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HCD Highland Distressed Opportunities, Inc.

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  0.00 0.00% 0.00 -

- Quarterly Report (10-Q)

07/05/2009 10:00pm

Edgar (US Regulatory)


Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2009
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period                      to                     
Commission file number: 814-00729
 
Highland Distressed Opportunities, Inc.
(Exact Name of Registrant as Specified in Charter)
 
     
Delaware   205423854
(State or Jurisdiction of Incorporation or Organization)   (IRS Employer Identification No.)
NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240

(Address of Principal Executive Offices)
(877) 247-1888
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ       No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large Accelerated Filer o
  Accelerated Filer þ   Non-Accelerated Filer o (Do not check if a smaller reporting company)   Smaller reporting company o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
On April 21, 2009, there were 17,716,771 shares outstanding of the Registrant’s common stock, $0.001 par value per share.
 
 

 


 

Highland Distressed Opportunities, Inc.
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  EX-10.16
  EX-31.1
  EX-31.2
  EX-32.1

2


Table of Contents

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Schedule of Investments
     
As of March 31, 2009 (unaudited)   Highland Distressed Opportunities, Inc.
                         
    Principal ($)   Cost ($)   Value ($)
Senior Loans (a) — 37.3%
                       
BROADCASTING 17.2%
                       
Comcorp Broadcasting, Inc.
                       
Revolving Loan, 7.75%, 10/03/12 (b) (c)
    1,884,953       1,884,953       855,391  
Term Loan, 7.75%, 04/03/13 (b) (c)
    18,849,521       18,546,505       8,553,913  
 
                       
 
            20,431,458       9,409,304  
 
                       
FOREST PRODUCTS/CONTAINERS 0.3%
                       
Tegrant Corp.
                       
Second Lien Term Loan, 6.72%, 03/08/15
    1,000,000       1,000,000       150,000  
 
                       
GAMING/LEISURE 13.8%
                       
Fontainebleu Florida Hotel, LLC
                       
Tranche C Term Loan, 7.33%, 06/06/12
    6,000,000       6,000,000       4,500,000  
Lake at Las Vegas Joint Venture/ LLV-1,LLC
                       
Revolving Loan Credit-Linked Deposit Account, 14.35%, 06/20/12 (d)
    3,611,111       3,611,111       347,570  
Term Loan, 14.35%, 06/20/12, PIK (d)
    35,076,245       28,269,771       2,720,966  
 
                       
 
            37,880,882       7,568,536  
 
                       
HOUSING 2.2%
                       
MetroFlag BP, LLC / MetroFlag Cable, LLC
                       
Second Lien Term Loan, 12.00% (d)
    5,000,000       5,000,000       375,000  
MPH Mezzanine II, LLC
                       
Mezzanine 2B, 7.48% (b) (d)
    10,000,000       10,000,000        
MPH Mezzanine III, LLC
                       
Mezzanine 3, 8.48% (b) (d)
    4,000,000       4,000,000        
Pacific Clarion, LLC
                       
Term Loan, 15.00% (b) (d) (e)
    4,950,573       4,939,006       822,785  
 
                       
 
            23,939,006       1,197,785  
 
                       
See accompanying Notes to Financial Statements.

3


Table of Contents

Schedule of Investments    
     
As of March 31, 2009 (unaudited) (continued)   Highland Distressed Opportunities, Inc.
                         
    Principal ($)   Cost ($)   Value ($)
Senior Loans (continued)
                       
SERVICE 3.7%
                       
Penhall Holding Co.
                       
Term Loan, 10.00%, 04/01/12
    5,797,571       5,742,869       2,029,150  
 
                       
TRANSPORTATION AUTOMOTIVE — 0.1%
                       
BST Safety Textiles Acquisition GmbH
                       
Second Lien Facility, 16.53%, 06/30/09, PIK (d)
    682,415       682,707       44,357  
 
                       
Total Senior Loans
            89,676,922       20,399,132  
 
                       
Corporate Notes and Bonds (f) 32.8%
                       
DIVERSIFIED MEDIA 3.7%
                       
Baker & Taylor, Inc.
                       
11.50%, 07/01/13
    8,300,000       8,746,939       2,033,500  
 
                       
HEALTHCARE 29.1%
                       
Argatroban Royalty Sub, LLC
                       
18.50%, 09/21/14
    3,306,706       3,306,706       2,976,035  
Azithromycin Royalty Sub, LLC
                       
16.00%, 05/15/19
    5,000,000       4,973,191       4,400,000  
Celtic Pharma Phinco B.V.
                       
17.00%, 06/15/12, PIK
    10,561,138       10,154,927       6,864,740  
Cinacalcet Royalty Sub, LLC
                       
15.50%, 03/30/17, PIK
    1,079,002       1,064,448       701,351  
Molecular Insight Pharmaceuticals, Inc.
                       
11.19%, 11/01/12, PIK (g)
    1,056,993       1,054,148       930,154  
 
                       
 
            20,553,420       15,872,280  
 
                       
Total Corporate Notes and Bonds
            29,300,359       17,905,780  
 
                       
Claims (h) 0.0%
                       
AEROSPACE 0.0%
                       
Northwest Airlines, Inc.
                       
ALPA Trade Claim
    3,000,000       428,371       2,430  
Bell Atlantic Trade Claim
    2,500,000       431,553       2,025  
EDC Trade Claims
    2,500,000       444,852       2,025  
Flight Attendant Claim
    5,326,500       734,164       4,314  
GE Trade Claim
    1,500,000       273,682       1,215  
IAM Trade Claim
    4,728,134       724,198       3,830  
Pinnacle Trade Claim
    8,433,116       1,520,621       6,831  
Retiree Claim
    3,512,250       484,102       2,845  
 
                       
Total Claims
            5,041,543       25,515  
 
                       
See accompanying Notes to Financial Statements.

4


Table of Contents

Schedule of Investments    
     
As of March 31, 2009 (unaudited) (continued)   Highland Distressed Opportunities, Inc.
                         
    Shares     Cost ($)     Value ($)  
Common Stocks (h) 28.1%
                       
AEROSPACE 0.1%
                       
Delta Air Lines, Inc.
    8,974       85,086       50,523  
 
                   
BROADCASTING 0.0%
                       
Communications Corp. of America (b) (c)
    1,256,635       7,187,203        
 
                   
HEALTHCARE 27.9%
                       
Genesys Ventures IA, LP (b) (c)
    12,000,000       12,000,000       15,240,000  
 
                   
WIRELESS COMMUNICATIONS 0.1%
                       
ICO Global Communications
    138,632       500,000       48,521  
 
                   
Total Common Stocks
            19,772,289       15,339,044  
 
                   
Total Investments (i) — 98.2%
            143,791,113       53,669,471  
 
                   
Other Assets & Liabilities, Net — 1.8%
                    974,541  
 
                     
Net Assets — 100.0%
                    54,644,012  
 
                     
 
(a)   Senior loans in which Highland Distressed Opportunities, Inc. (the “Company”) invests generally pay interest at rates which are periodically determined by reference to a base lending rate plus a premium (unless otherwise identified by footnote (e), all senior loans carry a variable rate of interest). These base lending rates are generally (i) the Prime Rate offered by one or more major United States banks, (ii) the lending rate offered by one or more European banks such as the London Interbank Offered Rate (“LIBOR”) or (iii) the Certificate of Deposit rate. Rate shown represents the weighted average rate at March 31, 2009. Senior loans, while exempt from registration under the Securities Act of 1933 (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 remaining maturity may be substantially less than the stated maturity shown.
 
(b)   Represents fair value as determined, in good faith, pursuant to the policies and procedures approved by the Company’s Board of Directors (the “Board”). Securities with a total aggregate market value of $25,472,089 or 46.6% of net assets, were fair valued as of March 31, 2009.
 
(c)   Affiliated issuer. See Note 7.
 
(d)   The issuer is in default of certain debt covenants. Income is not being accrued.
 
(e)   Fixed rate senior loan.
 
(f)   Securities exempt from registration under Rule 144A of the 1933 Act. These securities may only be resold, in transactions exempt from registration, to qualified institutional buyers. At March 31, 2009, these securities amounted to 17,905,780 or 32.8% of net assets.
 
(g)   Floating rate asset. The interest rate shown reflects the rate in effect at March 31, 2009.
 
(h)   Non-income producing security.
 
(i)   Cost basis for U.S. federal income tax purposes is $143,791,113.
 
PIK   Payment-in-Kind. All or a portion of the stated interest rate may be PIK interest.
See accompanying Notes to Financial Statements.

5


Table of Contents

Schedule of Investments
     
As of December 31, 2008
  Highland Distressed Opportunities, Inc.
                         
    Principal ($)   Cost ($)   Value ($)
Senior Loans (a) — 56.8%
                       
BROADCASTING — 16.0%
                       
Comcorp Broadcasting, Inc.
                       
Revolving Loan, 7.52%, 04/03/13 (b) (c) (d)
    1,825,953       1,825,953       843,134  
Term Loan, 7.75%, 04/03/13 (c) (d)
    18,849,521       18,525,278       8,835,713  
 
                       
 
            20,351,231       9,678,847  
 
                       
CONSUMER NON-DURABLES — 1.7%
                       
Totes Isotoner Corp.
Second Lien Term Loan, 9.88%, 01/31/14
    3,377,228       3,400,514       1,013,169  
 
                       
DIVERSIFIED MEDIA — 0.7%
                       
Penton Media, Inc.
Second Lien Term Loan, 8.42%, 02/01/14
    2,000,000       2,035,654       425,000  
 
                       
FINANCIAL — 9.4%
                       
Emerson Reinsurance Ltd.
Tranche C Term Loan, 7.25%, 12/15/11
    1,500,000       1,495,043       1,297,500  
Flatiron Re Ltd.
                       
Closing Date Term Loan, 5.71%, 12/29/10
    25,529       25,704       24,796  
Delayed Draw Term Loan, 5.71%, 12/29/10
    12,366       12,451       12,011  
Kepler Holdings Ltd.
Term Loan, 7.00%, 06/30/09
    5,000,000       5,006,959       4,400,000  
 
                       
 
            6,540,157       5,734,307  
 
                       
FOREST PRODUCTS/CONTAINERS — 0.2%
                       
Tegrant Corp.
Second Lien Term Loan, 6.96%, 03/08/15
    1,000,000       1,000,000       103,340  
 
                       
GAMING/LEISURE — 12.4%
                       
Fontainebleu Florida Hotel, LLC
Tranche C Term Loan, 8.00%, 06/06/12
    6,000,000       6,000,000       5,100,000  
Lake at Las Vegas Joint Venture/ LLV-1,LLC
                       
Revolving Loan Credit-Linked Deposit, 14.35%, 06/20/12 (e)
    3,611,111       3,611,111       273,831  
Term Loan, 14.35%, 06/20/12 PIK (e)
    33,756,283       28,269,771       2,143,697  
 
                       
 
            37,880,882       7,517,528  
 
                       
HEALTHCARE — 3.1%
                       
Life Technologies Corp.
Term B Facility, 09/30/15 (f)
    1,995,000       1,955,100       1,881,963  
 
                       
See accompanying Notes to Financial Statements.

6


Table of Contents

Schedule of Investments
     
As of December 31, 2008 (continued)
  Highland Distressed Opportunities, Inc.
                         
    Principal ($)   Cost ($)   Value ($)
Senior Loans (continued)
                       
HOUSING — 2.0%
                       
MetroFlag BP, LLC / MetroFlag Cable, LLC
Second Lien Term Loan, 12.00%, 01/06/09
    5,000,000       5,000,000       375,000  
MPH Mezzanine II, LLC
Mezzanine 2B, 7.48%, 02/09/08 (d) (e)
    10,000,000       10,000,000        
MPH Mezzanine III, LLC
Mezzanine 3, 8.48%, 02/09/08 (d) (e)
    4,000,000       4,000,000        
Pacific Clarion, LLC
Term Loan, 15.00%, 01/23/09 (d) (e) (g)
    4,950,573       4,945,680       841,053  
 
                       
 
            23,945,680       1,216,053  
 
                       
SERVICE — 11.1%
                       
LVI Services, Inc.
Tranche B Term Loan, 6.49%, 11/16/11
    9,377,348       9,317,890       4,102,590  
Penhall Holding Co.
Term Loan, 12.29%, 04/01/12 PIK
    5,821,220       5,762,042       2,619,549  
 
                       
 
            15,079,932       6,722,139  
 
                       
TRANSPORTATION — AUTOMOTIVE — 0.2%
                       
BST Safety Textiles Acquisition GmbH
Second Lien Facility, 14.60%, 06/30/09
    673,957       674,415       117,943  
 
                       
Total Senior Loans
            112,863,565       34,410,289  
 
                       
Corporate Notes and Bonds (h) — 33.4%
                       
DIVERSIFIED MEDIA — 5.8%
                       
Baker & Taylor, Inc.
11.50%, 07/01/13
    8,300,000       8,749,446       3,537,875  
 
                       
HEALTHCARE — 27.6%
                       
Argatroban Royalty Sub, LLC
18.50%, 09/21/14
    3,306,706       3,306,706       2,942,968  
Azithromycin Royalty Sub, LLC
16.00%, 05/15/19
    5,000,000       4,974,238       4,350,000  
Celtic Pharma Phinco B.V.
17.00%, 06/15/12 PIK
    10,561,138       10,132,572       7,815,242  
Cinacalcet Royalty Sub, LLC
15.50%, 03/30/17 PIK
    1,038,750       1,023,972       768,675  
Molecular Insight Pharmaceuticals, Inc.
10.80%, 11/01/12 (i)
    1,027,602       1,026,832       822,081  
 
                       
 
            20,464,320       16,698,966  
 
                       
Total Corporate Notes and Bonds
            29,213,766       20,236,841  
 
                       
See accompanying Notes to Financial Statements .

7


Table of Contents

Schedule of Investments
     
As of December 31, 2008 (continued)
  Highland Distressed Opportunities, Inc.
                         
    Principal ($)   Cost ($)   Value ($)
Claims (j) — 0.1%
                       
AEROSPACE — 0.1%
                       
Northwest Airlines, Inc.
                       
ALPA Trade Claim, 08/21/13
    3,000,000       431,377       5,640  
Bell Atlantic Trade Claim, 08/21/13
    2,500,000       434,058       4,700  
EDC Trade Claims, 08/21/13
    2,500,000       447,357       4,700  
Flight Attendant Claim, 08/21/13
    5,326,500       739,501       10,014  
GE Trade Claim, 08/21/13
    1,500,000       275,185       2,820  
IAM Trade Claim, 08/21/13
    4,728,134       728,935       8,889  
Pinnacle Trade Claim, 08/21/13
    8,433,116       1,529,071       15,854  
Retiree Claim, 08/21/13
    3,512,250       487,621       6,603  
 
                       
Total Claims
            5,073,105       59,220  
 
                       
See accompanying Notes to Financial Statements .

8


Table of Contents

Schedule of Investments
     
As of December 31, 2008 (continued)
  Highland Distressed Opportunities, Inc.
                         
    Shares   Cost ($)   Value ($)
Common Stock (j) — 29.6%
                       
AEROSPACE — 0.6%
                       
Delta Air Lines, Inc.
    30,433       215,657       348,762  
 
                       
BROADCASTING — 0.0%
                       
Communications Corp. of America (c) (d)
    1,256,635       7,187,203        
 
                       
HEALTHCARE — 28.7%
                       
Genesys Ventures IA, LP (c) (d)
    12,000,000       12,000,000       17,412,000  
 
                       
WIRELESS COMMUNICATIONS — 0.3%
                       
ICO Global Communications
    138,632       500,000       153,882  
 
                       
Total Common Stocks
            19,902,860       17,914,644  
 
                       
Total Investments (k) — 119.9%
            167,053,296       72,620,994  
 
                       
Other Assets & Liabilities, Net — (19.9)%
                    (12,064,566 )
 
                       
Net Assets — 100.0%
                    60,556,428  
 
                       
 
(a)   Senior loans in which Highland Distressed Opportunities, Inc. (the “Company”) invests generally pay interest at rates which are periodically determined 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 United States banks, (ii) the lending rate offered by one or more European banks such as the London Interbank Offered Rate (“LIBOR”) or (iii) the Certificate of Deposit rate. Rate shown represents the weighted average rate at December 31, 2008. Senior loans, while exempt from registration under the Securities Act of 1933 (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 remaining maturity may be substantially less than the stated maturity shown.
 
(b)   Senior loan asset has additional unfunded loan commitments. See Note 6.
 
(c)   Affiliated issuer. See Note 7.
 
(d)   Represents fair value as determined, in good faith, pursuant to the policies and procedures approved by the Company’s Board of Directors (the “Board’). Securities with a total aggregate market value of $27,931,900 or 46.1% of net assets, were fair valued as of December 31, 2008.
 
(e)   The issuer is in default of certain debt covenants. Income is not being accrued.
 
(f)   All or a portion of this position has not settled. Contract rates do not take effect until settlement date.
 
(g)   Fixed rate senior loan.
 
(h)   Securities exempt from registration under Rule 144A of the 1933 Act. These securities may only be resold, in transactions exempt from registration, to qualified institutional buyers. At December 31, 2008, these securities amounted to $20,236,841 or 33.4% of net assets.
 
(i)   Floating rate asset. The interest rate shown reflects the rate in effect at December 31, 3008.
 
(j)   Non-income producing security.
 
(k)   Cost basis for U.S. federal income tax purposes is $178,369,294.
PIK   Payment-in-Kind. All or a portion of the stated interest rate may be PIK interest.
See accompanying Notes to Financial Statements .

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Statement of Assets and Liabilities
Highland Distressed Opportunities, Inc.
                 
    As of    
    March 31, 2009   As of
    (unaudited)   December 31, 2008
    ($)   ($)
Assets:
               
Investments in:
               
Unaffiliated issuers, at value (cost $104,172,452 and $127,514,862, respectively)
    29,020,167       45,530,147  
Affiliated issuers, at value (cost $39,618,661 and $39,538,434, respectively)
    24,649,304       27,090,847  
 
               
Total investments, at value (cost $143,791,113 and $167,053,296, respectively)
    53,669,471       72,620,994  
Cash and cash equivalents
    2,488,838        
Foreign currency (cost $10,519 and $10, respectively)
    10,245       10  
Receivable for:
               
Investments sold
    3,741,270       12,106,871  
Dividend and interest
    1,992,008       2,337,202  
Other assets
    9,888       96,923  
 
               
Total assets
    61,911,720       87,162,000  
 
               
 
               
Liabilities:
               
Due to Custodian
          122,505  
Notes payable (Note 4)
    6,500,000       15,500,000  
Net discount and unrealized depreciation on unfunded transactions
          31,756  
Payables for:
               
Investments purchased
          9,809,787  
Investment advisory fee (Note 3)
    339,336       627,965  
Administration fee (Note 3)
    59,384       109,894  
Interest expense (Note 4)
    78,622       112,469  
Directors’ fees (Note 3)
    9,138       5,100  
Accrued expenses and other liabilities
    281,228       286,096  
 
               
Total liabilities
    7,267,708       26,605,572  
 
               
Stockholders’ equity (net assets)
    54,644,012       60,556,428  
 
               
 
               
Composition of stockholders’ equity (net assets):
               
Common Stock, par value $.001 per share: 550,000,000 common stock authorized, 17,716,771 common stock outstanding
    17,717       17,717  
Paid-in capital
    253,018,580       253,018,580  
Undistributed net investment income
    1,160,446       1,067,487  
Accumulated net realized gain/(loss) on investments, total return swaps and foreign currency transactions
    (109,430,815 )     (99,083,521 )
Net unrealized appreciation/(depreciation) on investments, unfunded transactions and translation of assets and liabilities denominated in foreign currency
    (90,121,916 )     (94,463,835 )
 
               
Stockholders’ equity (net assets)
    54,644,012       60,556,428  
 
               
 
               
Net Asset Value Per Share (Net Assets/Common Stock Outstanding)
    3.08       3.42  
 
               
See accompanying Notes to Financial Statements .

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Statement of Operations
Highland Distressed Opportunities, Inc.
                 
    For the Quarters Ended
    March 31, 2009   March 31, 2008
    (unaudited)   (unaudited)
    ($)   ($)
Investment Income:
               
Unaffiliated interest income
    982,077       7,387,171  
Affiliated interest income (Note 7)
    399,081       464,884  
Unaffiliated dividends (net of foreign taxes withheld)
          40,685  
 
               
Total investment income
    1,381,158       7,892,740  
 
               
Expenses:
               
Investment advisory fees (Note 3)
    339,336       1,484,400  
Incentive fees (Note 3)
          870,369  
Administration fees (Note 3)
    59,384       259,770  
Accounting service fees
    38,303       37,288  
Transfer agent fees
    8,860       7,583  
Legal fees
    156,685       62,158  
Audit and Tax fees
    21,000       31,701  
Directors’ fees (Note 3)
    8,972       6,915  
Custody fees
    6,539       11,073  
Registration fees
    23,699       6,041  
Reports to stockholders
    11,559       3,804  
Franchise tax expense
    4,316       14,918  
Rating agency fees
    37,952       20,749  
Interest expense (Note 4)
    261,928       1,434,603  
Reorganization expense (Note 12)
    69,705        
Other expense
    239,961       159,893  
 
               
Net expenses
    1,288,199       4,411,265  
 
               
Net investment income
    92,959       3,481,475  
 
               
Net Realized and Unrealized Gain/(Loss) on Investments:
               
Net realized gain/(loss) on investments
    (10,347,294 )     (12,488,132 )
Net realized gain/(loss) on foreign currency transactions
          33  
Net change in unrealized appreciation/(depreciation) on investments
    4,310,660       (22,002,712 )
Net change in unrealized appreciation/(depreciation) on unfunded transactions
    31,756       (22,921 )
Net change in unrealized appreciation/(depreciation) on translation of assets and liabilities denominated in foreign currency
    (497 )     2,369  
 
               
Net realized and unrealized gain/(loss) on investments
    (6,005,375 )     (34,511,363 )
 
               
Net decrease in stockholders’ equity (net assets) resulting from operations
    (5,912,416 )     (31,029,888 )
 
               
See accompanying Notes to Financial Statements .

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Statement of Changes in Stockholders’ Equity (Net Assets)
     
For the Year Ended December 31, 2008 and for the Quarter Ended
March 31, 2009 (unaudited)
  Highland Distressed Opportunities, Inc.
                                                         
                                                    Total
                            Undistributed   Undistributed   Net Unrealized   Stockholders’
    Common Stock   Paid-in Capital   Net Investment   Net Realized   Appreciation/   Equity
    Shares   Amount   in Excess of Par   Income   Gain/(Loss)   (Depreciation)   (Net Assets)
     
Balance at December 31, 2007
    17,716,771     $ 17,717     $ 253,163,644     $ 3,420,147     $ (14,547,689 )   $ (60,038,767 )   $ 182,015,052  
Distributions declared
                      (13,287,578 )                 (13,287,578 )
Net increase/(decrease) in stockholders’ equity (net assets) resulting from operations
                (145,064 )     10,934,918       (84,535,832 )     (34,425,068 )     (108,171,046 )
     
Balance at December 31, 2008
    17,716,771     $ 17,717     $ 253,018,580     $ 1,067,487     $ (99,083,521 )   $ (94,463,835 )   $ 60,556,428  
     
Distributions declared
                                         
Net increase/(decrease) in stockholders’ equity (net assets) resulting from operations
                      92,959       (10,347,294 )     4,341,919       (5,912,416 )
     
Balance at March 31, 2009
    17,716,771     $ 17,717     $ 253,018,580     $ 1,160,446     $ (109,430,815 )   $ (90,121,916 )   $ 54,644,012  
     
See accompanying Notes to Financial Statements .

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Statement of Cash Flows
Highland Distressed Opportunities, Inc.
                 
    For the Quarters Ended
    March 31, 2009   March 31, 2008
    (unaudited)   (unaudited)
    ($)   ($)
Cash Flow Provided by (Used in) Operating Activities:
               
Net increase/(decrease) in stockholders’ equity (net assets) resulting from operations
    (5,912,416 )     (31,029,888 )
Adjustments to reconcile net increase/(decrease) in stockholders’ equity (net assets) resulting from operations to net cash and foreign currency:
               
Net realized (gain)/loss on investments, total return swaps and foreign currency transactions
    10,347,294       12,488,099  
Net change in unrealized (appreciation)/depreciation on investments, unfunded transactions and translation of assets and liabilities denominated in foreign currency
    (4,341,919 )     22,000,343  
Purchase of investments securities
    (203,351 )     (28,193,997 )
Proceeds from disposition of investment securities, total return swaps and foreign currency transactions
    13,160,506       33,745,357  
Net amortization/(accretion) of premium/(discount)
    (42,266 )     (593,777 )
Net realized and change in unrealized gain/(loss) on foreign currency
    (497 )     2,402  
(Increase)/Decrease in dividends, interest and fees receivable
    345,194       (1,555,110 )
(Increase)/Decrease in receivable for investments sold
    8,365,601       23,259,434  
(Increase)/Decrease in other assets
    87,035       19,914  
Increase/(Decrease) in payable for investments purchased
    (9,809,787 )     (14,302,942 )
Increase/(Decrease) in payables to related parties
    (335,101 )     108,013  
Increase/(Decrease) in interest payable
    (33,847 )     (384,174 )
Increase/(Decrease) in other liabilities
    (4,868 )     (26,993 )
 
               
Net Cash Flow Provided by (Used in) Operating Activities
    11,621,578       15,536,681  
 
               
 
               
Cash Flows Provided by (Used in) Financing Activities:
               
Increase/(Decrease) in notes payable
    (9,000,000 )     (18,000,000 )
Increase/(Decrease) in due to custodian
    (122,505 )     2,827,451  
Distributions paid in cash
          (4,650,652 )
 
               
Net Cash Flow Provided by (Used in) Financing Activities
    (9,122,505 )     (19,823,201 )
 
               
Net Increase (Decrease) in Cash, Cash Equivalents and Foreign Currency
    2,499,073       (4,286,520 )
 
               
 
               
Cash, Cash Equivalents and Foreign Currency:
               
Beginning of the period
    10       4,291,098  
End of the period
    2,499,083       4,578  
 
               
 
               
Supplemental Information:
               
Interest paid during the period
    295,775       1,818,777  
 
               
See accompanying Notes to Financial Statements .

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Notes to Financial Statements
Highland Distressed Opportunities, Inc.
Note 1. Organization
Highland Distressed Opportunities, Inc. (the “Company”), is a closed-end company that has filed an election to be treated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). The Company was incorporated under the laws of Delaware on August 22, 2006. In addition, for tax purposes, the Company has elected to be treated as a regulated investment company, or RIC, under the Internal Revenue Code of 1986 (the “Code”). The Company’s investment objective is total return generated by both capital appreciation and current income. The Company intends to invest primarily in financially-troubled or distressed companies that are either middle-market companies or unlisted companies by investing in senior secured debt, mezzanine debt and unsecured debt, each of which may include an equity component, and in equity investments.
The Company commenced operations on January 18, 2007. On February 27, 2007, the Company closed its initial public offering (“IPO” or the “Offering”) and sold 17,000,000 shares of its common stock at a price of $15.00 per share, less an underwriting discount and commissions totaling $0.675 per share. The Company received $243,525,000 in total net proceeds from the Offering, before expenses.
On March 23, 2007, the Company issued 284,300 shares of common stock to cover the underwriters’ partial exercise of the over-allotment option on the Offering and received approximately $4,072,698 in net proceeds after deducting underwriting discounts and commissions.
As discussed in Note 14 to the financial statements, on December 19, 2008, the Company’s Board of Directors (the “Board”) approved a reorganization of the Company into Highland Credit Strategies Fund.
Note 2. Significant Accounting Policies
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 amount 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 reported period. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.
Interim unaudited financial statements are prepared in accordance with GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Regulation S-X, as appropriate. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements have been included. The unaudited interim financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission (“SEC”). Interim results are not necessarily indicative of results for a full year.
The following are significant accounting policies consistently followed by the Company in preparation of its financial statements:
(a) Investments in financial instruments
Investment transactions are recorded on the trade date.
The Company will use the following valuation methods to determine either current market value for investments for which market quotations are available, or if not available, then fair value, as determined in good faith pursuant to policies and procedures approved by the Board:

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Market Quotations Available
The market value of each security listed or traded on any recognized securities exchange or automated quotation system will be the last reported sale price at the relevant valuation date on the composite tape or on the principal exchange on which such security is traded. If no sale is reported on that date, the Company utilizes, when available, pricing quotations from principal market makers. Such quotations may be obtained from third-party pricing services or directly from investment brokers and dealers in the secondary market. Generally, the Company’s loan and bond positions are not traded on exchanges and consequently are valued based on market prices received from third-party pricing services or broker-dealer sources. The Company obtains multiple broker-dealer quotes when available, but places greater reliance on quotes from broker-dealers that serve as underwriters for the issuer. In order to validate market quotations, the Company evaluates information, as available and as applicable, to determine if the quotations are representative of fair value, including, but not limited to, the source and nature of the quotations, qualitative analysis of the issuer and internally developed expectations and models. The valuation of certain securities for which there is little to no market activity may take into account appraisal reports obtained by management from independent valuation firms. Short-term debt securities having a remaining maturity of 60 days or less when purchased and debt securities originally purchased with maturities in excess of 60 days but which currently have maturities of 60 days or less may be valued at cost adjusted for amortization of premiums and accretion of discounts.
Market Quotations Not Available
Securities for which market quotations are not readily available, or for which the Company has determined the price received from a pricing service or broker-dealer is “stale” or otherwise does not represent fair value, are valued by the Company at fair value, taking into account factors reasonably determined to be relevant, including: (i) the fundamental analytical data relating to the investment; (ii) the nature and duration of restrictions on disposition of the securities; and (iii) an evaluation of the forces that influence the market in which these securities are purchased and sold. The Company takes the following steps each time it determines its net asset value in order to determine the value of its securities for which market quotations are not readily available, as determined in good faith pursuant to policies and procedures approved by the Board:
  1.   The valuation process begins with each portfolio company or investment being initially valued by the investment professionals responsible for the portfolio investment.
 
  2.   Preliminary valuation conclusions are then documented and discussed with Highland Capital Management, L.P.’s (the “Investment Adviser”) senior management.
 
  3.   The Company’s valuation committee, comprised of the Investment Adviser’s investment professionals and other senior management, will then review these preliminary valuations. An independent valuation firm engaged by the Company’s Board reviews all of these preliminary valuations each quarter.
 
  4.   Finally, the Board discusses valuations and reviews the fair value of each investment in the Company’s portfolio in good faith, pursuant to policies and procedures approved by the Board, based on the input of the valuation committee and an independent valuation firm.
As part of the valuation process, management takes into account the following types of factors, if relevant, in determining the fair value of our investments: the enterprise value of a portfolio company (an estimate of the total fair value of the portfolio company’s debt and equity), the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, comparison to publicly traded securities, changes in the interest rate environment and the credit markets generally that may affect the price at which similar investments may be made in the future and other relevant factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we use the pricing indicated by the external event to corroborate our valuation.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Adoption of Statement of Financial Accounting Standards No. 157 “Fair Value Measurement” (“FAS 157”):
In September 2006, the Financial Accounting Standards Board (“FASB”) issued FAS 157, “Fair Value Measurement,” which is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. FAS 157 defines how fair value should be determined for financial reporting purposes, establishes a framework for measuring fair value under GAAP, and requires additional disclosures about the use of fair value measurements in interim and annual periods subsequent to initial recognition. FAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. Adoption of FAS 157 requires the Company to assume that the portfolio investment is sold in a principal market to a market participant, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. The principal market is the market in which the reporting entity would sell or transfer the asset with the greatest volume and level of activity for the asset. In determining the principal market for an asset or liability under FAS 157, it is assumed that the reporting entity has access to the market as of the measurement date. If no market for the asset exists or if the reporting entity does not have access to the principal market, the reporting entity should use a hypothetical market.
The Company has adopted FAS 157 as of January 1, 2008. In accordance with FAS 157 the Company has considered its principal market as the market in which the Company exits its portfolio investments with the greatest volume and level of activity or a hypothetical secondary market as of the measurement date. However, to the extent that an active market exists, the Company considers that as its principal market. The Company has performed an analysis of all existing investments and derivative instruments to determine the significance and character of all inputs to their fair value determination. Based on this assessment, the adoption of FAS 157 did not have any material effect on the Company’s net asset value. However, the adoption of FAS 157 does require the Company to provide additional disclosures about the inputs used to develop the measurements and the effect of certain measurements on changes in net assets for the reportable periods as contained in the Company’s periodic filings.
The levels of fair value inputs used to measure the Company’s investments are characterized in accordance with the fair value hierarchy established by FAS 157. Where inputs for an asset or liability fall into more than one level in the fair value hierarchy, the investment is classified in its entirety based on the lowest level input that is significant to that investment’s fair value measurement. The Company employs judgment and considers factors specific to the investment in determining the significance of an input to a fair value measurement. The three levels of the fair value hierarchy established under FAS 157 are described below:
    Level 1 — Quoted unadjusted prices for identical instruments in active markets to which the Company has access at the date of measurement;
 
    Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active, but are valued based on executed trades; broker quotations that constitute an executable price; and alternative pricing sources supported by observable inputs are classified within Level 2. Level 2 inputs are either directly or indirectly observable for the asset in connection with market data at the measurement date; and
 
    Level 3 — Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. Unobservable inputs are those inputs that reflect the Company’s own assumptions that market participants would use to price the asset or liability based on the best available information.
The determination of what constitutes “observable” requires significant judgment by management. Management considers observable data to be that market data which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market. Categorization within the hierarchy is based upon the pricing transparency of the investment and does not necessarily correspond to the Company’s perceived risk of that investment.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Consistent with the valuation policies and procedures, management evaluates the source of inputs, including any markets in which its investments are trading (or any markets in which securities with similar attributes are trading), in determining fair value. The Company’s valuation policy considers the fact that a readily available market value may not exist for a portion of the investments in its portfolio and that fair value for those investments will typically be determined using unobservable inputs.
Investments whose values are based on quoted market prices in active markets, and are therefore classified within Level 1, generally include active listed equities, certain U.S. government and sovereign obligations, and certain money market securities. The quoted price for such instruments are not adjusted, even in situations where the Company holds a large position and a sale could reasonably impact the quoted price.
Investments that trade in markets that are not considered to be active, but are valued based on executed trades, broker quotations that constitute an executable price, or alternative pricing sources supported by observable inputs are classified within Level 2. These may include investment-grade corporate bonds, certain bank loans and bridge loans, less liquid listed equities and certain loan commitments. While investments classified as Level 2 may include positions that are not traded in active markets and/or are subject to transfer restrictions, the Company does not adjust valuations to reflect illiquidity and/or non-transferability, which are generally based on available market information.
Investments classified within Level 3 have significant unobservable inputs, as they trade infrequently or not at all. Level 3 instruments may include private equity and real estate investments, certain bank loans and bridge loans, and less liquid corporate debt securities (including distressed debt instruments). In certain cases, investments classified within Level 3 may include securities for which the Company has obtained indicative quotes from broker-dealers that do not necessarily represent prices the broker may be willing to trade on, as such quotes can be subject to material management judgment. When observable prices are not available for these securities, management may employ one or more valuation techniques for which sufficient and reliable data is available.
The inputs used in estimating the value of Level 3 investments may include the original transaction price, comparable transactions in the same or similar instruments, completed or pending third-party transactions in the underlying investment or comparable issuers, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt capital markets, and estimates of and changes in financial ratios or cash flows. Level 3 investments may also be adjusted as appropriate for liquidity, credit, market and/or other risk factors to reflect illiquidity and/or non-transferability, with the amount of such discount estimated based on the availability of sufficient and reliable data in the absence of market information. The fair value measurement of Level 3 investments does not include transaction costs that may have been capitalized as part of the security’s cost basis. Assumptions utilized due to the lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s results of operations.
There is no single approach or methodology for determining fair value in good faith and, in fact, for any one portfolio investment, an estimate of fair value may be best expressed as a range of fair values. However, management must derive a single estimate of fair value. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a rational/credible valuation process for the types of investments we the Company makes.
Because of the type of investments that the Company makes and the nature of its business, the Company’s valuation process requires an analysis of various factors. The Company’s fair value methodology includes the examination of, among other things, the underlying investment performance, financial condition, and market changing events that impact valuation.
To determine the fair value of a given investment, management analyzes its historical and projected financial results. Such financial and other information may be obtained from the portfolio company, and may represent unaudited, projected or pro forma financial information.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
The Company may use Level 3 inputs for measuring the fair value of certain investments by employing one or more of the following valuation methodologies:
Enterprise Value (Multiples) Analysis
Under the enterprise value or residual value valuation methodology (“EV”), the Company estimates the portfolio company’s total EV then will allocate that value over the portfolio company’s securities in order of their legal priority relative to one another.
This methodology may be employed in valuing loan and debt securities as well as equity securities or other similar securities, subject to any applicable discounts when the Company has a minority ownership position, restrictions on resale, specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other factors, which the Company believes would lead a market participant to discount such securities.
To estimate the EV of the portfolio company, the Company prepares an analysis consisting of traditional valuation methodologies including market, income and cost approaches, and weighs the use of such methods based on the individual circumstances of the portfolio company in order to conclude on its estimate of the EV.
In determining a reasonable multiple to use for valuation purposes, conventional considerations include not only the fact that a portfolio company may be a private company relative to a peer group of public comparables, but also consider potential “size-of-issue” (e.g. liquidity) and “size-of-company-based” (middle-market company) discounts as well as its specific strengths and weaknesses. If a portfolio company is distressed or has a predetermined life (e.g. patents) a liquidation or exit analysis may provide the best indication of value.
Discounted Cash Flow Model
When relevant observable market data does not exist, an alternative technique of valuing investments is based on discounted cash flow, or DCF. For the purposes of using DCF to provide fair value estimates, the Company considers multiple inputs such as a risk-adjusted discount rate that incorporates adjustments that market participants would make both for nonperformance and liquidity risks.
Akin to the enterprise value methodology of valuation, a multiple is applied to the selected financial measure (e.g. EBITDA), and based on the portfolio company’s presumed horizon and the selected discount rate, the Company arrives at the present value of the portfolio company’s terminal value, which is added to the DCF estimate to determine the portfolio company’s total value.
Yield/Spread Model
The Company may also value its investments in loans and other debt securities by performing spread and yield analyses. To determine a hypothetical current sale of the investment, the analysis requires the Company to estimate the fair value based on such factors as third-party broker quotes and to make assumptions a market participant would use regarding the investments, including, but not limited to, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. The Company weighs the use of third-party broker quotes in determining fair value based on its understanding of the level of actual transactions used by the broker to develop the quote and whether the quote was an indicative price or binding offer. The assumptions used to estimate the fair value in a hypothetical secondary market incorporate a significant amount of Level 3 inputs.
Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may fluctuate from period to period. Additionally, the fair value of investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values the Company may ultimately realize. Further, such investments may be subject to legal and other restrictions on resale or otherwise less liquid than publicly traded securities.
In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. A summary of the inputs used to value the Company’s assets as of March 31, 2009 as follows:
                                 
Assets at Fair Value   Total     Level 1     Level 2     Level 3  
Portfolio Investments
  $ 53,669,471     $ 99,044     $     $ 53,570,427  
Cash and foreign currency
    2,499,083       2,499,083              
 
                       
Total
  $ 56,168,554     $ 2,598,127     $     $ 53,570,427  
 
                       
At March 31, 2009, portfolio investments recorded at fair value using level 3 inputs (as defined under FAS 157) represented approximately 99.8% of the Company’s portfolio, exclusive of cash and cash equivalents. The Company did not have any liabilities that were measured at fair value on a recurring basis at March 31, 2009.
The table below sets forth a summary of changes in the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarter ended March 31, 2009.
         
    For the Quarter Ended  
    March 31, 2009  
Assets at Fair Value Using Unobservable Inputs (Level 3)   Portfolio Investments  
Balance as of December 31, 2008
  $ 70,236,387  
Net transfers in/(out) of Level 3
     
Net amortization/(accretion) of premium/(discount)
    35,289  
Net realized gains/(losses)
    (10,015,517 )
Net unrealized gains/(losses)
    4,510,551  
Net purchases/(sales) *
    (11,196,283 )
 
     
Balance as of March 31, 2009
  $ 53,570,427  
 
     
 
*   Includes any applicable borrowings and/or paydowns made on revolving credit facilities held in the Company’s investment portfolio.
The net unrealized losses presented in the tables above relate to investments that are still held at March 31, 2009, and the Company presents these unrealized losses on the Statement of Operations as net change in unrealized appreciation/(depreciation) on investments.
Investments designated as Level 3 may include assets valued using quotes or indications furnished by brokers which are based on models or estimates and may not be executable prices.
New Accounting Pronouncements
In April 2009, FASB Staff Position No. 157-4 — Determining Fair Value when the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP 157-4”) was issued. FSP 157-4 clarifies the process for measuring the fair value of financial instruments when the markets become inactive and quoted prices may reflect distressed transactions. FSP 157-4 provides an illustrative list of factors a reporting entity should consider when determining whether there has been a significant decrease in the volume and level of activity for an asset or liability when compared with normal market activity. Under FSP 157-4, if a reporting entity concludes there has been a significant decrease in volume and level of activity for the asset or liability (or similar assets or liabilities), transactions or quoted prices may not be determinative of fair value. Further analysis of the transactions or quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value in accordance with FASB Statement No. 157 — Fair Value Measurements. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. Early adoption is permitted for periods ending after March 15, 2009. Earlier adoption for periods ending before March 15, 2009, is not permitted. At this time, management is evaluating the impact of FSP 157-4 on the Company’s financial statements and has not elected to adopt FSP 157-4 for the quarter ended March 31, 2009.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
(b) Net asset value per share
The net asset value per share disclosed on the Statement of Assets and Liabilities is calculated by dividing the net assets attributable to the shares of the Company’s common stock by the number of such shares outstanding at period-end.
(c) Securities transactions
All securities transactions are accounted for on a trade-date basis. Gains or losses on the sale of investments are calculated by using the specific identification method.
(d) Interest income
Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis. Origination, closing and/or commitment fees associated with investments in portfolio companies are accreted into interest income over the respective terms of the applicable loans. Upon the prepayment of a loan or debt security, any prepayment penalties and unamortized loan origination, closing and commitment fees are recorded as interest income. Payment-in-kind (“PIK”) interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income. To maintain the Company’s status as a RIC, this non-cash source of income must be paid out to stockholders in the form of distributions, even though the Company has not yet collected cash. For the quarter ended March 31, 2009, approximately $0.4 million of PIK interest income was recorded. For the year ended December 31, 2008, approximately $1.0 million of PIK interest income was recorded.
(e) Taxation — general
The Company intends to comply with the applicable provisions of the Code pertaining to regulated investment companies to make distributions of taxable income sufficient to relieve it from substantially all Federal income tax. However, depending on the level of taxable income earned in a year, the Company may choose to carry forward taxable income in excess of distributions and pay the 4% excise tax on the difference. Additionally, the Company is subject to franchise taxes in the states of Texas and Delaware.
In July 2006, the 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 Company’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. As of March 31, 2009 and December 31, 2008 the Company has evaluated the implications of FIN 48 and determined that there is no material impact on the financial statements.
(f) Taxation of distributions
Book and tax basis differences relating to stockholder distributions and other permanent book and tax differences are reclassified to paid-in capital. In addition, the character of income and gains to be distributed is determined in accordance with income tax regulations that may differ from GAAP.
(g) Payment of distributions
Distributions to common stockholders are recorded as of the date of declaration. The amount to be paid out as a distribution is determined by the Board and is generally based upon the earnings estimated by management. Net realized capital gains, if any, are distributed at least annually. The determination of the tax attributes of the Company’s distributions is made annually as of the end of the Company’s fiscal year based upon its taxable income for the full year and distributions paid during the full year, therefore, a determination of tax attributes made on a quarterly basis may not be representative of the actual tax attributes of its distributions for a full year.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
(h) Foreign currency
The accounting records of the Company are maintained in U.S. dollars. All assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the rate of exchange of such currencies against U.S. dollars on the date of valuation. The Company’s investments in foreign securities may involve certain risks such as foreign exchange restrictions, expropriation, taxation or other political, social or economic risks, all of which could affect the market and/or credit risk of the investment. In addition, changes in the relationship of foreign currencies to the U.S. dollar can significantly affect the value of these investments and therefore the earnings of the Company.
(i) Forward contracts
The Company may enter into forward exchange contracts in order to hedge against foreign currency risk. These contracts are marked-to-market by recognizing the difference between the contract exchange rate and the current market rate as unrealized appreciation or depreciation. Realized gains or losses are recognized when contracts are settled.
(j) Investment in swap agreements
Swap agreements are recorded at fair value as estimated by management in good faith. The net unrealized gain or loss on swap agreement is recorded as an asset or liability on the Statement of Assets and Liabilities. The change in unrealized gain or loss is recorded in the Statement of Operations. Cash paid or received on net settlements is recorded as realized gain or loss in the Statement of Operations.
(k) Cash and cash equivalents
Cash and cash equivalents consist of demand deposits and highly liquid investments with original maturities of three months or less when purchased. Cash and cash equivalents are carried at cost which approximates fair value.
(l) Incentive fee expense recognition
The realized capital gain component of the incentive fee (the “Capital Gains Fee”), is payable in arrears as of the end of each calendar year (or upon termination of the investment advisory agreement, as of the termination date.) The Capital Gains Fee is estimated as of the end of the each calendar quarter based on the Company’s realized capital gains, if any, net of all realized capital losses, unrealized capital depreciation and fees paid on such net capital gains, computed on a cumulative basis. To the extent that Capital Gains Fees are earned by the Investment Adviser, an accrual is made in the amount of the estimated Capital Gains Fee. Because unrealized losses may fluctuate from quarter to quarter, the accrual, if any, may fluctuate as well. For the quarter ended March 31, 2009 and for the year ended December 31, 2008 there were no Capital Gains Fees paid or accrued. (See Note 3 for additional information.)
Note 3. Agreements
Investment Advisory Fee
The Company has entered into an Investment Advisory and Management Agreement with the Investment Adviser, under which the Investment Adviser, subject to the overall supervision of the Company’s Board, manages the day-to-day operations of, and provides investment advisory services to, the Company. For providing these services, the Investment Adviser receives a base management fee and an incentive fee from the Company.
The base management fee is equal to 2.00% per annum of the Company’s Managed Assets. Managed Assets are the value of total assets of the Company less all accrued liabilities of the Company (other than the aggregate amount of any outstanding borrowings, preferred stock issuances, or other instruments or obligations constituting financial leverage). The base management fee is payable quarterly in arrears.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Incentive Fee
The incentive fee consists of two components: (1) the Pre-Incentive Fee Net Investment Income and (2) the Capital Gains Fee. Pre-Incentive Fee Net Investment Income is calculated and payable quarterly in arrears. For this purpose, Pre-Incentive Fee Net Investment Income means interest income, dividend income and any other income (including any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus the Company’s operating expenses for the quarter (including the base management fee, any expenses payable under the administration agreement, and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-Incentive Fee Net Investment Income includes, in the case of investments with a deferred interest feature (such as market discount, debt instruments with PIK interest, preferred stock with PIK dividends and zero coupon securities), and accrued income that we have not yet received in cash. The Investment Adviser is not under any obligation to reimburse the Company for any part of the Incentive Fee it received that was based on accrued income that we never received as a result of a default by an entity on an obligation that resulted in the accrual of such income. Pre-Incentive Fee Net Investment Income does not include any realized capital gains, realized and unrealized capital losses or unrealized capital appreciation or depreciation.
Pre-Incentive Fee Net Investment Income, expressed as a rate of return on the value of the Company’s net assets at the end of the immediately preceding calendar quarter, is compared to the “hurdle rate” of 1.75% per quarter (7.00% annualized) (the “Hurdle Rate”). The Company will pay the Investment Adviser an Incentive Fee with respect to the Company’s Pre-Incentive Fee Net Investment Income in each calendar quarter as follows: (1) no incentive fee in any calendar quarter in which Pre-Incentive Fee Net Investment Income does not exceed the Hurdle Rate; (2) 100% of Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the Hurdle Rate but is less than 2.1875% in any calendar quarter (8.75% annualized) (the “Catch-up Provision”); and (3) 20% of the amount of Pre-Incentive Fee Net Investment Income, if any, that exceeds 2.1875% in any calendar quarter (8.75% annualized).
The Investment Adviser agreed to waive the net investment income based incentive fees earned for the three-month period ended June 30, 2008. This voluntary waiver applied only to the second quarter ended June 30, 2008.
These calculations are appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during the relevant quarter.
The second part of the Incentive Fee (the “Capital Gains Fee”) is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory and Management Agreement), beginning on December 31, 2007, and is calculated at the end of each applicable year by subtracting (A) the sum of the Company’s cumulative aggregate realized capital losses and aggregate unrealized capital depreciation from (B) the Company’s cumulative aggregate realized capital gains, in each case calculated from the date of the IPO of the Company’s shares. If such amount is positive at the end of such year, then the Capital Gains Fee for such year is equal to 20% of such amount, less the aggregate amount of Capital Gains Fees paid in all prior years. If such amount is negative, then there is no Capital Gains Fee paid for such year.
For the quarter ended March 31, 2009, the Investment Adviser earned approximately $0.3 million, $0 and $0 in base management fees, in incentive fees related to pre-incentive fee net investment income and in incentive management fees related to capital gains, respectively.
For the year ended December 31, 2008, the Investment Adviser earned $4.2 million in base management fees, $1.7 million in incentive fees related to pre-incentive fee net investment income and $0 in incentive management fees related to capital gains.
For the quarter ended March 31, 2009, the Investment Adviser did not waive any of its base management or incentive fee.
For the year ended December 31, 2008, the Investment Adviser agreed to waive $0 in base management fees, and $0.8 million in incentive fees related to pre-incentive fee net investment income.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Administration Fee
Pursuant to a separate administration services agreement, the Investment Adviser furnishes the Company with office facilities, equipment, clerical, bookkeeping and recordkeeping services at such facilities. Under the administration agreement, the Investment Adviser also will perform, or oversee the performance of, the Company’s required administrative services, which include, among other things, being responsible for the financial records that the Company is required to maintain, monitoring portfolio and regulatory compliance matters and preparing reports to the Company’s stockholders and reports filed with the SEC. In addition, the Investment Adviser will assist the Company in determining, and arranging for the publishing of, the Company’s net asset value, overseeing the preparation and filing of tax returns and the printing and disseminating of reports to stockholders, and generally overseeing the payment of expenses and the performance of administrative and professional services rendered to the Company by others. For providing these services, the Investment Adviser will receive an annual administration fee, payable quarterly in arrears at an annual rate of 0.35% of the Company’s Managed Assets. Under a separate sub-administration agreement, the Investment Adviser has delegated certain administrative functions to PNC Global Investment Servicing (U.S.) Inc. (formerly PFPC Inc.) The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party. For the quarter ended March 31, 2009 and year ended December 31, 2008, the Investment Adviser earned administration fees of approximately $0.1 million and $0.7 million, respectively.
The Investment Adviser paid to the underwriters an additional sales load of $0.15 per share, for a total sales load of $0.825 per share. The Company had agreed to pay this amount to the Investment Adviser, together with an interest factor, pursuant to an Agreement Regarding Payment of Sales Load (i) if during either the period commencing with the date of the IPO through the end of the Company’s first fiscal year or during the period of the Company’s second fiscal year (each a “Measuring Period”), the sum of (a) the Company’s aggregate distributions to its stockholders plus (b) the change in the Company’s net assets, equaled or exceeded 7.00% of the net assets of the Company at the beginning of such Measuring Period (but after adjusting, if necessary, the net assets of the Company at the end of such Measuring Period as follows: by subtracting the net proceeds of any of the Company’s stock issuances, and by adding the amount of any of the Company’s stock repurchases, that occurred during such Measuring Period) and without taking into account any accrual for the total payment amount; or (ii) upon the Company’s liquidation. Inasmuch as neither (i) nor (ii) above has occurred by the conclusion of the second Measuring Period, the Agreement Regarding Payment of Sales Load terminated on December 31, 2008, without the Company having any payment obligation to the Investment Adviser.
Fees Paid to Directors and Officers
Each Director who is not an “interested person” of the Company as defined in the 1940 Act (the “Independent Directors”) receives an annual retainer of $150,000 payable in quarterly installments and allocated among each portfolio in the Highland Fund Complex based on relative net assets. The “Highland Fund Complex” consists of the Company and all of the registered investment companies advised by the Investment Adviser as of the date of this quarterly report.
The Company pays no compensation to its one interested Director or any of its Officers, all of whom are employees of the Investment Adviser.
Note 4. Credit Facility
In accordance with the 1940 Act, with certain limited exceptions, the Company is only allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing. On June 27, 2008, the Company entered into a Revolving Credit and Security Agreement (the “Credit Agreement”) with Liberty Street Funding LLC, as conduit lender, and The Bank of Nova Scotia, acting through its New York agency, as secondary lender and agent (the “Agent”). Under the Credit Agreement, the Company was permitted to borrow on a revolving basis up to $100 million, subject to the satisfaction of certain conditions including compliance with borrowing base tests and asset coverage limits. The Credit Agreement imposed stricter limitations than the 1940 Act, requiring generally that asset coverage be at least 300% after a borrowing. The Credit Agreement expired in December 2008 and borrowings thereunder were secured by substantially all of the assets in the Company’s portfolio, including cash and cash equivalents. The interest rate charged was based on prevailing commercial paper rates plus commitment and utilization fees. However, if the commercial paper market was at any time unavailable, the interest rate was, at the

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Company’s election, based on the prevailing Eurodollar rate, Federal Funds rate or the agent’s reference rate, in each case plus an applicable spread and commitment and utilization fees. The Company paid a commitment fee at the annual rate of 0.70% on the total commitment amount, and a utilization fee at the annual rate of 0.30% on outstanding borrowings. The Credit Agreement contained, and as amended, contains customary events of default (with grace periods where customary) including, among other things, failure to pay interest or principal when due and failure to comply with certain asset coverage and borrowing base tests.
On November 25, 2008, the Company entered into Amendment No. 1 to the Credit Agreement. As amended, the credit facility expires on May 29, 2009, and the Company may borrow up to $60 million. The credit facility, as amended, requires generally that asset coverage be at least 350% after a borrowing. The credit facility is secured by substantially all of the assets in the Company’s portfolio. Generally, the interest rate charged is based on prevailing commercial paper rates plus commitment and utilization fees. However, if the Company is unable to borrow at commercial paper rates, the interest rate is based on the prevailing Eurodollar rate, Federal Funds rate or the agent’s reference rate, in each case plus an applicable spread and commitment and utilization fees. The Company pays a commitment fee at the annual rate of 1.25% on the total commitment amount, and a utilization fee at the annual rate of 0.75% on outstanding borrowings.
At March 31, 2009, the Company had borrowings outstanding under the Credit Agreement of $6.5 million. The interest rate charged on this loan as of March 31, 2009 was approximately 1.45%. The average daily loan balance during the three months ended March 31, 2009 on the facility was approximately $9.5 million at a weighted average interest rate of approximately 1.80%. Interest expense incurred during the quarter ended March 31, 2009 was approximately $0.3 million.
At December 31, 2008, the Company had borrowings outstanding under the Credit Agreement of $15.5 million. The interest rate charged on this loan as of December 31, 2008 was approximately 2.61%. The average daily loan balance during the three months ended December 31, 2008 on the facility was approximately $28.9 million at a weighted average interest rate of approximately 3.13%. Interest expense incurred for the year ended December 31, 2008 was approximately $3.2 million.
See Note 13 below for information on the Credit Agreement subsequent to March 31, 2009.
Note 5. Net Asset Value Per Share
At March 31, 2009, and December 31, 2008, the Company’s total net assets and net asset value per share were $54,644,012 and $60,556,428, and $3.08 and $3.42, respectively.
Note 6. Unfunded Loan Commitments
As of March 31, 2009, the Company’s portfolio had no unfunded loan commitments.
As of March 31, 2009 and December 31, 2008, the Company’s portfolio had unfunded loan commitments of approximately $0.0 million, and $0.1 million, respectively. Unfunded loan commitments are marked to fair value along with the funded portion of the respective loans, in accordance with the Company’s valuation policy discussed in Note 2(a).
                 
    Unfunded Loan Commitment
Borrower   March 31, 2009   December 31, 2008
Comcorp Broadcasting, Inc.
  $ 0     $ 58,999  
Unfunded loan commitments are marked to market on the relevant day of valuation in accordance with the Company’s valuation policies. Any applicable unrealized gain/(loss) and unrealized appreciation/(depreciation) on unfunded loan commitments are recorded on the Statement of Assets and Liabilities and the Statement of Operations, respectively. As of December 31, 2008, the Company recognized net unrealized depreciation on unfunded transactions of approximately $0.03 million. The net change in unrealized depreciation on unfunded transactions for the year ending December 31, 2008 was approximately $0.03 million and is recorded in the Statement of Operations.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Note 7. Transactions in Securities of Affiliated Issuers
Under Section 2(a) (3) of the Investment Company Act of 1940, a portfolio company is defined as “affiliated” if a company owns five percent or more of its voting securities. Set forth in the tables below are the issuers in which the Company held at least five percent of the outstanding voting securities as of March 31, 2009 and December 31, 2008:
March 31, 2009
                         
Borrower   Shares     Principal     Market Value  
Comcorp Broadcasting, Inc.*
                       
Revolving Loan
          $ 1,884,953     $ 855,391  
Term Loan
            18,849,521       8,553,913  
Communications Corp. of America
    1,256,635                
Genesys Ventures IA, LP
    12,000,000               15,240,000  
 
                     
Total
                  $ 24,649,304  
 
                     
December 31, 2008
                         
Borrower   Shares     Principal     Market Value  
Comcorp Broadcasting, Inc.*
                       
Revolving Loan
          $ 1,825,953     $ 843,134  
Term Loan
            18,849,521       8,835,713  
Communications Corp. of America
    1,256,635                
Genesys Ventures IA, LP
    12,000,000               17,412,000  
 
                     
Total
                  $ 27,090,847  
 
                     
 
*   Company is a wholly owned subsidiary of Communications Corp. of America.
Note 8. Portfolio Information
For the three months ended March 31, 2009, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were approximately $203,351 and $13,160,506, respectively.
For the year ended December 31, 2008, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were approximately $98,191,348 and $219,668,727, respectively.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Note 9. Financial Highlights
The following is a schedule of financial highlights for the three months ended March 31, 2009 and March 31, 2008:
                 
    Quarter Ended     Quarter Ended  
    March 31, 2009     March 31, 2008  
Net asset value, beginning of period
  $ 3.42     $ 10.27  
 
           
Net investment income
    0.01       0.19  
Net realized and unrealized loss on investments
    (0.35 )     (1.94 )
 
           
Total from investment operations
    (0.34 )     (1.75 )
Distributions Paid
          (0.26 )
 
           
Net asset value, end of period
  $ 3.08     $ 8.26  
 
           
 
               
Market price per share, beginning of period
  $ 2.15     $ 8.57  
Market price per share, end of period
  $ 1.99     $ 7.00  
 
               
Total investment return (a)
               
Based on net asset value per share
    (9.94 )%  (b)     (16.73 )%  (b)
Based on market price per share
    (7.44 )%  (b)     (15.43 )%  (b)
 
               
Net assets, end of period (c)
  $ 54,644     $ 146,335  
 
               
Ratios to Average Net Assets/Supplemental Data:
               
Net expense
    9.04 %     10.72 %
Interest expense
    1.84 %     3.49 %
Net investment income
    0.65 %     8.46 %
Portfolio turnover rate
    (b)(e)     10 (b)
 
               
Debt:
               
Total loan outstanding, end of period (c)
  $ 6,500     $ 124,000  
Asset Coverage per $1000 indebtedness, end of period (d)
  $ 9,407     $ 2,180  
 
(a)   Total investment return based on market value may result in substantially different returns than investment return based on net asset value, because market value can be significantly greater or less than the net asset value. Investment return assumes reinvestment of distributions.
 
(b)   Not annualized.
 
(c)   Dollars in thousands.
 
(d)   Calculated by subtracting the Company’s total liabilities (not including any bank loans and senior securities) from the Company’s total assets, and dividing such amounts by the principal amount of the debt outstanding.
 
(e)   Portfolio turnover rate is less than 0.5%.

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Note 10. Income Tax Information and Distributions to Stockholders
For the quarter ended March 31, 2009, the Company’s Board did not declare a distribution.
For the year end December 31, 2008, the Company’s Board declared the following distributions:
                 
Date Declared
  Record Date   Payment Date   Amount  
March 7, 2008
  March 20, 2008   March 31, 2008   $ 0.2625  
June 6, 2008
  June 20, 2008   June 30, 2008   $ 0.2625  
September 5, 2008
  September 19, 2008   September 30, 2008   $ 0.1500  
December 4, 2008
  December 19, 2008   December 31, 2008   $ 0.0750  
 
             
Total declared during 2008
          $ 0.7500  
 
             
Reclassifications are made to the Company’s capital accounts for permanent tax differences to reflect income and gains available for distribution (or available capital loss carryforwards) under income tax regulations.
The tax character of distributions paid during the year ended December 31, 2008 and the period ended December 31, 2007 were as follows:
                 
Distributions paid from:   2008   2007
Ordinary income*
  $ 13,287,578     $ 13,915,795  
Long-term capital gains
  $     $  
 
*   For tax purposes short-term capital gains distributions, if any, are considered ordinary income distributions
As of December 31, 2008 and December 31, 2007, the components of distributable earnings on a tax basis were as follows:
                 
    2008   2007
Capital loss carryforward
  $ (79,324,572  )*   $ (9,946,969  )**
Undistributed ordinary income
  $ 1,165,348     $ 3,525,488  
Post-October Losses
  $ (8,442,951 )   $ (4,600,720 )
Net unrealized appreciation/(depreciation)
  $ (105,779,833 )   $ (60,038,767 )
 
*   Accumulated losses of $9,946,969 and $69,377,603 to offset future capital gains, if any, expire on December 31, 2015 and December 31, 2016, respectively.
 
**   Accumulated losses of $9,946,969 to offset future capital gains, if any, expire on December 31, 2015.
For the year ended December 31, 2008, and the period ended December 31, 2007, the Company elected to defer capital losses of $8,442,951 and $4,600,720, respectively attributable to post-October losses.
Unrealized appreciation and depreciation at March 31, 2009, 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 assets and liabilities resulting from changes in exchange rates was:
         
Unrealized appreciation
  $ 3,240,001  
Unrealized depreciation
    (93,361,643 )
 
     
Net unrealized depreciation
  $ (90,121,642 )
 
     

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Notes to Financial Statements (continued)
Highland Distressed Opportunities, Inc.
Unrealized appreciation and depreciation at December 31, 2008, 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 assets and liabilities resulting from changes in exchange rates was:
         
Unrealized appreciation
  $ 5,545,106  
Unrealized depreciation
    (111,293,406 )
 
     
Net unrealized depreciation
  $ (105,748,300 )
 
     
For the year ended December 31, 2008, the percentage of the income distributions qualifying for the dividends-received deduction available to corporations was 1.73%.
Note 11. Impact of New Accounting Standards
In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“FAS 161”). FAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. FAS 161 requires enhanced disclosures about the Company’s derivative and hedging activities, but is not expected to result in any changes to such activities. The Company has adopted FAS 161 as of January 1, 2009. As of March 31, 2009, the Company evaluated the implications of FAS 161 and determined that there is no material impact on the financial statements.
Note 12. Reorganization
On December 19, 2008 the Board approved a reorganization of the Company into Highland Credit Strategies Fund (“HCF”), a non-diversified closed-end management investment company also managed by the Investment Adviser (the “Reorganization”).
A Special Meeting of Stockholders in connection with the Reorganization was called to be held on April 9, 2009. Stockholders who submitted proxies voted overwhelmingly (>95%) in favor of the Reorganization. It was discovered, however, that the meeting date was not within the period required under the Delaware corporate law provision governing the number of days between the record date and the meeting date. Accordingly, the Company has called a new Special Meeting of Stockholders to be held on May 27, 2009, and is conducting a re-solicitation of stockholders. Assuming the Reorganization occurs, it is currently expected that the Reorganization will qualify as a tax-free reorganization for federal income tax purposes. The number of shares of HCF (and cash for fractional shares) that stockholders of the Company will receive in the Reorganization will be based on the relative net asset values of the Company and HCF as of the close of business on the closing date for the Reorganization.
The closing of the Reorganization is subject to several conditions, including the approval of the Company’s stockholders. If stockholders of the Company do not approve the Reorganization or, if such other conditions are not satisfied or waived, the Company will continue its current operations. There can be no assurance that the requisite stockholder approval will be obtained for the Reorganization or that such other conditions will be satisfied.
Subject to stockholder approval and the satisfaction or waiver of certain conditions, the Reorganization is currently expected to occur in June 2009.
Note 13. Subsequent Event
On April 14, 2009, the Company entered into Amendment No. 2 to the Credit Agreement. Under the Amendment, the maximum amount the Company may borrow on a revolving basis was reduced from $60 million to $10 million.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Some of the statements in this report constitute forward-looking statements, which relate to future events or the future performance or financial condition of Highland Distressed Opportunities, Inc. (the “Company,” “we,” “us” and “our”). The forward-looking statements contained in this report involve risks and uncertainties, including statements as to:
o   our future operating results;
 
o   our business prospects and the prospects of our portfolio companies;
 
o   the impact of investments that we expect to make;
 
o   our contractual arrangements and relationships with third parties;
 
o   the dependence of our future success on the general economy and its impact on the industries in which we invest;
 
o   our expected financings and investments;
 
o   the adequacy of our cash resources and working capital;
 
o   the timing of cash flows, if any from the operations of our portfolio companies; and
 
o   the ability of our investment adviser to locate suitable investments for us and to monitor and administer our investments.
We may use words such as “anticipates,” “believes,” “expects,” “intends,” “will,” “should,” “may,” “plans,” “could,” “estimates,” “potential,” “continue,” “target,” or the negative of these terms or other similar expressions to identify forward-looking statements. Our actual results could differ materially from those projected in the forward-looking statements for any reason. We have based the forward-looking statements included in this report on information available to us on the date of this report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the Securities and Exchange Commission (“SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Overview
We were incorporated in Delaware on August 22, 2006 and initially funded on January 18, 2007. We commenced material operations on February 27, 2007. Our investment objective is total return generated by both capital appreciation and current income. We will seek to achieve this objective by investing in financially-troubled or distressed companies that are either middle-market companies or unlisted companies by investing in senior secured debt, mezzanine debt and unsecured debt, each of which may include an equity component, and in equity investments.
Generally, distressed companies are those that (i) are facing financial or other difficulties and (ii) are or have been operating under the provisions of the U.S. Bankruptcy Code or other similar laws or, in the near future, may become subject to such provisions or otherwise be involved in a restructuring of their capital structure. We use the term “middle-market” to refer to companies with annual revenues between $50 million and $1 billion. We use the term “unlisted” to refer to companies not listed on a national securities exchange (for example, companies whose securities are quoted on the over-the-counter bulletin board or through Pink Sheets LLC would not be “listed” on a national securities exchange, although they may be considered “public” companies).
We have elected to be treated as a business development company (a “BDC”) under the Investment Company Act of 1940 (the “1940 Act”). As a BDC, we are required to comply with certain regulatory requirements. For instance, we are generally prohibited from acquiring assets other than “qualifying assets” unless, after giving effect to the acquisition, at least 70% of our total assets are qualifying assets. Qualifying assets generally include securities of “eligible portfolio companies” (as defined in the 1940 Act), cash, cash equivalents, U.S. government securities and high-quality debt instruments maturing in one year or less from the time of investment. Additionally, we have elected to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986 (the “Code”).

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On February 26, 2007, the Company closed its initial public offering (“IPO” or the “Offering”) and sold 17,000,000 shares of its common stock at a price of $15.00 per share, less an underwriting discount and commissions totaling $0.675 per share. We commenced material operations on February 27, 2007 as we received $243,525,000 in total net proceeds from the IPO. On March 23, 2007, the Company issued 284,300 shares of common stock to cover the underwriters’ partial exercise of the over-allotment option on the Offering and received approximately $4,072,698 in net proceeds after deducting underwriting discounts and commissions.
Portfolio and Investment Activity
The following table summarizes the historical composition of our investment portfolio, exclusive of cash and cash equivalents, as a percentage of total investments.
                                 
            Corporate        
    Senior Loans   Notes and Bonds   Claims   Equity Interests
March 31, 2009
    38.0 %     33.4 %     %     28.6 %
December 31, 2008
    47.4 %     27.8 %     0.1 %     24.7 %
September 30, 2008
    60.5 %     24.9 %     0.7 %     13.9 %
June 30, 2008
    68.1 %     27.0 %     0.2 %     4.7 %
March 31, 2008
    49.7 %     40.4 %     0.5 %     9.4 %
December 31, 2007
    48.4 %     34.8 %     0.5 %     16.3 %
September 30, 2007
    50.3 %     34.4 %     1.2 %     14.1 %
June 30, 2007
    45.9 %     35.4 %     0.8 %     17.9 %
March 31, 2007
    76.7 %     21.1 %     0.8 %     1.4 %
Bank debt typically accrues interest at variable rates determined by reference to a base lending rate, such as LIBOR or prime rate, and typically will have maturities of 3 to 5 years. Corporate notes and bonds will typically accrue interest at fixed rates and have stated maturities at origination that range from 5 to 10 years. At March 31, 2009, the weighted average yield of our portfolio investments, exclusive of cash and cash equivalents, was approximately 5.1%. At March 31, 2009, the weighted average yield of our investments in senior loans and corporate notes and bonds was approximately 5.4%. Yields are computed assuming a fully settled portfolio; using interest rates as of the report date and include amortization of senior loan discount points, original issue discount and market premium or discount; weighted by their respective costs when averaged.
As of March 31, 2009, approximately 95.9% of our portfolio consisted of investments in 10 issuers. Additional information regarding these specific investments has been outlined below. This additional information is limited to publicly available information, and does not address the creditworthiness or financial viability of the issuer, or the future plans of the Company as it relates to a specific investment. Furthermore, while the objective of the Company is to invest primarily in financially-troubled or distressed companies, the Company can and does invest in issuers that are not financially-troubled or distressed at the time of investment. The Company may have sold some, or all, of the positions outlined below subsequent to March 31, 2009.
Argatroban Royalty Sub, LLC
Argatroban Royalty Sub, LLC, a wholly-owned subsidiary of Encysive Pharmaceuticals, was established to issue senior secured bonds backed by the royalty cash stream from the sales of Argatroban, a branded pharmaceutical marketed by GlaxoSmithKline plc. Argatroban is a synthetic direct thrombin inhibitor indicated as an anticoagulant for prophylaxis or treatment of thrombosis in patients with heparin-induced thrombocytopenia, or HIT, which is a profound allergic reaction to anticoagulation therapy with heparin. More information can be found at www.argatroban.com.
Azithromycin Royalty Sub, LLC
Azithromycin Royalty Sub, LLC, a wholly-owned subsidiary of InSite Vision Inc., was established to issue senior secured bonds backed by the royalty cash stream from the sales of azithromycin ophthalmic solution, a branded pharmaceutical sold under the brand name AzaSite ® and marketed by Inspire Pharmaceuticals, Inc. The solution is used to treat conjunctivitis. More information can be found at www.azasite.com.

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Baker & Taylor, Inc.
Baker & Taylor, Inc. (“B&T”) is engaged in the distribution of books, music, video and game products. In addition, unique information services built around the B&T’s proprietary databases as well as specialized consulting and outsourcing services are provided to customers. Customers include retailers (including Internet retailers), public, academic and school libraries and various departments of federal and local governments. B&T distributes its products throughout the United States and worldwide.
Celtic Pharma Phinco B.V.
Celtic Pharmaceuticals Phinco B.V. (“Celtic Pharma”) is a private investment fund with a mandate to purchase a diversified portfolio of novel pharmaceutical products in the later stages of development that have already demonstrated initial proof of principle efficacy in human clinical trials. Celtic Pharma has $250 million of equity commitments in addition to raising $156 million of high-yield bonds. Celtic Pharma has invested in nine drug programs since its 2004 inception. More information can be found at www.celticpharma.com.
Comcorp Broadcasting, Inc. / Communications Corporation of America
Communications Corporation of America and its wholly owned subsidiaries, including Comcorp Broadcasting, Inc., (collectively, “CCA”) own and operate thirteen television stations in Louisiana, Texas, and Indiana. CCA also provides services to, but does not own, ten television stations under Joint Sales Agreements, Commercial Inventory Arrangements, and/or Local Marketing Agreements. Under these agreements CCA has the right to sell the stations’ available airtime. CCA’s revenue is primarily derived from the sale of advertising airtime. In addition CCA offers production services and receives a compensation fee under network affiliation agreements. CCA, on June 7, 2006 (the Petition Date), filed for protection against its creditors under Chapter 11 of the United States Bankruptcy Code after it was unable to meet its ongoing debt obligations. CCA and its direct and indirect subsidiaries, exited bankruptcy with an effective date of October 4, 2007 under reorganization plans filed with the United States Bankruptcy Court in the Western District of Louisiana (Case No. 06-50410).
Fontainebleau Florida Hotel, LLC
Fontainebleau Resorts, LLC (“Fontainebleau”) is led by Chairman Jeffrey Soffer, who also serves as Chief Executive Officer of Turnberry, Ltd., a creator of luxury condominium and condominium-hotel developments, and President and Chief Financial Officer Glenn Schaeffer, a former Chief Executive Officer of Mandalay Resort Group. Fontainebleau Miami Beach is a resort located in Miami Beach, Florida. Fontainebleau plans to renovate and expand this property into a 22-acre destination resort. More information can be found at www.bleaumiamibeach.com.
Genesys Ventures IA, LP
Genesys Ventures IA, LP, a limited partnership with Genesys Capital Partners of Toronto, Ontario, was established to hold the preferred equity of three late-stage venture healthcare companies.
Lake at Las Vegas Joint Venture, LLC
Lake at Las Vegas Joint Venture, LLC (“LLV”) is a 3,592-acre resort and destination community and is one of the larger master-planned communities in Las Vegas, NV. The development is located approximately 17 miles from the Las Vegas strip. On July 17, 2008, LLV filed to reorganize under Chapter 11 of the Bankruptcy Code, citing a combination of poor liquidity, substantial debt service, extremely challenging real estate market conditions and other legal and financial issues. More information can be found at www.lakelasvegas.com, at www.kccllc.net/llv, or by calling Kurtzman Carson Consultants LLC at 1-866-248-3389.
Molecular Insight Pharmaceuticals, Inc.
Molecular Insight Pharmaceuticals is a biopharmaceutical company specializing in the emerging field of molecular medicine, applying innovations in the identification and targeting of disease at the molecular level to improve patient healthcare by addressing significant unmet needs. The company is focused on discovering, developing and commercializing innovative and targeted radiotherapeutics and molecular imaging pharmaceuticals with initial applications in the areas of oncology and cardiology.

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Penhall Holding Company
Penhall Holding Company is the parent company of Penhall International Corporation (“Penhall”), one of the largest providers of concrete cutting, breaking and highway grinding services in the United States. Penhall’s business model is centered on utilizing a nationwide network of approximately 800 skilled operators and an extensive fleet of specialized construction equipment to perform primarily non-residential and infrastructure-related construction work. The company operates 41 locations in the United States and Canada, and has a customer base that includes construction contractors, industrial companies, manufacturers, government agencies and municipalities.
Results of Operations
Results comparisons are for the three months ended March 31, 2009 and March 31, 2008, and are as follows:
                 
    For the Three Months Ended March 31,
    2009   2008
Total investment income
  $ 1,381,158     $ 7,892,740  
Net expenses
  $ 1,288,199     $ 4,411,265  
Net investment income
  $ 92,959     $ 3,481,475  
Net realized and unrealized gain/(loss) on investments
  $ (6,005,375 )   $ (34,511,363 )
Net increase/(decrease) in stockholders’ equity (net assets) resulting from operations
  $ (5,912,416 )   $ (31,029,888 )
Investment Income
We primarily generate investment income in the form of interest on the debt securities that we own. We also may acquire investments, which may pay cash or in-kind (“PIK”) distributions on a recurring or otherwise negotiated basis. Investment income for the three months ended March 31, 2009 was approximately $1.4 million, of which approximately $0 was attributable to invested cash and cash equivalents and approximately $1.4 million was attributable to portfolio investments. For the three months ended March 31, 2009, of the approximately $1.4 million in investment income from investments other than cash and cash equivalents, approximately $0.4 million of PIK interest income was recorded. In comparison, investment income for the three months ended March 31, 2008 was approximately $7.9 million, of which approximately $0.2 million was attributable to invested cash and cash equivalents and approximately $7.7 million was attributable to portfolio investments. Investment income was lower in 2009 compared to the same period last year due to lower interest rates and a smaller asset base.
Operating Expenses
Operating expenses for the three months ended March 31, 2009 were approximately $1.3 million. This amount consisted of advisory fees of approximately $0.3 million, incentive fees of $0, interest expense of approximately $0.3 million, and administrative fees, accounting fees, professional fees, directors’ fees, taxes and other expenses of approximately $0.7 million for the three months ended March 31, 2009. For the comparative three-month period a year earlier, operating expenses were approximately $4.4 million. Included in operating expenses were advisory fees of approximately $1.5 million, incentive fees of approximately $0.9 million, interest expense of approximately $1.4 million, and administrative fees, accounting fees, professional fees, directors’ fees, taxes and other expenses of approximately $0.6 million for the three months ended March 31, 2008.
Net Investment Income
The Company’s net investment income for the three months ended March 31, 2009 was approximately $0.1 million, as compared to net investment income of approximately $3.5 million for the three months ended March 31, 2008. Although operating expenses were lower in 2009, the decrease was smaller than the decrease in investment income, resulting in lower net investment income.

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Net Unrealized Appreciation/Depreciation on Investments
For the three months ended March 31, 2009, the Company’s investments had net unrealized appreciation of approximately $4.3 million. This compares to net unrealized depreciation on the Company’s investments of approximately $22.0 million for the three months ended March 31, 2008.
Net Realized Gains/Losses
For the three months ended March 31, 2009, the Company had net realized losses on investments of approximately $10.3 million compared to net realized losses on investments of approximately $12.5 million for the three months ended March 31, 2008.
Net Increase/Decrease in Stockholders’ Equity (Net Assets) from Operations
For the three months ended March 31, 2009, the Company had a net decrease in stockholders’ equity (net assets) resulting from operations of approximately $5.9 million compared to a net decrease in stockholders’ equity (net assets) resulting from operations of approximately $31.0 million for the three months ended March 31, 2008. For the three months ended March 31, 2009, the decrease in stockholders’ equity (net assets) resulting from operations was primarily attributable to net realized loss on investments, as discussed above.
Financial Condition, Liquidity and Capital Resources
In light of the broader unprecedented market dislocation that began in 2007 and continued through 2008 and into 2009, we reduced our leverage from approximately 20.4% at December 31, 2008 to approximately 10.6% at March 31, 2009. Additionally, on December 19, 2008, the Board approved an agreement and plan of reorganization pursuant to which the Company would transfer all of it assets to Highland Credit Strategies Fund (“HCF”), a non-diversified closed-end management investment company also managed by the Investment Adviser, in exchange for shares of HCF.
During the quarter ended March 31, 2009, liquidity and capital resources were generated primarily from the sale of investments. The liquidity generated during the quarter was used primarily to reduce the amount outstanding on the credit facility and build our cash balance. At quarter end, the Company had approximately $2.5 million of cash on hand and approximately $5.7 million in receivables for investments sold and interest due from investments. At March 31, 2009, the Company had $6.5 million in borrowings outstanding. The Company does not anticipate drawing down any of the residual $3.5 million under the credit facility in the second quarter of 2009, and we are likely to fund our operations through additional sales of investments, if warranted, and interest from investments. During the second quarter, we intend to use excess funds to primarily repay borrowings under our credit facility, make strategic investments to meet our investment objectives and strategies, and to fund our operating expenses.
During the quarter ended March 31, 2009, the Company generated approximately $11.6 million in cash flows from operations, of which $9.0 million was used to repay borrowings under its credit facility.
Off-Balance Sheet Arrangements
At March 31, 2009, we did not have any off-balance sheet liabilities or other contractual obligations that are reasonably likely to have a current or future material effect on our financial condition, other than the investment advisory and management agreement and the administration agreement described above.
Distributions
We have elected to be taxed as a regulated investment company under Subchapter M of the Code. In order to maintain our status as a regulated investment company, we are required to meet specified source-of-income and asset diversification requirements and must distribute annually at least 90% of our investment company taxable income. Additionally, we must distribute at least 98% of our income (both ordinary income and net capital gains) to avoid an excise tax. We intend to make distributions to our stockholders of substantially all of our net operating income on at least an annual basis. We also intend to make distributions of net realized capital gains, if any, at least annually.

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We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings when applicable to us as a business development company under the Investment Company Act of 1940 and due to provisions in our credit facilities. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a regulated investment company. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.
The Company has established an “opt out” dividend reinvestment plan (the “Plan”) for its common stockholders. As a result, if the Company declares a cash distribution in future periods, a stockholder’s cash distribution will be automatically reinvested in additional shares of the Company’s common stock unless the stockholder specifically “opts out” of the Plan and elects to receive cash distributions. For the year ended December 31, 2008, distributions paid to stockholders totaled $0.7500 per share ($13,287,578). For the period ended December 31, 2007, distributions paid to stockholders totaled $0.7875 per share ($13,915,795). No distributions were paid to stockholders during the three months ended March 31, 2009. Tax characteristics of all distributions will be reported to stockholders on Form 1099-DIV after the end of the calendar year.
Recently Issued Accounting Pronouncements
See Note 11: New Accounting Interpretations and Standards in the accompanying notes to consolidated financial statements for details of recently issued accounting pronouncements and their expected impact on the Company’s financial statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are subject to financial market risks, including changes in interest rates and the valuations of our investment portfolio.
As of March 31, 2009, approximately 71.5% of our portfolio, exclusive of cash and cash equivalents, was invested in debt securities. This exposes the Company to a great degree of default risk with respect to the issuers in our portfolio. Defaults increased in 2008 from historic lows in 2007, and are likely to increase in the future. Derivative products are available to hedge against default risk; however, the Company did not hedge its exposure during the quarter ended March 31, 2009 as these hedges may be imperfect, unavailable or too costly. As of March 31, 2009, the total percentage of investments in default, measured by market value, was 8.0%.
As of March 31, 2009, approximately 38.4% and 33.1% of our portfolio, exclusive of cash and cash equivalents, was invested in securities that paid floating and fixed rates of interest, respectively. Increases or decreases in market interest rates may potentially affect the Company’s net asset value. When interest rates decline, the value of fixed rate securities in the Company’s portfolio may be expected to rise. Conversely, when interest rates rise, the value of fixed rate portfolio securities may decline. The sensitivity of the Company’s net asset value to changes in interest rates will increase to the extent that it holds a higher percentage of its portfolio in fixed rate investments. However, the technical dislocation in the debt markets in the past year and the contagion in the greater economy has changed this dynamic. Although interest rates declined during 2008 and have remained low during the first quarter of 2009, the leveraged loan and high yield debt markets have both performed well during the first quarter of 2009, as measured by the Standard & Poor’s/Loan Syndication Trading Association and Credit Suisse High Yield Indexes, respectively.
Increases or decreases in market interest rates may also affect the Company’s distributions. While the Company does not disclose whether it will be able to maintain historic distribution levels in the future, it is clear that for a portfolio holding a large percentage of floating rate investments, a decrease in market interest rates may have a negative impact on yield. There tends to be a lag in the effect of a decline in market interest rates has on the yield of floating rate investments. This is due to the resetting of the base rate underlying the individual investment, which typically happens every sixty to ninety days depending on the terms. As of March 31, 2009 the weighted average days for the underlying senior loans in the Company’s portfolio base rate to reset was approximately 77.0 days.

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Item 4. Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15 of the Securities Exchange Act of 1934). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our current disclosure controls and procedures are effective to ensure information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.
There have been no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are not a defendant in any material pending legal proceeding, and no such material proceedings are known to be contemplated.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, which could materially affect our business, financial condition or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We did not sell any securities of the registrant during the period covered in this report that were not registered under the Securities Act of 1933.
We did not repurchase any shares of our common stock during the period covered by this report.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.

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Item 6. Exhibits and Financial Statement Schedules
(a) Exhibits
     
Exhibit No.   Description
 
   
2.1
  Form of Agreement and Plan of Merger and Liquidation by and among Highland Credit Strategies Fund, the Company and HCF Acquisition LLC.(5)
 
   
3.1
  Amended and Restated Articles of Incorporation of the Company.(2)
 
   
3.2
  Bylaws of the Company.(1)
 
   
4.1
  Form of Specimen Certificate.(2)
 
   
10.1
  Form of Investment Advisory and Management Agreement between Company and Highland Capital Management, L.P.(1)
 
   
10.2
  Form of Custodian Services Agreement between Company and PFPC Inc.(1)
 
   
10.3
  Form of Administration Services Agreement between Company and Highland Capital Management, L.P.(2)
 
   
10.4
  Form of Sub-Administration Services Agreement between Highland Capital Management, L.P. and PFPC Inc.(1)
 
   
10.5
  Form of Transfer Agency Services Agreement between Company and PFPC Inc.(1)
 
   
10.6
  Form of Accounting Services Agreement.(1)
 
   
10.7
  Form of Structuring Fee Agreement between the Investment Adviser and Citigroup Global Markets Inc.(2)
 
   
10.8
  Form of Structuring Fee Agreement between the Investment Adviser and Merrill Lynch & Co.(2)
 
   
10.9
  Form of Structuring Fee Agreement between the Investment Adviser and Wachovia Capital Markets, LLC.(2)
 
   
10.10
  Form of Agreement Regarding Payment of Sales Load.(2)
 
   
10.11
  Form of Fee Waiver Agreement.(2)
 
   
10.12
  Confirmation Agreement between the Company and the Bank Nova Scotia.(2)
 
   
10.13
  Amendment No. 1 to the Administration Services Agreement dated as of June 6, 2008.(3)
 
   
10.14
  Revolving Credit and Security Agreement among the Company, Liberty Street Funding LLC and The Bank of Nova Scotia dated as of June 27, 2008.(3)
 
   
10.15
  Amendment No. 1 to the Revolving Credit and Security Agreement dated as of November 25, 2008.(4)
 
   
10.16
  Amendment No. 2 to the Revolving Credit and Security Agreement dated as of April 14, 2009.(6)
 
   
31.1
  Certification of Chief Executive Officer of Periodic Report Pursuant to Rule 13a—14(a) and Rule 15d—14(a)(3).(6)
 
   
31.2
  Certification of Chief Financial Officer of Periodic Report Pursuant to Rule 13a—14(a) and Rule 15d—14(a)(3).(6)
 
   
32.1
  Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350.(6)
 
(1)   Previously filed in Pre-Effective Amendment No. 1 to the Company’s Initial Registration Statement on Form N-2, File No. 333-137435, filed on January 18, 2007.
 
(2)   Previously filed in Pre-Effective Amendment No. 3 to the Company’s Initial Registration Statement on Form N-2, File No. 333-137435, filed on February 16, 2007.
 
(3)   Previously filed in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, File No. 814-00729, filed on August 8, 2008.
 
(4)   Previously filed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, File No. 814-00729, filed on February 27, 2009.
 
(5)   Incorporated by reference to Annex A to the Company’s Schedule 14A, File No. 814-00729, filed on April 24, 2009.
 
(6)   Filed herewith.

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Table of Contents

SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized.
       
HIGHLAND DISTRESSED OPPORTUNITIES, INC.
(Registrant)
 
          Dated: May 7, 2009  /s/ James D. Dondero 
  James D. Dondero 
  President (Principal Executive Officer) 
 
   
  /s/ M. Jason Blackburn 
  M. Jason Blackburn 
  Secretary and Treasurer (Principal Financial and Accounting Officer) 

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