/1/01 .............................................. B- 100,000 94,500
Stena AB, Senior Note, 10.50%, 12/15/05 .............. BB- 100,000 103,750
</TABLE>
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES.
23
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
(CONTINUED)
<TABLE>
<CAPTION>
Principal
S&P Amount Market
Name of Issuer Rating (g) or Shares Value (a)
- --------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Trism Inc., Senior Subordinated Note, 10.75%,
12/15/00 ............................................ B $ 215,000 209,625
----------
544,750
----------
TELECOMMUNICATIONS AND CELLULAR (2.9%):
Brooks Fiber Properties, Senior Discount Note, Delayed
Interest, 10.78%, 3/1/06 ............................ N-R 250,000(f)(e) 148,750
Cellular Communications, Note, 12.70%, 8/15/00 ....... CCC+ 150,000(c) 94,500
Dial Call Communications, Senior Discount Note,
Delayed Interest, 11.84%, 4/15/04 ................... CCC- 150,000(f) 98,250
Fonorola Inc., Senior Note, 12.50%, 8/15/02 .......... B+ 50,000 54,875
Mobilemedia Communications, Senior Subordinated Note,
9.38%, 11/1/07 ...................................... B- 50,000 51,125
Pronet Inc., Senior Subordinated Note, 11.88%,
6/15/05 ............................................. B- 100,000 108,500
USA Mobile Communications Inc II, Senior Note, 9.50%,
2/1/04 .............................................. B- 250,000 251,250
----------
807,250
----------
TEXTILES AND APPAREL (1.4%):
Dan River Inc., Senior Subordinated Note, 10.13%,
12/15/03 ............................................ B 100,000 95,500
Westpoint Stevens Inc., Senior Subordinated Debenture,
9.38%, 12/15/05 ..................................... B+ 300,000 301,500
----------
397,000
----------
Total High-Yield Corporate Bonds
(cost: $16,430,012) ............................... 17,003,177
----------
COMMON STOCK (0.2%):
CABLE TELEVISION (0.0%):
Pegasus Media & Communications ................................. 10 $ 3,000
Sullivan Broadcasting Holdings ................................. 400 --
----------
3,000
----------
PRINTING & PUBLISHING (0.0%):
Affiliated Newspaper Investments Class B ....................... 500 12,500
----------
</TABLE>
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES.
24
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
HIGHLANDER INCOME FUND
(CONTINUED)
<TABLE>
<CAPTION>
Principal
Amount Market
Name of Issuer or Shares Value (a)
- ------------------------------------------------------------------- --------- ----------
<S> <C> <C>
RETAIL TRADE (0.2%):
Grand Union Co. ................................................ 7,070 $ 43,083
----------
TEXTILE AND APPAREL (0.0%):
Hosiery Corp of America Inc .................................... 50 250
----------
Total Common Stock
(cost: $111,942) ............................................ 58,833
----------
PREFERRED STOCK (0.7%):
COMMERCIAL AND INDUSTRIAL SERVICES (0.3%):
Panamsat LP, Non-Convertible, 12.75%, 4/15/05 .................. 81 95,580
----------
COMMERCIAL SERVICES (0.4%):
K - III Comm, Non-Convertible, 11.63%, 5/1/05 .................. 1,059 110,132
----------
Total Preferred Stock
(cost: $170,000) ............................................ 205,712
----------
WARRANTS (0.1%):
Dial Call Communications, 4/25/97 .............................. 250 3
Icon Health and Fitness, 11/14/99 .............................. 150 4,500
Uniroyal Technology Corp., 6/1/03 .............................. 1,250 1,262
----------
Total Warrants
(cost: $8,098) .............................................. 5,765
----------
SHORT-TERM SECURITIES (0.0%):
Repurchase agreement with Morgan Stanley in a joint trading
account collateralized by U.S. government agency securities,
acquired on 2/29/96, accrued interest at repurchase date of $1,
5.20%, 3/1/96
(cost: $4,000) .............................................. $ 4,000 4,000
----------
Total Investments in Securities
(cost: $33,088,303)(h) ..................................... $ 33,595,126
----------
----------
</TABLE>
NOTES TO INVESTMENTS IN SECURITIES:
(A) SECURITIES ARE VALUED IN ACCORDANCE WITH PROCEDURES DESCRIBED IN NOTE 2 TO
THE FINANCIAL STATEMENTS.
(B) ON FEBRUARY 29, 1996, THE TOTAL COST OF INVESTMENTS PURCHASED ON A
WHEN-ISSUED BASIS WAS $7,111,875.
25
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
<TABLE>
<S> <C>
(C) FOR ZERO-COUPON INVESTMENTS, THE INTEREST RATE SHOWN IS THE EFFECTIVE YIELD
ON THE DATE OF PURCHASE.
(D) DESCRIPTIONS OF CERTAIN COLLATERALIZED MORTGAGE OBLIGATIONS ARE AS FOLLOWS:
Z-TRANCHE - REPRESENTS SECURITIES THAT PAY NO INTEREST OR PRINCIPAL DURING
THEIR INITIAL ACCRUAL PERIODS, BUT ACCRUE ADDITIONAL PRINCIPAL AT
SPECIFIED RATES. INTEREST RATE DISCLOSED REPRESENTS CURRENT YIELD BASED
UPON ESTIMATED TIMING OF FUTURE CASH FLOWS.
(E) SECURITIES SOLD WITHIN TERMS OF A PRIVATE PLACEMENT MEMORANDUM ARE EXEMPT
FROM REGISTRATION UNDER SECTION 144A OF THE SECURITIES ACT OF 1933, AS
AMENDED, AND MAY BE SOLD ONLY TO DEALERS IN THAT PROGRAM OR OTHER
"ACCREDITED INVESTORS." THESE INVESTMENTS HAVE BEEN IDENTIFIED BY PORTFOLIO
MANAGEMENT AS ILLIQUID SECURITIES. THE AGGREGATE VALUE OF THESE SECURITIES
AT FEBRUARY 29, 1996, IS $1,378,207, WHICH REPRESENTS 4.9% OF TOTAL NET
ASSETS.
(F) THE INTEREST RATES DISCLOSED FOR DELAYED INTEREST AND PIK BONDS REPRESENTS
EFFECTIVE YIELDS AT FEBRUARY 29, 1996, BASED UPON THE ESTIMATED TIMING AND
AMOUNT OF FUTURE INTEREST AND PRINCIPAL PAYMENTS.
PIK - PAYMENT-IN-KIND INTEREST IS GENERALLY PAID BY ISSUING ADDITIONAL PAR
OF THE SECURITY RATHER THAN PAYING CASH.
DELAYED INTEREST - SECURITIES THAT REMAIN ZERO-COUPON SECURITIES UNTIL A
PREDETERMINED DATE AT WHICH TIME THE STATED COUPON RATE BECOMES EFFECTIVE
AND INTEREST BECOMES PAYABLE AT REGULAR INTERVALS.
(G) THE STANDARD & POOR'S RATING IS A CURRENT ASSESSMENT OF THE CREDIT
WORTHINESS OF AN ISSUER WITH RESPECT TO A SPECIFIC OBLIGATION. SECURITIES
DESIGNATED AS "N-R" ARE NOT RATED BY STANDARD & POOR'S.
"BB" - LESS NEAR-TERM VULNERABILITY TO DEFAULT THAN OTHER SPECULATIVE
ISSUES. HOWEVER, IT FACES MAJOR ONGOING UNCERTAINTIES OR EXPOSURE TO
ADVERSE BUSINESS, FINANCIAL OR ECONOMIC CONDITIONS WHICH COULD LEAD TO
INADEQUATE CAPACITY TO MEET TIMELY INTEREST PRINCIPAL PAYMENTS.
"B" - A GREATER VULNERABILITY TO DEFAULT BUT CURRENTLY HAS THE CAPACITY TO
MEET INTEREST PAYMENTS AND PRINCIPAL REPAYMENTS. ADVERSE BUSINESS,
FINANCIAL OR ECONOMIC CONDITIONS WILL LIKELY IMPAIR CAPACITY OR
WILLINGNESS TO PAY INTEREST AND REPAY PRINCIPAL.
"CCC" - CURRENTLY IDENTIFIABLE VULNERABILITY TO DEFAULT, AND IS DEPENDENT
UPON FAVORABLE BUSINESS, FINANCIAL AND ECONOMIC CONDITIONS TO MEET TIMELY
PAYMENT OF INTEREST AND REPAYMENT OF PRINCIPAL. IN THE EVENT OF ADVERSE
BUSINESS, FINANCIAL OR ECONOMIC CONDITIONS, IT IS NOT LIKELY TO HAVE THE
CAPACITY TO PAY INTEREST AND REPAY PRINCIPAL.
"D" - PAYMENT IS IN DEFAULT. INTEREST OR PRINCIPAL PAYMENTS ARE NOT MADE ON
THE DATE DUE EVEN IF THE APPLICABLE GRACE PERIOD HAS NOT EXPIRED.
SECURITY REPRESENTS 0.7% OF NET ASSETS AT FEBRUARY 29, 1996.
THE RATINGS ABOVE MAY BE MODIFIED BY THE ADDITION OF A PLUS OR MINUS SIGN
TO SHOW RELATIVE STANDING WITHIN THE MAJOR RATING CATEGORIES.
(H) ALSO REPRESENTS COST FOR FEDERAL INCOME TAX PURPOSES. THE AGGREGATE GROSS
UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS IN SECURITIES BASED
ON THIS COST WERE AS FOLLOWS:
</TABLE>
<TABLE>
<S> <C>
GROSS UNREALIZED APPRECIATION .... $ 1,006,916
GROSS UNREALIZED DEPRECIATION ...... (500,093)
----------
NET UNREALIZED APPRECIATION .... $ 506,823
----------
----------
</TABLE>
26
<PAGE>
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INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS
HIGHLANDER INCOME FUND INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments in securities, of Highlander Income Fund Inc. as of
February 29, 1996, the related statement of operations for the year then ended,
and the statements of changes in net assets and the financial highlights for the
year then ended and the period from March 31, 1994 (commencement of operations)
to February 28, 1995. These financial statements and the financial highlights
are the responsibility of the fund's management. Our responsibility is to
express an opinion on these financial statements and the financial highlights
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Investment securities held in custody are confirmed to us by the
custodian. As to securities purchased and sold but not received or delivered, we
request confirmations from brokers, and where replies are not received, we carry
out other appropriate auditing procedures. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and the financial highlights referred
to above present fairly, in all material respects, the financial position of
Highlander Income Fund Inc. as of February 29, 1996, the results of its
operations for the year then ended, and the changes in its net assets and the
financial highlights for the periods stated in the first paragraph above, in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Minneapolis, Minnesota
April 12, 1996
27
<PAGE>
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FEDERAL INCOME TAX INFORMATION
Fiscal Year Ended February 29, 1996
Information for federal income tax purposes is presented as an aid to
shareholders in reporting distributions. Shareholders should consult a tax
adviser on how to report these distributions at the state and local levels.
Distributions shown below are taxable as dividend income except as otherwise
noted. None qualify for the corporate dividends received deduction. In early
February 1996, each shareholder should have received a breakdown of income
earned by investment category for calendar year 1995.
<TABLE>
<CAPTION>
Payable Date Per Share
- -------------------------------------------------- ------------
<S> <C>
March 29, 1995 ................................. $ 0.104
April 26, 1995.................................... 0.104
May 24, 1995...................................... 0.104
June 28, 1995..................................... 0.104
July 26, 1995..................................... 0.104
August 23, 1995................................... 0.104
September 27, 1995................................ 0.104
October 25, 1995.................................. 0.094
November 22, 1995................................. 0.094
December 27, 1995................................. 0.094
January 11, 1996.................................. 0.094
February 21, 1996................................. 0.094(a)
------
$ 1.198
------
------
</TABLE>
(A) DISTRIBUTION INCLUDES $0.013 TAX RETURN OF CAPITAL.
28
<PAGE>
- --------------------------------------------------------------------------------
SHAREHOLDER UPDATE
SHARE REPURCHASE PROGRAM
Your fund's board of directors has voted to discontinue the share repurchase
program, effective February 6, 1996. The program had enabled the fund to "buy
back" shares of its common stock in the open market.
TERMS AND CONDITIONS OF THE DIVIDEND REINVESTMENT PLAN
As a shareholder, you may choose to participate in the Dividend Reinvestment
Plan. It is a convenient and economical way to buy additional shares of the fund
by automatically reinvesting dividends and capital gains. The plan is
administered by Investors Fiduciary Trust Company (IFTC), the plan agent.
ELIGIBILITY/PARTICIPATION
You may join the plan at any time. Reinvestment of distributions will begin with
the next distribution paid, provided your enrollment card is received at least
10 days before the record date for that distribution.
If your shares are in certificate form, you may join the plan directly and have
your distributions reinvested in additional shares of the fund. To enroll in
this plan, call IFTC at 1-800-543-1627. If your shares are registered in your
brokerage firm's name or another name, ask the holder of your shares how you may
participate.
Banks, brokers or nominees, on behalf of their beneficial owners who wish to
reinvest dividend and capital gain distributions, may participate in the plan by
informing IFTC at least 10 days before each share's dividend and/or capital
gains distribution.
PLAN ADMINISTRATION
Fund shares to cover reinvestments will generally be purchased by IFTC in the
open market. However, if fund shares, plus commissions, are trading at a 10% or
greater premium over net asset value, and in certain other circumstances, the
fund may issue new shares to cover such reinvestments at a discount of up to 5%
of the market price without brokerage commissions.
Beginning no more than five business days before the dividend payment date, IFTC
may purchase fund shares on behalf of participants in the plan to satisfy
dividend reinvestments. Such purchases are made on the American Stock Exchange
(the Exchange) or elsewhere at any time when the price of the fund's common
stock on the Exchange, plus commissions, is at less than a 10% premium over the
fund's most recently calculated net asset value per share. If, at the close of
business on the dividend payment date, the shares purchased in the open market
are insufficient to satisfy the dividend reinvestment requirements -- either
because the fund's shares have been
29
<PAGE>
- --------------------------------------------------------------------------------
SHAREHOLDER UPDATE
trading at a greater than 10% premium over net asset value or because IFTC, for
any other reason, has not been able to purchase a sufficient number of shares --
IFTC will accept payment of the dividend, or the remaining portion therefore, in
authorized but unissued shares of the fund. Such shares will be issued at a
price per share equal to the higher of (1) the net asset value per share as of
the close of business on the payment date, or (2) 95% of the closing market
price per share on the payment date. The number of shares allocated to you will
be determined by dividing the amount of the dividend or distribution by the
applicable price per share.
There is no direct charge to you for reinvestment of dividends and capital
gains, since IFTC fees are paid by the fund. However, if fund shares are
purchased in the open market, each participant in the plan pays a pro rata
portion of the brokerage commissions. Brokerage charges are expected to be lower
than those for individual transactions because the plan purchases shares for all
participants in blocks. Distributions paid on the shares in your plan account
will also be reinvested as long as you continue to participate in the plan.
IFTC maintains accounts for plan participants holding shares in certificate form
and will furnish written confirmation of all transactions, including information
you need for tax records. Reinvested shares in your account will be held by IFTC
in non-certificated form in your name.
TAX INFORMATION
Distributions reinvested in shares purchased in the open market are subject to
income tax, the same as if such distributions were received in cash. When shares
are issued by the fund at a discount from market value, shareholders will be
treated as having received distributions of an amount equal to the full market
value of those shares. Shareholders, as required by the Internal Revenue
Service, will receive a Form 1099 information return regarding the Federal tax
status of the prior year's distributions.
PLAN WITHDRAWAL
If you hold your shares in certificate form, you may terminate your
participation in the plan at any time by giving written notice to IFTC. If your
shares are registered in your brokerage firm's name, you may terminate your
participation via verbal or written instructions to your investment
professional. Written instructions should include your name and address as they
appear on the certificate or account.
If notice is received at least 10 days before the record date, all future
distributions will be paid directly to the shareholder of record.
30
<PAGE>
- --------------------------------------------------------------------------------
SHAREHOLDER UPDATE
If your shares are in certificate form and you discontinue your participation in
the plan, you (or your nominee) will receive an additional certificate for all
full shares and a check for any fractional shares in your account.
PLAN AMENDMENT/TERMINATION
The fund reserves the right to amend or terminate the plan. Should the plan be
terminated, participants will be notified in writing at least 90 days before the
record date for the next dividend or distribution. The plan may also be amended
or terminated by IFTC with at least 90 days written notice to participants in
the plan.
Any questions about the plan should be directed to your investment professional
or to Investors Fiduciary Trust Company, P.O. Box 419432, Kansas City, Missouri
64141, 1-800-543-1627.
31
<PAGE>
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DIRECTORS AND OFFICERS
<TABLE>
<S> <C>
DIRECTORS David T. Bennett, CHAIRMAN, HIGHLAND HOMES, INC., USL
PRODUCTS, INC., KIEFER BUILT, INC., OF COUNSEL, GRAY,
PLANT, MOOTY, MOOTY & BENNETT, P.A.
Jaye F. Dyer, PRESIDENT, DYER MANAGEMENT COMPANY
William H. Ellis, PRESIDENT, PIPER JAFFRAY COMPANIES INC.,
PIPER CAPITAL MANAGEMENT INCORPORATED
Karol D. Emmerich, PRESIDENT, THE PARACLETE GROUP
Luella G. Goldberg, DIRECTOR, TCF FINANCIAL, RELIASTAR
FINANCIAL CORP., HORMEL FOODS CORP.
George Latimer, CHIEF EXECUTIVE OFFICER, NATIONAL EQUITY
FUNDS
OFFICERS William H. Ellis, CHAIRMAN OF THE BOARD
Thomas S. McGlinch, SENIOR VICE PRESIDENT
J. Bradley Stone, SENIOR VICE PRESIDENT
Robert H. Nelson, SENIOR VICE PRESIDENT AND TREASURER
Susan S. Miley, SECRETARY
INVESTMENT Piper Capital Management Incorporated
ADVISER 222 SOUTH NINTH STREET, MINNEAPOLIS, MN 55402
SUB ADVISER Federated Advisers
FEDERATED INVESTORS TOWER, PITTSBURGH, PA 15222-3779
CUSTODIAN AND Investors Fiduciary Trust Company
TRANSFER AGENT 127 WEST 10TH STREET, KANSAS CITY, MO 64105-1716
LEGAL COUNSEL Dorsey & Whitney LLP
220 SOUTH SIXTH STREET, MINNEAPOLIS, MN 55402
INDEPENDENT KPMG Peat Marwick LLP
AUDITORS 4200 NORWEST CENTER, MINNEAPOLIS, MN 55402
</TABLE>
32
<PAGE>
[PIPER CAPITAL MANAGEMENT - LOGO]
PIPER CAPITAL MANAGEMENT INCORPORATED
222 SOUTH NINTH STREET
MINNEAPOLIS, MN 55402-3804
PIPER JAFFRAY INC., NASD MEMBER
[LOGO] THIS DOCUMENT IS PRINTED ON PAPER MADE FROM 100% TOTAL RECOVERED
FIBER, INCLUDING 15% POST-CONSUMER WASTE.
In an effort to reduce costs to our shareholders, we have implemented
a process to reduce duplicate mailings of the fund's shareholder
reports. This householding process should allow us to mail one report
to each address where one or more registered shareholders with the
same last name reside. If you would like to have additional reports
mailed to your address, please call our Shareholder Services area at 1
800 866-7778, or mail your request to:
Piper Capital Management
Attn: Communications Department
222 South Ninth Street
Minneapolis, MN 55402-3804
STAPLES
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