<PAGE>
[PHOTOGRAPH]
[GRAPHIC]
SMITH BARNEY
DIVERSIFIED
STRATEGIC
INCOME FUND
- -----------------------------------
ANNUAL REPORT
- -----------------------------------
July 31, 1997
[LOGO] SMITH BARNEY MUTUAL FUNDS
Investing for your future.
Every day.(sm)
<PAGE>
SMITH BARNEY
DIVERSIFIED STRATEGIC
INCOME FUND
================================================================================
The Smith Barney Diversified Strategic Income Fund seeks high current income
through investments in bonds issued by the U.S. Government and its agencies,
high-yield corporate bonds and foreign government bond issues.
Smith Barney Diversified Strategic Income Fund's
Average Annual Total Returns Ended
July 31, 1997
<TABLE>
<CAPTION>
Without Sales Charge*
---------------------------------------
Class A Class B Class C
================================================================================
<S> <C> <C> <C>
One-Year 11.36% 10.89% 10.92%
- --------------------------------------------------------------------------------
Five-Year N/A 7.26 N/A
- --------------------------------------------------------------------------------
Since Inception++ 8.53 9.17 7.41
================================================================================
<CAPTION>
With Sales Charge**
---------------------------------------
Class A Class B Class C
================================================================================
<S> <C> <C> <C>
One-Year 6.33% 6.39% 9.92%
- --------------------------------------------------------------------------------
Five-Year N/A 7.12 N/A
- --------------------------------------------------------------------------------
Since Inception++ 7.48 9.17 7.41
================================================================================
</TABLE>
* Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect 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 Class C shares.
** 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 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.
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.
++ Inception dates for Class A, B and C shares are November 6, 1992, December
28, 1989 and March 19, 1993, respectively.
================================================================================
OUR INVESTMENT PHILOSOPHY
================================================================================
At Smith Barney Mutual Funds, your investment needs come first. Our goal is to
deliver consistent and competitive returns over time, using a wide range of
investment strategies.
================================================================================
NASDAQ SYMBOL
================================================================================
<TABLE>
<S> <C>
Class A SDSAX
Class B SLDSX
Class C SDSIX
</TABLE>
================================================================================
WHAT'S INSIDE
================================================================================
<TABLE>
<S> <C>
Shareholder Letter ........................................................ 1
An Interview with Portfolio Managers ...................................... 4
Historical Performance .................................................... 7
Smith Barney Diversified Strategic
Income Fund at a Glance ................................................... 10
Schedule of Investments ................................................... 11
Statement of Assets and Liabilities ....................................... 19
Statement of Operations ................................................... 20
Statements of Changes in Net Assets ....................................... 21
Notes to Financial Statements ............................................. 22
Financial Highlights ...................................................... 27
Tax Information ........................................................... 31
Independent Auditor's Report .............................................. 32
</TABLE>
<PAGE>
================================================================================
Shareholder Letter
================================================================================
[PHOTOGRAPH] [PHOTOGRAPH]
HEATH B. JAMES E.
McLENDON CONROY
Chairman Vice President and
Investment Officer
[PHOTOGRAPH] [PHOTOGRAPH]
JOHN C. SIMON
BIANCHI, CFA HILDRETH
Vice President and Vice President and
Investment Officer Investment Officer
Dear Shareholder:
We are pleased to provide the annual report for Smith Barney Diversified
Strategic Income Fund ("Fund") for the year ended July 31, 1997. In this report,
we summarize the period's prevailing economic and market conditions and briefly
outline our portfolio strategy. A detailed summary of performance and current
holdings can be found in the appropriate sections that follow.
The Fund seeks to provide investors with high current income while minimizing
the risk of interest rate and currency fluctuations. The Fund's managers follow
a flexible investment approach that emphasizes both diversification and balance.
Based on their analysis of current economic and market conditions, the Fund's
management team allocates assets across three classes of bonds: U.S. government
and mortgage securities, high-yield corporate bonds and foreign government
bonds.
For the year ended July 31, 1997, the Fund's Class A shares had a total return
of 11.36% and outperformed the Lehman Brothers Aggregate Bond Index Return of
10.76% for the same period. (The Lehman Brothers Aggregate Bond Index is made up
of U.S. Treasury Bonds, government agency bonds, mortgage-backed securities and
corporate bonds.) The Fund distributed income dividends totaling $0.67 per Class
A share over the past year. Based on the Fund's net asset value of $8.01 as of
July 31, 1997, this equates to an annualized dividend yield of 8.36%. As of July
31, 1997, the Fund's allocation was 35.5% in foreign government bonds, 19.7% in
high-yield corporate bonds and 38% in U.S. government and mortgage-backed
securities. Following are brief summaries of the economic and market conditions
that affected the Fund's three major sectors during the past fiscal year.
U.S. Government and Mortgage-Backed Securities
The U.S. economy continued to grow vigorously during 1997. An annualized rate of
increase in the Gross Domestic Product ("GDP") of 5.6% for the first quarter of
1997 came on the heels of an already brisk 3.8% annualized GDP growth for the
fourth quarter of 1996. This increase raised concerns from many investors that
the Federal Reserve Board ("Fed") would be forced to raise short-term interest
rates. The Fed has stated that it considers an annual economic growth rate of
approximately 2.0% or 2.5% to be the limit the U.S. economy can absorb without
increasing inflationary pressures. As a result of the unexpected strength in the
U.S. economy, the Fed raised the federal-funds rate by 25 basis points, or
0.25%, at its March 1997 meeting. (The federal-funds rate is the interest rate
banks charge each other for overnight
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 1
<PAGE>
loans and a closely watched indicator of the direction of interest rates.) The
Fed's monetary policy remain unchanged during its summer meetings.
Despite robust growth and historically low unemployment, inflationary pressures
have been nearly absent in the U.S. economy. In fact, the cost of manufactured
goods has been declining and consumer prices have risen at less than a 2% annual
rate so far this year, as represented by the Producers Price Index and the
Consumers Price Index, respectively.
Other significant factors that have affected the bond market during the year
include:
o The re-election of President Clinton and the continuing Republican majority
in Congress that was positively received by the financial markets.
o The U.S. government passing a balanced budget accord that limits government
spending.
o Recent elections in France that restored the Socialists to power have
heightened anxiety over the ultimate fate of European Monetary Union
("EMU").
o The handover of Hong Kong to China in July that was viewed favorably by the
investment community.
High Yield Corporate Bonds
The high yield bond market has continued to rally on strong demand from both
institutional investors and retail mutual funds. Given strong market conditions,
we have seen a record amount of new high yield issuance (more than $60 billion)
during the first seven months of this year, and we expect this trend to continue
over the remainder of 1997. There has been more than adequate demand to absorb
the heavy new issue supply. Increasing amounts of capital are flowing into the
high yield market from a variety of sources. Traditional open-end high yield
mutual funds have had more than $11 billion of cash inflows over the first seven
months of 1997, not to mention the roughly $5 billion of dividends that were
reinvested in additional mutual fund shares.
This strong demand has helped many high yield bonds appreciate to fully valued
levels relative to U.S. Treasuries. Besides the significant amount of capital
being invested into the market, the moderate growth and low inflation of the
U.S. economy have also supported the high yield bond market. Moreover, the
historically high valuations of the U.S. stock market have enabled a number of
companies to issue stock to further bolster their balance sheets.
In addition, the banking system remains highly liquid, enabling it to
accommodate high yield borrowers. Consequently, high yield bond default rates
remain at the low end of their historical range at approximately 1.5% per year
for the past two years. As long as overall economic and market conditions remain
relatively benign, high-yield bond spreads should remain at this same low end of
their historical range. Because of these positive fundamental factors, we do not
believe the high yield market is becoming any more speculative. However, we are
naturally becoming increasingly more sensitive to the possibility for
disappointment and underperformance among select individual issues.
If the economy were to reaccelerate and cause the Fed to actively raise
short-term interest rates to slow economic momentum, we could expect the high
yield bond market to be negatively affected along with other financial markets.
In light of the non-inflationary economic growth in the second quarter, we do
not believe the Fed will need to raise interest rates unless the U.S. economy
begins to accelerate in the third or fourth quarter of 1997. Nevertheless, we
believe that selectivity has become increasingly more important when making
investment decisions, especially given the high yield market's fully valued
levels and the potential for disappointment among individual companies.
Foreign Government Securities
After the steady gains witnessed during the year in the latter part of 1996, the
global bond market returns were generally mixed during the first quarter of
1997. Several factors became increasingly prominent in
- --------------------------------------------------------------------------------
2 1997 Annual Report to Shareholders
<PAGE>
determining overall global government bond performance. First and most
important, the Fed's decision to raise official interest rates, although widely
discounted, signaled a halt to rising bond prices around the globe.
The U.S. dollar proved to be the main beneficiary of the widening interest rate
differential between North America and the rest of the world, creating large
losses in unhedged bond returns in U.S. dollars. The Portfolio's foreign bond
holdings were partially hedged over the period. As a result, a portion of these
funds' securities were immunized from losses due to falling exchange rates
versus the dollar.
In Europe, investors generally believed that interest rates had bottomed in the
core economies of Germany, France and the United Kingdom, and the prospect of a
shift to higher official interest rates remained remote. Moreover, in the case
of the Southern European and Scandinavian economies it seemed likely that there
was still room for further monetary easing, given the improving inflation
outlook and the ongoing impetus towards an EMU. There was some profit-taking
across the board in some of the higher-yielding bond markets and currencies that
was triggered by concern that the EMU criteria for admission could not be
realistically met before the 1999 deadline.
After the broad sell-off that occurred in the first quarter of the year, the
global bond markets saw a revival during the second quarter that took the yield
on the benchmark ten-year U.S. Treasury bond back to around 6.5%. In Europe,
yields also fell across the Continent with the benchmark German government bond
yield falling to 5.6%. The Japanese government bond market was alone in
generating a relatively poor return, registering a slightly negative total
return over the last year.
During the past year, we have slowly reduced the Fund's targeted exposure to
high yield bonds from 30% to 19% and increased exposure to its mortgage-backed
securities from 25% to 38%. Given our expectations for continued volatility in
most foreign markets, we also reduced investments in global government bonds
from 45% to 35% while at the same time increasing the Fund's U.S. dollar hedge
from 50% to 70% of foreign holdings. At any given time during this period,
allocations may temporarily be above or below the agreed upon target.
Overall, the Fund benefitted from the strong performance of high yield corporate
bonds and the relatively competitive performance of U.S. Treasury and U.S.
government bonds. However, the Fund's performance was somewhat penalized by
volatility in global bond markets.
Market Outlook
In the coming months, we expect the U.S. economy to continue along its present
path of moderate growth with a relative absence of inflationary pressure. As a
result, we also expect interest rates to continue to decline and the yield on
the benchmark 30 year U.S. Treasury to fall to around 6%. These nearly ideal
conditions in the U.S. economy should also benefit all the asset classes
previously discussed. On a more somber note, we are saddened by the loss of two
outstanding business leaders and Trustees of the Fund: Antoinette C. Bentley and
Madelon De Voe Talley. Their knowledge and wisdom will be missed.
In closing, we thank you investing in the Smith Barney Diversified Strategic
Income Fund. We look forward to continuing to help you pursue your financial
goals.
Sincerely,
/s/ Heath B. McLendon /s/ James E. Conroy
Heath B. McLendon James E. Conroy
Chairman Vice President and
Investment Officer
/s/ John C. Bianchi /s/ Simon Hildreth
John C. Bianchi, CFA Simon Hildreth
Vice President and Vice President and
Investment Officer Investment Officer
September 19, 1997
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 3
<PAGE>
================================================================================
An Interview with Portfolio Managers
Jim Conroy, John C. Bianchi and Simon Hildreth
================================================================================
Jim Conroy is a Managing Director of Smith Barney and is the lead Portfolio
Manager of the Smith Barney Diversified Strategic Income Fund, heading the U.S.
government mortgage-backed securities portion of the Fund. Jim is responsible
for managing roughly $4 billion in government and mortgage-backed security
mutual fund assets for Smith Barney. He joined the firm in 1983 and since then
has served as head of Taxable Fixed Income Management. Prior to 1983 he was
associated with Equitable Asset Management as a portfolio manager. He holds a
B.A. in Economics from Muhlenberg College.
John C. Bianchi, CFA, is a Managing Director and Portfolio Manager of the Smith
Barney Diversified Strategic Income Fund heading the high yield securities
portion of the Fund. He has over 18 years of Wall Street experience, the lion's
share of which has been at Smith Barney. John manages more than $3.5 billion in
high yield assets for Smith Barney. He holds a B.A. in English from Seton Hall
University and an M.B.A. in Finance from Fairleigh Dickinson University.
Simon Hildreth is a Portfolio Manager of the Smith Barney Diversified Strategic
Income Fund heading the foreign government bond portion of the Fund. Simon
joined Smith Barney Global Capital Management Inc. in 1994 as Managing Director
and Senior Global Fixed Income Portfolio Manager. He was previously Director of
Mercury Asset Management (the largest U.K. Fund Management house, with
approximately $90 billion under management) where he had seven years' experience
managing multi-currency bond portfolios, with particular emphasis on non-U.S.
bonds and currencies.
Jim, how would you describe the Fund?
Jim: The Diversified Strategic Income Fund is an intermediate-term diversified
bond fund that seeks high current income by investing in U.S. Treasuries and
mortgage-backed bonds, foreign government bonds and high yield bonds that are
limited to a maximum of 35% of portfolio assets by prospectus.
With regard to your total-return emphasis, how do you select investments for the
Fund?
Jim: In terms of investment style, the first priority is to determine who the
people are who invest in our Fund. We allocate assets based on analysis of
current economic and market conditions, taking into account the relative income
opportunities and risks within each of the fixed-income sectors in which the
Fund invests.
We always keep the investor in mind when we make investment decisions. We can
make decisions that we think may be right in terms of the market, but if we are
wrong it's the shareholder who pays the price. So we typically stay away from
"riskier" types of securities. Instead, we take a very generic approach to the
marketplace. We tend to favor straightforward securities. We look at economic
growth, investor perceptions of the economy, inflation and political
developments throughout the world.
Then we analyze technical aspects of the market. Technical analysis takes into
account such things as market liquidity and day-to-day trading volume. We try to
analyze every one of our competitors and understand what they are doing. In
business, you could be the brightest person in the world and hard working and
still not do well. If you don't understand the competition and what they are
doing, you may be behind the eight ball. The best portfolio managers in this
business today are those who understand what makes the marketplace tick.
Simon: On the global government side, we use a unique investment process that
incorporates in-depth fundamental economic analysis of the 15 major world
government bond markets. That's step one. Our second step incorporates a high
component of quantitative analytical techniques that enable us to fashion and
arrive at an optimal portfolio, given our forecast for currencies and interest
rates around the world.
- --------------------------------------------------------------------------------
4 1997 Annual Report to Shareholders
<PAGE>
Simon, how do you decide what countries to invest in?
Simon: The country allocation in the non-dollar component is determined through
our quantitative processes. We use computer technology to determine the
respective weights that we should apply toward various global regions.
Given the turbulence in many markets around the world, how can investors
minimize volatility in their portfolios?
Jim: One of the most effective ways to minimize portfolio volatility is to
diversify broadly across regions, asset classes and currencies. Because market
and economic conditions are constantly changing, finding the most appropriate
mix is often complicated. With the Diversified Strategic Income Fund, we closely
monitor these conditions and adjust the Fund accordingly. We firmly believe that
diversification is key to minimizing risk.
John: I agree with Jim. I would also add that investors should start paying more
attention to the risks they maybe assuming in the stock market. Instead of
adding more money to equities, investors may want to consider taking a fresh
look at fixed-income securities. High-yield corporate bonds can be a good
defensive strategy. Although high-yield bonds are not a low-risk investment,
these securities are typically not as risky as stocks. In today's highly valued
stock market, high-yield corporate bonds are paying an average of 9% to 11%.
While high-yield bond prices can also decline in a down market, they generally
decline less than equities.
Simon: The benefit of global diversification lies in the fact that global
economies are usually not in sync. For example, the U.S. can be booming with the
threat of higher official interest rates, while Europe can be barely recovering
from recession with the possibility of lower interest rates. Therefore, the
ability to diversify risk around the globe enables us as an investment team to
constantly look for much more attractive opportunities on a macro economic
level. That is a compelling argument for global bond diversification.
In recent months, U.S. interest rates have been declining. Do you feel this
trend is sustainable?
Jim: We currently believe that U.S. interest rates are going lower. Investors
have been somewhat apprehensive, because everybody keeps talking about this
economy that all of a sudden is going to start growing again. We personally do
not think that is going to happen.
As a portfolio manager, no matter how strongly you believe that interest rates
are going up or down, you always have to look at the other side of the equation
and try to prove yourself wrong. We do not want to look only at research that
agrees with our thinking. We want to look at contrarian viewpoints to see if we
are missing anything.
John: One thing high yield bond investors need to watch for is a slowing economy
and interest rates are a good early signal. If the economy begins to slow down,
company earnings may come under pressure. That can undermine the stock market
and, to a lesser extent, the high yield bond market. If the economy continues to
grow full throttle, the Federal Reserve may feel it has to raise interest rates
to slow it down. Any meaningful tightening of monetary policy by the Fed could
negatively affect the high yield bond market, because higher interest rates
often affect profitability and sales growth of companies. However, it's
important to note that high-yield corporate bonds can be generally less
sensitive to interest rates than other types of bond investments such as U.S.
government securities.
Simon, what are the advantages of maintaining an office in London rather than in
New York?
Simon: Time zone is a primary advantage for global trading. We find it much
easier to analyze not only Europe but Far Eastern markets from London. Countries
such as Poland, Czechoslovakia and Russia, all fall effectively within our time
zone. We also have access to emerging Asian markets right now and it's possible
to cover those markets much more effectively from this time zone than from
America.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 5
<PAGE>
Why did you become portfolio managers?
Jim: I doubt anybody ever dreams of becoming a portfolio manager. I think that
anybody who tells you that is kidding themselves. But when I got into the
portfolio managing business in 1977, I received a phone call from a friend of
mine. He said, "Would you like to get in the bond business?" I said yeah, sure.
Though I wanted to be just a trader, I ended up becoming a portfolio manager.
And it's funny, recently somebody at a public seminar asked me where did I go to
school to become a portfolio manager. There is no such thing. Portfolio
management comes from experience, and you learn in the line of fire. Within six
months, people will generally know whether they're going to be successful.
I would say being a portfolio manager is just like being a good golfer. Unless
you have patience and realize that every bad shot is going to be followed by
some good shots, you will not be a good golfer. Patience applies to being a
portfolio manager as well.
Simon: For me, it's the constant challenge. On an intellectual level, the world
is a constantly changing, evolving place, and being a global bond portfolio
manager in particular gives me an opportunity to witness monumental changes such
as possible European Monetary Union, the collapse of the Berlin Wall and the
gradual opening of eastern European markets. Moreover, it's a job that's
exciting, and each day provides its own challenges and opportunities. I
originally took this job because it just absolutely fascinated me. And it still
does. And that's one of the surprising things about this sort of business. I've
been at it for 15 to 16 years now and yet I still retain the same level of
enthusiasm.
John: I've been managing money for more than eighteen years, not because of
professional ambition, but because I honestly care about helping investors
improve the quality of their lives.
Jim, John and Simon, thanks for spending some time with us today.
- --------------------------------------------------------------------------------
6 1997 Annual Report to Shareholders
<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>
7/31/97 $7.82 $8.01 $0.67 $0.00 $0.00 11.36%
- ------------------------------------------------------------------------------------------------------------------------------------
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 $2.84 $0.22 $0.28
====================================================================================================================================
</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>
7/31/97 $7.83 $8.03 $0.62 $0.00 $0.00 10.89%
- ------------------------------------------------------------------------------------------------------------------------------------
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 $4.60 $0.30 $0.42
====================================================================================================================================
</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>
7/31/97 $7.81 $8.01 $0.62 $0.00 $0.00 10.92%
- ------------------------------------------------------------------------------------------------------------------------------------
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 $2.43 $0.13 $0.26
====================================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 7
<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>
7/31/97 $7.82 $8.00 $0.70 $0.00 $0.00 11.64%
- ------------------------------------------------------------------------------------------------------------------------------------
Inception* -- 7/31/96 7.89 7.82 0.53 0.00 0.05 6.65+
====================================================================================================================================
Total $1.23 $0.00 $0.05
====================================================================================================================================
</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>
7/31/97 $7.82 $8.01 $0.69 $0.00 $0.00 11.69%
- ------------------------------------------------------------------------------------------------------------------------------------
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 $2.93 $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 7/31/97 11.36% 10.89% 10.92% 11.64% 11.69%
- ------------------------------------------------------------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 7.26 N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Inception* through 7/31/97 8.53 9.17 7.41 10.13 8.88
====================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
With Sales Charge(2)
------------------------------------------------------------------------------
Class A Class B Class C Class Y Class Z
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Year Ended 7/31/97 6.33% 6.39% 9.92% 11.64% 11.69%
- ------------------------------------------------------------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 7.12 N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Inception* through 7/31/97 7.48 9.17 7.41 10.13 8.88
====================================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
8 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Cumulative Total Return
================================================================================
<TABLE>
<CAPTION>
Without Sales Charge(1)
================================================================================
<S> <C>
Class A (Inception* through 7/31/97) 47.29%
- --------------------------------------------------------------------------------
Class B (Inception* through 7/31/97) 94.63
- --------------------------------------------------------------------------------
Class C (Inception* through 7/31/97) 36.68
- --------------------------------------------------------------------------------
Class Y (Inception* through 7/31/97) 19.06
- --------------------------------------------------------------------------------
Class Z (Inception* through 7/31/97) 49.57
================================================================================
</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 ("CDSCs") 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 representative of the
total return for the year.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 9
<PAGE>
================================================================================
Smith Barney Diversified Strategic Income Fund at a Glance (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 1997
[LINE GRAPH]
<TABLE>
<CAPTION>
Smith Barney Lehman Brothers
Diversified Strategic Aggregate Bond Index
Income Fund
<S> <C> <C>
Dec 1989 $ 10,000 $ 10,000
July 1990 10,600 10,425
July 1991 11,704 11,541
July 1992 13,707 13,247
July 1993 14,705 14,595
July 1994 14,801 14,609
July 1995 16,281 16,086
July 1996 17,551 16,976
July 1997 19,463 18,804
</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, 1997. 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.
<TABLE>
<CAPTION>
Top Ten Holdings* As of July 31, 1997
================================================================================
<S> <C>
1. Government National Mortgage Association 24.5%
- --------------------------------------------------------------------------------
2. Federal Home Loan Mortgage Corp. 8.7
- --------------------------------------------------------------------------------
3. UK Treasury 5.6
- --------------------------------------------------------------------------------
4. Deutschland Republic 5.6
- --------------------------------------------------------------------------------
5. U.S. Treasury 4.8
- --------------------------------------------------------------------------------
6. Government of Canada 3.9
- --------------------------------------------------------------------------------
7. Morgan Stanley Inc. 3.5
- --------------------------------------------------------------------------------
8. Kingdom of Spain 3.4
- --------------------------------------------------------------------------------
9. CS First Boston Corp. 3.3
- --------------------------------------------------------------------------------
10. Republic of Ireland 2.8
- --------------------------------------------------------------------------------
</TABLE>
* As a percentage of total investments.
Investment Breakdown
- --------------------------------------------------------------------------------
[THE FOLLOWING TABLE WAS REPRESENTED BY A PIE CHART IN THE PRINTED MATERIAL.]
<TABLE>
<S> <C>
U.S. Government Agencies & Obligations ................................. 38.0%
International Bonds .................................................... 35.5%
Corporate Bonds and Notes .............................................. 17.7%
Repurchase Agreements .................................................. 6.8%
Preferred Stock and Warrants ........................................... 2.0%
</TABLE>
- --------------------------------------------------------------------------------
10 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Schedule of Investments July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
==========================================================================================================
<C> <S> <C>
U.S. GOVERNMENT SECTOR -- 38.0%
U.S. Government Agencies & Obligations -- 38.0%
$ 10,000,000 U.S. Treasury Notes, 6.500% due 10/15/06 $ 10,305,800
102,500,000 U.S. Treasury Notes, 6.250% due 2/15/07(a) 104,039,550
32,000,000 U.S. Treasury Principal Strips, due 11/15/09 14,562,560
48,000,000 U.S. Treasury Principal Strips, due 2/15/15 16,007,520
387 Federal Home Loan Mortgage Corp., 10.000% due 7/1/20 387
24,884,899 Federal Home Loan Mortgage Corp., 9.000% due 5/1/03
through 1/1/23 26,447,916
65,249,494 Federal Home Loan Mortgage Corp., 8.000% due 1/1/22
through 1/1/23 67,431,437
159,714,589 Federal Home Loan Mortgage Corp. Gold, 9.000% due 4/15/25 169,746,259
72,017 Government National Mortgage Association, 9.000% due 2/15/21 76,674
498,066,232 Government National Mortgage Association, 8.000% due 3/15/25
through 3/15/27 514,716,658
208,036,186 Government National Mortgage Association Platinum, 9.000%
due 12/15/17 225,719,262
- ----------------------------------------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT SECTOR
(Cost -- $1,110,935,203) 1,149,054,023
==========================================================================================================
HIGH YIELD SECTOR -- 19.7% CORPORATE BONDS AND NOTES -- 17.7% Aerospace and
Defense -- 0.4%
4,875,000 Airplanes Pass Through Trust, 10.875% due 3/15/19 5,777,363
4,675,000 Howmet Corp., 10.000% due 12/1/03 5,054,843
2,375,000 UNC Inc., 11.000% due 6/1/06 2,814,375
- ----------------------------------------------------------------------------------------------------------
13,646,581
- ----------------------------------------------------------------------------------------------------------
Banking -- 0.3%
7,325,000 First Nationwide Holdings, 12.500% due 4/15/03 8,387,125
- ----------------------------------------------------------------------------------------------------------
Broadcasting - TV, Cable, and Radio -- 3.4%
1,425,000 All American Communications Inc., 10.875% due 10/15/01 1,526,531
475,000 Allbritton Communications Co., 11.500% due 8/15/04 499,937
6,775,000 Australis Holdings Pty Ltd., step bond to yield 15.000% due 11/1/02 5,623,250
3,800,000 Cablevision Systems Corp., 9.875% due 4/1/23 4,037,500
10,275,000 Comcast UK Cable, step bond to yield 11.200% due 11/15/07 7,873,219
2,675,000 Le Groupe Videotron Ltee., 10.625% due 2/15/05 2,962,563
2,150,000 Marcus Cable Operating Co., step bond to yield 13.500% due 8/1/04 1,918,875
Rogers Cablesystems Ltd.:
4,400,000 10.000% due 12/1/07 4,994,000
5,700,000 11.000% due 12/1/15 6,312,750
Rogers Communications Inc.:
9,875,000 10.875% due 4/15/04 10,442,813
3,225,000 8.875% due 7/15/07 3,273,375
7,800,000 RSL Communications Ltd., 12.250% due 11/15/06 8,482,500
4,000,000 SCI Television, 11.000% due 6/30/05 4,230,000
6,500,000 SFX Broadcasting, 10.750% due 5/15/06 7,320,625
3,100,000 TV Azteca S.A., 10.500% due 2/15/07(b) 3,301,500
12,325,000 UIH Australia/Pacific Communications Inc.,
step bond to yield 14.000% due 5/15/06 8,226,938
10,375,000 United International Holdings, zero coupon due 11/15/99 8,209,219
5,375,000 Videotron Holdings PLC, step bond to yield 11.000% due 8/15/05 4,602,343
</TABLE>
See Notes to Financial Statements
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 11
<PAGE>
================================================================================
Schedule of Investments (continued) July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
==========================================================================================================
<C> <S> <C>
Broadcasting - TV, Cable, and Radio -- 3.4% (continued)
$ 4,500,000 Videotron Ltee., 10.250% due 10/15/02 $ 4,803,750
2,000,000 Wireless One Inc., 13.000% due 10/15/03 1,220,000
2,850,000 Young Broadcasting Inc., 11.750% due 11/15/04 3,209,813
- ----------------------------------------------------------------------------------------------------------
103,071,501
- ----------------------------------------------------------------------------------------------------------
Building/Construction -- 0.0%
1,000,000 American Builders & Contractors Supply Co., 10.625% due 5/15/07(b) 1,046,250
- ----------------------------------------------------------------------------------------------------------
Chemicals -- 0.7%
2,125,000 NL Industries Inc., 11.750% due 10/15/03 2,345,469
2,150,000 Polytama International, 11.250% due 6/15/07 2,176,875
6,150,000 PT Polysindo Eka Perkasa, 13.000% due 6/15/01 7,011,000
8,350,000 Terra Industries Inc., 10.500% due 6/15/05 9,153,688
875,000 Texas Petrochemical Corp., 11.125% due 7/1/06 942,813
- ----------------------------------------------------------------------------------------------------------
21,629,845
- ----------------------------------------------------------------------------------------------------------
Consumer Durable Goods/Home Furnishings -- 0.2%
7,475,000 International Semi Tech Microelectronics Inc.,
step bond to yield 11.500% due 8/15/03 4,840,063
- ----------------------------------------------------------------------------------------------------------
Diversified/Conglomerate Manufacturing -- 0.2%
3,000,000 Alvey Systems Inc., 11.375% due 11/31/03 3,112,500
3,700,000 Interlake Corp., 12.125% due 3/1/02 3,871,125
- ----------------------------------------------------------------------------------------------------------
6,983,625
- ----------------------------------------------------------------------------------------------------------
Electric Utilities -- 0.4%
7,775,000 Calpine Corp., 10.500% due 5/15/06 8,494,188
3,076,281 Midland Funding Corp. I, 10.330% due 7/23/02 3,368,527
- ----------------------------------------------------------------------------------------------------------
11,862,715
- ----------------------------------------------------------------------------------------------------------
Electronics/Computers -- 0.8%
2,175,000 Celestica International, 10.500% due 12/31/06 2,368,031
3,175,000 Graphic Controls Corp., 12.000% due 9/15/05 3,544,094
Unisys Corp.:
8,500,000 12.000% due 4/15/03 9,371,250
6,175,000 11.750% due 10/15/04 6,807,938
2,600,000 Viasystems Inc., 9.750% due 6/1/07(b) 2,710,500
- ----------------------------------------------------------------------------------------------------------
24,801,813
- ----------------------------------------------------------------------------------------------------------
Finance Companies/Consumer Credit -- 0.1%
3,175,000 Imperial Credit Industries Inc., 9.875% due 1/15/07 3,182,938
- ----------------------------------------------------------------------------------------------------------
Food -- 0.2%
3,800,000 TLC Beatrice International Holdings, 11.500% due 10/1/05 4,332,000
2,475,000 Van de Kamp Inc., 12.000% due 9/15/05 2,775,094
- ----------------------------------------------------------------------------------------------------------
7,107,094
- ----------------------------------------------------------------------------------------------------------
Grocery/Convenience Stores -- 0.4%
Pathmark Stores Inc.:
4,500,000 12.625% due 6/15/02 4,618,125
12,850,000 Step bond to yield 10.750% due 11/1/03 8,995,000
- ----------------------------------------------------------------------------------------------------------
13,613,125
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
12 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Schedule of Investments (continued) July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
==========================================================================================================
<C> <S> <C>
Healthcare/Drugs/Hospital Supplies -- 0.7%
$ 6,350,000 Magellan Health Services Inc., 11.250% due 4/15/04 $ 7,088,188
2,800,000 Sun Healthcare Group Inc., 9.500% due 7/1/07 2,898,000
Tenet Healthcare Corp.:
4,400,000 8.000% due 1/15/05 4,609,000
5,600,000 8.625% due 1/15/07 5,929,000
1,700,000 Vencor Inc., 8.625% due 7/15/07(b) 1,734,000
- ----------------------------------------------------------------------------------------------------------
22,258,188
- ----------------------------------------------------------------------------------------------------------
Hotel/Gaming -- 0.9%
1,000,000 Aztar Corp., 13.750% due 10/1/04 1,150,000
1,600,000 Boyd Gaming Corp., 9.500% due 7/15/07(b) 1,620,000
5,375,000 Courtyard by Marriott, 10.750% due 2/1/08 5,865,469
2,300,000 Grand Casinos Inc., 10.125% due 12/1/03 2,475,375
HMH Properties Inc.:
4,215,000 9.500% due 5/15/05 4,467,900
2,100,000 8.875% due 7/15/07(b) 2,173,500
5,275,000 Mohegan Tribal Gaming Authority, 13.500% due 11/15/02 6,963,000
2,000,000 Showboat Inc., 13.000% due 8/1/09 2,325,000
- ----------------------------------------------------------------------------------------------------------
27,040,244
- ----------------------------------------------------------------------------------------------------------
Leasing -- 0.1%
2,600,000 Central Transport, Sr. Notes, 9.500% due 4/30/03 2,775,500
- ----------------------------------------------------------------------------------------------------------
Leisure/Amusement/Motion Pictures -- 0.1%
5,275,000 Coleman Escrow Corp., zero coupon due 5/15/01(b) 3,402,375
- ----------------------------------------------------------------------------------------------------------
Machinery -- 0.4%
10,175,000 Terex Corp., 13.250% due 5/15/02 11,663,094
- ----------------------------------------------------------------------------------------------------------
Metals/Mining -- 0.5%
3,050,000 Echo Bay Mines, 11.000% due 4/1/27 2,908,937
5,425,000 Kaiser Aluminum & Chemical Corp., 12.750% due 2/1/03 5,913,250
1,500,000 Russel Metals Inc., 10.250% due 6/15/00 1,575,000
3,410,000 UCAR Global Enterprises Inc., 12.000% due 1/15/05 3,895,925
- ----------------------------------------------------------------------------------------------------------
14,293,112
- ----------------------------------------------------------------------------------------------------------
Oil/Natural Gas -- 0.6%
2,700,000 Clark Oil & Refining Corp., 10.500% due 12/1/01 2,811,375
6,500,000 Clark USA, 10.875% due 12/1/05 7,052,500
3,725,000 Santa Fe Energy Resources Inc., 11.000% due 5/15/04 4,046,281
4,450,000 United Meridian Corp., 10.375% due 10/15/05 4,856,063
- ----------------------------------------------------------------------------------------------------------
18,766,219
- ----------------------------------------------------------------------------------------------------------
Oil Services -- 0.8%
3,200,000 DeepTech International Inc., 12.000% due 12/15/00 3,420,000
6,950,000 Global Marine Inc., 12.750% due 12/15/99 7,297,500
2,750,000 ICO Inc., 10.375% due 6/1/07(b) 2,880,625
6,525,000 Parker Drilling Corp., 9.750% due 11/15/06 7,014,375
3,625,000 Pride Petroleum Services Inc., 9.375% due 5/1/07 3,860,625
- ----------------------------------------------------------------------------------------------------------
24,473,125
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 13
<PAGE>
================================================================================
Schedule of Investments (continued) July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
==========================================================================================================
<C> <S> <C>
Packaging/Containers -- 0.3%
$ 2,425,000 Gaylord Container Corp., step bond to yield 12.750% due 5/15/05 $ 2,667,500
5,000,000 Ivex Holdings Corp., step bond to yield 13.250% due 3/15/05 3,968,750
2,700,000 Vicap SA, 11.375% due 5/15/07(b) 2,956,500
- ----------------------------------------------------------------------------------------------------------
9,592,750
- ----------------------------------------------------------------------------------------------------------
Paper/Forest Products/Printing -- 1.1%
4,696,000 American Pad & Paper Co., 13.000% due 11/15/05 5,488,450
12,950,000 Indah Kiat International Finance Co., 11.875% due 6/15/02 14,277,375
4,825,000 SD Warren Holdings Co., 12.000% due 12/15/04 5,434,156
6,750,000 Tjiwi Kimia International Finance Co., 13.250% due 8/1/01 7,669,688
- ----------------------------------------------------------------------------------------------------------
32,869,669
- ----------------------------------------------------------------------------------------------------------
Pollution Control/Waste Removal -- 0.1%
3,225,000 Envirosource Inc., 9.750% due 6/15/03 3,208,875
- ----------------------------------------------------------------------------------------------------------
Real Estate Development/Investment -- 0.2%
5,167,000 Trizec Finance Ltd., 10.875% due 10/15/05 5,922,674
- ----------------------------------------------------------------------------------------------------------
Retail -- 0.3%
7,550,000 Barnes & Noble Inc., 11.875% due 1/15/03 8,191,750
- ----------------------------------------------------------------------------------------------------------
Telephone/Communications -- 4.1%
Brooks Fiber Properties:
8,000,000 Step bond to yield 10.875% due 3/1/06 5,970,000
7,900,000 Step bond to yield 11.875% due 11/1/06 5,658,375
17,150,000 Clearnet Communications Inc., step bond to yield 14.750% due 12/15/05 12,498,063
7,600,000 Colt Telecom Group PLC, step bond to yield 12.000% due 12/15/06(c) 5,073,000
3,400,000 Fonorola Inc., 12.500% due 8/15/02 3,808,000
5,175,000 Intelcom Group Inc., step bond to yield 12.500% due 5/1/06 3,706,594
12,950,000 Intermedia Communications of Florida,
step bond to yield 12.500% due 5/15/06 9,615,375
2,600,000 Iridium LLC/ Capital Corp., 13.000% due 7/15/05(b)(c) 2,626,000
6,425,000 Metronet Communications, 12.000% due 8/15/07(c) 6,874,750
14,000,000 Millicom International Cellular, step bond to yield 13.500% due 6/1/06 10,517,500
20,050,000 Nextel Communications Inc., step bond to yield 9.750% due 8/15/04 16,466,063
9,125,000 Nextlink Communications Inc., 12.500% due 4/15/06 10,265,625
9,150,000 Pagemart Inc., step bond to yield 12.250% due 11/1/03 8,200,688
4,525,000 Pagemart Nationwide Inc., step bond to yield 15.000% due 2/1/05 3,570,542
5,100,000 Primus Telecom Group, 11.750% due 8/1/04 5,227,500
2,550,000 Qwest Communications International, 10.875% due 4/1/07(b) 2,862,375
5,750,000 Telesystem International Wireless Inc., step bond to yield 13.250%
due 6/30/07(b) 3,335,000
8,800,000 TeleWest Communications PLC, step bond to yield 11.000% due 10/1/07 6,600,000
- ----------------------------------------------------------------------------------------------------------
122,875,450
- ----------------------------------------------------------------------------------------------------------
Tobacco -- 0.2%
5,575,000 Consolidated Cigar Corp., 10.500% due 3/1/03 5,853,750
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
14 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Schedule of Investments (continued) July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
==========================================================================================================
<C> <S> <C>
Transportation/Shipping -- 0.2%
$ 6,800,000 Sea Containers Ltd. Series A, 12.500% due 12/1/04 $ 7,709,500
- ----------------------------------------------------------------------------------------------------------
TOTAL CORPORATE BONDS AND NOTES
(Cost -- $504,676,946) 541,068,950
==========================================================================================================
<CAPTION>
SHARES SECURITY VALUE
==========================================================================================================
<C> <S> <C>
PREFERRED STOCK -- 2.0%
Automobile/Auto Parts/Truck Manufacturing -- 0.3%
169,800 Navistar International Corp., Series G, Convertible until 12/31/49 10,230,450
- ----------------------------------------------------------------------------------------------------------
Banking -- 0.1%
121,000 California Federal Preferred Capital Corp., Series A, Exchangeable 3,191,375
- ----------------------------------------------------------------------------------------------------------
Broadcasting - TV, Cable, and Radio -- 0.9%
22,920 Time Warner Inc., Series M 26,186,100
- ----------------------------------------------------------------------------------------------------------
Healthcare/Drugs/Hospital Supplies -- 0.0%
88,518 Avatex Corp., Series A, Exchangeable(d) 802,194
- ----------------------------------------------------------------------------------------------------------
Publishing -- 0.0%
1,502 K-III Communications Corp., Series B, Exchangeable 159,493
- ----------------------------------------------------------------------------------------------------------
Telephone/Communications -- 0.7%
16,457 Panamsat Corp., Exchangeable 19,748,400
- ----------------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCK
(Cost -- $57,070,638) 60,318,012
==========================================================================================================
WARRANTS -- 0.0%
Broadcasting - TV, Cable, and Radio -- 0.0%
6,775 Australis Holdings, Expire 10/30/01(b)(d) 203
7,800 RSL Communications Ltd., Expire 11/15/06(d) 46,800
6,000 Wireless One Inc., Expire 10/19/00(d) 6,000
- ----------------------------------------------------------------------------------------------------------
53,003
- ----------------------------------------------------------------------------------------------------------
Paper/Forest Products/Printing -- 0.0%
8,500 SD Warren Holdings Co., Expire 12/15/06(b)(d) 110,500
- ----------------------------------------------------------------------------------------------------------
TELEPHONE/COMMUNICATIONS -- 0.0%
56,595 Clearnet Communications Inc., Expire 9/15/05(d) 311,273
6,775 Nextel Communications Inc., Expire 5/23/99(d) 68
42,090 Pagemart Inc., Expire 12/31/03(d) 263,063
19,250 Pagemart Nationwide Inc., Expire 11/30/03(b)(d) 185,281
- ----------------------------------------------------------------------------------------------------------
759,685
- ----------------------------------------------------------------------------------------------------------
TOTAL WARRANTS
(Cost -- $431,228) 923,188
==========================================================================================================
TOTAL HIGH YIELD SECTOR
(Cost -- $562,178,812) 602,310,150
==========================================================================================================
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 15
<PAGE>
================================================================================
Schedule of Investments (continued) July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT+ SECURITY VALUE
==========================================================================================================
<C> <S> <C>
INTERNATIONAL SECTOR -- 35.5%
BONDS -- 35.5%
Argentina -- 0.1%
3,000,000 Argentina Discount Series L, 6.875% due 3/31/23(e) $ 2,701,890
- ----------------------------------------------------------------------------------------------------------
Australia -- 3.4%
60,000,000 Australian Government, 7.500% due 7/15/05 48,165,859
66,000,000 Queensland Treasury Corp., 8.000% due 5/14/03 53,388,202
- ----------------------------------------------------------------------------------------------------------
101,554,061
- ----------------------------------------------------------------------------------------------------------
Austria -- 0.2%
8,000,000 Oesterreichische Kontrollbank, 10.250% due 7/27/99 6,363,044
- ----------------------------------------------------------------------------------------------------------
Brazil -- 0.1%
3,000,000 Banco Nac Desen, 10.375% due 4/27/98 3,041,673
- ----------------------------------------------------------------------------------------------------------
Canada -- 4.5%
456,000 Algoma Steel Inc., 12.375% due 7/15/05 529,530
Government of Canada:
20,000,000 7.000% due 9/1/01 15,475,329
30,000,000 9.000% due 12/1/04 26,093,619
95,000,000 7.250% due 6/1/07 76,869,860
5,400,000 International Finance Corp., 7.750% due 8/18/98 4,038,670
9,000,000 Kingdom of Sweden, 10.625% due 6/3/98 6,840,996
2,000,000 Province of Alberta, 7.750% due 2/4/98 1,474,273
5,700,000 Rogers Cablesystems, 9.650% due 1/15/14 4,381,602
- ----------------------------------------------------------------------------------------------------------
135,703,879
- ----------------------------------------------------------------------------------------------------------
Czech Republic -- 0.1%
100,000,000 Czech Electric Co., 14.375% due 1/27/01 2,765,970
- ----------------------------------------------------------------------------------------------------------
DENMARK -- 1.6%
Kingdom of Denmark:
100,000,000 8.000% due 5/15/03 16,262,056
200,000,000 7.000% due 12/15/04 31,038,080
- ----------------------------------------------------------------------------------------------------------
47,300,136
- ----------------------------------------------------------------------------------------------------------
Finland -- 0.4%
56,000,000 Government of Finland, 9.500% due 3/15/04 12,517,797
- ----------------------------------------------------------------------------------------------------------
Germany -- 5.6%
300,000,000 Deutschland Republic, 6.000% due 7/4/07 169,255,989
- ----------------------------------------------------------------------------------------------------------
Ireland -- 2.8%
55,000,000 Republic of Ireland, 8.000% due 10/18/00 85,461,773
- ----------------------------------------------------------------------------------------------------------
Italy -- 2.4%
Buoni Poliennali Del Tesoro:
40,000,000,000 8.500% due 8/1/99 23,224,222
80,000,000,000 8.500% due 8/1/04 49,877,583
- ----------------------------------------------------------------------------------------------------------
73,101,805
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
16 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Schedule of Investments (continued) July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT+ SECURITY VALUE
==========================================================================================================
<C> <S> <C>
Mexico -- 0.1%
5,000,000 United Mexican States Series B, 6.250% due 12/31/19 $ 4,134,400
7,000,000 United Mexican States Value Recovery Rights, Expire 6/30/03 0
- ----------------------------------------------------------------------------------------------------------
4,134,400
- ----------------------------------------------------------------------------------------------------------
New Zealand -- 1.8%
New Zealand Government:
52,000,000 6.500% due 2/15/00 33,395,851
27,000,000 10.000% due 3/15/02 19,704,147
- ----------------------------------------------------------------------------------------------------------
53,099,998
- ----------------------------------------------------------------------------------------------------------
Spain -- 4.2%
3,150,000,000 European Investment Bank, 11.250% due 3/15/00 23,258,101
Kingdom of Spain:
6,500,000,000 10.250% due 11/30/98 44,651,133
7,840,000,000 10.100% due 2/28/01 58,387,335
- ----------------------------------------------------------------------------------------------------------
126,296,569
- ----------------------------------------------------------------------------------------------------------
Sweden -- 2.1%
500,000,000 Kingdom of Sweden, 5.500% due 4/12/02 62,317,121
- ----------------------------------------------------------------------------------------------------------
Thailand -- 0.1%
50,000,000 ABN AMRO Bank N.V., 9.100% due 8/5/97 1,568,235
- ----------------------------------------------------------------------------------------------------------
Trinidad & Tobago -- 0.1%
2,000,000 Trinidad & Tobago, 11.500% due 11/20/97 2,012,500
- ----------------------------------------------------------------------------------------------------------
United Kingdom -- 5.6%
101,000,000 UK Treasury, 7.250% due 12/7/07 169,573,044
- ----------------------------------------------------------------------------------------------------------
Uruguay -- 0.2%
Uruguay Banco Central:
2,000,000 6.813% due 2/18/07(e) 1,990,000
4,500,000 6.750% due 2/19/21 4,140,000
- ----------------------------------------------------------------------------------------------------------
6,130,000
- ----------------------------------------------------------------------------------------------------------
Venezuela -- 0.1%
Republic of Venezuela:
1,000,000 7.063% due 12/28/98(e) 1,005,000
3,000,000 7.063% due 12/31/03(e) 2,959,800
- ----------------------------------------------------------------------------------------------------------
3,964,800
- ----------------------------------------------------------------------------------------------------------
TOTAL INTERNATIONAL SECTOR
(Cost -- $1,079,584,138) 1,068,864,684
==========================================================================================================
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 17
<PAGE>
================================================================================
Schedule of Investments (continued) July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
==========================================================================================================
<C> <S> <C>
REPURCHASE AGREEMENTS -- 6.8%
$ 99,500,000 CS First Boston Corp., 5.720% due 8/1/97;
Proceeds at maturity -- $99,515,809;
(Fully collateralized by U.S. Treasury Notes, 6.500%
due 5/31/02; Market value -- $101,564,650) $ 99,500,000
105,831,250 Morgan Stanley Inc., 5.550% due 8/5/97;
Proceeds at maturity -- $105,945,459; (Fully
collateralized by the following:
Federal Home Loan Bank, 6.620% due 6/25/02;
Market value -- $50,130,278;
Federal Home Loan Mortgage Corp., 7.861% due 1/1/24;
Market value -- $22,879,710;
Federal National Mortgage Association, 8.250% due 12/1/17;
Market value -- $4,678,818;
Federal National Mortgage Association, 6.072% due 8/1/34;
Market value -- $30,638,412;
Total Market value -- $108,327,218) 105,831,250
- ----------------------------------------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS
(Cost -- $205,331,250) 205,331,250
==========================================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $2,958,029,403*) $3,025,560,107
==========================================================================================================
</TABLE>
(a) Security segregated by Custodian for reverse repurchase agreements.
(b) Security is exempt from registration under Rule 144A of the Securities Act
of 1933. This security may be resold in transactions that are exempt from
registration, normally to qualified institutional buyers.
(c) Security issued with attached warrants.
(d) Non-income producing security.
(e) Variable rate security.
+ Represents local currency.
* Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
18 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Statement of Assets and Liabilities July 31, 1997
================================================================================
<TABLE>
<S> <C>
ASSETS:
Investments, at value (Cost -- $2,958,029,403) $ 3,025,560,107
Dividends and interest receivable 45,204,208
Receivable for securities sold 218,243,122
Receivable for Fund shares sold 8,791,620
Receivable for open forward foreign currency contracts (Note 5) 15,442,779
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets 3,313,241,836
- ------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Payable for securities purchased 306,801,256
Reverse repurchase agreement (Note 7) 105,831,250
Payable to bank 2,721,642
Payable for Fund shares purchased 2,337,276
Investment advisory fees payable 1,100,058
Distribution fees payable 762,147
Administration fees payable 488,915
Payable for open forward foreign currency contracts (Note 5) 336,592
Accrued expenses 1,057,098
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 421,436,234
- ------------------------------------------------------------------------------------------------------------------------------------
Total Net Assets $ 2,891,805,602
====================================================================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 360,434
Capital paid in excess of par value 2,878,690,709
Undistributed net investment income 218
Accumulated net realized loss from security transactions and foreign currencies (68,172,759)
Net unrealized appreciation of investments and foreign currencies 80,927,000
- ------------------------------------------------------------------------------------------------------------------------------------
Total Net Assets $ 2,891,805,602
====================================================================================================================================
Shares Outstanding:
Class A 33,385,804
-------------------------------------------------------------------------------------------------------------------------------
Class B 304,019,071
-------------------------------------------------------------------------------------------------------------------------------
Class C 10,427,596
-------------------------------------------------------------------------------------------------------------------------------
Class Y 10,055,765
-------------------------------------------------------------------------------------------------------------------------------
Class Z 2,545,737
-------------------------------------------------------------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $8.01
-------------------------------------------------------------------------------------------------------------------------------
Class B * $8.03
-------------------------------------------------------------------------------------------------------------------------------
Class C ** $8.01
-------------------------------------------------------------------------------------------------------------------------------
Class Y (and redemption price) $8.00
-------------------------------------------------------------------------------------------------------------------------------
Class Z (and redemption price) $8.01
-------------------------------------------------------------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 4.71% of net asset value per share) $8.39
====================================================================================================================================
</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.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 19
<PAGE>
================================================================================
Statement of Operations For the Year Ended July 31, 1997
================================================================================
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest $ 242,332,249
Dividends 5,810,138
Less: Interest Expense (Note 7) (1,617,709)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Investment Income 246,524,678
- ------------------------------------------------------------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 2) 19,195,740
Investment advisory fees (Note 2) 12,546,980
Administration fees (Note 2) 5,576,436
Shareholder and system servicing fees 2,001,419
Custody 597,813
Registration fees 149,725
Shareholder communications 95,901
Audit and legal 44,367
Trustees' fees 28,044
Pricing service fees 26,324
Other 66,106
- ------------------------------------------------------------------------------------------------------------------------------------
Total Expenses 40,328,855
- ------------------------------------------------------------------------------------------------------------------------------------
Net Investment Income 206,195,823
- ------------------------------------------------------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
AND FOREIGN CURRENCIES (NOTES 3 AND 5):
Realized Gain From:
Security transactions (excluding short-term securities) 46,765,776
Foreign currency transactions 6,655,705
- ------------------------------------------------------------------------------------------------------------------------------------
Net Realized Gain 53,421,481
- ------------------------------------------------------------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments
and Foreign Currencies:
Beginning of year 52,871,839
End of year 80,927,000
- ------------------------------------------------------------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 28,055,161
- ------------------------------------------------------------------------------------------------------------------------------------
Net Gain on Investments and Foreign Currencies 81,476,642
- ------------------------------------------------------------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 287,672,465
====================================================================================================================================
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
20 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Statements of Changes in Net Assets For the Years Ended July 31,
================================================================================
<TABLE>
<CAPTION>
1997 1996
====================================================================================================================================
<S> <C> <C>
OPERATIONS:
Net investment income $ 206,195,823 $ 177,161,540
Net realized gain 53,421,481 14,882,931
Increase in net unrealized appreciation 28,055,161 5,832,962
- ------------------------------------------------------------------------------------------------------------------------------------
Increase in Net Assets From Operations 287,672,465 197,877,433
- ------------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (220,307,575) (192,230,951)
Capital -- (16,857,212)
- ------------------------------------------------------------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (220,307,575) (209,088,163)
- ------------------------------------------------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 9):
Net proceeds from sale of shares 561,402,817 480,703,999
Net asset value of shares issued for
reinvestment of dividends 118,710,947 117,096,917
Cost of shares reacquired (523,282,497) (490,087,798)
- ------------------------------------------------------------------------------------------------------------------------------------
Increase in Net Assets From
Fund Share Transactions 156,831,267 107,713,118
- ------------------------------------------------------------------------------------------------------------------------------------
Increase in Net Assets 224,196,157 96,502,388
NET ASSETS:
Beginning of year 2,667,609,445 2,571,107,057
- ------------------------------------------------------------------------------------------------------------------------------------
End of year* $ 2,891,805,602 $ 2,667,609,445
====================================================================================================================================
* Includes undistributed net investment income of: $218 $1,045,741
====================================================================================================================================
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 21
<PAGE>
================================================================================
Notes to Financial Statements
================================================================================
1. Significant Accounting Policies
The Smith Barney Diversified Strategic 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 this 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 except
for the Smith Barney Premium Total Return Fund which will have an annual report
dated December 31, 1997.
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 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 value; (d) dividend income is recorded on ex-dividend date; foreign
dividends are recorded on the ex-dividend date or as soon as practical after the
Fund determines the existence of a dividend declaration after exercising
reasonable due diligence; (e) interest income, adjusted for accretion of
original issue discount, is recorded on an accrual basis; (f) gains or losses on
the sale of securities are calculated by using the specific identification
method; (g) dividends and distributions to shareholders are recorded on the
ex-dividend date; (h) 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 or expense
amounts recorded and collected or paid are adjusted when reported by the
custodian bank; (i) direct expenses are charged to each class; management fees
and general fund expenses are allocated on the basis of relative net assets; (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; (k) 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, 1997, reclassifications are made to the Fund'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 $6,919,973 has been reclassified to
paid-in capital. Net investment income, net realized gains and net assets were
not affected by this change; and (l) estimates and assumptions are required to
be made regarding assets, liabilities and changes in net assets resulting from
operations when financial statements
- --------------------------------------------------------------------------------
22 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
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. From its fee, SBMFM pays Global Capital
Management a sub-advisory fee calculated at an annual rate of 0.10% of the
Fund's 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, 1997, SB received sales charges of approximately $983,000 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 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 certain cases, 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, 1997, CDSCs paid to SB were:
<TABLE>
<CAPTION>
Class A Class B Class C
================================================================================
<S> <C> <C> <C>
CDSCs $6,000 $2,858,000 $26,000
================================================================================
</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 for each respective class. The Fund also pays a distribution
fee with respect to Class B and C shares calculated at the annual rates of 0.50%
and 0.45% of the average daily net assets of each class, respectively. For the
year ended July 31, 1997, total Distribution Plan fees incurred were:
<TABLE>
<CAPTION>
Class A Class B Class C
================================================================================
<S> <C> <C> <C>
Distribution Plan Fees $587,402 $18,181,189 $427,149
================================================================================
</TABLE>
All officers and one Trustee of the Trust are employees of SB.
3. Investments
During the year ended July 31, 1997, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
<TABLE>
================================================================================
<S> <C>
Purchases $2,482,189,703
- --------------------------------------------------------------------------------
Sales 2,298,525,057
================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 23
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
At July 31, 1997, the aggregate gross unrealized appreciation and depreciation
of investments for Federal income tax purposes were substantially as follows:
<TABLE>
================================================================================
<S> <C>
Gross unrealized appreciation $121,822,280
Gross unrealized depreciation (54,291,576)
- --------------------------------------------------------------------------------
Net unrealized appreciation $ 67,530,704
================================================================================
</TABLE>
4. Capital Loss Carryforward
At July 31, 1997, the Fund had, for Federal tax purposes, approximately
$64,213,000 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>
<CAPTION>
2004
================================================================================
<S> <C>
Carryforward Amounts $ 64,213,000
================================================================================
</TABLE>
5. Forward Foreign Currency Contracts
At July 31, 1997, 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:
Australian Dollar 65,000,000 $ 48,446,342 8/18/97 $ (336,592)
Danish Krone 330,000,000 47,201,319 8/18/97 1,203,521
German Deutschemark 310,000,000 168,984,572 8/18/97 4,296,591
Irish Punt 60,600,000 88,201,032 8/18/97 3,074,688
Italian Lira 128,000,000,000 71,391,919 8/18/97 2,041,314
Spanish Peseta 20,000,000,000 128,981,581 8/18/97 3,459,979
Swedish Krona 500,000,000 62,830,015 8/18/97 1,354,838
- ------------------------------------------------------------------------------------------------------------------------------------
15,094,339
- ------------------------------------------------------------------------------------------------------------------------------------
To Buy:
Canadian Dollar 46,440,937 33,601,416 8/1/97 11,848
- ------------------------------------------------------------------------------------------------------------------------------------
Net Unrealized Gain on Forward
Foreign Currency Contracts $ 15,106,187
====================================================================================================================================
</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.
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 securi-
- --------------------------------------------------------------------------------
24 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
ties. 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, 1997, the Fund had the following reverse repurchase agreement
outstanding:
<TABLE>
<CAPTION>
Face
Amount Security Value
====================================================================================================================================
<S> <C> <C>
$105,831,250 Reverse Repurchase Agreement with Morgan Stanley,
dated 7/29/97 bearing 4.80% to be repurchased at
$105,930,026 on 8/5/97, collateralized by
U.S. Treasury Note, 6.250% due 2/15/07 $105,831,250
====================================================================================================================================
</TABLE>
During the year ended July 31, 1997, the maximum and average amount of reverse
repurchase agreements outstanding were as follows:
<TABLE>
================================================================================
<S> <C>
Maximum amount outstanding $193,943,750
- --------------------------------------------------------------------------------
Average amount outstanding 176,716,477
================================================================================
</TABLE>
Interest rates ranged from 3.65% to 5.05% during the year. Total value of the
collateral for the reverse repurchase agreement is $106,977,223.
Interest expense for the year ended July 31, 1997 on borrowings by the Fund
under reverse repurchase agreements totalled $1,617,709.
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.
At July 31, 1997, the Fund held no TBA securities.
9. Shares of Beneficial Interest
At July 31, 1997, 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, 1997, 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 $259,802,519 $2,437,581,311 $81,923,949 $79,515,941 $20,227,423
====================================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 25
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
July 31, 1997 July 31, 1996*
--------------------------------------- --------------------------------------
Shares Amount Shares Amount
====================================================================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 13,256,070 $ 105,627,582 10,064,712 $ 79,242,075
Shares issued on
reinvestment 1,415,052 11,233,913 1,195,005 9,395,484
Shares redeemed (7,215,639) (57,534,430) (7,912,833) (62,199,723)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Increase 7,455,483 $ 59,327,065 3,346,884 $ 26,437,836
====================================================================================================================================
Class B
Shares sold 44,187,260 $ 352,736,728 42,794,620 $ 338,212,178
Shares issued on
reinvestment 12,856,077 102,306,573 13,269,424 104,516,969
Shares redeemed (56,866,196) (453,930,784) (53,265,139) (420,311,482)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Increase 177,141 $ 1,112,517 2,798,905 $ 22,417,665
====================================================================================================================================
Class C
Shares sold 5,723,599 $ 45,618,957 4,096,751 $ 32,284,568
Shares issued on
reinvestment 449,137 3,565,931 217,477 1,708,186
Shares redeemed (1,148,289) (9,138,226) (534,146) (4,194,091)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Increase 5,024,447 $ 40,046,662 3,780,082 $ 29,798,663
====================================================================================================================================
Class Y
Shares sold 6,772,038 $ 53,896,925 3,547,674 $ 27,875,262
Shares issued on
reinvestment 4,050 32,008 19,630 154,747
Shares redeemed (166,214) (1,305,484) (121,413) (955,401)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Increase 6,609,874 $ 52,623,449 3,445,891 $ 27,074,608
====================================================================================================================================
Class Z
Shares sold 440,488 $ 3,522,625 391,370 $ 3,089,916
Shares issued on
reinvestment 198,007 1,572,522 168,060 1,321,531
Shares redeemed (173,274) (1,373,573) (308,090) (2,427,101)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Increase 465,221 $ 3,721,574 251,340 $ 1,984,346
====================================================================================================================================
</TABLE>
* Transactions for Class Y shares are for the period from October 10, 1995
(inception date) to July 31, 1996
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.
- --------------------------------------------------------------------------------
26 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Financial Highlights
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1997 1996 1995 1994 1993(1)
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $7.82 $7.85 $7.76 $8.41 $8.24
- ------------------------------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income(2) 0.62 0.61 0.94 0.63 0.47
Net realized and unrealized gain (loss) 0.24 0.03 (0.18) (0.52) 0.27
- ------------------------------------------------------------------------------------------------------------------------------------
Total Income From Operations 0.86 0.64 0.76 0.11 0.74
- ------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.67) (0.62) (0.48) (0.62) (0.45)
Net realized gains -- -- (0.10) (0.12)
Capital -- (0.05) (0.19) (0.04) --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.67) (0.67) (0.67) (0.76) (0.57)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $8.01 $7.82 $7.85 $7.76 $8.41
- ------------------------------------------------------------------------------------------------------------------------------------
Total Return 11.36% 8.39% 10.35% 1.16% 9.30%++
- ------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $267,272 $202,700 $177,336 $76,019 $48,334
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses(2) 1.03% 1.04% 1.09% 1.10% 1.10%+
Net investment income 7.75 7.85 8.15 7.67 8.26+
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 85% 90% 83% 93% 116%
====================================================================================================================================
</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>
* 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.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 27
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class B Shares 1997 1996 1995 1994 1993
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $7.83 $7.86 $7.76 $8.41 $8.55
- ------------------------------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income(1) 0.59 0.58 0.70 0.59 0.65
Net realized and unrealized gain (loss) 0.23 0.01 0.02 (0.51) (0.07)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Income From Operations 0.82 0.59 0.72 0.08 0.58
- ------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.62) (0.57) (0.44) (0.60) (0.58)
Net realized gains -- -- (0.10) (0.14)
Capital -- (0.05) (0.18) (0.03) --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.62) (0.62) (0.62) (0.73) (0.72)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $8.03 $7.83 $7.86 $7.76 $8.41
- ------------------------------------------------------------------------------------------------------------------------------------
Total Return 10.89% 7.80% 10.00% 0.66% 7.28%
- ------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (millions) $2,440 $2,380 $2,367 $2,469 $2,105
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses(1) 1.51% 1.52% 1.56% 1.57% 1.59%
Net investment income 7.34 7.36 6.82 7.20 7.77
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 85% 90% 83% 93% 116%
====================================================================================================================================
</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 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 B $0.00* $0.00* 1.61% 1.59%
</TABLE>
* Amount represents less than $0.01 per share.
- --------------------------------------------------------------------------------
28 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class C Shares 1997 1996 1995(1) 1994 1993(2)
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $7.81 $7.84 $7.76 $8.41 $8.36
- ------------------------------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income(3) 0.58 0.52 1.16 0.55 0.22
Net realized and unrealized gain (loss) 0.24 0.07 (0.46) (0.47) 0.06
- ------------------------------------------------------------------------------------------------------------------------------------
Total Income From Operations 0.82 0.59 0.70 0.08 0.28
- ------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.62) (0.57) (0.44) (0.60) (0.20)
Net realized gains -- -- (0.10) (0.03)
Capital -- (0.05) (0.18) (0.03) --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.62) (0.62) (0.62) (0.73) (0.23)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $8.01 $7.81 $7.84 $7.76 $8.41
- ------------------------------------------------------------------------------------------------------------------------------------
Total Return 10.92% 7.82% 9.73% 0.66% 3.41%++
- ------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $83,543 $42,222 $12,730 $1,065 $11
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses(3) 1.46% 1.47% 1.46% 1.57% 1.50%+
Net investment income 7.19 7.61 10.23 7.20 7.87+
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 85% 90% 83% 93% 116%
====================================================================================================================================
</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:
<TABLE>
<CAPTION>
Per Share Decreases Expense Ratios
in Net Investment Income Without Fee Waivers
------------------------ --------------------
1995 1994 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
Class C $0.00* $0.00* 1.51% 1.58%
</TABLE>
* 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.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 29
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class Y Shares 1997 1996(1)
================================================================================
<S> <C> <C>
Net Asset Value, Beginning of Year $7.82 $7.89
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.64 0.50
Net realized and unrealized gain 0.24 0.01
- --------------------------------------------------------------------------------
Total Income From Operations 0.88 0.51
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.70) (0.53)
Capital -- (0.05)
- --------------------------------------------------------------------------------
Total Distributions (0.70) (0.58)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $8.00 $7.82
- --------------------------------------------------------------------------------
Total Return 11.64% 6.65%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $80,479 $26,940
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.70% 0.69%+
Net investment income 7.84 8.54+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 85% 90%
================================================================================
</TABLE>
(1) For the period from October 10, 1995 (inception date) to July 31, 1996.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
- --------------------------------------------------------------------------------
30 1997 Annual Report to Shareholders
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class Z Shares 1997 1996 1995(1) 1994 1993(2)
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $7.82 $7.85 $7.76 $8.41 $8.24
- ------------------------------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income(3) 0.65 0.64 0.84 0.68 0.51
Net realized and unrealized gain (loss) 0.23 0.02 (0.06) (0.54) 0.25
- ------------------------------------------------------------------------------------------------------------------------------------
Total Income From Operations 0.88 0.66 0.78 0.14 0.76
- ------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.69) (0.63) (0.49) (0.65) (0.47)
Net realized gains -- -- -- (0.10) (0.12)
Capital -- (0.06) (0.20) (0.04) --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.69) (0.69) (0.69) (0.79) (0.59)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $8.01 $7.82 $7.85 $7.76 $8.41
- ------------------------------------------------------------------------------------------------------------------------------------
Total Return 11.69% 8.72% 10.94% 1.43% 9.47%++
- ------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $20,397 $16,270 $14,361 $11,552 $11,803
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses(3) 0.69% 0.70% 0.75% 0.75% 0.80%+
Net investment income 8.08 8.19 8.30 8.02 8.56+
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 85% 90% 83% 93% 116%
====================================================================================================================================
</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>
* 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.
================================================================================
Tax Information (unaudited)
================================================================================
A total of 2.71% of the ordinary dividends paid by the Fund have been
derived from Federal obligations and may be exempt from taxation at the state
level.
- --------------------------------------------------------------------------------
Smith Barney Diversified Strategic Income Fund 31
<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, 1997, the related statement of
operations for the year then ended, the statements of changes in net assets for
each of the years in the two-year period then ended, and financial highlights
for each of the years in the three-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 two-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, 1997, by correspondence with the custodian. As to securities purchased and
sold but not received and delivered, 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, 1997, the results of its operations for the year then ended, the changes in
its net assets for each of the years in the two-year period then ended and the
financial highlights for each of the years in the three-year period then ended,
in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
September 15, 1997
- --------------------------------------------------------------------------------
32 1997 Annual Report to Shareholders
<PAGE>
SMITH BARNEY
DIVERSIFIED STRATEGIC
INCOME FUND
Trustees Investment Adviser
Lee Abraham Smith Barney Mutual Funds Management Inc.
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon, Chairman Distributor
Smith Barney Inc.
Officers
Heath B. McLendon
Investment Officer
Lewis E. Daidone Custodian
Senior Vice President and Treasurer The Chase Manhattan Bank
James E. Conroy
Vice President and Investment Officer Shareholder Servicing Agent
First Data Investor Services Group, Inc.
John C. Bianchi P.O. Box 9134
Vice President and Investment Officer Boston, MA 02205-9134
Simon Hildreth
Vice President and Investment Officer
This report is for the information of
Irving P. David shareholders of Smith Barney Diversified
Controller Strategic Income Fund, but it may also be
used as sales literature when preceded or
Christina T. Sydor accompanied by the current prospectus,
Secretary which gives details about charges,
expenses, investment objectives and
operating policies of the Fund. If used
as sales material after September 30,
1997, this report must be accompanied by
performance information for the most
recently completed calendar quarter.
SMITH BARNEY
----------------------------------------
A Member of TravelersGroup [LOGO]
SMITH BARNEY DIVERSIFIED STRATEGIC
INCOME FUND
Smith Barney Mutual Funds
388 Greenwich Street
New York, New York 10013
FD01184 9/97
<PAGE>
ANNUAL REPORT
1997
1997
1997
1997
1997
[GRAPHIC]
SMITH BARNEY
UTILITIES FUND
- ---------------------------------------------
July 31, 1997
[LOGO] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
- --------------------------------------------------------------------------------
Smith Barney Utilities Fund
- --------------------------------------------------------------------------------
Dear Shareholder:
We are pleased to provide the annual report for the Smith Barney Utilities Fund
("Fund") for the year ended July 31, 1997. 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.
Fund Performance
The Fund seeks 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. The Fund distributed income dividends totaling
$0.82 and a capital gain distribution of $0.32 per share for Class A shares over
the past year. As of July 31, 1997, the annualized distribution rate was 5.25%
based on the current income dividend of $0.068 per Class A share and the Fund's
Class A net asset value of $15.53. For the year ended July 31, 1997, the Fund's
Class A shares had a total return of 15.48% versus its Lipper peer group average
total return of 22.50%. (Lipper Analytical Services, Inc. is an independent
fund-tracking organization.) The Fund's underperformance versus its Lipper peer
group average was caused primarily by its emphasis on providing shareholders
with current income and is in keeping with its primary investment objective.
Other utility funds in the category tend to have a more total-return
orientation.
The Fund generally has a higher weighting in bonds than other utilities funds in
its category. The Fund's higher concentration in bonds has enabled it to provide
a relatively higher current yield to shareholders over the longer term.
Market and Economic Overview
Since the beginning of 1997, the U.S. economy has exhibited strong growth
characterized by improving worker productivity, yet with little or no signs of
higher inflation. Bond investors have benefited from a favorable Federal Reserve
Board monetary policy and economic data that has calmed most investor fears of
renewed inflation. The yield on the benchmark 30-year U.S. Treasury bond, which
stood at 6.64% on December 31, 1996, declined to 6.30% on July 31, 1997. The
yield on the 10-year U.S. Treasury note declined to 6.01% on July 31, 1997 from
6.42% at the end of 1996.
Our outlook for the stock market over the next six months is positive but with a
bit of cautious optimism following the dramatic rise in stock prices and with
equity valuation levels close to their historic highs. Inflation should remain
stable, but we may see some upward pressure on wages and we do expect
1
<PAGE>
increased market volatility. The recently announced balanced budget agreement
and passage of the new tax reform legislation in Washington, D.C. have been
favorable for most stock and bond investors. Since a correction in the stock
market is possible, this may be an opportune time for investors to rebalance
their portfolios to determine if their current asset allocation still meets
their investment objectives and tolerance for risk.
Industry Overview
As utilities are beginning to lose their natural monopoly status and protected
franchises and enter a new era of competition, the electric utility industry is
in a period of transition. The cost of electric power and the desire of
consumers to choose their energy suppliers are at the forefront of the
industry's evolution. Market forces, regulatory changes and political pressures
are reshaping the electric utility industry in much the same way as it has and
continues to affect the natural gas and telecommunications industries. For both
utility management teams and investors these changes represent new risks and new
opportunities. Innovative utilities must design new business strategies to deal
with regulatory changes in order to grow their businesses. Other companies may
follow a strategy of merging with other electric utilities or natural gas
companies to achieve greater economies-of-scale from serving more customers.
Utility monopolies are no longer necessary to ensure the delivery of reliable
electric service. This fundamental change in the utility industry will require a
shift from a cost-of-service structure to more market-based pricing and the
possible separation of the generation, transmission and distribution aspects of
the business. Clearly, the high-cost electricity provider will face significant
risks. However, despite these risks, there will always be business opportunities
because utilities will continue to provide essential services to consumers.
Someone will always be willing to produce electricity, sell it and make a
profit.
The continuing deregulation of the electric power generation market area will
probably result in increased earnings volatility as some companies will leave
the generation business and become pure transmission and distribution companies.
This will provide additional investment alternatives as the generation business
will be commodity-priced based with high volatility and high potential returns
while the distribution sector will be less volatile while providing a higher
current yield. We expect above-average volatility and earnings growth for those
companies with a larger percentage of their assets in non-regulated domestic or
foreign-based projects. In our view, domestic-based companies that focus on
regulated transmission and distribution services should offer investors greater
earnings stability and modest dividend growth in their service territory.
2
<PAGE>
Electric utility stock prices continue to be influenced by the direction of
interest rates. However, as the competitive evolution continues in the industry
and dividends growth slows, the industry's correlation to interest rates will
lessen. Industry analysts are now beginning to introduce additional valuation
models based on cash flow, economic value added, intrinsic value and other
value-based methodologies. These valuation tools will supplement interest rate
analysis, price-to-book valuations and dividend payout ratio studies and help
investment professionals to select the best total return opportunities from
utilities in the years ahead.
The utility industry is moving toward issuing asset-backed securities (ABS) as a
method for recovering all or part of their investments in high-cost generating
assets that would be uneconomic in a fully competitive environment. The detailed
structure may differ among individual states, but these bonds will be backed by
the statutory right to recover "stranded costs" through a surcharge on customers
electric bills. (Stranded costs are investments that utilities are at risk of
not recovering in a competitive environment.) The proceeds from these issues
will be used to reduce outstanding debt and should help to improve the balance
sheets of utilities.
Investment Strategy
As noted, the Fund's investment objective is current income and long term
capital appreciation through solid fundamental analysis that seeks to identify
attractive market valuations. The combination of stocks and bonds in the Fund's
portfolio has enabled it to provide the high current yield potential from bonds
as well as the additional income and long-term capital growth from stocks. As of
July 31, 1997, the Fund's portfolio mix was approximately 60% common stocks and
40% long term investment grade bonds. The Fund's ratio of stocks and bonds has
remained unchanged from our previous report, as the yield relationship between
utility stocks and bonds has remained relatively stable.
The common stock portion of the portfolio is a combination of growth-oriented
electric and gas companies combined with income-oriented issues and special
situations that we think are currently undervalued based on our projected
outcome of regulatory developments. Our goal is to continually increase the
Fund's growth component with a focus on total investment return. We favor those
companies that are lower cost producers of electricity and have a clearly
defined management strategy to grow in a more competitive environment.
Since our last report, we have initiated new positions or added to our existing
positions in the following companies because of their favorable valuations and
attractive growth prospects: Baltimore Gas & Electric Co., Bell Atlantic Corp.,
3
<PAGE>
KN Energy Inc. and MCN Energy Corp. The successful merger of Duke Power & Light
and Panenergy Corp. resulted in us owning Duke Energy Corp., a high-quality
company focused on long-term growth. We have reduced or eliminated our holdings
in select utilities because of their unattractive market valuations. These
companies include Pennsylvania Power & Light, Entergy Corp., U.S. West Media
Group, Houston Industries, Kansas City Power & Light and DTE Energy Co.
In the bond portion of the Fund, we have continued to focus on investment-grade
utility bonds. Recent portfolio changes have included an increase in our
holdings of telecommunication issues reflecting favorable price levels and a
reduction in electric utility issues that we believed were fully valued or faced
additional regulatory uncertainty.
Outlook
The changes occurring within the electric utility industry will result in a more
efficient and competitive industry truly benefiting customers and offering more
choices. Moreover, utility investors will also have new choices and access to
new investment opportunities.
On a more somber note, we were saddened by the untimely loss of two outstanding
business leaders and Trustees of the Fund, Antoinette C. Bentley and Madelon De
Voe Talley. Their knowledge and wisdom will be missed.
In closing, thank you for your investment 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 Vice President and
Investment Officer
August 25, 1997
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>
7/31/97 $14.51 $15.53 $0.82 $0.32 $0.00 15.48%
- --------------------------------------------------------------------------------
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 $3.93 $1.03 $0.02
================================================================================
</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>
7/31/97 $14.51 $15.52 $0.75 $0.32 $0.00 14.88%
- --------------------------------------------------------------------------------
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 $7.37 $1.66 $0.06
================================================================================
</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>
7/31/97 $14.51 $15.53 $0.75 $0.32 $0.00 15.01%
- --------------------------------------------------------------------------------
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 $3.40 $0.92 $0.02
================================================================================
</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>
7/31/97 $14.52 $15.56 $0.85 $0.32 $0.00 15.88%
- --------------------------------------------------------------------------------
Inception*
-7/31/96 14.88 14.52 0.71 0.00 0.00 2.28+
================================================================================
Total $1.56 $0.32 $0.00
================================================================================
</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>
7/31/97 $14.52 $15.55 $0.85 $0.32 $0.00 15.81%
- --------------------------------------------------------------------------------
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 $4.10 $1.04 $0.02
================================================================================
</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 7/31/97 15.48% 14.88% 15.01% 15.88% 15.81%
- --------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 7.87 N/A N/A N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/97 9.25 10.21 7.40 9.83 9.56
================================================================================
<CAPTION>
With Sales Charge(2)
---------------------------------------------
Class A Class B Class C Class Y Class Z
================================================================================
<S> <C> <C> <C> <C> <C>
Year Ended 7/31/97 9.73% 9.88% 14.01% 15.88% 15.81%
- --------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 7.72 N/A N/A N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/97 8.07 10.21 7.40 9.83 9.56
================================================================================
</TABLE>
6
<PAGE>
================================================================================
Cumulative Total Return
================================================================================
<TABLE>
<CAPTION>
Without Sales Charge(1)
================================================================================
<S> <C>
Class A (Inception* through 7/31/97) 52.04%
- --------------------------------------------------------------------------------
Class B (Inception* through 7/31/97) 148.20
- --------------------------------------------------------------------------------
Class C (Inception* through 7/31/97) 37.77
- --------------------------------------------------------------------------------
Class Y (Inception* through 7/31/97) 18.51
- --------------------------------------------------------------------------------
Class Z (Inception* through 7/31/97) 54.08
================================================================================
</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>
================================================================================
Historical Performance (unaudited)
================================================================================
Growth of $10,000 Invested in Class B Shares of
the Smith Barney Utilities Fund vs.
Standard & Poor's 500 Index and Lipper Utilities Fund Average+
- --------------------------------------------------------------------------------
March 1988 -- July 1997
[THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.]
<TABLE>
<CAPTION>
Smith Barney Lipper Utilities Standard & Poor's
Utilities Fund Fund Average 500 Index
-------------- ------------ ---------
<S> <C> <C> <C>
3/28/88 $10,000 $10,000 $10,000
7/88 10,208 10,476 10,624
7/89 12,210 13,180 14,012
7/90 12,785 13,670 14,923
7/91 14,362 14,948 16,822
7/92 16,997 17,917 18,970
7/93 19,494 21,008 20,624
7/94 17,636 19,744 21,685
7/95 19,861 21,745 27,338
7/96 21,605 24,239 31,864
7/31/97 23,315 29,744 48,468
</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, 1997. The Standard &
Poor's 500 Index is 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 (30 funds as of July 31, 1997) 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>
================================================================================
Portfolio Highlights July 31, 1997
================================================================================
Portfolio Breakdown
[THE FOLLOWING TABLE WAS REPRESENTED BY A PIE CHART IN THE PRINTED MATERIAL.]
Electric & Gas 80.5%
Telephone 19.5%
<TABLE>
<CAPTION>
Percentage of
Company Total Investments
================================================================================
<S> <C>
Top Five Equity Holdings
FPL Group, Inc. 5.1%
American Electric Power Co. 3.7
Nipsco Inc. 3.4
Cinergy Corp. 3.3
Texas Utilities Co. 3.2
Top Five Bond Holdings
Utilicorp United, Inc. 3.1
Hydro-Quebec 3.0
GTE Corp. 2.9
MCI Communications Corp. 2.8
Pacific Bell 2.5
================================================================================
</TABLE>
9
<PAGE>
================================================================================
Schedule of Investments July 31, 1997
================================================================================
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
================================================================================
COMMON STOCKS -- 59.7%
================================================================================
Electric & Gas -- 54.9%
<C> <S> <C>
500,000 Allegheny Power System, Inc.+ $ 14,656,250
1,000,000 American Electric Power Co. 44,750,000
750,000 Baltimore Gas & Electric Co. 20,859,375
1,200,000 Cinergy Corp.+ 40,350,000
350,000 Cipsco, Inc. 13,256,250
700,000 Coastal Corp. 38,062,500
500,000 Consolidated Edison Co. of New York, Inc. 15,812,500
500,000 Dominion Resources, Inc. 18,375,000
500,000 DPL, Inc. 12,312,500
500,000 DTE Energy Co. 14,968,750
750,000 Duke Energy Corp.+ 38,015,625
1,400,000 Edison International 35,350,000
250,000 Equitable Resources, Inc. 7,453,125
1,300,000 FPL Group, Inc. 62,237,500
750,000 GPU Inc. 26,015,625
750,000 Houston Industries, Inc. 15,703,125
750,000 Kansas City Power & Light Co. 22,125,000
250,000 KN Energy, Inc. 10,500,000
106,000 MCN Energy Corp. 3,358,875
1,000,000 Nipsco Inc.+ 42,125,000
300,000 Pacific Enterprises 10,031,250
600,000 PacifiCorp. 13,387,500
500,000 Pinnacle West Capital Corp. 15,781,250
800,000 Public Service Co. of Colorado 33,300,000
650,000 SCANA Corp. 16,250,000
500,000 Sierra Pacific Resources 15,968,750
1,000,000 Southern Co. 21,937,500
250,000 Southwest Gas Corp. 4,640,625
1,100,000 Texas Utilities Co. 38,981,250
250,000 Unicom Corp. 5,671,875
- --------------------------------------------------------------------------------
672,237,000
- --------------------------------------------------------------------------------
Telephone -- 4.8%
325,000 Bell Atlantic Corp. 23,582,813
750,000 GTE Corp. 34,875,000
- --------------------------------------------------------------------------------
58,457,813
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost -- $598,568,202) 730,694,813
================================================================================
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
================================================================================
Schedule of Investments (continued) July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
================================================================================
<C> <S> <C>
CORPORATE BONDS AND NOTES -- 40.3%
================================================================================
Electric & Gas -- 25.6%
$15,000,000 Atlantic City Electric Co., 7.000% due 8/1/28 $ 14,362,500
14,000,000 BellSouth Capital Funding, 7.120% due 7/15/2097 14,402,500
30,000,000 BellSouth Telecommunications Corp., 7.000%
due 12/1/2095 30,562,500
2,000,000 Citizens Utilities Co., 7.000% due 11/1/25 2,022,500
Coastal Corp.:
10,000,000 7.750% due 10/15/35 10,712,500
3,500,000 7.420% due 2/15/37 3,609,375
22,000,000 Columbia Gas Systems, Inc., 7.620% due 11/28/25 22,495,000
3,000,000 Duquesne Light Co., 7.625% due 4/15/23 3,060,000
12,000,000 Equitable Resources, Inc., 7.750% due 7/15/26 13,080,000
8,000,000 Gulf Power Co., 6.875% due 1/1/26 7,880,000
Hydro-Quebec:
20,000,000 8.250% due 1/15/27 22,675,000
12,500,000 8.625% due 6/15/29 14,656,250
13,000,000 Illinois Power Co., 7.500% due 7/15/25 12,935,000
5,000,000 Louisiana Power & Light Co., 8.750% due 3/1/26 5,500,000
17,000,000 Mississippi Power & Light Co., 8.650% due 1/15/23 18,147,500
New York State Electric & Gas Co.:
11,750,000 8.300% due 12/15/22 12,293,438
2,250,000 7.450% due 7/15/23 2,230,312
2,000,000 Northern States Power Co., 7.375% due 12/1/26 2,072,500
4,250,000 Pacific Gas & Electric Co., 6.750% due 10/1/23 4,106,562
10,000,000 Pacific Gas Transmission, 7.800% due 6/1/25 10,600,000
4,000,000 PacifiCorp, 6.710% due 6/15/26 3,795,000
3,100,000 Pennsylvania Power & Light Co., 6.750% due 10/1/23 2,964,375
7,000,000 Public Service Electric & Gas Co., 9.250%
due 6/1/21 8,715,000
16,000,000 South West Gas, 8.000% due 8/1/26 17,280,000
Southwestern Bell:
5,000,000 6.625% due 9/1/24 4,668,750
5,000,000 7.200% due 10/15/26 5,043,750
5,000,000 Tennessee Valley Authority, 7.625% due 4/1/37 5,312,500
Utilicorp United, Inc.:
23,000,000 9.000% due 11/15/21 24,955,000
13,000,000 8.000% due 3/1/23 13,585,000
- --------------------------------------------------------------------------------
313,722,812
- --------------------------------------------------------------------------------
Telephone -- 14.7%
Century Telephone Enterprises, Inc.:
15,000,000 8.250% due 5/1/24 16,087,500
13,000,000 7.200% due 12/1/25 13,000,000
GTE Corp.:
5,000,000 8.750% due 11/1/21 5,943,750
10,000,000 7.830% due 5/1/23 10,525,000
17,500,000 7.900% due 2/1/27 18,725,000
6,000,000 GTE Northwest, 7.875% due 6/1/26 6,420,000
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
================================================================================
Schedule of Investments (continued) July 31, 1997
================================================================================
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
================================================================================
<C> <S> <C>
Telephone -- 14.7% (continued)
MCI Communications Corp.:
$ 8,000,000 7.750% due 3/15/24 $ 8,340,000
25,000,000 7.750% due 3/23/25 26,093,750
20,000,000 NY Telephone, 7.000% due 8/15/25 19,550,000
Pacific Bell:
5,000,000 7.500% due 2/1/33 5,106,250
25,000,000 7.375% due 7/15/43 25,781,250
26,500,000 US West Communications Group, 6.875% due 9/15/33 24,976,250
- --------------------------------------------------------------------------------
180,548,750
- --------------------------------------------------------------------------------
TOTAL CORPORATE BONDS AND NOTES
(Cost -- $467,605,286) 494,271,562
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $1,066,173,488*) $1,224,966,375
================================================================================
</TABLE>
+ A portion of this security issue is on loan (See Note 5).
* 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, 1997
================================================================================
<TABLE>
<S> <C>
ASSETS:
Investments, at value (Cost -- $1,066,173,488) $1,224,966,375
Cash equivalents (Note 5) 29,993,400
Receivable for securities sold 27,126,731
Dividends and interest receivable 11,010,559
Receivable for Fund shares sold 493,121
- --------------------------------------------------------------------------------
Total Assets 1,293,590,186
- --------------------------------------------------------------------------------
LIABILITIES:
Payable for securities loaned (Note 5) 29,993,400
Payable for securities purchased 10,409,500
Payable to bank 2,366,846
Payable for Fund shares purchased 2,194,393
Investment advisory fees payable 466,775
Distribution fees payable 268,384
Administration fees payable 207,485
Accrued expenses 261,962
- --------------------------------------------------------------------------------
Total Liabilities 46,168,745
- --------------------------------------------------------------------------------
Total Net Assets $1,247,421,441
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 80,348
Capital paid in excess of par value 1,063,987,894
Overdistributed net investment income (3,238)
Accumulated net realized gains on security transactions 24,563,550
Net unrealized appreciation of investments 158,792,887
- --------------------------------------------------------------------------------
Total Net Assets $1,247,421,441
================================================================================
Shares Outstanding:
Class A 16,000,118
-----------------------------------------------------------------------------
Class B 61,280,779
-----------------------------------------------------------------------------
Class C 604,050
-----------------------------------------------------------------------------
Class Y 1,585,529
-----------------------------------------------------------------------------
Class Z 877,888
-----------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $15.53
-----------------------------------------------------------------------------
Class B* $15.52
-----------------------------------------------------------------------------
Class C** $15.53
-----------------------------------------------------------------------------
Class Y (and redemption price) $15.56
-----------------------------------------------------------------------------
Class Z (and redemption price) $15.55
-----------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 5.26% of net asset value per share) $16.35
================================================================================
</TABLE>
* Redemption price is NAV of Class B shares reduced by a 5.00% CDSC if shares
are redeemed less than 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, 1997
================================================================================
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest $ 46,730,900
Dividends 44,390,148
- --------------------------------------------------------------------------------
Total Investment Income 91,121,048
- --------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 2) 9,205,137
Investment advisory fees (Note 2) 6,431,624
Administration fees (Note 2) 2,858,500
Shareholder and system servicing fees 1,352,175
Shareholder communications 188,298
Registration fees 79,782
Custody 58,099
Audit and legal 42,245
Insurance fees 15,522
Trustees' fees 15,002
Other 19,315
- --------------------------------------------------------------------------------
Total Expenses 20,265,699
- --------------------------------------------------------------------------------
Net Investment Income 70,855,349
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN
ON INVESTMENTS (NOTE 3):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 1,107,546,884
Cost of securities sold 1,082,802,474
- --------------------------------------------------------------------------------
Net Realized Gain 24,744,410
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments:
Beginning of year 56,728,484
End of year 158,792,887
- --------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 102,064,403
- --------------------------------------------------------------------------------
Net Gain on Investments 126,808,813
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 197,664,162
================================================================================
</TABLE>
See Notes to Financial Statements.
14
<PAGE>
================================================================================
Statements of Changes in Net Assets For the Years Ended July 31,
================================================================================
<TABLE>
<CAPTION>
1997 1996
=====================================================================================================
<S> <C> <C>
OPERATIONS:
Net investment income $ 70,855,349 $ 92,572,143
Net realized gain 24,744,410 66,480,225
Increase (decrease) in net unrealized appreciation 102,064,403 (3,572,589)
- -----------------------------------------------------------------------------------------------------
Increase in Net Assets From Operations 197,664,162 155,479,779
- -----------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (72,735,428) (90,695,144)
Net realized gains (33,068,047) --
- -----------------------------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions To Shareholders (105,803,475) (90,695,144)
- -----------------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 8):
Net proceeds from sales 91,097,375 184,600,350
Net asset value of shares issued in connection
with the transfer of Smith Barney Funds, Inc.--
Utility Portfolio's net assets (Note 9) -- 77,275,976
Net asset value of shares issued for
reinvestment of dividends 81,248,229 69,393,301
Cost of shares reacquired (626,907,862) (546,072,751)
- -----------------------------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (454,562,258) (214,803,124)
- -----------------------------------------------------------------------------------------------------
Decrease in Net Assets (362,701,571) (150,018,489)
NET ASSETS:
Beginning of year 1,610,123,012 1,760,141,501
- -----------------------------------------------------------------------------------------------------
End of year* $ 1,247,421,441 $ 1,610,123,012
=====================================================================================================
* Includes undistributed (overdistributed)
net investment income of: $(3,238) $1,876,841
=====================================================================================================
</TABLE>
See Notes to Financial Statements.
15
<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 except
for the Smith Barney Premium Total Return Fund which will have an annual report
dated December 31, 1997.
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 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 value; (d) dividend income is
recorded on ex-dividend date and interest income is recorded on an 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 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, 1997, reclassifications were made to the
Fund's capital accounts to reflect permanent book/tax differences and income and
gains available for distributions under income tax regulations. 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.
16
<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 Fund
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, 1997, SB received sales charges of approximately $55,000 on
sales of the Fund's Class A shares and brokerage commissions of $138,150.
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 certain cases, 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 July 31, 1997, CDSCs paid
to SB were approximately:
<TABLE>
<CAPTION>
Class A Class B Class C
================================================================================
<S> <C> <C> <C>
CDSCs $1,000 $2,514,000 $3,000
================================================================================
</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 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, 1997, total Distribution Plan fees incurred were as follows:
<TABLE>
<CAPTION>
Class A Class B Class C
================================================================================
<S> <C> <C> <C>
Distribution Plan Fees $642,471 $8,488,970 $73,696
================================================================================
</TABLE>
All officers and one Trustee of the Trust are employees of SB.
17
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
3. INVESTMENTS
During the year ended July 31, 1997, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $ 625,439,768
- --------------------------------------------------------------------------------
Sales 1,107,546,884
================================================================================
At July 31, 1997, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were approximately
as follows:
================================================================================
Gross unrealized appreciation $ 162,977,590
Gross unrealized depreciation (4,184,703)
- --------------------------------------------------------------------------------
Net unrealized appreciation $ 158,792,887
================================================================================
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. LENDING OF PORTFOLIO SECURITIES
The Fund has an agreement with its custodian whereby the custodian may lend
securities owned by the Fund to brokers, dealers and other financial
organizations. Fees earned by the Fund on securities lending are recorded as
interest income. Loans of securities by the Fund are collateralized by cash,
U.S. government securities or high quality money market instruments that are
maintained at all times in an amount at least equal to the current market value
of the loaned securities, plus a margin depending on the type of securities
loaned. The custodian establishes and maintains the collateral in a segregated
account.
At July 31, 1997, the Fund loaned common stocks having a value of
approximately $29,572,075 and holds the following collateral for loaned
securities:
Security Description Value
================================================================================
First Union National Bank Time Deposit, 5.875% due 8/1/97 $ 2,884,742
Mercantile Bank Time Deposit, 5.844% due 8/1/97 4,425,646
Goldman Sachs Repurchase Agreement, 6.000% due 8/1/97 3,205,967
Goldman Sachs Repurchase Agreement, 5.840% due 8/1/97 5,310,776
Merrill Lynch Repurchase Agreement, 5.840% due 8/1/97 14,166,268
- --------------------------------------------------------------------------------
Total $29,993,400
================================================================================
18
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
6. 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 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.
At July 31, 1997, the Fund had no purchased call or put options
outstanding.
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 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 underlying
security, and the liability related to such option is eliminated. When a written
call option is exercised, the cost of the security sold will be reduced by the
premium originally received. When a written 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 decrease 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.
During the year ended July 31, 1997, the Fund had no written call or put
options outstanding.
19
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
7.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.
At July 31, 1997, the Fund had no open futures contracts.
8. SHARES OF BENEFICIAL INTEREST
At July 31, 1997, 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, 1997, 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 $216,174,101 $801,699,988 $9,171,106 $23,495,450 $13,527,597
=================================================================================================
</TABLE>
20
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
July 31, 1997 July 31, 1996
--------------------------- -----------------------------
Shares Amount Shares Amount
================================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 3,016,148 $ 44,679,765 5,522,642 $ 84,582,536
Net asset value of shares
issued in connection
with the transfer of
Smith Barney Funds,
Inc. - Utility Portfolio's
net assets (Note 9) -- -- 4,473,406 67,910,384
Shares issued on reinvestment 1,035,899 15,419,920 686,576 10,274,588
Shares redeemed (6,396,819) (95,087,891) (4,384,228) (65,447,502)
- ------------------------------------------------------------------------------------------------
Net Increase (Decrease) (2,344,772) $ (34,988,206) 6,298,396 $ 97,320,006
================================================================================================
Class B
Shares sold 1,887,342 $ 28,062,045 5,598,593 $ 83,916,266
Net asset value of shares
issued in connection
with the transfer of
Smith Barney Funds,
Inc. - Utility Portfolio's
net assets (Note 9) -- -- 130,708 1,973,562
Shares issued on reinvestment 4,302,881 64,064,587 3,863,108 57,767,942
Shares redeemed (35,244,383) (522,898,114) (31,436,995) (470,651,907)
- ------------------------------------------------------------------------------------------------
Net Decrease (29,054,160) $(430,771,482) (21,844,586) $(326,994,137)
================================================================================================
Class C
Shares sold 87,875 $ 1,301,475 252,794 $ 3,788,442
Net asset value of shares
issued in connection
with the transfer of
Smith Barney Funds,
Inc. - Utility Portfolio's
net assets (Note 9) -- -- 486,438 7,392,030
Shares issued on reinvestment 43,778 651,412 28,059 421,315
Shares redeemed (316,257) (4,689,386) (258,618) (3,895,440)
- ------------------------------------------------------------------------------------------------
Net Increase (Decrease) (184,604) $ (2,736,499) 508,673 $ 7,706,347
================================================================================================
Class Y
Shares sold 1,061,099 $ 15,727,332 681,967 $ 10,097,754
Shares issued on reinvestment 7 113 4,680 71,463
Shares redeemed (169) (2,436) (162,055) (2,399,434)
- ------------------------------------------------------------------------------------------------
Net Increase 1,060,937 $ 15,725,009 524,592 $ 7,769,783
================================================================================================
Class Z
Shares sold 89,172 $ 1,326,758 147,037 $ 2,215,352
Shares issued on reinvestment 74,689 1,112,197 57,372 857,993
Shares redeemed (285,690) (4,230,035) (247,957) (3,678,468)
- ------------------------------------------------------------------------------------------------
Net Decrease (121,829) $ (1,791,080) (43,548) $ (605,123)
================================================================================================
</TABLE>
21
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
9. 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:
<TABLE>
<CAPTION>
Total Net
Shares Assets of Total Net
Issued by Acquired Assets of
Acquired Portfolio the Fund Portfolio the Fund
===============================================================================
<S> <C> <C> <C>
Utility Portfolio 5,090,552 $77,275,976 $1,917,693,490
===============================================================================
</TABLE>
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.
10. 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.
22
<PAGE>
================================================================================
Financial Highlights
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1997 1996 1995 1994 1993(1)
=====================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $14.51 $14.03 $13.28 $15.97 $14.36
- -------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.80 0.83 0.85 0.56 0.66
Net realized and
unrealized gain (loss) 1.36 0.47 0.82 (1.92) 1.72
- -------------------------------------------------------------------------------------
Total Income (Loss) From Operations 2.16 1.30 1.67 (1.36) 2.38
- -------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.82) (0.82) (0.82) (0.83) (0.64)
Net realized gains (0.32) -- (0.08) (0.50) (0.13)
Capital -- -- (0.02) -- --
- -------------------------------------------------------------------------------------
Total Distributions (1.14) (0.82) (0.92) (1.33) (0.77)
- -------------------------------------------------------------------------------------
Net Asset Value, End of Year $15.53 $14.51 $14.03 $13.28 $15.97
- -------------------------------------------------------------------------------------
Total Return 15.48% 9.21% 13.24% (8.99)% 17.01%++
- -------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $248,439 $266,163 $168,963 $41,458 $53,856
- -------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.06% 1.04% 1.07% 1.07% 1.07%+
Net investment income 5.29 5.55 6.36 5.54 5.67+
- -------------------------------------------------------------------------------------
Portfolio Turnover Rate 45% 58% 36% 28% 37%
- -------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions (2) $0.06 $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.
23
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class B Shares 1997 1996 1995 1994 1993
=====================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $14.51 $14.02 $13.28 $15.97 $14.83
- -------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.73 0.77 0.78 0.75 0.79
Net realized and
unrealized gain (loss) 1.35 0.47 0.82 (2.19) 1.30
- -------------------------------------------------------------------------------------
Total Income (Loss) From Operations 2.08 1.24 1.60 (1.44) 2.09
- -------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.75) (0.75) (0.76) (0.75) (0.80)
Net realized gains (0.32) -- (0.08) (0.50) (0.15)
Capital -- -- (0.02) -- --
- -------------------------------------------------------------------------------------
Total Distributions (1.07) (0.75) (0.86) (1.25) (0.95)
- -------------------------------------------------------------------------------------
Net Asset Value, End of Year $15.52 $14.51 $14.02 $13.28 $15.97
- -------------------------------------------------------------------------------------
Total Return 14.88% 8.78% 12.62% (9.52)% 14.69%
- -------------------------------------------------------------------------------------
Net Assets, End of Year (millions) $951 $1,310 $1,573 $1,823 $2,766
- -------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.52% 1.55% 1.56% 1.54% 1.56%
Net investment income 4.85 5.13 5.82 5.07 5.17
- -------------------------------------------------------------------------------------
Portfolio Turnover Rate 45% 58% 36% 28% 37%
- -------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions (1) $0.06 $0.06 -- -- --
=====================================================================================
</TABLE>
(1) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
24
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class C Shares 1997(1) 1996 1995(2) 1994 1993(3)
=====================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $14.51 $14.02 $13.28 $15.97 $15.17
- -------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.73 0.77 0.78 0.73 0.35
Net realized and unrealized
gain (loss) 1.36 0.47 0.82 (2.17) 0.86
- -------------------------------------------------------------------------------------
Total Income (Loss) From Operations 2.09 1.24 1.60 (1.44) 1.21
- -------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.75) (0.75) (0.76) (0.75) (0.39)
Net realized gains (0.32) -- (0.08) (0.50) (0.02)
Capital -- -- (0.02) -- --
- -------------------------------------------------------------------------------------
Total Distributions (1.07) (0.75) (0.86) (1.25) (0.41)
- -------------------------------------------------------------------------------------
Net Asset Value, End of Year $15.53 $14.51 $14.02 $13.28 $15.97
- -------------------------------------------------------------------------------------
Total Return 15.01% 8.80% 12.62% (9.52)% 8.08%++
- -------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $9,381 $11,441 $3,925 $1,894 $252
- -------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.47% 1.50% 1.51% 1.48% 1.49%+
Net investment income 4.89 5.19 5.77 5.13 5.25+
- -------------------------------------------------------------------------------------
Portfolio Turnover Rate 45% 58% 36% 28% 37%
- -------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions (4) $0.06 $0.06 -- -- --
=====================================================================================
</TABLE>
(1) Per share amounts have been calculated using the monthly average shares
method, rather than the undistributed net investment income method, because
it more accurately reflects the per share data for the period.
(2) On November 7, 1994, the former Class D shares were renamed Class C shares.
(3) For the period from February 4, 1993 (inception date) to July 31, 1993.
(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.
25
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class Y Shares 1997 1996(1)
========================================================================================
<S> <C> <C>
Net Asset Value, Beginning of Year $14.52 $14.88
- ----------------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.83 0.64
Net realized and unrealized gain (loss) 1.38 (0.29)
- ----------------------------------------------------------------------------------------
Total Income From Operations 2.21 0.35
- ----------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.85) (0.71)
Net realized gains (0.32) --
- ----------------------------------------------------------------------------------------
Total Distributions (1.17) (0.71)
- ----------------------------------------------------------------------------------------
Net Asset Value, End of Year $15.56 $14.52
- ----------------------------------------------------------------------------------------
Total Return 15.88% 2.28%++
- ----------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $24,676 $7,617
- ----------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.67% 0.78%+
Net investment income 5.58 5.54+
- ----------------------------------------------------------------------------------------
Portfolio Turnover Rate 45% 58%
- ----------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions $0.06 $0.06
========================================================================================
</TABLE>
(1) For the period from October 9, 1995 (inception date) to July 31, 1996.
++ 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 Z Shares 1997(1) 1996 1995(2) 1994 1993(3)
=====================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $14.52 $14.02 $13.28 $15.97 $14.36
- -------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.83 0.88 0.89 0.89 0.69
Net realized and unrealized
gain (loss) 1.37 0.47 0.82 (2.21) 1.72
- -------------------------------------------------------------------------------------
Total Income (Loss) From Operations 2.20 1.35 1.71 (1.32) 2.41
- -------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.85) (0.85) (0.87) (0.87) (0.66)
Net realized gains (0.32) -- (0.08) (0.50) (0.14)
Capital -- -- (0.02) -- --
- -------------------------------------------------------------------------------------
Total Distributions (1.17) (0.85) (0.97) (1.37) (0.80)
- -------------------------------------------------------------------------------------
Net Asset Value, End of Year $15.55 $14.52 $14.02 $13.28 $15.97
- -------------------------------------------------------------------------------------
Total Return 15.81% 9.62% 13.55% (8.78)% 17.21%++
- -------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $13,654 $14,515 $14,631 $11,372 $22,251
Ratios to Average Net Assets:
Expenses 0.73% 0.78% 0.81% 0.69% 0.68%+
Net investment income 5.63 5.90 6.58 5.92 6.06+
- -------------------------------------------------------------------------------------
Portfolio Turnover Rate 45% 58% 36% 28% 37%
- -------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions (4) $0.06 $0.06 -- -- --
=====================================================================================
</TABLE>
(1) Per share amounts have been calculated using the monthly average shares
method, rather than the undistributed net investment income method, because
it more accurately reflects the per share data for the period.
(2) On November 7, 1994, the former Class C shares were renamed Class Z shares.
(3) For the period from November 6, 1992 (inception date) to July 31, 1993.
(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.
================================================================================
Tax Information (unaudited)
================================================================================
The Fund paid distributions of $32,887,187 from long-term capital gains.
A total of 59.06% of the ordinary dividends paid by the Fund qualified for the
dividends received deduction available to corporate taxpayers.
27
<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, 1997, and the related statement of operations
for the year then ended, the statements of changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the three-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 two-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, 1997, 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 Utilities Fund of Smith Barney Income Funds as of July 31, 1997,
the results of its operations for the year then ended, the changes in its net
assets for each of the years in the two-year period then ended, and the
financial highlights for each of the years in the three-year period then ended,
in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
September 15, 1997
28
<PAGE>
SMITH BARNEY SMITH BARNEY
UTILITIES FUND ---------------------------------
A Member of TravelersGroup [LOGO]
Trustees Investment Adviser
Lee Abraham Smith Barney Mutual Funds
Allan J. Bloostein Management Inc.
Richard E. Hanson, Jr.
Heath B. McLendon Distributor
Smith Barney Inc.
Officers
Heath B. McLendon Custodian
Chairman and PNC Bank, N.A.
Investment Officer
Shareholder
Lewis E. Daidone Servicing Agent
Senior Vice President First Data Investors Services Group, Inc.
and Treasurer P.O. Box 9134
Boston, MA 02205-9134
Jack S. Levande
Vice President and
Investment Officer
Thomas M. Reynolds This report is submitted for the general
Controller information of the shareholders of Smith
Barney Utilities Fund. It is not
Christina T. Sydor authorized for distribution to prospective
Secretary 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 9/97
ANNUAL REPORT
1997
Smith Barney
Exchange Reserve
Fund
July 31, 1997
[LOGO] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
- --------------------------------------------------------------------------------
Smith Barney Exchange Reserve Fund
- --------------------------------------------------------------------------------
Dear Shareholder:
We are pleased to provide the annual report for the Smith Barney Exchange
Reserve Fund ("Fund") for the year ended July 31, 1997. 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.
As of July 31, 1997, the Fund's average annual yield was 4.34% and the average
annual effective yield, which assumes the reinvestment of dividends, was 4.43%.
You should be aware that your investment in the 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 Update and Outlook
In 1996 the U.S. economy continued to perform well, although in an up and down
pattern, and averaged a 3.3% annual rate of growth. However, during the past six
months, the U.S. economy has grown vigorously. Gross Domestic Product, the total
output of goods and services, rose at a 4.9% annual rate in the first quarter of
1997. This comes on the heels of a 3.8% annual rate of growth in the fourth
quarter of 1996. Much of the growth in the first quarter of 1997 came from
higher personal consumption as evidenced by strong motor vehicle and durable
goods sales. High consumer confidence and a low unemployment rate have also
contributed to economic growth during the first half 1997. Absent from the
picture has been any concrete signs of inflation. For the first five months of
1997 consumer prices rose only 1.4%, down from the 3.8% for the comparable
period in 1996. Nevertheless, the Federal Open Market Committee ("FOMC") raised
short-term interest rates by 25 basis points (0.25%) at its meeting in March
1997.
Going forward, we expect economic growth to slow from its current pace. Part of
the growth in the first quarter of 1997 resulted from a buildup in business
inventories, a factor that will actually subtract from growth in future
quarters. Furthermore, reports from auto manufacturers and department stores
indicate that retail sales slowed in the second quarter of 1997. This slowdown
could be the result of temporary factors such as autoworker strikes and April
tax payments. Nevertheless, recently released economic reports gave the Federal
Reserve Board ("Fed") the necessary leeway to leave interest rates unchanged at
their May, July and August meetings while it continues to closely monitor for
any signs of excessive growth and inflationary pressures.
1
<PAGE>
It appears that Fed Chairman Alan Greenspan has adopted a new policy based on
the possibility that we have entered a new economic era. Chairman Greenspan
seems willing to allow faster economic growth because productivity gains are
helping to keep inflation in check. In addition, successful deficit reduction
and real high interest rates (based on our belief that the current rate of
inflation is overstated) have resulted in the Fed pursuing a less restrictive
monetary policy.
We believe the Fed will continue to fine tune monetary policy and there should
be less interest rate volatility in the next several months. If our expectations
are met and barring no inflation (as reflected in recent bond market yield
hovering below 6.5%), we will invest across the yield curve if we identify any
good values. We will target the average maturity of the Fund between 40-50 days.
Investment Strategy
The Fund is 45% invested in top-tier U.S. dollar denominated foreign debt
obligations and 55% in domestic debt obligations. A few split-rated issuers that
we purchased for the Fund's portfolio such as Fleet Financial, GTE and NYNEX
have had their short-term ratings upgraded by several of the nationally
recognized statistical rating organizations. In addition, we have recently added
several high-quality issuers such as Lucent Technologies and Hertz Corporation
to the Fund's portfolio.
On a more somber note, we recently were saddened by the loss of two outstanding
business leaders and Trustees of the Fund, Antoinette C. Bentley and Madelon
DeVoe Talley. Their knowledge and wisdom will be missed.
In closing, thank you for investing in the Smith Barney Exchange Reserve Fund.
We look forward to continuing to help you pursue your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ Phyllis M. Zahorodny
Heath B. McLendon Phyllis M. Zahorodny
Chairman Vice President and
Investment Officer
September 20, 1997
2
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments July 31, 1997
- --------------------------------------------------------------------------------
FACE ANNUALIZED
AMOUNT SECURITY YIELD VALUE
================================================================================
COMMERCIAL PAPER -- 64.1%
$5,000,000 Abbey National PLC matures 8/11/97 5.71% $ 4,992,194
5,000,000 Associates Corp. of North America
matures 8/12/97 5.71 4,991,415
2,000,000 Bank America National Trust Savings
Association matures 8/25/97 5.41 1,992,973
5,000,000 Bear Stearns matures 8/11/97 5.76 4,992,125
6,000,000 Citicorp matures 8/1/97 5.84 6,000,000
5,000,000 Creditanstalt Finance Inc. matures
10/24/97 5.58 4,935,833
3,000,000 Cregem North America matures 8/11/97 5.73 2,995,292
5,000,000 Ford Motor Credit Co. matures 8/6/97 5.70 4,996,097
5,000,000 General Electric Capital Corp.
matures 10/7/97 5.64 4,948,261
5,000,000 General Motors Acceptance Corp.
mature 8/25/97 to 11/7/97 5.48 to 6.00 4,945,363
5,000,000 Generale Bank matures 9/24/97 5.72 4,957,850
3,000,000 Glaxo Holdings PLC matures 10/8/97 5.63 2,968,550
2,000,000 Goldman Sachs matures 10/6/97 5.69 1,979,503
3,000,000 Grand Met Investment Corp. matures
10/30/97 5.62 2,958,600
5,000,000 Lloyds Bank matures 8/22/97 5.61 4,983,812
3,000,000 Merrill Lynch matures 11/20/97 5.85 2,947,460
5,000,000 Morgan Stanley Dean Witter Discover
& Co. matures 8/22/97 5.61 4,983,783
5,000,000 San Paolo Finance Inc. mature 9/24/97
to 1/5/98 5.77 4,925,911
1,951,000 Transamerica Finance Corp. matures
8/21/97 5.80 1,944,811
- --------------------------------------------------------------------------------
TOTAL COMMERCIAL PAPER
(Cost -- $78,439,833) 78,439,833
================================================================================
DOMESTIC BANK OBLIGATIONS -- 4.9%
3,000,000 FCC National matures 8/4/97 5.71 3,000,000
3,000,000 First Union National Bank matures
1/12/98 5.70 3,000,000
- --------------------------------------------------------------------------------
TOTAL DOMESTIC BANK OBLIGATIONS
(Cost -- $6,000,000) 6,000,000
================================================================================
FOREIGN CERTIFICATES OF DEPOSIT -- 12.7%
5,000,000 Bank of Nova Scotia matures 8/19/97 5.72 5,000,000
2,000,000 Deutsche Bank matures 1/30/98 5.85 1,999,714
1,500,000 Hessiche Landesbank matures 9/11/97 5.70 1,500,217
5,000,000 Royal Bank of Canada mature 1/13/98
to 1/14/98 5.72 to 5.84 5,002,504
2,000,000 Toronto Dominion Bank matures
11/20/97 5.82 2,000,181
- --------------------------------------------------------------------------------
TOTAL FOREIGN CERTIFICATES OF DEPOSIT
(Cost -- $15,502,616) 15,502,616
================================================================================
See Notes to Financial Statements.
3
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
FACE ANNUALIZED
AMOUNT SECURITY YIELD VALUE
================================================================================
MEDIUM-TERM NOTE -- 1.6%
$2,000,000 Merrill Lynch matures 1/26/98
(Cost -- $1,999,787) 5.71% $ 1,999,787
================================================================================
TIME DEPOSITS -- 16.7%
6,000,000 Bank Austriaengesellschaft matures
8/1/97 5.81 6,000,000
6,000,000 Chase Manhattan Bank matures 8/1/97 5.84 6,000,000
2,394,000 First Chicago National Bank matures
8/1/97 5.81 2,394,000
6,000,000 Republic National Bank matures 8/1/97 5.81 6,000,000
- --------------------------------------------------------------------------------
TOTAL TIME DEPOSITS
(Cost -- $20,394,000) 20,394,000
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $122,336,236*) $122,336,236
================================================================================
* Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
4
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities July 31, 1997
- --------------------------------------------------------------------------------
ASSETS:
Investments, at amortized cost $122,336,236
Cash 84,449
Interest receivable 412,905
Prepaid registration fees 280,070
- --------------------------------------------------------------------------------
Total Assets 123,113,660
- --------------------------------------------------------------------------------
LIABILITIES:
Dividends payable 265,837
Investment advisory fees payable 35,086
Distribution fees payable 30,574
Administrative fees payable 23,390
Accrued expenses 36,093
- --------------------------------------------------------------------------------
Total Liabilities 390,980
- --------------------------------------------------------------------------------
Total Net Assets $122,722,680
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 122,761
Capital paid in excess of par value 122,638,496
Accumulated net realized loss from security transactions (38,577)
- --------------------------------------------------------------------------------
Total Net Assets $122,722,680
================================================================================
Shares Outstanding:
Class B 116,954,867
-------------------------------------------------------------------------------
Class C 5,806,390
-------------------------------------------------------------------------------
Net Asset Value, Per Class $1.00
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
5
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended July 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $8,137,141
- --------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 3) 737,595
Investment advisory fees (Note 3) 442,557
Administration fees (Note 3) 295,038
Shareholder and system servicing fees 100,930
Audit and legal 39,500
Registration fees 34,946
Custody 29,500
Shareholder communications 26,500
Trustees' fees 13,500
Other 1,500
- --------------------------------------------------------------------------------
Total Expenses 1,721,566
- --------------------------------------------------------------------------------
Net Investment Income 6,415,575
- --------------------------------------------------------------------------------
Net Realized Gain From Security Transactions 16,879
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $6,432,454
================================================================================
See Notes to Financial Statements.
6
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended July 31,
- --------------------------------------------------------------------------------
1997 1996
================================================================================
OPERATIONS:
Net investment income $ 6,415,575 $ 6,646,611
Net realized gain 16,879 15,797
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 6,432,454 6,662,408
- --------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS (NOTE 2) (6,415,575) (6,646,611)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
Net proceeds from sale of shares 449,494,993 417,673,055
Net asset value of shares issued for
reinvestment of dividends 5,561,231 5,866,729
Cost of shares reacquired (492,215,760) (426,972,534)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (37,159,536) (3,432,750)
- --------------------------------------------------------------------------------
Decrease in Net Assets (37,142,657) (3,416,953)
NET ASSETS:
Beginning of year 159,865,337 163,282,290
- --------------------------------------------------------------------------------
End of year $122,722,680 $159,865,337
================================================================================
See Notes to Financial Statements.
7
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements.
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Smith Barney Exchange Reserve 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 this
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 except for the
Smith Barney Premium Total Return Fund which will have an annual report dated
December 31, 1997.
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, approxi mates
value; (c) interest income is recorded on an 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 of each class; (e) dividends
and distributions to shareholders are recorded on the ex-dividend date; (f)
gains or losses on the sale of securities are calculated by 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 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 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, 1997, CDSCs paid
to Smith Barney Inc. ("SB") were approximately:
Class B Class C
- --------------------------------------------------------------------------------
CDSCs $618,000 $7,000
- --------------------------------------------------------------------------------
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 each class, respectively. For the year ended July
31, 1997, total Distribution Plan fees incurred were:
Class B Class C
- --------------------------------------------------------------------------------
Distribution Plan Fees $699,916 $37,679
- --------------------------------------------------------------------------------
All officers and one Trustee of the Trust are employees of SB.
4. CAPITAL LOSS CARRYFORWARD
At July 31, 1997, the Fund had, for Federal income tax purposes, a capital
loss carryforward of approximately $38,500, 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.
Transactions in shares of beneficial interest of the Fund were as follows:
Year Ended Year Ended
July 31, 1997 July 31, 1996
================================================================================
Class B
Shares sold 352,876,972 341,531,323
Shares issued on reinvestment 5,264,223 5,711,961
Shares redeemed (391,663,064) (357,269,797)
- --------------------------------------------------------------------------------
Net Decrease (33,521,869) (10,026,513)
================================================================================
Class C
Shares sold 96,618,021 76,141,732
Shares issued on reinvestment 297,008 154,768
Shares redeemed (100,552,696) (69,702,737)
- --------------------------------------------------------------------------------
Net Increase (Decrease) (3,637,667) 6,593,763
================================================================================
10
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class B Shares 1997 1996 1995 1994 1993
=========================================================================================
<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 0.043 0.044 0.044 0.022 0.021
Dividends from net
investment income (0.043) (0.044) (0.044) (0.022) (0.021)
- -----------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
- -----------------------------------------------------------------------------------------
Total Return 4.43% 4.53% 4.49% 2.18% 2.15%
- -----------------------------------------------------------------------------------------
Net Assets,
End of Year (000s) $116,915 $150,421 $160,432 $252,246 $166,262
- -----------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.16% 1.17% 1.24% 1.26% 1.25%
Net investment income 4.34 4.45 4.35 2.24 2.16
=========================================================================================
</TABLE>
Class C Shares 1997 1996 1995(1)
================================================================================
Net Asset Value,
Beginning of Year $ 1.00 $ 1.00 $ 1.00
- --------------------------------------------------------------------------------
Net investment income 0.043 0.044 0.035
Dividends from net
investment income (0.043) (0.044) (0.035)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 1.00 $ 1.00 $ 1.00
- --------------------------------------------------------------------------------
Total Return 4.42% 4.51% 3.52%++
- --------------------------------------------------------------------------------
Net Assets,
End of Year (000s) $ 5,808 $ 9,444 $ 2,850
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.16% 1.17% 1.21%+
Net investment income 4.34 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>
- --------------------------------------------------------------------------------
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, 1997, and the related statement of
operations for the year then ended, the statements of changes in net assets for
each of the years in the two-year period then ended and the financial highlights
for each of the years in the three-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 two-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, 1997, 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 and financial highlights 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,
1997, the results of its operations for the year then ended, the changes in its
net assets for each of the years in the two-year period then ended and the
financial highlights for each of the years in the three-year period then ended,
in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
September 15, 1997
12
<PAGE>
Smith Barney SMITH BARNEY
Exchange Reserve Fund
A Member of TravelersGroup[LOGO]
Trustees
Lee Abraham
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon, Chairman
Officers
Heath B. McLendon
Investment Officer
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 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,
fees and expenses as well as other pertinent information.
Smith Barney
Exchange Reserve Fund
388 Greenwich Street
New York, New York 10013
FD01183 9/97
ANNUAL REPORT
================================================================================
1997
1997
1997
1997
1997
Smith Barney
Tax-Exempt
Income Fund
---------------------
July 31, 1997
[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 the annual report for the Smith Barney Tax-Exempt
Income Fund ("Fund") for the year ended July 31, 1997. 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.
Fund Performance Update
For the year ended July 31, 1997, the Smith Barney Tax-Exempt Income Fund's
Class A shares posted a total return of 10.40% and outperformed its Lipper
Analytical Services, Inc. peer group average of 10.08% for the same period.
(Lipper Analytical Services, Inc. is an independent fund-tracking organization.)
Over the past year, the Fund distributed income dividends totaling $0.984 per
Class A share. Based on its Class A shares net asset value of $18.07 as of July
31, 1997, the Fund provided shareholders with a tax-free yield of 5.45%. To
match this yield, investors in the 36% federal tax bracket would have to earn
8.52% on a taxable investment alternative. (According to the Internal Revenue
Service, nearly 10% of all U.S. taxpayers fall into the 36% federal tax
bracket.)
Market and Economic Overview
During the past year, the U.S. economy has continued to grow steadily. Although
the U.S. unemployment rate is near a thirty-year low and consumer confidence is
the highest it has been in over twenty years, there has not been a substantial
increase in inflationary pressures. Nevertheless, signs of lower unemployment
and rising wage costs prompted the Federal Reserve Board ("Fed") to raise the
federal-funds rate from 5.25% to 5.50%, in late March of this year. (The
federal-funds rate is the interest rate banks charge each other for overnight
loans and is a closely watched indicator of the direction of interest rates.)
The Fed has indicated that it prefers to head off any possible increase in
inflation with a preemptive action rather than wait for inflationary pressures
to build.
At subsequent meetings held throughout the summer, the Fed chose not to raise
the federal-funds rate any further. Despite the continued economic expansion,
there has been little increase in either consumer or wholesale prices as
measured by the Consumer Price Index and the Producer Price Index. This evidence
of continued moderate U.S. economic growth helped fuel a municipal bond market
rally in the weeks following the March meeting of the Fed.
1
<PAGE>
In our view, inflationary pressure remains well contained primarily because of
global competition and improved productivity. The increased use of new
technologies has enabled businesses to operate more efficiently while using
fewer workers. Because labor is the most substantial cost in production, the
resulting productivity gains from technology has tended to keep prices from
rising significantly. Moreover, U.S. companies continue to face fierce
competition from foreign companies, many of which operate with much lower wage
and production cost overheads than their U.S. counterparts. Despite the healthy
expansion in the U.S. economy, prices -- and particularly wages -- have remained
fairly stable.
Investment Strategy
The Fund seeks to maximize current income exempt from federal income taxes by
investing primarily in municipal bonds and notes. We continue to emphasize a
broadly diversified, high-quality orientation for the Fund's portfolio. As of
July 31, 1997, 83.7% of the Fund's portfolio was invested in investment grade
(BBB/Baa or higher) securities, as measured by Standard and Poor's Rating
Service or Moody's Investor Service, Inc. (Standard and Poor's and Moody's are
major credit rating and reporting agencies.) In addition, we continue to
maintain an average weighted maturity of 20 years or more. We also continue to
favor housing bonds because we believe they provided greater reward with less
risk and volatility than many other types of municipal bonds. Given our
expectations of lower interest rates, we believe there is less prepayment call
risk for these housing bonds. As of July 31, 1997, the Fund's holdings were
allocated across these major market sectors: utility bonds (14.5%), hospital
bonds (12.8%), housing bonds (11.8%), industrial development bonds (11.2%) and
pollution control bonds (11.1%).
Municipal Bond Market Outlook
Some investors have expressed concern that certain provisions of the recently
enacted Federal Taxpayer Relief Act passed as part of the Balanced Budget
Agreement could erode many of the tax advantages that municipal bonds now offer.
However, we believe that this legislation is largely positive for the municipal
bond market. The reduction to the long-term capital gains tax rate could benefit
investors who receive capital gain dividends from municipal bond funds. In
addition, the repeal of the alternative minimum tax for small business
corporations provides favorable tax treatment for many corporate municipal bond
investors. Moreover, the new tax act expands the issuance of education and
housing bonds, two key segments of the municipal bond market.
Going forward, we remain positive on the prospects for the municipal bond
market. We expect a moderately expanding U.S. economy with the Fed maintaining
its vigilance against higher inflationary pressure. We also expect a
2
<PAGE>
pick-up in the new issue supply in the municipal bond market in the months
ahead. An increase in supply of new municipal bonds could exert a modest upward
pressure on yields. We view such an increase in market volatility as an
opportunity to add value and enhance the Fund's yield. Moreover, current real
municipal yields, (i.e., the yield after taking into account the effects of
inflation) are very high by historical standards. For these reasons, we believe
that tax-free bonds should continue to provide investors with a competitive
total return.
On a more somber note, we are saddened by the loss of two outstanding business
leaders and Trustees of the Fund, Antoinette C. Bentley and Madelon DeVoe
Talley. Their knowledge and wisdom will be missed.
In closing, we thank you for your investment in Smith Barney Tax-Exempt Income
Fund. We look forward to continuing to help you pursue your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ Lawrence T. McDermott
Heath B. McLendon Lawrence T. McDermott
Chairman Vice President and
Investment Officer
August 20, 1997
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>
7/31/97 $17.31 $18.07 $0.98 $0.00 $0.00 10.40%
- ------------------------------------------------------------------------------------------
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 $4.87 $0.31 $0.04
==========================================================================================
</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>
7/31/97 $17.32 $18.09 $ 0.89 $0.00 $0.00 9.89%
- ------------------------------------------------------------------------------------------
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 $11.32 $0.67 $0.04
==========================================================================================
</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>
7/31/97 $17.31 $18.07 $0.89 $0.00 $0.00 9.79%
- ------------------------------------------------------------------------------------------
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 $2.42 $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 7/31/97 10.40% 9.89% 9.79%
- --------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 6.03 N/A
- --------------------------------------------------------------------------------
Ten Years Ended 7/31/97 N/A 7.56 N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/97 7.24 8.35 10.70
================================================================================
With Sales Charge(2)
---------------------------
Class A Class B Class C
================================================================================
Year Ended 7/31/97 5.99% 5.39% 8.79%
- --------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 5.88 N/A
- --------------------------------------------------------------------------------
Ten Years Ended 7/31/97 N/A 7.56 N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/97 6.31 8.35 10.70
================================================================================
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Without Sales Charge(1)
================================================================================
Class A (Inception* through 7/31/97) 39.20%
- --------------------------------------------------------------------------------
Class B (7/31/87 through 7/31/97) 107.35
- --------------------------------------------------------------------------------
Class C (Inception* through 7/31/97) 31.63
================================================================================
(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 1987 -- July 1997
[The following table was represented as a line graph in the printed material.]
Smith Barney Lehman Municipal
Tax-Exempt Income Fund Bond Index
---------------------- ----------
7/87 $10,000 $10,000
7/88 10,732 10,703
7/89 12,092 12,005
7/90 12,691 12,837
7/91 13,630 13,958
7/92 15,469 15,876
7/93 16,749 17,280
7/94 16,849 17,602
7/95 17,845 18,989
7/96 18,868 20,242
7/97 20,735 22,318
+ Hypothetical illustration of $10,000 invested in Class B shares on July
31, 1987, assuming reinvestment of dividends and capital gains, if any, at
net asset value through July 31, 1997. 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, 1997
- --------------------------------------------------------------------------------
Portfolio Breakdown
[The following table was represented as a pie graph in the printed material.]
Water & Sewer 2.9%
Transportation 10.4%
Hospital 12.8%
Education 4.8%
Utility 14.5%
Life Care Systems 1.6%
Housing 11.8%
Short-Term 0.9%
General Obligation 8.9%
Industrial Development 11.2%
Solid Waste 0.7%
Miscellaneous 7.0%
Pre-Refunded 1.0%
Public Facilities 0.4%
Pollution Control 11.1%
Top Five States Represented
Percentage of
State Total Investments
================================================================================
Pennsylvania 10.4%
New York 10.2
Texas 6.2
California 5.7
Massachusetts 4.5
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 37.3%
Aa AA 9.8
A A 13.2
Baa BBB 23.4
Ba BB 7.0
B B 1.5
NR NR 6.9
VMIG 1 A-1 0.9
-----
100.0%
=====
7
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
<C> <C> <S> <C>
============================================================================================================
MUNICIPAL BONDS AND NOTES -- 99.1%
============================================================================================================
Alabama -- 2.3%
$4,000,000 Baa3* Alabama IDA (Boise Cascade Project),
6.450% due 12/1/23(a) $ 4,180,000
2,000,000 AAA Birmingham, AL Airport Authority Revenue,
MBIA-Insured, 5.625% due 7/1/26 2,047,500
3,000,000 AAA Huntsville, AL Health Care Facilities Authority, Series A,
MBIA-Insured, 6.375% due 6/1/12 3,266,250
7,200,000 AAA Jefferson County, AL Sewer Revenue, Series A,
FGIC-Insured, 5.375% due 2/1/27 7,227,000
2,500,000 AAA Morgan County-Decatur, AL Healthcare Authority
Hospital Revenue, Decatur General Hospital,
CONNIE LEE-Insured, 6.250% due 3/1/13 2,715,625
- -----------------------------------------------------------------------------------------------------------
19,436,375
- -----------------------------------------------------------------------------------------------------------
Alaska -- 0.3%
2,250,000 Aa2* Alaska State Housing Finance Corp., Series A,
(Pre-Refunded -- Escrowed with U.S. Government
Securities to 12/1/02 Call @ 102),
6.600% due 12/1/23(b) 2,500,312
- -----------------------------------------------------------------------------------------------------------
Arizona -- 2.1%
1,000,000 Aa* Arizona Educational Loan Marketing Corp.,
Sr. Series, 6.375% due 9/1/05(a) 1,063,750
1,170,000 AAA Arizona State COP, FSA-Insured, 6.625% due 9/1/08 1,291,387
1,000,000 BBB Gila County, AZ IDA, PCR, Series 1987, (ASARCO Inc.
Project), 8.900% due 7/1/06 1,033,750
5,000,000 BB Maricopa County, AZ PCR, Public Service Co.,
Palo Verde, Series A, 6.375% due 8/15/23(c) 5,181,250
1,300,000 AAA Maricopa County, AZ School District, Fountain Hills,
No. 98, FGIC-Insured, 6.625% due 7/1/10 1,410,500
7,250,000 BBB Navajo County, AZ PCR, Arizona Public Service
Co., Series A, 5.875% due 8/15/28 7,467,500
326,000 NR Peoria, AZ IDA, Sierra Winds Life Care Inc.,
6.500% due 11/1/17 306,440
- -----------------------------------------------------------------------------------------------------------
17,754,577
- -----------------------------------------------------------------------------------------------------------
Arkansas -- 0.1%
890,000 AAA Arkansas State Development Authority, Single-Family
Mortgage Revenue, Series A, GNMA/FNMA-
Collateralized, 6.200% due 7/1/15 941,175
- -----------------------------------------------------------------------------------------------------------
California -- 5.7%
4,000,000 A- Burbank, CA Redevelopment Agency, Series A, (Golden
State Redevelopment Project), 6.250% due 12/1/24 4,235,000
1,500,000 A+ California Housing Finance Agency Revenue, Multi-Unit
Rental Housing, Series B-II, 6.700% due 8/1/15(a) 1,599,375
</TABLE>
See Notes to Financial Statements.
8
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
California -- 5.7% (continued)
$ 2,900,000 AA California PCR, (Mobil Oil Corp. Project),
5.500% due 12/1/29(a) $ 2,918,125
2,400,000 AAA California State University Revenue & Colleges, Housing
System, FGIC-Insured, 5.900% due 11/1/21 2,547,000
2,500,000 AAA California Statewide Community Development Authority
Revenue, COP, Sutter Health, AMBAC-Insured,
6.125% due 8/15/22 2,659,375
2,600,000 BBB- Central Valley Finance Authority, CA (Cogeneration/Carson
Ice Project), 6.200% due 7/1/20 2,723,500
3,000,000 Baa1* Duarte, CA Hope Medical Center, 6.250% due 4/1/23 3,120,000
Long Beach, CA (Aquarium of the Pacific Project),
Series A:
5,500,000 BBB 6.125% due 7/1/15 5,651,250
4,000,000 BBB 6.125% due 7/1/23 4,080,000
4,000,000 A- Los Angeles, CA Regional Airports Improvement,
Corporate Lease Revenue, LA International Airport,
6.800% due 1/1/27(a) 4,295,000
12,900,000 NR San Joaquin Hills, CA Transportation Authority,
(Transcorridor Agency Project), Toll Road,
Sr. Lien, 6.750% due 1/1/32(c) 13,932,000
- -----------------------------------------------------------------------------------------------------------
47,760,625
- -----------------------------------------------------------------------------------------------------------
Colorado -- 2.3%
4,750,000 BBB+ Colorado Springs, CO Airport Revenue, Series A,
7.000% due 1/1/22(a) 5,213,125
Denver, CO City & County Airport Revenue:
1,000,000 BBB 8.000% due 11/15/17(a) 1,030,080
250,000 BBB Series A, 7.500% due 11/15/23(a) 288,750
2,170,000 Baa1* Series C, 6.750% due 11/15/22(a) 2,346,312
3,000,000 AAA Denver, CO City & County Multi-Family Housing Revenue,
(Boston Lofts Project), Series A, FHA-Insured,
5.850% due 10/1/38(a) 3,000,000
2,250,000 AAA Jefferson County, CO COP, MBIA-Insured,
6.650% due 12/1/08 2,528,437
195,000 AAA Jefferson County, CO Single-Family Mortgage, Series A,
MBIA-Insured, 8.875% due 10/1/13 208,893
1,500,000 A2* Larimer County, CO COP, School District No. R-1,
Poudre-Ft. Collins, Colorado School Board Lease,
6.700% due 12/1/13 1,633,125
500,000 A3* Meridian, CO Metropolitan District, 7.000% due 12/1/98 513,750
2,015,000 AA- Pueblo County, CO Single-Family Housing Authority,
Series A, FNMA/GNMA-Collateralized,
6.850% due 12/1/25 2,133,381
- -----------------------------------------------------------------------------------------------------------
18,895,853
- -----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Connecticut -- 1.4%
$1,930,000 A Connecticut Development Authority, Resource
Recovery Authority, (Bridgeport Project), Series B,
8.500% due 1/1/00 $ 1,987,147
2,000,000 AAA Connecticut State Airport Revenue, Bradley International
Airport, FGIC-Insured, 7.650% due 10/1/12
2,362,500 Connecticut State Health and Educational
Facilities:
1,200,000 BBB- Quinnipiac College, Series D, 6.000% due 7/1/23 1,219,500
University of Hartford, Series D:
1,655,000 Ba2* 6.750% due 7/1/12 1,712,925
1,450,000 Ba2* 6.800% due 7/1/22 1,497,125
2,860,000 AA Connecticut State HFA, Series A, 6.750% due 11/15/23 3,060,200
- -----------------------------------------------------------------------------------------------------------
11,839,397
- -----------------------------------------------------------------------------------------------------------
Delaware -- 0.6%
Delaware State EDA, PCR, AMBAC-Insured:
2,500,000 AAA Series B, 6.750% due 5/1/19 2,740,625
2,000,000 AAA Water & Sewer Revenue, 6.200% due 6/1/25(a) 2,137,500
- -----------------------------------------------------------------------------------------------------------
4,878,125
- -----------------------------------------------------------------------------------------------------------
District of Columbia -- 1.0%
District of Columbia:
6,500,000 B COP, 7.300% due 1/1/13 7,296,250
1,000,000 A+ Georgetown University, 5.375% due 4/1/23 1,010,000
- -----------------------------------------------------------------------------------------------------------
8,306,250
- -----------------------------------------------------------------------------------------------------------
Florida -- 3.9%
340,000 AAA Alachua County, FL Health Facilities Authority, Health
Facilities Revenue, (Santa Fe Healthcare Facilities
Project), (Pre-Refunded-- Escrowed with U.S.
Government Securities to 11/15/00 Call @ 102),
6.875% due 11/15/02 371,025
Broward County, FL Resource Recovery, Waste Energy:
550,000 A North, 7.950% due 12/1/08 602,250
2,460,000 A South, 7.950% due 12/1/08 2,693,700
825,000 AAA Dade County, FL Aviation Revenue, Series B,
MBIA-Insured, 6.600% due 10/1/22(a) 903,375
1,250,000 AAA Dade County, FL Water & Sewer System Revenue,
FGIC-Insured, 5.250% due 10/1/21 1,243,750
2,140,000 AAA Florida State HFA, Single-Family Mortgage, GNMA/FNMA-
Collateralized, Series A, 6.650% due 1/1/24(a) 2,287,125
2,800,000 BBB+ Hillsborough County, FL Utility Revenue, Series A,
7.000% due 8/1/14 3,041,500
Jacksonville, FL Health Facilities Revenue:
2,000,000 AAA Children's Hospital- Baptist Medical Center,
MBIA-Insured, 7.000% due 6/1/11 2,222,500
3,440,000 AAA University Medical Center, CONNIE LEE-Insured,
6.600% due 2/1/21 3,710,900
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Florida -- 3.9% (continued)
$2,000,000 A+ Jacksonville, FL Sewer & Solid Waste Disposal
Facilities Revenue, (Anheuser-Busch Project),
5.875% due 2/1/36(a) $ 2,057,500
1,000,000 AAA Orange County, FL Tourist Development Tax Revenue,
Series B, AMBAC-Insured, 6.500% due 10/1/19 1,123,750
300,000 BBB Pace Property Finance Authority, Florida Utility Revenue,
6.250% due 9/1/13 309,000
6,000,000 AA Polk County, FL IDA, Solid Waste Disposal Facility Revenue,
(Tampa Electric Co. Project), 5.850% due 12/1/30(a) 6,187,500
3,000,000 BBB- Putnam County, FL Development Authority, PCR,
Georgia Pacific, 7.000% due 12/1/05 3,360,000
1,900,000 AAA Tampa, FL Utility Tax and Special Revenue,
AMBAC-Insured, 6.900% due 10/1/09 2,120,875
- -----------------------------------------------------------------------------------------------------------
32,234,750
- -----------------------------------------------------------------------------------------------------------
Georgia -- 2.7%
4,000,000 A Atlanta, GA Airport Facilities Revenue,
7.250% due 1/1/17(a)(c) 4,355,000
4,750,000 AA- George L. Smith, GA World Congress Center
Authority Revenue, (Domed Stadium Project),
7.875% due 7/1/20(a) 5,236,875
7,000,000 AAA Georgia Municipal Electric Authority Power Revenue,
Series EE, AMBAC-Insured, 6.400% due 1/1/23 7,743,750
5,000,000 AAA Medical Center Hospital Authority, Columbus
Healthcare, Series C, MBIA-Insured,
6.400% due 8/1/06 5,512,500
- -----------------------------------------------------------------------------------------------------------
22,848,125
- -----------------------------------------------------------------------------------------------------------
Guam -- 0.2%
1,500,000 A- Government of Guam, Limited Obligation Revenue,
Series A, 7.000% due 11/15/04 1,584,375
- -----------------------------------------------------------------------------------------------------------
Hawaii -- 0.9%
Hawaii State Department of Budget and Finance,
Special Purpose Mortgage Revenue:
2,000,000 AAA Hawaiian Electric Co. Project, Series B,
MBIA-Insured, 5.875% due 12/1/26(a) 2,085,000
2,000,000 A Kapiolani Health Care Systems, 6.400% due 7/1/13 2,132,500
3,620,000 Aa1* Hawaii State Housing Finance & Development Corp.,
Single-Family Mortgage Purpose Revenue,
Series A, 5.750% due 7/1/30(a) 3,633,575
- -----------------------------------------------------------------------------------------------------------
7,851,075
- -----------------------------------------------------------------------------------------------------------
Idaho -- 0.2%
1,280,000 AA Idaho Housing Agency, Single-Family Mortgage,
Series C, 7.875% due 1/1/21(a) 1,339,200
- -----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Illinois -- 3.7%
$1,700,000 AA Chicago, IL HDC, Section 8, Series A, FHA-Insured,
6.700% due 7/1/12 $ 1,806,250
Chicago, IL O'Hare International Airport, Special Facilities:
2,125,000 BB+ Delta Airlines, 6.450% due 5/1/18 2,223,280
1,800,000 AAA Lufthansa German Airlines Project, 7.125% due 5/1/18(a) 1,964,250
United Airlines:
1,345,000 BB 8.250% due 5/1/99(a) 1,405,525
3,180,000 BB Series B, 8.950% due 5/1/18(a) 3,621,225
3,755,000 BB Series C, 8.200% due 5/1/18 4,060,093
6,750,000 AAA Chicago, IL Skyway Toll Bridge Revenue,
MBIA-Insured, 5.500% due 1/1/23 6,817,500
3,000,000 BB- East Chicago, IL Industrial PCR, Inland Steel Co.,
(Project 10), 6.800% due 6/1/13 3,195,000
1,300,000 A- Illinois Education Facilities Authority Revenue, Northern
Illinois Medical Center, 6.000% due 9/1/19 1,316,250
1,500,000 A+ Illinois Housing and Development Authority, Multi-Family
Housing, Series A, 6.125% due 7/1/25 1,541,250
2,750,000 AAA Illinois State Toll Highway Authority, Series A,
FGIC-Insured, 6.200% due 1/1/16 2,908,125
- -----------------------------------------------------------------------------------------------------------
30,858,748
- -----------------------------------------------------------------------------------------------------------
Indiana -- 1.2%
Indianapolis, IN Airport Authority Revenue, Special Facility:
5,245,000 BBB Federal Express Corporate Project,
7.100% due 1/15/17(a) 5,887,513
3,970,000 BB+ United Airlines Project, Series A,
6.500% due 11/15/31(a) 4,213,163
- -----------------------------------------------------------------------------------------------------------
10,100,676
- -----------------------------------------------------------------------------------------------------------
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 1,102,500
- -----------------------------------------------------------------------------------------------------------
Kentucky -- 2.8%
5,000,000 AAA Jefferson County, KY Hospital Revenue, MBIA-Insured,
6.436% due 10/23/14(c)(d) 5,368,750
Kenton County, KY Airport Board Revenue,
Delta Airlines:
1,230,000 A 8.250% due 3/1/15(a) 1,280,602
4,250,000 A Project A, 7.500% due 2/1/20(a) 4,712,188
590,000 NR Kentucky Multi-County Residential Mortgage,
10.500% due 10/1/00 596,638
3,750,000 AAA Lexington-Lafayette Urban County Project, (University of
Kentucky Alumni Association Inc. Project),
MBIA-Insured, 6.750% due 11/1/24 4,185,938
4,000,000 A Pendleton County, KY Multi-County Lease Revenue,
Series A, 6.500% due 3/1/19 4,340,000
</TABLE>
See Notes to Financial Statements.
12
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Kentucky -- 2.8% (continued)
$2,605,000 AA Trimble County, KY PCR, Series B,
6.550% due 11/1/20(a) $ 2,780,838
- -----------------------------------------------------------------------------------------------------------
23,264,954
- -----------------------------------------------------------------------------------------------------------
Louisiana -- 2.8%
2,500,000 Aa3* Calcasieu Parish, LA, IDB Exempt Facility Revenue,
(Conoco Inc. Project), 5.750% due 12/1/26(a) 2,568,750
5,000,000 NR Hodge, LA Utility Revenue, 9.000% due 3/1/10(a) 5,425,000
2,600,000 Baa3* Lake Charles, LA Harbor and Terminal District,
(Trunkline Liquid Natural Gas Co. Project),
7.750% due 8/15/22 2,980,250
3,000,000 Aaa* Louisiana Housing Finance Agency Mortgage Revenue,
Single-Family, Series B-2, GNMA/FNMA-Collateralized,
5.750% due 12/1/28 3,000,000
2,500,000 Baa* Louisiana Public Facilities, Association of Independent
Colleges and Universities, 7.000% due 12/1/17 2,628,125
2,000,000 BB- Port of New Orleans, LA IDR, (Continental Grain
Co. Project), 7.500% due 7/1/13 2,182,500
1,210,000 AAA State Tammany Parish, LA Hospital Revenue, District 2,
CONNIE LEE-Insured, 6.250% due 10/1/14 1,312,850
3,000,000 BB+ West Feliciana Parish, LA PCR, Gulf State Utilities,
7.700% due 12/1/14 3,382,500
- -----------------------------------------------------------------------------------------------------------
23,479,975
- -----------------------------------------------------------------------------------------------------------
Maryland -- 2.3%
3,000,000 AAA Baltimore County, MD Mortgage Revenue, Series A,
Dunfield Townhouses, FHA-Insured, 6.900% due 8/1/28 3,206,250
1,980,000 AAA Howard County, MD Mortgage Revenue, Howard Hills
Townhouses, Series A, MBIA-Insured, 6.400% due 7/1/24 2,076,525
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 1,366,400
1,000,000 Aa* Single-Family Program, Fourth Series,
6.450% due 4/1/14 1,062,500
Northeast Maryland Waste Disposal Authority, Recovery
Revenue, Southwest Resource Recovery, MBIA-Insured:
3,000,000 AAA 7.200% due 1/1/06 3,487,500
3,000,000 AAA 7.200% due 1/1/07 3,480,000
2,500,000 Baa* Prince Georges County, MD Greater Southeast Healthcare
System, 6.375% due 1/1/23 2,556,250
2,155,000 AAA Prince Georges County, MD Housing Authority Mortgage
Revenue, (Langley Gardens Apartments Project),
Series A, GNMA-Collateralized, 5.875% due 2/20/39(a) 2,163,081
- -----------------------------------------------------------------------------------------------------------
19,398,506
- -----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
13
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Massachusetts -- 4.5%
Massachusetts Bay Transportation Authority, General
Transportation System:
$4,800,000 A+ Series A, 5.625% due 3/1/26 $ 4,950,000
4,000,000 A+ Series C, 5.000% due 3/1/24 3,820,000
3,000,000 A+ Massachusetts State GO, Series C, 5.000% due 8/1/17 2,910,000
Massachusetts State Health and Educational Facilities
Authority Revenue:
735,000 AAA Community College Program, Series A,
CONNIE LEE-Insured, 6.600% due 10/1/22 786,450
3,500,000 AAA New England Medical Center Hospitals, Series F,
FGIC-Insured, 6.625% due 7/1/25 3,836,875
1,500,000 B1* Saint Memorial Medical Center, Series A,
6.000% due 10/1/23 1,391,250
Massachusetts State HFA, Housing Projects:
Residential Development, FNMA-Collateralized:
2,445,000 A+ Series A, 6.375% due 4/1/21 2,582,531
2,000,000 AAA Series C, 6.875% due 11/15/11 2,175,000
3,000,000 AAA Series D, 6.800% due 11/15/12 3,258,750
2,500,000 AA Series 41, Single-Family Housing,
6.300% due 12/1/14(a) 2,650,000
Massachusetts State Industrial Financial Agency,
Resource Recovery Revenue, (Semass Project):
2,700,000 NR Series A, 9.000% due 7/1/15 3,074,625
4,335,000 NR Series B, 9.250% due 7/1/15(a) 4,947,319
1,300,000 AAA Massachusetts State Port Authority Revenue, (U.S. Air
Project), Series A, MBIA-Insured, 5.875% due 9/1/23(a) 1,345,500
- -----------------------------------------------------------------------------------------------------------
37,728,300
- -----------------------------------------------------------------------------------------------------------
Michigan -- 2.4%
3,000,000 AAA Detroit, MI Water Supply System, FGIC-Insured,
6.375% due 7/1/22(d) 3,202,500
5,000,000 AAA Michigan State Hospital Finance Authority Revenue,
FSA-Insured, 6.300% due 2/15/22(c)(d) 5,287,500
2,000,000 A- Michigan State Strategic Fund, PCR, General Motors
Corp., 6.200% due 9/1/20 2,152,500
4,500,000 AAA Monroe County, MI PCR, Detroit Edison Monroe,
Series 1, MBIA-Insured, 6.875% due 9/1/22(a) 4,905,000
750,000 AAA Rockford, MI Public School, FGIC-Insured,
5.250% due 5/1/27 735,938
3,750,000 AAA Western Townships, MI Utilities Authority, Sewer Disposal
Systems, FSA-Insured, 6.750% due 1/1/15 4,031,250
- -----------------------------------------------------------------------------------------------------------
20,314,688
- -----------------------------------------------------------------------------------------------------------
Minnesota -- 0.7%
1,200,000 NR Minneapolis, MN Commercial Development Revenue,
(Holiday Inn Metrodome Project), 10.500% due 6/1/03 1,210,020
</TABLE>
See Notes to Financial Statements.
14
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Minnesota -- 0.7% (continued)
$4,000,000 BBB- St. Paul, MN Housing and Redevelopment Authority,
(Healtheast Project), Series A, 6.625% due 11/1/17 $ 4,215,000
- -----------------------------------------------------------------------------------------------------------
5,425,020
- -----------------------------------------------------------------------------------------------------------
Mississippi -- 1.7%
9,000,000 BBB- Claireborne County, MS PCR, (System Energy Resource Inc.
Project), 6.200% due 2/1/26 9,202,500
2,250,000 AAA Gulfport, MS Hospital Facilities Revenue, Memorial Hospital
Gulfport, Series A, MBIA-Insured, 6.200% due 7/1/18 2,435,625
2,000,000 Aaa* Mississippi Home Corp., Single-Family Mortgage Revenue,
GNMA-Collateralized, 6.550% due 4/1/21(a) 2,125,000
- -----------------------------------------------------------------------------------------------------------
13,763,125
- -----------------------------------------------------------------------------------------------------------
Montana -- 0.6%
5,500,000 NR Montana State Board Resource Recovery, (Yellowstone
Energy LP Project), 7.000% due 12/31/19(a) 5,458,750
- -----------------------------------------------------------------------------------------------------------
Nebraska -- 0.2%
1,500,000 AAA Nebraska Investment Finance Authority, Single-Family
Housing Revenue, Series C, GNMA/FNMA-Collateralized,
Remarketed 5/1/97, 6.300% due 9/1/28(a) 1,584,375
- -----------------------------------------------------------------------------------------------------------
Nevada -- 0.3%
2,000,000 AAA Humboldt County, NV PCR, (Sierra Pacific Project),
AMBAC-Insured, 6.550% due 10/1/13 2,187,500
- -----------------------------------------------------------------------------------------------------------
New Hampshire -- 0.8%
3,340,000 BBB- New Hampshire Business Financing Authority,
PCR, United Illuminating Co., Series A,
5.875% due 10/1/33 3,310,775
1,000,000 AA- New Hampshire IDA, Resource Recovery
Series, (Concord Project), 8.500% due 1/1/09 1,033,470
2,000,000 A New Hampshire Turnpike System Revenue,
6.000% due 4/1/13 2,077,500
- -----------------------------------------------------------------------------------------------------------
6,421,745
- -----------------------------------------------------------------------------------------------------------
New Jersey -- 4.5%
775,000 B1* Atlantic County, NJ Utilities Authority, Solid Waste Revenue,
7.125% due 3/1/16 789,531
5,000,000 Baa2* Camden County, NJ Improvement Authority Revenue,
(Health Care Redevelopment Project), Cooper Health,
6.000% due 2/15/27 5,106,250
2,500,000 AAA Hoboken, Union City, Weehawken, NJ Sewer Authority
Revenue, MBIA-Insured, 6.200% due 8/1/19 2,681,250
905,000 BBB- Hudson County, NJ Improvement Authority, Solid Waste
Revenue, 7.100% due 1/1/20 919,706
</TABLE>
See Notes to Financial Statements.
15
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
New Jersey -- 4.5% (continued)
New Jersey EDA:
$2,500,000 AAA Irvington General Hospital, FHA-Insured,
6.375% due 8/1/15 $ 2,740,625
2,950,000 A- Kennedy Memorial University Medical Center,
Series D, 7.875% due 7/1/09 3,098,444
1,000,000 NR Raritan Bay Medical Center, 7.250% due 7/1/27 1,071,250
2,500,000 AAA RWJ Health Care Corp., FSA-Insured,
6.500% due 7/1/24 2,750,000
2,400,000 BBB- Zurbrugg Memorial Hospital, Series C,
8.500% due 7/1/12 2,480,136
1,205,000 NR New Jersey State Educational Facilities Authority,
Fairleigh Dickinson University, Series C,
7.750% due 7/1/01 1,305,919
3,700,000 AAA New Jersey State Housing & Mortgage Finance Agency,
Multi-Family Housing Revenue, Presidential Plaza,
FHA-Insured, 7.000% due 5/1/30 3,935,875
2,500,000 AAA Perth Amboy, NJ Board of Education COP,
FSA-Insured, 6.125% due 12/15/17 2,646,875
Union County, NJ Utility Authority, Solid Waste Revenue:
1,090,000 BB Series A, 7.100% due 6/15/06(a) 1,115,888
4,725,000 BB Series A, 7.200% due 6/15/14(a) 4,837,219
2,000,000 AA+ Series D, 6.850% due 6/15/14(a) 2,182,500
- -----------------------------------------------------------------------------------------------------------
37,661,468
- -----------------------------------------------------------------------------------------------------------
New Mexico -- 0.0%
79,358 Aaa* Santa Fe, NM Single-Family Mortgage Revenue,
8.450% due 12/1/11 85,608
- -----------------------------------------------------------------------------------------------------------
New York -- 10.2%
Metropolitan Transportation Authority, New York
Commuter Facilities Revenue:
2,650,000 BBB+ Series A, 6.500% due 7/1/24 2,832,188
5,660,000 Aaa* Series B, 5.125% due 7/1/24 5,553,875
New York, NY GO Bonds:
4,500,000 BBB+ Series A, 6.250% due 8/1/17 4,798,125
2,500,000 BBB+ Series A-1, 6.500% due 8/1/19 2,687,500
4,175,000 BBB+ Series B, 7.000% due 10/1/12 4,540,313
3,500,000 BBB+ Series B, 5.250% due 8/1/16 3,421,250
5,000,000 BBB+ Series B, 6.000% due 8/15/26 5,231,250
5,000,000 BBB+ Series C, 6.660% due 8/1/09 5,262,500
40,000 AAA Series D, FSA-Insured, 8.500% due 8/1/13 41,498
5,500,000 BBB+ Series F, 6.125% due 2/1/25 5,802,500
2,750,000 BBB+ Series H, 6.125% due 8/1/25 2,921,875
3,085,000 BBB New York State COP, (Hanson Redevelopment Project),
8.375% due 5/1/08 3,686,575
</TABLE>
See Notes to Financial Statements.
16
<PAGE>
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Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
New York -- 10.2% (continued)
New York State Dormitory Authority Revenue:
$3,000,000 AAA Beth Israel Medical Center, Series A,
5.125% due 11/1/16 $ 2,966,250
4,550,000 BBB+ Mental Health Services Facility, Series B,
5.500% due 8/15/17 4,578,438
4,000,000 BBB+ State University Educational Facilities,
5.500% due 5/15/26 4,005,000
4,500,000 BBB- Upstate Community College, Series A,
6.250% due 7/1/25 4,753,125
1,500,000 AA Wesley Garden Nursing Home, FHA-Insured,
6.125% due 8/1/35 1,582,500
New York State Energy, Research and Development
Authority, Long Island Lighting Co.:
3,000,000 BB+ 7.150% due 6/1/20(a) 3,236,250
1,150,000 BB+ 7.150% due 12/1/20(a) 1,240,563
New York State Medical Care Facilities Finance Agency
Revenue:
430,000 BBB+ 7.750% due 2/15/20 469,238
590,000 AAA Pre-Refunded -- Escrowed with U.S. Government
Securities to 2/15/00 Call @ 102,
7.750% due 2/15/20 654,163
2,895,000 AAA Series C, Long-Term Health Care, FSA-Insured,
6.400% due 11/1/14 3,112,125
4,500,000 BBB+ Series F, Mental Health Services Facilities,
6.500% due 2/15/19 4,786,875
5,500,000 AA- New York State Power Authority Revenue, Series Z,
MBIA-Insured, 6.500% due 1/1/19 6,008,750
1,000,000 A2* United Nations Development Corp., NY Revenue
Refunding, Sr. Lien, Series B, 5.500% due 7/1/17 1,001,250
- -----------------------------------------------------------------------------------------------------------
85,173,976
- -----------------------------------------------------------------------------------------------------------
North Carolina -- 2.6%
2,675,000 B+ Charlotte, NC Special Facilities Revenue, (Piedmont
Aviation Inc. Project), 9.000% due 7/1/17(a) 2,790,587
8,500,000 AAA New Hanover County, NC Hospital Revenue, (Regional
Medical Center Project), AMBAC-Insured,
5.750% due 10/1/26 8,829,375
8,700,000 A- North Carolina Eastern Municipal Power Agency, Power
System Revenue, Series B, 7.000% due 1/1/08(c) 10,026,750
- -----------------------------------------------------------------------------------------------------------
21,646,712
- -----------------------------------------------------------------------------------------------------------
North Dakota -- 1.0%
Mercer County, ND PCR, Basin Electric Power:
3,000,000 AAA Second Series, AMBAC-Insured, 6.050% due 1/1/19 3,221,250
4,765,000 A Series E, 7.000% due 1/1/19 5,015,163
- -----------------------------------------------------------------------------------------------------------
8,236,413
- -----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
17
<PAGE>
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Ohio -- 2.7%
$3,000,000 AAA Akron Bath Copley, OH JT Township, Hospital District
Revenue Facilities, (Akron General Medical Center
Project), AMBAC-Insured, 5.375% due 1/1/17 $ 3,041,250
4,000,000 NR Cleveland, OH Airport Special Revenue, Continental
Airlines Inc., 9.000% due 12/1/19(a) 4,345,000
Ohio State Air Quality Development Authority:
3,500,000 AAA Columbus and Southern Ohio, Series A, FGIC-Insured,
6.375% due 12/1/20 3,771,250
5,000,000 BB Pollution Control-Toledo Edison, 6.875% due 7/1/23(a) 5,206,250
Ohio State Water Development Authority Revenue,
Series A:
3,475,000 BB Cleveland Electric, 8.000% due 10/1/23(a) 3,896,344
1,500,000 BB Toledo Edison, 8.000% due 10/1/23(a) 1,672,500
Series B:
210,000 BB+ Pennsylvania Power Project, 8.100% due 9/1/18(a) 214,649
- -----------------------------------------------------------------------------------------------------------
22,147,243
- -----------------------------------------------------------------------------------------------------------
Oklahoma -- 0.9%
4,500,000 AAA Oklahoma HFA, Single-Family Mortgage, Series B,
GNMA-Collateralized, 7.997% due 8/1/18(a) 5,163,750
2,400,000 BB+ Tulsa, OK Municipal Airport Revenue, American Airlines,
7.350% due 12/1/11 2,670,000
- -----------------------------------------------------------------------------------------------------------
7,833,750
- -----------------------------------------------------------------------------------------------------------
Pennsylvania -- 10.4%
4,000,000 AAA Allegheny County, PA Airport Revenue, Greater
Pittsburgh International Airport, Series B,
FSA-Insured, 6.625% due 1/1/22(a) 4,335,000
2,500,000 BBB- Allegheny County, PA Series A, 6.700% due 12/1/20 2,712,500
4,500,000 BBB Allentown, PA Hospital Authority Revenue, Sacred Heart
Hospital of Allentown, Series B, 6.750% due 11/15/15 4,809,375
1,250,000 AAA Beaver County, PA Hospital Authority, Beaver Medical
Center, Series A, AMBAC-Insured, 6.250% due 7/1/22 1,332,813
3,000,000 AAA Berks County, PA Solid Waste Authority, FGIC-Insured,
6.000% due 4/1/11 3,217,500
2,000,000 A Delaware County, PA IDA, Resource Recovery Facilities,
Series A, 6.200% due 7/1/19 2,100,000
3,000,000 AAA Franklin, PA IDA, (Chamberburgs Hospital Project),
FGIC-Insured, 6.250% due 7/1/12 3,232,500
1,330,000 BBB- Grove City, PA Area Hospital Authority Revenue,
United Community Hospital, 8.125% due 7/1/12 1,354,738
4,475,000 AAA Lehigh County, PA General Purpose Authority Revenue,
Lehigh Valley Hospital, Series B, MBIA-Insured,
5.625% due 7/1/25 4,542,125
Lehigh County, PA IDA, PCR, MBIA-Insured:
7,500,000 AAA 6.400% due 9/1/29 8,184,375
1,750,000 AAA Series A, 6.400% due 11/1/21 1,887,813
</TABLE>
See Notes to Financial Statements.
18
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Pennsylvania -- 10.4% (continued)
Luzerne County, PA IDA, Pennsylvania Gas and
Water Co., Series A:
$2,500,000 BBB 7.200% due 10/1/17(a) $ 2,725,000
2,250,000 BBB 6.050% due 1/1/19 2,317,500
3,380,000 AAA Montgomery County, PA IDA, PCR, Series B,
MBIA-Insured, 6.700% due 12/1/21 3,713,775
6,750,000 NR Montgomery County, PA Redevelopment Authority,
Multi-Family Housing, Series A, 6.500% due 7/1/25 6,800,625
Pennsylvania EDA:
4,500,000 BBB- Resource Recovery Revenue, (Colver Project),
Series D, 7.125% due 12/1/15 4,910,625
4,000,000 BBB+ WasteWater Treatment Revenue, Sun Co. Inc.,
(RTM Project), Series A, 7.600% due 12/1/24(a) 4,590,000
5,000,000 AAA Pennsylvania State Higher Education, Student Loan
Revenue, Series D, AMBAC-Insured,
6.050% due 1/1/19(a) 5,206,250
2,750,000 AAA Pennsylvania State IDA Revenue, AMBAC-Insured,
6.000% due 1/1/12 2,956,250
1,000,000 AA Philadelphia, PA Authority for IDR, (Girard Estate
Facility Leasing Project), 5.000% due 5/15/27 956,250
Philadelphia, PA Municipal Authority Gas Works
Lease Revenue:
2,500,000 BBB- 7.625% due 5/1/14 2,643,750
990,000 BBB- Series B, 6.400% due 11/15/16 1,034,550
7,950,000 AAA Philadelphia, PA School District, Series B,
5.375% due 4/1/27 7,999,688
2,500,000 AAA Scranton-Lackawanna, PA Health & Welfare Authority
Revenue, Series B, Moses Taylor Hospital,
(Pre-Refunded -- Escrowed with U.S. Government
Securities to 7/1/01 Call @ 102), 8.500% due 7/1/20 2,931,250
- -----------------------------------------------------------------------------------------------------------
86,494,252
- -----------------------------------------------------------------------------------------------------------
Puerto Rico -- 0.8%
Commonwealth of Puerto Rico:
455,000 A GO, 8.000% due 7/1/08 478,983
5,760,000 BBB Urban Renewal & Housing Corp., 7.875% due 10/1/04 6,264,000
- -----------------------------------------------------------------------------------------------------------
6,742,983
- -----------------------------------------------------------------------------------------------------------
Rhode Island -- 1.6%
2,650,000 AAA Rhode Island Depositors Economic Protection Corp.,
Series B, MBIA-Insured, 6.000% due 8/1/17 2,825,563
9,500,000 AA+ Rhode Island Housing and Mortgage Finance Authority,
7.100% due 4/1/24(a)(c)(d) 10,105,625
- -----------------------------------------------------------------------------------------------------------
12,931,188
- -----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
19
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
South Carolina -- 1.1%
$2,400,000 A3* Fairfield County, SC IDR, Rite Aid Corp.,
7.900% due 12/1/16(a) $ 2,461,632
1,500,000 BBB+ Greenville County, SC IDR, (Lockheed Aeromod
Center Project), 7.200% due 11/1/21(a) 1,633,125
500,000 AAA Lexington County, SC Health Services District, Hospital
Revenue, FSA-Insured, 6.750% due 10/1/18 549,375
4,000,000 A- Richland County, SC PCR, (Union Camp Corp.
Project), 6.625% due 5/1/22 4,335,000
- -----------------------------------------------------------------------------------------------------------
8,979,132
- ------------------------------------------------------------------------------------------------------------
South Dakota -- 0.2%
Oglala Sioux , SD Tribal Revenue Bond:
1,865,000 NR 7.500% due 7/1/13 1,911,625
150,000 NR 7.000% due 7/1/99 152,062
- -----------------------------------------------------------------------------------------------------------
2,063,687
- -----------------------------------------------------------------------------------------------------------
Tennessee -- 3.2%
7,000,000 AA Humphreys County, TN IDB, 6.700% due 5/1/24(a) 7,726,250
7,100,000 A- Maury County, TN IDB, PCR, (Saturn Corp. Project),
6.500% due 9/1/24 7,792,250
3,150,000 BBB Memphis-Shelby County, TN Airport Authority,
Federal Express Corp., 6.750% due 9/1/12 3,453,188
5,000,000 AAA Metropolitan Nashville Airport Authority, TN Airport
Revenue, Special Facilities, Series C, FGIC-Insured,
6.600% due 7/1/15 5,437,500
1,000,000 NR Metropolitan Nashville & Davidson County, TN IDB
Revenue, Volunteer Health Care, Series A,
10.750% due 6/1/18(f) 300,000
1,500,000 AAA Tennessee Housing Development Mortgage Agency,
Series B, MBIA-Insured, 6.200% due 7/1/18 1,569,375
- -----------------------------------------------------------------------------------------------------------
26,278,563
- -----------------------------------------------------------------------------------------------------------
Texas -- 6.2%
5,100,000 BBB Alliance Airport Authority Inc., (Special Federal
Express Corp. Project), 6.375% due 4/1/21 5,374,125
Brazos River Authority, TX PCR, Houston Lighting &
Power Co.:
2,000,000 AAA Series A, AMBAC-Insured, 6.700% due 3/1/17 2,205,000
1,900,000 AAA Series B, FGIC- Insured, 7.200% due 12/1/18 2,052,000
4,000,000 AAA Dallas-Fort Worth, TX International Airport Facilities,
UPS Services, Inc., 6.600% due 5/1/32(a) 4,375,000
2,000,000 NR Denton County, TX Reclamation and Road District,
8.500% due 6/1/16 2,013,660
Harris County, TX Refunding Toll Road Authority:
970,000 AAA Series A, AMBAC-Insured, 6.500% due 8/15/17 1,060,937
4,000,000 AAA Sr. Lien, MBIA-Insured, 5.125% due 8/15/17 3,965,000
</TABLE>
See Notes to Financial Statements.
20
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Texas -- 6.2% (continued)
$ 95,000 BBB Heart of Texas, HFA, Single-Family Mortgage Revenue,
Series 1984, 11.000% due 1/1/11 $ 96,040
Matagorda County, TX PCR, Navajo District No. 1,
(Houston Light & Power Co. Project):
500,000 A Series B, 7.700% due 2/1/19 518,020
2,100,000 AAA Series E, FGIC-Insured, 7.200% due 12/1/18 2,275,875
600,000 NR North Texas, Higher Education Authority Inc.,
6.300% due 4/1/09(a) 623,250
4,000,000 AA- Port Corpus Christi, TX IDR, (Hoeschst Celanese Corp.
Project), 6.875% due 4/1/17(a) 4,370,000
Sam Rayburn, TX Municipal Power Agency, Power
Supply System Revenue:
2,645,000 BB Series A, 6.750% due 10/1/14 2,668,144
2,500,000 BB Series B, 6.125% due 10/1/13 2,384,375
San Antonio, TX Airport System Revenue, AMBAC-Insured:
3,000,000 AAA 7.125% due 7/1/06 3,472,500
1,000,000 AAA 7.125% due 7/1/08 1,157,500
2,000,000 AAA 7.375% due 7/1/13 2,315,000
2,000,000 AAA Terrel Hills, TX Higher Education, (Incarnate World College
Project), CONNIE LEE-Insured, 5.750% due 3/15/13 2,085,000
3,010,000 AAA Texas Municipal Power Agency Revenue Bonds,
Series A, AMBAC-Insured, 6.750% due 9/1/12 3,318,525
2,070,000 AAA Texas State Department of Housing and Community Affairs,
Home Mortgage Revenue, Series A, 6.950% due 7/1/23 2,207,137
2,605,000 AA Texas State Veterans Housing Assistance, Single-Family
Mortgage Revenue, 6.800% due 12/1/23(a) 2,790,606
- -----------------------------------------------------------------------------------------------------------
51,327,694
- -----------------------------------------------------------------------------------------------------------
Utah -- 0.6%
4,000,000 AAA Utah Municipal Power System Revenue, (San Juan
Project), MBIA-Insured, 6.375% due 6/1/22
4,345,000 Utah State HFA, Single-Family Mortgage:
335,000 AA Series D, 8.625% due 1/1/19(a) 365,987
305,000 Aa* Series D1, 6.200% due 7/1/16 313,006
- -----------------------------------------------------------------------------------------------------------
5,023,993
- -----------------------------------------------------------------------------------------------------------
Virginia -- 1.6%
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 2,620,669
1,720,000 NR Henrico County, VA IDA, Maryview Hospital, Series B,
(Pre-Refunded -- Escrowed with U.S. Government
Securities to 8/1/00 Call @ 102), 7.500% due 9/1/11(b) 1,909,200
8,000,000 A- Isle Wight County, VA IDA, Solid Waste Disposal Revenue,
6.550% due 4/1/24(a) 8,800,000
- -----------------------------------------------------------------------------------------------------------
13,329,869
- -----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
21
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
Washington -- 1.7%
$11,345,000 AAA Chelan County, WA Public Utility District No. 1,
Columbia River Rock, Capital Appreciation,
Series A, MBIA-Insured, zero coupon due 6/1/19 $ 3,545,312
2,000,000 BBB Port Moses Lake, WA PCR, Union Carbide,
7.875% due 8/1/06(a) 2,053,840
2,000,000 AAA Port of Seattle, WA Subordinated Lien, MBIA-Insured,
6.625% due 8/1/17 2,195,000
3,000,000 AAA Snohomish County, WA Electric Revenue Generation
System, Public Utility District No. 1, FGIC-Insured,
6.000% due 1/1/18 3,153,750
2,750,000 AAA Washington State Health Care Facilities Authority
Revenue, Franciscan Health, St. Joseph,
MBIA-Insured, 6.700% due 7/1/21 2,970,000
- -----------------------------------------------------------------------------------------------------------
13,917,902
- -----------------------------------------------------------------------------------------------------------
West Virginia -- 1.0%
2,000,000 A Beckley, WV IDR, (Water Commission Project),
7.000% due 10/1/17(a) 2,192,500
2,000,000 A Braxton County, WV, Solid Waste Disposal Revenue,
(Weyerhaeuser Co. Project), 5.800% due 6/1/24(a) 2,032,500
Marion County, WV Solid Waste Disposal Revenue,
American Power, Paper Recycling:
2,500,000 NR 7.750% due 12/1/11(a)(f) 1,250,000
5,000,000 NR 9.000% due 12/1/11(a)(f) 2,500,000
500,000 AAA West Virginia State Water Development Authority,
Series A, 7.000% due 11/1/25 548,750
- -----------------------------------------------------------------------------------------------------------
8,523,750
- -----------------------------------------------------------------------------------------------------------
Wisconsin -- 0.2%
1,670,000 BBB Racine County, WI Health Center Revenue,
8.125% due 8/1/21 1,727,046
- -----------------------------------------------------------------------------------------------------------
Wyoming -- 0.8%
Wyoming Community Development Authority Housing
Revenue:
1,250,000 AA 7.100% due 6/1/17 1,354,687
5,250,000 AA Series 4, Remarketed 8/21/97, 5.850% due 6/1/28(a) 5,328,750
- -----------------------------------------------------------------------------------------------------------
6,683,437
- -----------------------------------------------------------------------------------------------------------
TOTAL MUNICIPAL BONDS AND NOTES
(Cost -- $773,955,958) 826,067,742
===========================================================================================================
</TABLE>
See Notes to Financial Statements.
22
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
============================================================================================================
<C> <C> <S> <C>
SHORT-TERM INVESTMENTS(e) -- 0.9%
NewYork State Energy Research & Development
Authority, PCR, NYS Electric & Gas:
$2,500,000 VMIG 1* Series B, 3.350% due 2/1/29 $ 2,500,000
2,500,000 VMIG 1* Series C, 3.300% due 6/1/29 2,500,000
Port Authority NY & NJ, Special Obligation Revenue,
Versatile Structure Obligation:
1,300,000 VMIG 1* Series 2, 3.650% due 5/1/19 1,300,000
1,500,000 VMIG 1* Series 4, 3.550% due 4/1/24(a) 1,500,000
- -----------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS
(Cost -- $7,800,000) 7,800,000
============================================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $781,755,958**) $833,867,742
============================================================================================================
</TABLE>
(a) Income from this issue is considered a preference item for purposes of
calculating the alternative minimum tax.
(b) Pre-Refunded bond escrowed by U.S. Government securities is considered by
manager to be triple-A rated even if issuer has not applied for new
ratings.
(c) Security segregated by custodian for open purchase commitments.
(d) Residual interest bonds -- coupon varies inversely with level of short-term
tax-exempt interest rates.
(e) Variable rate municipal bonds and notes are payable upon not more than
seven business days notice.
(f) Security is in default.
** Aggregate cost for Federal income tax purposes is substantially the same.
See pages 24 and 25 for definition of ratings and certain security
descriptions.
See Notes to Financial Statements.
23
<PAGE>
- --------------------------------------------------------------------------------
Bond Ratings
- --------------------------------------------------------------------------------
All ratings are by Standard & Poor's Ratings Service ("Standard & Poor's"),
except that those identified by an asterisk (*) are rated by Moody's Investors
Service, Inc. ("Moody's"). The definitions of the applicable rating symbols are
set forth below:
Standard & Poor's -- Ratings from "AA" to "B" may be modified by the addition of
a plus (+) or minus (-) sign to show relative standings within the major rating
categories.
AAA -- Bonds rated "AAA"' have the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely
strong.
AA -- Bonds rated "AA" have a very strong capacity to pay interest and
repay principal and differ from the highest rated issue only in a small
degree.
A -- Bonds rated "A" have a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than bonds
in higher rated categories.
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 in higher
rated categories.
BB -- Bonds rated "BB" have less near-term vulnerability to default than
other speculative issues. However, they face 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.
B -- Bonds rated "B" have a greater vulnerability to default but currently
have the capacity to meet interest payments and principal payments.
Adverse business, financial, or economic conditions will likely impair
capacity or willingness to pay interest and repay principal. The "B"
rating category is also used for debt subordinated to senior debt that
is assigned an actual or implied "BB" or "BB-" rating.
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 or Moody's.
24
<PAGE>
- --------------------------------------------------------------------------------
Short-Term Security 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 Governments
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
25
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities July 31, 1997
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost -- $781,755,958) $ 833,867,742
Cash 8,047
Interest receivable 11,409,436
Receivable for securities sold 8,109,020
Receivable for Fund shares sold 639,160
- --------------------------------------------------------------------------------
Total Assets 854,033,405
- --------------------------------------------------------------------------------
LIABILITIES:
Payable for securities purchased 35,709,657
Payable for Fund shares redeemed 988,550
Investment advisory fees payable 314,954
Distribution fees payable 158,915
Administration fees payable 144,601
Accrued expenses 157,849
- --------------------------------------------------------------------------------
Total Liabilities 37,474,526
- --------------------------------------------------------------------------------
Total Net Assets $ 816,558,879
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 45,157
Capital paid in excess of par value 757,420,669
Overdistributed net investment income (4,147)
Accumulated net realized gain from security transactions 6,985,416
Net unrealized appreciation of investments 52,111,784
- --------------------------------------------------------------------------------
Total Net Assets $ 816,558,879
================================================================================
Shares Outstanding:
Class A 14,030,744
------------------------------------------------------------------------------
Class B 31,084,397
------------------------------------------------------------------------------
Class C 41,636
-----------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $ 18.07
------------------------------------------------------------------------------
Class B* $ 18.09
------------------------------------------------------------------------------
Class C** $ 18.07
------------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 4.17% of net asset value per share) $ 18.82
================================================================================
* 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.
See Notes to Financial Statements.
26
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended July 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $ 53,991,911
- --------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 3) 4,316,732
Investment advisory fees (Note 3) 3,395,338
Administration fees (Note 3) 1,697,669
Shareholder and system servicing fees 308,592
Registration fees 109,891
Shareholder communications 53,282
Pricing service fees 48,209
Audit and legal 43,332
Custody 33,953
Trustees' fees 25,371
Other 14,884
- --------------------------------------------------------------------------------
Total Expenses 10,047,253
- --------------------------------------------------------------------------------
Net Investment Income 43,944,658
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS (NOTE4):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 519,002,258
Cost of securities sold 508,887,749
- --------------------------------------------------------------------------------
Net Realized Gain 10,114,509
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments:
Beginning of year 25,816,358
End of year 52,111,784
- --------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 26,295,426
- --------------------------------------------------------------------------------
Net Gain on Investments 36,409,935
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 80,354,593
================================================================================
See Notes to Financial Statements.
27
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended July 31,
- --------------------------------------------------------------------------------
1997 1996
================================================================================
OPERATIONS:
Net investment income $ 43,944,658 $ 50,346,526
Net realized gain 10,114,509 4,816,209
Increase (decrease) in net unrealized
appreciation 26,295,426 (642,445)
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 80,354,593 54,520,290
- --------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM (NOTE 2):
Net investment income (44,020,626) (50,274,705)
Net realized gains (146,695) --
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (44,167,321) (50,274,705)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net proceeds from sale of shares 64,943,500 55,204,274
Net asset value of shares issued for
reinvestment of dividends 24,165,462 27,635,290
Cost of shares reacquired (194,060,215) (176,253,665)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (104,951,253) (93,414,101)
- --------------------------------------------------------------------------------
Decrease in Net Assets (68,763,981) (89,168,516)
NET ASSETS:
Beginning of year 885,322,860 974,491,376
- --------------------------------------------------------------------------------
End of year* $ 816,558,879 $ 885,322,860
================================================================================
* Includes undistributed (overdistributed)
net investment income of: $ (4,147) $ 71,821
================================================================================
See Notes to Financial Statements.
28
<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 this
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 except
for the Smith Barney Premium Total Return Fund which will have an annual report
dated December 31, 1997.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) securities are
valued at the mean between the bid and asked price provided 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 value; (d) interest income, adjusted for
amortization of premium and accretion of original issue discount, is recorded on
an accrual basis; (e) gains or losses on the sale of securities are calculated
by 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 character of income
and gains to be distributed are determined in accordance with income tax
regulations which may differ from generally accepted accepted accounting
principles. At July 31, 1997, reclassifications were made to undistributed net
investment income and accumulated net realized gains to reflect book/tax
differences and income and gains available for distributions under income tax
regulations. Net investment income, net realized gains and net assets were not
affected by this change; (i) 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 (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.
29
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
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.
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, 1997, SB received sales charges of
approximately $46,000 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 within 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 certain cases, 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, 1997, CDSCs paid to SB were approximately:
Class A Class B
================================================================================
CDSCs $1,000 $525,000
================================================================================
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 0.15% 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 rates of 0.50%
30
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
and 0.55% of the average daily net assets of each class, respectively. For the
year ended July 31, 1997, total Distribution Plan fees incurred were:
Class A Class B Class C
================================================================================
Distribution Plan Fees $360,300 $3,952,088 $4,344
================================================================================
All officers and one Trustee of the Trust are employees of SB.
4. INVESTMENTS
During the year ended July 31, 1997, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $431,018,180
- --------------------------------------------------------------------------------
Sales 519,002,258
================================================================================
At July 31, 1997, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were substantially
as follows:
================================================================================
Gross unrealized appreciation $56,682,600
Gross unrealized depreciation (4,570,816)
- --------------------------------------------------------------------------------
Net unrealized appreciation $52,111,784
================================================================================
5. SHARES OF BENEFICIAL INTEREST
At July 31, 1997, 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, 1997, total paid-in capital amounted to the following for each
class:
Class A Class B Class C
================================================================================
Total Paid-in Capital $241,749,647 $514,993,440 $722,739
================================================================================
31
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
July 31, 1997 July 31, 1996
------------------------ ---------------------------
Shares Amount Shares Amount
=======================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 2,790,664 $ 48,988,072 1,718,386 $ 29,741,505
Shares issued on reinvestment 447,061 7,854,117 435,764 8,042,396
Shares redeemed (2,583,632) (45,394,525) (2,554,580) (44,691,662)
- ---------------------------------------------------------------------------------------
Net Increase (Decrease) 654,093 $ 11,447,664 (400,430) $ (6,907,761)
=======================================================================================
Class B
Shares sold 895,576 $ 15,762,835 1,517,563 $ 25,090,157
Shares issued on reinvestment 926,744 16,286,642 1,032,778 19,575,379
Shares redeemed (8,446,167) (148,626,196) (7,527,055) (131,511,049)
- ---------------------------------------------------------------------------------------
Net Decrease (6,623,847) $(116,576,719) (4,976,714) $ (86,845,513)
=======================================================================================
Class C
Shares sold 10,961 $ 192,593 21,320 $ 372,612
Shares issued on reinvestment 1,406 24,703 908 17,515
Shares redeemed (2,269) (39,494) (2,922) (50,954)
- ---------------------------------------------------------------------------------------
Net Increase 10,098 $ 177,802 19,306 $ 339,173
=======================================================================================
</TABLE>
32
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1997 1996 1995 1994 1993(1)
======================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 17.31 $ 17.25 $ 17.26 $ 18.24 $ 17.45
- ------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.97 1.00 1.04 1.06 0.78
Net realized and unrealized gain (loss) 0.77 0.06 0.01* (0.85) 1.00
- ------------------------------------------------------------------------------------------------------
Total Income From Operations 1.74 1.06 1.05 0.21 1.78
- ------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.98) (1.00) (1.00) (1.06) (0.83)
Net realized gains 0.00** -- (0.02) (0.13) (0.16)
Capital -- -- (0.04) -- --
- ------------------------------------------------------------------------------------------------------
Total Distributions (0.98) (1.00) (1.06) (1.19) (0.99)
- ------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 18.07 $ 17.31 $ 17.25 $ 17.26 $ 18.24
- ------------------------------------------------------------------------------------------------------
Total Return 10.40% 6.28% 6.42% 1.14% 10.24%++
- ------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $253,580 $231,589 $237,656 $17,792 $13,508
- ------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.83% 0.84% 0.84% 0.84% 0.86%+
Net investment income 5.52 5.74 6.04 5.83 6.03+
- ------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 51% 44% 38% 39% 34%
======================================================================================================
</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.
** Amount represents less than $0.01. ++ Total return is not annualized, as it
may not be representative of the total return for the year.
+ Annualized.
33
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class B Shares 1997 1996 1995 1994 1993
================================================================================
Net Asset Value,
Beginning of Year $17.32 $17.26 $17.26 $18.24 $18.00
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.89 0.92 0.95 0.96 0.98
Net realized and unrealized
gain (loss) 0.77 0.06 0.02* (0.85) 0.45
- --------------------------------------------------------------------------------
Total Income From Operations 1.66 0.98 0.97 0.11 1.43
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.89) (0.92) (0.91) (0.96) (1.02)
Net realized gains 0.00** -- (0.02) (0.13) (0.17)
Capital -- -- (0.04) -- --
- --------------------------------------------------------------------------------
Total Distributions (0.89) (0.92) (0.97) (1.09) (1.19)
- --------------------------------------------------------------------------------
Net Asset Value,
End of Year $18.09 $17.32 $17.26 $17.26 $18.24
- --------------------------------------------------------------------------------
Total Return 9.89% 5.74% 5.91% 0.60% 8.28%
- --------------------------------------------------------------------------------
Net Assets,
End of Year (millions) $ 562 $ 653 $ 737 $1,069 $1,108
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.32% 1.33% 1.35% 1.33% 1.38%
Net investment income 5.04 5.23 5.61 5.34 5.52
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 51% 44% 38% 39% 34%
================================================================================
* 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.
** Amount represents less than $0.01.
34
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class C Shares 1997 1996 1995(1)
================================================================================
Net Asset Value, Beginning of Year $ 17.31 $ 17.25 $ 15.83
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.88 0.89 0.60
Net realized and unrealized gain 0.77 0.08 1.50*
- --------------------------------------------------------------------------------
Total Income From Operations 1.65 0.97 2.10
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.89) (0.91) (0.62)
Net realized gains 0.00** -- (0.02)
Capital -- -- (0.04)
- --------------------------------------------------------------------------------
Total Distributions (0.89) (0.91) (0.68)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 18.07 $ 17.31 $ 17.25
- --------------------------------------------------------------------------------
Total Return 9.79% 5.69% 13.45%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 752 $ 546 $ 211
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.40% 1.39% 1.18%+
Net investment income 4.94 5.18 5.56+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 51% 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.
** Amount represents less than $0.01.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
- --------------------------------------------------------------------------------
Additional Tax Information (unaudited)
- --------------------------------------------------------------------------------
For Federal income tax purposes the Fund hereby designates for the fiscal
year ended July 31, 1997:
o 100% of the dividends paid by the Fund from net investment income as
tax-exempt for regular Federal income tax purposes.
35
<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, 1997, and the related statement of
operations for the year then ended, the statements of changes in net assets for
each of the years in the two-year period then ended, and the financial
highlights for each of the years in the three-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 two-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, 1997, 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,
1997, the results of its operations for the year then ended, the changes in its
net assets for each of the years in the two-year period then ended, and the
financial highlights for each of the years in the three-year period then ended,
in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
September 15, 1997
36
<PAGE>
Smith Barney SMITH BARNEY
Tax-Exempt A Member of Travelers Group [LOGO]
Income Fund
Trustees
Lee Abraham
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon, Chairman
Officers
Heath B. McLendon
Chairman and Investment Officer
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 9/97
[PHOTO]
Smith Barney
Convertible
Fund
ANNUAL REPORT
July 31, 1997
[LOGO] Smith Barney Mutual Funds
Investing for your future.
Every day(sm).
<PAGE>
Smith Barney
Convertible Fund
================================================================================
The Smith Barney Convertible Fund seeks current income and capital appreciation
by investing in convertible securities. Convertibles are bonds or preferred
stocks that can be converted into a preset number of shares of common stocks
after a preset date.
Smith Barney Convertible Fund's
Average Annual Total Returns Ended
July 31, 1997
Without Sales Charges*
-------------------------------
Class A Class B Class C
=====================================================================
One-Year 26.94% 26.29% 26.37%
- ---------------------------------------------------------------------
Five-Year N/A 11.28 N/A
- ---------------------------------------------------------------------
Ten-Year N/A 9.08 N/A
- ---------------------------------------------------------------------
Since Inception+ 12.27 9.44 16.40
=====================================================================
With Sales Charges**
-------------------------------
Class A Class B Class C
=====================================================================
One-Year 20.62% 21.29% 25.37%
- ---------------------------------------------------------------------
Five-Year N/A 11.15 N/A
- ---------------------------------------------------------------------
Ten-Year N/A 9.08 N/A
- ---------------------------------------------------------------------
Since Inception+ 11.06 9.44 16.40
=====================================================================
* 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.
** 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. Thereafter, the CDSC declines 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.
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.
+ Inception dates for Class A, B and C shares are November 6, 1992, September
9, 1986 and November 7, 1994.
- --------------------------------------------------------------------------------
OUR INVESTMENT PHILOSOPHY
- --------------------------------------------------------------------------------
At Smith Barney Mutual Funds, your investment needs come first. Our goal is to
deliver consistent and competitive returns over time, using a wide range of
investment strategies.
- --------------------------------------------------------------------------------
NASDAQ SYMBOL
- --------------------------------------------------------------------------------
Class A SCRAX
Class B SCVSX
- --------------------------------------------------------------------------------
WHAT'S INSIDE
- --------------------------------------------------------------------------------
Shareholder Letter.............................................1
An Interview with Portfolio Manager
Robert E. Swab.................................................4
Historical Performance.........................................7
Smith Barney Convertible Fund at a Glance......................9
Schedule of Investments.......................................10
Statement of Assets and Liabilities...........................13
Statement of Operations.......................................14
Statements of Changes in Net Assets...........................15
Notes to Financial Statements.................................16
Financial Highlights..........................................19
Independent Auditors' Report..................................23
Tax Information...............................................24
<PAGE>
- --------------------------------------------------------------------------------
Shareholder Letter
- --------------------------------------------------------------------------------
[PHOTO]
HEATH B. MCLENDON
Chairman
[PHOTO]
ROBERT E. SWAB
Vice President and
Investment Officer
Dear Shareholder:
We are pleased to provide the annual report for the Smith Barney Convertible
Fund for the year ended July 31, 1997. In this report, we summarize the period's
prevailing economic and market conditions, and outline our portfolio strategy.
Detailed summaries of performance and current holdings can be found in the
appropriate sections that follow. In addition, an interview with Robert E. Swab,
the Fund's Portfolio Manager, appears on page four.
Performance Overview
For the year ended July 31, 1997, the Smith Barney Convertible Fund ("Fund") had
a total return of 26.94% for Class A shares compared with its Lipper Analytical
Services Inc. peer group average of 27.95% for the same period. (Lipper
Analytical Services, Inc. is an independent fund-tracking organization.)
Convertible securities have the characteristics of both stock and bond
investments. The stock portion of the Fund's convertible securities particularly
benefitted from the dramatic rise in stock prices during this period. We are
pleased with the Fund's performance since it is more conservatively managed than
many other convertible funds. Our conservative management style is demonstrated
by the following three key fundamentals: 1) the Fund invests primarily in
convertible securities and rarely invests in other asset classes such as common
stocks; 2) the Fund has a high quality orientation; and 3) the Fund tends to
offer more downside protection in a volatile market because it focuses on
providing higher yield.
Economic and Market Overview
The U.S. economy continued to grow this past year, extending the business cycle
expansion that began seven years ago. One unique characteristic in this late
phase of the expansion is the general absence of inflationary pressures. Over
the past year, the U.S. economy grew in excess of 3%, and inflation during this
period rose less than 3%. In fact, during the second quarter of 1997 inflation
actually fell to an annualized rate of 2.3%. In our view, the positive news on
inflation can be attributed to several factors. First, an increasingly
competitive world economy has made it more difficult for global companies to
raise prices for fear of losing market share. Second, the widespread strategic
decisions by corporate America over the past several years to substitute capital
(which includes technology) for labor has kept wages from rising significantly.
Finally, worker productivity has increased dramatically, thanks in large part to
the greater use of technology in general business operations. This rise in
worker productivity has limited the need for corporations to raise prices on
their products in order to sustain their profit margins.
The positive news on inflation was well received by bond investors this past
year as bond prices rose and interest rates declined. The yield on the
thirty-year U.S. Treasury bond dropped from 6.97% to 6.30%. With the exception
of a single quarter-point rate hike in the federal-funds rate earlier this year,
the Federal Reserve Bank ("Fed") has held monetary policy stable for the past
twelve months. (The federal-funds rate is the interest rate banks charge each
other for overnight loans and a closely watched indicator of the direction of
interest rates.) The bond market also got a boost from the then imminent federal
balanced budget agreement and from the continued strength of the U.S. dollar.
Lower interest rates, coupled with the growing U.S. economy and strength in
corporate earnings, helped
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 1
<PAGE>
drive the stock market to record highs throughout the year. Between July 31,
1996, and July 31,1997, the Standard & Poor's 500 Index ("S&P 500"), increased
from 639.95 to 954.29. (The S&P 500 Index is a capitalization-weighted measure
of 500 widely held common stocks.) The significant gain in the stock market,
(49% excluding dividends), surprised many investment professionals, who expected
milder returns following the sharp run-up in the market averages during 1995 and
1996. The real surprise over the past year came from corporate earnings. For
eighteen straight quarters now, overall corporate earnings have come in above
Wall Street analysts' estimates. Most of corporate America, benefitting from an
increase in final demand, cost cutting and productivity gains, has delivered
solid results for four consecutive years.
The convertible securities market continued to perform well this past year,
given the strength in both the stock and bond markets. As noted, convertible
securities are unique investments that have both stock and bond characteristics
and the increase in value of both stocks and bonds directly benefitted these
hybrid investments. In addition, convertible securities continue to gain in
popularity as a separate asset class because of their attractive risk-reward
characteristics and income-generating features.
The convertible securities market is now roughly $115 billion in size. The past
year has been another active period for the new-issue market, as the rising
stock market and lower interest rates have created excellent opportunities for
companies to raise money using convertible securities. Year to date, the amount
of money raised in the new-issue market is approaching $17 billion. On the other
hand, due to the stock market's strength, $19 billion of convertibles were
redeemed as many issues lost their call protection.
Investment Strategy
The Fund's objective, which is to seek current income and appreciation by
investing in convertible securities, has remained unchanged during the past
twelve months. We continue to invest in convertible securities that we believe
offer attractive total return opportunities based on our overall economic and
investment outlook. As noted, unlike many other convertible funds, we generally
do not invest in other asset classes such as common stocks. Our objective is to
offer investors an opportunity to participate in the long-term growth of the
stock market while providing the potential for less risk and lower volatility.
In our opinion, investing in other asset classes like common stocks would
increase both the risk and the volatility of the Fund's portfolio. The bond
component of convertible securities affords some downside protection if a
company's underlying common stock price loses value. In addition, we continue to
avoid for the most part unrated securities and illiquid private placements. We
continue to emphasize quality issues, with 40% - 50% of our assets in
convertible securities rated investment grade (i.e., Baa or higher by Moody's
Investors Service Inc. or BBB and above by Standard & Poor's Ratings Service,
two major credit reporting and bond rating agencies). Moreover, many of the
remaining issues in the Fund have the potential for credit upgrades by the major
rating agencies sometime in the future.
Diversification is another key element in reducing risk. We think the Fund is
well diversified, with more than 20 different industries represented spanning a
broad range of economic sectors. Some of the Fund's more heavily weighted
sectors of the market include financial services, energy, and technology. We
believe there are excellent capital appreciation opportunities in these areas.
Over the past year we have accordingly increased our technology holdings as the
underlying fundamentals for the group have improved. Since our last report, the
Fund established new positions in:
o 3Com Corp., the world's number one maker of hardware that lets computers
communicate with each other across networks.
o Adaptec Inc., a world leader in the manufacturing of hardware and software
that eliminates performance bottlenecks between computers.
o Unisys Corp., an information management company.
- --------------------------------------------------------------------------------
2 1997 Annual Report to Shareholders
<PAGE>
We also established new positions in:
o Airtouch Communications, a telecommunications company that provides
wireless services to nearly 8 million customers in the U.S. and
internationally.
o U.S. Filter, one of the world's leading manufacturers of water treatment
systems and replacement parts.
o Unocal, one of the biggest independent oil exploration and production
companies in the world.
o The Sports Authority, one of the largest sporting goods superstore chains
in the United States.
Over the past year we added to our positions in Alaska Air, Inco Ltd. and
International Paper. We sold our positions in Interpublic Group, McKesson Corp.,
and Chiron Corp. because the convertible pricing characteristics had changed for
these companies. Moreover, during the past six months, our holdings in Cooper
Industries, Chubb, USX/Marathon, The Equitable Cos. and GenCorp were called for
redemption.
Market Outlook
We expect the U.S. economy to continue to grow over the next twelve months,
extending for another year the economic expansion that began in 1990. During the
past few years, we think the Fed has done a superb job in keeping the economy
growing and limiting inflationary pressures through timely implementation of
monetary policy. We believe the Fed will continue to show resolve in its
inflation fighting efforts but will also be quick to change monetary policy if
economic growth slows.
Our forecast for the U.S. economy is an annual growth rate between 2% and 3%
over the next year, with inflation remaining in a stable 2% to 3% range. Since
1995, the returns on financial assets, especially on the stock market, have been
extraordinary, as the investment environment has been close to perfect. We
believe that the long-term fundamentals remain positive for the financial
markets, but recommend that investors manage their expectations in terms of
lower potential returns in the next few years. We are forecasting that stock
market returns should be closer to 10% to 12% over the next few years versus the
record returns generated between 1995 and 1997. We believe the Smith Barney
Convertible Fund should provide solid risk-adjusted returns in this type of
environment.
On a more somber note, we were saddened by the loss of two outstanding business
leaders and Trustees of the Fund, Antoinette C. Bentley and Madelon De Voe
Talley. Their knowledge and wisdom will be missed.
In closing, thank you for your investment in the Smith Barney Convertible Fund.
We look forward to helping you pursue your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ Robert E. Swab
Heath B. McLendon Robert E. Swab
Chairman Vice President and
Investment Officer
August 22, 1997
- --------------------------------------------------------------------------------
Top Five Stock Holdings* As of July 31, 1997
- --------------------------------------------------------------------------------
1. Corning Delaware LP 2.6%
- --------------------------------------------------------------------------------
2. International Paper Co. 2.1
- --------------------------------------------------------------------------------
3. Occidental Petroleum Corp. 2.1
- --------------------------------------------------------------------------------
4. Cyprus AMAX Minerals Co., Series A 2.0
- --------------------------------------------------------------------------------
5. H.F. Ahmanson & Co. 2.0
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Top Five Bond Holdings* As of July 31, 1997
- --------------------------------------------------------------------------------
1. Grand Metropolitan PLC 3.9%
- --------------------------------------------------------------------------------
2. Airborne Freight Corp. 3.8
- --------------------------------------------------------------------------------
3. Inco Ltd. 2.9
- --------------------------------------------------------------------------------
4. Mascotech Inc. 2.5
- --------------------------------------------------------------------------------
5. WMX Technologies Inc. 2.5
- --------------------------------------------------------------------------------
* As a percentage of total investments.
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 3
<PAGE>
- --------------------------------------------------------------------------------
An Interview with Portfolio Manager
Robert E. Swab
- --------------------------------------------------------------------------------
Bob Swab is a Vice President of Smith Barney and the Portfolio Manager of the
Smith Barney Convertible Fund. Bob co-managed the Fund from 1991 to 1994 and
assumed sole responsibility for making the Fund's investment decisions in 1995.
He previously worked for the Asset Management division of E.F. Hutton, where he
was responsible for managing a number of equity portfolios. Bob has more than 19
years of Wall Street experience and holds a B.A. degree in economics from
Rutgers University.
Bob, you were recently cited in a Fortune Magazine article as a "manager with a
proven, long-term record in good times and bad." Is there something about the
Smith Barney Convertible Fund and planning for retirement that makes particular
sense?
Bob: I think as people grow older, they look for more income from their
investments. At the same time, though, they recognize that growth of capital is
still important. But whether you're a retiree or a newlywed, you can use
convertible securities as a "portfolio stabilizer." Most investors have some
conservative, fixed-income assets on one side and growth-oriented, equity
investments on the other. Convertible securities belong in the middle. With
convertibles, you pick up some of the appreciation potential of stocks plus some
of the income of bonds. And there's also a low-volatility feature of convertible
securities that many investors find comforting.
Bob, the bull market in U.S. stocks hasn't shown much sign of letting up yet.
How is this affecting the average investor?
Bob: We think investors are of two minds about the stock market right now. On
the one hand, everybody's nervous about a correction, because it's hard to
believe that the handsome gains of the last few years can continue. On the other
hand, the market keeps defying all the pessimists, so nobody wants to miss out
on future gains.
Given that frame of mind, what role do convertible securities have to play?
Bob: We think convertible securities make a great deal of sense for anybody
who's worried about the lofty valuations of U.S. stocks. The prices of
convertibles tend to track the stock of the company that issues them, so that
gives you some participation as stock prices rise. At the same time, because
convertibles have higher yields than common stock, their prices are much more
stable during a market downturn.
Do you think most investors understand convertible securities?
Bob: We think most investors understand what convertibles can do for them.
However, what they may not understand is some of the more complicated
characteristics of these types of securities: how to handle call features, how
to evaluate conversion premiums, how to price the bonds and so forth. So a good
way to invest in convertible securities is through a mutual fund, where a
professional manager is responsible for all the decisions that may seem complex
to the average investor.
What should people be looking for when they invest in a typical convertible
securities fund?
Bob: When you look at any given convertible securities fund, the first thing to
do is check to see how much of the portfolio is invested in something other than
convertible securities. Many convertible funds invest a sizable portion of the
assets in common stocks. That's fine when markets are going up, but when markets
are consolidating, the risks are going to be substantially greater.
- --------------------------------------------------------------------------------
4 1997 Annual Report to Shareholders
<PAGE>
What about the Smith Barney Convertible Fund? Do you invest in common stocks?
Bob: The Smith Barney Convertible Fund is extremely close to being a pure
convertible securities play. We rarely hold common stock, and we also tend to
stay away from riskier issues like private placements and nonrated securities.
The reason for this is very simple: We don't think the extra boost in return
from these types of issues is worth the added risk.
Are there any other reasons why you believe it's so important to invest
primarily in plain-vanilla convertible securities?
Bob: Unlike many other equity-oriented investments, convertible securities have
a kind of floor under them -- a well-defined level below which they very rarely
fall. This floor, called "investment value," is the point at which the security
is treated as a yield-producing fixed-income vehicle. By staying almost
exclusively with convertible securities, we think we provide investors in the
Fund with a substantial measure of protection against risk.
What are some other ways you seek to minimize risk in the Fund?
Bob: One of the most important things about the Smith Barney Convertible Fund is
that we rank high in terms of overall credit quality, with 40% to 50% of the
Fund's portfolio in investment-grade securities. These securities are issued by
corporations that have solid track records and are generally less volatile than
bonds issued by smaller, less predictable companies. Our quality orientation
helps reduce the overall volatility of the Fund in comparison with many other
convertible securities funds.
What about the other 50% to 60% of the Fund's portfolio?
Bob: The non-investment grade holdings of the Fund tend to be in securities
where we have done a lot of fundamental research and there are compelling
reasons to believe these securities may be upgraded in the future as the major
rating agencies become more familiar with the financial and business prospects
of the issuing companies.
Is there a particular sector or industry where you find a large number of these
companies with improving fundamentals?
Bob: We have identified four basic, top-down themes that we think are going to
have a positive impact on certain types of firms going forward:
1) Global growers, companies that derive a substantial portion of their
revenues overseas.
2) Demographic beneficiaries, or companies that could benefit from the aging
of the baby boomers.
3) Restructuring candidates, namely firms that are changing themselves or
their balance sheets.
4) Technology/telecommunications, areas where so much of the global economy's
current growth is being generated.
When it comes to evaluating convertible securities, you often talk about
balancing fundamental analysis and security analysis. What does that mean and
why do you do it?
Bob: Remember that convertible securities are hybrid issues that resemble both
bonds and stocks. So you need a two-pronged approach in order to evaluate them.
We start with fundamental, top-down economic analysis, because any change in
interest rates will have a big impact on the bond component of a convertible
security. Yet a bottom-up approach is also important when selecting individual
issues, because the price of a convertible security will certainly be affected
by the fortunes of the issuing corporation.
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 5
<PAGE>
Bob, do you manage the Fund primarily for growth with income as a secondary
objective? Or is it the other way around?
Bob: We view the Smith Barney Convertible Fund as a conservative equity
alternative with a fixed-income component. The Fund's Class A shares are
currently yielding about 4%, which is some 2.5 percentage points greater than
the S&P 500's current yield. At the same time, the beta on the portfolio is .49,
as measured by Lipper Analytical Services, which means we have roughly half the
volatility of the overall equity market. (Beta is a measurement of a port
folio's sensitivity to market movements.) Our objectives are to generate returns
equal to about three-quarters of the average growth fund, but with half the
volatility. However, investors should understand that our objectives are only a
target.
Bob, how did you get started on Wall Street?
Bob: In college, I majored in economics with a strong concentration in
mathematics. A career on Wall Street seemed a logical step. I have thoroughly
enjoyed working on Wall Street the past nineteen years and I remain enthusiastic
about the investment management business and serving the needs of my
shareholders.
Bob, it sounds like you have an ideal background for doing the
top-down/bottom-up research you described earlier.
Bob: You're right. The combination of economics and math turned out to be
exactly the background I needed to effectively manage a portfolio of convertible
securities. I feel fortunate to have found a career that challenges my skills,
strengths and interests.
Bob, thanks for spending some time with us today.
- --------------------------------------------------------------------------------
6 1997 Annual Report to Shareholders
<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)
================================================================================================
<C> <C> <C> <C> <C> <C> <C>
7/31/97 $15.66 $18.61 $ 0.75 $ 0.36 $ 0.00 26.94%
- ------------------------------------------------------------------------------------------------
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 $ 3.45 $ 0.39 $ 0.00
================================================================================================
</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)
================================================================================================
<C> <C> <C> <C> <C> <C> <C>
7/31/97 $15.66 $18.60 $ 0.67 $ 0.36 $ 0.00 26.29%
- ------------------------------------------------------------------------------------------------
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
================================================================================================
Total $ 7.13 $ 0.79 $ 0.09
================================================================================================
</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)
================================================================================================
<C> <C> <C> <C> <C> <C> <C>
7/31/97 $15.64 $18.58 $ 0.68 $ 0.36 $ 0.00 26.37%
- ------------------------------------------------------------------------------------------------
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 $ 1.84 $ 0.36 $ 0.00
================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 7
<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)
================================================================================================
<C> <C> <C> <C> <C> <C> <C>
7/31/97 $15.68 $18.66 $ 0.80 $ 0.36 $ 0.00 27.45%
- ------------------------------------------------------------------------------------------------
Inception* -- 7/31/96 16.15 15.68 0.39 0.00 0.00 (0.56)+
================================================================================================
Total $ 1.19 $ 0.36 $ 0.00
================================================================================================
</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 7/31/97 26.94% 26.29% 26.37% 27.44%
- --------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 11.28 N/A N/A
- --------------------------------------------------------------------------------
Ten Years Ended 7/31/97 N/A 9.08 N/A N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/97 12.27 9.44 16.40 17.36
================================================================================
With Sales Charge(2)
-------------------------------------------
Class A Class B Class C Class Y
================================================================================
Year Ended 7/31/97 20.62% 21.29% 25.37% 27.44%
- --------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 11.15 N/A N/A
- --------------------------------------------------------------------------------
Ten Years Ended 7/31/97 N/A 9.08 N/A N/A
- --------------------------------------------------------------------------------
Inception* through 7/31/97 11.06 9.44 16.40 17.36
================================================================================
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Without Sales Charge(1)
================================================================================
Class A (Inception* through 7/31/97) 72.83%
- --------------------------------------------------------------------------------
Class B (7/31/87 through 7/31/97) 138.44
- --------------------------------------------------------------------------------
Class C (Inception* through 7/31/97) 51.42
- --------------------------------------------------------------------------------
Class Y (Inception* through 7/31/97) 26.72
================================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect 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 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. Thereafter, this CDSC declines 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.
- --------------------------------------------------------------------------------
8 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund at a Glance (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+
- --------------------------------------------------------------------------------
July 1987--July 1997
[Line graph omitted]
+ Hypothetical illustration of $10,000 invested in Class B shares on July
31, 1987, assuming reinvestment of dividends and capital gains, if any, at
net asset value through July 31, 1997. 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 Peer Group Average is composed of the Fund's peer group of
10 mutual funds, as of July 31, 1997, 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 values may be more or less than the original cost. No
adjustment has been made for shareholder tax liability on dividends or
capital gains.
[The following table was represented as a line chart in the original]
Industry Diversification*
- --------------------------------------------------------------------------------
Automobile Parts 3.4%
Electronics-Computers 3.4%
Environmental Control 6.5%
Finance Companies-Consumer Credit 5.7%
Healthcare, Drugs and Hospital Supplies 6.4%
Metals and Mining 12.0%
Oil and Natural Gas 6.7%
Restaurants-Food Service 6.5%
Retail 3.8%
Transportation Services 7.2%
Other 23.5%
* As a percentage of total investments.
Investment Breakdown
- --------------------------------------------------------------------------------
[The following table was represented as a pie chart in the original]
Repurchase Agreement 14.9%
Convertible
Bonds and Notes 51.7%
Convertible Preferred Stocks 33.4%
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 9
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
======================================================================================
<S> <C> <C>
CONVERTIBLE PREFERRED STOCKS -- 33.4%
Bank - Savings and Loans -- 1.2%
20,000 Union Planters Corp., Series E, Exchange 8.000% $ 1,325,000
- --------------------------------------------------------------------------------------
Broadcast Radio and Television -- 0.8%
30,000 Cable Systems Corp., Series I, Exchange 8.500% 870,000
- --------------------------------------------------------------------------------------
Building and Construction -- 1.1%
40,000 Beazer Homes USA, Series A, Exchange 8.000% 1,175,000
- --------------------------------------------------------------------------------------
Finance Companies - Consumer Credit -- 5.7%
30,000 American General Corp., Series A, Exchange $3.00 2,085,000
20,000 H.F. Ahmanson & Co., Series D, Exchange 6.000% 2,180,000
30,000 St. Paul Capital LLC, Exchange 6.000% 2,118,750
- --------------------------------------------------------------------------------------
6,383,750
- --------------------------------------------------------------------------------------
Metals and Mining -- 9.1%
30,000 Amax Gold Inc., Series B, Exchange $3.75 1,601,250
Bethlehem Steel Corp.:
30,000 Exchange $3.50+ 1,282,500
32,000 Exchange $5.00 1,730,000
40,000 Cyprus AMAX Minerals Co., Series A, Exchange $4.00 2,230,000
30,000 Timet Capital Trust I, Exchange 6.625% 1,635,000
40,000 WHX Corp., Series A, Exchange 6.500% 1,592,500
- --------------------------------------------------------------------------------------
10,071,250
- --------------------------------------------------------------------------------------
Oil and Natural Gas -- 3.7%
40,000 Occidental Petroleum Corp., Series 1993, Exchange $3.875+ 2,340,000
30,000 Unocal Capital Trust, Exchange 6.250% 1,751,250
- --------------------------------------------------------------------------------------
4,091,250
- --------------------------------------------------------------------------------------
Packaging and Containers -- 2.6%
30,000 Corning Delaware LP, Exchange 6.000% 2,850,000
- --------------------------------------------------------------------------------------
Paper, Forest Products and Printing -- 2.1%
40,000 International Paper Co., Exchange 5.250% 2,350,000
- --------------------------------------------------------------------------------------
Real Estate Development - REITS -- 2.3%
50,000 Security Capital Corp., Series A, Exchange $1.75 1,543,750
40,000 Tanger Factory Outlet Centers Inc., Depository Shares,
Series A, Exchange $1.802 995,000
- --------------------------------------------------------------------------------------
2,538,750
- --------------------------------------------------------------------------------------
Restaurants - Food Service -- 1.0%
20,000 Wendy's Financing I, Series A, Exchange 5.000% 1,157,500
- --------------------------------------------------------------------------------------
Retail -- 1.5%
30,000 Kmart Financing, Exchange 7.750% 1,635,000
- --------------------------------------------------------------------------------------
Telecommunications Equipment -- 1.4%
20,000 Airtouch Communications, Series C, Exchange 4.250% 1,085,000
10,000 Loral Space & Communications, Exchange 6.000%+ 485,000
- --------------------------------------------------------------------------------------
1,570,000
- --------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
10 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
======================================================================================
<S> <C> <C>
Transportation Services -- 0.9%
15,000 CNF Trust I, Series A, Exchange 5.000% $ 862,500
2,500 Hvide Capital Trust, Exchange 6.500%+ 150,000
- --------------------------------------------------------------------------------------
1,012,500
- --------------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(Cost-- $32,061,181) 37,030,000
======================================================================================
Face
Amount SECURITY VALUE
======================================================================================
CONVERTIBLE BONDS AND NOTES -- 51.7%
Automobile Parts -- 3.4%
$2,500,000 Deutsche Bank Finance B.V., zero coupon due 2/2/17 1,209,375
2,000,000 Magna International Inc., 5.000% due 10/15/02 2,597,500
- --------------------------------------------------------------------------------------
3,806,875
- --------------------------------------------------------------------------------------
Communications -- 1.5%
1,000,000 California Microwave Inc., Sub. Notes, 5.250% due 12/15/03 857,500
500,000 3Com Corp., 10.250% due 11/1/01+ 830,000
- --------------------------------------------------------------------------------------
1,687,500
- --------------------------------------------------------------------------------------
Diversified and Conglomerate Manufacturing -- 2.5%
3,000,000 Mascotech Inc., 4.500% due 12/15/03 2,801,250
- --------------------------------------------------------------------------------------
Electronics - Computers -- 3.4%
500,000 Adaptec Inc., 4.750% due 2/1/04+ 547,500
1,000,000 Micron Technology Inc., 7.000% due 7/1/04 1,080,000
2,000,000 National Semiconductor, 6.500% due 10/1/02+ 2,117,500
- --------------------------------------------------------------------------------------
3,745,000
- --------------------------------------------------------------------------------------
Environmental Control -- 6.5%
1,000,000 Thermo Electron Corp., 4.250% due 1/1/03 1,101,250
1,000,000 U.S. Filter Corp., 4.500% due 12/15/01 1,018,750
2,000,000 USA Waste Services Inc., 4.000% due 2/1/02 2,250,000
3,000,000 WMX Technologies Inc., 2.000% due 1/24/05 2,793,750
- --------------------------------------------------------------------------------------
7,163,750
- --------------------------------------------------------------------------------------
Health Care, Drugs and Hospital Supplies -- 6.4%
2,000,000 Alza Corp., 5.000% due 5/1/06 2,135,000
1,000,000 Nabi Inc., 6.500% due 2/1/03+ 865,000
1,000,000 Phycor Inc., 4.500% due 2/15/03 1,075,000
2,500,000 Tenet Healthcare Corp., 6.000% due 12/1/05 3,037,500
- --------------------------------------------------------------------------------------
7,112,500
- --------------------------------------------------------------------------------------
Home Improvements -- 1.1%
1,000,000 Home Depot Inc., 3.250% due 10/1/01 1,200,000
- --------------------------------------------------------------------------------------
Leisure, Amusement and Motion Picture -- 1.8%
500,000 Scholastic Corp., 5.000% due 8/15/05 435,625
4,000,000 Time Warner Inc., zero coupon due 12/17/12 1,575,000
- --------------------------------------------------------------------------------------
2,010,625
- --------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 11
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Face
Amount SECURITY VALUE
======================================================================================
<S> <C> <C>
Lodging -- 3.1%
$ 1,000,000 HFS Inc., 4.750% due 3/1/03 $ 1,131,250
2,000,000 Hilton Hotels Corp., 5.000% due 5/15/06 2,302,500
- --------------------------------------------------------------------------------------
3,433,750
- --------------------------------------------------------------------------------------
Metals and Mining -- 2.9%
3,000,000 Inco Ltd., 7.750% due 3/15/16 3,198,750
- --------------------------------------------------------------------------------------
Office and Business Equipment -- 2.0%
2,000,000 Unisys Corp., 8.250% due 8/1/00 2,212,500
- --------------------------------------------------------------------------------------
Oil and Natural Gas -- 3.0%
1,000,000 Diamond Offshore Drilling, 3.750% due 2/15/07 1,310,000
1,000,000 Nabors Industries, Inc., 5.000% due 5/15/06 1,800,000
200,000 Parker Drilling Corp., 5.500% due 8/1/04 221,000
- --------------------------------------------------------------------------------------
3,331,000
- --------------------------------------------------------------------------------------
Restaurants - Food Service -- 5.5%
Boston Chicken:
1,000,000 7.750% due 5/1/04 885,000
1,500,000 Zero coupon due 6/1/15 318,750
500,000 Einstein/Noah Bagel Corp., 7.250% due 6/1/04+ 466,250
3,000,000 Grand Metropolitan PLC, 6.500% due 1/31/00+ 4,372,500
- --------------------------------------------------------------------------------------
6,042,500
- --------------------------------------------------------------------------------------
Retail -- 2.3%
500,000 Saks Holdings, 5.500% due 9/15/06 443,125
1,000,000 The Men's Wearhouse, Inc., 5.250% due 3/1/03 1,232,500
1,000,000 The Sports Authority, Inc., 5.250% due 9/15/01 915,000
- --------------------------------------------------------------------------------------
2,590,625
- --------------------------------------------------------------------------------------
Transportation - Non Rail -- 6.3%
3,000,000 Airborne Freight Corp., 6.750% due 8/15/01 4,200,000
2,000,000 Alaska Air Group, 6.500% due 6/15/05 2,827,500
- --------------------------------------------------------------------------------------
7,027,500
- --------------------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS AND NOTES
(Cost-- $51,471,315) 57,364,125
======================================================================================
SUB-TOTAL INVESTMENTS
(Cost -- $83,532,496) 94,394,125
======================================================================================
REPURCHASE AGREEMENT -- 14.9%
16,561,000 Goldman Sachs &Co., 5.730% due 8/1/97;
Proceeds at maturity -- $16,563,636; (Fully collateralized
by U.S. Treasury Notes, 6.250% due 6/30/98;
Market value -- $16,900,260) (Cost -- $16,561,000) 16,561,000
======================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $100,093,496*) $110,955,125
======================================================================================
</TABLE>
+ Security is exempt from registration under Rule 144A of the Securities Act
of 1933. This security 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 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities July 31, 1997
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost -- $83,532,496) $ 94,394,125
Repurchase agreement, at value (Cost -- $16,561,000) 16,561,000
Receivable for Fund shares sold 367,256
Dividends and interest receivable 914,974
- --------------------------------------------------------------------------------
Total Assets 112,237,355
- --------------------------------------------------------------------------------
LIABILITIES:
Investment advisory fees payable 45,608
Payable for Fund shares purchased 22,320
Administration fees payable 18,243
Distribution fees payable 14,496
Accrued expenses 74,207
- --------------------------------------------------------------------------------
Total Liabilities 174,874
- --------------------------------------------------------------------------------
Total Net Assets $112,062,481
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 6,019
Capital paid in excess of par value 95,560,997
Undistributed net investment income 171,445
Accumulated net realized gain on security transactions 5,462,391
Net unrealized appreciation of investments 10,861,629
- --------------------------------------------------------------------------------
Total Net Assets $112,062,481
================================================================================
Shares Outstanding:
Class A 2,084,987
----------------------------------------------------------------------------
Class B 2,307,864
----------------------------------------------------------------------------
Class C 67,377
----------------------------------------------------------------------------
Class Y 1,558,358
----------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $18.61
----------------------------------------------------------------------------
Class B* $18.60
----------------------------------------------------------------------------
Class C** $18.58
----------------------------------------------------------------------------
Class Y (and redemption price) $18.66
----------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 5.26% of net asset value) $19.59
================================================================================
* 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.
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 13
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended July 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $ 3,787,407
Dividends 1,996,339
- -------------------------------------------------------------------------------
Total Investment Income 5,783,746
- -------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2) 489,663
Distribution fees (Note 2) 413,173
Administration fees (Note 2) 195,865
Shareholder and system servicing fees 112,936
Registration fees 62,999
Shareholders communications 41,878
Audit and legal 38,750
Trustees' fees 15,000
Custody 5,194
Other 8,000
- -------------------------------------------------------------------------------
Total Expenses 1,383,458
- -------------------------------------------------------------------------------
Net Investment Income 4,400,288
- -------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS (NOTE3):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 52,011,163
Cost of securities sold 44,363,905
- -------------------------------------------------------------------------------
Net Realized Gain 7,647,258
- -------------------------------------------------------------------------------
Change in Net Unrealized Appreciation (Depreciation) of
Investments:
Beginning of year (757,866)
End of year 10,861,629
- -------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 11,619,495
- -------------------------------------------------------------------------------
Net Gain on Investments 19,266,753
- -------------------------------------------------------------------------------
Increase in Net Assets From Operations $23,667,041
===============================================================================
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
14 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended July 31,
- --------------------------------------------------------------------------------
1997 1996
================================================================================
OPERATIONS:
Net investment income $ 4,400,288 $ 3,680,821
Net realized gain 7,647,258 4,983,498
Increase (decrease) in net unrealized
appreciation 11,619,495 (3,181,315)
-------------------------------------------------------------------------------
Increase in Net Assets From Operations 23,667,041 5,483,004
-------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (4,250,885) (3,651,779)
Net realized gains (2,061,461) --
-------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (6,312,346) (3,651,779)
-------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
Net proceeds from sale of shares 23,690,727 21,711,359
Net asset value of shares issued for
reinvestment of dividends 4,067,509 2,647,871
Cost of shares reacquired (20,188,440) (19,897,156)
-------------------------------------------------------------------------------
Increase in Net Assets From Fund Share
Transactions 7,569,796 4,462,074
-------------------------------------------------------------------------------
Increase in Net Assets 24,924,491 6,293,299
NET ASSETS:
Beginning of year 87,137,990 80,844,691
-------------------------------------------------------------------------------
End of year* $ 112,062,481 $ 87,137,990
===============================================================================
* Includes undistributed net investment
income of: $ 171,445 $ 29,042
===============================================================================
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 15
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
The Smith Barney Convertible 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
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 except for the Smith Barney
Premium Total Return Fund which will have an annual report dated December 31,
1997.
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 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, which
approximates value; (d) dividend income is recorded on ex-dividend date and
interest income, adjusted for accretion of original discount, is recorded on an
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; (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, 1997, reclassifications
were made to undistributed net investment income and accumulated net realized
gains to reflect book/tax differences and income and gains available for
distributions under income tax regulations. 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.
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 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 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, 1997, SB received sales charges of approximately $19,000 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
- --------------------------------------------------------------------------------
16 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
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. For the year ended July 31, 1997, CDSCs paid to SB for Class
Bshares were approximately $59,000.
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, 1997, total Distribution Plan fees incurred were:
Class A Class B Class C
===============================================================
Distribution Plan Fees $89,116 $317,592 $6,465
===============================================================
All officers and one Trustee of the Trust are employees of SB.
3. Investments
During the year ended July 31, 1997, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
=========================================================================
Purchases $48,915,871
- -------------------------------------------------------------------------
Sales 52,011,163
=========================================================================
At July 31, 1997, aggregate gross unrealized appreciation and depreciation of
investments for Federal income tax purposes were substantially as follows:
=========================================================================
Gross unrealized appreciation $12,755,954
Gross unrealized depreciation (1,894,325)
- -------------------------------------------------------------------------
Net unrealized appreciation $10,861,629
=========================================================================
4. Repurchase Agreements
The Fund purchases (and its custodian takes pos session 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. Options Contracts
Premiums paid when put or call options are purchased by the Fund represent
investments, which are marked-to-market daily and are included in the schedule
of investments. 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.
At July 31, 1997, the Fund had no open purchased put or call options contracts.
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 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 written call option is
exercised, the cost of the security sold will be decreased
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 17
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
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
covered 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 a
loss if the market price of the underlying security declines.
During the year ended July 31, 1997, the Fund did not write any options.
6. Shares of Beneficial Interest
At July 31, 1997, 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, 1997, total paid-in capital amounted to the following for each
class:
Class A Class B Class C Class Y
================================================================================
Total Paid-in Capital $30,069,125 $38,692,418 $1,081,828 $25,723,645
================================================================================
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
July 31, 1997 July 31, 1996*
--------------------------- ---------------------------
Shares Amount Shares Amount
================================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 163,074 $ 2,748,028 343,603 $ 5,423,126
Shares issued on reinvestment 116,254 1,943,840 83,599 1,324,932
Shares redeemed (422,237) (7,047,021) (506,755) (7,997,467)
- ------------------------------------------------------------------------------------------------
Net Decrease (142,909) $ (2,355,153) (79,553) $ (1,249,409)
================================================================================================
Class B
Shares sold 244,740 $ 4,102,534 374,014 $ 5,938,214
Shares issued on reinvestment 124,505 2,077,233 82,158 1,306,252
Shares redeemed (770,612) (12,939,859) (727,414) (11,577,304)
- ------------------------------------------------------------------------------------------------
Net Decrease (401,367) $ (6,760,092) (271,242) $ (4,332,838)
================================================================================================
Class C
Shares sold 35,625 $ 596,934 55,056 $ 869,581
Shares issued on reinvestment 2,775 46,436 1,049 16,687
Shares redeemed (12,011) (201,552) (20,518) (322,369)
- ------------------------------------------------------------------------------------------------
Net Increase 26,389 $ 441,818 35,587 $ 563,899
================================================================================================
Class Y
Shares sold 972,230 $ 16,243,231 586,130 $ 9,480,438
Shares issued on reinvestment 0 0 -- --
Shares redeemed (1) (8) (1) (16)
- ------------------------------------------------------------------------------------------------
Net Increase 972,229 $16,243,223 586,129 $ 9,480,422
================================================================================================
</TABLE>
* For Class Y shares, transactions are for the period from February 7, 1996
(inception date) to July 31, 1996.
- --------------------------------------------------------------------------------
18 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1997 1996(1) 1995 1994 1993(2)
==============================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 15.66 $ 15.27 $ 14.56 $ 14.99 $ 13.82
- --------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.78 0.74 0.74 0.72 0.49
Net realized and unrealized gain (loss) 3.28 0.38 0.70 (0.42) 1.22
- --------------------------------------------------------------------------------------------------------------
Total Income From Operations 4.06 1.12 1.44 0.30 1.71
- --------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.75) (0.73) (0.73) (0.73) (0.51)
Net realized gains (0.36) -- -- -- (0.03)
- --------------------------------------------------------------------------------------------------------------
Total Distributions (1.11) (0.73) (0.73) (0.73) (0.54)
- --------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 18.61 $ 15.66 $ 15.27 $ 14.56 $ 14.99
- --------------------------------------------------------------------------------------------------------------
Total Return 26.94% 7.41% 10.35% 1.99% 12.63%++
- --------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 38,803 $ 34,888 $ 35,238 $ 2,294 $ 1,655
- --------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.27% 1.40% 1.40% 1.40% 1.37%+
Net investment income 4.61 4.68 5.13 4.80 4.86+
- --------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 57% 59% 48% 54% 95%
- --------------------------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(3) $ 0.06 $ 0.06 -- -- --
==============================================================================================================
</TABLE>
(1) Per share amounts have been calculated using the monthly average shares
method, rather than the undistributed net investment income method,
because it more accurately reflects the per share data for the period.
(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.
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 19
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class B Shares 1997 1996(1) 1995 1994 1993
===============================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 15.66 $ 15.27 $ 14.56 $ 14.99 $ 13.84
- ---------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.69 0.66 0.67 0.65 0.61
Net realized and unrealized gain (loss) 3.28 0.39 0.70 (0.42) 1.20
- ---------------------------------------------------------------------------------------------------------------
Total Income From Operations 3.97 1.05 1.37 0.23 1.81
- ---------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.67) (0.66) (0.66) (0.66) (0.62)
Net realized gain (0.36) -- -- -- (0.04)
- ---------------------------------------------------------------------------------------------------------------
Total Distributions (1.03) (0.66) (0.66) (0.66) (0.66)
- ---------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 18.60 $ 15.66 $ 15.27 $ 14.56 $ 14.99
- ---------------------------------------------------------------------------------------------------------------
Total Return 26.29% 6.91% 9.80% 1.50% 13.40%
- ---------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 42,927 $ 42,420 $ 45,524 $ 85,190 $ 74,857
- ---------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.77% 1.90% 1.90% 1.88% 2.00%
Net investment income 4.12 4.18 4.63 4.32 4.20
- ---------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 57% 59% 48% 54% 95%
- ---------------------------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(2) $ 0.06 $ 0.06 -- -- --
===============================================================================================================
</TABLE>
(1) Per share amounts have been calculated using the monthly average shares
method, rather than the undistributed net investment income method,
because it more accurately reflects the per share data for the period.
(2) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
- --------------------------------------------------------------------------------
20 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class C Shares 1997 1996(1) 1995(2)(3)
================================================================================
Net Asset Value, Beginning of Year $ 15.64 $ 15.27 $ 14.09
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.67 0.67 0.50
Net realized and unrealized gain 3.31 0.37 1.17
- --------------------------------------------------------------------------------
Total Income From Operations 3.98 1.04 1.67
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.68) (0.67) (0.49)
Net realized gains (0.36) -- --
- --------------------------------------------------------------------------------
Total Distributions (1.04) (0.67) (0.49)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 18.58 $ 15.64 $ 15.27
- --------------------------------------------------------------------------------
Total Return 26.37% 6.82% 12.17%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 1,252 $ 641 $ 83
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.74% 1.86% 1.87%+
Net investment income 4.14 4.17 4.77+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 57% 59% 48%
- --------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(4) $ 0.06 $ 0.06 --
================================================================================
(1) Per share amounts have been calculated using the monthly average shares
method, rather than the undistributed net investment income method,
because it more accurately reflects the per share data for the period.
(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.
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 21
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class Y Shares 1997 1996(1)(2)
================================================================================
Net Asset Value, Beginning of Year $ 15.68 $ 16.15
- --------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.83 0.38
Net realized and unrealized gain (loss) 3.31 (0.46)
- --------------------------------------------------------------------------------
Total Income (Loss) From Operations 4.14 (0.08)
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.80) (0.39)
Net realized gains (0.36) --
- --------------------------------------------------------------------------------
Total Distributions (1.16) (0.39)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 18.66 $ 15.68
- --------------------------------------------------------------------------------
Total Return 27.44% (0.56)%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 29,080 $ 9,189
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.85% 1.00%+
Net investment income 5.04 4.98+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 57% 59%
- --------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions $ 0.06 $ 0.06
================================================================================
(1) Per share amounts have been calculated using the monthly average shares
method, rather than the undistributed net investment income method,
because it more accurately reflects the per share data for the period.
(2) For the period from February 7, 1996 (inception date) to July 31, 1996.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
- --------------------------------------------------------------------------------
22 1997 Annual Report to Shareholders
<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, 1997, and the related statement of operations for
the year then ended, the statements of changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the three-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 two-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, 1997, 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 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, 1997, the
results of its operations for the year then ended, the changes in its net assets
for each of the years in the two-year period then ended, and the financial
highlights for each of the years in the three-year period then ended, in
conformity with generally accepted accounting principles.
/s/ KPMG Peat Markwick LLP
New York, New York
September 15, 1997
- --------------------------------------------------------------------------------
Smith Barney Convertible Fund 23
<PAGE>
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
For Federal tax purposes the Fund hereby designates for the fiscal year
ended July 31, 1997:
-- long-term capital gain distributions paid of $2,061,461.
- --------------------------------------------------------------------------------
24 1997 Annual Report to Shareholders
<PAGE>
Smith Barney
Convertible Fund
Trustees
Lee Abraham
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon, Chairman
Officers
Heath B. McLendon
Chief Executive Officer
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 for the information of shareholders of Smith Barney Convertible
Fund, but it may also be used as sales literature when preceded or accompanied
by the current prospectus, which gives details about charges, expenses,
investment objectives and operating policies of the Fund. If used as sales
material after September 30, 1997, this report must be accompanied by
performance for the most recently completed calendar quarter.
SMITH BARNEY
A Member of TravelersGroup[LOGO]
Smith Barney Convertible Fund
Smith Barney Mutual Funds
388 Greenwich Street
New York, New York 10013
FD01020 9/97
<PAGE>
[PHOTO]
[GRAPHIC]
SMITH BARNEY
HIGH INCOME
FUND
- ---------------------------------
ANNUAL REPORT
- ---------------------------------
July 31, 1997
[LOGO] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
SMITH BARNEY
HIGH INCOME FUND
================================================================================
The Smith Barney High Income Fund seeks high current income by investing in
high-yield corporate bonds, debentures and notes.
Smith Barney High Income Fund's
Average Annual Total Returns Ended
July 31, 1997
Without Sales Charges*
-----------------------------------
Class A Class B Class C
- --------------------------------------------------------------------------------
One-Year 18.31% 17.72% 17.77%
- --------------------------------------------------------------------------------
Five-Year N/A 11.03 N/A
- --------------------------------------------------------------------------------
Ten-Year N/A 9.32 N/A
- --------------------------------------------------------------------------------
Since Inception++ 11.89 9.41 12.83
- --------------------------------------------------------------------------------
With Sales Charges**
-----------------------------------
Class A Class B Class C
- --------------------------------------------------------------------------------
One-Year 12.96% 13.22% 16.77%
- --------------------------------------------------------------------------------
Five-Year N/A 10.90 N/A
- --------------------------------------------------------------------------------
Ten-Year N/A 9.32 N/A
- --------------------------------------------------------------------------------
Since Inception++ 10.81 9.41 12.83
- --------------------------------------------------------------------------------
* 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.
** 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. Thereafter, the CDSC declines 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.
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.
++ Inception dates for Class A, B and C shares are November 6, 1992, September
2, 1986 and August 24, 1994,respectively.
- --------------------------------------------------------------------------------
OUR INVESTMENT PHILOSOPHY
- --------------------------------------------------------------------------------
At Smith Barney Mutual Funds, your investment needs come first. Our goal is to
deliver consistent and competitive returns over time, using a wide range of
investment strategies.
- --------------------------------------------------------------------------------
NASDAQ SYMBOL
- --------------------------------------------------------------------------------
Class A SHIAX
Class B SHIBX
- --------------------------------------------------------------------------------
WHAT'S INSIDE
- --------------------------------------------------------------------------------
Shareholder Letter..................................1
An Interview with Portfolio Manager
John C. Bianchi, CFA................................4
Historical Performance..............................7
Smith Barney High Income Fund at a Glance..........10
Schedule of Investments............................11
Statement of Assets and Liabilities................19
Statement of Operations............................20
Statements of Changes in Net Assets................21
Notes to Financial Statements......................22
Financial Highlights...............................27
Independent Auditors' Report.......................32
<PAGE>
- --------------------------------------------------------------------------------
Shareholder Letter
- --------------------------------------------------------------------------------
[PHOTO] [PHOTO]
Heath B. John C.
McLendon Bianchi
Chairman Vice President and
Investment Officer
Dear Shareholder:
We are pleased to provide the annual report for the Smith Barney High Income
Fund ("Fund") for the period ended July 31, 1997. 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 addition, an interview with John C.
Bianchi, CFA, the Fund's Portfolio Manager, appears on page four.
Performance Update
For the year ended July 31, 1997, the Smith Barney High Income Fund's Class A
shares generated a total return of 18.31%, which compares favorably to the
average one-year total return of 17.33% for open-end high yield funds as
reported by Lipper Analytical Services Inc., an independent fund-tracking
performance organization. In addition, during the past 12 months, the Fund paid
income dividends totaling $1.08 for Class A shares; based on a net asset value
(NAV) of $11.82 per share as of July 31, 1997, this equates to an annual
distribution rate of 9.14%.
Market and Economic Overview
The U.S. bond market rebounded from a weak first quarter of 1997 to post its
best quarterly return in the second quarter since the fourth quarter of 1995. A
strong economy in the first quarter caused the Federal Reserve Board ("Fed") to
tighten interest rates by 25 basis points (0.25%) and led to relatively poor
bond returns. However, in the second quarter of 1997 the economy continued to
grow moderately with little apparent increase in inflationary pressures. These
market conditions enabled the Fed to keep monetary policy on hold and the bond
markets responded with solid returns in the second quarter. Since the end of
March, the long-term U.S. Treasury bond's yield dropped by roughly 70 basis
points (0.70%) from a peak of 7.20% to 6.50% as of this report.
The high yield bond market has continued to rally on strong demand from both
institutional investors and retail mutual funds. Given the strong market
conditions, we have witnessed a record amount of new high yield issuance (more
than $60 billion) during the first seven months of this year. We expect this
trend to continue over the remainder of 1997. There has been more than adequate
demand to absorb the heavy new issue supply. Increasing amounts of capital are
flowing into the high yield market from a variety of sources. Traditional
open-end high yield mutual funds have had over $11 billion of cash inflows over
the first seven months of 1997, not to mention the roughly $5 billion of
dividends that were reinvested in additional mutual fund shares.
More importantly, the high yield bond market has continued to broaden and mature
into a more widely accepted investment alternative among more traditional
institutional investors. Pension funds are allocating increasing percentages of
their investment portfolios to the high yield market. For example, two large New
York City pension funds that together have nearly $13 billion in assets recently
boosted their high yield investments by over $250 million, concentrating on the
better quality B and BB rated high yield issues.
During the past 12 months, there has been a meaningful increase in the number of
structured transactions incorporating high yield securities that have raised the
demand for high yield bonds even further. In the past two years, a number of
institutions, particularly insurance companies, have begun creating
collateralized bond obligations ("CBOs") that use high
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 1
<PAGE>
yield securities as collateral. Given the intense demand for current yield over
the past year, there has been a significant increase in the creation of CBOs.
The total amount of capital deployed into the high yield market has risen to
record levels.
Given this record demand, many high yield bonds have appreciated to fully valued
levels with yield premiums over U.S. Treasuries approximately 100 basis points
tighter than their historical averages. In addition to these positive technical
factors, there are a number of positive fundamental factors driving high yield
bond valuations. In addition to the significant amount of capital being invested
in the market, economic conditions remain supportive with moderate growth and
low inflation. The stock market, with its historically high valuations, has
enabled a number of high yield companies to issue stock to further bolster their
balance sheets.
In addition, the banking system remains highly liquid, allowing it to
accommodate high yield borrowers. Consequently, high yield bond default rates
remain at the low end of their historical range at approximately 1.5% per year
for the past two years. As long as overall economic and market conditions remain
relatively benign, high yield bond spreads should stay at the tighter end of
their historical range. Because of these positive fundamental factors, we do not
believe the high yield market is becoming increasingly speculative. However, we
are naturally becoming increasingly sensitive to the possibility for
disappointment and underperformance among individual issues. This has been the
case in the stock market throughout the year.
Given the relatively strong performance of the high yield market compared to
U.S. Treasuries over recent months, high yield bond premiums remain roughly 100
basis points (one percentage point) tighter than they were in early 1996. As a
result, we continue to describe the high yield market as fully valued at this
time. Since we still expect the economy to grow moderately over the foreseeable
future, with little serious threat of either higher inflation or an economic
recession, we do not anticipate any material deterioration in the performance of
most high yield bonds.
However, if the economy were to reaccelerate and cause the Fed to actively raise
short-term interest rates to slow economic momentum, we could expect the high
yield bond market to be negatively affected along with all of the other
financial markets. In light of the non-inflationary economic growth in the
second quarter, we do not believe the Fed will need to raise interest rates
unless the economy begins to accelerate in the third or fourth quarter.
Therefore, the overall environment remains positive for the high yield market.
Nevertheless, selectivity has become increasingly more important when making
investment decisions, especially given the high yield market's fully valued
levels and the potential for disappointment among individual companies.
Portfolio Strategy
The Fund's primary objective remains to focus on delivering a consistently high
level of current income. To achieve this goal, we employ a consistent and
disciplined strategy of investing primarily in better quality, high yielding
corporate bonds that are likely to receive an upgrade in their credit rating
over the next one to three years.
We remain optimistic about the total return prospects for the high bond yield
market in 1997. We would expect interest rates to remain in a confined range as
economic activity remains moderate and inflation remains subdued. In this
moderate growth environment, we would expect stronger high yield companies to
generate the most consistent results. These companies tend to be in industries
that continue to benefit from new technology. We have found many attractive
opportunities in the telecommunications, media, cable TV and oil and natural gas
industries, and the Fund is overweighted in these areas. Some of the issues that
we continue to favor include Time Warner, Cablevision Systems Corp., Brooks
Fiber, Nextel Communications Inc., Rogers Cablesystems, Teleport, Pride
Petroleum and Parker
- --------------------------------------------------------------------------------
2 1997 Annual Report to Shareholders
<PAGE>
Drilling, to name a few. All of these companies continue to generate improving
results through either increased market share or improved internal cost
controls.
We firmly believe that over a full economic cycle the better quality high yield
issues offer superior risk adjusted returns and lower default risk relative to
lower-quality issues. Considering the trend toward greater industry competition
and little pricing power in most sectors of the domestic economy, we believe our
prudent approach to high yield investing will generate consistent positive
returns in 1997. We therefore will continue to avoid the sectors of the economy
that are experiencing weak growth trends as well as heavy industry competition.
Market Outlook
In our opinion, the U.S. economy should grow moderately over the next several
months with continued modest inflation. Given our expectations, we have been
more focused on maintaining sound credit quality throughout the Fund. We firmly
believe this prudent approach will continue to generate the most consistent
performance results for investors.
On a more somber note, we are saddened by the loss of two outstanding business
leaders and Trustees of the Fund, Antoinette C. Bentley and Madelon De Voe
Talley. Their knowledge and wisdom will be missed.
In closing, thank you for investing in the Smith Barney High Income Fund. We
look forward to continuing to help you pursue your investment goals.
Sincerely,
/s/ Heath B. McLendon /s/ John C. Bianchi
Heath B. McLendon John C. Bianchi, CFA
Chairman Vice President and
Investment Officer
August 14, 1997
- --------------------------------------------------------------------------------
Top Ten Holdings* As of July 31, 1997
- --------------------------------------------------------------------------------
1. Rogers Cablesystems 3.2%
- --------------------------------------------------------------------------------
2. Cablevision Systems Corp. 3.2
- --------------------------------------------------------------------------------
3. Nextel Communications 2.9
- --------------------------------------------------------------------------------
4. Unisys Corp. 2.6
- --------------------------------------------------------------------------------
5. Pathmark Stores Inc. 2.3
- --------------------------------------------------------------------------------
6. Brooks Fiber Properties Inc. 2.0
- --------------------------------------------------------------------------------
7. First Nationwide Parent Holdings Ltd. 2.0
- --------------------------------------------------------------------------------
8. Indah Kiat International Finance Co. 1.9
- --------------------------------------------------------------------------------
9. Terex Corp. 1.9
- --------------------------------------------------------------------------------
10. Pagemart Nationwide, Inc. 1.5
- --------------------------------------------------------------------------------
* As a percentage of total corporate bonds and notes.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 3
<PAGE>
- --------------------------------------------------------------------------------
An Interview with Portfolio Manager
John C. Bianchi, CFA
- --------------------------------------------------------------------------------
John C. Bianchi, CFA, is a Managing Director of Smith Barney and Portfolio
Manager of the Smith Barney High Income Fund and has over 18 years of Wall
Street experience, the lion's share of which has been at Smith Barney. John
manages more than $3.5 billion in high yield investments for Smith Barney. He
holds a B.A. in English from Seton Hall University and an M.B.A. in Finance from
Fairleigh Dickinson University.
John, you were recently cited in a Fortune Magazine article as a "manager with a
proven, long-term record in good times and bad." How do you feel about all of
the attention?
John: I'm flattered. But more than that, I feel a sense of fulfillment. I've
been managing money for individuals for more than eighteen years, not only
because of professional ambition, but because I want to help them improve the
quality of their lives. This Fortune citation tells me that I've been successful
in helping investors reach their goals while keeping them from harm's way. This
is a very personal and rewarding accomplishment.
Will this national recognition change the way you manage money?
John: While national recognition is always gratifying, it won't change our
investment approach. In fact, the attention reinforces that what we've been
doing for our shareholders is working. But what I think is most exciting about
the Fortune citation is that it confirms that we've been around the block in the
high-yield securities market. We were recognized for providing quality long-term
investing, not just providing investors with short-term success. What this
article implied was that high-yield corporate bonds can be a smart choice for
adding momentum to a person's long-term retirement savings.
Why haven't high-yield bonds been recognized as a smart long-term investment
before now?
John: The 1980s left many investors with a bad taste in their mouths. High yield
corporate bonds were originally perceived to be risky investments with poor
quality and high default rates. High yield bonds then became fashionable as the
economy expanded. A lot of people decided to get in on the action and invested
in high-yield bonds, but many of them got burned. Part of the reason for the
downturn was the excitement surrounding the economy at that time, which was
really a presumption. The economy and the quality of many companies simply were
not as strong as many high yield bond investors had believed.
Why have the 1990s been such a great time for high yield bonds versus the 1980s?
John: The economy now is genuinely in great shape. More importantly, the
enthusiasm surrounding the economy is justified. That was not the case in the
1980s. Today, interest rates and inflation are low, as well as the rate of
unemployment. Consumers are spending more, which increases production and
corporate earnings. All of these factors create stronger companies to invest in.
Another important difference is that we've all learned from the growing pains
experienced in the early days of the high-yield bond market. Investors are much
more careful now about weighing the risks versus the potential rewards of
investing in high yield bonds. Moreover, many investors maintain a longer-term
perspective today and are generally more informed about what investments may be
suitable for them based on their age, risk tolerance and investment time
horizon.
John, besides people saving for retirement, what types of investors are
attracted to today's high-yield bond market?
John: We think high-yield corporate bonds may be appropriate for just about any
type of investor, except perhaps for those who are interested simply in
preserving their capital. High-yield corporates are also becoming a viable
investment choice for many institutions, as well as pension plans. Institutional
investors
- --------------------------------------------------------------------------------
4 1997 Annual Report to Shareholders
<PAGE>
are starting to realize the potential of high yield bonds for helping to smooth
out volatility in the equity market and enhancing their return potential with
respect to the fixed-income portion of their portfolios.
The U.S. stock market is trading at an all-time high. What impact have these
extraordinary returns from stocks had on the high yield corporate bond market?
John: A healthy bull market in stocks generally has a positive effect on
companies issuing high-yield bonds because it gives these companies an
alternative source of capital to grow their businesses. Yet the opposite is also
true: the same factors that can cause a downturn in the stock market will
eventually affect the high-yield bond market.
What should high yield bond investors be concerned about today?
John: One thing high yield bond investors need to watch for is a slowing
economy. If the economy begins to slow down, company earnings may come under
pressure. That can undermine the stock market and, to a lesser extent, the high
yield bond market. Another potential issue is interest rates. If the economy
continues to grow full throttle, the Federal Reserve may feel it has to raise
interest rates to slow it down. Any meaningful tightening of monetary policy by
the Fed could negatively affect the high yield bond market because higher
interest rates often influence the profitability and sales growth of companies.
However, it's important to note that high-yield corporate bonds can be generally
less sensitive to interest rates than other types of bonds such as U.S.
government securities. Moreover, high yield bonds have also historically
performed better than U.S. Treasuries and investment-grade bonds.
Is there anything that investors can do right now to hedge against future market
volatility?
John: Absolutely. We would suggest that investors start paying more attention to
the risks they are assuming in the stock market. Instead of adding more money to
equities, investors may want to consider taking a fresh look at fixed-income
securities. High yield corporate bonds can be a good defensive strategy.
Although high yield bonds are not a low-risk investment, these securities are
typically not as risky as stocks. In today's highly valued market, high yield
corporate bonds are paying an average of 9% to 11%. While high yield bond prices
can also decline in a down market, they generally decline less than equities.
What areas of the high yield corporate bond market do you currently favor?
John: We think the telecommunications sector is a particularly exciting
opportunity. Telecommunications is an extremely large growth industry fueled by
deregulation, changes in digital technology and higher-speed transactions. And
many of the mid- to small-cap telecommunications high yield bonds that we focus
on are poised to take some market share from large blue-chip competitors.
Why do you think some of the smaller telecommunications companies may perform
better than some of their larger, more-established counterparts?
John: Technology today is moving so fast. To keep up, a company has to be able
to switch gears in the blink of an eye. Large companies sometimes suffer from
what we refer to as the "elephant burden" syndrome: being too big to make quick
changes in response to an ever more competitive and dynamic marketplace. On the
other hand, many smaller-sized companies today are often more innovative and
adaptable than larger-sized ones. Telecommunications companies in particular
also tend to be very debt conscious, because of the potentially rapid
obsolescence of their products.
What other sectors of the high yield bond market do you currently favor?
John: We believe that the oil and gas sector is certainly a very exciting area.
There are a large number of new medium- and small- sized companies taking over
mature oil fields that were once the stomping ground of the big oil and gas
producers. Through more efficient use of technology, many of these small-
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 5
<PAGE>
er oil and gas companies are able to squeeze out the remaining resources at an
extremely low cost.
John, what is your outlook for the Smith Barney High Income Bond Fund in the
next twelve months?
John: We are going to continue to seek out companies that have a strong
likelihood of succeeding in the future. We are interested in companies that we
believe are going to provide our shareholders with the best opportunities for
not only high current income but solid total returns as well. We think our
bottom-up approach to selecting securities, along with our sensitivity to larger
economic issues, should help us achieve our objective. A major contributor to
performance over the next five years will be avoiding companies that are likely
to default.
What is the biggest pressure you face in managing the Smith Barney High Income
Bond Fund?
John: Both my mother and my mother-in-law have invested their money in the Fund.
Now that's my definition of pressure!
John, we're sure you're getting plenty of feedback.
John: You'd better believe it! But honestly, I feel like I have an immense
responsibility to every single one of my shareholders. They are my customers and
I understand why they're investing in the Smith Barney High Income Fund. At the
end of the day, I want to say that I've done my very best to help them
accomplish their investment goals.
John, thanks for spending some time with us today.
- --------------------------------------------------------------------------------
6 1997 Annual Report to Shareholders
<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>
7/31/97 $10.98 $11.82 $1.08 $0.00 $0.00 18.31%
- ------------------------------------------------------------------------------------------------------------
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 $5.19 $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>
7/31/97 $10.99 $11.83 $ 1.02 $0.00 $0.00 17.72%
- ------------------------------------------------------------------------------------------------------------
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
- ------------------------------------------------------------------------------------------------------------
Total $12.25 $0.04 $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>
7/31/97 $11.00 $11.84 $1.03 $0.00 $0.00 17.77%
- ------------------------------------------------------------------------------------------------------------
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 $2.96 $0.00 $0.07
- ------------------------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 7
<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>
7/31/97 $10.99 $11.84 $1.11 $0.00 $0.00 18.68%
- --------------------------------------------------------------------------------------------------------------------
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 $2.06 $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>
7/31/97 $10.99 $11.80 $1.11 $0.00 $0.00 18.29%
- --------------------------------------------------------------------------------------------------------------------
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 $5.33 $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 7/31/97 18.31% 17.72% 17.77% 18.68% 18.29%
- --------------------------------------------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 11.03 N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------
Ten Years Ended 7/31/97 N/A 9.32 N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------
Inception* through 7/31/97 11.89 9.41 12.83 13.19 12.15
====================================================================================================================
<CAPTION>
With Sales Charge(2)
----------------------------------------------------------------------
Class A Class B Class C Class Y Class Z
====================================================================================================================
<S> <C> <C> <C> <C> <C>
Year Ended 7/31/97 12.96% 13.22% 16.77% 18.68% 18.29%
- --------------------------------------------------------------------------------------------------------------------
Five Years Ended 7/31/97 N/A 10.90 N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------
Ten Years Ended 7/31/97 N/A 9.32 N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------
Inception* through 7/31/97 10.81 9.41 12.83 13.19 12.15
====================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
8 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Without Sales Charge(1)
====================================================================================================================
<S> <C>
Class A (Inception* through 7/31/97) 70.25%
- --------------------------------------------------------------------------------------------------------------------
Class B (7/31/87 through 7/31/97) 143.71
- --------------------------------------------------------------------------------------------------------------------
Class C (Inception* through 7/31/97) 42.55
- --------------------------------------------------------------------------------------------------------------------
Class Y (Inception* through 7/31/97) 20.21
- --------------------------------------------------------------------------------------------------------------------
Class Z (Inception* through 7/31/97) 72.07
====================================================================================================================
</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 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 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, 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.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 9
<PAGE>
- --------------------------------------------------------------------------------
Smith Barney High Income Fund at a Glance (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+
- --------------------------------------------------------------------------------
July 1987--July 1997
[GRAPHIC]
Salomon Brothers
Smith Barney Intermediate-Term
High Income Fund High-Yield Index
July 1987 $ 10,000 $ 10,000
July 1988 11,006 10,844
July 1989 11,732 11,914
July 1990 10,716 11,386
July 1991 11,661 12,879
July 1992 14,443 16,044
July 1993 17,123 18,518
July 1994 17,396 19,112
July 1995 19,096 21,665
July 1996 20,702 23,620
July 1997 24,371 27,652
+ Hypothetical illustration of $10,000 invested in Class B shares on July
31, 1987, assuming reinvestment of dividends and capital gains, if any, at
net asset value through July 31, 1997. 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.
Industry Diversification*
- --------------------------------------------------------------------------------
Broadcasting/Cable 16.6%
Chemicals 3.0%
Electronics/Computers 6.5%
Finance 3.7%
Grocery/Convenience Stores 2.8%
Hotels, Casinos & Gambling 4.8%
Metals & Mining 3.9%
Oil & Natural Gas 8.0%
Paper & Printing 5.7%
Telecommunications 23.5%
Other 21.5%
* As a percentage of total corporate bonds and notes.
Investment Breakdown
- --------------------------------------------------------------------------------
[PIE CHART]
Preferred Stock 6.5%
Repurchase Agreement 8.0%
Other 1.1%
Corporate Bonds and Notes 84.4%
- --------------------------------------------------------------------------------
10 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
==========================================================================================================
CORPORATE BONDS AND NOTES -- 84.4%
Aerospace/Defense -- 1.6%
<C> <C> <S> <C>
$ 10,050,000 BB Airplanes Pass-Through Trust, Corporate Collateralized
Mortgage Obligation, Series D, 10.875% due 3/15/19 $ 11,910,255
4,750,000 B Howmet Corp., Sr. Sub. Notes, 10.000% due 12/1/03 5,135,938
2,750,000 B UNC Inc., Sr. Sub. Notes, 11.000% due 6/1/06 3,258,750
- ----------------------------------------------------------------------------------------------------------
20,304,943
- ----------------------------------------------------------------------------------------------------------
Broadcasting/Cable -- 14.0%
4,125,000 B- All American Communications Inc., Sr. Sub. Notes,
10.875% due 10/15/01 4,418,906
5,148,000 B- Allbritton Communications Co., Sr. Sub. Debenture,
11.500% due 8/15/04 5,418,270
13,350,000 B2* Australis Holdings, Ltd., Sr. Discount Notes,
step bond to yield 13.707% due 11/1/02 11,080,500
Cablevision Systems Corp., Sr. Sub. Debentures:
12,650,000 B 9.875% due 2/15/13 13,503,875
13,075,000 B 10.500% due 5/15/16 14,611,313
6,150,000 B 9.875% due 4/1/23 6,534,375
16,525,000 B- Comcast UK Cable, Sr. Sub. Debenture,
step bond to yield 11.395% due 11/15/07 12,662,281
Marcus Cable Capital Corp., Sr. Discount Notes:
5,700,000 B Step bond to yield 11.392% due 8/1/04 5,087,250
4,850,000 B Step bond to yield 12.661% due 12/15/05 4,001,250
Rogers Cablesystems:
11,357,000 BB- Sr. Debenture, 10.875% due 4/15/04 12,010,028
4,675,000 BB+ Sr. Secured Debenture, 10.000% due 12/1/07 5,306,125
5,350,000 BB+ Sr. Secured Second Priority Debenture, 9.650% due 1/15/14 4,112,556
12,490,000 BB- Sr. Sub. Debenture, 11.000% due 12/1/15 13,832,675
6,900,000 BB Rogers Communications, Sr. Notes, 8.875% due 7/15/07 7,003,500
5,000,000 BB- SCI Television Inc., Sr. Notes, 11.000% due 6/30/05 5,287,500
7,525,000 B- SFX Broadcasting Inc., Sr. Sub. Notes, 10.750% due 5/15/06 8,475,031
5,600,000 Ba3* TV Azteca SA, Sr. Notes, 10.500% due 2/15/07+ 5,964,000
16,250,000 B- UIH Australia Inc., Sr. Discount Notes, 10,846,875
step bond to yield 14.058% due 5/15/06
United International Holdings Inc., Zero Coupon Sr.
Discount Notes to yield:
5,350,000 B- 13.629% due 11/15/99 4,233,188
8,035,000 B- 13.882% due 11/15/99 6,357,694
Videotron Holdings:
4,975,000 B+ Sr. Discount Notes, step bond to yield 11.286% due 8/15/05 4,259,844
4,075,000 BB+ Sr. Notes, 10.625% due 2/15/05 4,513,063
7,625,000 BB+ Sr. Sub. Notes, 10.250% due 10/15/02 8,139,688
2,450,000 B Young Broadcasting, Sr. Sub. Notes, 11.750% due 11/15/04 2,759,313
- ----------------------------------------------------------------------------------------------------------
180,419,100
- ----------------------------------------------------------------------------------------------------------
Building/Construction -- 0.7%
1,900,000 B American Builders, Sr. Sub. Notes, 10.625% due 5/15/07+ 1,987,875
7,000,000 BB- CIA Latino, Sr. Secured Notes, 11.625% due 6/1/04+ 7,490,000
- ----------------------------------------------------------------------------------------------------------
9,477,875
- ----------------------------------------------------------------------------------------------------------
Chemicals -- 2.5%
6,025,000 B NL Industries, Sr. Secured Notes, 11.750% due 10/15/03 6,650,094
6,800,000 BB Pt. Polysindo Eka Perkasa, Sr. Secured Notes, 13.000% due 6/15/01 7,752,000
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 11
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
==========================================================================================================
<C> <C> <S> <C>
Chemicals -- 2.5% (continued)
$ 5,450,000 B+ Polytama International, Sr. Notes, 11.250% due 6/15/07 $ 5,518,125
9,400,000 B+ Terra Industries, Inc., Sr. Notes, Series B, 10.500% due 6/15/05 10,304,750
2,275,000 B Texas Petrochemical Inc., Sr. Sub. Notes, 11.125% due 7/1/06 2,451,313
- ----------------------------------------------------------------------------------------------------------
32,676,282
- ----------------------------------------------------------------------------------------------------------
Consumer Durables -- 1.2%
Coleman Escrow Corp., Sr. Discount Notes:
10,325,000 NR Zero coupon to yield 11.236% due 5/15/01+ 6,659,625
3,000,000 NR Zero coupon to yield 12.714% due 5/15/01+ 1,762,500
10,050,000 B+ International Semi-Tech Microelectronics Inc., Sr. Secured
Notes, step bond to yield 11.128% due 8/15/03 6,507,375
- ----------------------------------------------------------------------------------------------------------
14,929,500
- ----------------------------------------------------------------------------------------------------------
Diversified/Conglomerate Manufacturing -- 2.3%
4,200,000 B Goss Graphic System Inc., Sr. Sub. Notes, 12.000% due 10/15/06 4,672,500
5,675,000 B3* Interlake Corp., Sr. Sub. Debentures, 12.125% due 3/1/02 5,937,469
7,150,000 B Intertek Finance PLC, Sr. Sub. Notes, 10.250% due 11/1/06 7,471,750
5,150,000 B- Outsourcing Solutions Inc., Sr. Sub Notes, 11.000% due 11/1/06 5,748,688
5,650,000 B Unifrax Investment Corp., Sr. Notes, 10.500% due 11/1/03 5,932,500
- ----------------------------------------------------------------------------------------------------------
29,762,907
- ----------------------------------------------------------------------------------------------------------
Electric-Utilities -- 1.3%
8,350,000 B+ Calpine Corp., Sr. Notes, 10.500% due 5/15/06 9,122,375
2,106,589 BB- Midland Cogeneration Venture Limited Partnership,
Midland Funding, Sr. Secured Lease Bond, Series C,
10.330% due 7/23/02 2,306,715
5,246,590 BB- Midland Cogeneration Venture, Sr. Secured Lease Obligation Bond,
10.330% due 7/23/02 5,745,016
- ----------------------------------------------------------------------------------------------------------
17,174,106
- ----------------------------------------------------------------------------------------------------------
Electronics/Computers -- 5.5%
6,550,000 B Celestica International Inc., Sr. Sub. Notes, 10.500% due 12/31/06 7,131,313
5,000,000 B- DecisionOne Corp., Sr. Sub. Notes, 9.750% due 8/1/07 5,125,000
3,500,000 B- DecisionOne Holdings, Unit, step bond to yield 11.500% due 8/1/08++ 2,091,250
10,300,000 B Fairchild Semiconductor, Sr. Sub. Notes, 10.125% due 3/15/07+ 10,995,250
4,275,000 NR FSC Semiconductor, Sr. Notes, 11.740% due 3/14/08@ 4,272,259
6,375,000 B- Graphic Controls Corp., Sr. Sub. Notes, 12.000% due 9/15/05 7,116,094
Unisys Corp., Sr. Notes:
15,000,000 B+ 12.000% due 4/15/03 16,537,499
11,100,000 B+ 11.750% due 10/15/04 12,237,749
5,150,000 B- ViaSystems Inc., Sr. Sub. Notes, 9.750% due 6/1/07+ 5,368,875
- ----------------------------------------------------------------------------------------------------------
70,875,289
- ----------------------------------------------------------------------------------------------------------
Environmental -- 1.1%
7,150,000 B+ Allied Waste North America Inc., Sr. Sub Notes, 10.250% due 12/1/06+ 7,847,125
6,300,000 B Envirosource, Sr. Notes, 9.750% due 6/15/03 6,268,500
- ----------------------------------------------------------------------------------------------------------
14,115,625
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
12 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
==========================================================================================================
<C> <C> <S> <C>
Finance -- 3.1%
$ 8,000,000 B Amresco, Sr. Sub. Notes, 10.000% due 3/15/04 $ 8,100,000
18,655,000 B First Nationwide Parent Holdings Ltd., Sr. Exchange Notes,
12.500% due 4/15/03 21,359,974
5,225,000 B+ Imperial Credit, Sr. Notes, 9.875% due 1/15/07 5,238,063
3,500,000 B+ Ocwen Federal Bank, Sub. Debenture, 12.000% due 6/15/05 3,911,250
1,250,000 B+ Ocwen Financial Corp., Sr. Notes, 11.875% due 10/1/03 1,396,875
- ----------------------------------------------------------------------------------------------------------
40,006,162
- ----------------------------------------------------------------------------------------------------------
Food -- 0.3%
2,825,000 B- Van de Kamp Inc., Sr. Sub. Notes, 12.000% due 9/15/05 3,167,531
- ----------------------------------------------------------------------------------------------------------
Grocery/Convenience Stores -- 2.3%
Pathmark Stores Inc., Debentures:
5,500,000 B 12.625% due 6/15/02 5,644,375
2,300,000 B 9.625% due 5/1/03 2,202,250
25,000,000 B Step bond to yield 12.899% due 11/1/03 17,499,999
4,075,000 BB- TLC Beatrice International Inc., Sr. Secured Notes,
11.500% due 10/1/05 4,645,500
- ----------------------------------------------------------------------------------------------------------
29,992,124
- ----------------------------------------------------------------------------------------------------------
Healthcare -- 2.3%
6,300,000 B Magellan Health Services, Sr. Sub. Notes, 11.250% due 4/15/04 7,032,375
5,525,000 B- Sun Healthcare Group, Inc., Sr. Sub. Notes, 9.500% due 7/1/07+ 5,718,375
Tenet Healthcare:
5,500,000 BB Sr. Notes, 8.000% due 1/15/05 5,761,250
6,900,000 B+ Sr. Sub Notes, 8.625% due 1/15/07 7,305,375
3,400,000 B Vencor, Inc., Sr. Sub. Notes, 8.625% due 7/15/07+ 3,468,000
- ----------------------------------------------------------------------------------------------------------
29,285,375
- ----------------------------------------------------------------------------------------------------------
Hotels, Casinos & Gaming -- 4.0%
3,000,000 B Aztar Corp., Sr. Sub. Notes, 13.750% due 10/1/04 3,450,000
3,425,000 BB- Boyd Gaming Corp., Sr. Sub. Notes, 9.500% due 7/15/07+ 3,467,813
6,300,000 B- Courtyard by Marriott, Sr. Secured Notes, 10.750% due 2/1/08 6,874,875
10,050,000 BB Grand Casinos, Sr. Sub. Notes, 10.125% due 12/1/03 10,816,312
2,000,000 Ba3* HMC Acquisition Properties, Sr. Notes, 9.000% due 12/15/07 2,075,000
HMH Properties Inc., Sr. Sub. Notes
6,100,000 BB- 9.500% due 5/15/05 6,466,000
2,575,000 BB- 8.875% due 7/15/07+ 2,665,125
6,025,000 BB+ Mohegan Tribal Gaming Authority, Sr. Secondary Notes,
13.500% due 11/15/02 7,953,000
6,975,000 B Showboat Inc., Sr. Sub. Notes, 13.000% due 8/1/09 8,108,438
- ----------------------------------------------------------------------------------------------------------
51,876,563
- ----------------------------------------------------------------------------------------------------------
Leasing -- 0.4%
5,000,000 B3* Central Transport, Sr. Notes, 9.500% due 4/30/03 5,337,500
- ----------------------------------------------------------------------------------------------------------
Machinery -- 1.9%
3,775,000 B- Alvey Systems, Inc. Sr. Sub. Notes, 11.325% due 1/31/03 3,916,563
18,040,000 B- Terex Corp., Sr. Notes, 13.250% due 5/15/02 20,678,349
- ----------------------------------------------------------------------------------------------------------
24,594,912
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 13
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
==========================================================================================================
<C> <C> <S> <C>
Metals & Mining -- 3.3%
$ 412,000 B Algoma Steel Inc., 12.375% due 7/15/05 $ 478,435
4,800,000 B- Commonwealth Aluminum Corp., Sub. Notes, 10.750% due 10/1/06 5,124,000
6,050,000 BB- Echo Bay Mines, Jr. Sub. Notes, 11.000% due 4/1/27 5,770,188
6,175,000 B- Kaiser Aluminum Corp., Sr. Sub. Notes, 12.750% due 2/1/03 6,730,750
13,315,000 B- Haynes International Inc., Sr. Notes, 11.625% due 9/1/04 14,663,143
8,330,000 B+ UCAR Global Enterprises Inc., Sr. Sub. Notes, 12.000% due 1/15/05 9,517,025
- ----------------------------------------------------------------------------------------------------------
42,283,541
- ----------------------------------------------------------------------------------------------------------
Oil & Natural Gas -- 6.7%
5,050,000 BB Clark Oil Refinery, Sr. Notes, 10.500% due 12/1/01 5,258,313
7,050,000 B+ Clark USA Inc., Sr. Notes, 10.875% due 12/1/05 7,649,250
11,895,000 B+ Dawson Product Services, Sr. Notes, 9.375% due 2/1/07 12,341,062
5,400,000 CCC+ Deeptech International, Sr. Notes, 12.000% due 12/15/00 5,771,250
9,320,000 B+ Global Marine, Sr. Secured Notes, 12.750% due 12/15/99 9,786,000
7,600,000 B+ ICO Inc., Sr. Notes, 10.375% due 6/1/07+ 7,961,000
2,475,000 B Lomak Petroleum Inc., Sr. Sub. Notes, 8.750% due 1/15/07 2,487,375
10,375,000 B+ Parker Drilling, Sr. Notes, 9.750% due 11/15/06 11,153,125
4,050,000 B3* PETSEC Energy Inc., Sr. Sub. Notes, 9.500% due 6/15/07+ 4,125,938
6,750,000 BB- Pride Petroleum Service, Sr. Notes, 9.375% due 5/1/07 7,188,750
6,825,000 BB- Santa Fe Energy Resources, Sr. Sub. Debenture,
11.000% due 5/15/04 7,413,656
5,375,000 B United Meridian Corp., Sr. Sub. Notes, 10.375% due 10/15/05 5,865,469
- ----------------------------------------------------------------------------------------------------------
87,001,188
- ----------------------------------------------------------------------------------------------------------
Packaging & Containers -- 2.4%
7,500,000 B+ Container Corp. of America, Guaranteed Sr. Notes, 11.250% due 5/1/04 8,292,300
4,875,000 B- Gaylord Container Corp., Sr. Sub. Debenture, 12.750% due 5/15/05 5,362,500
8,425,000 NR Impress Metal, Sr. Sub. Notes, 9.875% due 5/29/07+ 4,827,587
8,400,000 B- Ivex Holdings Corp., Debenture, step bond to yield 12.917%
due 3/15/05 6,667,500
5,775,000 B+ Vicap SA, Sr. Notes, 11.375% due 5/15/07+ 6,323,625
- ----------------------------------------------------------------------------------------------------------
31,473,512
- ----------------------------------------------------------------------------------------------------------
Paper & Printing -- 4.9%
4,810,000 B- American Pad & Paper Co., Inc., Sr. Sub. Notes, 13.000%
due 11/15/05 5,621,688
12,400,000 NR Asia Pulp and Paper, Sr. Sub. Notes, 12.000% due 12/29/49+ 12,586,000
18,950,000 BB Indah Kiat International Finance Co., Sr. Secured Notes,
11.875% due 6/15/02 20,892,375
13,175,000 B+ SD Warren Co., Sr. Sub. Notes, 12.000% due 12/15/04 14,838,344
7,600,000 BB Tjiwi Kimia International, Sr. Notes, 13.250% due 8/1/01 8,635,500
- ----------------------------------------------------------------------------------------------------------
62,573,907
- ----------------------------------------------------------------------------------------------------------
Real Estate -- 0.4%
5,041,000 BB- Trizec Finance, Sr. Notes, 10.875% due 10/15/05 5,778,246
- ----------------------------------------------------------------------------------------------------------
Retail -- 0.8%
10,025,000 B+ Barnes and Noble, Sr. Sub. Notes, 11.875% due 1/15/03 10,877,125
- ----------------------------------------------------------------------------------------------------------
Steel -- 0.4%
5,000,000 B- Russel Metals Inc., Sr. Notes, 10.250% due 6/15/00 5,250,000
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
14 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT RATING SECURITY VALUE
==========================================================================================================
<C> <C> <S> <C>
Telecommunications -- 19.8%
Brooks Fiber Properties Inc., Sr. Discount Notes:
$ 12,820,000 NR Step bond to yield 10.899% due 3/1/06 $ 9,566,925
17,325,000 NR Step bond to yield 11.704% due 11/1/06 12,409,031
19,800,000 B3* Clearnet Communications Inc., Sr. Discount Notes,
step bond to yield 13.784% due 12/15/05 14,429,250
13,100,000 NR Colt Telecom Group, Sr. Discount Notes,
step bond to yield 11.374% due 12/15/06+++ 8,744,250
4,000,000 NR Dobson Communications Corp., Sr. Notes, 11.750% due 4/15/07 3,910,000
4,425,000 B+ Fonorola Inc., Sr. Sub. Notes, 12.500% due 8/15/02 4,956,000
5,000,000 B+ GCI Inc., Sr. Notes, 9.750% due 8/1/07 5,156,250
6,250,000 B Globalstar LP, Unit, 11.375% due 2/15/04+++ 5,968,750
10,100,000 NR Intelcom Group, Sr. Notes, step bond to yield 12.011% due 5/1/06 7,234,125
20,300,000 B- Intermedia Communications of Florida, Sr. Discount Notes,
step bond to yield 11.973% due 5/15/06 15,072,750
5,125,000 B- Iridium, Notes and Warrants, 13.000% due 7/15/05+++ 5,176,250
16,475,000 B McLeod Inc., Sr. Discount Notes,
step bond to yield 10.577% due 3/1/07+ 11,038,250
12,700,000 NR Metronet Communications, Sr. Notes, 12.000% due 8/15/07+++ 13,589,000
18,875,000 B- Millicom International Cellular SA, Sr. Sub. Discount Notes,
step bond to yield 13.500% due 6/1/06 14,179,844
38,900,000 B3* Nextel Communications, Sr. Discount Notes,
step bond to yield 12.168% due 8/15/04 31,946,625
10,950,000 NR Nextlink Communications, Sr. Discount Notes, 12.500% due 4/15/06 12,318,750
Pagemart Nationwide, Inc., Sr. Discount Notes:
12,050,000 NR Step bond to yield 12.128% due 11/1/03 10,799,813
7,475,000 NR Step bond to yield 13.243% due 2/1/05 5,898,298
9,925,000 B- Primus Telecomm Group, Unit, 9.375% due 8/1/04++ 10,173,125
5,600,000 B+ Qwest Communications International, Sr. Notes, 10.875% due 4/1/07+ 6,286,000
9,550,000 NR RSL Communications Ltd., 12.250% due 11/15/06 10,385,625
16,950,000 B Teleport Communications, Sr. Discount Notes:
step bond to yield 11.462% due 7/1/07 12,966,750
14,025,000 B- Telesystems International Wireless, Sr. Discount Notes, step bond
to yield 13.066% due 6/30/07+ 8,134,500
15,500,000 BB Telewest Communications PLC, Sr. Discount Debenture,
step bond to yield 11.135% due 10/1/07 11,625,000
6,275,000 B- Wireless One Inc., Sr. Discount Notes, 13.000% due 10/15/03 3,827,750
- ----------------------------------------------------------------------------------------------------------
255,792,911
- ----------------------------------------------------------------------------------------------------------
Tobacco -- 0.5%
5,550,000 B Consolidated Cigar Corp., Sr. Sub. Notes, 10.500% due 3/1/03 5,827,500
- ----------------------------------------------------------------------------------------------------------
Transportation -- 0.7%
7,575,000 BB- Sea Containers Ltd., Sr. Sub. Debenture, 12.500% due 12/1/04 8,588,156
- ----------------------------------------------------------------------------------------------------------
TOTAL CORPORATE BONDS AND NOTES
(Cost -- $ 1,028,139,012) 1,089,441,880
==========================================================================================================
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 15
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
==========================================================================================================
<C> <S> <C>
COMMON STOCK -- 0.2%
Healthcare -- 0.2%
28,086 Tyco International Ltd. (Cost -- $614,002) $ 2,274,966
==========================================================================================================
PREFERRED STOCK -- 6.5%
Broadcasting -- 3.8%
21,788 Time Warner Inc., Series K, Exchange 10.250%+ 49,318,903
- ----------------------------------------------------------------------------------------------------------
Finance -- 1.0%
491,300 California Federal Bank Preferred Capital 12,958,037
- ----------------------------------------------------------------------------------------------------------
Miscellaneous -- 0.2%
274,916 Avatex Corp.# 2,491,426
- ----------------------------------------------------------------------------------------------------------
Publishing -- 0.0%
1,355 K-III Communications Corp., Series B, Exchange 11.625% 143,830
- ----------------------------------------------------------------------------------------------------------
Telecommunications -- 1.5%
274,916 PanAmSat Corp., Series A, Exchange $31.875 19,033,573
- ----------------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCK
(Cost -- $84,739,254) 83,945,769
==========================================================================================================
CONVERTIBLE PREFERRED STOCK -- 0.8%
Automobiles/Trucking -- 0.8%
166,100 Navistar International Corp., Series G, Convertible $6.00
(Cost -- $9,275,014) 10,007,525
==========================================================================================================
WARRANTS -- 0.1 %
13,350 Australis Holdings, Expire 10/30/01+# 401
65,340 Clearnet Communications, Expire 9/15/05+# 359,370
62,500 Globalstar LP, Expire 2/15/04+# 375,000
18,522 Nextel Communications Inc., Expire 4/25/99+# 186
37,490 Pagemart Inc., Expire 12/31/03# 234,313
18,375 Pagemart Nationwide, Expire 12/31/03+# 176,859
9,550 RSL Communications, Expire 11/15/06# 57,300
8,025 S.D. Warren, & Co., Expire 12/15/06+# 104,325
213,479 Trump Castle Hotel & Casino, Expire 9/15/00# 0
5,925 Wireless One, Inc., Expire 10/15/03# 5,925
- ----------------------------------------------------------------------------------------------------------
TOTAL WARRANTS
(Cost -- $920,483) 1,313,679
==========================================================================================================
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
16 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) July 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
==========================================================================================================
<C> <S> <C>
REPURCHASE AGREEMENT -- 8.0%
$ 103,012,000 Goldman, Sachs & Co., 5.725% due 8/1/97;
Proceeds at maturity -- $103,028,382; (Fully
collateralized by U.S. Treasury Notes, 6.250% due 6/30/98;
Market value -- $105,122,251)
(Cost -- $103,012,000) $ 103,012,000
==========================================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $1,226,699,765**) $1,289,995,819
==========================================================================================================
</TABLE>
+ Security is exempt from registration under Rule 144A of the Securities Act
of 1933. This security may be resold in transactions that are exempt from
registration, normally to qualified institutional buyers.
++ Security issued with attached warrants.
@ Restricted security (See Note 8).
# Non-income producing security.
** Aggregate cost for Federal income tax purposes is substantially the same.
See page 18 for definition of ratings.
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 17
<PAGE>
- --------------------------------------------------------------------------------
Bond Ratings
- --------------------------------------------------------------------------------
All ratings are by Standard & Poor's Rating Service ("Standard & Poor's"),
except those identified by an asterisk (*) are rated by Moody's Investors
Services, Inc. ("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 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.
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.
NR -- Indicates that the bond is not rated by Standard & Poor's or
Moody's.
- --------------------------------------------------------------------------------
18 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities July 31, 1997
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost-- $1,226,699,765) $1,289,995,819
Cash 708,008
Receivable for Fund shares sold 4,581,912
Receivable for securities sold 3,344,500
Interest receivable 19,554,222
Dividend receivable 6,429
- --------------------------------------------------------------------------------
Total Assets 1,318,190,890
- --------------------------------------------------------------------------------
LIABILITIES:
Payable for securities purchased 27,523,314
Payable for Fund shares purchased 612,759
Investment advisory fees payable 523,787
Administration fees payable 209,515
Distribution fees payable 204,114
Accrued expenses 297,775
- --------------------------------------------------------------------------------
Total Liabilities 29,371,264
- --------------------------------------------------------------------------------
Total Net Assets $1,288,819,626
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $108,945
Capital paid in excess of par value 1,424,393,330
Undistributed net investment income 873,947
Accumulated net realized loss from security
transactions, options and futures contracts (199,848,782)
Net unrealized appreciation of investments
and foreign currencies 63,292,186
- --------------------------------------------------------------------------------
Total Net Assets $1,288,819,626
================================================================================
Shares Outstanding:
Class A 35,865,802
----------------------------------------------------------------------------
Class B 57,550,302
----------------------------------------------------------------------------
Class C 3,752,857
----------------------------------------------------------------------------
Class Y 11,767,040
----------------------------------------------------------------------------
Class Z 8,845
----------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $11.82
----------------------------------------------------------------------------
Class B * $11.83
----------------------------------------------------------------------------
Class C ** $11.84
----------------------------------------------------------------------------
Class Y (and redemption price) $11.84
----------------------------------------------------------------------------
Class Z (and redemption price) $11.80
----------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 4.71% of net asset value per share) $12.38
================================================================================
* 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.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 19
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended July 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $112,951,939
Dividends 7,487,698
- --------------------------------------------------------------------------------
Total Investment Income 120,439,637
- --------------------------------------------------------------------------------
EXPENSES:
Distribution fees (Note 2) 5,818,152
Investment advisory fees (Note 2) 5,646,405
Administrative fees (Note 2) 2,258,562
Shareholder and system servicing fees 760,401
Registration fees 180,000
Shareholder communications 78,001
Custody 45,599
Audit and legal 38,000
Trustees' fees 24,999
Pricing service fees 12,001
Other 29,959
- --------------------------------------------------------------------------------
Total Expenses 14,892,079
- --------------------------------------------------------------------------------
Net Investment Income 105,547,558
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS, OPTIONS,
FUTURES CONTRACTS AND FOREIGN CURRENCIES (NOTES 3, 5 AND 6):
Realized Gain (Loss) From:
Security transactions (excluding short-term securities) 15,609,240
Options purchased (515,134)
Futures contracts 835,151
- --------------------------------------------------------------------------------
Net Realized Gain 15,929,257
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments
and Foreign Currencies:
Beginning of year (4,516,037)
End of year 63,292,186
- --------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 67,808,223
- --------------------------------------------------------------------------------
Net Gain on Investments, Options, Futures Contracts
and Foreign Currencies 83,737,480
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $189,285,038
================================================================================
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
20 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended July 31
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
=========================================================================================
<S> <C> <C>
OPERATIONS:
Net investment income $ 105,547,558 $ 84,120,788
Net realized gain 15,929,257 5,895,839
Increase (decrease) in net unrealized appreciation 67,808,223 (16,205,851)
- -----------------------------------------------------------------------------------------
Increase in Net Assets From Operations 189,285,038 73,810,776
- -----------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (104,694,362) (84,933,098)
- -----------------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (104,694,362) (84,933,098)
- -----------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 9):
Net proceeds from sale of shares 518,083,066 368,319,175
Net asset value of shares issued for
reinvestment of dividends 49,296,162 43,349,499
Cost of shares reacquired (327,525,297) (257,795,961)
- -----------------------------------------------------------------------------------------
Increase in Net Assets From
Fund Share Transactions 239,853,931 153,872,713
- -----------------------------------------------------------------------------------------
Increase in Net Assets 324,444,607 142,750,391
NET ASSETS:
Beginning of year 964,375,019 821,624,628
- -----------------------------------------------------------------------------------------
End of year* $ 1,288,819,626 $ 964,375,019
=========================================================================================
* Includes undistributed net investment income of: $ 873,947 $ 20,751
=========================================================================================
</TABLE>
See Notes to Financial Statements.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 21
<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 this
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 with the
exception of the Smith Barney Premium Total Return Fund which will have an
annual report dated December 31, 1997.
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 securities for which no
sales price was 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 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 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 or expense amounts
recorded and collected or paid are adjusted when reported by the custodian bank;
(f) interest income, adjusted for amortization of premium and accretion of
discount, is recorded on an accrual basis; (g) dividend income is recorded on
ex-dividend date; foreign dividend income is recorded on the ex-dividend date or
as soon as practical after the Fund determines the existence of a dividend
declaration after exercising reasonable due diligence; (h) gains or losses on
the sale of securities are recorded using the specific identification method;
(i) dividends and distributions to shareholders are recorded on the ex-dividend
date; (j) direct expenses are charged to each class; management fees and general
fund expenses are allocated on the basis of the relative net assets; (k) 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, 1997, reclassifications were made to the Fund'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 $23,975,095 has been reclassified
to paid-in capital. Net investment income, net realized gains and net assets
were not affected by this change; (l) 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 (m) 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.
- --------------------------------------------------------------------------------
22 1997 Annual Report to Shareholders
<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 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 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. 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, 1997, SB received sales charges of approximately $726,000 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. 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 July 31, 1997, CDSCs paid to SB were
approximately:
Class A Class B Class C
================================================================================
CDSCs $7,000 $831,000 $17,000
================================================================================
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. 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, 1997, total Distribution Plan fees incurred
were:
Class A Class B Class C
================================================================================
Distribution Plan Fees $952,323 $4,639,862 $225,967
================================================================================
All officers and one Trustee of the Trust are employees of SB.
3. Investments
During the year ended July 31, 1997, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $1,123,534,191
- --------------------------------------------------------------------------------
Sales 912,932,397
================================================================================
At July 31, 1997, aggregate gross unrealized appreciation and depreciation of
investments for Federal income tax purposes were substantially as follows:
================================================================================
Gross unrealized appreciation $96,875,667
Gross unrealized depreciation (33,579,613)
- --------------------------------------------------------------------------------
Net unrealized appreciation $63,296,054
================================================================================
4. Capital Loss Carryforward
At July 31, 1997, the Fund had, for Federal income tax purposes, capital loss
carryforwards of approximately $199,831,000 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:
Carryforward
Year Amounts
================================================================================
1998 $68,550,000
1999 84,656,000
2000 9,861,000
2003 13,404,000
2004 23,360,000
================================================================================
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 23
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
5. Futures Contracts
Initial margin deposits made upon entering into futures contracts are recognized
as assets. Securities equal to the initial margin amount are segregated by the
custodian in the name of the broker. Additional securities are also segregated
up to the current market value of the futures contracts. 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 received or made 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.
At July 31, 1997, 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 and are included in the schedule
of investments. 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
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.
At July 31, 1997, the Fund had no open purchased call or put options contracts.
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 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 written call option is
exercised, the cost of the security sold will be decreased 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
covered 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 a
loss if the market price of the underlying security declines.
During the year ended July 31, 1997, the Fund did not write any options.
- --------------------------------------------------------------------------------
24 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
7. 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.
8. Restricted Security
The following security held by the Fund on July 31, 1997, is a restricted
security under Federal securities laws and is valued at fair value in good faith
by, or under the direction of, the Fund's Board of Directors taking into
consideration the appropriate economic, financial and other pertinent available
information pertaining to this security.
<TABLE>
<CAPTION>
Value Percentage
Acquisition Face Per Fair of total
Security Date Amount Unit Value Net Assets Cost
==================================================================================================
<S> <C> <C> <C> <C> <C>
FSC Semiconductor, Sr. Notes,
11.740% due 3/14/08 6/5/97 $4,275,000 $1.045 $4,467,375 0.35% $4,171,731
==================================================================================================
</TABLE>
The Fund may purchase securities which are subject to legal or contractual
restrictions on resale if not more than 15% of the value of the Fund's total
assets would be invested in such securities or in securities for which there is
no readily available market. In purchasing securities which could not be sold by
the Fund without registration under the Securities Act of 1933, as amended, the
Fund will endeavor to obtain the right to registration at the expense of the
issuer. There generally will be a lapse of time between the decision by the Fund
to sell any such security and the registration of the security permitting sale.
During any such period, the security will be subject to market fluctuations.
9. Shares of Beneficial Interest
At July 31, 1997, 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 specifically related to the distribution of its shares.
At July 31, 1997, 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 $423,111,748 $825,408,198 $42,287,512 $131,338,346 $2,356,471
=================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 25
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
July 31, 1997 July 31, 1996
-------------------------- ------------------------
Shares Amount Shares Amount
========================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 11,251,248 $ 128,184,460 8,308,861 $ 92,921,114
Shares issued on reinvestment 1,783,139 20,333,664 1,612,994 17,961,926
Shares redeemed (8,215,949) (93,966,990) (7,405,625) (82,925,205)
- ----------------------------------------------------------------------------------------
Net Increase 4,818,438 $ 54,551,134 2,516,230 $ 27,957,835
========================================================================================
Class B
Shares sold 14,926,125 $ 170,353,508 15,087,459 $ 168,856,580
Shares issued on reinvestment 2,193,852 25,024,236 2,055,044 22,903,819
Shares redeemed (10,519,955) (119,922,846) (9,273,067) (103,699,076)
- ----------------------------------------------------------------------------------------
Net Increase 6,600,022 $ 75,454,898 7,869,436 $ 88,061,323
========================================================================================
Class C
Shares sold 2,371,080 $ 27,157,044 1,609,793 $ 18,045,708
Shares issued on reinvestment 149,311 1,707,734 66,555 742,283
Shares redeemed (681,148) (7,785,579) (303,748) (3,396,461)
- ----------------------------------------------------------------------------------------
Net Increase 1,839,243 $ 21,079,199 1,372,600 $ 15,391,530
========================================================================================
Class Y
Shares sold 16,943,643 $ 192,376,935 7,916,081 $ 88,491,973
Shares issued on reinvestment 172,615 1,971,806 76,423 856,979
Shares redeemed (8,542,613) (98,240,791) (5,727,363) (64,207,334)
- ----------------------------------------------------------------------------------------
Net Increase 8,573,645 $ 96,107,950 2,265,141 $ 25,141,618
========================================================================================
Class Z
Shares sold 872 $ 11,119 340 $ 3,800
Shares issued on reinvestment 23,013 258,722 79,450 884,492
Shares redeemed (666,462) (7,609,091) (322,209) (3,567,885)
- ----------------------------------------------------------------------------------------
Net Decrease (642,577) $ (7,339,250) (242,419) $ (2,679,593)
========================================================================================
</TABLE>
- --------------------------------------------------------------------------------
26 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class A Shares 1997 1996 1995 1994 1993(1)
====================================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 10.98 $ 11.10 $ 11.16 $ 12.01 $ 11.03
- --------------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 1.09 1.08 1.08 1.08 0.75
Net realized and unrealized gain (loss) 0.83 (0.12) (0.02) (0.81) 1.09
- --------------------------------------------------------------------------------------------------------------------
Total Income From Operations 1.92 0.96 1.06 0.27 1.84
- --------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (1.08) (1.08) (1.05) (1.12) (0.86)
Capital -- -- (0.07) -- --
- --------------------------------------------------------------------------------------------------------------------
Total Distributions (1.08) (1.08) (1.12) (1.12) (0.86)
- --------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 11.82 $ 10.98 $ 11.10 $ 11.16 $ 12.01
- --------------------------------------------------------------------------------------------------------------------
Total Return 18.31% 8.95% 10.28% 2.11% 17.29%++
- --------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 424,087 $ 341,040 $ 316,716 $ 233,678 $ 242,371
- --------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.06% 1.10% 1.11% 1.11% 1.16%+
Net investment income 9.57 9.65 10.03 9.27 9.52+
- --------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 78% 72% 60% 98% 95%
====================================================================================================================
</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.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 27
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class B Shares 1997 1996 1995 1994 1993
=================================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 10.99 $ 11.11 $ 11.16 $ 12.01 $ 11.15
- -----------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 1.03 1.02 1.03 1.02 1.08
Net realized and unrealized gain (loss) 0.83 (0.12) (0.02) (0.81) 0.88
- -----------------------------------------------------------------------------------------------------------------
Total Income From Operations 1.86 0.90 1.01 0.21 1.96
- -----------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (1.02) (1.02) (0.99) (1.06) (1.10)
Capital -- -- (0.07) -- --
- -----------------------------------------------------------------------------------------------------------------
Total Distributions (1.02) (1.02) (1.06) (1.06) (1.10)
- -----------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 11.83 $ 10.99 $ 11.11 $ 11.16 $ 12.01
- -----------------------------------------------------------------------------------------------------------------
Total Return 17.72% 8.41% 9.77% 1.60% 18.55%
- -----------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 680,916 $ 560,031 $ 478,499 $ 509,608 $ 448,639
- -----------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.55% 1.59% 1.61% 1.60% 1.66%
Net investment income 9.07 9.16 9.52 8.77 9.02
- -----------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 78% 72% 60% 98% 95%
=================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
28 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class C Shares 1997 1996 1995(1)(2)
================================================================================
Net Asset Value, Beginning of Year $ 11.00 $ 11.11 $ 10.90
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 1.04 1.03 0.95
Net realized and unrealized gain (loss) 0.83 (0.11) 0.23
- --------------------------------------------------------------------------------
Total Income From Operations 1.87 0.92 1.18
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (1.03) (1.03) (0.90)
Capital -- -- (0.07)
- --------------------------------------------------------------------------------
Total Distributions (1.03) (1.03) (0.97)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 11.84 $ 11.00 $ 11.11
- --------------------------------------------------------------------------------
Total Return 17.77% 8.56% 11.50%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 44,444 $21,049 $ 6,011
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.48% 1.51% 1.56%+
Net investment income 9.14 9.23 9.58+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 78% 72% 60%
================================================================================
(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.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 29
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
Class Y Shares 1997 1996 1995(1)
================================================================================
Net Asset Value, Beginning of Year $ 10.99 $ 11.10 $ 10.88
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 1.12 0.92 0.09
Net realized and unrealized gain (loss) 0.84 (0.11) 0.23
- --------------------------------------------------------------------------------
Total Income From Operations 1.96 0.81 0.32
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (1.11) (0.92) (0.03)
Capital -- -- (0.07)
- --------------------------------------------------------------------------------
Total Distributions (1.11) (0.92) (0.10)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 11.84 $ 10.99 $ 11.10
- --------------------------------------------------------------------------------
Total Return 18.68% 9.32% 2.91%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $139,269 $ 35,097 $ 10,306
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.73% 0.76% 0.86%+
Net investment income 9.90 9.98 10.28+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 78% 72% 60%
================================================================================
(1) 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.
- --------------------------------------------------------------------------------
30 1997 Annual Report to Shareholders
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of beneficial interest outstanding throughout each
year:
<TABLE>
<CAPTION>
Class Z Shares 1997(1) 1996 1995(2) 1994 1993(3)
=============================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 10.99 $ 11.09 $ 11.16 $ 12.01 $ 11.03
- -------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 1.12 1.11 1.11 1.10 0.79
Net realized and unrealized gain (loss) 0.80 (0.10) (0.03) (0.80) 1.07
- -------------------------------------------------------------------------------------------------------------
Total Income From Operations 1.92 1.01 1.08 0.30 1.86
- -------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (1.11) (1.11) (1.08) (1.15) (0.88)
Capital -- -- (0.07) -- --
- -------------------------------------------------------------------------------------------------------------
Total Distributions (1.11) (1.11) (1.15) (1.15) (0.88)
- -------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 11.80 $ 10.99 $ 11.09 $ 11.16 $ 12.01
- -------------------------------------------------------------------------------------------------------------
Total Return 18.29% 9.42% 10.55% 2.37% 17.47%++
- -------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 104 $ 7,158 $ 9,917 $ 11,370 $ 26,112
- -------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.75% 0.77% 0.86% 0.77% 0.81%+
Net investment income 9.88 9.98 10.28 9.61 9.88+
- -------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 78% 72% 60% 98% 95%
=============================================================================================================
</TABLE>
(1) Per share amounts have been calculated using the monthly average shares
method, rather than the undistributed net investment income method,
because it more accurately reflects the per share data for the period.
(2) On November 7, 1994, the former Class C shares were renamed Class Z
shares.
(3) 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.
- --------------------------------------------------------------------------------
Smith Barney High Income Fund 31
<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, 1997, and the related statement of operations
for the year then ended, the statements of changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the three-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 two-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, 1997, 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 High Income Fund of Smith Barney Income Funds as of July 31, 1997,
the results of its operations for the year then ended, the changes in its net
assets for each of the years in the two-year period then ended, and the
financial highlights for each of the years in the three-year period then ended,
in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
September 15, 1997
- --------------------------------------------------------------------------------
32 1997 Annual Report to Shareholders
<PAGE>
SMITH BARNEY
HIGH INCOME FUND
Trustees
Lee Abraham
Allan J. Bloostein
Richard E. Hanson, Jr.
Heath B. McLendon, Chairman
Officers
Heath B. McLendon
Chief Executive Officer
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 for the information of shareholders of Smith Barney High Income
Fund, but it may also be used as sales literature when preceded or accompanied
by the current prospectus, which gives details about charges, expenses,
investment objectives and operating policies of the Fund. If used as sales
material after September 30, 1997, this report must be accompanied by
performance information for the most recently completed calendar quarter.
SMITH BARNEY
- ---------------------------------------
A Member of TravelersGroup [LOGO]
SMITH BARNEY
HIGH INCOME FUND
Smith Barney Mutual Funds
388 Greenwich Street
New York, New York 10013
FD0429 9/97
