ANNUAL REPORT
================================================================================
1996
1996
1996
1996
1996
Smith Barney
Exchange
Reserve
Fund
----------------------
July 31, 1996
[Logo] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
- ----------------------------------
Smith Barney Exchange Reserve Fund
- ----------------------------------
Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney
Exchange Reserve Fund for the year ended July 31, 1996. For your convenience, we
have summarized the period's prevailing economic and market conditions. In
addition, a detailed summary of performance and current holdings can be found in
the appropriate sections that follow in the annual report. As of July 31, 1996,
the Fund's average annual yield was 4.44%, and the average annual effective
yield, which assumes the reinvestment of dividends, was 4.53%.
You should be aware that your investment in the Smith Barney Exchange Reserve
Fund is neither insured nor guaranteed by the U.S. government. The Fund will
seek to maintain a stable net asset value of $1.00 per share; however, there is
no assurance that it will be able to do so at all times.
Market and Economic Overview
The past year, and certainly the most recent six months, has been an interesting
period for the financial markets. The time period from August 1995 through
January of this year was characterized by low inflation and somewhat weaker
economic growth. In response to these conditions, the Federal Reserve Board (the
Fed) lowered the fed funds rate (the rate banks charge each other for overnight
loans) by two increments of 25 basis points in December 1995 and January 1996,
from 5.75% to 5.25%. In addition to lowering the fed funds rate, the Fed lowered
the discount rate (the rate the Fed charges commercial banks for overnight
loans) to 5% and cited reduced potential inflationary pressures as a reason for
its easing of monetary policy.
However, since then, a number of events have reversed the direction of the money
markets and short-term interest rates. Hedge fund selling, an oversupply of new
issues from Treasury auctions, and concern over the strength of U.S. economic
growth have increased market uncertainty. For example, economic data released
between February and the end of June has indicated that the U.S. economy was
growing more rapidly than previously expected, as evidenced by strong job
creation and higher consumer spending. In addition, inventories, especially in
the automobile industry, had declined, and were replenished throughout the
second quarter. New and existing home sales have also shown continued solid
momentum, with the Northeast region of the U.S. the newest area to exhibit
growth. As a result, 1996 second quarter growth, as measured by gross domestic
product (GDP) was reported at an annual rate of 4.20%.
Despite the apparent strength in the U.S. economy, the Fed left short-term
interest rates unchanged at its Open Market Committee meeting held at the
1
<PAGE>
beginning of July, but many investors anticipated that the Fed would raise
short-term interest rates in the near future. However, in his semi-annual
"Humphrey-Hawkins" testimony to Congress, Fed Chairman Alan Greenspan reported
that the Fed would tighten monetary policy only if signs of inflation appeared.
Moreover, Greenspan also cited a number of reasons why he expects the U.S.
economy to slow down in the second half of the year and recently released
statistics seem to indicate that inflation remains under control. For the
moment, investor concerns over the possibility of higher interest rates have
become somewhat subdued.
In our view, the Fed will continue to monitor signs of inflation, especially if
the unemployment rate continues to stabilize or decline, consumer spending
remains strong, and payroll growth in the economy stays at a monthly level of
approximately 200,000 new jobs. As a result, we believe that short-term interest
rates may trade in a narrow range, and will continue to face pressure resulting
from ongoing investor concerns over possible future monetary tightening by the
Fed. Although we believe that an interest rate increase at the next Open Market
Committee meeting is unlikely, the Fed remains committed to fighting inflation,
and a more restrictive monetary policy going forward cannot be completely
discounted.
Fund's Investment Strategy
From late 1995 through the early part of 1996, we had anticipated that
short-term interest rates would continue to decline. We therefore extended the
average maturity of the Fund. However, as short-term interest rates rose, we
shortened the average maturity. As of July 31, 1996, the Fund's average maturity
was 37 days.
Looking ahead, we believe that the economy will continue to expand during the
second half of the year, although the annual rate of growth should be moderate.
Given our positive economic outlook, we will maintain a targeted average
maturity on the Fund in the 40 to 50-day range.
In closing, thank you for investing in the Smith Barney Exchange Reserve Fund
and we look forward to continuing to help you achieve your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ Phyllis M. Zahorodny
Heath B. McLendon Phyllis M. Zahorodny
Chairman and Vice President and
Investment Officer Investment Officer
August 12, 1996
2
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments July 31, 1996
- --------------------------------------------------------------------------------
ANNUALIZED
FACE YIELD ON DATE
AMOUNT SECURITY OF PURCHASE VALUE
================================================================================
U.S. GOVERNMENT AND GOVERNMENT
AGENCY OBLIGATIONS -- 3.1%
$5,000,000 Student Loan Marketing Association
matures 8/1/96
(Cost -- $5,000,000) 5.60% $ 5,000,000
================================================================================
DOMESTIC BANK OBLIGATIONS -- 13.7%
5,000,000 Bank of America matures 9/18/96 5.45 5,000,000
5,000,000 FCC National matures 10/18/96 5.51 5,000,480
5,000,000 First Union National Bank matures 8/20/96 5.37 5,000,000
2,000,000 Morgan Guaranty matures 8/20/96 5.00 2,000,010
5,000,000 National Bank of Detroit matures 8/19/96 5.35 4,986,813
- --------------------------------------------------------------------------------
TOTAL DOMESTIC BANK OBLIGATIONS
(Cost -- $21,987,303) 21,987,303
================================================================================
COMMERCIAL PAPER -- 55.2%
5,000,000 Abbey National PLC matures 9/17/96 5.45 4,964,750
5,000,000 ABN AMRO Bank N.V. matures 10/25/96 5.50 4,936,014
6,000,000 Bank Brussels Lambert matures 8/1/96 5.70 6,000,000
5,000,000 Canadian Imperial Holdings Inc.
matures 8/28/96 5.35 4,980,200
6,000,000 Citicorp matures 8/1/96 5.70 6,000,000
5,000,000 Den Danske Corp. matures 8/20/96 5.42 4,985,829
5,000,000 Ford Motor Credit Corp. matures 10/28/96 5.52 4,933,511
5,000,000 General Electric Capital Corp.
matures 8/26/96 5.44 4,981,285
2,000,000 J.P. Morgan & Co. matures 12/16/96 5.61 1,958,443
5,000,000 Merrill Lynch & Co., Inc. matures 8/14/96 5.40 4,990,304
2,000,000 NationsBank Corp. matures 12/17/96 5.64 1,957,987
6,000,000 New Center Asset Trust matures 8/1/96 5.75 6,000,000
5,000,000 Ontario Hydro matures 8/29/96 5.40 4,979,272
5,000,000 Philip Morris Co., Inc. matures 9/19/96 5.45 4,963,250
5,000,000 Raytheon matures 8/23/96 5.35 4,983,714
2,000,000 Toronto Dominion matures 10/15/96 5.54 1,977,250
2,750,000 Transamerica Finance Corp. matures 8/14/96 5.37 2,744,727
7,000,000 Union Bank of Switzerland matures 8/1/96 5.66 7,000,000
5,000,000 USAA Capital Corp. matures 10/2/96 5.45 4,953,500
- --------------------------------------------------------------------------------
TOTAL COMMERCIAL PAPER
(Cost -- $88,290,036) 88,290,036
================================================================================
TIME DEPOSITS -- 6.9%
5,000,000 Republic National Bank matures 8/1/96 5.69 5,000,000
6,000,000 Z - Landerbank Bank Austria AG
matures 8/1/96 5.75 6,000,000
- --------------------------------------------------------------------------------
TOTAL TIME DEPOSITS
(Cost -- $11,000,000) 11,000,000
================================================================================
See Notes to Financial Statements.
3
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- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
ANNUALIZED
FACE YIELD ON DATE
AMOUNT SECURITY OF PURCHASE VALUE
================================================================================
FOREIGN CERTIFICATES OF DEPOSIT -- 16.9%
$2,000,000 Bayerische Vereinsbank AG matures 1/9/97 5.71% $ 1,999,629
5,000,000 Cariplo matures 8/28/96 5.41 4,999,785
5,000,000 Credit Suisse matures 9/6/96 5.50 5,000,050
5,000,000 Royal Bank of Canada matures 8/1/96 5.01 5,000,000
5,000,000 Societe Generale matures 9/5/96 5.50 5,000,000
3,000,000 Swiss Bank Corp. matures 8/7/96 5.00 3,000,004
2,000,000 Toronto Dominion matures 1/13/97 5.78 2,000,222
- --------------------------------------------------------------------------------
TOTAL FOREIGN CERTIFICATES OF DEPOSIT
(Cost -- $26,999,690) 26,999,690
================================================================================
REPURCHASE AGREEMENT -- 4.2%
6,663,000 Morgan Stanley Group, Inc., 5.63%
due 8/1/96; Proceeds at maturity
-- $6,664,041; (Fully collateralized
by U.S. Treasury Notes, 5.88%
due 8/15/98; Market value -- $6,696,612)
(Cost -- $6,663,000) 5.66 6,663,000
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $159,940,029*) $159,940,029
================================================================================
* Aggregate cost for Federal income tax purposes is substanially the same.
See Notes to Financial Statements.
4
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities July 31, 1996
- --------------------------------------------------------------------------------
ASSETS:
Investments, at amortized cost $159,940,029
Cash 579
Interest receivable 441,974
- --------------------------------------------------------------------------------
Total Assets 160,382,582
- --------------------------------------------------------------------------------
LIABILITIES:
Dividends payable 292,406
Distribution fees payable 142,115
Investment advisory fees payable 40,603
Administration fees payable 27,068
Accrued expenses 15,053
- --------------------------------------------------------------------------------
Total Liabilities 517,245
- --------------------------------------------------------------------------------
Total Net Assets $159,865,337
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 159,920
Capital paid in excess of par value 159,760,873
Accumulated net realized loss on investments (55,456)
- --------------------------------------------------------------------------------
Total Net Assets $159,865,337
================================================================================
Shares Outstanding 159,920,793
- --------------------------------------------------------------------------------
Net Asset Value, Per Share $1.00
================================================================================
See Notes to Financial Statements.
5
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended July 31, 1996
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $8,390,077
- --------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 3) 748,208
Investment advisory fees (Note 3) 448,925
Administration fees (Note 3) 299,283
Registration fees 101,382
Shareholder and system servicing fees 69,540
Audit and legal 30,378
Custody 15,006
Shareholders communications 15,006
Trustees' fees 9,882
Other 5,856
- --------------------------------------------------------------------------------
Total Expenses 1,743,466
- --------------------------------------------------------------------------------
Net Investment Income 6,646,611
- --------------------------------------------------------------------------------
Net Realized Gain From Security Transactions 15,797
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $6,662,408
================================================================================
See Notes to Financial Statements.
6
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended July 31,
- --------------------------------------------------------------------------------
1996 1995
================================================================================
OPERATIONS:
Net investment income $ 6,646,611 $ 7,953,182
Net realized gain on security transactions 15,797 36,423
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 6,662,408 7,989,605
- --------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS (NOTE 2) (6,646,611) (7,953,182)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
Net proceeds from sales of shares 417,673,055 394,980,881
Net asset value of shares issued for
reinvestment of dividends 5,866,729 7,200,684
Cost of shares reacquired (426,972,534) (491,181,738)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (3,432,750) (89,000,173)
- --------------------------------------------------------------------------------
Decrease in Net Assets (3,416,953) (88,963,750)
NET ASSETS:
Beginning of year 163,282,290 252,246,040
- --------------------------------------------------------------------------------
End of year $159,865,337 $163,282,290
================================================================================
See Notes to Financial Statements.
7
<PAGE>
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Notes to Financial Statements
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Barney Exchange Reserve Fund ("Fund") is a separate investment
fund of the Smith Barney Income Funds ("Trust"). The Trust, a Massachusetts
business trust, is registered under the Investment Company Act of 1940, as
amended, as a diversified, open-end management investment company. The Trust
consists of the Fund and six other separate investment funds: Smith Barney
Convertible Fund, Smith Barney Diversified Strategic Income Fund, Smith Barney
High Income Fund, Smith Barney Premium Total Return Fund, Smith Barney
Tax-Exempt Income Fund and Smith Barney Utilities Fund. The financial statements
and financial highlights for the other Funds are presented in separate annual
reports.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) the Fund uses the
amortized cost method for valuing investments; accordingly, the cost of
securities plus accreted discount, or minus amortized premium, approximates
market value; (c) interest income is recorded on the accrual basis; (d) direct
expenses are charged to each class; management fees and general Fund expenses
are allocated on the basis of the relative net assets; (e) dividends and
distributions to shareholders are recorded on the ex-dividend date; (f) gains or
losses on the sale of securities are calculated using the specific
identification method; (g) the Fund intends to comply with the applicable
provisions of the Internal Revenue Code of 1986, as amended, pertaining to
regulated investment companies and to make distributions of taxable income
sufficient to relieve it from substantially all Federal income and excise taxes;
and (h) estimates and assumptions are required to be made regarding assets,
liabilities and changes in net assets resulting from operations when financial
statements are prepared. Changes in the economic environment, financial markets
and any other parameters used in determining these estimates could cause actual
results to differ.
2. DIVIDENDS
The Fund declares and records a dividend of substantially all of its net
investment income on each business day. Such dividends are paid or reinvested
monthly on the payable date. Net realized gains, if any, are distributed
annually.
8
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
3. INVESTMENT ADVISORY AGREEMENT, ADMINISTRATION
AGREEMENT AND OTHER TRANSACTIONS
Smith Barney Mutual Funds Management Inc. ("SBMFM"), a subsidiary of Smith
Barney Holdings Inc. ("SBH"), acts as investment adviser to the Fund. The Fund
pays SBMFM an advisory fee calculated at an annual rate of 0.30% of the average
daily net assets. SBMFM also acts as the Fund's administrator for which the Fund
pays a fee calculated at an annual rate of 0.20% of the average daily net
assets. These fees are calculated daily and paid monthly.
There is a contingent deferred sales charge ("CDSC") of 5.00% on Class B
shares, which applies if redemption occurs less than one year from initial
purchase and thereafter declines by 1.00% per year until no CDSC is incurred.
Class C shares have a 1.00% CDSC, which applies if redemption occurs within the
first year from the date such investment was made. For the year ended July 31,
1996, CDSCs paid to Smith Barney Inc. ("SB") were approximately:
Class B Class C
================================================================================
CDSCs $765,000 $5,000
================================================================================
Pursuant to a Distribution Plan, the Fund pays a distribution fee with
respect to Class B and C shares calculated at the annual rate of 0.50% of the
average daily net assets for that class. For the year ended July 31, 1996, total
Distribution Plan fees incurred were:
Class B Class C
================================================================================
Distribution Plan Fees $727,645 $20,563
================================================================================
All officers and one Trustee of the Fund are employees of SB.
4. CAPITAL LOSS CARRYFORWARD
At July 31, 1996, the Fund had, for Federal tax purposes, a capital loss
carryforward of approximately $55,000, available to offset future capital gains
through 1998. To the extent that these carryforward losses are used to offset
capital gains, it is probable that any gains so offset will not be distributed.
5. REPURCHASE AGREEMENTS
The Fund purchases, and its custodian takes possession of, U.S. Government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day),
at an agreed-upon higher repurchase price. The Fund requires continual
maintenance of the market value of the collateral in amounts at least equal to
the repurchase price.
9
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
6. SHARES OF BENEFICIAL INTEREST
The Fund may issue an unlimited number of shares of beneficial interest
with a par value of $.001 per share. The Fund has the ability to issue multiple
classes of shares. Each share of a class represents an identical interest and
has the same rights, except that each class bears certain direct expenses,
including those specifically related to the distribution of its shares. Because
the Fund has sold shares, issued shares as reinvestments of dividends and
redeemed shares only at a constant net asset value of $1.00 per share, the
number of shares represented by such sales, reinvestments and redemptions is the
same as the amounts shown below for such transactions.
At July 31, 1996, the Fund had the following shares outstanding for each
class:
Class B Class C
================================================================================
Exchange Reserve 150,476,736 9,444,057
================================================================================
Transactions in shares of beneficial interest of the Fund were as follows:
Year Ended Year Ended
July 31, 1996 July 31, 1995*
================================================================================
Class B
Shares sold 341,531,323 361,779,702
Shares issued on reinvestment 5,711,961 7,111,345
Shares redeemed (357,269,797) (460,741,514)
- --------------------------------------------------------------------------------
Net Decrease (10,026,513) (91,850,467)
================================================================================
Class C
Shares sold 76,141,732 33,201,179
Shares issued on reinvestment 154,768 89,339
Shares redeemed (69,702,737) (30,440,224)
- --------------------------------------------------------------------------------
Net Increase 6,593,763 2,850,294
================================================================================
* Transactions for Class C shares are for the period from November 7, 1994
(inception date) to July 31, 1995.
10
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class B Shares 1996 1995 1994 1993 1992
=================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
- -------------------------------------------------------------------------------------------------
Net investment income 0.044 0.044 0.022 0.021 0.040
Dividends from net
investment income (0.044) (0.044) (0.022) (0.021) (0.040)
- -------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
- -------------------------------------------------------------------------------------------------
Total Return 4.53% 4.49% 2.18% 2.15% 4.06%
- -------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 150,421 $ 160,432 $ 252,246 $ 166,262 $ 225,476
- -------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.17% 1.24% 1.26% 1.25% 1.22%
Net investment income 4.45 4.35 2.24 2.16 4.13
=================================================================================================
</TABLE>
Class C Shares 1996 1995(1)
================================================================================
Net Asset Value, Beginning of Year $1.00 $1.00
- --------------------------------------------------------------------------------
Net investment income 0.044 0.035
Dividends from net
investment income (0.044) (0.035)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $1.00 $1.00
- --------------------------------------------------------------------------------
Total Return 4.51% 3.52%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $9,444 $2,850
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.17% 1.21%+
Net investment income 4.39 4.76+
================================================================================
(1) For the period from November 7, 1994 (inception date) to July 31, 1995.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
11
<PAGE>
Smith Barney Exchange Reserve Fund
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
The Shareholders and Board of Trustees of
Smith Barney Income Funds:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Smith Barney Exchange Reserve Fund of
Smith Barney Income Funds as of July 31, 1996, the related statement of
operations for the year then ended and the statement of changes in net assets
and financial highlights for each of the years in the two-year period then
ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits. The financial highlights for each of the years in the three-year period
ended July 31, 1994, were audited by other auditors whose report thereon dated
September 9, 1994, expressed an unqualified opinion on those financial
highlights.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of July
31, 1996, by correspondence with the custodian. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Smith Barney Exchange
Reserve Fund of Smith Barney Income Funds as of July 31, 1996, the results of
its operations for the year then ended and the changes in its net assets and
financial highlights for each of the years in the two-year period then ended, in
conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwirk LLP
New York, New York
September 23, 1996
12
<PAGE>
Smith Barney SMITH BARNEY
Exchange Reserve Fund ------------
A Member of TravelersGroup[Logo]
Trustees
Lee Abraham
Antoinette C. Bentley
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon
Madelon DeVoe Talley
Officers
Heath B. McLendon
Chairman and Investment Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President
and Treasurer
Phyllis M. Zahorodny
Vice President and Investment Officer
Irving P. David
Controller
Christina T. Sydor
Secretary
Investment Adviser
and Administrator
Smith Barney Mutual Funds
Management Inc.
Distributor
Smith Barney Inc.
Custodian
PNC Bank, N.A.
Shareholder Servicing
Agent
First Data Investor Services
Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for
the general information of the
shareholders of Smith Barney
Exchange Reserve Fund. It is not author-
ized for distribution to prospective
investors unless accompanied or preceded
by a current Prospectus for the Fund,
which contains information concerning
the Fund's investment policies, fees and
expenses as well as other pertinent infor-
mation.
Smith Barney
Exchange Reserve Fund
388 Greenwich Street
New York, New York 10013
ANNUAL REPORT
================================================================================
1996
1996
1996
1996
1996
Smith Barney
Convertible
Fund
--------------------------
July 31, 1996
[Logo] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
- -----------------------------
Smith Barney Convertible Fund
- -----------------------------
Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney
Convertible Fund for the year ended July 31, 1996. In this report, we summarize
the period's prevailing economic and market conditions, and outline our
portfolio strategy. A detailed summary of performance and current holdings can
be found in the appropriate sections that follow in the annual report.
Fund Performance Update
The Smith Barney Convertible Fund seeks current income and capital appreciation
by investing in convertible securities. Convertible securities, unique
investments that have both equity and fixed income characteristics, offer
investors an opportunity to participate in the long-term growth of the stock
market and generally possess a lower risk profile than the underlying common
stocks. Convertible securities, which increase in value when interest rates
decline, as well as when stock prices move higher, performed well during the
second half of 1995 as a result of the strength in the U.S. stock and bond
markets. Although interest rates have risen during the first half of 1996, the
strength in the stock market has helped the equity component of convertible
securities. For the year ended July 31, 1996, the Smith Barney Convertible Fund
paid dividends totaling $0.7344 per share and had a total return of 7.41% for
Class A shares. Although the Fund's performance was slightly below the Lipper
Convertible Securities Fund Average total return of 8.53% for the same period,
we are pleased with the results. The Smith Barney Convertible Fund has a
conservative risk-reward profile relative to other convertible funds.
Economic and Market Overview
During the past twelve months, and since our last report, the U.S. economy
continued to grow, picking up steam and gaining momentum through the second
quarter of this year. Led by a surge in retail sales, auto sales, and housing
starts, the U.S. economy's strength since January surprised many of the experts,
who were looking for a continuance of the sluggish growth that had been seen in
late 1995. U.S. consumers had an increase in cash flow this spring from early
tax refunds and mortgage refinancings that were done at last year's lower rates,
and went on a buying spree. This helped to ignite the economy after a period of
minimal growth in the last quarter of 1995. Further evidence of the U.S.
economy's strength during the first half of this year was seen in the employment
statistics, as the number of new jobs created during the period rose
significantly. The economy, as measured by gross domestic product (GDP),
1
<PAGE>
grew 2.00% and 4.20% respectively, during the first and second quarters of 1996.
During the latter part of 1995, long-term interest rates declined steadily in
response to sluggish economic growth and low inflation. The yield on the 30-year
U.S. Treasury bond dropped from 6.86% to 5.94% between July and December of
1995. In response to these conditions, the Federal Reserve Board (the Fed)
lowered the Fed Funds rate (the rate banks charge each other for overnight
loans) in December 1995 and January of this year in an effort to buoy the
economy. The 5.94% yield on the 30-year Treasury registered on the last trading
day of 1995 marked the low yield for the 12-month period ended July 31, 1996.
The momentum in the economy the past two quarters put a scare into the bond
market as fears of inflation resurfaced. Long-term interest rates rose
dramatically -- the yield on the 30-year Treasury increased from 5.94% at the
beginning of January, to 6.96% on July 31, 1996. Although the Fed has held
interest rates steady since the beginning of the year, there is a growing
concern that the Fed will move toward a more restrictive monetary policy if U.S.
economic growth continues to accelerate.
Over the past year, the U.S. stock market has performed well in response to
lower interest rates and strong corporate earnings growth. From July 31, 1995 to
July 31, 1996, the Standard and Poor's 500 Index ("S&P 500"), a widely reported
stock market average, has risen by 13.86%. Although interest rates have moved
higher since the beginning of the year, stocks have continued to perform well in
response to corporate earnings that have exceeded Wall Street analysts'
projections. The U.S. stock market has thus far showed solid performance,
despite a correction experienced in July. However, this year's gains do not come
close to the spectacular performance witnessed in 1995.
Fund's Investment Strategy
The Convertible Fund's strategy has not changed over the past year. We continue
to focus on quality issues, that in our view offer attractive total return
potential based on in-depth fundamental and security pricing analysis. The Fund
holds over 50% of its investments in securities rated investment grade (BBB/Baa
or higher by Standard and Poor's and Moody's). In addition, many of the Fund's
other investments are in securities issued by improving companies which we
believe have a great likelihood of receiving upgrades and, as a consequence,
should experience price appreciation. The Fund primarily invests in convertible
securities and rarely purchases common stock. Moreover, we rarely buy illiquid
private placements or invest in unrated securities. Approximately 60% of the
Fund's assets are invested in convertible bonds and the remaining 40% are
invested in convertible preferred stocks.
2
<PAGE>
The Fund is well-diversified with over 20 industries represented. Currently
there are 59 issues in the portfolio. The broad range of economic sectors
covered should benefit from a continuance of the U.S. economic expansion. Some
of the top sectors in which the Convertible Fund invests are financial services,
which should perform well given our positive view on interest rates; metals;
mining; manufacturing; and selected technology groups. Since our last report,
the Fund took sizable positions in Grand Metropolitan, a large food and beverage
producer and retailer; Vencor, which operates a network of healthcare services;
K-Mart, the nation's 3rd largest retailer; and National Semiconductor, a
designer and manufacturer of semiconductors. During the period covered by this
report, the Fund sold a large position in Chevron at a significant profit. Our
holdings in AMR and EDS were called for redemption.
The size of the convertible securities market is in excess of $110 billion, and
1996 has been an active year for new issues. Three significant new issues came
to market with very favorable pricing. In fact, these issues, K-Mart 7.75%
preferred, Apple Computer 6.00% due 6/1/2000 bond, and Hilton Hotels 5.00% due
5/15/2006, represent about 15% of the face amount of convertible securities
issued this year. Relative to other convertibles issued around the same time,
K-Mart and Apple offered more attractive dividend or coupon rates, while Hilton
Hotels had an investment grade rating. So far this year, approximately $17
billion of convertibles have been redeemed, while about $13 billion of new
issues have come to market.
Market Outlook
Over the next fiscal year, we believe the U.S. economy will continue to grow at
a sustained moderate pace, and inflation should remain in check. In our view,
interest rates should remain stable or drift lower in reaction to the general
slowdown we expect in the U.S. economy over the next several quarters. Stock
market investors should not expect to see the returns of 1995 replicated over
the next year, since 1995 was truly a unique period where everything seemed to
click at the same time. Moreover, we believe corporate profit growth will slow
over the next year. During the past several years, corporations have benefited
from a fast-growing economy, productivity gains, and lower production costs as a
result of restructuring. We believe that cost cutting and restructuring can
continue, however, not to the extent seen over the past few years. We project
corporate earnings to grow 7-9% over the next year, and expect that the stock
market should provide investors with solid returns. However, these returns
should be closer to the historical norm of 10-12%. In this environment, the
Convertible Fund should continue to provide investors with attractive
risk-adjusted returns.
3
<PAGE>
In closing, we would like to thank you for your investment in the Smith Barney
Convertible Fund. We look forward to continuing to help you achieve your
financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ Robert E. Swab
Heath B. McLendon Robert E. Swab
Chairman and Vice President and
Investment Officer Investment Officer
August 16, 1996
4
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance -- Class A Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===============================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $15.27 $15.66 $0.73 $0.00 $0.00 7.41%
- -----------------------------------------------------------------------------------------------
7/31/95 14.56 15.27 0.73 0.00 0.00 10.35
- -----------------------------------------------------------------------------------------------
7/31/94 14.99 14.56 0.73 0.00 0.00 1.99
- -----------------------------------------------------------------------------------------------
Inception* - 7/31/93 13.82 14.99 0.51 0.03 0.00 12.63+
===============================================================================================
Total $2.70 $0.03 $0.00
===============================================================================================
- --------------------------------------------------------------------------------
Historical Performance -- Class B Shares
- --------------------------------------------------------------------------------
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===============================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $15.27 $15.66 $0.66 $0.00 $0.00 6.91%
- -----------------------------------------------------------------------------------------------
7/31/95 14.56 15.27 0.66 0.00 0.00 9.80
- -----------------------------------------------------------------------------------------------
7/31/94 14.99 14.56 0.66 0.00 0.00 1.50
- -----------------------------------------------------------------------------------------------
7/31/93 13.84 14.99 0.62 0.04 0.00 13.40
- -----------------------------------------------------------------------------------------------
7/31/92 12.51 13.84 0.64 0.00 0.02 16.25
- -----------------------------------------------------------------------------------------------
7/31/91 12.21 12.51 0.68 0.00 0.03 8.86
- -----------------------------------------------------------------------------------------------
7/31/90 13.80 12.21 0.83 0.11 0.04 (4.53)
- -----------------------------------------------------------------------------------------------
7/31/89 13.04 13.80 0.86 0.01 0.00 13.09
- -----------------------------------------------------------------------------------------------
7/31/88 13.93 13.04 0.85 0.27 0.00 2.22
- -----------------------------------------------------------------------------------------------
Inception* - 7/31/87 13.00 13.93 0.62 0.03 0.00 12.34+
===============================================================================================
Total $7.08 $0.46 $0.09
===============================================================================================
- --------------------------------------------------------------------------------
Historical Performance -- Class C Shares
- --------------------------------------------------------------------------------
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===============================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $15.27 $15.64 $0.67 $0.00 $0.00 6.82%
- -----------------------------------------------------------------------------------------------
Inception*- 7/31/95 14.09 15.27 0.49 0.00 0.00 12.17+
===============================================================================================
Total $1.16 $0.00 $0.00
===============================================================================================
</TABLE>
5
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance -- Class Y Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===============================================================================================
<S> <C> <C> <C> <C> <C> <C>
Inception*- 7/31/96 $16.15 $15.68 $0.39 $0.00 $0.00 (0.56)%+
===============================================================================================
</TABLE>
It is the Fund's policy to distribute dividends monthly and capital gains, if
any, annually.
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
Without Sales Charge(1)
----------------------
Class A Class B Class C Class Y
================================================================================
Year Ended 7/31/96 7.41% 6.91% 6.82% N/A
- --------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 9.45 N/A N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/96 8.63 7.88 11.01 (0.56)%+
================================================================================
With Sales Charge(2)
-------------------
Class A Class B Class C Class Y
================================================================================
Year Ended 7/31/96 2.06% 1.91% 5.82% N/A
- --------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 9.31 N/A N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/96 7.14 7.88 11.01 (0.56)%+
================================================================================
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Without Sales Charge(1)
================================================================================
Class A (Inception* through 7/31/96) 36.15%
- --------------------------------------------------------------------------------
Class B (Inception* through 7/31/96) 112.09
- --------------------------------------------------------------------------------
Class C (Inception* through 7/31/96) 19.83
- --------------------------------------------------------------------------------
Class Y (Inception* through 7/31/96) (0.56)+
================================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable sales charges with respect to Class A shares or the applicable
contingent deferred sales charges ("CDSC") with respect to Class B and C
shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, Class A shares reflect the deduction
of the maximum initial sales charge of 5.00%; Class B shares reflect the
deduction of a 5.00% CDSC, which applies if shares are redeemed within one
year from initial purchase and declines thereafter by 1.00% per year until
no CDSC is incurred. Class C shares reflect the deduction of a 1.00% CDSC,
which applies if shares are redeemed within the first year of purchase.
* Inception dates for Class A, B, C and Y shares are November 6, 1992,
September 9, 1986, November 7, 1994, and February 7, 1996, respectively.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
6
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Class B Shares of the
Smith Barney Convertible Fund vs. Standard & Poor's 500 Index and
Lipper Convertible Securities Fund Peer Group Average+
- --------------------------------------------------------------------------------
September 1986 -- July 1996
[The following table appeared as a line graph in the printed material]
Smith Barney Lipper Convertible
Convertible Fund Securities Index S&P 500 Index
---------------- ---------------- -------------
9/9/86 10000 10000 10000
7/87 11234 11643 14136
7/88 11483 10875 12479
7/89 12992 12533 16464
7/90 12404 12710 17534
7/91 13503 13952 19773
7/92 15698 16339 22301
7/93 17801 19296 24250
7/94 18069 19956 25500
7/95 19839 22592 32158
7/96 21209 24528 37483
+ Hypothetical illustration of $10,000 invested in Class B shares at
inception on September 9, 1986, assuming reinvestment of dividends and
capital gains, if any, at net asset value through July 31, 1996. The
Standard & Poor's 500 Index is composed of widely held common stocks listed
on the New York Stock Exchange, American Stock Exchange and the
over-the-counter market. Figures for the index include reinvestment of
dividends. The Lipper Convertible Securities Fund Average is composed of
the Fund's peer group of 42 mutual funds, as of July 31, 1996, investing in
convertible securities. The index is unmanaged and is not subject to the
same management and trading expenses as a mutual fund. The performance of
the Fund's other classes may be greater or less than the Class B shares'
performance indicated on this chart, depending on whether greater or lesser
sales charges and fees were incurred by shareholders investing in the other
classes.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital gains.
7
<PAGE>
- --------------------------------------------------------------------------------
Portfolio Highlights (unaudited) July 31, 1996
- --------------------------------------------------------------------------------
Portfolio Breakdown
[The following table appeared as a pie graph in the printed material]
Other Convertible Preferred Stocks and Convertible Bonds and Notes
26.3%
Finance Companies/Consumer Credit
13.2%
Metals/Mining
11.8%
Repurchase Agreement
9.6%
Oil/Natural Gas
6.6%
Restaurants/Food Services
5.6%
Transportation (Non-Rail)
3.4%
Electronics/Computers
7.4%
Retail
3.7%
Healthcare/
Drugs/Hospital Supplies
5.1%
Diversified/
Conglomerate Manufacturing
4.8%
Real Estate Development/
REITS
2.5%
Percentage of
Total Investments
================================================================================
Top Five Equity Holdings
H.F. Ahmanson & Co. 2.7%
Corning Delaware LP 2.6
Cyprus AMAX Minerals Co. 2.4
St. Paul Capital 2.4
Salomon, Inc. 2.2
Top Five Bond Holdings
USXMarathon Group 4.3%
Equitable Companies, Inc. 3.8
Grand Metropolitan PLC 3.8
Airborne Freight 3.4
Chubb Capital Corp. 2.4
================================================================================
8
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments July 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
CONVERTIBLE PREFERRED STOCK -- 36.0%
Bank/Savings and Loans -- 1.7%
40,000 Union Planters Corp., Series E, Exchange 8.000% $1,490,000
- --------------------------------------------------------------------------------
Broadcast Radio & Television -- 0.8%
30,000 Cable Systems Corp., Series I, Exchange 8.500% 716,250
- --------------------------------------------------------------------------------
Building/Construction -- 1.2%
40,000 Beazer Homes USA, Series A, Exchange 8.000% 1,050,000
- --------------------------------------------------------------------------------
Electrical Equipment -- 1.9%
100,000 Westinghouse Electric Corp., Depository Shares,
Series C, Exchange $1.30+ 1,600,000
- --------------------------------------------------------------------------------
Electronics/Computers -- 2.3%
40,000 Salomon, Inc., Series ORCL, Exchange 7.250% 1,940,000
- --------------------------------------------------------------------------------
Finance Companies/Consumer Credit -- 8.9%
30,000 American General Corp., Series A, Exchange $3.00 1,500,000
40,000 H.F. Ahmanson & Co., Series D, Exchange 6.000% 2,310,000
30,000 Great Western Financial Corp., Depository Shares,
Exchange 4.375% 1,807,500
40,000 St. Paul Capital LLC, Exchange 6.000% 2,075,000
- --------------------------------------------------------------------------------
7,692,500
- --------------------------------------------------------------------------------
Metals/Mining -- 9.4%
30,000 Amax Gold Inc., Series B, Exchange $3.75 1,515,000
Bethlehem Steel Corp.:
30,000 Exchange $3.50+ 1,188,750
32,000 Exchange $5.00 1,644,000
40,000 Cyprus AMAX Minerals Co., Series A, Exchange $4.00 2,120,000
40,000 WHX Corp., Series A, Exhange 6.500% 1,655,000
- --------------------------------------------------------------------------------
8,122,750
- --------------------------------------------------------------------------------
Oil/Natural Gas -- 2.0%
30,000 Occidental Petroleum Corp.,
Series 1993, Exchange $3.875+ 1,676,250
- --------------------------------------------------------------------------------
Packaging/Containers -- 2.6%
42,000 Corning Delaware LP, Exchange 6.000% 2,278,500
- --------------------------------------------------------------------------------
Paper/Forest Products/Printing -- 1.6%
30,000 International Paper Co., Exchange 5.250%+ 1,341,875
- --------------------------------------------------------------------------------
Real Estate Development/REITS -- 2.5%
50,000 Security Capital Corp., Series A, Exchange $1.75 1,268,750
40,000 Tangier Factory Outlet Centers Inc., Depository
Shares, Series A, Exchange $1.802 845,000
- --------------------------------------------------------------------------------
2,113,750
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
9
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Retail -- 1.1%
20,000 K Mart Financing, Exchange 7.750% $ 972,500
- --------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCK
(Cost -- $31,118,127) 30,994,375
================================================================================
FACE
AMOUNT SECURITY VALUE
================================================================================
CONVERTIBLE BONDS AND NOTES -- 54.4%
Automobile Parts -- 2.3%
$1,000,000 Magna International Inc., 5.000% due 10/15/02 1,042,500
1,000,000 McKesson Corp., 4.500% due 3/1/04 895,000
- --------------------------------------------------------------------------------
1,937,500
- --------------------------------------------------------------------------------
Building/Construction -- 1.2%
1,000,000 Medusa Corp., 6.000% due 11/15/03 1,040,000
- --------------------------------------------------------------------------------
Communications -- 0.9%
1,000,000 California Microwave Inc.,
Sub. Notes, 5.250% due 12/15/03 813,750
- --------------------------------------------------------------------------------
Electronics/Computers -- 5.1%
500,000 3Com Corp., 10.250% due 11/1/01 702,500
500,000 Apple Computer, 6.000% due 6/1/01 478,750
1,000,000 EMC Corp., 4.250% due 1/1/01 1,087,500
500,000 Integrated Device Technology Corp., 5.500% due 6/1/02 375,000
2,000,000 Natural Semiconductor Corp., 6.500% due 10/1/02+ 1,750,000
- --------------------------------------------------------------------------------
4,393,750
- --------------------------------------------------------------------------------
Diversified/Conglomerate Manufacturing -- 4.8%
2,000,000 Cooper Industries Inc., 7.050% due 1/1/15 2,127,500
2,000,000 Gen Corp Inc., Sub. Debentures, 8.000% due 8/1/02 2,032,500
- --------------------------------------------------------------------------------
4,160,000
- --------------------------------------------------------------------------------
Environmental Control -- 3.2%
1,000,000 Sanifill Inc., 5.000% due 3/1/06 1,062,500
2,000,000 WMX Technologies Inc., 6.500% due 7/1/02 1,730,000
- --------------------------------------------------------------------------------
2,792,500
- --------------------------------------------------------------------------------
Finance Companies/Consumer Credit -- 4.3%
3,000,000 Equitable Companies, Inc., 6.125% due 12/15/24 3,348,750
325,000 Pioneer Financial Service, 6.500% due 4/1/03 324,188
- --------------------------------------------------------------------------------
3,672,938
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
10
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
================================================================================
Healthcare/Drugs/Hospital Supplies -- 5.1%
$ 100,000 Alza Corp., 5.000% due 5/1/06 $ 92,500
500,000 Chiron Corp., 1.900% due 11/17/00 454,375
1,000,000 Nabi Inc., 6.500% due 2/1/03 915,000
1,000,000 Phycor Inc., 4.500% due 2/15/03 977,500
2,000,000 Tenet Healthcare Corp., 6.000% due 12/1/05 1,957,500
- --------------------------------------------------------------------------------
4,396,875
- --------------------------------------------------------------------------------
Insurance -- 2.5%
2,000,000 Chubb Capital Corp., 6.000% due 5/15/98 2,130,000
- --------------------------------------------------------------------------------
Leisure/Amusement/Motion Picture -- 1.1%
3,000,000 Coleman WorldWide Corp., zero coupon due 5/27/20 945,000
- --------------------------------------------------------------------------------
Lodging -- 2.8%
500,000 HFS Inc., 4.750% due 3/1/03 561,250
1,000,000 Hilton Hotels Corp., 5.000% due 5/15/06 1,025,000
500,000 Prime Hospitality Corp., 7.000% due 4/15/02 783,750
- --------------------------------------------------------------------------------
2,370,000
- --------------------------------------------------------------------------------
Metals/Mining -- 2.4%
2,000,000 Inco Ltd., 7.750% due 3/15/16 2,090,000
- --------------------------------------------------------------------------------
Miscellaneous -- 1.2%
1,000,000 Interpublic Group Cos., Inc., 3.750% due 4/1/02+ 988,750
- --------------------------------------------------------------------------------
Office/Business Equipment -- 1.3%
1,000,000 Danka, 6.750% due 4/1/02+ 1,136,250
- --------------------------------------------------------------------------------
Oil/Natural Gas -- 4.6%
200,000 Nabors Industries, Inc., 5.000% due 5/15/06 212,000
4,000,000 USX Marathon Group, Sub. Debentures, 7.000% due 6/15/17 3,720,000
- --------------------------------------------------------------------------------
3,932,000
- --------------------------------------------------------------------------------
Restaurants/Food Service -- 5.6%
Boston Chicken:
500,000 4.500% due 2/1/04 533,125
1,500,000 Zero coupon due 6/1/15 397,500
3,000,000 Grand Metropolitan PLC, 6.500% due 1/31/00+ 3,315,000
500,000 Starbucks Corp., 4.250% due 11/1/02 615,000
- --------------------------------------------------------------------------------
4,860,625
- --------------------------------------------------------------------------------
Retail -- 2.6%
500,000 Baby Superstore, Inc. 4.875% due 10/1/00 378,125
1,000,000 The Men's Wearhouse Inc., 5.250% due 3/1/03 840,000
1,000,000 Waban Inc., 6.500% due 7/1/02 980,000
- --------------------------------------------------------------------------------
2,198,125
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
11
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
================================================================================
Transportation (Non Rail) -- 3.4%
$3,000,000 Airborne Freight Corp., 6.750% due 8/15/01 $ 2,955,000
- --------------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS AND NOTES
(Cost -- $47,447,177) 46,813,063
================================================================================
REPURCHASE AGREEMENT -- 9.6%
8,299,000 Chase Manhattan Bank, 5.544% due 8/1/96;
Proceeds at maturity -- $8,300,279;
(Fully collateralized by U.S. Treasury Notes,
6.250% due 7/31/98;
Market value -- $8,468,384) (Cost -- $8,299,000) 8,299,000
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $86,864,304*) $86,106,438
================================================================================
+ Securities exempt from registration under Rule 144A of the Securities Act
of 1933. These securities may be resold in transactions that are exempt
from registration, normally to qualified institutional buyers.
* Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
12
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities July 31, 1996
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost -- $86,864,304) $86,106,438
Cash 255
Receivable for Fund shares sold 543,198
Dividend and interest receivable 847,857
- --------------------------------------------------------------------------------
Total Assets 87,497,748
- --------------------------------------------------------------------------------
LIABILITIES:
Payable for Fund shares purchased 43,326
Investment advisory fees payable 37,036
Distribution fees payable 35,116
Administration fees payable 14,814
Accrued expenses 229,466
- --------------------------------------------------------------------------------
Total Liabilities 359,758
- --------------------------------------------------------------------------------
Total Net Assets $87,137,990
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 5,564
Capital paid in excess of par value 87,991,656
Undistributed net investment income 29,042
Accumulated net realized loss on security transactions (130,406)
Net unrealized depreciation of investments (757,866)
- --------------------------------------------------------------------------------
Total Net Assets $87,137,990
================================================================================
Shares Outstanding:
Class A 2,227,896
- --------------------------------------------------------------------------------
Class B 2,709,231
- --------------------------------------------------------------------------------
Class C 40,988
- --------------------------------------------------------------------------------
Class Y 586,129
- --------------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $15.66
- --------------------------------------------------------------------------------
Class B* $15.66
- --------------------------------------------------------------------------------
Class C** $15.64
- --------------------------------------------------------------------------------
Class Y (and redemption price) $15.68
- --------------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 5.26% of net asset value) $16.48
================================================================================
* Redemption price is NAV of Class B shares reduced by a 5.00% CDSC if shares
are redeemed within one year from initial purchase (See Note 2).
** Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
are redeemed within the first year of purchase.
See Notes to Financial Statements.
13
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended July 31, 1996
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $ 2,981,681
Dividends 2,090,711
- --------------------------------------------------------------------------------
Total Investment Income 5,072,392
- --------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 2) 433,951
Investment advisory fees (Note 2) 417,942
Administration fees (Note 2) 167,177
Shareholder and system servicing fees 120,466
Shareholder communications 90,248
Registration fees 60,163
Audit and legal 42,617
Trustees' fees 25,067
Custody 5,516
Other 28,424
- --------------------------------------------------------------------------------
Total Expenses 1,391,571
- --------------------------------------------------------------------------------
Net Investment Income 3,680,821
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS (NOTE3):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 42,249,444
Cost of securities sold 37,265,946
- --------------------------------------------------------------------------------
Net Realized Gain 4,983,498
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation (Depreciation)
of Investments:
Beginning of year 2,423,449
End of year (757,866)
- --------------------------------------------------------------------------------
Increase in Net Unrealized Depreciation (3,181,315)
- --------------------------------------------------------------------------------
Net Gain on Investments 1,802,183
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 5,483,004
================================================================================
See Notes to Financial Statements.
14
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended July 31,
- --------------------------------------------------------------------------------
1996 1995
================================================================================
OPERATIONS:
Net investment income $ 3,680,821 $ 3,910,252
Net realized gain 4,983,498 1,064,918
Increase in net unrealized
appreciation (depreciation) (3,181,315) 2,491,224
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 5,483,004 7,466,394
- --------------------------------------------------------------------------------
DISTRIBUTION TO SHAREHOLDERS FROM:
Net investment income (3,651,779) (3,879,601)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions To Shareholders (3,651,779) (3,879,601)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
Net proceeds from sale of shares 21,711,359 38,989,009
Net asset value of shares issued
for reinvestment of dividends 2,647,871 3,110,213
Cost of shares reacquired (19,897,156) (52,325,213)
- --------------------------------------------------------------------------------
Increase (Decrease) in Net Assets From
Fund Share Transactions 4,462,074 (10,225,991)
- --------------------------------------------------------------------------------
Increase (Decrease) in Net Assets 6,293,299 (6,639,198)
NET ASSETS:
Beginning of year 80,844,691 87,483,889
- --------------------------------------------------------------------------------
End of year* $87,137,990 $80,844,691
================================================================================
* Includes undistributed net investment income of: $29,042 --
================================================================================
See Notes to Financial Statements.
15
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Barney Convertible Fund ("Fund"), a separate investment fund of
the Smith Barney Income Funds ("Trust"), a Massachusetts business trust, is
registered under the Investment Company Act of 1940, as amended, as a
diversified, open-end management investment company. The Trust consists of the
Fund and six other separate investment funds: Smith Barney Exchange Reserve
Fund, Smith Barney Premium Total Return Fund, Smith Barney High Income Fund,
Smith Barney Tax-Exempt Income Fund, Smith Barney Diversified Strategic Income
Fund and Smith Barney Utilities Fund. The financial statements and financial
highlights for the other funds are presented in separate annual reports.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) securities traded
on national securities markets are valued at the closing price on such markets;
securities traded in the over-the-counter market and listed securities for which
no sales price were reported are valued at bid price, or in the absence of a
recent bid price, at the bid equivalent obtained from one or more of the major
market makers; (c) securities maturing within 60 days are valued at cost plus
accreted discount, or minus amortized premium, as applicable; (d) dividend
income is recorded on ex-dividend date and interest income, adjusted for
accretion of original issue discount, is recorded on the accrual basis; (e)
gains or losses on the sale of securities are calculated using the specific
identification method; (f) dividends and distributions to shareholders are
recorded on the ex-dividend date; (g) direct expenses are charged to each class;
management fees and general fund expenses are allocated on the basis of relative
net assets; (h) the Fund intends to comply with the applicable provisions of the
Internal Revenue Code of 1986, as amended, pertaining to regulated investment
companies and to make distributions of taxable income sufficient to relieve it
from substantially all Federal income and excise taxes; and (i) estimates and
assumptions are required to be made regarding assets, liabilities and changes in
net assets resulting from operations when financial statements are prepared.
Changes in the economic environment, financial markets and any other parameters
used in determining these estimates could cause actual results to differ.
2. INVESTMENT ADVISORY AGREEMENT, ADMINISTRATION
AGREEMENT AND OTHER TRANSACTIONS
Smith Barney Mutual Funds Management Inc. ("SBMFM"), a subsidiary of Smith
Barney Holdings Inc. ("SBH"), acts as investment adviser to the Trust. The Fund
pays SBMFM an advisory fee calculated at an annual rate of 0.50% of the average
daily net assets. This fee is calculated daily and paid monthly.
16
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
SBMFM also acts as the Trust's administrator for which the Fund pays a fee
calculated at an annual rate of 0.20% of the average daily net assets. This fee
is calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SBH, acts as distributor of
Trust shares and primary broker for its portfolio agency transactions. For the
year ended July 31, 1996, SB received sales charges of approximately $49,000 on
sales of the Fund's Class A shares.
There is a contingent deferred sales charge ("CDSC") of 5.00% on Class B
shares, which applies if redemption occurs less than one year from initial
purchase and declines thereafter by 1.00% per year until no CDSC is incurred.
Class C shares have a 1.00% CDSC, which applies if redemption occurs within the
first year of purchase. In addition, Class A shares also have a 1.00% CDSC,
which applies if redemption occurs within the first year of purchase. This CDSC
only applies to those purchases of Class A shares, which when combined with
current holdings of Class A shares, equal or exceed $500,000 in the aggregate.
These purchases do not incur an initial sales charge. For the year ended July
31, 1996, CDSCs paid to SB were:
Class A Class B
================================================================================
CDSCs $5,000 $95,000
================================================================================
Pursuant to a Distribution Plan, the Fund pays a service fee with respect
to Class A, B and C shares calculated at the annual rate of 0.25% of the average
daily net assets of each respective class. The Fund also pays a distribution fee
with respect to Class B and C shares calculated at the annual rate of 0.50% and
0.45% of the average daily net assets of each class, respectively. For the year
ended July 31, 1996, total Distribution Plan fees incurred were:
Class A Class B Class C
================================================================================
Distribution Plan Fees $88,991 $341,822 $3,138
================================================================================
All officers and one Trustee of the Trust are employees of SB.
3. INVESTMENTS
During the year ended July 31, 1996, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $51,246,755
- --------------------------------------------------------------------------------
Sales 42,249,444
================================================================================
17
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
At July 31, 1996, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were approximately
as follows:
================================================================================
Gross unrealized appreciation $ 2,668,000
Gross unrealized depreciation (3,426,000)
- --------------------------------------------------------------------------------
Net unrealized depreciation $ (758,000)
================================================================================
4. CAPITAL LOSS CARRYFORWARD
At July 31, 1996, the Fund had, for Federal income tax purposes,
approximately $130,000 of unused capital loss carryforwards available to offset
future capital gains expiring July 31, 1999. To the extent that these
carryforward losses are used to offset capital gains, it is probable that the
gains so offset will not be distributed.
5. REPURCHASE AGREEMENTS
The Fund purchases (and its custodian takes possession of) U.S. Government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day),
at an agreed-upon higher repurchase price. The Fund requires continual
maintenance of the market value of the collateral in amounts at least equal to
the repurchase price.
6. SHARES OF BENEFICIAL INTEREST
At July 31, 1996, the Trust had an unlimited number of shares of beneficial
interest authorized with a par value of $0.001 per share. The Fund has the
ability to issue multiple classes of shares. Each share of a class represents an
identical interest and has the same rights, except that each class bears certain
direct expenses, including those specifically related to the distribution of its
shares.
At July 31, 1996, total paid-in capital amounted to the following for each
class:
Class A Class B Class C Class Y
================================================================================
Total Paid-in Capital $32,424,278 $45,452,510 $640,010 $9,480,422
================================================================================
18
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
Transactions in shares of each class were as follows:
Year Ended Year Ended
July 31, 1996 July 31, 1995*
-------------------- --------------------
Shares Amount Shares Amount
================================================================================
Class A
Shares sold 343,603 $ 5,423,126 2,416,840 $ 35,169,487
Shares issued on
reinvestment 83,599 1,324,932 94,756 1,357,564
Shares redeemed (506,755) (7,997,467) (361,719) (5,183,624)
- --------------------------------------------------------------------------------
Net Increase (Decrease) (79,553) $(1,249,409) 2,149,877 $ 31,343,427
================================================================================
Class B
Shares sold 374,014 $ 5,938,214 260,183 $ 3,745,273
Shares issued on
reinvestment 82,158 1,306,252 121,846 1,750,785
Shares redeemed (727,414) (11,577,304) (3,252,464) (47,141,589)
- --------------------------------------------------------------------------------
Net Decrease (271,242) $(4,332,838) (2,870,435) $(41,645,531)
================================================================================
Class C+
Shares sold 55,056 $ 869,581 5,273 $ 74,249
Shares issued on
reinvestment 1,049 16,687 128 1,864
Shares redeemed (20,518) (322,369) -- --
- --------------------------------------------------------------------------------
Net Increase 35,587 $ 563,899 5,401 $ 76,113
================================================================================
Class Y
Shares sold 586,130 $ 9,480,438 -- --
Shares issued on
reinvestment -- -- -- --
Shares redeemed (1) (16) -- --
- --------------------------------------------------------------------------------
Net Increase 586,129 $ 9,480,422 -- --
================================================================================
* For Class C shares, transactions are for the period from November 7, 1994
(inception date) to July 31, 1995.
+ On November 7, 1994, the former Class D shares were renamed Class C shares.
19
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class A Shares 1996(1) 1995 1994 1993(2)
================================================================================
Net Asset Value, Beginning of Year $ 15.27 $ 14.56 $ 14.99 $ 13.82
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.74 0.74 0.72 0.49
Net realized and unrealized
gain (loss) 0.38 0.70 (0.42) 1.22
- --------------------------------------------------------------------------------
Total Income From Operations 1.12 1.44 0.30 1.71
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.73) (0.73) (0.70) (0.50)
Overdistribution of net
investment income -- -- (0.03) (0.01)
Overdistribution of net
realized gains -- -- -- (0.03)
- --------------------------------------------------------------------------------
Total Distributions (0.73) (0.73) (0.73) (0.54)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 15.66 $ 15.27 $ 14.56 $ 14.99
- --------------------------------------------------------------------------------
Total Return 7.41% 10.35% 1.99% 12.63%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $34,888 $35,238 $ 2,294 $ 1,655
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.40% 1.40% 1.40% 1.37%+
Net investment income 4.68 5.13 4.80 4.86+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate .59% .48% .54% .95%
- --------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(3) $ 0.06 -- -- --
================================================================================
(1) Per share amounts have been calculated using the monthly average shares
method, which more appropriately presents per share data for this year
since the use of the undistributed income method did not accord with
results of operations.
(2) For the period from November 6, 1992 (inception date) to July 31,1993.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
20
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class B Shares 1996(1) 1995 1994 1993 1992
================================================================================
Net Asset Value,
Beginning of Year $ 15.27 $ 14.56 $ 14.99 $ 13.84 $ 12.51
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.66 0.67 0.65 0.61 0.64
Net realized and unrealized
gain (loss) 0.39 0.70 (0.42) 1.20 1.35
- --------------------------------------------------------------------------------
Total Income From Operations 1.05 1.37 0.23 1.81 1.99
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.66) (0.66) (0.64) (0.60) (0.64)
Overdistribution of
net investment income -- -- (0.02) (0.02) --
Overdistribution of
net realized gains -- -- -- (0.04) --
Capital -- -- -- -- (0.02)
- --------------------------------------------------------------------------------
Total Distributions (0.66) (0.66) (0.66) (0.66) (0.66)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 15.66 $ 15.27 $ 14.56 $ 14.99 $ 13.84
- --------------------------------------------------------------------------------
Total Return 6.91% 9.80% 1.50% 13.40% 16.25%
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $42,420 $45,524 $85,190 $74,857 $57,120
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.90% 1.90% 1.88% 2.00% 1.88%
Net investment income 4.18 4.63 4.32 4.20 4.76
- --------------------------------------------------------------------------------
Portfolio Turnover Rate .59% .48% .54% .95% .77%
- --------------------------------------------------------------------------------
Average commissions per
share paid on equity
transactions(2) $ 0.06 -- -- -- --
================================================================================
(1) Per share amounts have been calculated using the monthly average shares
method, which more appropriately presents per share data for this year
since the use of the undistributed income method did not accord with
results of operations.
(2) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
21
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class C Shares 1996(1) 1995(2)(3)
================================================================================
Net Asset Value, Beginning of Year $ 15.27 $ 14.09
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.67 0.50
Net realized and unrealized gain 0.37 1.17
- --------------------------------------------------------------------------------
Total Income From Operations 1.04 1.67
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.67) (0.49)
- --------------------------------------------------------------------------------
Total Distributions (0.67) (0.49)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 15.64 $ 15.27
- --------------------------------------------------------------------------------
Total Return 6.82% 12.17%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 641 $ 83
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.86% 1.87%+
Net investment income 4.17 4.77+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 59% 48%
- --------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(4) $ 0.06 --
================================================================================
(1) Per share amounts have been calculated using the monthly average shares
method, which more appropriately presents per share data for this year
since the use of the undistributed income method did not accord with
results of operations.
(2) On November 7, 1994, the former Class D shares were renamed Class C shares.
(3) For the period from November 7, 1994 (inception date) to July 31,1995.
(4) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
22
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class Y Shares 1996(1)(2)
================================================================================
Net Asset Value, Beginning of Year $16.15
- --------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.38
Net realized and unrealized loss (0.46)
- --------------------------------------------------------------------------------
Total Loss From Operations (0.08)
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.39)
- --------------------------------------------------------------------------------
Total Distributions (0.39)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $15.68
- --------------------------------------------------------------------------------
Total Return++ (0.56)%
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $9,189
- --------------------------------------------------------------------------------
Ratios to Average Net Assets+:
Expenses 1.00%
Net investment income 4.98
- --------------------------------------------------------------------------------
Portfolio Turnover Rate .59%
- --------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(3) $0.06
================================================================================
(1) Per share amounts have been calculated using the monthly average shares
method, which more appropriately presents per share data for this year
since the use of the undistributed income method did not accord with
results of operations.
(2) For the period from February 7, 1996 (inception date) to July 31, 1996.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
23
<PAGE>
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
The Shareholders and Board of Trustees of
Smith Barney Income Funds:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Smith Barney Convertible Fund of Smith
Barney Income Funds as of July 31, 1995, the related statement of operations for
the year then ended, statement of changes in net assets and financial highlights
for each of the years in the two-year period then ended. These financial
statements and financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits. The financial
highlights for each of the years in the three-year period ended July 31, 1994,
were audited by other auditors whose report thereon, dated September 19, 1994,
expressed an unqualified opinion on those financial highlights.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of July
31, 1996, by correspondence with the custodian. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Smith Barney Convertible Fund of Smith Barney Income Funds as of July 31, 1996,
the results of its operations for the year then ended, changes in its net assets
and financial highlights for each of the years in the two-year period then
ended, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
September 23, 1996
24
<PAGE>
Smith Barney SMITH BARNEY
Convertible ------------
Fund
A Member of TravelersGroup[Logo]
Trustees
Lee Abraham
Antoinette C. Bentley
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon
Madelon De Voe Talley
Officers
Heath B. McLendon
Chairman and Investment Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President
and Treasurer
Robert E. Swab
Vice President and
Investment Officer
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
Investment Adviser
Smith Barney Mutual Funds
Management Inc.
Distributor
Smith Barney Inc.
Custodian
PNC Bank, N.A.
Shareholder
Servicing Agent
First Data Investor Services Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for
the general information of the
shareholders of Smith Barney
Convertible Fund. It is not authorized for
distribution to prospective investors unless
accompanied or preceded by a current
Prospectus for the Fund, which contains
information concerning the Fund's invest-
ment policies and expenses as well as
other pertinent information.
Smith Barney
Convertible Fund
388 Greenwich Street
New York, New York 10013
FD01020 9/96
<PAGE>
ANNUAL REPORT
===========================================================================
1996
1996
1996
1996
1996
Smith Barney
Tax-Exempt
Income Fund
-------------
July 31, 1996
[Logo] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
- -----------------------------------
Smith Barney Tax-Exempt Income Fund
- -----------------------------------
Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney
Tax-Exempt Income Fund for the year ended July 31, 1996. In this report, we
summarize the period's prevailing economic and market conditions and outline our
portfolio strategy. A detailed summary of performance can be found in the
appropriate sections that follow in the annual report.
Fund Performance Update
For the year ended July 31, 1996, the Class A shares of the Tax-Exempt Income
Fund had a total return of 6.28% and outperformed its Lipper Analytical
Services, Inc. peer group average total return of 5.90%. (Lipper is an
independent fund tracking organization.) Over the past year, the Fund
distributed dividends totaling $1.0064 per share; based on its net asset value
of $17.31 as of July 31, 1996, this equates to an annualized distribution rate
of 5.81%. For an individual in the Federal income tax bracket of 36%, the tax
free yield of 5.81% is equivalent to a taxable yield of 9.08%.
Municipal Bond Market Update
In response to low inflation and very sluggish economic growth, interest rates
declined steadily over the latter part of 1995. However, during the first half
of 1996, rates rose sharply, as U.S. economic reports pointed to much greater
growth than was previously expected by many investors. In our view, there have
been several factors effecting uncertainty in the municipal bond market, such as
a strengthening U.S. economy, which usually increases the risk of inflation, as
well as the possibility of an interest rate hike by the Federal Reserve Board
(the Fed). The continuing rise in the U.S. stock market, as well as the ongoing
debate involving tax reform, have also put pressure on the municipal bond
market, with yields recently reaching their highest levels in over a year.
Although this has been a challenging period for the fixed income markets,
municipal bonds have outperformed U.S. Treasuries. This can be attributed to the
simple economic theory of "supply and demand." In recent months, investors have
been seeking to reinvest proceeds of municipal bonds that have either matured or
been called, back into the municipal bond market. However, at the same time, the
supply of new issues has been far below recent averages, and is very close to
lows for the year. This increased demand combined with light supply, has in some
states, created shortages. Therefore, following supply and demand theory (when
supply is low and demand is high, prices are high), municipal bond prices have
stayed relatively higher, and yields have conversely remained lower, relative to
those of U.S. Treasury securities.
1
<PAGE>
Toward the end of July, Fed Chairman Alan Greenspan gave his semi-annual
"Humphrey-Hawkins" testimony to Congress. In his testimony, Greenspan cited a
number of reasons why he expects the U.S. economy to slow down, which has
subdued the bond market's concerns over higher interest rates. In addition, the
most recent U.S. employment report has suggested that the U.S. economy is not
expanding as quickly as many bond market investors had earlier expected. As a
result, the municipal bond market rallied, and yields have since come down from
the high levels that were seen in June and July.
Fund's Investment Strategy
The Smith Barney Tax-Exempt Income Fund seeks to maximize current income exempt
from federal income taxes by investing primarily in municipal bonds and notes.
During the past year, we have maintained a defensive posture in the portfolio
and have attempted to provide a competitive dividend while capitalizing on
market opportunities by taking profits in select municipal issues.
In terms of investment strategy, the Fund continues to emphasize high-coupon and
high-quality issues. As of July 31, 1996, roughly 86% of the Fund was invested
in investment grade (BBB/Baa and higher) securities, as measured by Standard and
Poor's Corporation or Moody's Investors Service, Inc. (Standard and Poor's and
Moody's are major credit rating and reporting agencies.) In our view, higher
quality issues represent good value given the fact that spreads have narrowed
considerably between higher- and lower-grade issues.
The Tax-Exempt Income Fund has remained broadly diversified and the majority of
the Fund's assets were allocated among the following sectors: utility bonds
(15.6%), pollution control revenue bonds (14.6%), hospital bonds (14.2%), and
housing bonds (11.2%). The Fund's average life as of July 31, 1996 was just over
11 years and the average weighted maturity was 22.3 years.
Municipal Bond Market Outlook
Although rates have come down slightly, over the near term, we believe the
municipal bond market will settle into a narrow trading range, with less
volatility until after the Presidential election in November. In our view, the
bond market will continue to face pressure resulting from ongoing investor
concerns over possible monetary tightening by the Fed. The Fed remains committed
to fighting inflation, and a more restrictive monetary policy going forward
cannot be completely discounted.
2
<PAGE>
Another issue that has been hanging over the municipal bond market is tax
reform. In fact, the Republican Presidential nominee, Bob Dole recently
announced a tax reform plan which calls for a 15% reduction in the federal
income tax rate and a reduction in the capital gains tax rate from 28% to 14%.
Dole's plan, however, received little reaction from Wall Street. Regardless of
the final outcome of the tax reform debate, the municipal bond market remains
quite attractive. Moreover, the Tax-Exempt Income Fund is well positioned to
meet the challenges presented by a more volatile market.
Thank you for investing in the Tax-Exempt Income Fund. We look forward to
continuing to help you achieve your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ Lawrence T. McDermott
Heath B. McLendon Lawrence T. McDermott
Chairman and Vice President and
Investment Officer Investment Officer
August 9, 1996
3
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance -- Class A Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===============================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $17.25 $17.31 $1.00 $0.00 $0.00 6.28%
- -----------------------------------------------------------------------------------------------
7/31/95 17.26 17.25 1.00 0.02 0.04 6.42
- -----------------------------------------------------------------------------------------------
7/31/94 18.24 17.26 1.06 0.13 0.00 1.14
- -----------------------------------------------------------------------------------------------
Inception*- 7/31/93 17.45 18.24 0.83 0.16 0.00 10.24+
===============================================================================================
Total $3.89 $0.31 $0.04
===============================================================================================
- --------------------------------------------------------------------------------
Historical Performance -- Class B Shares
- --------------------------------------------------------------------------------
<CAPTION>
Net Asset Value
-------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===============================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $17.26 $17.32 $ 0.92 $0.00 $0.00 5.74%
- -----------------------------------------------------------------------------------------------
7/31/95 17.26 17.26 0.91 0.02 0.04 5.91
- -----------------------------------------------------------------------------------------------
7/31/94 18.24 17.26 0.96 0.13 0.00 0.60
- -----------------------------------------------------------------------------------------------
7/31/93 18.00 18.24 1.02 0.17 0.00 8.28
- -----------------------------------------------------------------------------------------------
7/31/92 16.97 18.00 1.04 0.14 0.00 13.50
- -----------------------------------------------------------------------------------------------
7/31/91 16.98 16.97 1.10 0.11 0.00 7.40
- -----------------------------------------------------------------------------------------------
7/31/90 17.31 16.98 1.12 0.03 0.00 4.95
- -----------------------------------------------------------------------------------------------
7/31/89 16.44 17.31 1.13 0.01 0.00 12.68
- -----------------------------------------------------------------------------------------------
7/31/88 16.48 16.44 1.13 0.06 0.00 7.32
- -----------------------------------------------------------------------------------------------
7/31/87 16.30 16.48 1.10 0.00 0.00 7.90
===============================================================================================
Total $10.43 $0.67 $0.04
===============================================================================================
- --------------------------------------------------------------------------------
Historical Performance -- Class C Shares
- --------------------------------------------------------------------------------
<CAPTION>
Net Asset Value
-------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===============================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $17.25 $17.31 $0.91 $0.00 $0.00 5.69%
- -----------------------------------------------------------------------------------------------
Inception*- 7/31/95 15.83 17.25 0.62 0.02 0.04 13.45+
===============================================================================================
Total $1.53 $0.02 $0.04
===============================================================================================
</TABLE>
It is the Fund's policy to distribute dividends monthly and capital gains, if
any, annually.
4
<PAGE>
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
Without Sales Charge(1)
--------------------------
Class A Class B Class C
================================================================================
Year Ended 7/31/96 6.28% 5.74% 5.69%
- --------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 6.73 N/A
- --------------------------------------------------------------------------------
Ten Years Ended 7/31/96 N/A 7.37 N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/96 6.41 8.21 11.25
================================================================================
With Sales Charge(2)
--------------------------
Class A Class B Class C
================================================================================
Year Ended 7/31/96 2.03% 1.24% 4.69%
- --------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 6.57 N/A
- --------------------------------------------------------------------------------
Ten Years Ended 7/31/96 N/A 7.37 N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/96 5.25 8.21 11.25
================================================================================
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Without Sales Charge(1)
================================================================================
Class A (Inception* through 7/31/96) 26.11%
- --------------------------------------------------------------------------------
Class B (7/31/86 through 7/31/96) 103.62
- --------------------------------------------------------------------------------
Class C (Inception* through 7/31/96) 19.92
================================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable sales charges with respect to Class A shares or the applicable
contingent deferred sales charges ("CDSC") with respect to Class B and C
shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, Class A shares reflect the deduction
of the maximum initial sales charge of 4.00% and Class B shares reflect the
deduction of a 4.50% CDSC, which applies if shares are redeemed within one
year from initial purchase. This CDSC declines by 0.50% the first year
after purchase and thereafter by 1.00% per year until no CDSC is incurred.
Class C shares reflect the deduction of a 1.00% CDSC, which applies if
shares are redeemed within the first year of purchase.
* Inception dates for Class A, B and C shares are November 6, 1992, September
16, 1985 and November 17, 1994, respectively.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
5
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Class B Shares of
Smith Barney Tax-Exempt Income Fund vs.
the Lehman Municipal Bond Index (+)
- --------------------------------------------------------------------------------
July 1986 -- July 1996
[The following table appeared as a line graph in the printed material]
Smith Barney Lehman Muni
Tax-Exempt Fund Bond Index
--------------- ----------
7/86 10,000 10,000
7/87 10,790 10,907
7/88 11,579 11,674
7/89 13,047 13,095
7/90 13,693 14,002
7/91 14,706 15,225
7/92 16,691 17,317
7/93 18,072 18,848
7/94 18,180 19,199
7/95 19,254 20,712
7/96 20,362 22,079
(+) Hypothetical illustration of $10,000 invested in Class B shares on July 31,
1986, assuming reinvestment of dividends and capital gains, if any, at net
asset value through July 31, 1996. The Lehman Municipal Bond Index is a
broad-based index which includes about 8,000 tax-free bonds and reflects
approximately $300 billion of market capitalization. The index is unmanaged
and is not subject to the same management and trading expenses as a mutual
fund. The performance of the Fund's other classes may be greater or less
than the Class B shares' performance indicated on this chart, depending on
whether greater or lesser sales charges and fees were incurred by
shareholders investing in other classes.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital gains.
6
<PAGE>
- --------------------------------------------------------------------------------
Portfolio Highlights (unaudited) July 31, 1996
- --------------------------------------------------------------------------------
[The following table appeared as a pie graph in the printed material]
Portfolio Breakdown
Education 3.8%
Water/Sewer 2.7%
Utility 15.6%
General Obligation 9.3%
Transportation 8.4%
Hospital 14.2%
Public Facilities 0.1%
Housing 11.2%
Pollution Control 14.6%
Industrial Development 10.5%
Life Care Systems 1.0%
Miscellaneous 8.1%
Short-Term 0.5%
Top Five States Represented
Percentage of
State Total Investments
================================================================================
Texas 10.3%
Pennsylvania 9.0
New York 7.9
California 6.7
New Jersey 5.5
Summary of Municipal Bonds and Notes and
Short-Term Tax-Exempt Investments by Combined Ratings
Standard & Percentage of
Moody's or Poor's Total Investments
================================================================================
Aaa AAA 39.1%
Aa AA 9.0
A A 13.9
Baa BBB 24.0
Ba BB 4.1
B B 1.7
D D 0.2
NR NR 7.5
VMIG 1 A-1 0.5
-----
100.0%
=====
7
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Schedule of Investments July 31, 1996
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<TABLE>
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AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
MUNICIPAL BONDS AND NOTES -- 99.5%
Alabama -- 0.7%
$ 3,000,000 AAA Huntsville, AL Health Care Facilities Authority,
Series A, MBIA-Insured, 6.375% due 6/1/12 $3,123,750
2,500,000 AAA Morgan County-Decatur, AL Healthcare Authority
Hospital Revenue, Decatur General Hospital,
CONNIE LEE-Insured, 6.250% due 3/1/13 2,590,625
- -------------------------------------------------------------------------------------------------------
5,714,375
- -------------------------------------------------------------------------------------------------------
Alaska -- 0.7%
Alaska State Housing Finance Corp.:
840,000 AAA 1st Series, Veteran's Mortgage Purchase,
FHA-Insured, 5.875% due 12/1/35 817,950
2,250,000 A+ Series A, 6.000% due 12/1/23 2,463,750
3,000,000 AA Valdez, AK Marine Terminal Revenue,
(Pipelines Inc. Project),
Series A, 5.850% due 8/1/25 2,880,000
- -------------------------------------------------------------------------------------------------------
6,161,700
- -------------------------------------------------------------------------------------------------------
Arizona -- 2.4%
1,000,000 Aa* Arizona Educational Loan Marketing Corp.,
Sr. Series, 6.375% due 9/1/05(a) 1,043,750
Arizona State COP, FSA-Insured:
1,170,000 AAA 6.625% due 9/1/08 1,262,137
1,000,000 AAA Revenue Refunding Bonds, 6.500% due 3/1/08 1,072,500
70,000 AAA Arizona State Municipal Financing COP, Series 10,
BIG-Insured, (Pre-Refunded -- Escrowed with U.S.
Government Securities to 8/1/97 Call @ 101),
7.900% due 8/1/17(b) 73,518
1,000,000 BBB Gila County, AZ IDA, PCR, Series 1987, (ASARCO Inc.
Project), 8.900% due 7/1/06 1,061,420
1,825,000 AAA Maricopa County, AZ IDA, Mortgage Loan, Multi-Family
Housing Revenue, Series A, FHA-Insured,
5.900% due 7/1/24 1,802,187
5,000,000 BB Maricopa County, AZ PCR, Public Service Co.,
Palo Verde, Series A, 6.375% due 8/15/23 4,731,250
1,300,000 AAA Maricopa County, AZ School District, Fountain Hills,
No. 98, FGIC-Insured, 6.625% due 7/1/10 1,384,500
1,000,000 AAA Mohave County, AZ Industrial Development Authority,
Hospital Systems Revenue, Baptist Hospital,
MBIA-Insured, 5.700% due 9/1/15 985,000
6,500,000 BBB Navajo County, AZ PCR, Arizona Public Service
Co., Series A, 5.875% due 8/15/28 6,231,875
344,000 NR Peoria, AZ IDA, Sierra Winds Life Care, Inc.,
6.500% due 11/1/17 268,320
1,500,000 AAA Scottsdale, AZ IDR, Scottsdale Memorial Hospital,
Series A, AMBAC-Insured, 5.625% due 9/1/12 1,477,500
- -------------------------------------------------------------------------------------------------------
21,393,957
- -------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
8
<PAGE>
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<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Arkansas -- 0.1%
$ 1,000,000 AAA Arkansas State Development Authority, Single-Family
Mortgage Revenue, Series A, GNMA/FNMA-Collateralized,
6.200% due 7/1/15 $ 1,022,500
- -------------------------------------------------------------------------------------------------------
California -- 6.7%
4,000,000 A- Burbank, CA Redevelopment Agency, Series A, (Golden
State Redevelopment Project), 6.250% due 12/1/24 4,025,000
5,000,000 AA California Health Facilities Finance Authority Revenue,
Kaiser Permanente, 5.550% due 8/15/25 4,637,500
California Housing Finance Agency Revenue:
1,500,000 AAA Home Mortgage, Series E, MBIA-Insured,
6.150% due 8/1/25 1,490,625
1,500,000 A+ Multi-Unit Rental Housing, Series B-II,
6.700% due 8/1/15 1,565,625
2,400,000 AAA California State University Revenue & Colleges, Housing
System, FGIC-Insured, 5.900% due 11/1/21 2,412,000
California Statewide Community Development Authority
Revenue, COP:
2,235,000 AAA Huntington Memorial Hospital, CONNIE LEE-Insured,
5.800% due 7/1/26 2,176,331
2,500,000 AAA Sutter Health, AMBAC-Insured,
6.125% due 8/15/22 2,537,500
2,000,000 AAA Central Coast Water Project, (California State Water
Project), AMBAC-Insured, 6.600% due 10/1/22 2,142,500
2,600,000 BBB- Central Valley Finance Authority, CA (Cogeneration/Carson
Ice Project), 6.200% due 7/1/20 2,557,750
3,000,000 Baa1* Duarte, CA Hope Medical Center, 6.250% due 4/1/23 2,958,750
Long Beach, CA (Aquarium of the Pacific Project),
Series A:
5,500,000 BBB 6.125% due 7/1/15 5,163,125
4,000,000 BBB 6.125% due 7/1/23 3,690,000
4,000,000 A- Los Angeles, CA Regional Airports Improvement, Corporate
Lease Revenue, LA International Airport,
6.800% due 1/1/27(a) 4,035,000
1,500,000 AAA LA County, CA Metropolitan Transportation Authority,
Series A, MBIA-Insured, 6.000% due 7/1/26 1,507,500
5,000,000 AAA San Diego, CA Water Stars and Cars, MBIA-Insured,
6.300% due 4/8/21(a) 5,000,000
12,900,000 NR San Joaquin Hills, CA Transportation Authority,
(Transcorridor Agency Project), Toll Road,
Sr. Lien, 6.750% due 1/1/32 13,190,250
- -------------------------------------------------------------------------------------------------------
59,089,456
- -------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
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<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Colorado -- 2.0%
$ 1,500,000 B* Arvada, CO Urban Renewal Authority, Arvada City
Center, Series R, 8.750% due 3/1/06 $ 1,473,750
4,750,000 BBB+ Colorado Springs, CO Airport Revenue, Series A,
7.000% due 1/1/22(a) 4,945,938
Denver, CO City and County Airport Revenue:
1,000,000 BBB 8.000% due 11/15/17(a) 1,057,500
250,000 BBB Series A, 7.500% due 11/15/23(a) 272,187
2,170,000 BBB Series C, 6.750% due 11/15/22(a) 2,207,975
1,000,000 NR Dove Valley, CO Metropolitan District, Improvement
Authority, 9.500% due 12/1/08 1,023,750
2,250,000 AAA Jefferson County, CO COP, MBIA-Insured,
6.650% due 12/1/08 2,418,750
265,000 AAA Jefferson County, CO Single-Family Mortgage, Series A,
MBIA-Insured, 8.875% due 10/1/13 280,900
1,500,000 A* Larimer County, CO COP, School District No. R-1,
Poudre-Ft. Collins, Colorado School Board Lease,
6.700% due 12/1/13 1,597,500
500,000 A3* Meridian, CO Metropolitian District, 7.000% due 12/1/98 520,625
2,065,000 AA- Pueblo County, CO Single-Family Housing Authority, Series A,
FNMA/GNMA-Collateralized, 6.850% due 12/1/25 2,137,275
- -------------------------------------------------------------------------------------------------------
17,936,150
- -------------------------------------------------------------------------------------------------------
Connecticut -- 2.2%
1,930,000 A Connecticut Development Authority, Resource Recovery
Authority, (Bridgeport Project), Series B,
8.500% due 1/1/00 1,981,570
2,000,000 AAA Connecticut State Airport Revenue, Bradley International
Airport, FGIC-Insured, 7.650% due 10/1/12 2,290,000
Connecticut State Health and Educational Facilities:
2,125,000 AAA Bridgeport Hospital, Series C, CONNIE LEE-Insured,
5.375% due 7/1/25 1,947,031
1,200,000 BBB- Quinnipiac College, Series D, 6.000% due 7/1/23 1,119,000
University of Hartford, Series D:
1,655,000 Baa* 6.750% due 7/1/12 1,671,550
1,450,000 Baa* 6.800% due 7/1/22 1,457,250
Connecticut State HFA, Series A:
3,260,000 AA 6.750% due 11/15/23 3,418,925
5,000,000 AA 6.250% due 11/15/27 5,000,000
- -------------------------------------------------------------------------------------------------------
18,885,326
- -------------------------------------------------------------------------------------------------------
Delaware --0.5%
Delaware State EDA, PCR, AMBAC-Insured:
2,500,000 AAA Series B, 6.750% due 5/1/19 2,678,125
2,000,000 AAA Water & Sewer Revenue, 6.200% due 6/1/25(a) 2,030,000
- -------------------------------------------------------------------------------------------------------
4,708,125
- -------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
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Schedule of Investments (continued) July 31, 1996
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<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
District of Columbia -- 1.3%
District of Columbia:
$ 6,500,000 B COP, 7.300% due 1/1/13 $ 6,500,000
1,000,000 A+ Georgetown University, 5.375% due 4/1/23 948,750
4,350,000 B GO, Series A, 6.000% due 6/1/07 4,219,500
- -------------------------------------------------------------------------------------------------------
11,668,250
- -------------------------------------------------------------------------------------------------------
Florida -- 3.4%
1,500,000 AAA Atlantic Beach, FL Utility Systems Revenue, MBIA-Insured,
5.500% due 10/1/25 1,445,625
Alachua County, FL Health Facilities Authority, Health
Facilities Revenue, (Santa Fe Healthcare Facilities Project):
385,000 AAA Pre-Refunded -- Escrowed with
U.S. Government Securities to 11/15/00
Call @ 102, 6.875% due 11/15/02(b) 421,575
500,000 AAA Pre-Refunded -- Escrowed with U.S. Government
Securities to 11/15/00 Call @ 102, 7.600%
due 11/15/13(b) 567,500
Broward County, FL Resource Recovery, Waste Energy:
570,000 A North, 7.950% due 12/1/08 627,713
2,605,000 A South, 7.950% due 12/1/08 2,868,756
825,000 AAA Dade County, FL Aviation Revenue, Series B,
MBIA-Insured, 6.600% due 10/1/22(a) 870,375
Florida State HFA, Series A:
500,000 AAA General Mortgage, FHA-Insured, 6.400% due 6/1/24 518,125
2,140,000 AAA Single-Family Mortgage, GNMA/FNMA-Collateralized,
6.650% due 1/1/24(a) 2,212,225
1,350,000 NR Hialeah, FL Hospital Revenue Refunding, Hialeah Hospital,
Class B, (Escrowed to Maturity with U.S.
Government Directs), 8.000% due 2/1/14 1,518,750
2,800,000 BBB+ Hillsborough County, FL Utility Revenue, Series A,
7.000% due 8/1/14 2,985,500
Jacksonville, FL Health Facilities Revenue:
2,000,000 AAA Children's Hospital- Baptist Medical Center,
MBIA-Insured, 7.000% due 6/1/11 2,190,000
3,440,000 AAA University Medical Center, CONNIE LEE-Insured,
6.600% due 2/1/21 3,616,300
1,000,000 AAA Orange County, FL Tourist Development Tax Revenue,
Series B, AMBAC-Insured, 6.500% due 10/1/19 1,071,250
300,000 BBB Pace Property Finance Authority, Florida Utility Revenue,
6.250% due 9/1/13 299,625
990,000 AAA Palm Beach County, FL Health Facilities Authority
Revenue, J.F.K. Medical Center, (Pre-Refunded --
Escrowed with U.S. Government Securities
to 12/1/98 Call @102), 8.875% due 12/1/18(b) 1,112,513
3,000,000 BBB- Putnam County, FL Development Authority, PCR,
Georgia Pacific, 7.000% due 12/1/05 3,292,500
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
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Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Florida -- 3.4% (continued)
$ 1,900,000 AAA Tampa, FL Utility Tax and Special Revenue,
AMBAC-Insured, 6.900% due 10/1/09 $ 2,106,625
1,850,000 NR Tampa, FL Water System Revenue, (Aquarium Inc.
Project), 7.750% due 5/1/27 1,824,562
- -------------------------------------------------------------------------------------------------------
29,549,519
- -------------------------------------------------------------------------------------------------------
Georgia -- 2.5%
4,000,000 A Atlanta, GA Airport Facilities Revenue,
7.250% due 1/1/17(a) 4,305,000
4,750,000 AA- George L. Smith, Georgia World Congress Center
Authority Revenue, (Domed Stadium Project),
7.875% due 7/1/20(a) 5,159,687
7,000,000 AAA Georgia Municipal Electric Authority Power Revenue,
Series EE, AMBAC-Insured, 6.400% due 1/1/23 7,481,250
5,000,000 AAA Medical Center Hospital Authority, GA Columbus Healthcare,
Series C, MBIA-Insured, 6.400% due 8/1/06 5,368,750
- -------------------------------------------------------------------------------------------------------
22,314,687
- -------------------------------------------------------------------------------------------------------
Guam -- 0.2%
1,500,000 A- Government of Guam, Limited Obligation Revenue,
Series A, 7.000% due 11/15/04 1,575,000
- -------------------------------------------------------------------------------------------------------
Hawaii -- 0.2%
2,000,000 A Hawaii State Department of Budget and Finance,
Special Purpose Mortgage Revenue, Kapiolani Health
Care Systems, 6.400% due 7/1/13 2,042,500
- -------------------------------------------------------------------------------------------------------
Idaho -- 0.2%
1,750,000 AA Idaho Housing Agency, Single-Family Mortgage,
Series C, 7.875% due 1/1/21(a) 1,828,750
- -------------------------------------------------------------------------------------------------------
Illinois -- 3.8%
1,815,000 AA Chicago, IL HDC, Section 8, Series A, FHA-Insured,
6.700% due 7/1/12 1,887,600
Chicago, IL O'Hare International Airport, Special Facilities:
2,125,000 BB+ Delta Airlines, 6.450% due 5/1/18 2,127,656
1,800,000 AAA Lufthansa German Airlines Project, 7.125% due 5/1/18(a) 1,944,000
United Airlines:
1,940,000 BB 8.250% due 5/1/99 2,075,800
3,240,000 BB Series B, 8.950% due 5/1/18(a) 3,640,950
3,830,000 BB Series C, 8.200% due 5/1/18 4,131,612
4,000,000 AAA Cook County, IL Series A, MBIA-Insured,
6.600% due 11/15/22(a) 4,235,000
3,000,000 BB- East Chicago, IL Industrial PCR, Inland Steel Co.,
(Project 10), 6.800% due 6/1/13 2,996,250
1,300,000 A- Illinois Education Facilities Authority Revenue, Northern
Illinois Medical Center, 6.000% due 9/1/19 1,204,125
</TABLE>
See Notes to Financial Statements.
12
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Illinois -- 3.8% (continued)
$ 1,500,000 A+ Illinois Housing and Development Authority, Multi-Family
Housing, Series A, 6.125% due 7/1/25 $ 1,490,625
2,750,000 AAA Illinois State Toll Highway Authority, Series A,
FGIC-Insured, 6.200% due 1/1/16 2,784,375
3,600,000 A+ Metropolitan Pier and Exposition Authority,
(McCormick Place Expansion Project), Series A,
AMBAC-Insured, 6.500% due 6/15/27 3,676,500
790,000 NR Sauget, IL Special Service Area No. 1, 10.250% due 1/1/00 815,391
- -------------------------------------------------------------------------------------------------------
33,009,884
- -------------------------------------------------------------------------------------------------------
Indiana -- 1.4%
Indianapolis, IN Airport Authority Revenue, Special Facility:
5,245,000 BBB Federal Express Corporate Project, 7.100% due 1/15/17(a) 5,533,475
3,970,000 BB United Airlines Project, Series A, 6.500% due 11/15/31(a) 3,905,488
250,000 AA+ Indianapolis, IN Local Public Improvement, Series A,
6.000% due 1/10/18 251,250
2,500,000 BBB Lawrenceburg, IN PCR, Indiana Power Co.,
Series E, 5.900% due 11/1/19 2,359,375
- -------------------------------------------------------------------------------------------------------
12,049,588
- -------------------------------------------------------------------------------------------------------
Iowa -- 0.1%
1,000,000 AAA Dubuque County, IA Hospital Revenue, Sisters of Mercy
Hospital, Series L, FSA-Insured, 7.000% due 8/15/21 1,083,750
- -------------------------------------------------------------------------------------------------------
Kentucky -- 2.6%
5,000,000 AAA Jefferson County, KY Hospital Revenue, MBIA-Insured,
6.436% due 10/23/14(a)(c) 5,206,250
Kenton County, KY Airport Board Revenue, Delta Airlines:
1,230,000 A 8.250% due 3/1/15 (a) 1,313,025
4,250,000 A Project A, 7.500% due 2/1/20(a) 4,531,563
590,000 Aaa* Kentucky Multi-County Residential Mortgage,
10.500% due 10/1/00 589,262
3,750,000 AAA Lexington-Lafayette Urban County Project, (University of
Kentucky Alumni Assoc. Inc. Project), MBIA-Insured,
6.750% due 11/1/24 4,021,875
4,000,000 A Pendleton County, KY Multi-County Lease Revenue,
Series A, 6.500% due 3/1/19 4,120,000
2,605,000 AA Trimble County, KY PCR, Series B,
6.550% due 11/1/20(a) 2,679,894
- -------------------------------------------------------------------------------------------------------
22,461,869
- -------------------------------------------------------------------------------------------------------
Louisiana -- 2.2%
2,000,000 Baa3* Beaugard Parish LA, (Boise Cascade Corp. Project),
6.125% due 3/1/23 1,932,500
5,000,000 NR Hodge, LA Utility Revenue, 9.000% due 3/1/10(a) 5,406,250
</TABLE>
See Notes to Financial Statements.
13
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Louisiana -- 2.2% (continued)
$ 2,600,000 Baa3* Lake Charles, LA Harbor and Terminal District, (Trunkline
Liquid Natural Gas Co. Project), 7.750% due 8/18/22 $ 2,899,000
2,500,000 Baa* Louisiana Public Facilities, Association of Independent
Colleges and Universities, 7.000% due 12/1/17 2,559,375
2,000,000 BB- Port of New Orleans, LA IDR, (Continental Grain
Co. Project), 7.500% due 7/1/13 2,065,000
1,210,000 AAA State Tammany Parish, LA Hospital Revenue, District 2,
CONNIE LEE-Insured, 6.250% due 10/1/14 1,241,762
3,000,000 BB+ West Feliciana Parish, PCR, Gulf State Utilities,
7.700% due 12/1/14 3,225,000
- -------------------------------------------------------------------------------------------------------
19,328,887
- -------------------------------------------------------------------------------------------------------
Maryland -- 1.9%
3,000,000 AAA Baltimore County, MD Mortgage Revenue, Series A,
Dunfield Townhouses, FHA-Insured, 6.900% due 8/1/28 3,135,000
2,000,000 AAA Howard County, MD Mortgage Revenue, Howard Hills
Townhouses, Series A, MBIA-Insured, 6.400% due 7/1/24 2,045,000
Maryland State, Community Development Administration,
Department of Housing & Community Development:
1,280,000 Aa* Multi-Family Housing, Insured Mortgage,
Series A, FHA-Insured, 6.625% due 5/15/23 1,321,600
1,000,000 Aa* Single-Family Program, Fourth Series,
6.450% due 4/1/14 1,028,750
Northeast Maryland Waste Disposal Authority, Recovery
Revenue, MBIA-Insured, Southwest Resource Recovery:
3,000,000 AAA 7.200% due 1/1/06 3,397,500
3,000,000 AAA 7.200% due 1/1/07 3,378,750
1,600,000 Baa* Prince Georges County, MD Greater Southeast Healthcare
System, 6.375% due 1/1/23 1,474,000
500,000 AAA Prince Georges County, MD Housing Authority,
(Stevenson Apartments Project), Series A,
GNMA-Collateralized, 6.350% due 7/20/20 508,750
- -------------------------------------------------------------------------------------------------------
16,289,350
- -------------------------------------------------------------------------------------------------------
Massachusetts -- 5.0%
5,000,000 AA- Boston, MA Hospital Revenue, Boston City Hospital,
Series B, FHA-Insured, 5.750% due 2/15/23 4,756,250
530,000 AAA Haverhill, MA Revenue Bonds, Series A, AMBAC-Insured,
6.700% due 9/1/10 567,100
4,800,000 A+ Massachusetts Bay Transportation Authority, General
Transportation System, Series C, 6.100% due 3/1/23 4,896,000
2,000,000 A+ Massachusetts State Construction Loan, Series D,
7.000% due 7/1/07 2,192,500
1,000,000 AAA Massachusetts State IDA, College of the Holy Cross,
MBIA-Insured, 5.625% due 3/1/26 953,750
</TABLE>
See Notes to Financial Statements.
14
<PAGE>
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Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Massachusetts -- 5.0% (continued)
Massachusetts State Health and Educational Facilities
Authority Revenue:
CONNIE LEE-Insured:
$ 735,000 AAA Community College, Series A, 6.600% due 10/1/22 $ 752,456
Suffolk University, Series B:
2,700,000 AAA 6.250% due 7/1/12 2,757,375
775,000 AAA 6.350% due 7/1/22 789,531
2,650,000 AAA University of Massachusetts, (Medical School
Research Project), 6.000% due 7/1/23 2,610,250
3,500,000 AAA New England Medical Center, Series F,
FGIC-Insured, 6.625% due 7/1/25 3,692,500
1,500,000 B1* Saint Memorial Medical Center,
Series A, 6.000% due 10/1/23 1,201,875
Massachusetts State HFA:
Housing Projects:
2,445,000 A+ Series A, 6.375% due 4/1/21 2,460,281
2,000,000 A+ Series 41, Single-Family Housing,
6.300% due 12/1/14 2,035,000
Residental Development, FNMA-Collateralized:
2,000,000 AAA Series C, 6.875% due 11/15/11 2,150,000
3,000,000 AAA Series D, 6.800% due 11/15/12 3,206,250
Massachusetts State Industrial Financial Agency,
Resource Recovery Revenue, (Semass Project):
2,700,000 NR Series A, 9.000% due 7/1/15 3,044,250
4,335,000 NR Series B, 9.250% due 7/1/15(a) 4,903,969
1,000,000 AAA Quincy, MA Quincy Hospital, FSA-Insured,
5.500% due 1/15/13 962,500
- -------------------------------------------------------------------------------------------------------
43,931,837
- -------------------------------------------------------------------------------------------------------
Michigan -- 3.0%
3,680,000 AAA Detroit, MI Economic Development Corp.,
Resource Recovery, Series A, FSA-Insured,
6.450% due 5/1/01 3,910,000
Detroit, MI Water Supply System, FGIC-Insured:
3,500,000 AAA 6.500% due 7/1/15 3,863,125
3,000,000 AAA 6.375% due 7/1/22(a)(c) 3,086,250
5,000,000 AAA Michigan State Hospital Finance Authority Revenue,
FSA-Insured, 6.300% due 2/15/22(a)(c) 5,106,250
2,000,000 A- Michigan State Strategic PCR, General Motors
Corp., 6.200% due 9/1/20(c) 2,025,000
4,500,000 AAA Monroe County, MI PCR, Detroit Edison Monroe,
Series 1, MBIA-Insured, 6.875% due 9/1/22(a) 4,770,000
3,750,000 AAA Western Townships, MI Utilities Authority, Sewer Disposal
Systems, FSA-Insured, 6.750% due 1/1/15 3,942,187
- -------------------------------------------------------------------------------------------------------
26,702,812
- -------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
15
<PAGE>
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Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Minnesota -- 0.6%
$ 1,200,000 NR Minneapolis, MN Commercial Development Revenue,
(Holiday Inn Metrodome Project), 10.500% due 6/1/03 $ 1,207,740
4,000,000 BBB- St. Paul, MN Housing and Redevelopment Authority,
(Healtheast Project), Series A, 6.625% due 11/1/17 4,005,000
- -------------------------------------------------------------------------------------------------------
5,212,740
- -------------------------------------------------------------------------------------------------------
Mississippi -- 1.7%
9,000,000 BBB- Claireborne County PCR, (System Energy Resource Inc.
Project), 6.200% due 2/1/26 8,437,500
2,250,000 AAA Gulfport, MS Hospital Facilities Revenue, Memorial Hospital
Gulfport, Series A, MBIA-Insured, 6.200% due 7/1/18 2,317,500
2,000,000 Aaa* Mississippi Home Corp., Single-Family Mortgage Revenue,
GNMA-Collateralized, 6.550% due 4/1/21(a) 2,057,500
2,400,000 AAA Mississippi Hospital Equipment and Facilities Authority
Revenue, North Mississippi Health Service,
AMBAC-Insured, Series 1, 5.750% due 5/15/16 2,376,000
- -------------------------------------------------------------------------------------------------------
15,188,500
- -------------------------------------------------------------------------------------------------------
Montana -- 0.4%
4,000,000 NR Montana State Board Resource Recovery, (Yellowstone
Energy LP Project), 7.000% due 12/31/19(a) 3,715,000
- -------------------------------------------------------------------------------------------------------
Nevada -- 0.2%
2,000,000 AAA Humboldt County, NV PCR, (Sierra Pacific Project),
AMBAC-Insured, 6.550% due 10/1/13 2,130,000
- -------------------------------------------------------------------------------------------------------
New Hampshire -- 0.9%
3,340,000 BBB- New Hampshire Business Financing Authority,
PCR, United Illuminating Company, Series A,
5.875% due 10/1/33 3,018,525
1,500,000 AAA New Hampshire Higher Education and Health Facilities
Authority Revenue, Concord Hospital, FGIC-Insured,
7.000% due 10/1/12 1,616,250
1,000,000 AA- New Hampshire IDA, Resource Recovery
Series, (Concord Project), 8.500% due 1/1/09 1,056,250
2,000,000 A New Hampshire Turnpike System Revenue,
6.000% due 4/1/13 2,020,000
- -------------------------------------------------------------------------------------------------------
7,711,025
- -------------------------------------------------------------------------------------------------------
New Jersey -- 5.5%
775,000 Ba* Atlantic County, NJ Utilities Authority, Solid Waste Revenue,
7.125% due 3/1/16 756,594
2,500,000 AAA Hoboken, Union City, Weehawken, NJ Sewer Authority
Revenue, MBIA-Insured, 6.200% due 8/1/19 2,618,750
2,500,000 BBB- Hudson County, NJ Improvement Authority, Solid Waste
Revenue, 7.100% due 1/1/20 2,459,375
</TABLE>
See Notes to Financial Statements.
16
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
New Jersey -- 5.5% (continued)
$ 6,300,000 AAA Mercer County, NJ Improvement Authority, (Solid
Waste Site Project), Series A, FGIC-Insured,
6.700% due 4/1/13(a) $ 6,489,000
New Jersey EDA:
1,500,000 NR Arbor Glen Project, Series A, 8.750% due 5/15/26 1,492,500
495,000 D First Mortgage Gross Revenue, Dayton Manor
Residential Health Care, 13.000% due 9/1/15 336,600
2,500,000 AAA Irvington General Hospital, FHA-Insured,
6.375% due 8/1/15 2,606,250
2,950,000 A- Kennedy Memorial University Medical Center,
Series D, 7.875% due 7/1/09 3,104,875
1,000,000 NR Raritan Bay Medical Center, 7.250% due 7/1/27 1,020,000
2,500,000 AAA RWJ Health Care Corporation, FSA-Insured,
6.500% due 7/1/24 2,659,375
670,000 Aa3* Series A, 6.250% 12/1/01(a) 685,913
2,400,000 BBB- Zurbrugg Memorial Hospital, Series C,
8.500% due 7/1/12 2,505,408
1,450,000 NR New Jersey State Educational Facilities Authority,
Fairleigh Dickinson University, Series C,
7.750% due 7/1/01 1,549,687
3,700,000 AAA New Jersey State Housing & Mortgage Finance Agency,
Multi-Family Housing Revenue Refunding,
Presidential Plaza, FHA-Insured, 7.000% due 5/1/30 3,871,125
2,150,000 AAA New Jersey State Transportation Corp. COP,
FSA-Insured, 6.500% due 10/1/16 2,330,062
2,500,000 AAA Perth Amboy, NJ Board of Education COP,
FSA-Insured, 6.125% due 12/15/17 2,568,750
Salem County, NJ PCR, Financing Authority Waste
Disposal Revenue:
2,000,000 AA- E.I. dupont De Nemours, Chambers Works Project,
Series A, 6.500% due 11/15/21(a) 2,080,000
2,500,000 AAA Public Service Electric & Gas Co. Project, Series B,
MBIA-Insured, 6.250% due 6/1/31 2,565,625
Union County, NJ Utility Authority, Solid Waste Revenue:
4,600,000 A- Series A, 7.200% due 6/15/14(a) 4,646,000
2,000,000 Aaa* Series D, 6.850% due 6/15/14(a) 2,117,500
- -------------------------------------------------------------------------------------------------------
48,463,389
- -------------------------------------------------------------------------------------------------------
New Mexico -- 0.1%
600,000 AAA Rio Rancho, NM Water & Wastewater System Revenue,
Series A, FSA-Insured, 6.000% due 5/15/22 604,500
97,972 Aaa* Santa Fe, NM Single-Family Mortgage Revenue,
8.450% due 12/1/11(c) 104,341
- -------------------------------------------------------------------------------------------------------
708,841
- -------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
17
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
New York -- 7.9%
$ 2,650,000 BBB+ Metropolitan Transportation Authority, New York Commuter
Facilities Revenue, Series A, 6.500% due 7/1/24 $ 2,703,000
2,500,000 Aa* Municipal Assistance Corp. for City of New York, NY,
5.200% due 7/1/08 2,490,625
2,500,000 AA New York Housing Corp. Revenue Refunding,
5.500% due 11/1/20 2,268,750
New York, NY GO Bonds:
4,500,000 BBB+ Series A, 6.250% due 8/1/17 4,471,875
2,500,000 BBB+ Series A-1, 6.500% due 8/1/19 2,537,500
4,175,000 BBB+ Series B, 7.000% due 10/1/12 4,368,094
5,000,000 BBB+ Series C, 6.660% due 8/1/09 5,025,000
40,000 AAA Series D, FSA-Insured, 8.500% due 8/1/13 41,565
5,500,000 BBB+ Series F, 6.125% due 2/1/25 5,335,000
5,550,000 BBB+ Series J, 6.000% due 2/15/24 5,279,438
3,085,000 BBB New York State COP, (Hanson Redevelopment Project),
8.375% due 5/1/08 3,547,750
New York State Dormitory Authority Revenue:
2,500,000 AAA Ellis Hospital, MBIA/FHA-Insured, 5.625% due 8/1/35 2,362,500
4,500,000 Baa1* Upstate Community College, Series A, 6.250% due 7/1/25 4,545,000
1,500,000 AA Wesley Garden Nursing Home, FHA-Insured,
6.125% due 8/1/35 1,509,375
New York State Energy, Research & Development
Authority, Long Island Lighting Co.:
3,000,000 BB+ 7.150% due 6/1/20(a) 2,966,250
1,150,000 BB+ 7.150% due 12/1/20(a) 1,137,062
New York State Medical Care Facilities, Finance Agency
Revenue:
1,540,000 BBB+ 7.750% due 2/15/20 1,682,450
2,895,000 AAA Series C, Long-Term Health Care, FSA-Insured,
6.400% due 11/1/14 3,007,181
4,500,000 BBB+ Series F, Mental Health Services Facilities,
6.500% due 2/15/19 4,640,625
5,500,000 AAA New York State Power Authority Revenue, Series Z,
MBIA-Insured, 6.500% due 1/1/19 5,726,875
1,850,000 A* New York State Refunding & General Purpose Bonds,
7.000% due 11/15/02 2,065,062
State of New York Municipal Bond Banking Agency,
Special Program, Buffalo, Series A:
575,000 BBB+ 6.500% due 3/15/00 601,594
1,610,000 BBB+ 6.600% due 3/15/01 1,684,463
- -------------------------------------------------------------------------------------------------------
69,997,034
- -------------------------------------------------------------------------------------------------------
North Carolina -- 2.3%
2,675,000 B- Charlotte, NC Special Facilities Revenue, (Piedmont
Aviation Inc. Project), 9.000% due 7/1/17(a) 2,790,694
</TABLE>
See Notes to Financial Statements.
18
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
North Carolina -- 2.3% (continued)
North Carolina Eastern Municipal Power Agency,
Power Systems Revenue:
$8,700,000 A* Series B, 7.000% due 1/1/08 $ 9,428,625
280,000 AAA Pre-Refunded -- Escrowed with U.S. Government
Securities to 1/1/98 Call @ 102, 8.000% due 1/1/21(b) 300,650
2,300,000 A* North Carolina Municipal Power Agency No. 1, Catawba
Electric Revenue Refunding, 6.250% due 1/1/17 2,300,000
North Carolina HFA:
3,000,000 AA Multi-Family Housing, Series H, 6.050% due 7/1/28 3,018,750
1,500,000 AA Single-Family Housing, Series FF, 6.250% due 9/1/28(a) 1,515,000
1,000,000 AAA Pitt County, NC COP, FGIC-Insured, 6.900% due 4/1/08 1,071,250
- -------------------------------------------------------------------------------------------------------
20,424,969
- -------------------------------------------------------------------------------------------------------
North Dakota -- 0.9%
Mercer County, ND PCR, Basin Electric Power:
3,000,000 AAA Second Series, AMBAC-Insured, 6.050% due 1/1/19 3,037,500
4,815,000 A Series E, 7.000% due 1/1/19 5,043,713
- -------------------------------------------------------------------------------------------------------
8,081,213
- -------------------------------------------------------------------------------------------------------
Ohio -- 3.0%
4,000,000 NR Cleveland, OH Airport Special Revenue, Continental
Airlines Inc., 9.000% due 12/1/19(a) 4,160,000
2,900,000 AAA Cleveland, OH Public Power System Revenue,
AMBAC-Insured, 7.000% due 11/15/24 3,226,250
3,000,000 AAA Cleveland, OH Waterworks Revenue Refunding &
Improvement, First Mortgage, Series H, MBIA-Insured,
5.750% due 1/1/26 2,955,000
Cuyahoga County, OH Hospital Revenue Refunding
& Improvement, University Hospitals, Series A,
MBIA-Insured:
500,000 AAA 5.625% due 1/15/14 491,250
1,000,000 AAA 5.625% due 1/15/21 967,500
750,000 BBB Miami County, OH Hospital Facilities Refunding &
Improvement, Upper Valley Medical Center, Series C,
6.250% due 5/15/13 738,750
Ohio State Air Quality Development Authority:
4,000,000 AAA Columbus & Southern Ohio, Series A, FGIC-Insured,
6.375% due 12/1/20 4,145,000
5,000,000 BB Pollution Control-Toledo Edison, 6.875% due 7/1/23(a) 4,662,500
Ohio State Water Development Authority Revenue:
Series A:
3,475,000 BB Cleveland Electric, 8.000% due 10/1/23(a) 3,557,531
1,500,000 BB Toledo Edison, 8.000% due 10/1/23(a) 1,535,625
210,000 BB+ Series B, Pennsylvania Power Project,
8.100% due 9/1/18(a) 219,379
- -------------------------------------------------------------------------------------------------------
26,658,785
- -------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
19
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Oklahoma -- 1.4%
$ 4,600,000 AAA Oklahoma HFA, Single-Family Mortgage Revenue,
Series B, GNMA-Collateralized, 7.997% due 8/1/18(a) $ 5,019,750
Tulsa, OK Municipal Airport Revenue, American Airlines:
2,400,000 Baa2* 7.350% due 12/1/11 2,580,000
4,700,000 Baa2* 6.250% due 6/1/20 4,658,875
- -------------------------------------------------------------------------------------------------------
12,258,625
- -------------------------------------------------------------------------------------------------------
Pennsylvania -- 9.0%
4,000,000 AAA Allegheny County, PA Airport Revenue, Greater
Pittsburgh International Airport, Series B,
FSA-Insured, 6.625% due 1/1/22(a) 4,150,000
2,500,000 BB+ Allegheny County, PA Series A, 6.700% due 12/1/20 2,559,375
4,500,000 BBB Allentown, PA Hospital Authority Revenue, Sacred Heart
Hospital of Allentown, Series B, 6.750% due 11/15/15 4,477,500
1,250,000 AAA Beaver County, PA Hospital Authority, Beaver Medical
Center, Series A, AMBAC-Insured, 6.250% due 7/1/22 1,282,813
3,000,000 AAA Berks County, PA Solid Waste Authority, FGIC-Insured,
6.000% due 4/1/11 3,101,250
2,000,000 AAA Delaware County, PA Hospital Authority, Crozer-Chester
Medical Center, MBIA-Insured, 5.300% due 12/15/20 1,865,000
2,000,000 AA- Delaware County, PA IDA, Resource Recovery Project,
Series A, 8.100% due 12/1/13 2,077,340
3,000,000 AAA Franklin, PA IDA, (Chamberburgs Hospital Project),
FGIC-Insured, 6.250% due 7/1/12 3,116,250
1,380,000 BBB- Grove City, PA Area Hospital Authority Revenue, United
Community Hospital, 8.125% due 7/1/12 1,392,075
4,475,000 AAA Lehigh County General Purpose Authority Revenue,
Lehigh Valley Hospital, Series B, MBIA-Insured,
5.625% due 7/1/25 4,279,219
Lehigh County, PA IDA, PCR, MBIA-Insured:
7,500,000 AAA 6.400% due 9/1/29 7,762,500
1,750,000 AAA Series A, 6.400% due 11/1/21 1,813,437
Luzerne County, PA IDA, Pennsylvania Gas and
Water Co., Series A:
2,500,000 BBB- 7.200% due 10/1/17(a) 2,600,000
2,250,000 BBB- 6.050% due 1/1/19 2,137,500
3,380,000 AAA Montgomery County, PA IDA, PCR, Series B,
MBIA-Insured, 6.700% due 12/1/21 3,599,700
6,750,000 NR Montgomery County, PA Redevelopment Authority,
Multi-Family Housing, Series A, 6.500% due 7/1/25 6,547,500
500,000 BBB- Northampton County, PA IDA, PCR, Commercial
Development, (Strawbridge Project), 7.200% due 12/15/01 540,000
350,000 AAA North Huntington Township, PA Municipal Guaranteed
Sewer Revenue, MBIA-Insured, 6.875% due 4/1/14 366,188
</TABLE>
See Notes to Financial Statements.
20
<PAGE>
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Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Pennsylvania -- 9.0% (continued)
Pennsylvania EDA:
$ 4,500,000 BBB- Resource Recovery Revenue, (Colver Project),
Series D, 7.125% due 12/1/15 $ 4,612,500
4,000,000 BBB+ WasteWater Treatment Revenue, Sun Co. Inc.,
(RTM Project), Series A, 7.600% due 12/1/24(a) 4,425,000
2,750,000 AAA Pennsylvania State, IDA Revenue, AMBAC-Insured,
6.000% due 1/1/12 2,815,312
5,000,000 AAA Pennsylvania State Higher Education, Student Loan Revenue,
Series D, AMBAC-Insured, 6.050% due 1/1/19(a) 5,050,000
Philadelphia, PA Municipal Authority Gas Works
Lease Revenue:
2,500,000 Baa* 7.625% due 5/1/14 2,653,125
2,750,000 Baa1* 14th Series, 6.375% due 7/1/26 2,794,687
990,000 Baa* Series B, 6.400% due 11/15/16 990,000
2,500,000 BB+ Scranton-Lackawanna, PA Health & Welfare Authority
Revenue, Series B, Moses Taylor Hospital,
8.500% due 7/1/20 2,653,125
- -------------------------------------------------------------------------------------------------------
79,661,396
- -------------------------------------------------------------------------------------------------------
Puerto Rico -- 1.0%
Commonwealth of Puerto Rico:
455,000 AAA GO, (Pre-Refunded -- Escrowed with U.S. Government
Securities to 7/1/98 Call @ 102), 8.000% due 7/1/08(b) 489,694
1,000,000 AAA Highway & Transportation Authority, Highway Revenue,
Series Y, FSA-Insured, 5.000% due 7/1/16 918,750
1,100,000 A- Municipal Finance Agency, Series A, 8.250% due 7/1/08 1,196,250
5,760,000 BBB Urban Renewal & Housing Corp., 7.875% due 10/1/04 6,350,400
- -------------------------------------------------------------------------------------------------------
8,955,094
- -------------------------------------------------------------------------------------------------------
Rhode Island -- 1.4%
2,650,000 AAA Rhode Island Depositors Economic Protection Corp.,
Series B, MBIA-Insured, 6.000% due 8/1/17 2,693,063
9,500,000 AA+ Rhode Island Housing & Mortgage Finance Authority,
7.100% due 4/1/24(a)(c) 9,820,625
- -------------------------------------------------------------------------------------------------------
12,513,688
- -------------------------------------------------------------------------------------------------------
South Carolina -- 1.0%
2,400,000 A3* Fairfield County, SC IDR, Rite Aid Corp.,
7.900% due 12/1/16(a) 2,462,520
1,500,000 BBB+ Greenville County, SC IDR, (Lockheed Aeromod
Center Project), 7.200% due 11/1/21(a) 1,595,625
500,000 AAA Lexington County, SC Health Services District, Hospital
Revenue, FSA-Insured, 6.750% due 10/1/18 530,625
4,000,000 A- Richland County, SC PCR, (Union Camp Corp.
Project), 6.625% due 5/1/22 4,215,000
- -------------------------------------------------------------------------------------------------------
8,803,770
- -------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
21
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
South Dakota -- 0.2%
Ogalala Sioux, SD Tribal Revenue Bond:
$ 1,865,000 NR 7.500% due 7/1/13 $ 1,876,656
265,000 NR 7.000% due 7/1/99 265,994
- -------------------------------------------------------------------------------------------------------
2,142,650
- -------------------------------------------------------------------------------------------------------
Tennessee -- 3.0%
7,000,000 AA- Humphreys County, TN IDB, 6.700% due 5/1/24 7,420,000
1,400,000 AAA Knoxville, TN Community Development Corp.,
GNMA-Collateralized, Morningside Gardens,
6.100% due 7/20/20 1,401,750
7,100,000 A- Maury County, TN IDB, PCR, Saturn Corp. Project,
6.500% due 9/1/24(c) 7,339,625
3,150,000 BBB Memphis-Shelby County, TN Airport Authority,
Federal Express Corp., 6.750% due 9/1/12 3,276,000
1,000,000 NR Metropolitan Nashville & Davidson County, TN IDB
Revenue, Volunteer Health Care, Series A,
10.750% due 6/1/18 280,000
5,000,000 AAA Metropolitan Nashville Airport Authority, TN Airport
Revenue, Special Facilities, Series C, FGIC-Insured,
6.600% due 7/1/15 5,318,750
1,500,000 AAA Tennessee Housing Development Mortgage Agency,
Series B, MBIA-Insured, 6.200% due 7/1/18 1,511,250
- -------------------------------------------------------------------------------------------------------
26,547,375
- -------------------------------------------------------------------------------------------------------
Texas -- 10.3%
7,500,000 BBB Alliance Airport Authority Inc., Special Federal Express
Corp. Project, 6.375% due 4/1/21 7,359,375
2,325,000 AAA Austin, TX Utility System Revenue, AMBAC-Insured,
7.000% due 5/15/16 2,516,813
935,000 NR Bell County, TX Health Care Facilities, Series A,
(Living Tech Inc. Project), 10.500% due 6/15/18 794,750
Brazos River Authority, TX PCR, Houston Lighting &
Power Co.:
3,000,000 BBB+ 8.250% due 12/1/16(a) 3,087,060
2,000,000 AAA Series A, AMBAC-Insured, 6.700% due 3/1/17 2,162,500
1,900,000 AAA Series B, FGIC-Insured, 7.200% due 12/1/18 2,049,625
4,000,000 AAA Dallas-Fort Worth, TX International Airport Facilities,
UPS Services, Inc., 6.600% due 5/1/32(a) 4,185,000
2,000,000 NR Denton County, TX Reclamation & Road District,
8.500% due 6/1/16 2,009,860
Gulf Coast Waste Disposal Authority, TX Waste Disposal
& Sewer System Control, Revenue Refunding,
Bay Port Area System, Series A, FSA-Insured:
1,395,000 AAA 6.700% due 10/1/10 1,469,981
990,000 AAA 6.700% due 10/1/11 1,044,450
</TABLE>
See Notes to Financial Statements.
22
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Texas -- 10.3% (continued)
$ 970,000 AAA Harris County, TX Refunding Toll Road Authority,
Series A, AMBAC-Insured, 6.500% due 8/15/17 $ 1,030,625
130,000 BBB- Heart of Texas, HFA, Single-Family Mortgage Revenue,
Series 1984, 11.000% due 1/1/11 133,088
Matagorda County, TX PCR, Navajo District No. 1:
Central Power & Light Co. Project:
3,250,000 A- 7.875% due 12/1/16(a) 3,344,152
7,500,000 AAA MBIA-Insured, 6.10% due 7/1/28 7,528,125
Houston Light & Power Co. Project:
1,300,000 A 7.875% due 11/1/26(a) 1,333,943
7,200,000 AAA AMBAC-Insured, 6.700% due 3/1/27 7,722,000
500,000 A Series B, 7.700% due 2/1/19 528,125
2,100,000 AAA Series E, FGIC-Insured, 7.200% due 12/1/18 2,275,875
3,000,000 A* North Texas, Higher Education Authority Inc.,
6.300% due 4/1/09(a) 3,026,250
Port Corpus Christi, TX IDR:
4,000,000 A+ Hoechst Celanese Corp. Project, 6.875% due 4/1/17(a) 4,210,000
2,000,000 BBB- Valero Refining and Manufacturing, Series A,
10.250% due 6/1/17 2,138,500
4,000,000 A+ Red River Authority, TX PCR, (Hoechst Celanese
Corp. Project), 6.875% due 4/1/17(a) 4,210,000
5,000,000 AAA Red River Authority, TX PCR, Utility Project,
MBIA-Insured, 6.000% due 6/1/20 5,006,250
Sam Rayburn, TX Municipal Power Agency, Power
Supply System Revenue:
2,200,000 BB Series A, 6.750% due 10/1/14 2,010,250
2,500,000 BB Series B, 6.125% due 10/1/13 2,140,625
San Antonio, TX Airport System Revenue, AMBAC-Insured:
3,000,000 AAA 7.125% due 7/1/06 3,371,250
1,000,000 AAA 7.125% due 7/1/08 1,130,000
2,000,000 AAA 7.375% due 7/1/13 2,252,500
2,000,000 AAA Terrel Hills, TX Higher Education, (Incarnate World College
Project), CONNIE LEE-Insured, 5.750% due 3/15/13 2,000,000
3,010,000 AAA Texas Municipal Power Agency Revenue Bonds,
Series A, AMBAC-Insured, 6.750% due 9/1/12 3,224,462
2,085,000 AAA Texas State Department, Housing and Community Affairs,
Home Mortgage Revenue, Series A, GNMA-Collateralized,
6.950% due 7/1/23 2,186,644
2,715,000 AA Texas State Veterans Housing Assistance, Single-Family
Mortgage Revenue, 6.800% due 12/1/23(a) 2,796,450
960,000 NR Tyler, TX Health Facilities Revenue, (Park Place Limited
Project), 8.500% due 12/1/18 939,600
- -------------------------------------------------------------------------------------------------------
91,218,128
- -------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
23
<PAGE>
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Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
Utah -- 0.6%
$4,000,000 AAA Utah Municipal Power System Revenue, (San Juan
Project), MBIA-Insured, 6.375% due 6/1/22 $ 4,145,000
Utah State HFA, Single-Family Mortgage:
510,000 AA Series D, 8.625% due 1/1/19(a) 531,675
365,000 Aaa* Series D1, 6.200% due 7/1/16 370,475
- -------------------------------------------------------------------------------------------------------
5,047,150
- -------------------------------------------------------------------------------------------------------
Virginia -- 1.5%
2,435,000 AAA Fairfax County, VA Redevelopment and Housing Authority
Revenue, Multi-Family Housing, Series A, Kingsley,
FHA-Insured, 7.000% due 5/1/26 2,611,538
1,780,000 A- Henrico County, VA IDA, Maryview Hospital, Series B,
7.500% due 9/1/11 1,993,600
8,000,000 A- Isle Wight County, VA IDA, Solid Waste Disposal Revenue,
6.550% due 4/1/24(a) 8,260,000
- -------------------------------------------------------------------------------------------------------
12,865,138
- -------------------------------------------------------------------------------------------------------
Washington -- 1.8%
1,500,000 AAA King County, WA Public Hospital District No. 1, Hospital
Facilities Revenue, Valley Medical Center, AMBAC-Insured,
7.250% due 9/1/15 1,636,875
2,000,000 BBB Port Moses Lake, WA PCR, Union Carbide,
7.875% due 8/1/06(a) 2,072,540
2,000,000 AAA Port of Seattle, WA Subordinated Lien, MBIA-Insured,
6.625% due 8/1/17 2,137,500
3,000,000 AAA Snohomish County, WA Electric Revenue Generation
System, Public Utility District No. 1, FGIC-Insured,
6.000% due 1/1/18 3,011,250
2,750,000 AAA Washington State Health Care Facilities Authority Revenue,
Franciscan Health, St. Joseph, MBIA-Insured,
6.700% due 7/1/21 2,908,125
Washington State Public Power Supply System,
(Nuclear Project No. 1):
3,000,000 AA 7.500% due 7/1/07 3,236,250
500,000 AAA Series A, MBIA-Insured, 6.250% due 7/1/17 515,000
- -------------------------------------------------------------------------------------------------------
15,517,540
- -------------------------------------------------------------------------------------------------------
West Virginia -- 1.1%
2,000,000 A Beckley, WV IDR, (Water Commission Project),
7.000% due 10/1/17(a) 2,127,500
Marion County, WV Solid Waste Disposal Revenue,
American Power, Paper Recycling:
2,500,000 NR 7.750% due 12/1/11(a)(d) 1,500,000
5,000,000 NR 9.000% due 12/1/11(a)(d) 3,000,000
2,300,000 AAA West Virginia School Building Authority Revenue,
Series A, MBIA-Insured, 7.000% due 7/1/11 2,472,500
</TABLE>
See Notes to Financial Statements.
24
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
=======================================================================================================
<C> <C> <S> <C>
West Virginia -- 1.1% (continued)
$ 500,000 AAA West Virginia State Water Development Authority,
Series A, FSA-Insured, 7.000% due 11/1/25 $ 537,500
- -------------------------------------------------------------------------------------------------------
9,637,500
- -------------------------------------------------------------------------------------------------------
Wisconsin -- 0.2%
2,000,000 BBB Racine County, WI Health Center Revenue,
8.125% due 8/1/21 2,062,120
- -------------------------------------------------------------------------------------------------------
Wyoming -- 0.4%
2,000,000 A Sweetwater County, WY PCR, Idaho Power Co. Project,
Series A, 6.050% due 7/15/26 2,002,500
1,250,000 AA Wyoming Community Development Authority, Housing
Revenue, 7.100% due 6/1/17 1,317,188
- -------------------------------------------------------------------------------------------------------
3,319,688
- -------------------------------------------------------------------------------------------------------
TOTAL MUNICIPAL BONDS AND NOTES
(Cost -- $851,773,272) 877,589,630
=======================================================================================================
SHORT-TERM INVESTMENTS(e) -- 0.5%
700,000 VMIG 1* Cuyahoga County, OH University Hospital Revenue,
3.700% due 1/1/16 700,000
1,100,000 VMIG 1* Massachusetts State, Series B, 3.550% due 12/1/97 1,100,000
3,000,000 VMIG 1* Puerto Rico Commonwealth, Government
Development Bank, 3.250% due 12/1/15 3,000,000
- -------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS
(Cost -- $4,800,000) 4,800,000
=======================================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $856,573,272**) $882,389,630
=======================================================================================================
</TABLE>
(a) Income from this issue is considered a preference item for purposes of
calculating the alternative minimum tax.
(b) Pre-Refunded bonds escrowed by U.S. Government Securities and bonds
escrowed to maturity by U.S. Government Securities are considered by
manager to be triple-A rated even if issuer has not applied for new
ratings.
(c) Residual interest bonds -- coupon varies inversely with level of short-term
tax-exempt interest rates.
(d) Security is valued by the Fund's Board of Directors (See Note 7).
(e) Variable rate municipal bonds and notes are payable upon not more than
seven business days' notice.
** Aggregate cost for Federal income tax purposes is substantially the same.
See pages 26 and 27 for definition of ratings and certain security
descriptions.
See Notes to Financial Statements.
25
<PAGE>
- --------------------------------------------------------------------------------
Bond Ratings
- --------------------------------------------------------------------------------
All ratings are by Standard & Poor's Corporation ("Standard & Poors"), except
that those identified by an asterisk (*) are rated by Moody's Investors Services
("Moodys"). The definitions of the applicable rating symbols are set forth
below:
Standard & Poor's -- Rating from "AA" to "BB" may be modified by the addition of
a plus (+) or a minus (-) sign to show relative standings within the major
rating categories.
AAA -- Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely
strong.
AA -- Debt rated "AA" has a very strong capacity to pay interest and
repay principal and differs from the highest rated issue only in a
small degree.
A -- Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher rated categories.
BBB -- Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher
rated categories.
BB -- Debt rated "BB" has less near-term vulnerability to default than
other speculative issues. However, it faces major ongoing
uncertainties of exposure to adverse business, financial, or economic
conditions which could lead to inadequate capacity to meet timely
interest and principal payments.
D -- Bonds rated "D" are in default, and payment of interest and/or
repayment of principal is in arrears.
Moody's-- Numerical modifiers 1, 2, and 3 may be applied to each generic
rating from "Aa" to "B", where 1 is the highest and 3 the lowest
rating within its generic category.
Aaa -- Bonds that are rated "Aaa" are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally
referred to as "gilt edge." Interest payments are protected by a large
or by an exceptionally stable margin and principal is secure. While
the various protective elements are likely to change, such changes as
can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa -- Bonds that are rated "Aa" are judged to be of high quality by all
standards. Together with the "Aaa" group they comprise what are
generally known as high grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in
"Aaa" securities or fluctuation of protective elements may be of
greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in "Aaa" securities.
A -- Bonds that are rated "A" possess many favorable investment
attributes and are to be considered as upper medium grade obligations.
Factors giving security to principal and interest are considered
adequate but elements may be present which suggest a susceptibility to
impairment some time in the future.
Baa -- Bonds that are rated "Baa" are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly
secured. Interest payments and principal security appear adequate for
the present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba -- Bonds that are rated "Ba" are judged to have speculative elements;
their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B -- Bonds that are rated "B" generally lack characteristics of
desirable investments. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
NR -- Indicates that the bond is not rated by Standard & Poor's
Corporation or Moody's Investor's Services.
26
<PAGE>
- --------------------------------------------------------------------------------
Short-Term Securities Ratings
- --------------------------------------------------------------------------------
SP-1 -- Standard & Poor's highest rating indicating very strong or strong
capacity to pay principal and interest; those issues determined to
possess overwhelming safety characteristics are denoted with a plus
(+) sign.
A-1 -- Standard & Poor's highest commercial paper and variable-rate demand
obligation (VRDO) rating indicating that the degree of safety
regarding timely payment is either overwhelming or very strong; those
issues determined to possess overwhelming safety characteristics are
denoted with a plus (+) sign.
VMIG 1 -- Moody's highest rating for issues having demand feature -- VRDO.
P-1 -- Moody's highest rating for commercial paper and for VRDOprior to
the advent of the VMIG1 rating.
- --------------------------------------------------------------------------------
Security Descriptions
- --------------------------------------------------------------------------------
ABAG -- Association of Bay Area Governors
AIG -- American International Guaranty
AMBAC -- AMBAC Indemnity Corporation
BAN -- Bond Anticipation Notes
BIG -- Bond Investors Guaranty
CGIC -- Capital Guaranty Insurance Company
CHFCLI -- California Health Facility Construction Loan Insurance
CONNIE LEE-- College Construction Loan Association
COP -- Certificate of Participation
EDA -- Economic Development Authority
ETM -- Escrowed to Maturity
FAIRS -- Floating Adjustable Interest Rate Securities
FGIC -- Financial Guaranty Insurance Company
FHA -- Federal Housing Administration
FHLMC -- Federal Home Loan Mortgage Corporation
FNMA -- Federal National Mortgage Association
FRTC -- Floating Rate Trust Certificates
FSA -- Federal Savings Association
GIC -- Guaranteed Investment Contract
GNMA -- Government National Mortgage Association
GO -- General Obligation
HDC -- Housing Development Corporation
HFA -- Housing Finance Authority
IDA -- Industrial Development Agency
IDB -- Industrial Development Board
IDR -- Industrial Development Revenue
INFLOS -- Inverse Floaters
LOC -- Letter of Credit
MBIA -- Municipal Bond Investors Assurance Corporation
MVRICS -- Municipal Variable Rate Inverse Coupon Security
PCR -- Pollution Control Revenue
RAN -- Revenue Anticipation Notes
RIBS -- Residual Interest Bonds
RITES -- Residual Interest Tax-Exempt Securities
SYCC -- Structured Yield Curve Certificate
TAN -- Tax Anticipation Notes
TECP -- Tax-Exempt Commercial Paper
TOB -- Tender Option Bonds
TRAN -- Tax and Revenue Anticipation Notes
VA -- Veterans Administration
VRWE -- Variable Rate Wednesday Demand
27
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities July 31, 1996
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost -- $856,573,272) $ 882,389,630
Cash 90,170
Interest receivable 12,944,275
Receivable for securities sold 4,923,724
Receivable for Fund shares sold 133,578
- -------------------------------------------------------------------------------
Total Assets 900,481,377
- -------------------------------------------------------------------------------
LIABILITIES:
Payable for securities purchased 13,822,024
Distribution fees payable 391,273
Investment advisory fees payable 333,494
Payable for Fund shares purchased 253,694
Administration fees payable 153,871
Accrued expenses 204,161
- -------------------------------------------------------------------------------
Total Liabilities 15,158,517
- -------------------------------------------------------------------------------
Total Net Assets $ 885,322,860
===============================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 51,116
Capital paid in excess of par value 862,365,963
Undistributed net investment income 71,821
Accumulated net realized loss on security transactions (2,982,398)
Net unrealized appreciation of investments 25,816,358
- -------------------------------------------------------------------------------
Total Net Assets $ 885,322,860
===============================================================================
Shares Outstanding:
Class A 13,376,651
----------------------------------------------------------------------------
Class B 37,708,244
----------------------------------------------------------------------------
Class C 31,538
----------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $ 17.31
----------------------------------------------------------------------------
Class B* $ 17.32
----------------------------------------------------------------------------
Class C** $ 17.31
----------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 4.17% of net asset value per share) $ 18.03
===============================================================================
* Redemption price is NAV of Class B shares reduced by a 4.50% CDSC if shares
are redeemed within one year from initial purchase (See Note 3).
** Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
are redeemed within the first year of purchase.
28
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended July 31, 1996
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $ 61,696,811
- -------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 3) 4,945,112
Investment advisory fees (Note 3) 3,771,279
Administration fees (Note 3) 1,885,640
Shareholder and system servicing fees 350,536
Shareholder communications 95,160
Registration fees 88,102
Audit and legal 59,580
Pricing service fees 48,024
Custody 46,725
Trustees' fees 26,220
Other 33,907
- -------------------------------------------------------------------------------
Total Expenses 11,350,285
- -------------------------------------------------------------------------------
Net Investment Income 50,346,526
- -------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS (NOTE4):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 503,611,492
Cost of securities sold 498,795,283
- -------------------------------------------------------------------------------
Net Realized Gain 4,816,209
- -------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments:
Beginning of year 26,458,803
End of year 25,816,358
- -------------------------------------------------------------------------------
Decrease in Net Unrealized Appreciation (642,445)
- -------------------------------------------------------------------------------
Net Gain on Investments 4,173,764
- -------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 54,520,290
===============================================================================
See Notes to Financial Statements.
29
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended July 31,
- --------------------------------------------------------------------------------
1996 1995
================================================================================
OPERATIONS:
Net investment income $ 50,346,526 $ 57,517,554
Net realized gain (loss) 4,816,209 (7,798,607)
Increase (decrease) in net
unrealized appreciation (642,445) 5,121,672
- -------------------------------------------------------------------------------
Increase in Net Assets
From Operations 54,520,290 54,840,619
- -------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS
FROM (NOTE 2):
Net investment income (50,274,705) (55,145,310)
Net realized gains -- (3,348,702)
Capital -- --
- -------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (50,274,705) (58,494,012)
- -------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
Net proceeds from sale of shares 55,204,274 308,956,540
Net asset value of shares issued for
reinvestment of dividends 27,635,290 32,996,530
Cost of shares reacquired (176,253,665) (451,067,162)
- -------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (93,414,101) (109,114,092)
- -------------------------------------------------------------------------------
Decrease in Net Assets (89,168,516) (112,767,485)
NET ASSETS:
Beginning of year 974,491,376 1,087,258,861
- -------------------------------------------------------------------------------
End of year* $ 885,322,860 $ 974,491,376
===============================================================================
* Includes undistributed net investment
income of: $ 71,821 --
===============================================================================
See Notes to Financial Statements.
30
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Barney Tax-Exempt Income Fund ("Fund"), a separate investment
fund of the Smith Barney Income Funds ("Trust"), a Massachusetts business trust,
is registered under the Investment Company Act of 1940, as amended, as a
diversified, open-end management investment company. The Trust consists of the
Fund and six other separate investment funds: Smith Barney Exchange Reserve
Fund, Smith Barney Premium Total Return Fund, Smith Barney High Income Fund,
Smith Barney Convertible Fund, Smith Barney Diversified Strategic Income Fund
and Smith Barney Utilities Fund. The financial statements and financial
highlights for the other funds are presented in separate annual reports.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) securities are
valued at mean prices by an independent pricing service that are based on
transactions in municipal obligations, quotations from municipal bond dealers,
market transactions in comparable securities and various relationships between
securities; (c) securities maturing within 60 days are valued at cost plus
accreted discount, or minus amortized premium which approximates market value;
(d) interest income, adjusted for amortization of premiums and accretion of
original issue discount, is recorded on the accrual basis; (e) gains or losses
on the sale of securities are calculated using the specific identification
method; (f) direct expenses are charged to each class; management fees and
general Fund expenses are allocated on the basis of relative net assets of each
class; (g) dividends and distributions to shareholders are recorded on the
ex-dividend date; (h) the Fund intends to comply with the applicable provisions
of the Internal Revenue Code of 1986, as amended, pertaining to regulated
investment companies and to make distributions of taxable income sufficient to
relieve it from substantially all Federal income and excise taxes; and (i)
estimates and assumptions are required to be made regarding assets, liabilities
and changes in net assets resulting from operations when financial statements
are prepared. Changes in the economic environment, financial markets and any
other parameters used in determining these estimates could cause actual results
to differ.
2. EXEMPT-INTEREST DIVIDENDS AND OTHER DISTRIBUTIONS
The Fund intends to satisfy requirements that allows interest from
municipal securities, which is exempt from regular Federal income tax and from
certain states' income taxes, to retain its exempt-interest status when
distributed to the shareholders of the Fund.
Capital gain distributions, if any, are taxable to shareholders, and are
declared and paid at least annually. Additional taxable distributions may be
made if necessary to avoid a Federal excise tax.
31
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
3. INVESTMENT ADVISORY AGREEMENT, ADMINISTRATION
AGREEMENT AND OTHER TRANSACTIONS
Smith Barney Mutual Funds Management Inc. ("SBMFM"), a subsidiary of Smith
Barney Holdings Inc. ("SBH"), acts as investment adviser to the Trust. The Fund
pays SBMFM an advisory fee calculated at an annual rate of 0.40% of the average
daily net assets. This fee is calculated daily and paid monthly.
SBMFM acts as the Trust's administrator for which the Fund pays a fee
calculated at an annual rate of 0.20% of the average daily net assets. This fee
is calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SBH, acts as distributor of
Trust shares. For the year ended July 31, 1996, SB received sales charges of
approximately $47,000 of the Fund's Class A shares.
There is a contingent deferred sales charge ("CDSC") of 4.50% on Class B
shares, which applies if redemption occurs less than one year from initial
purchase and thereafter declines by 0.50% the first year after purchase and by
1.00% per year until no CDSC is incurred. Class C shares have a 1.00% CDSC,
which applies if redemption occurs within the first year of purchase. In
addition, Class Ashares also have a 1.00% CDSC, which applies if redemption
occurs within the first year of purchase. This CDSC only applies to those
purchases of Class A shares, which when combined with current holdings of Class
A shares, equal or exceed $500,000 in the aggregate. These purchases do not
incur an initial sales charge. For the year ended July 31, 1996, CDSCs paid to
SB were approximately:
Class A Class B
================================================================================
CDSCs $2,000 $929,000
================================================================================
Pursuant to a Distribution Plan, the Fund pays a service fee with respect
to Class A, B, C shares calculated at the annual rate of 0.15% of the average
daily net assets of each respective class. The Fund also pays a distribution fee
with respect to Class B and C shares calculated at the annual rate of 0.50% and
0.55% of the average daily net assets of each class, respectively. For the year
ended July 31, 1996, total Distribution Plan fees incurred were:
Class A Class B Class C
================================================================================
Distribution Plan Fees $355,031 $4,587,028 $3,053
================================================================================
All officers and one Trustee of the Fund are employees of SB.
32
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
4. INVESTMENTS
During the year ended July 31, 1996, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $409,868,089
- --------------------------------------------------------------------------------
Sales 503,611,492
================================================================================
At July 31, 1996, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were approximately
as follows:
================================================================================
Gross unrealized appreciation $34,941,000
Gross unrealized depreciation (9,125,000)
- --------------------------------------------------------------------------------
Net unrealized appreciation $25,816,000
================================================================================
5. CAPITAL LOSS CARRYFORWARD
At July 31, 1996, the Fund had for Federal tax purposes approximately
$2,982,000 of loss carryforwards available to offset future capital gains. To
the extent that these carryforward losses are used to offset capital gains, it
is probable that the gains so offset will not be distributed. The amount and
expiration of the carryforwards are indicated below. Expiration occurs on July
31 of the year indicated:
2003 2004
================================================================================
Carryforward Amounts $2,037,000 $945,000
================================================================================
6. SHARES OF BENEFICIAL INTEREST
At July 31, 1996, the Trust had an unlimited number of shares of beneficial
interest authorized with a par value of $0.001 per share. The Fund has the
ability to issue multiple classes of shares. Each share of a class represents an
identical interest and has the same rights, except that each class bears certain
direct expenses, including those specifically related to the distribution of its
shares.
At July 31, 1996, total paid-in capital amounted to the following for each
class:
Class A Class B Class C
================================================================================
Total Paid-in Capital $230,301,983 $631,570,159 $544,937
================================================================================
33
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended*
July 31, 1996 July 31, 1995*
------------------------ -------------------------
Shares Amount Shares Amount
=========================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 1,718,386 $ 29,741,505 15,203,943 $260,143,513
Shares issued on reinvestment 435,764 8,042,396 485,637 8,176,630
Shares redeemed (2,554,580) (44,691,662) (2,943,568) (49,239,168)
- -----------------------------------------------------------------------------------------
Net Increase (Decrease) (400,430) $ (6,907,761) 12,746,012 $219,080,975
=========================================================================================
Class B
Shares sold 1,517,563 $ 25,090,157 2,897,328 $ 48,582,535
Shares issued on reinvestment 1,032,778 19,575,379 1,470,435 24,816,156
Shares redeemed (7,527,055) (131,511,049) (23,643,756) (401,799,664)
- -----------------------------------------------------------------------------------------
Net Decrease (4,976,714) $(86,845,513) (19,275,993) $(328,400,973)
=========================================================================================
Class C
Shares sold 21,320 $ 372,612 13,738 $ 230,492
Shares issued on reinvestment 908 17,515 206 3,744
Shares redeemed (2,922) (50,954) (1,712) (28,330)
- -----------------------------------------------------------------------------------------
Net Increase 19,306 $ 339,173 12,232 $ 205,906
=========================================================================================
</TABLE>
* Transactions for Class C shares are for the period from November 17, 1994
(inception date) to July 31, 1995.
7. SECURITIES VALUED BY THE FUND'S BOARD OF DIRECTORS
Two of the Fund's investments are valued at the direction of the Fund's
Board of Directors and have been valued in good faith, taking into consideration
the appropriate economic, financial and other pertinent available information
pertaining to the defaulted securities. The table below shows the security
valued by the Fund's Board of Directors:
<TABLE>
<CAPTION>
Value as of
Acquisition Par 7/31/96 Percentage
Security Date Amount Value of Net Assets Cost
==============================================================================================
<S> <C> <C> <C> <C> <C>
Marion County, WV Solid Waste
Disposal Revenue, American
Power, Paper Recycling
7.750% due 12/1/11 11/13/94 $2,500,000 $1,500,000 0.17% $2,500,000
Marion County, WV Solid Waste
Disposal Revenue, American
Power, Paper Recycling
9.000% due 12/1/11 11/13/94 $5,000,000 $3,000,000 0.34% $5,000,000
==============================================================================================
</TABLE>
34
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1996 1995 1994 1993(1)
========================================================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 17.25 $ 17.26 $ 18.24 $ 17.45
- --------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 1.00 1.04 1.06 0.78
Net realized and unrealized gain (loss) 0.06 0.01* (0.85) 1.00
- --------------------------------------------------------------------------------------------------------
Total Income From Operations 1.06 1.05 0.21 1.78
- --------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (1.00) (1.00) (1.02) (0.80)
Overdistribution of net investment income -- -- (0.04) (0.03)
Net realized gains -- -- (0.13) (0.16)
Overdistribution of net realized gains -- (0.02) -- --
Capital -- (0.04) -- --
- --------------------------------------------------------------------------------------------------------
Total Distributions (1.00) (1.06) (1.19) (0.99)
- --------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 17.31 $ 17.25 $ 17.26 $ 18.24
- --------------------------------------------------------------------------------------------------------
Total Return 6.28% 6.42% 1.14% 10.24%++
- --------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 231,589 $ 237,656 $ 17,792 $ 13,508
- --------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.84% 0.84% 0.84% 0.86%+
Net investment income 5.74 6.04 5.83 6.03+
- --------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate .44% .38% .39% .34%
========================================================================================================
<CAPTION>
Class B Shares 1996 1995 1994 1993 1992
==============================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 17.26 $ 17.26 $ 18.24 $ 18.00 $ 16.97
- --------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.92 0.95 0.96 0.98 1.04
Net realized and unrealized gain (loss) 0.06 0.02* (0.85) 0.45 1.17
- --------------------------------------------------------------------------------------------------------------
Total Income From Operations 0.98 0.97 0.11 1.43 2.21
- --------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.92) (0.91) (0.92) (0.98) (1.04)
Overdistribution of net investment income -- -- (0.04) (0.04) --
Net realized gains -- (0.02) (0.13) (0.17) (0.14)
Capital -- (0.04) -- -- --
- --------------------------------------------------------------------------------------------------------------
Total Distributions (0.92) (0.97) (1.09) (1.19) (1.18)
- --------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 17.32 $ 17.26 $ 17.26 $ 18.24 $ 18.00
- --------------------------------------------------------------------------------------------------------------
Total Return 5.74% 5.91% 0.60% 8.28% 13.50%
- --------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (millions) $ 653 $ 737 $ 1,069 $ 1,108 $ 871
- --------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.33% 1.35% 1.33% 1.38% 1.45%
Net investment income 5.23 5.61 5.34 5.52 5.96
- --------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 44% 38% 39% 34% 61%
==============================================================================================================
</TABLE>
(1) For the period from November 6, 1992 (inception date) to July 31, 1993.
* Includes the net per share effect of shareholder sales and redemption
activity during the period, most of which occurred at net asset values less
than the beginning of the period.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
35
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class C Shares 1996 1995(1)
================================================================================
Net Asset Value, Beginning of Year $ 17.25 $ 15.83
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.89 0.60
Net realized and unrealized gain 0.08 1.50*
- --------------------------------------------------------------------------------
Total Income From Operations 0.97 2.10
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.91) (0.62)
Net realized gains -- (0.02)
Capital -- (0.04)
- --------------------------------------------------------------------------------
Total Distributions (0.91) (0.68)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 17.31 $ 17.25
- --------------------------------------------------------------------------------
Total Return 5.69% 13.45%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 546 $ 211
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.39% 1.18%+
Net investment income 5.18 5.56+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 44% 38%
================================================================================
(1) For the period from November 17, 1994 (inception date) to July 31, 1995.
* Includes the net per share effect of shareholder sales and redemption
activity during the period, most of which occurred at net asset values less
than the beginning of the period.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
100% of the dividends paid by the Fund from net investment income for the
year ended July 31, 1996, are tax-exempt for regular Federal income tax
purposes.
36
<PAGE>
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
The Shareholders and Board of Trustees of
Smith Barney Income Funds:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Smith Barney Tax-Exempt Income Fund of
Smith Barney Income Funds as of July 31, 1996, and the related statement of
operations for the year then ended and the statement of changes in net assets
and financial highlights for each of the years in the two-year period then
ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits. The financial highlights for each of the years in the three-year period
ended July 31, 1994, were audited by other auditors whose report thereon, dated
September 16, 1994, expressed an unqualified opinion on those financial
highlights.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of July
31, 1996, by correspondence with the custodian. As to securities sold and
purchased but not delivered and received, we performed other appropriate
auditing procedures. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Smith Barney Tax-Exempt Income Fund of Smith Barney Income Funds as of July 31,
1996, the results of its operations for the year then ended and the changes in
its net assets and financial highlights for each of the years in the two-year
period then ended, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
September 23, 1996
37
<PAGE>
Smith Barney SMITH BARNEY
Tax-Exempt ------------
Income Fund
A Member of Travelers Group [Logo]
Trustees
Lee Abraham
Antoinette C. Bentley
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon
Madelon DeVoe Talley
Officers
Heath B. McLendon
Chairman and Investment Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President
and Treasurer
Lawrence T. McDermott
Vice President and
Investment Officer
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
Investment Adviser
Smith Barney Mutual Funds
Management Inc.
Distributor
Smith Barney Inc.
Custodian
PNC Bank, N.A.
Shareholder
Servicing Agent
First Data Investors Services
Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for the general
information of the shareholders of Smith
Barney Tax-Exempt Income Fund. It is not
authorized for distribution to
prospective investors unless accompanied
or preceded by a current Prospectus for
the Fund, which contains information
concerning the Fund's investment
policies and expenses as well as other
pertinent information.
Smith Barney Tax-Exempt
Income Fund
388 Greenwich Street
New York, New York 10013
FD0427 9/96
<PAGE>
Annual Report
1996 [PICTURE OF CALCULATOR APPEARS HERE]
1996
1996
1996
1996
Smith Barney
Premium Total
Return Fund
----------------------------
July 31, 1996
[LOGO Smith Barney Mutual Funds
APPEARS Investing for your future.
HERE] Everyday.
<PAGE>
Smith Barney Premium Total Return Fund
Dear Shareholder:
We are pleased to provide you with the annual report for the year ended July 31,
1996 for the Smith Barney Premium Total Return Fund. In this report, we
summarize the period's prevailing economic and market conditions and outline our
portfolio strategy. A detailed summary of performance can be found in the
appropriate sections that follow in the annual report.
Overview of Fund's Performance
For the year ended July 31, 1996, the Smith Barney Premium Total Return Fund
generated a total return of 14.76% for Class A shares. In addition, the Fund
paid monthly dividends which totaled $1.2825 per Class A share over the same
time period. During this time, the U.S. stock market, as measured by the widely-
followed Standard & Poor's 500 Index ("S&P 500"), had a total return of 16.55%.
Although the Premium Total Return Fund underperformed the S&P 500 during the
period covered by this report, we are pleased with its performance because the
Fund is meeting one of its key objectives, which is to provide shareholders the
potential benefits of stock investing with less risk than investing in the
overall stock market. The Premium Total Return Fund seeks to achieve its
objectives by employing a conservative and defensive investment strategy that
will cause it to underperform in a rising stock market and experience less
losses when the stock market declines. One of the key elements of the Fund's
conservative and defensive investment strategy, which is explained in greater
detail later on in this letter, involves the use of S&P 500 index call options
which help to reduce the volatility of the Fund's net asset value (NAV).
Over the long term, the Premium Total Return Fund's defensive strategy has
generated a competitive total return versus the S&P 500. For the five-year
period ended July 31, 1996, the Fund had an average total return for Class B
shares of 12.38%, which compares with the S&P 500's annual total return of
13.63% during the same time period. In addition to providing shareholders with
competitive total returns over the long term, the Fund continues to make monthly
distributions of approximately $0.10 per Class B share. Additional information
about the Smith Barney Premium Total Return FundOs dividend policy can be found
at the end of this letter.
<PAGE>
Fund's Investment Strategy
The Smith Barney Premium Total Return Fund seeks total return consisting of
long-term capital appreciation and income by investing in a well diversified
portfolio made up of primarily dividend-paying common stocks. Historically,
these kinds of dividend-paying common stocks have offered relatively low
volatility.
In selecting individual stocks, the Fund follows a "bottom up" value approach to
stock investing. Therefore, the Fund generally does not rely on economic or
market forecasting, but instead selects individual stocks based on whether the
stock is available at a reasonable price, the issuing company is financially
healthy and whether its business is improving.
The Fund's investment process usually begins with a close examination of all the
public information available on a particular company. The Fund then conducts
extensive company and industry research to determine whether a company's
business momentum is positive, negative or neutral. In addition to conducting
extensive hands-on research, the Fund also considers traditional measurements of
a stock's relative value in order to identify undervalued stocks. Another way
the Fund tries to manage risk and further limit potential portfolio volatility
is through diversification. At the end of July, the Fund owned approximately 130
securities from a wide range of companies and industries.
A Defensive Hedging Strategy
The Fund's defensive hedging strategy, which seeks to limit the volatility of
NAV, involves index call options which have been sold (or written) by the Fund's
portfolio manager to hedge a portion of the portfolio. The Fund's defensive
hedging strategy has been used in varying degrees during the past twelve months.
For example, at the end of July, 17% of the Fund had been hedged by selling
index call options.
The Fund's defensive hedging strategy means that an outside investor has
purchased index call options from the Fund. When the Fund sells (or writes)
these options, it collects a premium from the investor who purchases them. If
the market goes down, the Fund has sold this market exposure and the net gain to
the Fund is positive. If the market goes up (as it has over the last twelve
months), the Fund loses the market gain on that portion of the portfolio because
an outside investor who purchased the option contracts from the Fund will
exercise his or her rights and earn what the market has gained.
2
<PAGE>
During the period covered by this report, the Fund's defensive hedging strategy
has cost the Fund relative to the performance of the S&P 500. However, when the
broad market goes down (as it did dramatically in July of 1996), the Fund's
defensive hedging strategy helped to protect the portfolio from the market
decline. For example, the U.S. stock market, as measured by the S&P 500, has
experienced only one down year since 1981 through 1990, when the index had a
total return of -3.17%. For the same year, the Premium Total Return Fund's Class
B shares (the only class of shares offered prior to November of 1991) generated
a total return of 2.02%.
Over the long term, the Fund's defensive hedging strategy will potentially help
to reduce NAV volatility and protect the portfolio when the market declines. Our
goal is to participate in rising markets while safeguarding principal in falling
markets. The trade-off is that the Fund's performance will lag the broad market
in periods when stock prices rise rapidly. Therefore, the Premium Total Return
Fund may be suitable for investors who want greater protection of principal in a
declining market and who are willing to accept less total return potential in a
rising market.
During the period covered by this report, the Premium Total Return Fund
emphasized the stocks of financial companies, particularly insurance companies.
Over the past twelve months, the Fund was underweighted in cyclical company
stocks such as companies in the automobile industry. In addition, the Fund was
underweighted in technology stocks because of our concerns that many of these
companies may not enjoy the same profit margins in the future that they have had
in the past. However, we will closely monitor the technology sector in the
coming months and we plan to take advantage of any opportunities if they arise.
Market Overview and Outlook
From the beginning of January through the end of June, the S&P 500 Index rose by
approximately 10%. However, the U.S. stock market, as measured by the S&P 500
Index, lost more than 4.4% during the month of July, bringing its year-to-date
total return to 5.2%. So far in 1996, the best performing stocks have been
large, consumer-oriented growth companies. In contrast, the stocks of technology
firms have dropped dramatically from their lofty price levels earlier this year.
In our past reports, we stated our belief that the stock market's future
performance would depend in large part on the outcome of the tug-of-war between
interest rates and corporate earnings. So far in 1996, interest rates have gone
up slightly and corporate earnings growth, while generally meeting the
expectations of many analysts, has begun to slow down.
3
<PAGE>
By most measurements, the stock market continues to trade at historically high
values. As the month of July drew to a close, the U.S. stock market took a
"breather" from its recent advances. Uncertainty and market volatility increased
as economic news about a strengthening U.S. economy once again heightened
investor concerns about the possible re-emergence of inflation. In addition,
because many investors now expect the Federal Reserve Board to raise interest
rates at a time when corporate earnings are slowing, many people believe the
aging bull market may slow down dramatically over the near term.
Against this backdrop of higher market volatility and growing uncertainty, we
believe the Premium Total Return Fund's conservative and defensive strategy make
it well positioned to meet the challenges of a more volatile and uncertain
market.
In closing, we would like to thank you for your investment in the Smith Barney
Premium Total Return Fund. We look forward to continuing to serve your
investment needs.
Sincerely,
/s/ Heath B. Mclendon /s/ Harry J. Rosenbluth
Heath B. McLendon Harry J. Rosenbluth
Chairman and Investment Officer
Investment Officer
August 19, 1996
4
<PAGE>
Smith Barney Premium Total
Return Fund Dividend Policy
A mutual fund pays dividends to satisfy one of the requirements to qualify as a
regulated investment company and to avoid paying income tax at the fund level.
As such, the Smith Barney Premium Total Return Fund must distribute (as do all
mutual funds) at least 90% of its investment company taxable income, but will
generally distribute all of its ordinary and net capital gains in order to avoid
any federal income taxes. As a regulated investment company, the tax benefits of
net long-term capital gains can be passed through to shareholders. A mutual
fund's distributions at calendar year-end generally are designed to ensure that
all earned income and net capital gains have been distributed to shareholders;
which could cause these amounts to differ from the regular distributions. Based
on its objectives, an individual fund may, as a result of its dividend
distribution policy, return a portion of the shareholders' principal in the form
of a return of capital, which is not considered taxable income.
The Smith Barney Premium Total Return Fund's distribution policy is designed to
provide an attractive level of monthly distributions. Since 1989, the Fund has
paid out approximately $0.10 per share each month. The Fund's distribution
strategy takes into account the long-term total return potential of its
investment in equities. Over time, the Fund has been able to distribute a
relatively high level of income as well as provide its shareholders with
moderate growth of principal. The Smith Barney Premium Total Return Fund meets
its objectives by distributing substantially all dividends, interest and net
capital gains earned over the course of the year. In certain years, the Fund
will supplement this income with a return of capital gained in order to maintain
the Fund's distributions. Each year, shareholders of the Fund receive a 1099
federal tax form that indicates the amount of the distributions which
represented ordinary income (dividends, interest and short-term capital gains),
long-term capital gains and return of capital.
5
<PAGE>
<TABLE>
<CAPTION>
Historical Performance - Class A Shares
Net Asset Value
-------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $16.33 $ 17.40 $ 0.37 $ 0.91 $0.00 14.76%
- ------------------------------------------------------------------------------------------------------------------------
7/31/95 15.69 16.33 0.43 0.14 0.71 12.92
- ------------------------------------------------------------------------------------------------------------------------
7/31/94 15.65 15.69 0.55 0.52 0.21 8.65
- ------------------------------------------------------------------------------------------------------------------------
Inception*-7/31/93 15.15 15.65 0.20 0.49 0.33 10.31+
========================================================================================================================
Total $ 1.55 $ 2.06 $ 1.25
========================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Historical Performance - Class B Shares
Net Asset Value
-------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $16.33 $17.40 $0.28 $0.91 $0.00 14.21%
- ------------------------------------------------------------------------------------------------------------------------
7/31/95 15.69 16.33 0.34 0.14 0.72 12.36
- ------------------------------------------------------------------------------------------------------------------------
7/31/94 15.65 15.69 0.49 0.52 0.20 8.12
- ------------------------------------------------------------------------------------------------------------------------
7/31/93 15.21 15.65 0.19 0.63 0.44 11.68
- ------------------------------------------------------------------------------------------------------------------------
7/31/92 14.26 15.21 0.22 0.00 0.98 15.68
- ------------------------------------------------------------------------------------------------------------------------
7/31/91 13.30 14.26 0.24 0.00 0.96 17.53
- ------------------------------------------------------------------------------------------------------------------------
7/31/90 13.98 13.30 0.22 0.00 1.06 4.62
- ------------------------------------------------------------------------------------------------------------------------
7/31/89 12.90 13.98 0.89 0.26 0.33 21.49
- ------------------------------------------------------------------------------------------------------------------------
7/31/88 14.47 12.90 0.18 1.28 0.00 0.21
- ------------------------------------------------------------------------------------------------------------------------
7/31/87 14.52 14.47 0.28 1.42 0.00 12.07
========================================================================================================================
Total $3.33 $5.16 $4.69
========================================================================================================================
</TABLE>
<PAGE>
Historical Performance - Class C Shares
<TABLE>
<CAPTION>
Net Asset Value
-------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns/(1)/
========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $16.33 $ 17.41 $ 0.29 $ 0.91 $0.00 14.30%
- ------------------------------------------------------------------------------------------------------------------------
7/31/95 15.69 16.33 0.35 0.14 0.71 12.36
- ------------------------------------------------------------------------------------------------------------------------
7/31/94 15.65 15.69 0.49 0.52 0.20 8.12
- ------------------------------------------------------------------------------------------------------------------------
Inception*-7/31/93 15.45 15.65 0.04 0.09 0.07 2.60+
========================================================================================================================
Total $ 1.17 $ 1.66 $ 0.98
========================================================================================================================
</TABLE>
Historical Performance - Class Y Shares
<TABLE>
<CAPTION>
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns/(1)/
========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Inception*-7/31/96 $17.57 $ 17.42 $ 0.21 $ 0.46 $0.00 2.93%+
========================================================================================================================
</TABLE>
It is the Fund's policy to distribute dividends monthly and capital
gains, if any, annually.
Average Annual Total Return
<TABLE>
<CAPTION>
Without Sales Charge/(1)/
---------------------------------------------------------
Class A Class B Class C Class Y
========================================================================================================================
<S> <C> <C> <C> <C>
Year Ended 7/31/96 14.76% 14.21% 14.30% N/A
- ------------------------------------------------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 12.38 N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
Ten Years Ended 7/31/96 N/A 11.64 N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
Inception* through 7/31/96 12.51 12.63 11.83 2.93%+
========================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Without Sales Charge/(2)/
---------------------------------------------------------
Class A Class B Class C Class Y
========================================================================================================================
<S> <C> <C> <C> <C>
Year Ended 7/31/96 9.02% 9.21% 13.30% N/A
- ------------------------------------------------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 12.26 N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
Ten Years Ended 7/31/96 N/A 11.64 N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
Inception* through 7/31/96 10.97 12.63 11.83 2.93%
========================================================================================================================
</TABLE>
7
<PAGE>
Cumulative Total Return
<TABLE>
<CAPTION>
<S> <C>
Without Sales Charge/(1)/
========================================================================================================================
Class A (Inception* through 7/31/96) 55.30%
- ------------------------------------------------------------------------------------------------------------------------
Class B (7/31/86* through 7/31/96) 200.70
- ------------------------------------------------------------------------------------------------------------------------
Class C (Inception* through 7/31/96) 42.48
- ------------------------------------------------------------------------------------------------------------------------
Class Y (Inception* through 7/31/96) 2.93+
========================================================================================================================
</TABLE>
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable sales charges with respect to Class A shares or the applicable
contingent deferred sales charges ("CDSC") with respect to Class B and C
shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, Class A shares reflect the deduction
of the maximum initial sales charge of 5.00% and Class B shares reflect the
deduction of a 5.00% CDSC, which applies if shares are redeemed within one
year from initial purchase and declines thereafter by 1.00% per year until
no CDSC occurs. Class C shares reflect the deduction of a 1.00% CDSC, which
applies if shares are redeemed within the first year of purchase.
* Inception dates for Class A, B, C and Y shares are November 6, 1992,
September 16, 1985, June 1, 1993 and February 7, 1996, respectively.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
8
<PAGE>
Historical Performance (unaudited)
Growth of $10,000 Invested in Class B Shares of
Smith Barney Premium Total Return Fund
vs. the Standard & Poor's 500 Index+
- -----------------------------------------------------------------------------
July 1986 - July 1996
[LINE GRAPH APPEARS HERE]
+ Hypothetical illustration of $10,000 invested in Class B shares on July 31,
1986, assuming reinvestment of dividends and capital gains, if any, at net
asset value through July 31, 1996. The Standard & Poor's 500 Index is an
index composed of widely held common stocks listed on the New York Stock
Exchange, American Stock Exchange and over-the-counter market. Figures for
the index include reinvestment of dividends. The index is unmanaged and is
not subject to the same management and trading expenses as a mutual fund. The
performance of the Fund's other classes may be greater or less than the Class
B shares' performance indicated on this chart, depending on whether greater
or lesser sales charges and fees were incurred by shareholders investing in
other classes.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital
gains.
9
<PAGE>
Portfolio Highlights (unaudited) July 31, 1996
Portfolio Breakdown
[PIE CHART APPEARS HERE]
Repurchase Agreements 16.1%
Banking & Financial Services 13.0%
Utilities 11.3%
Insurance 9.8%
Consumer Services 8.3%
Consumer Non-Durables 7.1%
Energy 6.8%
Healthcare 6.6%
Tobacco 5.5%
Transportation 3.5%
Financial 3.1%
Other Common Stocks 7.0%
Other Preferred Stocks, Corporate Bonds, Convertible Bonds
and Options Purchased 1.9%
Top Ten Common Stock Holdings
Percentage of
Company Total Investments
- --------------------------------------------------------------------------------
Philip Morris Cos., Inc. 4.7%
Loews Corp. 4.6
Student Loan Marketing Association 3.3
Bristol Myers Squibb Co. 2.8
Sprint Corp. 2.0
Lehman Brothers Holdings Inc. 2.0
Republic of New York Corp. 1.8
Canadian Pacific Ltd. 1.8
Dun & Bradstreet Corp. 1.7
Telefonica Espana SA 1.7
10
<PAGE>
Schedule of Investments July 31, 1996
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
============================================================================
<C> <S> <C>
COMMON STOCKS--78.9%
Agricultural Products -- 0.7%
1,000,000 Archer-Daniels-Midland $ 17,750,000
- ----------------------------------------------------------------------------
Banking & Financial Services--13.0%
552,692 Bank of Boston Corp. 29,292,676
105,000 Cal Fed BanCorp Inc. 2,375,625
600,000 Dean Witter Discover & Co. 30,525,000
142,900 Federal Home Loan Mortgage Corp. 12,039,325
748,600 H & R Block Inc. 19,557,175
462,100 J.P. Morgan & Co., Inc. 39,740,600
143,700 JSB Financial Inc. 4,724,138
2,249,500 Lehman Brothers Holdings Inc. 52,019,688
70,200 PHH Corp. 3,738,150
484,140 PNC Bank Corp. 14,100,578
766,900 Republic of New York Corp. 48,602,288
1,201,400 Student Loan Marketing Association 87,702,197
- ----------------------------------------------------------------------------
344,417,440
- ----------------------------------------------------------------------------
Capital Goods--2.7%
217,100 Emerson Electric Co. 18,317,813
330,300 Lockheed Martin Corp. 27,373,613
258,100 Lubrizol Corp. 7,388,113
400,000 Raytheon Co. 19,400,000
6,000 Textron Inc. 479,998
- ----------------------------------------------------------------------------
72,959,537
- ----------------------------------------------------------------------------
Consumer Durables -- 1.1%
140,000 Borg-Warner Automotive Inc. 4,900,000
1,175,800 Volvo Aktie Bolaget, Sponsored ADR 25,279,700
- ----------------------------------------------------------------------------
30,179,700
- ----------------------------------------------------------------------------
Consumer Non-Durables--7.1%
305,300 Dial Corp. 8,930,025
356,700 Hasbro Inc. 12,796,613
1,523,100 Loews Corp. 122,799,938
458,600 Nestle S.A., Sponsored ADR 26,254,850
18,260 Nestle S.A., Sponsored ADR+ 1,043,103
394,300 Tupperware Corp. 16,856,324
- ----------------------------------------------------------------------------
188,680,853
- ----------------------------------------------------------------------------
Consumer Services -- 8.3%
493,600 360 Communications Co. 11,414,500
210,000 Alberto Culver Co., Class A Shares 7,691,250
600,000 American Stores Co. 22,350,000
416,400 Big B Inc. 4,007,850
308,900 Bowne & Co., Inc. 6,332,450
678,600 Comsat Corp. 13,063,050
196,500 Deluxe Corp. 7,245,938
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
============================================================================
<C> <S> <C>
Consumer Services--8.3% (continued)
789,100 Dun & Bradstreet Corp. $ 45,373,250
949,378 Limited Inc. 18,275,527
268,312 Luby's Cafeterias Inc. 6,506,566
100,000 Mercantile Stores Co., Inc. 4,900,000
394,300 Premark International Inc. 7,097,400
304,900 RFS Hotels Investment Inc. 4,878,400
1,417,700 Rite Aid Corp. 42,176,575
221,500 Sbarro Inc. 5,122,188
171,466 Sears, Roebuck & Co. 7,030,106
400,000 Thrifty Payless Holdings, Inc. 5,599,999
- ----------------------------------------------------------------------------
219,065,049
- ----------------------------------------------------------------------------
Energy -- 6.8%
117,700 Amoco Corp. 7,871,188
141,751 British Petroleum PLC ADR 15,574,891
252,400 Diamond Shamrock Inc. 7,004,100
311,400 Exxon Corp. 25,612,650
1,066,200 Horsham Corp. 13,860,600
240,100 Mobil Oil Corp. 26,501,038
1,242,800 Repsol S.A., Sponsored ADR 41,478,450
322,500 Shell Transport & Trading ADR 27,976,875
278,200 Tosco Corp. 13,597,024
- ----------------------------------------------------------------------------
179,476,816
- ----------------------------------------------------------------------------
Forest Products -- 1.0%
606,000 Champion International Corp. 25,603,500
- ----------------------------------------------------------------------------
Healthcare--6.6%
253,700 Abbott Labs., Inc. 11,162,800
519,600 Astra AB, Class A Shares ADR 21,953,100
847,400 Bristol-Myers Squibb Co. 73,406,025
1,100,000 Glaxo Welcome PLC, Sponsored ADR 30,525,000
333,000 Pharmacia & Upjohn Inc. 13,736,250
418,600 Schering Plough Corp. 23,075,325
- ----------------------------------------------------------------------------
173,858,500
- ----------------------------------------------------------------------------
Insurance--9.8%
731,300 Ace Ltd. 32,177,200
526,300 Allmerica Financial Corp. 15,591,638
464,300 Allmerica Property & Casualty
Companies, Inc. 12,187,875
299,750 Allstate Corp. 13,413,813
275,200 American International Group Inc. 25,903,200
350,450 Aon Corp. 17,040,631
156,000 CIGNA Corp. 16,614,000
464,600 Exel Ltd. 15,447,950
215,000 Financial Security Assurance Inc. 5,751,250
</TABLE>
See Notes to Financial Statements.
12
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
==============================================================================
<C> <S> <C>
Insurance--9.8% (continued)
221,500 GCR Holdings Ltd. $ 5,066,813
100,600 Horace Mann Educators Co. 3,143,750
297,500 IPC Holdings Ltd. 5,912,813
308,900 John Alden Financial Corp. 6,216,613
253,300 Mid Ocean Ltd. 10,195,325
251,600 Partnerre Ltd. 7,107,700
319,000 Prudential Reinsurance Holdings Corp. 7,695,875
502,300 St. Paul Cos., Inc. 25,994,025
205,000 Terra Nova (Bermuda) Holdings Ltd. 3,433,750
603,500 TIG Holdings Inc. 16,747,125
123,200 Transatlantic Holdings Inc. 8,100,400
348,100 Western National Corp. 5,961,213
1,800 Zurich Reinsurance Centre Holdings 53,997
- ------------------------------------------------------------------------------
259,756,956
- ------------------------------------------------------------------------------
Real Estate--1.5%
200,000 Ambassador Apartments Inc. 3,400,000
89,200 Associated Estates Realty Corp. 1,806,300
120,700 Avalon Properties Inc. 2,715,750
142,433 Camden Property Trust 3,454,000
154,800 Charles E. Smith Residential Realty Inc. 3,560,400
60,000 Chateau Properties Inc. 1,365,000
328,800 Equity Inns Inc. 3,822,300
286,300 Mid-America Apartment Communities 7,264,863
201,800 Storage Trust Realty 4,086,450
160,000 Summit Properties Inc. 2,920,000
250,600 Wellsford Residential Property Trust 5,450,550
- ------------------------------------------------------------------------------
39,845,613
- ------------------------------------------------------------------------------
Tobacco--5.5%
900,000 B.A.T. Industries PLC, Sponsored ADR 14,400,000
1,202,500 Philip Morris Cos., Inc.++ 125,811,563
100,000 RJR Nabisco Holdings Corp. 3,375,000
117,580 Swedish Match Co., Sponsored ADR 3,424,517
- ------------------------------------------------------------------------------
147,011,080
- ------------------------------------------------------------------------------
Transportation--3.5%
2,157,100 Canadian Pacific Ltd. 46,916,925
592,700 Kansas City Southern Industries, Inc. 22,967,125
362,700 Pittston Brink's Group 10,336,950
543,500 Pittston Burlington Group Inc. 9,918,875
94,400 Stolt Nielson S.A. 1,604,800
127,400 Stolt Nielson S.A. ADR 2,261,350
- ------------------------------------------------------------------------------
94,006,025
- ------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
13
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
==============================================================================
<C> <S> <C>
Utilities--11.3%
436,500 American Telephone & Telegraph Corp. $ 22,752,563
719,600 BCE Inc. 28,694,050
835,500 CMS Energy Corp. 25,378,313
711,000 Entergy Corp. 18,130,500
339,600 Illinova Corp. 8,744,700
575,000 Nynex Corp. 25,803,125
864,300 Pinnacle West Capital Corp. 24,416,475
475,000 Portland General Corp. 16,862,500
982,500 Powergen PLC, Sponsored ADR 30,211,875
8,500 Public Service New Mexico 168,938
1,481,000 Sprint Corp. 54,241,625
867,300 Telefonica Espana S.A. ADR 45,316,424
- ------------------------------------------------------------------------------
300,721,088
- ------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost--$1,711,522,072) 2,093,332,157
==============================================================================
PREFERRED STOCKS--3.7%
Financial--3.1%
100,000 Allstate Corp., Convertible 6.765% 4,262,500
200,000 First Washington Realty Inc.,
Convertible Series A+ 3,950,000
760,000 Glendale Federal Bank, Federal
Savings Bank of California,
Convertible, Series E,
Exchange 8.750% 36,670,000
304,767 Riggs National Corp., Washington D.C.,
Series B, Exchange 10.750% 8,457,284
Salomon Inc.:
250,000 Convertible 6.750% 8,531,250
250,000 Convertible 7.625% 6,687,500
103,000 Time Warner Financial Corp. 3,669,375
400,000 Walden Residential Properties Inc. 9,900,000
- ------------------------------------------------------------------------------
82,127,909
- ------------------------------------------------------------------------------
Industrial--0.5%
305,000 Bowater Inc., Depository Shares,
Convertible, Series B,
Exchange 7.000% 8,273,125
243,000 Prime Retail Inc., Series A,
Exchange 10.500% 5,832,000
- ------------------------------------------------------------------------------
14,105,125
- ------------------------------------------------------------------------------
Real Estate--0.1%
77,700 Security Capital Pacific Trust 1,971,638
- ------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS
(Cost--$85,097,510) 98,204,672
==============================================================================
</TABLE>
See Notes to Financial Statements.
14
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
================================================================================
CORPORATE BONDS--1.2%
Gas Transmission--0.2%
<S> <C>
Columbia Gas Systems Inc., Debentures:
$ 774,000 6.390% due 12/28/00 $ 755,618
771,000 6.610% due 11/28/02 750,761
771,000 6.800% due 11/28/05 737,269
771,000 7.050% due 11/28/07 732,450
771,000 7.320% due 11/28/10 725,704
771,000 7.420% due 11/28/15 714,139
771,000 7.620% due 11/28/25 715,101
- -----------------------------------------------------------------------------
5,131,042
- -----------------------------------------------------------------------------
Industrial - 1.0%
5,635,000 Comcast Corp., 9.375% due 5/15/05 5,522,300
4,915,000 Paging Network, 8.875% due 2/1/06 4,534,088
3,000,000 Riveria Holdings Corp., First Mortgage, 11.000%
due 12/31/02 2,992,500
6,000,000 Rogers Cable Systems Inc., 10.000% due 3/15/05 6,000,000
6,000,000 Tenet Healthcare Corp., 10.125% due 3/1/05 6,375,000
- -----------------------------------------------------------------------------
25,423,888
- -----------------------------------------------------------------------------
TOTAL CORPORATE BONDS
(Cost--$30,423,867) 30,554,930
=============================================================================
CONVERTIBLE BONDS--0.1%
2,500,000 Ashanti Capital, 5.500% due 3/15/03 2,262,500
1,500,000 Pacific Concord Financial, 4.750% due 12/10/98+ 1,466,250
- -----------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(Cost--$4,000,000) 3,728,750
=============================================================================
REPURCHASE AGREEMENTS - 16.1%
300,000,000 Goldman Sachs & Co., 5.522% due 8/1/96;
Proceeds at maturity - $300,046,017; (Fully
collateralized by U.S. Treasury Notes,
7.750% due 1/31/00; Market value - $306,205,360) 300,000,000
27,725,000 Chase Manhattan Bank, 5.545% due 8/1/96;
Proceeds at maturity - $27,729,270; (Fully
collateralized by U.S. Treasury Notes, 6.250%
due 7/31/98;
Market value--$28,290,873) 27,725,000
100,000,000 CS First Boston, 5.544% due 8/1/96;
Proceeds at maturity - $100,015,400; (Fully
collateralized by U.S. Treasury Notes, 6.000%
due 5/31/98;
Market value - $102,041,419) 100,000,000
- -----------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS
(Cost--$427,725,000) 427,725,000
=============================================================================
</TABLE>
See Notes to Financial Statements.
15
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
=============================================================================
<S> <C>
OPTIONS PURCHASED - 0.0%
12,025 Philip Morris Cos., Inc., Put @
65, Expires 10/1/96
(Cost--$601,250) $ 12,025
=============================================================================
TOTAL INVESTMENTS - 100%
(Cost--$2,259,369,699*) $2,653,557,534
=============================================================================
</TABLE>
+ Security exempt from registration under Rule 144A of the Securities Act of
1933. These securities may be resold in transactions that are exempt from
registration, normally to qualified institution buyers.
+
+ Security segregrated to cover written call options.
* Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements
16
<PAGE>
Statement of Assets and Liabilities July 31, 1996
<TABLE>
<CAPTION>
ASSETS:
<S> <C>
Investments, at value
(Cost--$2,259,369,699) $2,653,557,534
Cash 737
Receivable for Fund shares sold 4,936,478
Dividend and interest receivable 4,280,072
- -------------------------------------------------------------------------------
Total Assets 2,662,774,821
- -------------------------------------------------------------------------------
LIABILITIES:
Options written 33,365,425
Payable for securities purchase 25,436,899
Distribution fees payable 1,420,018
Investment advisory fees payable 1,187,758
Payable for Fund shares purchase 968,900
Administration fees payable 443,866
Accrued expenses 588,439
- -------------------------------------------------------------------------------
Total Liabilities 63,411,305
- -------------------------------------------------------------------------------
Total Net Assets $2,599,363,516
===============================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 149,364
Capital paid in excess
of par value 2,137,918,020
Undistribution of net investment income 252,227
Undistributed net realized gain on security transactions 54,879,768
Net unrealized appreciation of investments and
options written 406,164,137
- -------------------------------------------------------------------------------
Total Net Assets $2,599,363,516
===============================================================================
Shares Outstanding:
Class A 30,700,279
- -------------------------------------------------------------------------------
Class B 116,123,502
- -------------------------------------------------------------------------------
Class C 1,783,030
- -------------------------------------------------------------------------------
Class Y 757,375
- -------------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $17.40
- -------------------------------------------------------------------------------
Class B * $17.40
- -------------------------------------------------------------------------------
Class C ** $17.41
- -------------------------------------------------------------------------------
Class Y (and redemption price) $17.42
- -------------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(Net asset value plus 5.26% of net asset value per share) $18.32
</TABLE>
===============================================================================
* Redemption price is NAV of Class B shares reduced by a 5.00% CDSC if shares
are redeemed within one year from initial purchase (See Note 2).
** Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
are redeemed within one year from initial purchase.
See Notes to Financial Statements.
17
<PAGE>
Statement of Operations For the Year Ended July 31, 1996
<TABLE>
<CAPTION>
INVESTMENT INCOME:
<S> <C>
Dividends $ 57,823,881
Interest 22,784,773
Less: Foreign withholding tax (1,449,040)
- ------------------------------------------------------------------------------
Total Investment Income 79,159,614
- ------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 2) 15,646,147
Investment advisory fees (Note 2) 13,381,076
Administration fees (Note 2) 4,866,536
Shareholder and system servicing fees 1,859,000
Shareholder communications 373,000
Registration fees 158,000
Custody 96,000
Audit and legal 50,000
Trustee's fees 10,000
Insurance 10,000
Other 105,509
- ------------------------------------------------------------------------------
Total Expenses 36,555,268
- ------------------------------------------------------------------------------
Net Investment Income 42,604,346
- ------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
AND OPTIONS (NOTES 3 AND 4):
Realized Gain (Loss) From:
Security transactions (excluding
short-term securities) 286,092,703
Options written (100,824,489)
- ------------------------------------------------------------------------------
Net Realized Gain 185,268,214
- ------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments
and Options Written:
Beginning of year 317,932,020
End of year 406,164,137
- ------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 88,232,117
- ------------------------------------------------------------------------------
Net Gain on Investments and Options Written 273,500,331
- ------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 316,104,677
==============================================================================
</TABLE>
See Notes to Financial Statements.
18
<PAGE>
Statements of Changes in Net Assets For the Years Ended July 31,
<TABLE>
<CAPTION>
1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Net investment income $ 42,604,346 $ 46,438,616
Net realized gain 185,268,214 32,038,891
Increase in net unrealized appreciation 88,232,117 155,800,233
- -------------------------------------------------------------------------------
Increase in Net Assets From Operations 316,104,677 234,277,740
- -------------------------------------------------------------------------------
DISTRIBUTION TO SHAREHOLDERS FROM:
Net investment income (42,253,658) (43,873,984)
Net realized gains (129,273,168) (17,566,601)
Capital -- (88,629,006)
- -------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions To Shareholders (171,526,826) (150,069,591)
- -------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
Net proceeds from sales 535,462,312 809,725,275
Net asset value of shares issued
for reinvestment of dividends 126,644,485 112,530,432
Cost of shares reacquire (346,996,312) (633,759,102)
- -------------------------------------------------------------------------------
Increase in Net Assets From Fund
Share Transactions 315,110,485 288,496,605
- -------------------------------------------------------------------------------
Increase in Net Assets 459,688,336 372,704,754
NET ASSETS:
Beginning of year 2,139,675,180 1,766,970,426
- -------------------------------------------------------------------------------
End of year* $2,599,363,516 $2,139,675,180
===============================================================================
* Includes undistributed net
investment income of: $ 252,227 $ 319,650
===============================================================================
</TABLE>
See Notes to Financial Statements.
19
<PAGE>
Notes to Financial Statements
1. Significant Accounting Policies
The Smith Barney Premium Total Return Fund ("Fund"), a separate investment
fund of the Smith Barney Income Funds ("Trust"), a Massachusetts business trust,
is registered under the Investment Company Act of 1940, as amended, as a
diversified, open-end management investment company. The Trust consists of the
Fund and six other separate investment funds: Smith Barney Exchange Reserve
Fund, Smith Barney Convertible Fund, Smith Barney High Income Fund, Smith Barney
Tax-Exempt Income Fund, Smith Barney Diversified Strategic Income Fund and Smith
Barney Utilities Fund. The financial statements and financial highlights for the
other Funds are presented in separate annual reports.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) investments are
valued at market value or, in the absence of market value with respect to any
portfolio securities, at fair value as determined by or under the direction of
the Trust's Board of Trustees. Portfolio securities that are traded primarily on
a domestic or foreign exchange are valued at the last sale price on that
exchange or, if there were no sales during the day, at the current quoted bid
price. Over-the-counter securities are valued on the basis of the bid price at
the close of business each day. Options are generally valued at the last sale
price or, in the absence of the last price, the last offer price. Investments in
U.S. government securities (other than short-term securities) are valued at the
mean of the quoted bid and ask price; (c) securities maturing within 60 days or
less are valued at cost plus accreted discount, or minus amortized premium, as
applicable; (d) dividend income is recorded on ex-dividend date and interest
income is recorded on the accrual basis; (e) dividends and distributions to
shareholders are recorded on the ex-dividend date; (f) gains or losses on the
sale of securities calculated using the specific identification method; (g) the
accounting records 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. Purchases and sales of securities, and income and expenses are
translated at the rate of exchange quoted on the respective date that such
transactions are recorded. Differences between income and expense amounts
recorded and collected or paid are adjusted when reported by the custodian bank;
(h) direct expenses are charged to each fund and
20
<PAGE>
Notes to Financial Statements (continued)
each class; management fees and general fund expenses are allocated on the basis
of relative net assets of each class; (i) the character of income and gains to
be distributed are determined in accordance with income tax regulations which
may differ from generally accepted accounting prinicples. At July 31, 1996,
reclassifications are made to the Portfolio's capital accounts to reflect
permanent book/tax differences and income and gains available for distributions
under income tax regulations. Accordingly, a portion of undistributed net
investment income amounting to $319,650 has been reclassified to paid-in
capital. Net investment income, net realized gains and net assets were not
affected by this change; (j) the Fund intends to comply with the applicable
provisions of the Internal Revenue Code of 1986, as amended, pertaining to
regulated investment companies and to make distributions of taxable income
sufficient to relieve it from substantially all Federal income and excise taxes;
and (k) estimates and assumptions are required to be made regarding assets,
liabilities and changes in net assets resulting from operations when financial
statements are prepared. Changes in the economic environment, financial markets
and any other parameters used in determining these estimates could cause actual
results to differ.
In addition, the Fund may from time to time enter into options and/or
futures contracts in order to hedge market risk.
2. Investment Advisory Agreement, Administration Agreement and Other
Transactions
Smith Barney Strategy Advisers Inc. ("SBSA"), a subsidiary of Smith Barney
Mutual Funds Management Inc. ("SBMFM"), which, in turn, is a subsidiary of Smith
Barney Holdings Inc. ("SBH"), acts as investment adviser to the Trust. The Fund
pays SBSA an advisory fee calculated at an annual rate of 0.55% of the average
daily net assets. This fee is calculated daily and paid monthly.
In addition, The Boston Company Advisors, Inc. ("Boston Advisors"), an
indirect wholly owned subsidiary of Mellon Bank Corporation, acted as
Sub-Investment Advisor to the Trust. SBSA paid Boston Advisors a sub-advisory
fee calculated at an annual rate of 0.275% of average daily net assets. This fee
was calculated daily and paid monthly. As of August 15, 1995 this relationship
was terminated.
21
<PAGE>
Notes to Financial Statements (continued)
On August 10, 1995 at a special meeting, the shareholders of the Fund
approved a new investment advisory agreement between the Fund and SBSA and a new
sub-investment advisory agreement ("Sub-Advisory Agreement") among the Fund,
SBSA and Boston Partners Asset Management, L.P. ("Boston Partners"). Under the
Sub-Advisory Agreement, which went into effect August 16, 1995, SBSA pays Boston
Partners a fee calculated at an annual rate of 0.10% of the average daily net
assets. This fee is paid monthly.
SBMFM acts as the Fund's administrator for which the Fund pays a fee
calculated at an annual rate of 0.20% of the average daily net assets. This fee
is calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SBH, acts as distributor of
Fund shares and primary broker for its portfolio agency transactions. For the
year ended July 31, 1996, SB received brokerage commissions of $628,778 and
sales charges of approximately $968,000 for sales of the Fund's Class A shares.
There is a contingent deferred sales charge ("CDSC") of 5.00% on Class B
shares, which applies if redemption occurs less than one year from initial
purchase and thereafter declines by 1.00% per year until no CDSC is incurred.
Class C shares have a 1.00% CDSC, which applies if redemption occurs within the
first year of purchase. In addition, Class A shares also have a 1.00% CDSC,
which applies if redemption occurs within the first year of purchase. This CDSC
only applies to those purchases of Class A shares, which when combined with
current holdings of Class A shares, equal or exceed $500,000 in the aggregate.
These purchases do not incur an initial sales charge. For the year ended July
31, 1996, CDSCs paid to SB were:
<TABLE>
<CAPTION>
Class A Class B Class C
=========================================================================
<S> <C> <C> <C>
CDSCs $1,000 $2,905,000 $12,000
=========================================================================
</TABLE>
Pursuant to a Distribution Plan, the Fund pays a service fee with respect
to Class A, B and C shares calculated at the annual rate of 0.25% of the average
daily net assets of each respective class. The Fund also pays a distribution fee
with respect to Class B and C shares calculated at the annual rate of 0.50% and
0.45% of the average daily
22
<PAGE>
Notes to Financial Statements (continued)
net assets of each class, respectively. For the year ended July 31, 1996, total
Distribution Plan fees incurred were:
<TABLE>
<CAPTION>
Class A Class B Class C
=========================================================================
<S> <C> <C> <C>
Distribution Plan Fees $1,284,390 $14,202,022 $159,735
=========================================================================
</TABLE>
All officers and one Trustee of the Trust are employees of SB.
3. Investments
During the year ended July 31, 1996, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding short-
term securities) were as follows:
<TABLE>
<CAPTION>
=========================================================================
<S> <C>
Purchases $1,315,509,171
Sales 1,326,019,663
=========================================================================
</TABLE>
At July 31, 1996, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were approximately
as follows:
<TABLE>
<CAPTION>
=========================================================================
<S> <C>
Gross unrealized appreciation $438,637,000
Gross unrealized depreciation (44,449,000)
- -------------------------------------------------------------------------
Net unrealized appreciation $394,188,000
</TABLE>
4. Option Contracts
Premiums paid when put or call options are purchased by the Fund, represent
investments, which are marked-to-market daily. When a purchased option expires,
the Fund will realize a loss in the amount of the premium paid. When the Fund
enters into a closing sales transaction, the Fund will realize a gain or loss
depending on whether the proceeds from the closing sales transaction are greater
or less than the premium paid for the option. When the Fund exercises a put
option, it will realize a gain or loss from the sale of the underlying security
and the proceeds from such sale will be decreased by the premium originally
paid. When the Fund exercises a call option, the cost of the security which the
Fund purchases upon exercise will be increased by the premium originally paid.
As of July 31, 1996, the Fund held one purchased put option with a cost of
$601,250.
When a Fund writes a call or put option, an amount equal to the premium
received by the Fund is recorded as a liability, the value of which is marked-
to-market daily. When a written option expires, the Fund realizes a gain equal
to the amount of the premium received. When the
23
<PAGE>
Notes to Financial Statements (continued)
Fund enters into a closing purchase transaction, the Fund realizes a gain (or
loss if the cost of the closing purchase transaction exceeds the premium
received when the option was sold) without regard to any unrealized gain or loss
on the underlying security, and the liability related to such option is
eliminated. When a call option is exercised the cost of the security sold will
be increased by the premium originally received. When a put option is exercised,
the amount of the premium originally received will reduce the cost of the
security which the Fund purchased upon exercise. When written index options are
exercised, settlement is made in cash. The risk associated with purchasing
options is limited to the premium originally paid. The Fund enters into options
for hedging purposes. The risk in writing a call option is that the Fund gives
up the opportunity to participate in any increase in the price of the underlying
security beyond the exercise price. The risk in writing a put option is that the
Fund is exposed to the risk of loss if the market price of the underlying
security declines.
The following option transactions occurred during the year ended July 31,
1996:
<TABLE>
<CAPTION>
Number of
Premiums Contracts
===============================================================================
<S> <C> <C>
Options written, outstanding at July 31, 1995 $ 18,923,528 13,000
Options written during the fiscal year 197,213,865 81,325
Options cancelled in closing purchase transactions (170,795,666) (71,300)
- ------------------------------------------------------------------------------
Options written, outstanding at July 31, 1996 $ 45,341,727 23,025
===============================================================================
</TABLE>
The following table represents the open options contracts as of
July 31, 1996:
<TABLE>
<CAPTION>
Number of Strike
Contracts Expiration Price Value
===============================================================================
Call Options Written
<S> <C> <C> <C>
8,000 S&P 500 Index 3/22/97 $675 $(17,300,000)
3,000 S&P 500 Index 3/22/97 635 (12,975,000)
12,025 Philip Morris Cos., Inc. 10/19/96 109 (3,090,425)
- -------------------------------------------------------------------------------
Total Call Options Written
(Premiums received -- $45,341,727) $(33,365,425)
===============================================================================
</TABLE>
5. Repurchase Agreements
The Fund purchases (and its custodian takes possession of) U.S. Government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires continual maintenance
of the market value of the collateral in amounts at least equal to the
repurchase price.
24
<PAGE>
Notes to Financial Statements (continued)
6. Shares of Beneficial Interest
At July 31, 1996, the Trust had an unlimited number of shares of beneficial
interest authorized with a par value of $.001 per share. The Fund has the
ability to issue multiple classes of shares. Each share of a class represents an
identical interest and has the same rights, except that each class bears certain
direct expenses specifically related to the distribution of its shares.
At July 31, 1996, total paid-in capital amounted to the following for each
class:
<TABLE>
<CAPTION>
Class A Class B Class C Class Y
====================================================================================================================
<S> <C> <C> <C> <C>
Total Paid-in Capital $ 461,113,941 $1,634,365,464 $29,194,227 $13,393,752
====================================================================================================================
</TABLE>
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
July 31, 1996* July 31, 1995**
------------------------------------ -------------------------------------
Shares Amount Shares Amount
=====================================================================================================================
Class A
<S> <C> <C> <C> <C>
Shares sold 4,407,887 $ 74,401,892 26,713,759 $ 417,476,828
Shares issued on
reinvestment 1,719,698 29,658,966 1,700,397 26,539,686
Shares redeemed (4,309,199) (74,624,179) (3,846,700) (60,728,442)
- ---------------------------------------------------------------------------------------------------------------------
Net Increase 1,818,386 $ 29,436,679 24,567,456 $ 383,288,072
=====================================================================================================================
Class B
Shares sold 24,708,121 $ 427,376,024 24,240,345 $ 379,429,438
Shares issued on
reinvestment 5,545,245 95,657,996 5,471,457 85,566,358
Shares redeemed (15,497,442) (267,822,402) (36,520,145) (570,325,145)
- ---------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) 14,755,924 $ 255,211,618 (6,808,343) $(105,329,349)
=====================================================================================================================
Class C
Shares sold 1,176,592 $ 20,291,428 817,749 $ 12,819,009
Shares issued on
reinvestment 76,551 1,327,523 26,905 424,388
Shares redeemed (262,293) (4,549,731) (172,141) (2,705,515)
- ---------------------------------------------------------------------------------------------------------------------
Net Increase 990,850 $ 17,069,220 672,513 $ 10,537,882
=====================================================================================================================
Class Y
Shares sold 757,375 $ 13,392,968 -- --
Shares issued on
reinvestment -- -- -- --
Shares redeemed -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Net Increase 757,375 $ 13,392,968 -- --
=====================================================================================================================
</TABLE>
* Transaction for Class Y Shares are for the period from February 7, 1996
(inception date) to July 31, 1996.
** On November 7, 1994 the former Class D shares were renamed Class C shares.
25
<PAGE>
Financial Highlights
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1996 1995 1994 1993(1)
==============================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 16.33 $ 15.69 $ 15.65 $ 15.15
- ------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.37 0.44 0.33 0.19
Net realized and unrealized gain 1.98 1.48 0.99 1.33
- ------------------------------------------------------------------------------
Total Income From Operations 2.35 1.92 1.32 1.52
- ------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.37) (0.43) (0.31) (0.17)
Overdistribution of net
investment income -- -- (0.24) (0.03)
Net realized gains (0.91) (0.14) (0.52) (0.44)
Overdistribution of net
realized gains -- -- -- (0.05)
Capital -- (0.71) (0.21) (0.33)
- ------------------------------------------------------------------------------
Total Distributions (1.28) (1.28) (1.28) (1.02)
- ------------------------------------------------------------------------------
Net Asset Value, End of Year $ 17.40 $ 16.33 $ 15.69 $ 15.65
- ------------------------------------------------------------------------------
Total Return 14.76% 12.92% 8.65% 10.31%++
- ------------------------------------------------------------------------------
Net Assets, End of Year (000s) $534,329 $471,578 $67,699 $39,677
- ------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.12% 1.16% 1.19% 1.20%+
Net investment income 2.16 2.81 2.05 1.64+
- ------------------------------------------------------------------------------
Portfolio Turnover Rate 58% 63% 34% 55%
==============================================================================
Average commissions per share
paid on equity transactions(2) $ 0.06 -- -- --
==============================================================================
</TABLE>
(1) For the period from November 6, 1992 (inception date) to July 31, 1993.
(2) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
26
<PAGE>
Financial Highlights (continued)
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class B Shares 1996 1995 1994 1993 1992
===============================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning
of Year $16.33 $15.69 $15.65 $15.21 $14.26
- -------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.28 0.36 0.25 0.23 0.22
Net realized and unrealized
gain 1.99 1.48 1.00 1.47 1.93
- -------------------------------------------------------------------------------
Total Income From Operations 2.27 1.84 1.25 1.70 2.15
- -------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.29) (0.34) (0.27) (0.16) (0.22)
Overdistribution of net
investment income -- -- (0.22) (0.03) --
Net realized gains (0.91) (0.14) (0.52) (0.57) --
Overdistribution of net
realized gains -- -- -- (0.06) --
Capital -- (0.72) (0.20) (0.44) (0.98)
- -------------------------------------------------------------------------------
Total Distributions (1.20) (1.20) (1.21) (1.26) (1.20)
- -------------------------------------------------------------------------------
Net Asset Value, End of Year $17.40 $16.33 $15.69 $15.65 $15.21
- -------------------------------------------------------------------------------
Total Return 14.21% 12.36% 8.12% 11.68% 15.68%
- -------------------------------------------------------------------------------
Net Assets, End of Year (millions) $2,021 $1,655 $1,697 $1,231 $ 585
- -------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.62% 1.66% 1.66% 1.69% 1.69%
Net investment income 1.66 2.31 1.58 1.16 1.53
- -------------------------------------------------------------------------------
Portfolio Turnover Rate 58% 63% 34% 55% 57%
===============================================================================
Average commissions per share
paid on equity transactions(1) $ 0.06 -- -- -- --
===============================================================================
</TABLE>
(1) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
27
<PAGE>
Financial Highlights (continued)
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class C Shares 1996 1995 1994(1) 1993(2)
==============================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $16.33 $15.69 $15.65 $15.45
- ------------------------------------------------------------------------------
Income From Operations From:
Net investment income 0.29 0.36 0.23 0.05
Net realized and unrealized gain 1.99 1.48 1.02 0.35
- ------------------------------------------------------------------------------
Total Income From Operations 2.28 1.84 1.25 0.40
- ------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.29) (0.35) (0.27) (0.03)
Overdistribution of net
investment income -- -- (0.22) (0.01)
Net realized gains (0.91) (0.14) (0.52) (0.08)
Overdistribution of net
realized gains -- -- -- (0.01)
Capital -- (0.71) (0.20) (0.07)
- ------------------------------------------------------------------------------
Total Distributions (1.20) (1.20) (1.21) (0.20)
- ------------------------------------------------------------------------------
Net Asset Value, End of Year $17.41 $16.33 $15.69 $15.65
- ------------------------------------------------------------------------------
Total Return 14.30% 12.36% 8.12% 2.60%++
- ------------------------------------------------------------------------------
Net Assets, End of Year (000s) $31,044 $12,937 $1,878 $357
- ------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.59% 1.62% 1.60% 1.31%+
Net investment income 1.68 2.35 1.65 1.54+
- ------------------------------------------------------------------------------
Portfolio Turnover Rate 58% 63% 34% 55%
==============================================================================
Average commissions per share
paid on equity transactions(3) $0.06 -- -- --
==============================================================================
</TABLE>
(1) On November 7, 1994 the former Class D shares were renamed Class C shares.
(2) For the period from June 1, 1993 (inception date) to July 31, 1993.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
28
<PAGE>
Financial Highlights (continued)
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class Y Shares 1996(1)
===========================================================================
<S> <C>
Net Asset Value, Beginning of Year $17.57
- ---------------------------------------------------------------------------
Income From Operations:
Net investment income 0.19
Net realized and unrealized gain 0.33
- ---------------------------------------------------------------------------
Total Income From Operations 0.52
- ---------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.21)
Net realized gains (0.46)
- ---------------------------------------------------------------------------
Total Distributions (0.67)
- ---------------------------------------------------------------------------
Net Asset Value, End of Year $17.42
- ---------------------------------------------------------------------------
Total Return++ 2.93%
- ---------------------------------------------------------------------------
Net Assets, End of Year (000s) $13,192
- ---------------------------------------------------------------------------
Ratios to Average Net Assets+:
Expenses 0.87%
Net investment income 2.24
- ---------------------------------------------------------------------------
Portfolio Turnover Rate 58%
===========================================================================
Average commissions per share
paid on equity transactions(2) $0.06
===========================================================================
</TABLE>
(1) For the period from February 7, 1996 (inception date) to July 31, 1996.
(2) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
Tax Information (unaudited)
The amount of long-term capital gains paid by the Fund to its shareholders
for the fiscal year ended July 31, 1996, was $103,221,880.
29
<PAGE>
Independent Auditor's Report
The Shareholders and Board of Trustees of
Smith Barney Income Funds:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Smith Barney Premium Total Return Fund
of Smith Barney Income Funds as of July 31, 1996, the related statement of
operations for the year then ended, statement of changes in net assets and
financial highlights for each of the years in the two-year period then ended.
These financial statements and financial highlights are the responsibility of
the Fund's management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audits. The financial
highlights for each of the years in the three-year period ended July 31, 1994,
were audited by other auditors whose report thereon, dated September 19, 1994,
expressed an unqualified opinion on those financial highlights.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of July
31, 1996, by correspondence with the custodian. As to securities purchased but
not received, we performed other appropriate auditing procedures. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights
referred to above present fairly, in all material respects, the financial
position of Smith Barney Premium Total Return Fund of Smith Barney Income Funds
as of July 31, 1996, the results of its operations for the year then ended,
changes in its net assets and financial highlights for each of the years in the
two-year period then ended, in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
New York, New York
September 23, 1996
30
<PAGE>
Additional Shareholder Information (unaudited)
On August 10, 1995 the annual meeting of shareholders of the Fund was held for
the purpose of voting on the following matters:
1. To approve or disapprove a new investment advisory agreement between the
Trust, on behalf of the Fund, and Smith Barney Strategy Advisers Inc.
("SBSA").
2. To approve or disapprove a sub-investment advisory agreement between the
Trust, on behalf of the Fund, SBSA, as adviser, and Boston Partners Asset
Management, L.P. ("Boston Partners"), as sub-adviser.
The results of Proposal 1 were as follows:
<TABLE>
<CAPTION>
% of % of % of
Outstanding Outstanding Votes Outstanding
Votes For Shares Voted Votes Against Shares Voted Abstained Shares Voted
==============================================================================================================
<S> <C> <C> <C> <C> <C>
63,168,074.889 87.48% 1,703,339.799 2.36% 7,336,089.560 10.16%
</TABLE>
The results of Proposal 2 were as follows:
<TABLE>
<CAPTION>
% of % of % of
Outstanding Outstanding Votes Outstanding
Votes For Shares Voted Votes Against Shares Voted Abstained Shares Voted
==============================================================================================================
<S> <C> <C> <C> <C> <C>
62,964,869.342 87.20% 2,061,802,266 2.85% 7,180,832.636 9.95%
</TABLE>
31
<PAGE>
[LOGO OF SMITH BARNEY APPEARS HERE]
Smith Barney
Premium Total
Return Fund
Trustees
Lee Abraham
Antoinette C. Bentley
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon
Madelon DeVoe Talley
Officers
Heath B. McLendon
Chairman and Investment Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President
and Treasurer
Harry J. Rosenbluth
Investment Officer
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
Investment Adviser
Smith Barney Strategy Advisers Inc.
Distributor
Smith Barney Inc.
Custodian
PNC Bank, N.A.
Shareholder
Servicing Agent
First Data Investors Services Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for the general information of the shareholders of
Smith Barney Premium Total Return Fund. It is not authorized for distribution
to prospective investors unless accompanied or preceded by an effective
Prospectus for the Fund, which contains information concerning the Fund's
investment policies and expenses as well as other pertinent information.
Smith Barney
Premium Total
Return Fund
388 Greenwich Street
New York, New York 10013
FD0420 9/96
<PAGE>
1996
1996
1996
1996
1996
[ART]
Smith Barney
Diversified
Strategic Income Fund
- ---------------------
July 31, 1996
Annual Report
Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
SMITH BARNEY DIVERSIFIED STRATEGIC INCOME FUND
Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney
Diversified Strategic Income Fund for the year ended July 31, 1996. In this
report, we summarize the period's prevailing economic and market conditions and
outline our portfolio strategy. A detailed summary of performance and current
holdings can be found in the appropriate sections that follow in the annual
report.
Diversification and balance are essential components of the Diversified
Strategic Income Fund. While most bond funds concentrate primarily on one class
of bonds, the Diversified Strategic Income Fund seeks to provide investors with
high current income by investing in a combination of three different classes of
bonds: U.S. government and mortgage securities, high-yield corporate bonds and
foreign government bonds. Since not all sectors of the fixed income markets
perform equally well at the same time, and different economies around the world
seldom move in tandem, the diversification offered by the Fund allows investors
to take advantage of income opportunities available in both the domestic and
international markets and also helps reduce the volatility associated with
investing in a single market. The Fund's management team allocates assets based
on a current analysis of economic and market conditions, with the goal of
producing high current income, while minimizing the risks of interest-rate and
currency fluctuations. For the year ended July 31, 1996 the Diversified
Strategic Income Fund had a total return of 8.39% for Class A shares. During
that time period, the Fund paid dividends totaling $0.666 per share; based on a
net asset value (NAV) of $7.82 per share as of July 31, 1996, this equates to an
annual distribution rate of 8.52%.
Recent events such as the stock market correction and statements made by the
Federal Reserve Board, combined with our year-to-date portfolio strategy
success, have prompted a change in sector allocation since our last letter. At
the end of July 1996, we reduced the Fund's asset allocation in the foreign
government bond and high-yield sectors. The Diversified Strategic Income Fund's
current portfolio allocation is 35.0% in U.S. government and mortgage
securities, 27.5% in high-yield corporate bonds, and 37.5% in foreign government
bonds.
1
<PAGE>
U.S. Government and Mortgage Securities
While the end of 1995 witnessed a strong rally in the U.S. bond market, the
first half of 1996 saw increased volatility in the U.S. bond market as well as
bond markets worldwide. Stronger-than-expected U.S. economic growth sparked
concerns about the possible re-emergence of inflation, and has led to a decline
in U.S. bond prices (and a rise in yields). Treasury bonds were the most
negatively impacted. The yield on the benchmark 30-year Treasury rose from
5.94% in the beginning of January to 6.97% on July 31, 1996.
During the 12-month period covered by this report, our investment strategy has
continued to remain focused on the income provided by higher-coupon mortgage
securities. Given the significant rise in interest rates during the first half
of 1996, which peaked above 7% in June, but have since moderated, the income
provided by these mortgage securities has offset the erosion of principal of our
U.S. Treasury investments. More recently, we have become slightly more
aggressive, by modestly extending the maturities of our U.S. Treasury positions.
High-Yield Corporate Bonds
Despite the increased volatility that has been hanging over the bond-market,
high yield bonds, which tend to be slightly less sensitive to interest rate
fluctuations than government or investment-grade corporate bonds, have posted
positive total returns over the past 12 months as investors remained optimistic
that U.S. economic expansion would continue. Over the 12-month period covered
by this report, as the general economic conditions remained volatile, the high
income sector of the Fund maintained a relatively conservative investment
strategy with a strong emphasis on the upper- and middle-rated tiers of the
high-yield market. We have generally invested in bonds issued by improving
companies which we believe have a great likelihood of receiving upgrades and, as
a consequence, should experience price appreciation. Moreover, we believe our
investment strategy of concentrating on improving high yield bonds is prudent
over the long term.
In addition, we have invested in companies within industries that continue to
experience meaningful growth trends. In our view, the telecommunications, cable
TV, technology and media industries exhibit the potential to grow substantially.
Because of our positive views on these industries, we have added the following
holdings to the high yield sector of the Fund: Time Warner, which has
significantly expanded its cable and programming segments, and now has
approximately 11.4 million subscribers; Intelcom Group, an expanding Colorado-
based company which provides alternate local telecommunications access;
Intermedia Communications of Florida, which
2
<PAGE>
gives local telephone companies in the Southeast access to its extensive fiber-
optic system and its voice and data networks; and United International
Holdings, an international cable company. Considering the extreme swings in
interest rates and bond prices over the past year, the high yield sector of the
Fund has maintained a conservative maturity in the 5-to-6-year range.
Foreign Government Securities
The foreign government bond component of the Fund was defensively positioned
during the 12-month period covered by this report. Bond market returns have
varied considerably thus far in 1996. For example, fears of rapid economic
growth leading to increased inflation erased the gains posted in the later half
of 1995 in core markets like the U.S., Germany and Japan. Bond markets in core
European countries that followed the U.S. rally in the end of 1995, also had
price declines in 1996, but not as great as those experienced by the U.S. bond
markets. On the other hand, the peripheral European markets, such as Spain,
Italy and Sweden, showed extraordinary performance in both local currency and
U.S. dollar terms during the first half of 1996. In addition, the appreciation
of the U.S. dollar versus the German mark has helped the currencies of these
peripheral markets rally against the mark as well, providing a boost to those
countries' total return performance. The foreign government securities sector
of the Fund maintained a significant position in the bonds of these higher-
yielding European markets during this time period, and although the exposure in
these markets is mainly for high income purposes, the capital appreciation that
occurred during the period covered by this report contributed significantly to
the Diversified Strategic Income Fund's performance.
At the beginning of the fiscal year, 35% of the foreign government securities
portfolio was invested in dollar block bonds, evenly distributed among
Australia, Canada and New Zealand. Throughout the year, however, this exposure
was reduced to approximately 21%. The Fund's assets were subsequently allocated
to the bonds of core European nations, which outperformed the dollar block bond
markets during this time period.
The Fund's allocation to the core European countries was extended from 28% of
the foreign sector's assets, to over 51% during the fourth quarter of 1995, and
remained at 51% throughout the first quarter of 1996. As previously mentioned,
it was our view that these markets would outperform the dollar block markets
during the first half of 1996. This strategy has provided the Diversified
Strategic Income Fund with broader portfolio diversification, and less
volatility, due to the non-U.S. dollar bond exposure.
The Fund has not owned any Japanese yen-denominated bonds during the 12-month
period covered by this report. This is due to the extremely low yields
3
<PAGE>
available on Japanese bonds and the risk of significant price erosion that could
occur as the Japanese economy recovers from a multi-year recession.
Currently, the foreign government securities sector of the Fund is approximately
50% hedged into dollar block currencies. In our view, this exposure to foreign
currencies may mitigate any adverse changes in the performance of the U.S. bond
market sectors that the Diversified Strategic Income Fund invests in.
In closing, we would like to thank you for your investment in the Smith Barney
Diversified Strategic Income Fund. We look forward to continuing to help you
achieve your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ James E. Conroy
Heath B. McLendon James E. Conroy
Chairman and Vice President and
Investment Officer Investment Officer
/s/ John C. Bianchi, /s/ Victor S. Filatov
John C. Bianchi, CFA Victor S. Filatov
Vice President and Vice President and
Investment Officer Investment Officer
August 14, 1996
4
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Historical Performance--Class A Shares
- -----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value
-------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $7.85 $ 7.82 $0.62 $ 0.00 $0.05 8.39%
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/95 7.76 7.85 0.48 0.00 0.19 10.35
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/94 8.41 7.76 0.62 0.10 0.04 1.16
- -----------------------------------------------------------------------------------------------------------------------------------
Inception* - 7/31/93 8.24 8.41 0.45 0.12 0.00 9.30+
===================================================================================================================================
Total $2.17 $ 0.22 $0.28
===================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Historical Performance -- Class B Shares
- -----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $7.86 $ 7.83 $0.57 $ 0.00 $0.05 7.80%
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/95 7.76 7.86 0.44 0.00 0.18 10.00
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/94 8.41 7.76 0.60 0.10 0.03 0.66
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/93 8.55 8.41 0.58 0.14 0.00 7.28
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/92 7.98 8.55 0.68 0.00 0.07 17.12
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/91 8.06 7.98 0.71 0.06 0.09 10.42
- -----------------------------------------------------------------------------------------------------------------------------------
Inception* - 7/31/90 8.00 8.06 0.40 0.00 0.00 6.00+
===================================================================================================================================
Total $3.98 $ 0.30 $0.42
===================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Historical Performance -- Class C Shares
- -----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value
-------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $7.84 $ 7.81 $0.57 $ 0.00 $0.05 7.82%
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/95 7.76 7.84 0.44 0.00 0.18 9.73
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/94 8.41 7.76 0.60 0.10 0.03 0.66
- -----------------------------------------------------------------------------------------------------------------------------------
Inception* - 7/31/93 8.36 8.41 0.20 0.03 0.00 3.41+
===================================================================================================================================
Total $1.81 $ 0.13 $0.26
===================================================================================================================================
</TABLE>
5
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance -- Class Y Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-----------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Inception* - 7/31/96 $7.89 $7.82 $0.53 $0.00 $0.05 6.65%+
===================================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Historical Performance -- Class Z Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-----------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $7.85 $7.82 $0.63 $0.00 $0.06 8.72%
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/95 7.76 7.85 0.49 0.00 0.20 10.94
- -----------------------------------------------------------------------------------------------------------------------------------
7/31/94 8.41 7.76 0.65 0.10 0.04 1.43
- -----------------------------------------------------------------------------------------------------------------------------------
Inception* - 7/31/93 8.24 8.41 0.47 0.12 0.00 9.47+
===================================================================================================================================
Total $2.24 $0.22 $0.30
===================================================================================================================================
</TABLE>
It is the Fund's policy to distribute dividends monthly and capital
gains, if any, annually.
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Without Sales Charge(1)
----------------------------------------------------
Class A Class B Class C Class Y Class Z
===================================================================================================================================
<S> <C> <C> <C> <C> <C>
Year Ended 7/31/96 8.39% 7.80% 7.82% N/A 8.72%
- -----------------------------------------------------------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 8.44 N/A N/A N/A
- -----------------------------------------------------------------------------------------------------------------------------------
Inception* through 7/31/96 7.78 8.90 6.37 6.65%+ 8.13
===================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Without Sales Charge(2)
----------------------------------------------------
Class A Class B Class C Class Y Class Z
===========================================================================================
<S> <C> <C> <C> <C> <C>
Year Ended 7/31/96 3.51% 3.30% 6.82% N/A 8.72%
- -------------------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 8.30 N/A N/A N/A
- -------------------------------------------------------------------------------------------
Inception* through 7/31/96 6.45 8.90 6.37 6.65%+ 8.13
===========================================================================================
</TABLE>
6
<PAGE>
- -----------------------------------------------------------------------------
Cumulative Total Return
- -----------------------------------------------------------------------------
Without Sales Charges(1)
=============================================================================
Class A (Inception* through 7/31/96) 32.25%
- -----------------------------------------------------------------------------
Class B (Inception* through 7/31/96) 75.51
- -----------------------------------------------------------------------------
Class C (Inception* through 7/31/96) 23.14
- -----------------------------------------------------------------------------
Class Y (Inception* through 7/31/96) 6.65+
- -----------------------------------------------------------------------------
Class Z (Inception* through 7/31/96) 33.92
==============================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable sales charge with respect to Class A shares or the applicable
contingent deferred sales charges ("CDSC") with respect to Class B and C
shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, Class A shares reflect the deduction
of the maximum initial sales charge of 4.50% and Class B shares reflect the
deduction of a 4.50% CDSC, which applies if shares are redeemed within one
year from initial purchase. This CDSC declines by 0.50% the first year
after purchase and thereafter by 1.00% per year until no CDSC is incurred.
Class C shares reflect the deduction of a 1.00% CDSC, which applies if
shares are redeemed within the first year of purchase.
* Inception dates for Class A, B, C, Y and Z shares are November 6, 1992,
December 28, 1989, March 19, 1993, October 10, 1995 and November 6, 1992,
respectively.
+ Total return is not annualized, as it may not be representive of the total
return for the year.
7
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
Historical Performance (unaudited)
- ------------------------------------------------------------------------------------------
Growth of $10,000 Invested in Class B Shares of
the Smith Barney Diversified Strategic Income Fund vs.
Lehman Brothers Aggregate Bond Index+
------------------------------------------------------
December 1989 -- July 1996
[LINE GRAPH]
Smith Barney Diversified Strategic Income Fund Lehman Brothers Aggregate Bond Index
<S> <C> <C>
12/28/89 10,000 10,000
7/90 10,600 10,425
7/91 11,704 11,541
7/92 13,707 13,247
7/93 14,705 14,595
7/94 14,801 14,609
7/95 16,281 16,086
7/31/96 17,551 16,976
</TABLE>
+ Hypothetical illustration of $10,000 invested in Class B shares at inception
on December 28, 1989, assuming reinvestment of dividends and capital gains,
if any, at net asset value through July 31, 1996. The Lehman Brothers
Aggregate Bond Index is composed of the Government Corporate Bond Index, the
Asset-Backed Securities Index and the Mortgage-Backed Securities Index and
includes treasury issues, agency issues, corporate bond issues and mortgage-
backed issues. The index is unmanaged and it is not subject to the same
management and trading expenses as a mutual fund. The performance of the
Fund's other classes may be greater or less than the Class B shares'
performance indicated on this chart, depending on whether greater or lesser
sales charges and fees were incurred by shareholders investing in other
classes.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital gains.
8
<PAGE>
- -------------------------------------------------------------------------------
Portfolio Highlights (unaudited) July 31, 1996
- -------------------------------------------------------------------------------
Portfolio Breakdown
[PIE CHART PLOT POINTS]
Preferred Stock,
Convertible Preferred Stocks,
Common Stocks, and Warrants 1.7%
Foreign Bonds 35.6%
Repurchase Agreements 3.3%
U.S. Government & Agency
Obligations 34.4%
Corporate Bonds and Notes 25.0%
9
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
Schedule of Investments July 31, 1996
- ----------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
======================================================================================================================
U.S. GOVERNMENT SECTOR -- 34.4%
======================================================================================================================
<S> <C> <C>
U.S. Government & Agency
Obligations -- 34.4%
$27,000,000 U.S. Treasury Notes, 6.625% due 6/30/01 $ 27,059,130
27,500,000 U.S. Treasury Principal Strips, 10.750% due 8/15/05 14,920,950
115,300,000 U.S. Treasury Principal Strips, 11.250% due 2/15/15 31,178,273
29,992,288 FHLMC, 9.000% due 9/1/21 31,285,555
73,461,647 FHLMC, 8.000% due 1/1/23 74,012,610
202,304,773 FHLMC Gold, 9.000% due 4/15/25 211,028,156
88,617 GNMA, 9.000% due 2/15/21 92,743
357,798,208 GNMA, 8.000% due 9/14/25* 359,885,705
193,974,466 GNMA Platinum, 9.000% due 12/15/17 206,035,799
- ----------------------------------------------------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT SECTOR
(Cost -- $944,813,660) 955,498,921
======================================================================================================================
HIGH YIELD SECTOR -- 26.7%
======================================================================================================================
CORPORATE BONDS AND NOTES -- 25.0%
Aerospace and Defense -- 0.6%
4,875,000 Airplanes Pass Through Trust, 10.875% due 3/15/19 5,082,188
4,675,000 Howmet Corp., 10.000% due 12/1/03@ 4,932,125
3,925,000 Tracor Inc., 10.875% due 8/15/01 4,204,656
2,375,000 UNC, Inc., 11.000% due 6/1/06 2,434,375
- ----------------------------------------------------------------------------------------------------------------------
16,653,344
- ----------------------------------------------------------------------------------------------------------------------
Automobile/Auto Parts/Truck Manufacturing -- 0.2%
Harvard Industries Inc.:
5,250,000 12.000% due 7/15/04 5,158,125
1,250,000 11.125% due 8/1/05 1,175,000
- ----------------------------------------------------------------------------------------------------------------------
6,333,125
Broadcasting - TV, Cable and Radio -- 5.6%
16,225,000 Australis Media Ltd., step bond to yield 14.000% due 5/15/03+++ 9,167,125
Bell Cablemedia PLC:
17,875,000 Step bond to yield 11.950% due 7/15/04 12,870,000
11,795,000 Step bond to yield 11.875% due 9/15/05 7,430,850
Cablevision Systems Corp.:
7,700,000 10.750% due 4/1/04 7,786,625
5,450,000 9.875% due 2/15/13 5,068,500
12,950,000 Comcast Cable, step bond to yield 11.200% due 11/15/07 7,705,250
27,600,000 Marcus Cable Co., 11.875% due 8/1/04 18,167,279
23,900,000 NWCG Holdings, zero coupon due 6/15/99 18,851,125
Rogers Cablesystems Ltd.:
4,400,000 10.000% due 12/1/07 4,323,000
5,700,000 9.650% due 1/15/14 3,670,329
5,700,000 11.000% due 12/1/15 5,828,250
9,875,000 Rogers Communications Inc., 10.875% due 4/15/04 10,134,219
4,000,000 SCI Television, 11.000% due 6/30/05 4,290,000
</TABLE>
See Notes to Financial Statments.
10
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- --------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
====================================================================================================================
<S> <C> <C>
Broadcasting - TV, Cable and
Radio -- 5.6% (continued)
$ 6,500,000 SFX Broadcasting, 10.750% due 5/15/06 $ 6,565,000
12,325,000 UIH Australia/Pacific, step bond to yield 14.000%
due 5/15/06+++ 6,501,438
UIH Inc.:
9,375,000 Step bond to yield 14.000% due 11/15/99 6,187,500
7,450,000 Zero coupon due 11/15/99 4,917,000
2,675,000 Videotron Groupe Ltd., 10.625% due 2/15/05 2,835,500
5,375,000 Videotron Holdings PLC, step bond to yield
11.000% due 8/15/05 3,520,625
4,500,000 Videotron Ltee., 10.250% due 10/15/02 4,657,500
2,000,000 Wireless One, 13.000% due 10/15/03+++ 2,092,500
2,850,000 Young Broadcasting Inc., 11.750% due 11/15/04 3,021,000
- --------------------------------------------------------------------------------------------------------------------
155,590,615
- --------------------------------------------------------------------------------------------------------------------
Building/Construction -- 0.3%
2,250,000 American Standard Inc., 11.375% due 5/15/04 2,441,250
4,850,000 Greystone Homes Inc., 10.750% due 3/1/04 4,783,313
2,800,000 Miles Home Services Inc., 12.000% due 4/1/01 2,072,000
- --------------------------------------------------------------------------------------------------------------------
9,296,563
- --------------------------------------------------------------------------------------------------------------------
Chemicals -- 1.4%
NL Industries Inc.:
15,400,000 11.750% due 10/15/03 15,708,000
8,075,000 Step bond to yield 13.000% due 10/15/05 6,278,313
6,150,000 Pt. Polysindo Eka Perkasa, 13.000% due 6/15/01 6,765,000
8,350,000 Terra Industries Inc., 10.500% due 6/15/05 8,788,375
2,525,000 Texas Petrochemical Corp., 11.125% due 7/1/06 2,603,906
- --------------------------------------------------------------------------------------------------------------------
40,143,594
- --------------------------------------------------------------------------------------------------------------------
Consumer Durable Goods/Home Furnishings -- 0.6%
23,425,000 International Semi Tech Microelectronics Inc.,
step bond to yield 11.500% due 8/15/03 13,352,250
3,675,000 TAG-Heuer International, 12.000% due 12/15/05@ 3,822,000
- --------------------------------------------------------------------------------------------------------------------
17,174,250
- --------------------------------------------------------------------------------------------------------------------
Diversified/Conglomerate Manufacturing -- 0.6%
4,696,000 American Pad & Paper, 13.000% due 11/15/05 5,329,960
Interlake Corp.:
1,075,000 12.000% due 11/15/01 1,139,500
9,800,000 12.125% due 3/1/02 9,824,500
- --------------------------------------------------------------------------------------------------------------------
16,293,960
- --------------------------------------------------------------------------------------------------------------------
Electric Utilities -- 0.4%
7,775,000 Calpine Corp., 10.500% due 5/15/06 7,775,000
3,529,972 Midland Funding Corp. I, 10.330% due 7/23/02 3,666,758
- --------------------------------------------------------------------------------------------------------------------
11,441,758
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- ------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
========================================================================================================================
<S> <C> <C>
Electronics/Computers -- 0.4%
$3,175,000 Graphic Controls, 12.000% due 9/15/05 $ 3,385,344
8,500,000 Unisys Corp., 12.000% due 4/15/03 8,595,625
- ------------------------------------------------------------------------------------------------------------------------
11,980,969
- ------------------------------------------------------------------------------------------------------------------------
Food -- 0.2%
3,800,000 TLC Beatrice International, 11.500% due 10/1/05 3,885,500
2,475,000 Van De Kamp Inc., 12.000% due 9/15/05 2,645,156
- ------------------------------------------------------------------------------------------------------------------------
6,530,656
- ------------------------------------------------------------------------------------------------------------------------
Grocery/Convenience Stores -- 0.4%
190 Kash N' Karry, 11.500% due 2/1/03 191
Pathmark Stores Inc.:
4,125,000 11.625% due 6/15/02 4,125,000
7,615,000 12.625% due 6/15/02 7,691,150
- ------------------------------------------------------------------------------------------------------------------------
11,816,341
- ------------------------------------------------------------------------------------------------------------------------
Healthcare/Drugs/Hospital Supplies -- 0.9%
6,350,000 Magellan Health Services, 11.250% due 4/15/04 6,873,875
17,425,000 OrNda Healthcorp, 12.250% due 5/15/02 18,819,000
- ------------------------------------------------------------------------------------------------------------------------
25,692,875
- ------------------------------------------------------------------------------------------------------------------------
Hotel/Gaming -- 1.7%
8,525,000 Aztar Corp., 13.750% due 10/1/04 9,761,125
12,000,000 Bally's Grand Inc., 10.375% due 12/15/03 13,140,000
5,375,000 Courtyard by Marriott II, 10.750% due 2/1/08@ 5,321,250
5,275,000 Mohegan Tribal Gaming Authority, 13.500% due
11/15/02@ 6,620,125
2,000,000 Showboat Inc., 13.000% due 8/1/09 2,287,500
Station Casinos Inc.:
6,975,000 9.625% due 6/1/03 6,696,000
2,375,000 10.125% due 3/15/06 2,303,750
- ------------------------------------------------------------------------------------------------------------------------
46,129,750
- ------------------------------------------------------------------------------------------------------------------------
Insurance Companies -- 0.7%
7,455,000 Bankers Life Holding Corp., 13.000% due 11/1/02 8,517,338
9,720,000 Life Partners Group Inc., 12.750% due 7/15/02 10,594,800
- ------------------------------------------------------------------------------------------------------------------------
19,112,138
- ------------------------------------------------------------------------------------------------------------------------
Leisure/Amusement/Motion Pictures -- 0.4%
2,928,675 Gillett Holdings Inc., 12.250% due 6/30/02 3,067,787
8,350,000 Remington Arms Inc., 10.000% due 12/1/03@ 7,640,250
- ------------------------------------------------------------------------------------------------------------------------
10,708,037
- ------------------------------------------------------------------------------------------------------------------------
Machinery -- 0.1%
3,000,000 Alvey Systems Inc., 11.375% due 1/31/03@ 3,097,500
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
12
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- ------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
========================================================================================================================
<S> <C> <C>
Metals/Mining -- 1.1%
$ 5,000,000 Ivex Holdings Corp., step bond to yield
13.250% due 3/15/05 $ 3,237,500
14,925,000 Kaiser Aluminum & Chemical Corp., 12.750% due 2/1/03 15,633,938
4,325,000 Renco Metals Inc., 11.500% due 7/1/03 4,454,750
4,700,000 Russel Metals Inc., 10.250% due 6/15/00 4,582,500
3,410,000 UCAR Global Enterprises Inc., 12.000% due 1/15/05 3,878,875
- ------------------------------------------------------------------------------------------------------------------------
31,787,563
- ------------------------------------------------------------------------------------------------------------------------
Oil/Natural Gas -- 1.1%
2,650,000 Clark R&M Holdings, zero coupon due 2/15/00 1,828,500
8,700,000 Clark USA, 10.875% due 12/1/05 8,895,750
6,950,000 Global Marine Inc., 12.750% due 12/15/99 7,540,750
2,900,000 Kelley Oil & Gas, 13.500% due 6/15/99 3,106,625
3,725,000 Santa Fe Energy Resources Inc., 11.000% due 5/15/04 4,018,344
4,450,000 United Meridian Corp., 10.375% due 10/15/05 4,589,063
- ------------------------------------------------------------------------------------------------------------------------
29,979,032
- ------------------------------------------------------------------------------------------------------------------------
Packaging/Containers -- 0.2%
Gaylord Container Corp.:
2,000,000 11.500% due 5/15/01 2,060,000
2,225,000 12.750% due 5/15/05 2,375,188
- ------------------------------------------------------------------------------------------------------------------------
4,435,188
- ------------------------------------------------------------------------------------------------------------------------
Paper/Forest Products/Printing -- 1.6%
1,850,000 Crown Paper Co., 11.000% due 9/1/05 1,785,250
3,400,000 Grupo Industrial Durango, 12.625% due 8/1/03 3,446,750
16,950,000 Indah Kiat International Finance Co., 11.875% due 6/15/02 18,009,375
3,300,000 Polysindo International Finance, 11.375% due 6/15/06 3,382,500
4,925,000 Repap New Brunswick Inc., 10.625% due 4/15/05 4,715,688
4,825,000 SD Warren Co., 12.000% due 12/15/04@ 5,126,563
6,750,000 Tjiwi Kimia International Finance Co., 13.250% due 8/1/01 7,576,875
- ------------------------------------------------------------------------------------------------------------------------
44,043,001
- ------------------------------------------------------------------------------------------------------------------------
Personal Care Products/Cosmetics -- 0.9%
5,750,000 Revlon Consumer Products Corp., 10.500% due 2/15/03 5,843,438
22,850,000 Revlon Worldwide Corp., zero coupon due 3/15/98 19,194,000
- ------------------------------------------------------------------------------------------------------------------------
25,037,438
- ------------------------------------------------------------------------------------------------------------------------
Real Estate Development/Investment -- 0.3%
7,725,000 Trizec Finance, 10.875% due 10/15/05 7,879,500
- ------------------------------------------------------------------------------------------------------------------------
Retail -- 0.3%
7,550,000 Barnes & Noble Inc., 11.875% due 1/15/03 8,116,250
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
13
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- ------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
========================================================================================================================
<S> <C> <C>
Telephone/Communications -- 4.5%
Albritton Communications Co.:
$ 1,175,000 11.500% due 8/15/04 $ 1,222,000
5,650,000 9.750% due 11/30/07 5,311,000
17,150,000 Clearnet Communications, step bond to yield
14.750% due 12/15/05 10,633,000
8,200,000 Dial Call Communications Inc., step bond to yield
12.250% due 4/15/04 5,289,000
3,400,000 Fonorola Inc., 12.500% due 8/15/02 3,693,250
16,000,000 Intelcom Group Inc., step bond to yield
12.500% due 5/1/06 8,720,000
10,950,000 Intermedia Communications of Florida, step bond to
yield 12.500% due 5/15/06 5,967,750
4,050,000 International Cabletel Inc., step bond to yield
11.500% due 2/1/06@ 2,308,500
3,325,000 Metrocall Inc., 10.375% due 10/1/07 2,917,688
14,000,000 Millicom International Cellular, step bond to yield
13.500% due 6/1/06@ 7,070,000
8,045,000 Mobile Telecommunications Technology,
13.500% due 12/15/02 8,386,913
28,700,000 Nextel Communications Inc., step bond to yield
9.750% due 8/15/04 16,072,000
9,125,000 Nextlink Communications, 12.500% due 4/15/06@ 8,896,875
9,150,000 Pagemart Inc., step bond to yield 12.250% due 11/1/03 7,034,063
8,950,000 Pagemart Nationwide Inc., step bond to yield
15.000% due 2/1/05@ 5,951,750
32,725,000 Telewest Communications, step bond to yield
11.000% due 10/1/07 19,225,935
5,300,000 U.S.A. Mobile Communications Inc., 14.000% due 11/1/04 5,969,125
- ------------------------------------------------------------------------------------------------------------------------
124,668,849
- ------------------------------------------------------------------------------------------------------------------------
Tobacco -- 0.2%
5,575,000 Consolidated Cigar Corp., 10.500% due 3/1/03 5,846,781
- ------------------------------------------------------------------------------------------------------------------------
Transportation/Shipping -- 0.3%
6,800,000 Sea Containers Ltd., Series A, 12.500% due 12/1/04 7,463,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL CORPORATE BONDS AND NOTES
(Cost -- $680,788,674) 697,252,077
========================================================================================================================
SHARES SECURITY VALUE
========================================================================================================================
COMMON STOCK -- 0.2%
Metals/Mining -- 0.2%
328,658 Algoma Steel Inc.# 1,033,034
</TABLE>
See Notes to Financial Statements.
14
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- ------------------------------------------------------------------------------------------------------------------------
SHARES SECURITY VALUE
========================================================================================================================
<S> <C> <C>
Metals/Mining -- 0.2% (continued)
160,800 Freeport McMoRan Resource Partners, L.P. $ 3,195,900
- ------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK
(Cost -- $5,148,485) 4,228,934
========================================================================================================================
CONVERTIBLE PREFERRED STOCKS -- 1.1%
Automobile/Auto Parts/Truck Manufacturing -- 0.3%
169,800 Navistar International Corp., Series G,
Exchange $6.000 9,339,000
- ------------------------------------------------------------------------------------------------------------------------
Healthcare/Drugs/Hospital Supplies -- 0.2%
311,995 Foxmeyer Health Corp., Series A, Exchange $4.200 6,395,898
- ------------------------------------------------------------------------------------------------------------------------
Publishing -- 0.0%
1,418 K-III Communications Corp., Series B, Exchange $11.625 136,968
- ------------------------------------------------------------------------------------------------------------------------
Telephone/Communications -- 0.6%
14,516 Panamsat Corp., Exchange $12.750 16,185,338
- ------------------------------------------------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(Cost -- $35,468,241) 32,057,204
========================================================================================================================
PREFERRED STOCK -- 0.4%
Broadcasting - TV, Cable and Radio -- 0.4%
10,401 Time Warner Inc., Series K@
(Cost -- $10,401,719) 10,374,998
========================================================================================================================
WARRANTS -- 0.0%
Broadcasting - TV, Cable and Radio -- 0.0%
6,000 Wireless One, Expire 9/9/09@# 30,000
- ------------------------------------------------------------------------------------------------------------------------
Building/Construction -- 0.0%
33,600 Miles Homes Inc., Expire 4/1/97# 8,400
- ------------------------------------------------------------------------------------------------------------------------
Paper/Forest Products/Printing -- 0.0%
8,500 SD Warren Holdings Corp., Expire 12/15/06@# 110,500
- ------------------------------------------------------------------------------------------------------------------------
Telephone/Communications -- 0.0%
6,775 Nextel Communications Inc., Expire 5/23/99# 68
42,090 Pagemart Inc., Expire 11/1/03# 273,585
19,250 Pagemart Nationwide Inc., Expire 12/31/03@# 206,937
- ------------------------------------------------------------------------------------------------------------------------
480,590
- ------------------------------------------------------------------------------------------------------------------------
TOTAL WARRANTS
(Cost -- $102,200) 629,490
========================================================================================================================
TOTAL HIGH YIELD SECTOR
(Cost -- $731,909,319) 744,542,703
========================================================================================================================
</TABLE>
See Notes to Financial Statements.
15
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- -------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT+ SECURITY VALUE
=========================================================================================================================
INTERNATIONAL SECTOR -- 35.6%
=========================================================================================================================
<S> <C> <C>
BONDS -- 35.6%
Argentina -- 0.1%
3,000,000 Argentina Discount Series L, 6.438% due 3/31/23++ $ 2,000,640
- -------------------------------------------------------------------------------------------------------------------------
Australia -- 3.5%
Queensland Treasury Corp.:
60,000,000 8.000% due 5/14/97 46,519,094
66,000,000 8.000% due 5/14/03 50,167,101
- -------------------------------------------------------------------------------------------------------------------------
96,686,195
- -------------------------------------------------------------------------------------------------------------------------
Austria -- 0.6%
Oesterreichischekontrollbank:
2,000,000 9.000% due 5/21/97 1,497,017
8,000,000 10.250% due 7/27/99 6,359,139
10,000,000 10.750% due 8/8/01 8,289,981
- -------------------------------------------------------------------------------------------------------------------------
16,146,137
- -------------------------------------------------------------------------------------------------------------------------
Barbados -- 0.0%
1,000,000 Barbados Government, 10.500% due 6/9/97 1,022,500
- -------------------------------------------------------------------------------------------------------------------------
Brazil -- 0.1%
3,000,000 Banco Nac Desen, 10.375% due 4/27/98 3,060,000
- -------------------------------------------------------------------------------------------------------------------------
Canada -- 3.0%
7,000,000 Autobahn Schnell, 10.125% due 3/15/01 5,650,193
6,500,000 Electric Power Development, 8.750% due 6/11/97 4,859,393
6,000,000 Eurofima, 10.750% due 7/31/01 4,971,260
60,000,000 Government of Canada, 9.000% due 12/1/04 47,702,265
5,400,000 International Finance Corp., 7.750% due 8/18/98 4,041,946
9,000,000 Kingdom of Sweden, 10.625% due 6/3/98 7,039,435
2,000,000 Province of Alberta, 7.750% due 2/4/98 1,496,958
3,000,000 Province of Ontario, 10.000% due 9/30/96 2,201,870
7,000,000 Tokyo Electric Power, 10.500% due 6/14/01 5,723,407
- -------------------------------------------------------------------------------------------------------------------------
83,686,727
- -------------------------------------------------------------------------------------------------------------------------
Czech Republic -- 0.1%
100,000,000 Czech Electric Co., 14.375% due 1/27/01 3,744,126
- -------------------------------------------------------------------------------------------------------------------------
Denmark -- 1.9%
Kingdom of Denmark:
100,000,000 8.000% due 5/15/03 18,684,890
200,000,000 7.000% due 12/15/04 34,941,939
- -------------------------------------------------------------------------------------------------------------------------
53,626,829
- -------------------------------------------------------------------------------------------------------------------------
Finland -- 0.5%
56,000,000 Government of Finland, 9.500% due 3/15/04 14,164,933
- -------------------------------------------------------------------------------------------------------------------------
France -- 0.3%
11,000,000 Electricite de France, 9.750% due 9/8/99 8,648,774
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
16
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- -------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT+ SECURITY VALUE
=========================================================================================================================
<S> <C> <C>
Germany -- 5.9%
162,500,000 Bundesrepublic Deutschland, 6.250% due 4/26/06 $ 109,330,017
67,500,000 Bundesobligation, 5.250% due 2/21/01 45,798,988
10,000,000 Treuhandanstalt, 7.500% due 9/9/04 7,302,417
- -------------------------------------------------------------------------------------------------------------------------
162,431,422
- -------------------------------------------------------------------------------------------------------------------------
Ireland -- 3.3%
55,000,000 Republic of Ireland, 8.000% due 10/18/00 91,920,443
- -------------------------------------------------------------------------------------------------------------------------
Italy -- 2.8%
Buoni Poliennali Del Tesoro:
40,000,000,000 12.000% due 1/1/98 27,373,356
40,000,000,000 8.500% due 8/1/99 26,255,593
40,000,000,000 8.500% due 8/1/04 25,237,771
- -------------------------------------------------------------------------------------------------------------------------
78,866,720
- -------------------------------------------------------------------------------------------------------------------------
Mexico -- 0.2%
2,000,000 Mexico Repackage Foreign, 7.102% due 3/31/08++ 1,872,500
10,000,000 Mexican States Value Recovery Rights, Expire 6/30/03 0
5,000,000 United Mexican States Series B, 6.250% due 12/31/19 3,218,750
- -------------------------------------------------------------------------------------------------------------------------
5,091,250
- -------------------------------------------------------------------------------------------------------------------------
New Zealand -- 2.0%
New Zealand Government:
50,000,000 9.000% due 11/15/96 34,397,153
27,000,000 10.000% due 3/15/02 19,937,384
- -------------------------------------------------------------------------------------------------------------------------
54,334,537
- -------------------------------------------------------------------------------------------------------------------------
Spain -- 5.3%
3,150,000,000 European Investment Bank, 11.250% due 3/15/00 27,431,401
Government of Spain:
6,500,000,000 10.250% due 11/30/98 54,375,671
7,840,000,000 10.100% due 2/28/01 66,857,838
- -------------------------------------------------------------------------------------------------------------------------
148,664,910
- -------------------------------------------------------------------------------------------------------------------------
Sweden -- 2.4%
400,000,000 Kingdom of Sweden, 10.250% due 5/5/03 67,446,541
- -------------------------------------------------------------------------------------------------------------------------
Thailand -- 0.1%
50,000,000 ABN AMRO Bank N.V., 9.100% due 8/5/97 1,985,460
- -------------------------------------------------------------------------------------------------------------------------
Trinidad -- 0.1%
2,000,000 Trinidad & Tobago, 11.500% due 11/20/97 1,935,000
- -------------------------------------------------------------------------------------------------------------------------
United Kingdom -- 3.1%
U.K. Treasury:
26,000,000 7.000% due 11/6/01 39,885,398
30,000,000 7.750% due 9/8/06 46,180,440
- -------------------------------------------------------------------------------------------------------------------------
86,065,838
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
17
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- ------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT+ SECURITY VALUE
========================================================================================================================
<S> <C> <C>
Uruguay -- 0.2%
4,500,000 Uruguay Banco Central, 6.750% due 2/19/21 $ 3,285,000
2,000,000 Uruguay Banco Central Foreign, 6.688% due 2/18/07++ 1,720,000
- ------------------------------------------------------------------------------------------------------------------------
5,005,000
- ------------------------------------------------------------------------------------------------------------------------
Venezuela -- 0.1%
Republic of Venezuela Foreign:
1,000,000 6.938% due 12/28/98++ 958,300
3,000,000 6.938% due 12/31/03++ 1,980,000
- ------------------------------------------------------------------------------------------------------------------------
2,938,300
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INTERNATIONAL SECTOR
(Cost -- $956,290,903) 989,472,282
========================================================================================================================
<CAPTION>
FACE
AMOUNT SECURITY VALUE
========================================================================================================================
<S> <C> <C>
REPURCHASE AGREEMENT -- 3.3%
$90,946,000 CS First Boston, 5.550% due 8/1/96; Proceeds at maturity --
$90,960,021; (Fully collateralized by U.S. Treasury Notes, 5.125%
due 2/28/98; Market value -- $92,838,710) (Cost -- $90,946,000) 90,946,000
========================================================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $2,723,959,882**) $2,780,459,906
========================================================================================================================
</TABLE>
* Range includes certain securities traded on a "to-be-announced" basis (See
Note 8).
@ Securities exempt from registration under Rule 144A of the Securities Act of
1933. These securities may be resold in transactions that are exempt from
registration, normally to qualified institutional buyers.
+++ Security issued with attached warrants.
# Non-income producing security.
+ Represents local currency.
++ Variable rate security.
** Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
18
<PAGE>
- ---------------------------------------------------------------------------
Statement of Assets and Liabilities July 31, 1996
- ---------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C>
ASSETS:
Investments, at value (Cost -- $2,723,959,882) $ 2,780,459,906
Foreign currency (Cost -- $538,576) 537,585
Cash 1,465,660
Receivable for securities sold 9,807,005
Receivable for Fund shares sold 4,954,938
Receivable for open forward foreign currency contracts 360,306
Dividends and interest receivable 50,376,215
- ----------------------------------------------------------------------------------
Total Assets 2,847,961,615
- ----------------------------------------------------------------------------------
LIABILITIES:
Payable for securities purchased 171,523,724
Payable for open forward foreign currency contracts 4,318,365
Distribution fees payable 1,890,543
Investment advisory fees payable 1,012,674
Administration fees payable 450,077
Accrued expenses and other liabilities 1,156,787
- ----------------------------------------------------------------------------------
Total Liabilities 180,352,170
- ----------------------------------------------------------------------------------
Total Net Assets $2,667,609,445
==================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 340,702
Capital paid in excess of par value 2,728,799,147
Undistributed net investment income 1,045,741
Accumulated net realized loss from investments (115,447,984)
Net unrealized appreciation of investments
and foreign currencies 52,871,839
- ----------------------------------------------------------------------------------
Total Net Assets $2,667,609,445
==================================================================================
Shares Outstanding:
Class A 25,930,321
-------------------------------------------------------------------------------
Class B 303,841,930
-------------------------------------------------------------------------------
Class C 5,403,149
-------------------------------------------------------------------------------
Class Y 3,445,891
-------------------------------------------------------------------------------
Class Z 2,080,516
-------------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $7.82
-------------------------------------------------------------------------------
Class B* $7.83
-------------------------------------------------------------------------------
Class C** $7.81
-------------------------------------------------------------------------------
Class Y (and redemption price) $7.82
-------------------------------------------------------------------------------
Class Z (and redemption price) $7.82
-------------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 4.71% of net asset value per share) $8.19
==================================================================================
</TABLE>
* Redemption price is NAV of Class B shares reduced by a 4.50% CDSC if shares
are redeemed within one year from initial purchase (See Note 2).
** Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
are redeemed within the first year of purchase.
See Notes to Financial Statements.
19
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
Statement of Operations For the Year Ended July 31, 1996
- ----------------------------------------------------------------------------------
INVESTMENT INCOME:
<S> <C>
Interest (net of interest expense of $783,833) $ 210,999,542
Dividends 5,293,243
Less: Foreign withholding tax (380,537)
- ----------------------------------------------------------------------------------
Total Investment Income 215,912,248
- ----------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 2) 18,641,336
Investment advisory fees (Note 2) 11,818,108
Administration fees (Note 2) 5,252,493
Shareholder and system servicing fees 1,802,768
Custody 739,151
Registration fees 234,716
Shareholder communications 97,995
Audit and legal 34,882
Trustees' fees 30,000
Pricing service fees 25,250
Other 74,009
- ----------------------------------------------------------------------------------
Total Expenses 38,750,708
- ----------------------------------------------------------------------------------
Net Investment Income 177,161,540
- ----------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
AND FOREIGN CURRENCIES (NOTES 3 AND 5):
Realized Gain (Loss) From:
Security transactions (excluding short-term securities) (2,768,842)
Foreign currency transactions 17,651,773
- ----------------------------------------------------------------------------------
Net Realized Gain 14,882,931
- ----------------------------------------------------------------------------------
Change in Net Unrealized Appreciation
of Investments and Foreign Currencies:
Beginning of year 47,038,877
End of year 52,871,839
- ----------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 5,832,962
- ----------------------------------------------------------------------------------
Net Gain on Investments and Foreign Currencies 20,715,893
- ----------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 197,877,433
==================================================================================
</TABLE>
See Notes to Financial Statements.
20
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended July 31,
- -------------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Net investment income $ 177,161,540 $ 194,342,067
Net realized gain (loss) 14,882,931 (120,060,362)
Increase in net unrealized
appreciation 5,832,962 158,509,479
- -------------------------------------------------------------------------------------
Increase in Net Assets From
Operations 197,877,433 232,791,184
- -------------------------------------------------------------------------------------
DISTRIBUTIONS TO
SHAREHOLDERS FROM:
Net investment income (192,230,951) (144,007,998)
Capital (16,857,212) (58,367,013)
- -------------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (209,088,163) (202,375,011)
- -------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 9):
Net proceeds from sale of shares 480,703,999 434,771,060
Net asset value of shares issued for
reinvestment of dividends 117,096,917 116,727,753
Cost of shares reacquired (490,087,798) (568,365,595)
- -------------------------------------------------------------------------------------
Increase (Decrease) in Net
Assets From Fund Share Transactions 107,713,118 (16,866,782)
- -------------------------------------------------------------------------------------
Increase in Net Assets 96,502,388 13,549,391
NET ASSETS:
Beginning of year 2,571,107,057 2,557,557,666
- -------------------------------------------------------------------------------------
End of year* $2,667,609,445 $2,571,107,057
=====================================================================================
*Includes undistributed (overdistributed)
net investment income of: $1,045,741 $(11,805,103)
=====================================================================================
</TABLE>
See Notes to Financial Statements.
21
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
The Smith Barney Diversified Strategic Income Fund ("Fund"), a separate
investment fund of Smith Barney Income Funds ("Trust"), a Massachusetts business
trust, is registered under the Investment Company Act of 1940, as amended, as a
diversified, open-end management investment company. The Trust consists of the
Fund and six other separate investment funds: Smith Barney Exchange Reserve
Fund, Smith Barney Convertible Fund, Smith Barney High Income Fund, Smith Barney
Tax-Exempt Income Fund, Smith Barney Premium Total Return Fund and Smith Barney
Utilities Fund. The financial statements and financial highlights for the other
funds are presented in separate annual reports.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) securities traded
in national securities markets are valued at the closing prices in the primary
exchange on which they are traded; securities listed or traded on certain
foreign exchanges or other markets whose operations are similar to the U.S.
over-the-counter market (including securities listed on exchanges where the
primary market is believed to be over-the-counter) and listed securities for
which no sales were reported on that date are valued at the mean between the bid
and ask prices. Securities which are listed or traded on more than one exchange
or market are valued at the quotations on the exchange or market determined to
be the primary market for such securities; (c) securities maturing within 60
days are valued at cost plus accreted discount, or minus amortized premium,
which approximates market value; (d) dividend income is recorded on ex-dividend
date and interest income, adjusted for accretion of original issue discount, is
recorded on the accrual basis; (e) gains or losses on the sale of securities are
calculated using the specific identification method; (f) dividends and
distributions to shareholders are recorded on the ex-dividend date; (g) the
accounting records 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. Purchases and sales of securities and income and expenses are
translated at the rate of exchange quoted on the respective date that such
transactions are recorded. Differences between income and expense amounts
recorded and collected or paid are adjusted when reported by the custodian bank;
(h) direct expenses are charged to the Fund and each class; management fees and
general fund expenses are allocated on the basis of relative net assets; (i) the
Fund intends to comply with the applicable provisions of the Internal Revenue
Code of 1986, as amended, pertaining to regulated investment
22
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
companies and to make distributions of taxable income sufficient to relieve it
from substantially all Federal income and excise taxes; (j) the character of
income and gains to be distributed are determined in accordance with income tax
regulations which may differ from generally accepted accounting principles. At
July 31, 1996, reclassifications are made to the Portfolio's capital accounts to
reflect permanent book/tax differences and income and gains available for
distributions under income tax regulations. Accordingly, a portion of
accumulated net investment loss amounting to $16,811,606 has been reclassified
to paid-in capital. Net investment income, net realized gains and net assets
were not affected by this change; and (k) estimates and assumptions are required
to be made regarding assets, liabilities and changes in net assets resulting
from operations when financial statements are prepared. Changes in the economic
environment, financial markets and any other parameters used in determining
these estimates could cause actual results to differ.
In addition, the Fund may enter into forward exchange contracts in order to
hedge against foreign currency risk. These contracts are marked to market daily,
by recognizing the difference between the contract exchange rate and the current
market rate as an unrealized gain or loss. Realized gains or losses are
recognized when contracts are settled.
2. Investment Advisory Agreement, Administration
Agreement and Other Transactions
Smith Barney Mutual Funds Management Inc. ("SBMFM"), a subsidiary of Smith
Barney Holdings Inc. ("SBH"), acts as investment adviser to the Trust. The Fund
pays SBMFM an investment advisory fee calculated at an annual rate of 0.45% of
the average daily net assets. The Fund has also entered into a sub-advisory
agreement with Smith Barney Global Capital Management ("Global Capital
Management"), a subsidiary of SBH. SBMFM pays Global Capital Management a sub-
advisory fee calculated at an annual rate of 0.10% of the average daily net
assets. These fees are calculated daily and paid monthly.
SBMFM also acts as the Trust's administrator for which the Fund pays a fee
calculated at an annual rate of 0.20% of the average daily net assets. This fee
is calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SBH, acts as distributor of
Trust shares and primary broker for its portfolio agency transactions. For the
year ended July 31, 1996, SB received sales charges of approximately $792,000 on
sales of the Fund's Class A shares.
23
<PAGE>
- ---------------------------------------------------------------------------
Notes to Financial Statements (continued)
- ---------------------------------------------------------------------------
There is a contingent deferred sales charge ("CDSC") of 4.50% on Class B
shares, which applies if redemption occurs within one year from initial
purchase. This CDSC declines by 0.50% the first year after purchase and
thereafter by 1.00% per year until no CDSC is incurred. Class C shares have a
1.00% CDSC, which applies if redemption occurs within the first year of
purchase. In addition, Class A shares also have a 1.00% CDSC, which applies if
redemption occurs within the first year of purchase. This CDSC only applies to
those purchases of Class A shares, which when combined with current holdings of
Class A shares, equal or exceed $500,000 in the aggregate. These purchases do
not incur an initial sales charge. For the year ended July 31, 1996, CDSCs paid
to SB were:
Class A Class B Class C
============================================================================
CDSCs $2,000 $4,015,000 $16,000
============================================================================
Pursuant to a Distribution Plan, the Fund pays a service fee with respect
to Class A, B and C shares calculated at the annual rate of 0.25% of the average
daily net assets for each respective class. The Fund also pays a distribution
fee with respect to Class B and C shares calculated at the annual rate of 0.50%
and 0.45% of the average daily net assets of each class, respectively. For the
year ended July 31, 1996, total Distribution Plan fees incurred were:
Class A Class B Class C
============================================================================
Distribution Plan Fees $473,863 $17,979,685 $187,788
============================================================================
All officers and one Trustee of the Trust are employees of SB.
3. Investments
During the year ended July 31, 1996, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding short-
term securities) were as follows:
============================================================================
Purchases $2,676,886,533
- ----------------------------------------------------------------------------
Sales 2,320,582,702
============================================================================
At July 31, 1996, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were approximately
as follows:
============================================================================
Gross unrealized appreciation $75,623,000
Gross unrealized depreciation (19,123,000)
- ----------------------------------------------------------------------------
Net unrealized appreciation $56,500,000
============================================================================
24
<PAGE>
- -------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- -------------------------------------------------------------------------------
4. Capital Loss Carryforward
At July 31, 1996, the Fund had, for Federal tax purposes, approximately
$113,189,000 of capital loss carryforwards available to offset future capital
gains. To the extent that these carryforward losses are used to offset capital
gains, it is probable that the gains so offset will not be distributed. The
amount and expiration of the carryforwards are indicated below. Expiration
occurs on July 31 of the year indicated:
<TABLE>
<S> <C> <C>
2003 2004
- ---------------------------------------------------------------------------------
Carryforward Amounts $22,009,000 $91,180,000
- ---------------------------------------------------------------------------------
</TABLE>
5. Forward Foreign Currency Contracts
At July 31, 1996, the Fund had the following open forward foreign
currency contracts:
<TABLE>
<CAPTION>
Local Market Settlement Unrealized
Foreign Currency Currency Value Date Gain(Loss)
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
To Sell:
Canadian Dollar 1,465,000 $ 1,065,949 8/1/96 $ 436
Canadian Dollar 35,000,000 25,480,322 8/21/96 128,247
Finnish Markka 125,000,000 27,869,064 8/21/96 (861,483)
German Deutschmark 52,430,000 35,644,940 8/21/96 (1,174,424)
Irish Punt 27,000,000 43,710,681 8/21/96 (780,681)
Italian Lira 2,975,000,000 1,955,889 8/1/96 (7,433)
Spanish Peseta 7,700,000,000 61,177,630 8/21/96 (1,251,718)
Swedish Krona 90,000,000 13,619,339 8/21/96 (242,626)
- ------------------------------------------------------------------------------------------
210,523,814 (4,189,682)
- ------------------------------------------------------------------------------------------
To Buy:
Finnish Markka 125,000,000 27,869,064 8/21/96 231,623
- ------------------------------------------------------------------------------------------
Total Market Value and
Unrealized Loss on Forward
Foreign Currency Contracts $ 238,392,878 $(3,958,059)
==========================================================================================
</TABLE>
6. Repurchase Agreements
The Fund purchases (and its custodian takes possession of) U.S. Government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires continual maintenance
of the market value of the collateral in amounts at least equal to the
repurchase price.
25
<PAGE>
- -------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- -------------------------------------------------------------------------------
7. Reverse Repurchase Agreement
The Fund may enter into reverse repurchase agreement transactions for
leveraging purposes. A reverse repurchase agreement involves a sale by the Fund
of securities that it holds with an agreement by the Fund to repurchase the same
securities at an agreed upon price and date. A reverse repurchase agreement
involves the risk that the market value of the securities sold by the Fund may
decline below the repurchase price of the securities. The Fund will establish a
segregated account with its custodian, in which the Fund will maintain cash,
U.S. government securities or other liquid high grade debt obligations equal in
value to its obligations with respect to reverse repurchase agreements.
At July 31, 1996, the Fund had no open reverse repurchase agreements.
8. Securities Traded on a To-Be-Announced Basis
The Fund may trade securities on a "to-be-announced" ("TBA") basis. In a
TBA transaction, the Fund commits to purchasing or selling securities for which
specific information is not yet known at the time of the trade, particularly the
face amount and maturity date in GNMA transactions. Securities purchased on a
TBA basis are not settled until they are delivered to the Fund, normally 15 to
45 days later. These transactions are subject to market fluctuations and their
current value is determined in the same manner as for other securities.
As of July 31, 1996, the Fund held three TBA securities with a cost of
$167,347,188.
9. Shares of Beneficial Interest
At July 31, 1996, the Trust had an unlimited number of shares of beneficial
interest authorized with a par value of $0.001 per share. The Fund has the
ability to issue multiple classes of shares. Each share of a class represents an
identical interest and has the same rights, except that each class bears certain
direct expenses, including those specifically related to the distribution of its
shares. Effective November 7, 1994, the Fund adopted a new class structure,
renaming the former Class C and Class D shares as Class Z and Class C shares,
respectively.
At July 31, 1996, total paid-in capital amounted to the following for each
class:
<TABLE>
<CAPTION>
Class A Class B Class C Class Y Class Z
===========================================================================================================
<S> <C> <C> <C> <C> <C>
Total Paid-in
Capital $201,038,128 $2,442,512,893 $ 42,021,900 $ 27,017,719 $16,549,209
===========================================================================================================
</TABLE>
26
<PAGE>
- -------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- -------------------------------------------------------------------------------
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
July 31, 1996* July 31, 1995**
------------------------------------ ---------------------------
Shares Amount Shares Amount
=====================================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 10,064,712 $ 79,242,075 16,995,643 $ 130,357,316
Shares issued on
reinvestment 1,195,005 9,395,484 1,056,344 8,081,035
Shares redeemed (7,912,833) (62,199,723) (5,260,464) (40,179,768)
- -----------------------------------------------------------------------------------------------------
Net Increase 3,346,884 $ 26,437,836 12,791,523 $ 98,258,583
=====================================================================================================
Class B
Shares sold 42,794,620 $ 338,212,178 37,672,470 $ 288,491,309
Shares issued on
reinvestment 13,269,424 104,516,969 14,007,761 107,194,835
Shares redeemed (53,265,139) (420,311,482) (68,658,784) (524,800,223)
- -----------------------------------------------------------------------------------------------------
Net Increase (Decrease) 2,798,905 $ 22,417,665 (16,978,553) $(129,114,079)
=====================================================================================================
Class C
Shares sold 4,096,751 $ 32,284,568 1,589,260 $ 12,192,975
Shares issued on
reinvestment 217,477 1,708,186 39,755 306,081
Shares redeemed (534,146) (4,194,091) (143,121) (1,099,986)
- -----------------------------------------------------------------------------------------------------
Net Increase 3,780,082 $ 29,798,663 1,485,894 $ 11,399,070
=====================================================================================================
Class Y
Shares sold 3,547,674 $ 27,875,262 -- --
Shares issued on
reinvestment 19,630 154,747 -- --
Shares redeemed (121,413) (955,401) -- --
- -----------------------------------------------------------------------------------------------------
Net Increase 3,445,891 $ 27,074,608 -- --
=====================================================================================================
Class Z
Shares sold 391,370 $ 3,089,916 489,667 $ 3,729,460
Shares issued on
reinvestment 168,060 1,321,531 149,667 1,145,802
Shares redeemed (308,090) (2,427,101) (298,158) (2,285,618)
- -----------------------------------------------------------------------------------------------------
Net Increase 251,340 $ 1,984,346 341,176 $ 2,589,644
=====================================================================================================
</TABLE>
* Transactions for Class Y shares are for the period from October 10, 1995
(inception date) to July 31, 1996
** On November 7, 1994, the former Class D shares were renamed Class C shares
and the former Class C shares were renamed Class Z shares.
.
27
<PAGE>
- -------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- -------------------------------------------------------------------------------
10. FUND CONCENTRATION
The Fund's investment in foreign securities may involve risks not present
in domestic investments. Since securities may be denominated in a foreign
currency and may require settlement in foreign currencies and pay interest and
or dividends in foreign currencies, changes in the relationship of these foreign
currencies to the U.S. dollar can significantly affect the value of the
investments and earnings of the Fund. Foreign investments may also subject the
Fund to foreign government exchange restrictions, expropriation, taxation or
other political, social or economic developments, all of which could affect the
market and/or credit risk of the investments.
28
<PAGE>
Financial Highlights
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1996 1995 1994 1993(1)
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 7.85 $ 7.76 $ 8.41 $ 8.24
- -----------------------------------------------------------------------------------------
Income From Operations:
Net investment income(2) 0.61 0.94 0.63 0.47
Net realized and unrealized gain (loss) 0.03 (0.18) (0.52) 0.27
- -----------------------------------------------------------------------------------------
Total Income From Operations 0.64 0.76 0.11 0.74
- -----------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.62) (0.48) (0.56) (0.45)
Overdistributions of net investment income -- -- (0.06) --
Net realized gains -- -- (0.10) (0.12)
Capital (0.05) (0.19) (0.04) --
- -----------------------------------------------------------------------------------------
Total Distributions (0.67) (0.67) (0.76) (0.57)
- ------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 7.82 $ 7.85 $ 7.76 $ 8.41
- ------------------------------------------------------------------------------------------
Total Return 8.39% 10.35% 1.16% 9.30%+++
- ------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $202,700 $177,336 $76,019 $ 48,334
- ------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses(2) 1.04% 1.09% 1.10% 1.10%+
Net investment income 7.85 8.15 7.67 8.26+
- ------------------------------------------------------------------------------------------
Portfolio Turnover Rate 90% 83% 93% 116%
- ------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(3) $ 0.00* -- -- --
- ------------------------------------------------------------------------------------------
</TABLE>
(1) For the period from November 6, 1992 (inception date) to July 31, 1993.
(2) The manager waived part of its fees for the years ended July 31, 1995 and
1994. If such fees were not waived, the per share effect on net investment
income and the expense ratios would have been as follows:
<TABLE>
<CAPTION>
Per Share Decreases Expense Ratios
in Net Investment Income Without Fee Waivers
------------------------ ----------------------
1995 1994 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
Class A $0.01 $0.00* 1.14% 1.12%
</TABLE>
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
* Amount represents less than $0.01 per share.
+++ Total return is not annualized, as it may not be representative of
the total return for the year.
+ Annualized.
29
<PAGE>
- -------------------------------------------------------------------------
Financial Highlights (continued)
- -------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout
each year:
<TABLE>
<CAPTION>
Class B Shares 1996 1995 1994 1993 1992
=========================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning
of Year $7.86 $7.76 $8.41 $8.55 $7.98
- -------------------------------------------------------------------------
Income From Operations:
Net investment income(1) 0.58 0.70 0.59 0.65 0.68
Net realized and
unrealized gain (loss) 0.01 0.02 (0.51) (0.07) 0.64
- -------------------------------------------------------------------------
Total Income From
Operations 0.59 0.72 0.08 0.58 1.32
- -------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.57) (0.44) (0.54) (0.58) (0.68)
Overdistributions of net
investment income -- -- (0.06) -- --
Net realized gains -- -- (0.10) (0.14) --
Capital (0.05) (0.18) (0.03) -- (0.07)
- -------------------------------------------------------------------------
Total Distributions (0.62) (0.62) (0.73) (0.72) (0.75)
- -------------------------------------------------------------------------
Net Asset Value, End of
Year $7.83 $7.86 $7.76 $8.41 $8.55
- -------------------------------------------------------------------------
Total Return 7.80% 10.00% 0.66% 7.28% 17.12%
- -------------------------------------------------------------------------
Net Assets, End of Year
(millions) $2,380 $2,367 $2,469 $2,105 $1,465
- -------------------------------------------------------------------------
Ratios to Average Net
Assets:
Expenses(1) 1.52% 1.56% 1.57% 1.59% 1.62%
Net investment income 7.36 6.82 7.20 7.77 7.99
- -------------------------------------------------------------------------
Portfolio Turnover Rate 90% 83% 93% 116% 125%
- -------------------------------------------------------------------------
Average commissions per
share paid on equity
transactions(2) $0.00* -- -- -- --
- -------------------------------------------------------------------------
</TABLE>
(1) The manager waived part of its fees for the years ended July 31, 1995 and
1994. If such fees were not waived, the per share effect on net investment
income and the ratios of expenses to average net assets would have been as
follows:
<TABLE>
<CAPTION>
Per Share Decreases Expense Ratios
in Net Investment Income Without Fee Waivers
------------------------ -------------------
1995 1994 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
Class B $0.00* $0.00* 1.61% 1.59%
</TABLE>
(2) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
* Amount represents less than $0.01 per share.
30
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
Financial Highlights (continued)
- ----------------------------------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class C Shares 1996 1995(1) 1994 1993(2)
==========================================================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 7.84 $ 7.76 $ 8.41 $ 8.36
- ----------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income(3) 0.52 1.16 0.55 0.22
Net realized and unrealized
gain (loss) 0.07 (0.46) (0.47) 0.06
- ----------------------------------------------------------------------------------------------------------
Total Income From Operations 0.59 0.70 0.08 0.28
- ----------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.57) (0.44) (0.54) (0.20)
Overdistributions of net investment income -- -- (0.06) --
Net realized gains -- -- (0.10) (0.03)
Capital (0.05) (0.18) (0.03) --
- ----------------------------------------------------------------------------------------------------------
Total Distributions (0.62) (0.62) (0.73) (0.23)
- ----------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 7.81 $ 7.84 $ 7.76 $ 8.41
- ----------------------------------------------------------------------------------------------------------
Total Return 7.82% 9.73% 0.66% 3.41%+++
- ----------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $42,222 $12,730 $1,065 $ 11
- ----------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses(3) 1.47% 1.46% 1.57% 1.50%+
Net investment income 7.61 10.23 7.20 7.87+
- ----------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 90% 83% 93% 116%
- ----------------------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(4) $ 0.00* -- -- --
==========================================================================================================
</TABLE>
(1) On November 7, 1994, the former Class D shares were renamed Class C shares.
(2) For the period from March 19, 1993 (inception date) to July 31, 1993.
(3) The manager waived part of its fees for the years ended July 31, 1995 and
1994. If such fees were not waived, the per share effect on net investment
income and the expense ratios would have been as follows:
Per Share Decreases Expense Ratios
in Net Investment Income Without Fee Waivers
------------------------ --------------------
1995 1994 1995 1994
---- ---- ---- ----
Class C $0.00* $0.00* 1.51% 1.58%
(4) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
* Amount represents less than $0.01 per share.
+++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
31
<PAGE>
- --------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------
For a share of each class of beneficial
interest outstanding throughout each
year:
Class Y Shares 1996(1)
====================================================================
Net Asset Value, Beginning of Year $7.89
- --------------------------------------------------------------------
Income From Operations:
Net investment income 0.50
Net realized and unrealized gain 0.01
- --------------------------------------------------------------------
Total Income From Operations 0.51
- --------------------------------------------------------------------
Less Distributions From:
Net investment income (0.53)
Capital (0.05)
- --------------------------------------------------------------------
Total Distributions (0.58)
- --------------------------------------------------------------------
Net Asset Value, End of Year $7.82
- --------------------------------------------------------------------
Total Return+++ 6.65%
- --------------------------------------------------------------------
Net Assets, End of Year (000s) $26,940
- --------------------------------------------------------------------
Ratios to Average Net Assets+:
Expenses 0.69%
Net investment income 8.54
- --------------------------------------------------------------------
Portfolio Turnover Rate 90%
- --------------------------------------------------------------------
Average commissions per share
paid on equity transactions $0.00*
====================================================================
(1) For the period from October 10, 1995 (inception date) to July 31, 1996.
* Amount represents less than $0.01 per share.
+++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
32
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
Financial Highlights (continued)
- -------------------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class Z Shares 1996 1995(1) 1994 1993(2)
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $7.85 $7.76 $8.41 $8.24
- -------------------------------------------------------------------------------------------
Income From Operations:
Net investment income(3) 0.64 0.84 0.68 0.51
Net realized and unrealized gain
(loss) 0.02 (0.06) (0.54) 0.25
- -------------------------------------------------------------------------------------------
Total Income From Operations 0.66 0.78 0.14 0.76
- -------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.63) (0.49) (0.59) (0.47)
Overdistributions of net
investment income -- -- (0.06) --
Net realized gains -- -- (0.10) (0.12)
Capital (0.06) (0.20) (0.04) --
- -------------------------------------------------------------------------------------------
Total Distributions (0.69) (0.69) (0.79) (0.59)
- -------------------------------------------------------------------------------------------
Net Asset Value, End of Year $7.82 $7.85 $7.76 $8.41
- -------------------------------------------------------------------------------------------
Total Return 8.72% 10.94% 1.43% 9.47%+++
- -------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $16,270 $14,361 $11,552 $ 11,803
- -------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses(3) 0.70% 0.75% 0.75% 0.80%+
Net investment income 8.19 8.30 8.02 8.56+
- -------------------------------------------------------------------------------------------
Portfolio Turnover Rate 90% 83% 93% 116%
- -------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(4) $0.00* -- -- --
- -------------------------------------------------------------------------------------------
</TABLE>
(1) On November 7, 1994, the former Class C shares were renamed Class Z shares.
(2) For the period from November 6, 1992 (inception date) to July 31, 1993.
(3) The manager waived part of its fees for the years ended July 31, 1995 and
1994. If such fees were not waived, the per share effect on net investment
income and the expense ratios would have been as follows:
<TABLE>
<CAPTION>
Per Share Decreases Expense Ratios
in Net Investment Income Without Fee Waivers
------------------------ -------------------
1995 1994 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
Class Z $0.00* $0.00* 0.80% 0.77%
</TABLE>
(4) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
* Amount represents less than $0.01 per share.
+++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
33
<PAGE>
- -------------------------------------------------------------------------------
Independent Auditors' Report
- -------------------------------------------------------------------------------
The Shareholders and Board of Trustees of
Smith Barney Income Funds:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Smith Barney Diversified Strategic
Income Fund of Smith Barney Income Funds as of July 31, 1996, the related
statement of operations for the year then ended and the statement of changes in
net assets and financial highlights for each of the years in the two-year period
then ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits. The financial highlights for each of the years in the three-year period
ended July 31, 1994, were audited by other auditors whose report thereon, dated
September 30, 1994, expressed an unqualified opinion on those financial
highlights.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of July
31, 1996, by correspondence with the custodian. As to securities purchased and
sold but not delivered and received, we performed other appropriate auditing
procedures. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Smith Barney Diversified Strategic Income Fund of Smith Barney Income Funds as
of July 31, 1996, the results of its operations for the year then ended and the
changes in its net assets and financial highlights for each of the years in the
two-year period then ended, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
New York, New York
September 23, 1996
34
<PAGE>
SMITH BARNEY
------------
A Member of TravelersGroup[LOGO]
Smith Barney
Diversified
Strategic Income
Fund
Trustees
Lee Abraham
Antoinette C. Bentley
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon
Madelon DeVoe Talley
Officers
Heath B. McLendon
Chairman and Investment Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President and
Treasurer
James E. Conroy
First Vice President and
Investment Officer
John C. Bianchi
Vice President and
Investment Officer
Victor S. Filatov
Vice President and
Investment Officer
Irving P. David
Controller
Christina T. Sydor
Secretary
Investment Adviser
Smith Barney Mutual Funds
Management Inc.
Distributor
Smith Barney Inc.
Custodian
The Bank of New York
Shareholder
Servicing Agent
First Data Investor Services Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for the general information of the shareholders of
Smith Barney Diversified Strategic Income Fund. It is not authorized for
distribution to prospective investors unless accompanied or preceded by an
effective Prospectus for the Fund, which contains information concerning the
Fund's investment policies and expenses as well as other pertinent information.
Smith Barney
Diversified Strategic
Income Fund
388 Greenwich Street
New York, New York 10013
FD01184 9/96
<PAGE>
ANNUAL REPORT
1996
1996
1996 [LOGO]
1996
1996
Smith Barney
Utilities Fund
-------------------------------------
July 31, 1996
[LOGO] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
- --------------------------------------------------------------------------------
Smith Barney Utilities Fund
- --------------------------------------------------------------------------------
Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney
Utilities Fund for the fiscal year ended July 31, 1996. In this report, we
summarize the period's prevailing economic and market conditions and outline our
portfolio strategy. A detailed summary of performance and current holdings can
be found in the appropriate sections that follow in the annual report.
It was another eventful year in the utilities industry -- a year of ever-
increasing competition, industry consolidation and mergers, generally strong but
volatile performance among companies, and an overall evolutionary environment in
what has long been considered a familiar and staid industry. For the utilities
industry and its investors, the past several years have shown that it's clearly
not business as usual.
We realize that the evolution occurring within the electric utilities industry
can be unsettling to our investors, and therefore have decided to take a
somewhat different approach to this year's annual report. In addition to
providing an update on your Fund's performance and summarizing the economic and
market conditions that influenced our investment decisions during the past
twelve months, we have also included a separate research report on the electric
utilities industry. Prepared exclusively for investors in the Smith Barney
Utilities Fund by experts at Smith Barney, "No Song & Dance: Straight Talk on
Utilities" is a detailed, no nonsense look at the changes occurring within the
electric utilities industry and the opportunities available right now and in the
future. We urge you to spend a few minutes reading it, and to speak with your
Financial Consultant should you have any questions or concerns.
Fund Performance
The investment objective of the Smith Barney Utilities Fund is to provide
investors with current income and long-term capital growth by investing in a
balanced portfolio of utility stocks and investment grade utility bonds.
Consistent with this objective, the Smith Barney Utilities Fund provided
investors in Class A shares with a total return of 9.21% for this fiscal year
and an annualized distribution rate of 5.62% (based on the Fund's net asset
value of $14.51 per share as of July 31, 1996 and dividends totaling $0.816 per
share for Class A shares). In comparison, the one-year total return for the
Lipper Utilities Fund Average was 11.43% and the annualized distribution rate
for the Fund's peer group of utility funds averaged 3.64%. (Lipper is an
independent mutual fund performance ranking organization.) The Smith Barney
Utilities Fund generally has a higher weighting in bonds than other utilities
funds in its
1
<PAGE>
category, which hindered its one-year total return performance versus the Lipper
average since the bond market experienced more of a decline during the second
half of the Fund's fiscal year than did utility stocks. On the other hand, its
higher bond concentration contributed to the Fund's higher current yield to
investors. Over the longer term, the Fund's allocation between stocks and bonds
has resulted in attractive performance numbers.
MARKET AND ECONOMIC OVERVIEW
During the last fiscal year, and since our last shareholder report dated January
31, 1996, the domestic equity markets continued to move higher. However, the
level of volatility in the market increased as investors focused on higher
corporate earnings, stronger-than-expected growth in the U.S. economy, and the
potential of monetary tightening by the Federal Reserve Board. The U.S. fixed
income markets also experienced an increase in volatility, but moved downward
rather than up, as investor fears over the re-emergence of inflation caused
long-term interest rates to rise by more than 1%. The yield on the benchmark 30-
year U.S. Treasury bond, which stood at 5.95% on December 31, 1995, peaked to a
high of 7.21% during the months of June and July 1996, before declining to below
the psychologically important level of 7.00% on July 31, 1996.
Going forward, we expect the U.S. economy to grow at a more moderate,
sustainable rate. In our opinion, inflation should remain under control as the
Federal Reserve remains resolved to maintaining control over the pace of U.S.
economic growth. Although we do not expect the Federal Reserve to raise interest
rates before the November presidential election, it remains a possibility.
Should economic growth accelerate in the fourth quarter, we believe this would
cause a rate increase in early 1997. Moreover, we believe corporate earnings
growth will continue to match or exceed the expectations of many analysts.
INDUSTRY OVERVIEW
The electric utility industry continues to evolve from a monopolistic to a more
competitive environment in which consumers will have a greater choice of energy
suppliers. In response to these competitive pressures, the utilities industry is
attempting to become more efficient. Utility companies are restructuring,
downsizing their organizations, and refocusing their business strategies to
enable them to compete more effectively and continue to grow earnings. For
example, some utilities have restructured their businesses into discrete units
involved in power generation and distribution, making it possible to sell off
one of the components or spin it off to shareholders. Also, the pace of mergers
and acquisitions within the electric utilities industry has increased due to the
significant cost savings that can be realized, thus improving the combined
2
<PAGE>
company's competitive position. In addition, we expect electric utility
companies to continue to explore business opportunities in the natural gas
industry, with the goal of becoming a diversified energy supplier. The merger
trend is likely to continue and could eventually involve both electric utility
and natural gas companies in the same geographic areas.
Jurisdiction over the industry is currently divided among federal and state
agencies, with the states controlling the distribution and sale of electricity
to retail customers. The final structure of the industry will therefore be the
product of both federal and state regulatory agencies. As a result, industry
changes will evolve at an uneven pace across the United States and will result
in uneven performance among utility companies.
The reduction in regulatory protection will increase business risks for those
companies with high costs, yet provide significant opportunities for well-
managed and lower-cost companies. Investors in the financial markets have
already begun to differentiate between more competitive companies with lower
costs, strong management teams and better growth potential, versus those
companies that will face pressure due to higher costs, lack of a clear corporate
strategy and limited growth potential. In our view, those companies that are
growth-oriented, have a solid competitive position, a growing service territory
and a strong management team should provide better investment opportunities.
INVESTMENT STRATEGY
The Smith Barney Utilities Fund's investment strategy is to focus on solid
fundamental analysis and favorable market valuations with the objective of
providing investors with current income and long-term capital growth. The
combination of stocks and bonds in the portfolio enables the Utilities Fund to
achieve high current yield potential from the bond sector as well as additional
income and long-term capital growth from stocks. As of July 31, 1996, the Fund's
portfolio mix was approximately 59% common stocks, 40% long-term investment
grade bonds and 1% cash.
The stock portion of the portfolio includes both yield- and growth-oriented
investments in the electric utility, natural gas and telecommunications
industries. We have increased the Fund's holdings of growth-oriented electric
utility companies with solid competitive positions, growing service territories,
and strong management teams. However, at the present time we are looking to
increase the Fund's holdings in the stocks of select natural gas companies and
decrease its holdings in telecommunication stocks because of their declining
prices this year due to competitive pressures affecting the industry's fee
structure. Since our last report, we have initiated new positions or added to
our existing positions in the following companies: American Electric Power,
3
<PAGE>
Carolina Power and Light, CMS Energy, Entergy Corporation, Kansas City Power and
Light, Pacificorp, Pinnacle West Capital, Portland General Corporation, SCE
Corporation, Sierra Pacific Corporation, and Texas Utilities. We sold or reduced
holdings in Boston Edison Company, Eastern Utilities Association, Enova
Corporation, New England Electric Systems, Public Service Enterprise Group,
Southern Company and Unicom Corporation. Moreover, the Fund increased its
natural gas holdings of Panenergy Corporation and liquidated its portions in
Washington Energy Company and MCN Corporation. In the telecommunications sector,
the Fund reduced its holdings in Bell South, Frontier Corporation, GTE and
NYNEX, but did add to its holdings in AT&T due to attractive valuation levels.
In the bond portion of the Fund, we focused on investment grade utility bonds.
Looking ahead, the bond portion of the Fund will require increased analysis of
those utilities that have high costs, face increasing competition, and have the
possibility of writing off plant and equipment due to changing market
conditions.
CONCLUSION
Evolution is never an easy process, but it can provide opportunities if
weathered successfully. Despite the changes occurring in the electric utility
industry, we continue to believe that utilities remain attractive investments
for conservative investors seeking current income and long-term capital growth.
In closing, thank you for investing in the Smith Barney Utilities Fund. We look
forward to continuing to help you reach your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ Jack S. Levande
Heath B. McLendon Jack S. Levande
Chairman and Vice President and
Investment Officer Investment Officer
August 14, 1996
4
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
Historical Performance -- Class A Shares
- ----------------------------------------------------------------------------------------
Net Asset Value
----------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $14.03 $14.51 $0.82 $0.00 $0.00 9.21%
- ----------------------------------------------------------------------------------------
7/31/95 13.28 14.03 0.82 0.08 0.02 13.24
- ----------------------------------------------------------------------------------------
7/31/94 15.97 13.28 0.83 0.50 0.00 (8.99)
- ----------------------------------------------------------------------------------------
Inception*
-7/31/93 14.36 15.97 0.64 0.13 0.00 17.01+
- ----------------------------------------------------------------------------------------
Total $3.11 $0.71 $0.02
========================================================================================
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
Historical Performance -- Class B Shares
- ----------------------------------------------------------------------------------------
Net Asset Value
---------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $14.02 $14.51 $0.75 $0.00 $0.00 8.78%
- ----------------------------------------------------------------------------------------
7/31/95 13.28 14.02 0.76 0.08 0.02 12.62
- ----------------------------------------------------------------------------------------
7/31/94 15.97 13.28 0.75 0.50 0.00 (9.52)
- ----------------------------------------------------------------------------------------
7/31/93 14.83 15.97 0.80 0.15 0.00 14.69
- ----------------------------------------------------------------------------------------
7/31/92++ 13.95 14.83 0.35 0.00 0.01 8.98+
- ----------------------------------------------------------------------------------------
2/28/92 13.21 13.95 0.84 0.15 0.03 13.63
- ----------------------------------------------------------------------------------------
2/28/91 12.93 13.21 0.90 0.10 0.00 10.46
- ----------------------------------------------------------------------------------------
2/28/90 12.09 12.93 0.90 0.21 0.00 16.34
- ----------------------------------------------------------------------------------------
Inception*
-2/28/89 12.00 12.09 0.57 0.15 0.00 6.80+
- ----------------------------------------------------------------------------------------
Total $ 6.62 $1.34 $0.06
========================================================================================
- ----------------------------------------------------------------------------------------
Historical Performance -- Class C Shares
- ----------------------------------------------------------------------------------------
Net Asset Value
-------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $14.02 $14.51 $0.75 $0.00 $0.00 8.80%
- ----------------------------------------------------------------------------------------
7/31/95 13.28 14.02 0.76 0.08 0.02 12.62
- ----------------------------------------------------------------------------------------
7/31/94 15.97 13.28 0.75 0.50 0.00 (9.52)
- ----------------------------------------------------------------------------------------
Inception*
-7/31/93 15.17 15.97 0.39 0.02 0.00 8.08+
- ----------------------------------------------------------------------------------------
Total $2.65 $0.60 $0.02
========================================================================================
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
Historical Performance -- Class Y Shares
- ---------------------------------------------------------------------------------------------
Net Asset Value
--------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
=============================================================================================
<S> <C> <C> <C> <C> <C> <C>
Inception*
-7/31/96 $14.88 $14.52 $0.71 $0.00 $0.00 2.28%+
=============================================================================================
<CAPTION>
- ---------------------------------------------------------------------------------------------
Historical Performance -- Class Z Shares
- ---------------------------------------------------------------------------------------------
Net Asset Value
----------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $14.02 $ 14.52 $0.85 $0.00 $0.00 9.62%
- ---------------------------------------------------------------------------------------------
7/31/95 13.28 14.02 0.87 0.08 0.02 13.55
- ---------------------------------------------------------------------------------------------
7/31/94 15.97 13.28 0.87 0.50 0.00 (8.78)
- ---------------------------------------------------------------------------------------------
Inception*
-7/31/93 14.36 15.97 0.66 0.14 0.00 17.21+
=============================================================================================
Total $3.25 $0.72 $0.02
=============================================================================================
</TABLE>
It is the Fund's policy to distribute dividends monthly and capital
gains, if any, annually.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
Average Annual Total Return
- ---------------------------------------------------------------------------------------------
Without Sales Charge(1)
-----------------------------------------------------------
Class A Class B Class C Class Y Class Z
=============================================================================================
<S> <C> <C> <C> <C> <C>
Year Ended 7/31/96 9.21% 8.78% 8.80% N/A 9.62%
- ---------------------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 8.51 N/A N/A N/A
- ---------------------------------------------------------------------------------------------
Inception* through 7/31/96 7.64 9.67 5.32 2.28%+ 7.95
=============================================================================================
With Sales Charge (2)
-----------------------------------------------------------
Class A Class B Class C Class Y Class Z
=============================================================================================
Year Ended 7/31/96 3.74% 3.78% 7.80% N/A 9.62%
- ---------------------------------------------------------------------------------------------
Five Years Ended 7/31/96 N/A 8.36 N/A N/A N/A
- ---------------------------------------------------------------------------------------------
Inception* through 7/31/96 6.17 9.67 5.32 2.28%+ 7.95
=============================================================================================
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
Cumulative Total Return
- ---------------------------------------------------------------------------------------------
Without Sales Charge(1)
- ---------------------------------------------------------------------------------------------
<S> <C>
Class A (Inception* through 7/31/96) 31.66%
- ---------------------------------------------------------------------------------------------
Class B (Inception* through 7/31/96) 116.04
- ---------------------------------------------------------------------------------------------
Class C (Inception* through 7/31/96) 19.80
- ---------------------------------------------------------------------------------------------
Class Y (Inception* through 7/31/96) 2.28+
- ---------------------------------------------------------------------------------------------
Class Z (Inception* through 7/31/96) 33.05
=============================================================================================
</TABLE>
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable sales charges with respect to Class A shares or the applicable
contingent deferred sales charges ("CDSC") with respect to Class B and C
shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, Class A shares reflect the deduction
of the maximum initial sales charge of 5.00%; Class B shares reflect the
deduction of a 5.00% CDSC, which applies if shares are redeemed within one
year from initial purchase and declines thereafter by 1.00% per year until
no CDSC charge is incurred. Class C shares reflect the deduction of a 1.00%
CDSC, which applies if shares are redeemed within the first year of
purchase.
+ Total return is not annualized, as it may not be representative of the total
return for the year.
++ For the period from March 1, 1992 to July 31, 1992, which reflects a change
in the fiscal year end of the Fund.
* Inception dates for Class A, B, C, Y and Z shares are November 6, 1992,
March 28, 1988, February 4, 1993, October 9, 1995 and November 6, 1992,
respectively.
7
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
Historical Performance (unaudited)
- ---------------------------------------------------------------------------------------------
Growth of $10,000 Invested in Class B Shares of
the Smith Barney Utilities Funds vs.
Standard & Poor's 500 Index and Lipper
Utilities Fund Average+
-----------------------------------------------
March 1988 - July 1996
[LINE GRAPH]
Smith Barney Utilities Fund Standard & Poor's 500 Index Lipper
Utilities Fund Average
<S> <C> <C> <C>
3/28/88 10,000 10,000 10,000
- --------------------------------------------------------------------------------------------------
7/88 10,208 10,624 10,476
- --------------------------------------------------------------------------------------------------
7/89 12,210 14,012 13,180
- --------------------------------------------------------------------------------------------------
7/90 12,785 14,923 13,670
- --------------------------------------------------------------------------------------------------
7/91 14,362 16,822 14,948
- --------------------------------------------------------------------------------------------------
7/92 16,997 18,970 17,917
- --------------------------------------------------------------------------------------------------
7/93 19,494 20,624 21,008
- --------------------------------------------------------------------------------------------------
7/94 17,636 21,685 19,744
- --------------------------------------------------------------------------------------------------
7/95 19,861 27,338 21,745
- --------------------------------------------------------------------------------------------------
7/31/96 21,605 31,864 24,239
</TABLE>
+ Hypothetical illustration of $10,000 invested in Class B shares at inception
on March 28, 1988, assuming reinvestment of dividends and capital gains, if
any, at net asset value through July 31, 1996. The Standard & Poor's 500
Index is an index composed of widely held common stocks listed on the New
York Stock Exchange, American Stock Exchange and over-the-counter market.
Figures for the index include reinvestment of dividends. The index is
unmanaged and is not subject to the same management and trading expenses of a
mutual fund. The Lipper Analytical Services, Inc. Utilities Fund Average
("Lipper Utilities Fund Average") is composed of the Fund's peer group of
mutual funds (13 funds as of July 31, 1996) investing in utilities
securities. The performance of the Fund's other classes may be greater or
less than the Class B shares' performance indicated on this chart, depending
on whether greater or lesser sales charges and fees were incurred by
shareholders investing in other classes.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital gains.
8
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Portfolio Highlights (unaudited) July 31, 1996
- -----------------------------------------------------------------------------------------
Portfolio Breakdown
[PIE CHART]
Electric & Gas 92.5%
Telephone 6.9%
Other Corporate Bonds & Notes and Repurchase Agreement 0.6%
Percentage of
Company Total Investments
- -----------------------------------------------------------------------------------------
<S> <C>
Top Five Equity Holdings
Texas Utilities Co. 4.5%
American Electric Power Co. 4.1
FPL Group Inc. 3.4
Southern Co. 2.9
American Telephone & Telegraph Corp. 2.5
Top Five Bond Holdings
Utilicorp United Inc. 2.3%
Hydro-Quebec 2.2
Atlantic City Electric Co. 1.8
Commonwealth Edison Co. 1.6
Bell South Telecommunications 1.6
- -----------------------------------------------------------------------------------------
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
Schedule of Investments July 31, 1996
- ------------------------------------------------------------------------------------------------------------
SHARES SECURITY VALUE
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS -- 58.6%
Electric & Gas -- 53.6%
650,000 Allegheny Power System $ 19,012,500
1,550,000 American Electric Power Co. 64,325,000
550,000 Carolina Power & Light 19,800,000
1,000,000 Central & Southwest Corp. 26,750,000
1,200,000 Cinergy Corp. 35,550,000
350,000 Cipsco 12,512,500
250,000 CMS Energy Corp. 7,593,750
700,000 Coastal Corp. 26,075,000
600,000 Consolidated Edison Company of New York Inc. 16,200,000
1,000,000 DPL Inc. 22,625,000
1,000,000 DTE Energy Co. 28,750,000
2,000,000 Edison International 31,000,000
850,000 Entergy Corp. 21,675,000
200,000 Enron Corp. 7,875,000
600,000 Florida Progress Corp. 20,100,000
1,200,000 FPL Group Inc. 54,450,000
600,000 General Public Utilities Corp. 19,500,000
1,400,000 Houston Industries Inc. 31,675,000
1,065,000 Kansas City Power & Light 28,488,750
400,000 New York State Electric & Gas Corp. 8,650,000
1,000,000 Nipsco 37,375,000
300,000 Oklahoma Gas & Electric Co. 11,775,000
850,000 Pacificorp 17,743,750
950,000 Panenergy Corp. 30,162,500
600,000 Peco Energy Co. 14,100,000
450,000 Pennsylvania Power & Light Co. 10,068,750
500,000 Pinnacle West Capital Corp. 14,125,000
500,000 Portland General Corp. 17,750,000
800,000 Public Service Company of Colorado 28,300,000
650,000 SCANA Corp. 16,818,750
450,000 Sierra Pacific Resources 11,306,250
2,000,000 Southern Co. 45,250,000
1,700,000 Texas Utilities Co. 71,400,000
900,000 Unicom Corp. 21,150,000
- ------------------------------------------------------------------------------------------------------------
849,932,500
- ------------------------------------------------------------------------------------------------------------
Telephone -- 5.0%
775,000 American Telephone & Telegraph Corp. 40,396,875
750,000 GTE Corp. 30,937,500
500,000 U.S. West Media Group 8,625,000
- ------------------------------------------------------------------------------------------------------------
79,959,375
- ------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost -- $867,740,084) 929,891,875
============================================================================================================
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- ---------------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
- ---------------------------------------------------------------------------------------
CORPORATE BONDS & NOTES -- 41.0%
Electric & Gas -- 38.9%
<S> <C> <C>
$5,000,000 Arkansas Power & Light, 8.700% due 11/1/22 $ 5,256,250
Atlantic City Electric Co.:
16,000,000 7.000% due 9/1/23 14,640,000
15,000,000 7.000% due 8/1/28 13,518,750
Bell South Telecommunications:
13,500,000 7.625% due 5/15/35 13,162,500
13,500,000 7.000% due 12/1/95 12,420,000
Boston Edison Co.:
5,000,000 9.875% due 6/1/20 5,400,000
7,000,000 8.250% due 9/15/22 6,658,750
8,000,000 7.800% due 3/15/23 7,290,000
Carolina Power & Light Co.:
11,950,000 8.625% due 9/15/21 13,219,688
10,000,000 8.200% due 7/1/22 10,112,500
2,000,000 Central Illinois Light Co., 8.200% due 1/15/22 2,067,500
4,000,000 Central Power & Light Co., 7.500% due 4/1/23 3,920,000
2,800,000 Cincinnati Gas & Electric Co., 8.500% due 9/1/22 2,940,000
3,000,000 Cleveland Electric Illuminating Co., 9.000% due
7/1/23 2,636,250
Coastal Corp.:
2,000,000 10.750% due 10/1/10 2,505,000
2,000,000 9.625% due 5/15/12 2,290,000
5,000,000 7.750% due 10/15/35 4,812,500
10,000,000 Columbia Gas, 7.620% due 11/28/25 9,275,000
Commonwealth Edison Co.:
2,000,000 7.500% due 7/1/13 1,917,500
14,250,000 8.375% due 9/15/22 14,089,688
10,850,000 7.750% due 7/15/23 10,144,750
5,000,000 Duke Power, 7.000% due 7/1/33 4,512,500
Duquesne Light Co.:
3,000,000 7.625% due 4/15/23 2,823,750
15,000,000 7.550% due 6/15/25 14,118,750
10,000,000 Florida Power Corp., 8.625% due 11/1/21 10,650,000
8,000,000 Gulf Power Co., 6.875% due 1/1/26 7,180,000
15,100,000 Houston Lighting & Power Co., 9.150% due 3/15/21 17,421,625
Hydro-Quebec:
20,000,000 8.250% due 1/15/27 20,675,000
12,500,000 8.625% due 6/15/29 13,453,125
11,800,000 Idaho Power Co., 8.750% due 3/15/27 12,316,250
13,000,000 Illinois Power Co., 7.500% due 7/15/25 12,057,500
10,500,000 Interstate Power Co., 8.625% due 9/15/21 11,248,125
Iowa Illinois Gas & Electric Co.:
3,500,000 7.450% due 3/15/23 3,438,750
8,500,000 6.950% due 10/15/25 7,905,000
10,000,000 Jersey Central Power & Light Co., 6.750% due 11/1/25 8,650,000
15,500,000 Kentucky Utilities Co., 8.550% due 5/15/27 16,391,250
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- ----------------------------------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
- ----------------------------------------------------------------------------------------------------------
Electric & Gas -- 38.9% (continued)
<S> <C> <C>
$ 5,000,000 Louisiana Power & Light Co., 8.750% due 3/1/26 $ 4,893,750
Mississippi Power & Light Co.:
17,000,000 8.650% due 1/15/23 17,892,500
4,800,000 6.875% due 12/1/25 4,350,000
3,000,000 Montana Power Co., 8.950% due 2/1/22 3,191,250
2,000,000 Narragansett Power Co., 9.125% due 5/1/21 2,127,500
3,000,000 Nevada Power & Light Co., 8.500% due 1/1/23 3,101,250
18,450,000 New Orleans Public Service Inc., 8.000% due 3/1/23 18,334,687
New York State Electric & Gas Co.:
11,750,000 8.300% due 12/15/22 11,647,187
2,250,000 7.450% due 7/15/23 2,115,000
Niagara Power:
5,000,000 8.750% due 4/1/22 4,293,750
5,000,000 8.500% due 7/1/23 4,175,000
6,275,000 7.785% due 4/1/24 4,996,469
1,920,000 Northern States Power Co., 9.125% due 4/1/21 2,023,200
4,250,000 Pacific Gas & Electric Co., 6.750% due 10/1/23 3,724,062
10,000,000 Pacific Gas Transmission, 7.800% due 1/1/25 9,612,500
4,000,000 PacifiCorp., 6.710% due 6/15/26 3,560,000
Pennsylvania Power & Light Co.:
7,500,000 8.500% due 5/1/22 7,846,875
3,100,000 6.750% due 10/1/23 2,724,125
7,000,000 Philadelphia Electric Co., 8.750% due 4/1/22 7,236,250
6,000,000 Portland General Electric Co., 7.750% due 4/15/23 5,880,000
5,000,000 Potomac Edison Co., 7.750% due 2/1/23 4,993,750
5,000,000 Potomac Electric, 8.500% due 5/15/27 5,200,000
10,000,000 Public Service Co. of Colorado, 8.750% due 3/1/22 10,437,500
7,000,000 Public Service Electric & Gas Co., 9.250% due 6/1/21 8,050,000
12,500,000 San Diego Gas & Electric Co., 8.500% due 4/1/22 13,046,875
18,500,000 South Carolina Electric & Gas Co., 7.625% due 6/1/23 18,060,625
3,000,000 South West Gas, 8.000% due 8/1/26 2,937,646
10,000,000 Southern California Edison, 7.250% due 3/1/26 9,137,500
15,000,000 Southwestern Electric Power Co., 6.875% due 10/1/25 13,762,500
5,000,000 Tennessee Valley Authority, 7.250% due 7/15/43 4,637,500
26,500,000 U.S. West Communications, 6.875% due 9/15/33 22,988,750
Utilicorp United Inc.:
23,000,000 9.000% due 11/15/21 23,603,750
13,000,000 8.000% due 3/1/23 12,707,500
5,000,000 Virginia Electric Power Co., 8.625% due 10/1/04 5,306,250
11,500,000 Western Pennsylvania Power Co., 8.875% due 2/1/21 12,161,250
4,500,000 Western Resources, 8.500% due 7/1/22 4,606,875
- ----------------------------------------------------------------------------------------------------------
616,481,877
- ----------------------------------------------------------------------------------------------------------
Miscellaneous -- 0.2%
3,000,000 Selkirk Cogen, 8.980% due 6/26/12 3,157,500
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
12
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1996
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
===========================================================================================
Telephone -- 1.9%
<S> <C> <C>
$5,000,000 Century Telephone Enterprise, 7.200% due 12/1/25 $ 4,631,250
GTE Corp.:
5,000,000 8.750% due 11/1/21 5,575,000
10,000,000 7.830% due 5/1/23 9,725,000
6,000,000 GTE Northwest, 7.875% due 6/1/26 6,030,000
5,000,000 Pacific Bell, 7.375% due 7/15/43 4,693,750
- -------------------------------------------------------------------------------------------
30,655,000
- -------------------------------------------------------------------------------------------
TOTAL CORPORATE BONDS & NOTES
(Cost -- $655,717,684) 650,294,377
===========================================================================================
REPURCHASE AGREEMENT -- 0.4%
6,402,000 Chase Manhattan Bank, 5.545% due 8/1/96; Proceeds at
maturity -- $6,402,986; (Fully collateralized by U.S.
Treasury Note, 6.250% due 7/31/98;
Market value -- $6,532,600) (Cost -- $6,402,000) 6,402,000
===========================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $1,529,859,768*) $ 1,586,588,252
===========================================================================================
* Aggregate cost for Federal income tax purposes is substantially the same.
</TABLE>
See Notes to Financial Statements.
13
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
Statement of Assets and Liabilities July 31, 1996
- ---------------------------------------------------------------------
<S> <C>
ASSETS:
Investments, at value (Cost -- $1,529,859,768) 1,586,588,252
Cash 589
Receivable for Fund shares sold 773,529
Receivable for securities sold 13,530,437
Interest receivable 13,416,608
Dividends receivable 3,164,110
- ---------------------------------------------------------------------
Total Assets 1,617,473,525
- ---------------------------------------------------------------------
LIABILITIES:
Payable for securities purchased 2,993,127
Payable for Fund shares purchased 1,633,840
Distribution fees payable 904,569
Investment advisory fees payable 626,477
Administration fees payable 278,464
Accrued expenses 914,036
- ---------------------------------------------------------------------
Total Liabilities 7,350,513
- ---------------------------------------------------------------------
Total Net Assets $1,610,123,012
- ---------------------------------------------------------------------
NET ASSETS:
Par value of shares of beneficial interest 110,993
Capital paid in excess of par value 1,518,519,507
Undistributed net investment income 1,876,841
Accumulated net realized gain on security transactions 32,887,187
Net unrealized appreciation of investments 56,728,484
- ---------------------------------------------------------------------
Total Net Assets $1,610,123,012
- ---------------------------------------------------------------------
Shares Outstanding:
Class A 18,344,890
- ---------------------------------------------------------------------
Class B 90,334,939
- ---------------------------------------------------------------------
Class C 788,654
- ---------------------------------------------------------------------
Class Y 524,592
- ---------------------------------------------------------------------
Class Z 999,717
- ---------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $14.51
- ---------------------------------------------------------------------
Class B* $14.51
- ---------------------------------------------------------------------
Class C** $14.51
- ---------------------------------------------------------------------
Class Y (and redemption price) $14.52
- ---------------------------------------------------------------------
Class Z (and redemption price) $14.52
- ---------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 5.26% of net asset value per share) $15.27
======================================================================
</TABLE>
* Redemption price is NAV of Class B shares reduced by a 5.00% CDSC if
shares are redeemed within one year from initial purchase (See Note 2).
**Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if
shares are redeemed within the first year of purchase.
See Notes to Financial Statements.
14
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
Statement of Operations For the Year Ended July 31, 1996
- ---------------------------------------------------------------------------------------
INVESTMENT INCOME:
<S> <C>
Interest $ 62,018,482
Dividends 56,981,280
Less: Foreign withholding tax (25,973)
- ---------------------------------------------------------------------------------------
Total Investment Income 118,973,789
- ---------------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 2) 12,152,329
Investment advisory fees (Note 2) 8,094,511
Administration fees (Note 2) 3,597,560
Shareholder and system servicing fees 1,729,000
Shareholder communications 450,000
Audit and legal 115,000
Registration fees 110,000
Custody 77,000
Trustees' fees 30,000
Pricing fees 12,000
Other 34,246
- ---------------------------------------------------------------------------------------
Total Expenses 26,401,646
- ---------------------------------------------------------------------------------------
Net Investment Income 92,572,143
- ---------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN
ON INVESTMENTS (NOTE 3):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 1,135,049,267
Cost of securities sold 1,068,569,042
- ---------------------------------------------------------------------------------------
Net Realized Gain 66,480,225
Decrease in Net Unrealized Appreciation (3,572,589)
- ---------------------------------------------------------------------------------------
Net Gain on Investments 62,907,636
- ---------------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 155,479,779
=======================================================================================
</TABLE>
See Notes to Financial Statements.
15
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended July 31,
- ------------------------------------------------------------------------------------------------------------
1996 1995
============================================================================================================
OPERATIONS:
<S> <C> <C>
Net investment income $ 92,572,143 $ 102,821,489
Net realized gain (loss) 66,480,225 (33,514,243)
Increase (decrease) in net unrealized appreciation (3,572,589) 135,112,680
- ------------------------------------------------------------------------------------------------------------
Increase in Net Assets From Operations 155,479,779 204,419,926
- ------------------------------------------------------------------------------------------------------------
DISTRIBUTION TO SHAREHOLDERS FROM:
Net investment income (90,695,144) (100,155,893)
Overdistribution of net realized gains -- (10,931,878)
Capital -- (2,430,498)
- ------------------------------------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions To Shareholders (90,695,144) (113,518,269)
- ------------------------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net proceeds from sales 184,600,350 281,385,409
Net asset value of shares issued in connection
with the transfer of Smith Barney Funds, Inc.--
Utility Portfolio's net assets (Note 6) 77,275,976 --
Net asset value of shares issued for
reinvestment of dividends 69,393,301 91,060,017
Cost of shares reacquired (546,072,751) (580,475,140)
- ------------------------------------------------------------------------------------------------------------
Decrease in Net Assets From Fund
Share Transactions (214,803,124) (208,029,714)
- ------------------------------------------------------------------------------------------------------------
Decrease in Net Assets (150,018,489) (117,128,057)
NET ASSETS:
Beginning of year 1,760,141,501 1,877,269,558
- ------------------------------------------------------------------------------------------------------------
End of year* $1,610,123,012 $1,760,141,501
============================================================================================================
* Includes undistributed net investment income of: $1,876,841 --
============================================================================================================
</TABLE>
See Notes to Financial Statements.
16
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
The Smith Barney Utilities Fund ("Fund"), a separate investment fund of the
Smith Barney Income Funds ("Trust"), a Massachusetts business trust, is
registered under the Investment Company Act of 1940, as amended, as a
diversified, open-end management investment company. The Trust consists of the
Fund and six other separate investment funds: Smith Barney Convertible Fund,
Smith Barney Diversified Strategic Income Fund, Smith Barney High Income Fund,
Smith Barney Premium Total Return Fund, Smith Barney Tax-Exempt Income Fund and
Smith Barney Exchange Reserve Fund. The financial statements and financial
highlights for the other funds are presented in separate annual reports.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) securities traded
on national securities markets are valued at the closing price on such markets;
securities traded in the over-the-counter market and listed securities for which
no sales price were reported and U.S. Government and Agency Obligations are
valued at bid price, or in the absence of a recent bid price, at the bid
equivalent obtained from one or more of the major market makers; (c) securities
maturing within 60 days are valued at cost plus accreted discount, or minus
amortized premium, which approximates market value (d) dividend income is
recorded on ex-dividend date and interest income is recorded on the accrual
basis; (e) dividends and distributions to shareholders are recorded on the ex-
dividend date; (f) gains or losses on the sale of securities are recorded on the
identified cost basis; (g) direct expenses are charged to each fund and each
class; management fees and general fund expenses are allocated on the basis of
relative net assets of each class; (h) the Fund intends to comply with the
applicable provisions of the Internal Revenue Code of 1986, as amended,
pertaining to regulated investment companies and to make distributions of
taxable income sufficient to relieve it from substantially all Federal income
and excise taxes; (i) the character of income and gains to be distributed are
determined in accordance with income tax regulations which may differ from
generally accepted accounting principles. At July 31, 1996, reclassifications
are made to the Portfolio's capital accounts to reflect permanent book/tax
differences and income and gains available for distributions under income tax
regulations. Accordingly, a portion of accumulated net realized loss amounting
to $78,795 and a portion of undistributed net investment income amounting to
$158 has been reclassified to paid-in-capital. Net investment income, net
realized gains and net assets were not affected by this change; and (j)
estimates and assumptions are required to be made regarding assets, liabilities
and changes in net assets resulting from operations when financial statements
are prepared. Changes in the economic environment, financial markets and any
other parameters used in determining these estimates could cause actual results
to differ.
17
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
2. Investment Advisory Agreement, Administration
Agreement and Other Transactions
Smith Barney Mutual Funds Management Inc. ("SBMFM"), a subsidiary of Smith
Barney Holdings Inc. ("SBH"), acts as investment adviser to the Trust. The Funds
pays SBMFM an advisory fee calculated at an annual rate of 0.45% of the average
daily net assets. This fee is calculated daily and paid monthly.
SBMFM also acts as the Fund's administrator for which the Fund pays a fee
calculated at an annual rate of 0.20% of the average daily net asset. This fee
is calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SBH, acts as distributor
of Fund shares and primary broker for its portfolio agency transactions. For the
year ended July 31, 1996, SB received brokerage commissions of $91,818 and sales
charges of approximately $228,000 on sales of the Fund's Class A shares.
There is a contingent deferred sales charge ("CDSC") of 5.00% on Class B
shares, which applies if redemption occurs less than one year from initial
purchase and declines thereafter by 1.00% per year until no CDSC is incurred.
Class C shares have a 1.00% CDSC if redemption occurs within the first year of
purchase. In addition, Class A shares have a 1.00% CDSC, which applies if
redemption occurs within the first year of purchase. This CDSC only applies to
those purchases of Class A shares, which, when combined with current holdings of
Class A shares, equal or exceed $500,000 in the aggregate. These purchases do
not incur an initial sales charge. For the year ended ended July 31, 1996, CDSCs
paid to SB were approximately:
Class A Class B Class C
- --------------------------------------------------------------------------------
CDSCs $1,000 $3,393,000 $5,000
- --------------------------------------------------------------------------------
Pursuant to a Distribution Plan, the Fund pays a service fee with respect
to Class A, B and C shares calculated at the annual rate of 0.25% of the average
daily net assets for each respective class. In addition, the Fund pays a
distribution fee with respect to Class B and C shares calculated at the annual
rate of 0.50% and 0.45% of the average daily net assets for each class. For the
year ended July 31, 1996, total Distribution Plan fees incurred were as follows:
Class A Class B Class C
- --------------------------------------------------------------------------------
Distribution Plan Fees $599,679 $11,483,866 $68,784
- --------------------------------------------------------------------------------
All officers and one Trustee of the Trust are employees of SB.
18
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
3. Investments
During the year ended July 31, 1996, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $ 994,405,162
- --------------------------------------------------------------------------------
Sales 1,135,049,267
================================================================================
At July 31, 1996, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were approximately
as follows:
================================================================================
Gross unrealized appreciation $105,028,000
Gross unrealized depreciation (48,299,000)
- --------------------------------------------------------------------------------
Net unrealized appreciation $ 56,729,000
================================================================================
4. Repurchase Agreements
The Fund purchases (and its custodian takes possession of) U.S. Government
Securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day),
at an agreed-upon higher repurchase price. The Fund requires continual
maintenance of the market value of the collateral in amounts at least equal to
the repurchase price.
5. Shares of Beneficial Interest
At July 31, 1996, the Trust had an unlimited number of shares of beneficial
interest authorized with a par value of $0.001 per share. The Fund has the
ability to issue multiple classes of shares. Each share of a class represents an
identical interest and has the same rights, except that each class bears certain
expenses, specifically related to the distribution of its shares. Effective
November 7, 1994, the Fund adopted a new class structure, renaming the former
Class D and C shares as Class C and Z shares, respectively.
At July 31, 1996, total paid-in capital amounted to the following for each
class:
<TABLE>
<CAPTION>
Class A Class B Class C Class Y Class Z
=======================================================================================
<S> <C> <C> <C> <C> <C>
Total Paid-in
Capital $251,162,307 $1,232,471,470 $11,907,605 $7,770,441 $15,318,677
=======================================================================================
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
Notes Financial Statements (continued
- ------------------------------------------------------------------------------------------------
Transactions in shares of each class were as follows:
Year Ended Year Ended
July 31, 1996 July 31, 1995
------------------------ ----------------------------
Shares Amount Shares Amount
- ------------------------------------------------------------------------------------------------
Class A
<S> <C> <C> <C> <C>
Shares sold 5,522,642 $ 84,582,536 12,200,129 $ 155,398,366
Net asset value of shares
issued in connection
with the transfer of
Smith Barney Funds,
Inc. - Utility Portfolio's
net assets (Note 6) 4,473,406 67,910,384 -- --
Shares issued on
reinvestment 686,576 10,274,588 635,849 8,481,967
Shares redeemed (4,384,228) (65,447,502) (3,912,440) (51,670,012)
- ------------------------------------------------------------------------------------------------
Net Increase 6,298,396 $ 97,320,386 8,923,538 $ 112,210,321
- ------------------------------------------------------------------------------------------------
Class B
Shares sold 5,598,593 $ 83,916,266 8,946,045 $ 116,256,568
Net asset value of shares
issued in connection
with the transfer of
Smith Barney Funds,
Inc. - Utility Portfolio's
net assets (Note 6) 130,708 1,973,562 -- --
Shares issued on
reinvestment 3,863,108 57,767,942 5,975,380 81,512,249
Shares redeemed (31,436,995) (470,651,907) (40,024,691) (522,321,582)
- ------------------------------------------------------------------------------------------------
Net Decrease (21,844,586) $ (326,994,517) (25,103,266) $(324,552,765)
- ------------------------------------------------------------------------------------------------
Class C+
Shares sold 252,794 $ 3,788,442 304,315 $ 4,058,795
Net asset value of shares
issued in connection
with the transfer of
Smith Barney Funds,
Inc. - Utility Portfolio's
net assets (Note 6) 486,438 7,392,030 -- --
Shares issued on
reinvestment 28,059 421,315 12,479 167,141
Shares redeemed (258,618) (3,895,440) (179,428) (2,396,381)
- ------------------------------------------------------------------------------------------------
Net Increase 508,673 $ 7,706,347 137,366 $ 1,829,555
- ------------------------------------------------------------------------------------------------
Class Y
Shares sold 681,967 $ 10,097,754 -- --
Shares issued on
reinvestment 4,680 71,463 -- --
Shares redeemed (162,055) (2,399,434) -- --
- ------------------------------------------------------------------------------------------------
Net Increase 524,592 $ 7,769,783 -- --
- ------------------------------------------------------------------------------------------------
Class Z++
Shares sold 147,037 $ 2,215,352 428,912 $ 5,671,680
Shares issued on
reinvestment 57,372 857,993 67,336 898,660
Shares redeemed (247,957) (3,678,468) (309,629) (4,087,165)
- ------------------------------------------------------------------------------------------------
Net Increase (Decrease) (43,548) $ (605,123) 186,619 $ 2,483,175
- ------------------------------------------------------------------------------------------------
</TABLE>
+ On November 7, 1994, the former Class D shares were renamed Class C
shares.
++ On November 7, 1994, the former Class C shares were renamed Class Z shares.
20
<PAGE>
- -------------------------------------------------------------------------------
Notes to Financial Statements(continued)
- -------------------------------------------------------------------------------
6. Transfer of Net Assets
On November 17, 1995, the Fund acquired the assets and certain liabilities
of the Smith Barney Funds, Inc. -- Utility Portfolio ("Utility Portfolio")
pursuant to a plan of reorganization approved by Utility Portfolio shareholders
on November 15, 1995. Total shares issued by the Fund and the total net assets
of Utility Portfolio on the date of transfer were:
Total Net
Shares Assets of Total Net
Issued by Acquired Assets of
Acquired Portfolio the Fund Portfolio the Fund
- -------------------------------------------------------------------------------
Utility Portfolio 5,090,552 $77,275,976 $1,917,693,490
- -------------------------------------------------------------------------------
The total net assets of the Utility Portfolio before acquisition included
unrealized appreciation of $7,088,433, an overdistribution of income of $43,610
and a net realized loss of $74,262. Total net assets of the Fund immediately
after the transfer were $1,994,969,466. The transaction was structured for tax
purposes to qualify as a tax-free reorganization under the Internal Revenue
Code.
7. Concentration of Credit Risk
Because the Fund concentrates its investments in the utilities industry,
its portfolio may be subject to greater risk and market fluctuations than a
portfolio of securities representing a broader range of investment alternatives.
The economic risks associated with the concentration of the Fund in only one
industry could mean that adverse conditions could substantially impact the
income earned by the Fund and the value of the Fund's holdings.
21
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Financial Highlights
- -----------------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class A Shares 1996 1995 1994 1993(1)
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $14.03 $13.28 $15.97 $14.36
- ------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.83 0.85 0.56 0.66
Net realized and unrealized gain (loss) 0.47 0.82 (1.92) 1.72
- ------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 1.30 1.67 (1.36) 2.38
- ------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.82) (0.82) (0.80) (0.63)
Overdistribution of net investment income -- -- (0.03) (0.01)
Net realized gains -- -- (0.50) (0.13)
Overdistribution of net realized gains -- (0.08) -- --
Capital -- (0.02) -- --
- ------------------------------------------------------------------------------------------
Total Distributions (0.82) (0.92) (1.33) (0.77)
- ------------------------------------------------------------------------------------------
Net Asset Value, End of Year $14.51 $14.03 $13.28 $15.97
- ------------------------------------------------------------------------------------------
Total Return 9.21% 13.24% (8.99)% 17.01%++
- ------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $266,163 $168,963 $41,458 $53,856
- ------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.04% 1.07% 1.07% 1.07%+
Net investment income 5.55 6.36 5.54 5.67+
- ------------------------------------------------------------------------------------------
Portfolio Turnover Rate 58% 36% 28% 37%
- ------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions (2) $0.06 -- -- --
- ------------------------------------------------------------------------------------------
</TABLE>
(1) For the period from November 6, 1992 (inception date) to July 31, 1993.
(2) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
22
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
Financial Highlights (continued)
- ------------------------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each year:
Class B Shares 1996 1995 1994 1993 1992(1) 1992(2)
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning
of Year $14.02 $13.28 $15.97 $14.83 $13.95 $13.21
- ------------------------------------------------------------------------------------------------
Income (Loss) From
Operations:
Net investment income 0.77 0.78 0.75 0.79 0.35 0.82
Net realized and
unrealized gain (loss) 0.47 0.82 (2.19) 1.30 0.89 0.94
- ------------------------------------------------------------------------------------------------
Total Income (Loss) From
Operations 1.24 1.60 (1.44) 2.09 1.24 1.76
- ------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.75) (0.76) (0.72) (0.79) (0.35) (0.84)
Overdistribution of net
investment income -- -- (0.03) (0.01) -- --
Net realized gains -- -- (0.50) (0.15) -- (0.15)
Overdistribution of net
realized gains -- (0.08) -- -- -- --
Capital -- (0.02) -- -- (0.01) (0.03)
- ------------------------------------------------------------------------------------------------
Total Distributions (0.75) (0.86) (1.25) (0.95) (0.36) (1.02)
- ------------------------------------------------------------------------------------------------
Net Asset Value, End of
Year 14.51 $14.02 $13.28 $15.97 $14.83 $13.95
- ------------------------------------------------------------------------------------------------
Total Return 8.78% 12.62% (9.52)% 14.69% 8.98%++ 13.63%++
- ------------------------------------------------------------------------------------------------
Net Assets, End of Year
(millions) 1,310,387 $1,573 $1,823 $2,766 $1,721 $1,275
- ------------------------------------------------------------------------------------------------
Ratios to Average Net
Assets:
Expenses 1.55% 1.56% 1.54% 1.56% 1.57%+ 1.58%+
Net investment income 5.13 5.82 5.07 5.17 5.78+ 6.04+
- ------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 58% 36% 28% 37% 10% 33%
- ------------------------------------------------------------------------------------------------
Average commissions per
share paid on equity
transactions (3) $0.06 -- -- -- -- --
- ------------------------------------------------------------------------------------------------
</TABLE>
(1) For the period from March 1, 1992 to July 31, 1992.
(2) For the period from March 1, 1991 to February 28, 1992.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the total
return for the year.
+ Annualized.
23
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------------------------------------------------------
For a share of each class of beneficial
interest outstanding throughout each year:
Class C Shares 1996 1995(1) 1994 1993(2)
================================================================================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $14.02 $13.28 $15.97 $15.17
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.77 0.78 0.73 0.35
Net realized and unrealized gain (loss) 0.47 0.82 (2.17) 0.86
- --------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 1.24 1.60 (1.44) 1.21
- --------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.75) (0.76) (0.72) (0.38)
Overdistribution of net investment
income -- -- (0.03) (0.01)
Net realized gains -- -- (0.50) (0.02)
Overdistribution of net realized gains -- (0.08) -- --
Capital -- (0.02) -- --
- --------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.75) (0.86) (1.25) (0.41)
- --------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 14.51 $14.02 $ 13.28 $ 15.97
- --------------------------------------------------------------------------------------------------------------------------------
Total Return 8.80% 12.62% (9.52)% 8.08%++
- --------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $11,441 $3,925 $1,894 $252
- --------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.50% 1.51% 1.48% 1.49%+
Net investment income 5.19 5.77 5.13 5.25+
- --------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 58% 36% 28% 37%
- --------------------------------------------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions (3) $ 0.06 -- -- --
================================================================================================================================
</TABLE>
(1) On November 7, 1994, the former Class D shares were renamed Class C
shares.
(2) For the period from February 4, 1993 (inception date) to July 31, 1993.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the total
return for the year.
+ Annualized.
24
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
Financial Highlights (continued)
- -------------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each year:
<S> <C>
Class Y Shares 1996(1)
=====================================================================================
Net Asset Value, Beginning of Year $14.88
- -------------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.64
Net realized and unrealized gain (0.29)
- -------------------------------------------------------------------------------------
Total Income From Operations 0.35
- -------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.71)
- -------------------------------------------------------------------------------------
Total Distributions (0.71)
- -------------------------------------------------------------------------------------
Net Asset Value, End of Year $14.52
- -------------------------------------------------------------------------------------
Total Return++ 2.28%
- -------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $7,617
- -------------------------------------------------------------------------------------
Ratios to Average Net Assets+:
Expenses 0.78%
Net investment income 5.54%
- -------------------------------------------------------------------------------------
Portfolio Turnover Rate 58%
- -------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions $0.06
=====================================================================================
</TABLE>
(1) For the period October 9, 1995 through July 31, 1996.
++ Total return is not annualized, as it may not be representative of the total
return for the year.
+ Annualized.
25
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each year:
Class Z Shares 1996 1995(1) 1994 1993(2)
================================================================================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $14.02 $13.28 $15.97 $14.36
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.88 0.89 0.89 0.69
Net realized and unrealized gain (loss) 0.47 0.82 (2.21) 1.72
- --------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 1.35 1.71 (1.32) 2.41
- --------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.85) (0.87) (0.84) (0.65)
Overdistribution of net investment
income -- -- (0.03) (0.01)
Net realized gains -- -- (0.50) (0.14)
Overdistribution of net realized gains -- (0.08) -- --
Capital -- (0.02) -- --
- --------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.85) (0.97) (1.37) (0.80)
- --------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 14.52 $ 14.02 $ 13.28 $ 15.97
- --------------------------------------------------------------------------------------------------------------------------------
Total Return 9.62% 13.55% (8.78)% 17.21%++
- --------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $14,515 $14,631 $11,372 $22,251
- --------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.78% 0.81% 0.69% 0.68%+
Net investment income 5.90 6.58 5.92 6.06+
- --------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 58% 36% 28% 37%
- --------------------------------------------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions (3) $ 0.06 -- -- --
================================================================================================================================
</TABLE>
(1) On November 7, 1994, the former Class C shares were renamed Class Z
shares.
(2) For the period from November 6, 1992 (inception date) to July 31, 1993.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
+ Total return is not annualized, as it may not be representative of the total
return for the year.
++ Annualized.
26
<PAGE>
- -------------------------------------------------------------------------------
Independent Auditors' Report
- -------------------------------------------------------------------------------
The Shareholders and Board of Trustees of
Smith Barney Income Funds:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Smith Barney Utilities Fund of Smith
Barney Income Funds as of July 31, 1996, the related statement of operations for
the year then ended, statement of changes in net assets and financial highlights
for each of the years in the two-year period then ended. These financial
statements and financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits. The financial
highlights for each of the years or periods in the three-year period ended July
31, 1994, were audited by other auditors whose report thereon, dated September
9, 1994, expressed an unqualified opinion on those financial highlights.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of July
31, 1996, by correspondence with the custodian. As to securities sold and
purchased but not delivered and received, we performed other appropriate
auditing procedures. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Smith Barney Utilities Fund of Smith Barney Income Funds as of July 31, 1996,
the results of its operations for the year then ended, changes in its net assets
and financial highlights for each of the years in the two-year period then
ended, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
September 23, 1996
27
<PAGE>
SMITH BARNEY
UTILITIES FUND
TRUSTEES
Lee Abraham
Antoinette C. Bentley
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon
Madelon DeVoe Talley
OFFICERS
Heath B. McLendon
Chairman and
Investment Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President and Treasurer
Jack S. Levande
Vice President and
Investment Officer
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
SMITH BARNEY
------------
A Member of Travelersgroup[logo]
INVESTMENT ADVISER
Smith Barney Mutual Funds
Management Inc.
DISTRIBUTOR
Smith Barney Inc.
CUSTODIAN
PNC Bank, N.A.
SHAREHOLDER
SERVICING AGENT
First Data Investors Services Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for the general information of the shareholders of
Smith Barney Utilities Fund. It is not authorized for distribution to
prospective investors unless accompanied or preceded by a current Prospectus
for the Fund, which contains information concerning the Fund's investment
policies and expenses as well as other pertinent information.
SMITH BARNEY
UTILITIES FUND
388 Greenwich Street
New York, New York 10013
FD0426 9/96
ANNUAL REPORT
1996
1996
1996
1996
1996
Smith Barney
High Income
Fund
- -------------------------------
July 31, 1996
[LOGO] Smith Barney Mutual Funds
Investing for your future.
Every day
<PAGE>
Smith Barney High Income Fund
Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney High
Income Fund for the year ended July 31, 1996. In this report we summarize the
period's prevailing economic and market conditions and outline our portfolio
strategy. A detailed summary of performance and current holdings can be found in
the appropriate sections that follow in the annual report.
Fund Performance and Investment Objectives
During the 12-month period covered by this report, the Smith Barney High Income
Fund paid dividends totaling $1.08 per share for Class A shares; based on a net
asset value (NAV) of $10.98 per share as of July 31, 1996, this equates to an
annual distribution rate of 9.84%. The Fund's total return for this same period
for Class A shares of 8.95%, was below the high yield mutual fund average 1-year
total return of 9.89% as reported by Lipper Analytical Services, an independent
fund tracking organization. We believe that relative to its peer group, the High
Income Fund's conservative intermediate average maturity, along with its
conservative credit quality contributed to its slight underperformance. However,
we continue to subscribe to the belief that over time, a relatively conservative
maturity and credit strategy will generate more consistent, less volatile
returns. Despite our conservative posture, our outlook on the high yield market
remains positive and we are convinced that in this period of U.S. economic
strength, high yield bonds can continue to generate attractive performance
results driven by their superior current income.
The Fund's primary objective continues to focus on delivering a consistently
high level of current income, with total return as its secondary objective. To
achieve these goals, we use the consistent and disciplined strategy of investing
primarily in better quality, high yielding corporate bonds that are likely to
receive an upgrade in credit rating over the next one to three years. We have
also selectively added attractively valued convertible bonds, preferred stocks
and common stocks to the portfolio to further enhance total return. By
emphasizing the improving credits in the high yield market we can generate not
only attractive current dividend yields for shareholders, but capital
appreciation as well. While the Fund has a level dividend policy, we do not
attempt to maximize yield regardless of credit risk. Instead, we seek to provide
a competitive dividend yield with superior total return.
1
<PAGE>
Market and Economic Overview
The bond markets encountered significant volatility over the past 12 months.
During the second half of 1995, interest rates declined significantly, only to
backup during the first half of 1996. Toward the end of 1995, investors were
convinced that the U.S. economy was headed for a meaningful slowdown, with less
risk of higher inflation, and the bond market rallied, with the yield on the
benchmark 30-year U.S. Treasury bond dipping below 6%. However, investors were
surprised in the first half of 1996 by stronger-than-expected U.S. economic
growth across a number of sectors. In response to unfounded fears over the
potential re-emergence of inflation, bond prices suffered a meaningful decline
in the first half of 1996, with interest rates rising by roughly 1%. In recent
weeks, the bond market has exhibited some signs of stability. Interest rates
have come down over the last four weeks in response to weaker-than-expected U.S.
economic statistics.
Fund Strategy
During the past six months as the general economic conditions remained volatile,
the High Income Fund maintained a more conservative credit posture with
significant exposure to stronger, better capitalized companies. In addition, we
have invested in companies within industries that continue to experience
meaningful growth trends. In our view, the telecommunications, cable TV,
technology and media industries exhibit the potential to grow substantially.
Because of our positive views on these industries, we have added the following
holdings to the Fund: Time Warner, which has significantly expanded its cable
and programming segments, and now has approximately 11.4 million subscribers;
Intelcom Group, an expanding Colorado-based company which provides alternate
local telecommunications access; Intermedia Communications of Florida, which
gives local telephone companies in the Southeast access to its extensive fiber-
optic system and its voice and data networks; and United International
Holdings, an international cable company. Considering the extreme swings in
interest rates and bond prices over the past year, the Fund has maintained a
relatively short maturity in the 5- to 6-year range. In addition, we would
expect to be fully invested by the fourth quarter after having experienced a
modest increase in our cash reserves as a result of new cash subscriptions into
the Fund.
Outlook
In our opinion, U.S. economic growth should continue to moderate in the second
half of 1996. While the economy has exhibited unexpected strength in the second
quarter of 1996, we still believe that U.S. economic growth remains in a
comfortable range, with little pent up demand in any particular sector. As a
result, we do not expect any meaningful rise in inflation from current range of
between 2.5% to 3.0%. We would also expect various economic forces to
2
<PAGE>
hold interest rates in a confined range, with no major moves in either
direction. This "Goldilocks" economy -- not too hot and not too cold -- is ideal
for the high yield investor. Consequently it is not surprising to us that over
the past six and twelve-month periods, the high yield market has generated
superior investment results compared to the rest of the domestic bond markets.
Simplistically, in this range-bound environment, investing for current income
has achieved superior results. Going forward, we do not expect to witness any
major changes in the domestic bond markets.
In closing, we would like to thank you for your investment in the Smith Barney
High Income Fund. We look forward to continuing to help you achieve your
financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ John C. Bianchi, CFA
- --------------------- ------------------------
Heath B. McLendon John C. Bianchi, CFA
Chairman and Vice President and
Investment Officer Investment Officer
August 14, 1996
3
<PAGE>
Historical Performance -- Class A Shares
<TABLE>
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $11.10 $10.98 $1.08 $0.00 $0.00 8.95%
7/31/95 11.16 11.10 1.05 0.00 0.07 10.28
7/31/94 12.01 11.16 1.12 0.00 0.00 2.11
Inception*
- 7/31/93 11.03 12.01 0.86 0.00 0.00 17.29+
- --------------------------------------------------------------------------------------
Total $4.11 $0.00 $0.07
======================================================================================
</TABLE>
Historical Performance-- Class B Shares
<TABLE>
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $11.11 $10.99 $1.02 $0.00 $0.00 8.41%
7/31/95 11.16 11.11 0.99 0.00 0.07 9.77
7/31/94 12.01 11.16 1.06 0.00 0.00 1.60
7/31/93 11.15 12.01 1.10 0.00 0.00 18.55
7/31/92 10.05 11.15 1.11 0.00 0.06 23.86
7/31/91 10.59 10.05 1.27 0.00 0.02 8.82
7/31/90 13.36 10.59 1.61 0.00 0.01 (8.66)
7/31/89 14.01 13.36 1.53 0.00 0.00 6.60
7/31/88 14.26 14.01 1.54 0.04 0.00 10.06
Inception*
- 7/31/87 14.00 14.26 1.03 0.03 0.00 9.55+
- --------------------------------------------------------------------------------------
Total $12.26 $0.07 $0.16
======================================================================================
</TABLE>
Historical Performance -- Class C Shares
<TABLE>
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $11.11 $11.00 $1.03 $0.00 $0.00 8.56%
Inception*
- 7/31/95 10.90 11.11 0.90 0.00 0.07 11.50+
- --------------------------------------------------------------------------------------
Total $1.93 $0.00 $0.07
======================================================================================
</TABLE>
4
<PAGE>
Historical Performance -- Class Y Shares
<TABLE>
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $11.10 $10.99 $0.92 $0.00 $0.00 9.32%
Inception*
- 7/31/95 10.88 11.10 0.03 0.00 0.07 2.91+
- --------------------------------------------------------------------------------------
Total $0.95 $0.00 $0.07
======================================================================================
</TABLE>
Historical Performance-- Class Z Shares
<TABLE>
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Return Total
Year Ended of Year of Year Dividends Distributions of Capital Returns(1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
7/31/96 $11.09 $10.99 $1.11 $0.00 $0.00 9.42%
7/31/95 11.16 11.09 1.08 0.00 0.07 10.55
7/31/94 12.01 11.16 1.15 0.00 0.00 2.37
Inception*
- 7/31/93 11.03 12.01 0.88 0.00 0.00 17.47+
- --------------------------------------------------------------------------------------
Total $4.22 $0.00 $0.07
======================================================================================
</TABLE>
It is the Fund's policy to distribute dividends monthly and capital gains, if
any, annually.
Average Annual Total Return
<TABLE>
<CAPTION>
Without Sales Charge(1)
-------------------------------------------------------
Class A Class B Class C Class Y Class Z
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year Ended 7/31/96 8.95% 8.41% 8.56% 9.32% 9.42%
Five Years
Ended 7/31/96 N/A 12.17 N/A N/A N/A
Inception*
through 7/31/96 10.24 8.61 10.36 8.35 10.56
- --------------------------------------------------------------------------------
<CAPTION>
Without Sales Charge(2)
-------------------------------------------------------
Class A Class B Class C Class Y Class Z
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year Ended 7/31/96 4.08% 3.91% 7.56% 9.32% 9.42%
Five Years
Ended 7/31/96 N/A 12.04 N/A N/A N/A
Inception*
through 7/31/96 8.89 8.61 10.36 8.35 10.56
- -------------------------------------------------------------------------------
</TABLE>
5
<PAGE>
Cumulative Total Return
Without Sales Charge(1)
- -----------------------------------------------------------------------------
Class A (Inception* through 7/31/96) 43.90%
Class B (Inception* through 7/31/96) 126.79
Class C (Inception* through 7/31/96) 21.04
Class Y (Inception* through 7/31/96) 12.50
Class Z (Inception* through 7/31/96) 45.46
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable sales charges with respect to Class A shares or the applicable
contingent deferred sales charges ("CDSC") with respect to Class B and C
shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, Class A shares reflect the deduction
of the maximum initial sales charge of 4.50%; Class B shares reflect the
deduction of a 4.50% CDSC, which applies if shares are redeemed within the
first year from initial purchase. This CDSC declines by 0.50% the first
year after purchase and thereafter by 1.00% per year until no CDSC is
incurred. Class C shares reflect the deduction of a 1.00% CDSC which
applies, if shares are redeemed within the first year of purchase.
* Inception dates for Class A, B, C, Y and Z shares are November 6, 1992,
September 2, 1986, August 24, 1994, April 28, 1995 and November 6, 1992,
respectively.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
6
<PAGE>
Historical Performance (unaudited)
Growth of $10,000 Invested in Class B Shares of
the Smith Barney High Income Fund vs.
Salomon Brothers Intermediate-Term High-Yield Index
September 1986 -- July 1996
Smith Barney High Income Fund Salomon Brothers Intermediate-Term High-Yield
Index
[lLINE CHART APPEARS HERE-- (SEE PLOT POINTS BELOW)]
9/2/86 10,000.00 10,000.00
7/87 10,955.10 10,829.40
7/88 12,056.90 11,743.28
7/89 12,852.40 12,901.77
7/90 11,739.00 12,330.62
7/91 12,774.20 13,945.78
7/92 15,822.40 17,374.02
7/93 18,758.10 20,053.96
7/94 19,057.60 20,698.36
7/95 20,919.80 23,462.52
7/96 22,679.00 25,436.00
+ Hypothetical illustration of $10,000 invested in Class B shares at inception
on September 2, 1986, assuming reinvestment of dividends and capital gains,
if any, at net asset value through July 31, 1996. The Salomon Brothers
Intermediate-Term High-Yield Index includes cash-pay and deferred-interest
bonds with a remaining maturity of at least seven years, but less than ten
years. This index is unmanaged and is not subject to the same management and
trading expenses as a mutual fund. The performance of the Fund's other
classes may be greater or less than the Class B shares' performance indicated
on this chart, depending on whether greater or lesser sales charges and fees
were incurred by shareholders investing in other classes.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital gains.
7
<PAGE>
Portfolio Highlights (unaudited) July 31, 1996
Portfolio Breakdown
[lPIE CHART APPEARS HERE-- (SEE PLOT POINTS BELOW)]
Other Corporate Bonds and Notes 19.1% 0.191
Broadcasting 18.0% 0.18
Communications 16.3% 0.163
Repurchase Agreements 9.7% 0.097
Hotel, Casinos and Gaming 5.8% 0.058
Other Preferred Stock,
Convertible Preferred Stock,
Common Stock and
Warrants 5.5% 0.055
Paper & Printing 5.5% 0.055
Chemicals 4.4% 0.044
Oil & Natural Gas 4.0% 0.04
Metals/Mining 3.8% 0.038
Personal Care 2.9% 0.029
Healthcare 2.5% 0.025
Consumer Durables 2.5% 0.025
Top Ten Holdings
Percentage of
Company Total Investments
- --------------------------------------------------------------
Telewest Communications PLC 2.4%
Marcus Cable Capital Corp. 2.2
Revlon Worldwide Corp. 2.2
NWCG Holdings Inc. 2.1
Indah Kiat International 2.0
Nextel Communications Inc. 2.0
Kaiser Aluminum Corp. 2.0
Ornda Healthcorp. 1.8
PanAmSat Corp. 1.6
NL Industries Inc. 1.5
- --------------------------------------------------------------
8
<PAGE>
Schedule of Investments July 31, 1996
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CORPORATE BONDS AND NOTES -- 84.8%
Aerospace/Defense -- 1.8%
$ 5,375,000 BB Airplanes Pass-Through Trust, Trust Certificates,
10.875% due 3/15/19 $ 5,603,438
4,750,000 B Howmet Corp., Sr. Sub. Notes, 10.000% due 12/1/03+ 5,011,250
3,800,000 B Tracor Inc., Sr. Sub. Notes, 10.875% due 8/15/01 4,070,750
2,750,000 B UNC Inc., Sr. Sub. Notes, 11.000% due 6/1/06 2,818,750
- -----------------------------------------------------------------------------------------------
17,504,188
- -----------------------------------------------------------------------------------------------
Automobile -- 0.9%
Harvard Industries, Inc., Sr. Notes:
7,600,000 B+ 12.000% due 7/15/04 7,467,000
1,300,000 B3* 11.125% due 8/1/05+ 1,222,000
- -----------------------------------------------------------------------------------------------
8,689,000
- -----------------------------------------------------------------------------------------------
Broadcasting -- 18.0%
21,600,000 CCC Australis Media Ltd., Sr. Discount Notes,
step bond to yield 12.583% due 5/15/03++ 12,204,000
Bell Cablemedia PLC, Sr. Discount Notes,
step bond to yield:
18,725,000 BB- 13.436% due 7/15/99 13,482,000
15,550,000 BB- 11.493% due 9/15/05 9,796,500
Cablevision Systems Corp., Sr. Sub. Debentures:
7,325,000 B 10.750% due 4/1/04 7,407,406
7,075,000 B 9.875% due 2/15/13 6,579,750
14,025,000 B Comcast UK Cable, Sr. Sub. Debentures,
step bond to yield 11.418% due 11/15/07 8,344,875
2,250,000 BB Grupo Televisa S.A., Sr. Notes,
Series B, 11.875% due 5/15/06 2,283,750
29,200,000 B Marcus Cable Capital Corp., Sr. Discount Notes,
step bond to yield 11.941% due 8/1/04 21,133,500
25,275,000 B NWCG Holdings, Sr. Discount Notes,
zero coupon bond to yield 11.435% due 6/15/99 19,935,656
Rogers Cablesystems:
11,357,000 BB- Sr. Debentures, 10.875% due 4/15/04 11,655,121
4,675,000 BB+ Sr. Secured Debentures, 10.000% due 12/1/07 4,593,188
5,350,000 BB+ Sr. Secured Second Priority Debentures,
9.650% due 1/15/14 3,444,958
5,725,000 BB- Sr. Sub. Debentures, 11.000% due 12/1/15 5,853,812
5,000,000 BB- SCI Television Inc., Sr. Notes, 11.000% due 6/30/05 5,362,500
7,525,000 B- SFX Broadcasting, Inc., Sr. Sub. Notes,
10.750% due 5/15/06 7,600,250
13,250,000 B- UIH Australia Inc., Sr. Discount Notes,
step bond to yield 14.000% due 5/15/06 6,989,375
15,485,000 B- United International Holdings Inc., Sr. Discount Notes,
zero coupon to yield 12.320% due 11/15/99 10,220,100
Videotron Holdings PLC:
4,975,000 B+ Sr. Discount Notes, step bond to yield
11.286% due 8/15/05 3,258,625
4,075,000 BB+ Sr. Notes, 10.625% due 12/15/05 4,319,500
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Broadcasting -- 18.0% (continued)
Videotron Holdings PLC: (continued)
$ 4,525,000 BB+ Sr. Sub. Notes, 10.250% due 10/15/02 $ 4,683,375
2,450,000 B Young Broadcasting, Sr. Sub. Notes, 11.750%
due 11/15/04 2,597,000
- ------------------------------------------------------------------------------------------------
171,745,241
- ------------------------------------------------------------------------------------------------
Building/Construction -- 1.5%
2,800,000 BB- American Standard Inc., Sr. Sub. Debentures,
11.375% due 5/15/04 3,038,000
5,225,000 B Greystone Homes, Inc., Sr. Notes, 10.750% due 3/1/04 5,153,156
2,400,000 CCC+ Miles Homes Services Inc., Sr. Notes, 12.000%
due 4/1/01 1,776,000
3,925,000 BB Ryland Group Inc., Sr. Notes, 10.500% due 7/1/06 3,885,750
- ------------------------------------------------------------------------------------------------
13,852,906
- ------------------------------------------------------------------------------------------------
Chemicals -- 4.4%
NL Industries, Inc., Sr. Secured Notes:
14,400,000 B 12.241% due 10/15/03 14,688,000
8,705,000 B step bond to yield 12.430% due 10/15/05 6,768,138
6,800,000 BB- Pt. Polysindo Eka Perkasa, Sr. Notes,
13.000% due 6/15/01 7,480,000
9,400,000 B+ Terra Industries, Inc., Sr. Notes, Series B,
10.500% due 6/15/05 9,893,500
2,775,000 B3* Texas Petrochemical Inc., Sr. Sub. Notes,
11.125% due 7/1/06+ 2,861,719
- ------------------------------------------------------------------------------------------------
41,691,357
- ------------------------------------------------------------------------------------------------
Communications -- 16.3%
5,925,000 Allbritton Communications Co., Sr. Sub. Debentures,
4,598,000 B- 9.750% due 11/30/07+ 5,569,500
19,800,000 B- 11.500% due 8/15/04 4,781,920
NR Clearnet Communications Inc., Sr. Discount Notes,
step bond to yield 13.784% due 12/15/05 12,276,000
Dial Call Communications, Inc., Sr. Discount Notes,
8,050,000 step bond to yield:
7,500,000 CCC- 13.630% due 4/15/04 5,192,250
4,425,000 Caa* 10.217% due 12/15/05+ 4,612,500
17,300,000 B+ Fonorola Inc., Sr. Sub. Notes, 12.500% due 8/15/02 4,806,656
NR Intelcommunications Group USA Inc., Sr. Discount Notes,
14,925,000 step bond to yield 12.500% due 5/1/06 9,428,500
B- Intermedia Communications Inc., Sr. Discount Notes,
4,350,000 step bond to yield 12.527% due 5/15/06+ 8,134,125
B International Cabletelecommunications Inc.,
Sr. Deferred Coupon Notes, step bond to yield
4,250,000 11.486% due 2/1/06 2,479,500
19,175,000 B- Metrocall Inc., Sr. Sub. Notes, 10.375% due 10/1/07 3,729,375
B- Millicom International Cellular SA, Sr. Sub.
Discount Notes, step bond to yield 13.500% due 6/1/06 9,683,375
9,125,000 B- Mobile Telecommunications Tech. Corp., Sr. Notes,
13.500% due 12/15/02 9,512,813
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Communications -- 16.3% (continued)
$ 10,950,000 NR Nextlink Communications, Sr. Discount Notes,
12.500% due 4/15/06 $ 10,676,250
33,300,000 CCC- Nextel Communications, Inc., Sr. Discount Notes,
step bond to yield 12.716% due 8/15/04 18,648,000
Pagemart Nationwide, Inc., Sr. Discount Notes,
step bond to yield:
9,550,000 NR 11.969% due 11/1/03+ 7,341,563
9,475,000 NR 13.486% due 2/1/05+ 6,300,875
38,975,000 BB Telewest Communications, PLC, Sr. Discount Debentures,
step bond to yield 11.049% due 10/1/07 22,897,813
6,125,000 B- USA Mobile Communication Inc., Sr. Discount Notes,
14.000% due 11/1/04 6,898,281
1,975,000 B- Wireless One Inc., Sr. Discount Notes,
13.000% due 10/15/03 2,066,344
- -------------------------------------------------------------------------------------------------
155,035,640
- -------------------------------------------------------------------------------------------------
Consumer Durables -- 2.5%
23,650,000 B+ International Semi-Tech., Sr. Secured Notes,
step bond to yield 11.344% due 8/15/03 13,480,500
5,625,000 B- TAG-Heuer International Inc., Sr. Sub. Notes,
12.000% due 12/15/05 5,850,000
4,075,000 BB- TLC Beatrice International Inc., Sr. Secured Notes,
11.500% due 10/1/05 4,166,688
- -------------------------------------------------------------------------------------------------
23,497,188
- -------------------------------------------------------------------------------------------------
Diversified/Conglomerate Manufacturing -- 2.4%
Interlake Corp., Sr. Sub. Debentures:
2,725,000 B- 12.000% due 11/15/01 2,888,500
11,350,000 CCC+ 12.125% due 3/1/02 11,378,375
7,400,000 B3* Williamhouse Regency, Sr. Sub. Notes,
13.000% due 11/15/05 8,399,000
- -------------------------------------------------------------------------------------------------
22,665,875
- -------------------------------------------------------------------------------------------------
Electric Utilities -- 1.8%
8,350,000 B Calpine Corp., Sr. Notes, 10.500% due 5/15/06+ 8,350,000
8,437,613 BB- Midland Cogeneration Venture Limited Partnership,
Midland Funding, Sr. Secured Lease Bond, Series C,
10.330% due 7/23/02 8,764,571
- -------------------------------------------------------------------------------------------------
17,114,571
- -------------------------------------------------------------------------------------------------
Electronics/Computers -- 1.7%
6,375,000 B- Graphic Controls Corp., Sr. Sub. Notes,
12.000% due 9/15/05+ 6,797,344
9,100,000 B+ Unisys Corp., Sr. Notes, 12.000% due 4/15/03+ 9,202,375
- -------------------------------------------------------------------------------------------------
15,999,719
- -------------------------------------------------------------------------------------------------
Finance -- 0.8%
7,525,000 BB- Trizec Finance Ltd., Sr. Notes, 10.875% due 10/15/05 7,675,500
- -------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Grocery/Convenience Stores -- 1.7%
$ 21,862 B- Kash-N-Karry, Sr. Notes, 11.500% due 2/1/03 $ 21,999
Pathmark Stores Inc.:
4,275,000 B- Sub. Notes, 11.625% due 6/15/02 4,275,000
8,500,000 B- Debentures, 12.625% due 6/15/02 8,585,000
2,825,000 B- Van De Kamps Inc., Sr. Sub. Notes, 12.000% due 9/15/05 3,019,219
- ---------------------------------------------------------------------------------------------
15,901,218
- ---------------------------------------------------------------------------------------------
Healthcare -- 2.5%
6,300,000 B Magellan Health Services, Sr. Sub. Notes,
11.250% due 4/15/04 6,819,750
15,960,000 B- Ornda Healthcorp, Sr. Sub. Notes, 12.250% due 5/15/02 17,236,800
- ---------------------------------------------------------------------------------------------
24,056,550
- ---------------------------------------------------------------------------------------------
Hotel, Casinos & Gaming -- 5.8%
11,125,000 B Aztar Corp., Sr. Sub. Notes, 13.750% due 10/1/04 12,738,125
12,120,000 BB Bally's Grand, 1st Mortgage Notes,
10.375% due 12/15/03 13,271,400
6,000,000 B- Courtyard by Marriott II, Sr. Secured Notes,
10.750% due 2/1/08 5,940,000
6,025,000 NR Mohegan Tribal Gaming Authority, Sr. Secured Notes,
13.500% due 11/15/02 7,561,375
5,475,000 B Showboat Inc., Sr. Sub. Notes, 13.000% due 8/1/09 6,262,031
Station Casinos Inc., Sr. Sub. Notes:
7,350,000 B 9.625% due 6/1/03 7,056,000
2,700,000 B 10.125% due 3/15/06 2,619,000
- ---------------------------------------------------------------------------------------------
55,447,931
- ---------------------------------------------------------------------------------------------
Insurance -- 2.0%
7,570,000 BBB- Bankers Life Holdings, Sr. Sub. Debentures,
Series B, 13.000% due 11/1/02 8,648,725
9,675,000 BBB- Life Partners Group Inc., Sr. Sub. Notes,
12.750% due 7/15/02 10,545,750
- ---------------------------------------------------------------------------------------------
19,194,475
- ---------------------------------------------------------------------------------------------
Leisure -- 1.1%
2,861,025 NR Gillett Holdings, Inc., Sr. Sub. Notes,
12.250% due 6/30/02 2,996,924
8,125,000 B Remington Arms Co., Inc., Sr. Sub. Notes,
9.500% due 12/1/03 (Current penalty
coupon 10.000%)+ 7,434,375
- --------------------------------------------------------------------------------------------
10,431,299
- --------------------------------------------------------------------------------------------
Machinery -- 0.4%
3,775,000 B- Alvey Systems, Inc., Sr. Sub. Notes,
11.325% due 1/31/03 3,897,687
- --------------------------------------------------------------------------------------------
Metals & Mining -- 3.8%
6,000,000 B- Ivex Holdings Corp., Debentures, step bond to yield
12.910% due 3/15/05+ 3,885,000
17,800,000 B- Kaiser Aluminum Corp., Sr. Sub. Notes,
12.750% due 2/1/03 18,645,500
</TABLE>
See Notes to Financial Statements.
12
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Metals & Mining -- 3.8% (continued)
$ 4,675,000 B Renco Metals Inc., Sr. Notes, 11.500% due 7/1/03 $ 4,815,250
5,500,000 B- Russel Metals Inc., Sr. Notes, 10.250% due 6/15/00 5,362,500
3,255,000 BB- UCAR Global Enterprises Inc., Sr. Sub. Notes,
12.000% due 1/15/05 3,702,562
- ----------------------------------------------------------------------------------------------
36,410,812
- ----------------------------------------------------------------------------------------------
Oil & Natural Gas -- 4.0%
5,000,000 B+ Clark R & M Holdings Inc., Sr. Notes, zero
coupon bond to yield
10.412% due 2/15/00 3,450,000
9,500,000 B+ Clark USA Inc., Sr. Notes, 10.875% due 12/1/05 9,713,750
7,670,000 B+ Global Marine, Sr. Secured Notes, 12.750% due 12/15/99 8,321,950
3,100,000 B+ Kelley Oil & Gas Corp., Sr. Notes, 13.500% due 6/15/99 3,320,875
6,825,000 BB- Santa Fe Energy Resources, Sr. Sub. Debentures,
11.000% due 5/15/04 7,362,469
5,375,000 B United Meridian Corp., Sr. Sub. Notes,
10.375% due 10/15/05 5,542,969
- ----------------------------------------------------------------------------------------------
37,712,013
- ----------------------------------------------------------------------------------------------
Packaging & Containers -- 0.5%
Gaylord Container Corp., Sr. Sub. Debentures:
2,000,000 B- 11.500% due 5/15/01 2,060,000
2,525,000 B- 12.750% due 5/15/05 2,695,438
- ----------------------------------------------------------------------------------------------
4,755,438
- ----------------------------------------------------------------------------------------------
Paper & Printing -- 5.5%
4,925,000 B Crown Paper Co., Sr. Sub. Notes, 11.000% due 9/1/05 4,752,625
4,950,000 BB- Grupo Industrial Durango Inc., Sr. Notes, 12.625%
due 8/1/03 5,018,062
18,350,000 BB Indah Kiat International Finance Co., Sr.
Secured Notes, 11.875% due 6/15/02 19,496,875
3,850,000 BB Polysindo International Finance, Sr. Notes,
11.375% due 6/15/06 3,946,250
5,300,000 B+ Repap New Brunswick, Sr. Notes, 10.625% due 4/15/05 5,074,750
5,950,000 B+ SD Warren Co., Sr. Sub. Notes, 12.000% due 12/15/04 6,321,875
7,100,000 BB Tjiwi Kimia International, Sr. Notes,
13.250% due 8/1/01 7,969,750
- ----------------------------------------------------------------------------------------------
52,580,187
- ----------------------------------------------------------------------------------------------
Personal Care -- 2.9%
6,025,000 B- Revlon Consumer Products Corp., Sr. Sub. Notes,
Series B, 10.500% due 2/15/03 6,122,906
25,000,000 B- Revlon Worldwide Corp., Sr. Secured Notes,
zero coupon bond to yield 21.917% due 3/15/98+ 21,000,000
- ----------------------------------------------------------------------------------------------
27,122,906
- ----------------------------------------------------------------------------------------------
Retail -- 1.1%
10,025,000 B Barnes and Noble, Sr. Sub. Notes,
11.875% due 1/15/03 10,776,875
- ----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
13
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tobacco -- 0.6%
$ 5,550,000 B Consolidated Cigar Acquisition Corp., Sr. Sub. Notes,
10.500% due 3/1/03 $ 5,820,562
- ------------------------------------------------------------------------------------------------
Transportation -- 0.8%
7,075,000 BB- Sea Containers Ltd., Sr. Sub. Debentures,
12.500% due 12/1/04 7,764,812
- ------------------------------------------------------------------------------------------------
TOTAL CORPORATE BONDS AND NOTES
(Cost -- $808,640,578) 807,343,950
- ------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS -- 0.6%
Diversified/Conglomerate Manufacturing -- 0.1%
28,086 Tyco International Ltd. 1,151,526
- ------------------------------------------------------------------------------------------------
Metals & Mining -- 0.1%
297,744 Algoma Steel Inc. 935,865
- ------------------------------------------------------------------------------------------------
Oil & Natural Gas -- 0.4%
165,000 Freeport McMoran Resource, LP Depository Unit 3,279,375
- ------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
Cost -- $5,729,509) 5,366,766
================================================================================================
PREFERRED STOCKS -- 3.8%
Broadcasting -- 1.1%
10,606 Time Warner Inc., Series K,
Exchange 10.250%+ 10,579,660
- ------------------------------------------------------------------------------------------------
Chemicals -- 0.4%
35,000 El Paso Electric Co., Series A, Payment-in-kind,
Exchange 11.400% 3,710,000
- ------------------------------------------------------------------------------------------------
Healthcare & Pharmaceuticals -- 0.7%
337,885 Foxmeyer Health Corp., Series A,
Payment-in-kind, Exchange $4.20
(Formerly National Intergroup) 6,926,644
- ------------------------------------------------------------------------------------------------
Publishing -- 0.0%
1,280 K-III Communications Corp., Series B,
Exchange 11.625% 123,512
- ------------------------------------------------------------------------------------------------
Telecommunications -- 1.6%
13,894 PanAmSat Corp., Series A, Exchange $31.875 15,491,626
- ------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS
(Cost -- $39,995,708) 36,831,442
================================================================================================
</TABLE>
See Notes to Financial Statements.
14
<PAGE>
Schedule of Investments (continued) July 31, 1996
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
CONVERTIBLE PREFERRED STOCKS -- 1.0%
Automobiles/Trucking -- 1.0%
166,100 Navistar International Corp., Series G,
Convertible $6.00
(Cost -- $9,275,013) $ 9,135,500
================================================================================================
WARRANTS -- 0.1%
29,000 Miles Homes Inc., Expires 4/1/97+ 7,250
18,222 Nextel Communications Inc., Expires 4/25/99 182
18,375 Pagemart Inc., Expires 12/31/04+ 197,531
37,490 Pagemart Nationwide, Expires 12/31/03+ 243,685
8,025 SD Warren, Expires 12/15/06+ 104,325
213,479 Trump Castle Hotel & Casino, Expires 9/15/00 0
5,925 Wireless One Corp., Expires 10/15/03 29,625
- ------------------------------------------------------------------------------------------------
TOTAL WARRANTS
(Cost -- $135,440) 582,598
================================================================================================
<CAPTION>
FACE
AMOUNT SECURITY VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENTS -- 9.7%
$ 90,000,000 CS First Boston, 5.544% due 8/1/96,
Proceeds at maturity-- $90,013,860; (Fully
collateralized by U.S. Treasury Notes,
6.000% due 5/31/98; Market value-- $91,837,277)
(Cost-- $90,000,000) 90,000,000
2,818,000 Chase Manhattan Bank, 5.544% due 8/1/96,
Proceeds at maturity-- $2,818,434; (Fully
collateralized by U.S. Treasury Notes,
6.250% due 7/31/98; Market value-- $2,875,516)
(Cost-- $2,818,000) 2,818,000
- ------------------------------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS
(Cost-- $92,818,000) 92,818,000
================================================================================================
TOTAL INVESTMENTS-- 100%
(Cost-- $956,594,248**) $952,078,256
================================================================================================
</TABLE>
+ Security exempt from registration under Rule 144A of the Securities Act of
1933. These securities may be resold in transactions exempt from
registration, normally to qualified institutional buyers.
++ Security issued with attached warrants.
** Aggregate cost for federal income tax purposes is substantially the same.
See page 16 for definition of ratings.
See Notes to Financial Statements.
15
<PAGE>
Description of Ratings
All ratings are by Standard & Poor's Corporation ("Standard & Poor's"), except
that those identified by an asterisk (*) are rated by Moody's Investors Services
("Moody's"). The definitions of the applicable rating symbols are set forth
below:
Standard & Poor's letter ratings may be modified by the addition of a
plus (+) or a minus (-) sign, which is used to show relative standing within the
major rating categories, except in the AAA-Prime Grade category.
BBB -- Bonds rated "BBB" are regarded as having an adequate
capacity to pay interest and repay principal. Whereas
they normally exhibit adequate protection parameters,
adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to pay
interest and repay principal for bonds in this category
than for bonds in higher rated categories.
BB, B and CCC -- Bonds rated "BB" and "B" are regarded, on balance, as
predominantly speculative with respect to capacity to
pay interest and repay principal in accordance with the
terms of the obligation. BB represents a lower degree of
speculation than B, and CCC the highest degree of
speculation. While such bonds will likely have some
quality and protective characteristics, these are
outweighed by large uncertainties or major risk
exposures to adverse conditions.
C -- The rating "C" is reserved for income bonds on which no
interest is being paid.
Moody's applies the numerical modifiers 1, 2 and 3 in each generic rating
classification from "Aa" through "B". The modifier 1 indicates that the security
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and the modifier 3 indicates that the issue ranks in the
lower end of its generic category.
Baa -- Bonds rated "Baa" are considered to be medium grade
obligations; that is they are neither highly protected
nor poorly secured. Interest payment and principal
security appear adequate for the present but certain
protective elements may be lacking or may be
characteristically unreliable over any great length of
time. These bonds lack outstanding investment
characteristics and may have speculative characteristics
as well.
Ba -- Bonds that are rated "Ba" are judged to have speculative
elements; their future cannot be considered as well
assured. Often the protection of interest and principal
payments may be very moderate and thereby may not well
characterize bonds in this class.
B -- Bonds that are rated "B" generally lack characteristics
of desirable investments. Assurance of interest and
principal payment or of maintenance of other terms of
the contract over any long period of time may be small.
Caa -- Bonds that are rated "Caa" are of poor standing. These
issues may be in default, or present elements of danger
may exist with respect to principal or interest.
Ca -- Bonds that are rated "Ca" represent obligations which
are speculative in a high degree. Such issues are often
in default or have other marked shortcomings.
C -- Bonds that are rated "C" are the lowest rated class of
bonds, and issues so rated can be regarded as having
extremely poor prospects of ever attaining any real
investment standing.
NR -- Indicates that the bond is not rated by Standard &
Poor's or Moody's.
16
<PAGE>
Statement of Assets and Liabilities July 31, 1996
ASSETS:
Investments, at value (Cost-- $956,594,248) $ 952,078,256
Receivable for Fund shares sold 4,027,240
Dividends receivable 104,977
Interest receivable 14,942,498
Other assets 7,453
- -----------------------------------------------------------------------------
Total Assets 971,160,424
- -----------------------------------------------------------------------------
LIABILITIES:
Payable for securities purchased 4,813,781
Payable for Fund shares purchased 493,244
Distribution fees payable 424,728
Investment advisory fees payable 406,122
Administration fees payable 162,449
Payable to bank 45,771
Accrued expenses 439,310
- -----------------------------------------------------------------------------
Total Liabilities 6,785,405
- -----------------------------------------------------------------------------
Total Net Assets $ 964,375,019
=============================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 87,756
Capital paid in excess of par value 1,208,535,683
Undistributed net investment income 20,751
Accumulated net realized loss on security
transactions, options and futures contracts (239,753,134)
Net unrealized depreciation on investments and foreign
currencies (4,516,037)
- -----------------------------------------------------------------------------
Total Net Assets $ 964,375,019
=============================================================================
Shares Outstanding:
Class A 31,047,364
Class B 50,950,280
Class C 1,913,614
Class Y 3,193,395
Class Z 651,422
Net Asset Value:
Class A (and redemption price) $10.98
Class B * $10.99
Class C ** $11.00
Class Y (and redemption price) $10.99
Class Z (and redemption price) $10.99
Class A Maximum Public Offering Price Per Share
(net asset value plus 4.71% of net asset value per share) $11.50
==============================================================================
* Redemption price is NAV of Class B shares reduced by a 4.50% CDSC if shares
are redeemed within one year from initial purchase (See Note 2).
** Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
are redeemed within the first year of purchase.
See Notes to Financial Statements.
17
<PAGE>
Statement of Operations For the Year Ended July 31, 1996
INVESTMENT INCOME:
Interest (net of foreign withholding tax of $1,238) $91,424,180
Dividends 5,115,821
- -----------------------------------------------------------------------------
Total Investment Income 96,540,001
- -----------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 2) 4,893,170
Investment advisory fees (Note 2) 4,506,352
Administration fees (Note 2) 1,802,541
Shareholder and system servicing fees 656,491
Registration fees 133,280
Shareholder communications 78,214
Custody 45,724
Audit and legal 38,104
Trustees' fees 25,067
Other 240,270
- -----------------------------------------------------------------------------
Total Expenses 12,419,213
- -----------------------------------------------------------------------------
Net Investment Income 84,120,788
- -----------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS, OPTIONS, FUTURES CONTRACTS
AND FOREIGN CURRENCIES (NOTES 3, 5 AND 6):
Realized Gain (Loss) From:
Security transactions (excluding short-term securities) 3,998,082
Options purchased (163,189)
Futures contracts 1,166,354
Foreign currency transactions 894,592
- -----------------------------------------------------------------------------
Net Realized Gain 5,895,839
- -----------------------------------------------------------------------------
Change in Net Unrealized Appreciation (Depreciation) of
Investments and Foreign Currencies:
Beginning of year 11,689,814
End of year (4,516,037)
- -----------------------------------------------------------------------------
Increase in Net Unrealized Depreciation (16,205,851)
- -----------------------------------------------------------------------------
Net Loss on Investments, Options, Futures Contracts
and Foreign Currencies (10,310,012)
- -----------------------------------------------------------------------------
Increase in Net Assets From Operations $ 73,810,776
=============================================================================
See Notes to Financial Statements.
18
<PAGE>
Statements of Changes in Net Assets For the Years Ended July 31,
<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
OPERATIONS:
Net investment income $ 84,120,788 $ 71,957,052
Net realized gain (loss) 5,895,839 (41,846,542)
Increase (decrease) in net
unrealized appreciation (16,205,851) 42,592,053
- -----------------------------------------------------------------------------------------------------
Increase in Net Assets From Operations 73,810,776 72,702,563
- -----------------------------------------------------------------------------------------------------
DISTRIBUTION TO SHAREHOLDERS FROM:
Net investment income (84,933,098) (69,255,332)
Capital -- (5,002,147)
- -----------------------------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions To Shareholders (84,933,098) (74,257,479)
- -----------------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 8):
Net proceeds from sale of shares 368,319,175 285,162,914
Net asset value of shares issued
for reinvestment of dividends 43,349,499 44,650,818
Cost of shares reacquired (257,795,961) (251,291,059)
- -----------------------------------------------------------------------------------------------------
Increase in Net Assets From
Fund Share Transactions 153,872,713 78,522,673
- -----------------------------------------------------------------------------------------------------
Increase in Net Assets 142,750,391 76,967,757
NET ASSETS
Beginning of year 821,624,628 744,656,871
- -----------------------------------------------------------------------------------------------------
End of year* $964,375,019 $821,624,628
=====================================================================================================
* Includes undistributed (overdistributed)
net investment income of: $20,751 $(61,531)
=====================================================================================================
</TABLE>
See Notes to Financial Statements.
19
<PAGE>
Notes to Financial Statements
1. Significant Accounting Policies
The Smith Barney High Income Fund ("Fund"), a separate investment fund of
the Smith Barney Income Funds ("Trust"), a Massachusetts business trust, is
registered under the Investment Company Act of 1940, as amended, as a
diversified, open-end management investment company. The Trust consists of the
Fund and six other separate investment funds: Smith Barney Exchange Reserve
Fund, Smith Barney Premium Total Return Fund, Smith Barney Convertible Fund,
Smith Barney Tax-Exempt Income Fund, Smith Barney Diversified Strategic Income
Fund and Smith Barney Utilities Fund. The financial statements and financial
highlights for the other funds are presented in separate annual reports.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) securities traded
on national securities markets are valued at the closing price on such markets;
securities traded in the over-the-counter market and listed securities for which
no sales price was reported and U.S. Government and Agency Obligations are
valued at bid price, or in the absence of a recent bid price, at the bid
equivalent obtained from one or more of the major market makers; (c) securities
that have a maturity of more than 60 days are valued at prices based on market
quotations for securities of similar type, yield and maturity; (d) securities
maturing within 60 days are valued at cost plus accreted discount, or minus
amortized premium, which approximates market value; (e) the accounting records
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.
Purchases and sales of securities, and income and expenses are translated at the
rate of exchange quoted on the respective date that such transactions are
recorded. Differences between income and expense amounts recorded and collected
or paid are adjusted when reported by the custodian bank; (f) dividend income is
recorded on ex-dividend date and interest income is recorded on the accrual
basis; (g) gains or losses on the sale of securities are recorded on the
identified cost basis; (h) dividends and distributions to shareholders are
recorded on the ex-dividend date; (i) direct expenses are charged to each fund
and each class; management fees and general fund expenses are allocated on the
basis of the relative net assets of each class; (j) the character of income and
gains to be distributed are determined in accordance with income tax regulations
which may differ from generally accepted accounting principles. At July 31,
1996, reclassifications are made to the Portfolio's capital accounts to reflect
permanent book/tax differences and income and gains available for distributions
under income tax regulations. Accordingly, a portion of accumulated net realized
loss
20
<PAGE>
Notes to Financial Statements (continued)
amounting to $3,088,904 has been reclassified to paid-in capital. Net investment
income, net realized gains and net assets were not affected by this change; (k)
the Fund intends to comply with the applicable provisions of the Internal
Revenue Code of 1986, as amended, pertaining to regulated investment companies
and to make distributions of taxable income sufficient to relieve it from
substantially all Federal income and excise taxes; and (l) estimates and
assumptions are required to be made regarding assets, liabilities and changes in
net assets resulting from operations when financial statements are prepared.
Changes in the economic environment, financial markets and any other parameters
used in determining these estimates could cause actual results to differ.
In addition, the Fund from time to time may enter into options and/or
futures contracts to hedge market risk.
2. INVESTMENT ADVISORY AGREEMENT, ADMINISTRATION AGREEMENT AND OTHER
TRANSACTIONS
Smith Barney Mutual Funds Management Inc. ("SBMFM"), a subsidiary
of Smith Barney Holdings Inc. ("SBH"), acts as investment adviser to the Fund.
The Fund pays SBMFM an investment advisory fee calculated at an annual rate of
0.50% of the average daily net assets. This fee is calculated daily and paid
monthly.
SBMFM acts as the Fund's administrator for which the Fund pays a fee
calculated at an annual rate of 0.20% of the average daily net assets. This fee
is calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SBH, acts as distributor
of Trust shares and primary broker for its portfolio agency transactions. For
the year ended July 31, 1996, SB received sales charges of approximately
$593,000 on sales of the Fund's Class A shares.
There is a contingent deferred sales charge ("CDSC") of 4.50% on Class B
shares, which applies if redemption occurs less than one year from initial
purchase. This CDSC declines by 0.50% the first year after purchase and
thereafter by 1.00% per year until no CDSC is incurred. Class C shares have a
1.00% CDSC, which applies if redemption occurs within the first year of
purchase. For the year ended July 31, 1996, CDSCs paid to SB were approximately:
Class B Class C
CDSCs $915,000 $6,000
21
<PAGE>
Notes to Financial Statements (continued)
Pursuant to a Distribution Plan, the Fund pays a service fee with respect
to Class A, B and C shares calculated at the annual rate of 0.25% of the average
daily net assets of each respective class. In addition, the Fund pays a
distribution fee with respect to Class B and C shares calculated at an annual
rate of 0.50% and 0.45%, respectively, of the average daily net assets for each
class. For the year ended July 31, 1996, total Distribution Plan fees incurred
were:
Class A Class B Class C
==========================================================================
Distribution Plan Fees $828,402 $3,970,095 $94,673
==========================================================================
All officers and one Trustee of the Trust are employees of SB.
3. INVESTMENTS
During the year ended July 31, 1996, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding short-
term securities) were as follows:
====================================================
Purchases $729,827,657
- ----------------------------------------------------
Sales 598,752,736
====================================================
At July 31, 1996, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were approximately
as follows:
============================================================
Gross unrealized appreciation $ 28,929,000
Gross unrealized depreciation (33,445,000)
- ------------------------------------------------------------
Net unrealized depreciation $ (4,516,000)
============================================================
4. CAPITAL LOSS CARRYFORWARD
At July 31, 1996, the Fund had, for Federal tax purposes, capital loss
carryforwards of approximately $239,724,000 available, to offset future realized
capital gains. To the extent that these capital carryforward losses are used to
offset realized capital gains, it is probable that the gains so offset will not
be distributed. The following capital loss carryforward amounts expire on July
31 in the year indicated below:
Year Amount
=============================================================================
Carryforward Amounts 1997 $39,893,000
1998 68,550,000
1999 84,656,000
2000 9,861,000
2003 13,404,000
2004 23,360,000
=============================================================================
22
<PAGE>
Notes to Financial Statements (continued)
5. FUTURES CONTRACTS
Initial margin deposits made upon entering into futures contracts are
recognized as assets. The initial margin is segregated by the custodian and is
noted in the schedule of investments. During the period the futures contract is
open, changes in the value of the contract are recognized as unrealized gains or
losses by "marking-to-market" on a daily basis to reflect the market value of
the contract at the end of each day's trading. Variation margin payments are
made or received and recognized as assets due from or liabilities due to broker,
depending upon whether unrealized gains or losses are incurred. When the
contract is closed, the Fund records a realized gain or loss equal to the
difference between the proceeds from (or cost of) the closing transactions and
the Fund's basis in the contract. The Fund enters into such contracts to hedge a
portion of its portfolio. The Fund bears the market risk that arises from
changes in the value of the financial instruments and securities indices
(futures contracts) and the credit risk should a counterparty fail to perform
under such contracts.
As of July 31, 1996, the Fund had no open futures contracts.
6. OPTIONS CONTRACTS
Premiums paid when put or call options are purchased by the Fund,
represent investments, which are marked-to-market daily. When a purchased option
expires, the Fund will realize a loss in the amount of the premium paid. When
the Fund enters into closing sales transaction, the Fund will realize a gain or
loss depending on whether the sales proceeds from the closing sales transaction
are greater or less than the premium paid for the option. When the Fund
exercises a put option, it will realize a gain or loss from the sale of the
underlying security and the proceeds from such sale will be decreased by the
premium originally paid. When the Fund exercises a call option, the cost of the
security which the Fund purchases upon exercise will be increased by the premium
originally paid.
As of July 31, 1996, the Fund had no call or put options.
When a Fund writes a covered call or put option, an amount equal to the
premium received by the Fund is recorded as a liability, the value of which is
marked-to-market daily. When a written option expires, the Fund realizes a gain
equal to the amount of the premium received. When the Fund enters into a closing
purchase transaction, the Fund realizes a gain (or loss if the cost of the
closing purchase transaction exceeds the premium received when the option was
written) without regard to any unrealized gain or loss on the
23
<PAGE>
Notes to Financial Statements (continued)
underlying security, and the liability related to such option is eliminated.
When a call option is exercised the cost of the security sold will be reduced by
the premium originally received. When a put option is exercised, the amount of
the premium received will reduce the cost of the security which the Fund
purchased upon exercise. When written index options are exercised, settlement is
made in cash. The risk associated with purchasing options is limited to the
premium originally paid. The Fund enters into options for hedging purposes. The
risk in writing a call option is that the Fund gives up the opportunity to
participate in any increase in the price of the underlying security beyond the
exercise price. The risk in writing a put option is that the Fund is exposed to
the risk of loss if the market price of the underlying security declines.
As of July 31, 1996, the Fund had no written call options.
7. REPURCHASE AGREEMENTS
The Fund purchases (and its custodian take possession of) U.S. Government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires continual maintenance
of the market value of the collateral in amounts at least equal to the
repurchase price.
8. SHARES OF BENEFICIAL INTEREST
At July 31, 1996, the Trust had an unlimited number of shares of
beneficial interest authorized with a par value of $0.001 per share. The Fund
has the ability to issue multiple classes of shares. Each share of a class
represents an identical interest and has the same rights, except that each class
bears certain expenses specifically related to the distribution of its shares.
At July 31, 1996, total paid-in capital amounted to the following for each
class:
<TABLE>
<CAPTION>
Class A Class B Class C Class Y Class Z
=============================================================================================
<S> <C> <C> <C> <C> <C>
Total Paid-in Capital $368,560,614 $773,928,395 $21,208,313 $35,230,396 $9,695,721
=============================================================================================
</TABLE>
24
<PAGE>
Notes to Financial Statements (continued)
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Year Ended Year Ended
July 31, 1996 July 31, 1995*
--------------------- ---------------------
Shares Amount Shares Amount
==================================================================================================
Class A
Shares sold 8,308,861 $ 92,921,114 12,886,749 $ 139,781,741
Shares issued on
reinvestment 1,612,994 17,961,926 1,614,753 17,374,914
Shares redeemed (7,405,625) (82,925,205) (6,015,698) (64,660,153)
- --------------------------------------------------------------------------------------------------
Net Increase 2,516,230 $ 27,957,835 8,485,804 $ 92,496,502
==================================================================================================
Class B
Shares sold 15,087,459 $ 168,856,580 11,842,820 $ 128,268,988
Shares issued on
reinvestment 2,055,044 22,903,819 1,944,542 20,943,077
Shares redeemed (9,273,067) (103,699,076) (16,367,117) (177,858,172)
- --------------------------------------------------------------------------------------------------
Net Increase (Decrease) 7,869,436 $ 88,061,323 (2,579,755) $ (28,646,107)
==================================================================================================
Class C+
Shares sold 1,609,793 $ 18,045,708 619,375 $ 6,712,636
Shares issued on
reinvestment 66,555 742,283 10,332 112,382
Shares redeemed (303,748) (3,396,461) (88,693) (954,980)
- --------------------------------------------------------------------------------------------------
Net Increase 1,372,600 $ 15,391,530 541,014 $ 5,870,038
==================================================================================================
Class Y
Shares sold 7,916,081 $ 88,491,973 1,388,740 $ 10,167,461
Shares issued on
reinvestment 76,423 856,979 7,966 5,132,628
Shares redeemed (5,727,363) (64,207,334) (468,452) (5,148,953)
- --------------------------------------------------------------------------------------------------
Net Increase 2,265,141 $ 25,141,618 928,254 $ 10,151,136
==================================================================================================
Class Z++
Shares sold 340 $ 3,800 21,215 $ 232,088
Shares issued on
reinvestment 79,450 884,492 101,127 1,087,817
Shares redeemed (322,209) (3,567,885) (247,365) (2,668,801)
- --------------------------------------------------------------------------------------------------
Net Decrease (242,419) $ (2,679,593) (125,023) $ (1,348,896)
==================================================================================================
</TABLE>
* For Class C and Y shares, transactions are for the periods from August 24,
1994 (inception date) to July 31, 1995 and from April 28, 1995 (inception
date) to July 31, 1995, respectively.
+ On November 7, 1994, the former Class D shares were renamed Class C
shares.
++ On November 7, 1994, the former Class C shares were renamed Class Z
shares.
25
<PAGE>
Financial Highlights
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1996 1995 1994 1993(1)
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $11.10 $11.16 $12.01 $11.03
Income From Operations:
Net investment income 1.08 1.08 1.08 0.75
Net realized and unrealized gain (loss) (0.12) (0.02) (0.81) 1.09
Total Income From Operations 0.96 1.06 0.27 1.84
Less Distributions From:
Net investment income (1.08) (1.05) (1.06) (0.82)
Overdistribution of net investment income -- -- (0.06) (0.04)
Capital -- (0.07) -- --
Total Distributions (1.08) (1.12) (1.12) (0.86)
Net Asset Value, End of Year $10.98 $11.10 $11.16 $12.01
Total Return 8.95% 10.28% 2.11% 17.29%++
Net Assets, End of Year (000s) $341,040 $316,716 $233,678 $242,371
Ratios to Average Net Assets:
Expenses 1.10% 1.11% 1.11% 1.16%+
Net investment income 9.65 10.03 9.27 9.52+
- ---------------------------------------------------------------------------------
Portfolio Turnover Rate 72% 60% 98% 95%
=================================================================================
<CAPTION>
Class B Shares 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $11.11 $11.16 $12.01 $11.15 $10.05
Income From Operations:
Net investment income 1.02 1.03 1.02 1.08 1.1
Net realized and unrealized
gain (loss) (0.12) (0.02) (0.81) 0.88 1.16
Total Income From Operations 0.90 1.01 0.21 1.96 2.27
Less Distributions From:
Net investment income (1.02) (0.99) (1.00) (1.05) (1.11)
Overdistribution of net
investment income -- -- (0.06) (0.05) --
Capital -- (0.07) -- -- (0.06)
Total Distributions (1.02) (1.06) (1.06) (1.10) (1.17)
Net Asset Value, End of Year $10.99 $11.11 $11.16 $12.01 $11.15
Total Return 8.41% 9.77% 1.60% 18.55% 23.86%
Net Assets, End of Year (000s) $560,031 $478,499 $509,608 $448,639 $304,035
Ratios to Average Net Assets:
Expenses 1.59% 1.61% 1.60% 1.66% 1.65%
Net investment income 9.16 9.52 8.77 9.02 10.52
- ---------------------------------------------------------------------------------
Portfolio Turnover Rate 72% 60% 98% 95% 137%
=================================================================================
</TABLE>
(1) For the period from November 6, 1992 (inception date) to July 31, 1993.
++ Total return is not annualized, as it may not be representative of the total
return for the year.
+ Annualized.
26
<PAGE>
Financial Highlights (continued)
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class C Shares 1996 1995(1)(2)
- -----------------------------------------------------------------
<S> <C> <C>
Net Asset Value, Beginning of Year $11.11 $10.90
Income From Operations:
Net investment income 1.03 0.95
Net realized and unrealized gain (loss) (0.11) 0.23
Total Income From Operations 0.92 1.18
Less Distributions From:
Net investment income (1.03) (0.90)
Capital -- (0.07)
Total Distributions (1.03) (0.97)
Net Asset Value, End of Year $11.00 $11.11
Total Return 8.56% 11.50%++
Net Assets, End of Year (000s) $21,049 $6,011
Ratios to Average Net Assets:
Expenses 1.51% 1.56%+
Net investment income 9.23 9.58+
- -----------------------------------------------------------------
Portfolio Turnover Rate 72% 60%
=================================================================
<CAPTION>
Class Y Shares 1996 1995(3)
- -----------------------------------------------------------------
<S> <C> <C>
Net Asset Value, Beginning of Year $11.10 $10.88
Income From Operations:
Net investment income 0.92 0.09
Net realized and unrealized gain (loss) (0.11) 0.23
Total Income From Operations 0.81 0.32
Less Distributions From:
Net investment income (0.92) (0.03)
Capital -- (0.07)
Total Distributions (0.92) (0.10)
Net Asset Value, End of Year $10.99 $11.10
Total Return 9.32% 2.91%++
Net Assets, End of Year (000s) $35,097 $10,306
Ratios to Average Net Assets:
Expenses 0.76% 0.86%+
Net investment income 9.98 10.28+
- -----------------------------------------------------------------
Portfolio Turnover Rate 72% 60%
=================================================================
</TABLE>
(1) On November 7, 1994, the former Class D shares were renamed Class C shares.
(2) For the period from August 24, 1994 (inception date) to July 31, 1995.
(3) For the period from April 28, 1995 (inception date) to July 31, 1995.
++ Total return is not annualized, as it may not be representative of the total
return for the year.
+ Annualized.
27
<PAGE>
Financial Highlights (continued)
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class Z Shares 1996 1995(1) 1994 1993(2)
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $11.09 $11.16 $12.01 $11.03
Income From Operations:
Net investment income 1.11 1.11 1.10 0.79
Net realized and unrealized gain (loss) (0.10) (0.03) (0.80) 1.07
Total Income From Operations 1.01 1.08 0.30 1.86
Less Distributions From:
Net investment income (1.11) (1.08) (1.09) (0.84)
Overdistribution of net
investment income -- -- (0.06) (0.04)
Capital -- (0.07) -- --
Total Distributions (1.11) (1.15) (1.15) (0.88)
Net Asset Value, End of Year $10.99 $11.09 $11.16 $12.01
Total Return 9.42% 10.55% 2.37% 17.47%++
Net Assets, End of Year (000s) $7,158 $9,917 $11,370 $26,112
Ratios to Average Net Assets:
Expenses 0.77% 0.86% 0.77% 0.81%+
Net investment income 9.98 10.28 9.61 9.88+
- -----------------------------------------------------------------------------
Portfolio Turnover Rate 72% 60% 98% 95%
=============================================================================
</TABLE>
(1) On November 7, 1994, the former Class C shares were renamed Class Z shares.
(2) For the period from November 6, 1992 (inception date) to July 31, 1993.
++ Total return is not annualized, as it may not be representative of the total
return for the year.
+ Annualized.
28
<PAGE>
Independent Auditors' Report
The Shareholders and Board of Trustees of
Smith Barney Income Funds:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Smith Barney High Income Fund of Smith
Barney Income Funds as of July 31, 1996, the related statement of operations for
the year then and the statement of changes in net assets and financial
highlights for each of the years in the two-year period then ended. These
financial statements and financial highlights are the responsibility of the
Fund's management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audits. The financial
highlights for each of the years in the three-year period ended July 31, 1994,
were audited by other auditors whose report thereon, dated September 19, 1994,
expressed an unqualified opinion on those financial highlights.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of July
31, 1996, by correspondence with the custodian. As to securities purchased but
not received, we performed other appropriate auditing procedures. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Smith
Barney High Income Fund of Smith Barney Income Funds as of July 31, 1996, the
results of its operations for the year then ended and the changes in its net
assets and financial highlights for each of the years in the two-year period
then ended, in conformity with generally accepted accounting principles.
/S/ KPMG Peat Marwick LLP
KPMG Peat Marwick LLP
New York, New York
September 23, 1996
29
<PAGE>
Smith Barney
High Income
Fund
Trustees
Lee Abraham
Antoinette C. Bentley
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon
Madelon DeVoe Talley
Officers
Heath B. McLendon
Chairman and Investment Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President
and Treasurer
John C. Bianchi
Vice President and
Investment Officer
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
Investment Adviser
Smith Barney Mutual Funds
Management Inc.
Distributor
Smith Barney Inc.
Custodian
PNC Bank, N.A.
Shareholder
Servicing Agent
First Data Investor Services Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for the general information of the shareholders of
Smith Barney High Income Fund. It is not authorized for distribution to
prospective investors unless accompanied or preceded by an effective Prospectus
for the Fund, which contains information concerning the Fund's investment
policies and expenses as well as other pertinent information.
Smith Barney High Income Fund
388 Greenwich Street
New York, New York 10013
FD0429 9/96
