<PAGE>
[LOGO OF KPMG APPEARS HERE]
SMITH BARNEY VARIABLE ACCOUNT FUNDS
ANNUAL REPORT
December 31, 1998
<PAGE>
Dear Shareholder:
We are pleased to provide the annual report for the year ended December 31, 1998
for the Smith Barney Variable Account Funds. In this report, we review the
performance of the financial markets in 1998 and briefly discuss the strategies
employed by each Portfolio.
MARKET AND ECONOMIC COMMENTARY
Although by the end of 1998 several market indices (e.g., S&P 500, 28.57%; Dow
Jones Industrial Average, 18.13%; NASDAQ Composite, 40.20%) had posted
double-digit gains, their healthy advances contradicted a historic period of
volatility that whipsawed the global markets, perplexed seasoned Wall Street
experts and violently swung investor's emotions between the extremities of
optimism and fear.
In the process, investors received a thorough primer in the complexities of
global deflation, as the tentacles of the Asian contagion extended toward other
emerging markets and the event that began as a major regional disruption evolved
into a full-blown global economic crisis. Amid the turmoil, disturbing fissures
in the global financial infrastructure were revealed. Although Russia's
default, a major hedge fund debacle and spread of the economic crisis to Brazil
each surfaced separately, these threats embodied evidence of several systemic
risks and lacked any `quick fix' solutions. Moreover, these concerns contributed
to a meltdown of all major international markets, a crisis of confidence in
global leaders and swift reassessment of risk among investors.
Following the summer swoon in the markets and overwhelming evidence validating a
continuation of benign inflation, a major paradigm shift occurred among global
central bankers, as the economic risks associated with deflation and slowing
global economies displaced their historical fixation on inflation. Through
assurances of reform by Japanese and Brazilian leaders, billions in the
International Monetary Fund ("IMF") funds to build fire walls around vulnerable
markets, and an avalanche of 66 interest rate reductions globally after
September 29, 1998, monetary policymakers ultimately offered prescriptions for
each of the concerns that led investors to flee stocks. Following these actions,
stock markets around the world staged a vigorous rally that propelled most
markets back to pre-crisis heights. The S&P 500 Index, for its part, completed a
28% leap from its October low to finish the fourth quarter up 21.3%, its
strongest quarterly return since 1987.
Throughout the year, the global business climate posed a formidable challenge
for companies across many industries, as deflationary forces and stumbling
economies created an environment that proved treacherous for corporate earnings.
In fact, overall S&P 500 reported earnings entered their first profits recession
since 1992, posting declines during each of the first three quarters. Such
paltry earnings might generally have suggested that only modest market gains
would be achievable. However, the importance of rates relative to earnings was
confirmed during the fourth quarter, as rate reductions were of adequate
strength and frequency to direct attention from an uninspiring earnings outlook
and allowed the market to post impressive gains.
<PAGE>
We believe that the dominant issues in 1999 will be the advent of the Euro, the
prospects for economic recovery throughout Asia and other less developed
countries, the future sustainability of U.S. economic growth and the ongoing
resiliency of U.S. financial markets.
The Euro introduces a new variable to macroeconomic analysis that has not been
faced since the demise of the Soviet empire and the advent of true global
competition. Opportunities should abound in the financial markets as corporate
financing expands in creative new ways. However, the implications for the U.S.
dollar as the world's premier currency has now been brought into question by the
Euro's introduction. The economic picture throughout Asia and Russia remains
critically unclear. Rising employment, the need to dump finished goods in the
face of uncertain currencies and fiscal policies that are slow to change and
less than dramatic, do not bode well for the financial markets of less developed
countries.
In our view, the U.S. economy and the financial markets will continue to soul
search as to prospects for continued good fortune. The positive include such
variables as low unemployment, strong productivity and the dramatic increase in
defined contribution plans (i.e., 401(k) plans) and estate planning as key
market influences. However, historically low savings (the traditional standard)
being redefined, as the "wealth effect" as measured by investment growth remains
an ever-present shadow that can change with the ups and downs of the financial
markets.
INCOME AND GROWTH PORTFOLIO
The Income and Growth Portfolio ("Portfolio") seeks current income and long-term
growth of capital. The Portfolio invests primarily, but not exclusively, in
common stocks. The Income and Growth Portfolio is managed conservatively with a
bottom-up value approach. (A bottom-up approach to investing focuses on the
potential outstanding performance of individual companies rather than
considering the impact of major economic trends.) For the year ended 1998, the
Portfolio returned 12.89% versus the 28.57% return for the S&P 500 Index over
the same period.
Amid the global turmoil and high market volatility, the Portfolio's investment
approach remained unchanged, focusing on high quality companies with attractive
valuations, identifiable catalysts, earnings visibility and revenues
predominantly derived from developed economies. This approach resulted in a
general emphasis on stocks in sectors characterized by strong unit growth,
adequate pricing and minimal emerging markets exposure. The health care,
technology, consumer cyclical and communications industries, to varying degrees,
had these traits and consequently, several of the Portfolio's best performing
stocks were in these sectors.
<PAGE>
With the Federal Reserve Board ("Fed") now officially on the sidelines and the
prospect of additional rate cuts diminished, we suspect that during 1999 the
outlook for corporate earnings will return to the fore among investor concerns.
But although it appears that a primary catalyst propelling markets higher -
aggressive rate reductions - has been at least temporarily removed, continued
low inflation, stronger than expected economic growth and low interest rates
should still create a favourable backdrop for stocks.
U.S. GOVERNMENT/HIGH QUALITY SECURITIES PORTFOLIO
Please note that the U.S. Government/High Quality Securities Portfolio
("Portfolio") owned only one repurchase agreement during the reporting period.
For fixed income market commentary, refer to the "Market and Economic
Commentary" section at the beginning of this shareholder letter.
RESERVE ACCOUNT PORTFOLIO
Please note that the Reserve Account Portfolio ("Portfolio") had insufficient
assets to enable it to invest in accordance with its investment program during
the reporting period and currently holds only cash. For fixed income
market commentary, refer to the "Market and Economic Commentary" section at the
beginning of this shareholder letter.
In closing, thank you for your investment in Smith Barney Variable Account
Funds. We look forward to helping you pursue your investment needs in 1999.
Sincerely,
/s/ Heath B. McLendon
Heath B. McLendon
Chairman
February 22, 1999
<PAGE>
Income and Growth Portfolio
Historical Performance
<TABLE>
<CAPTION>
Net Asset Value
---------------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distribution Returns(1)
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
12/31/98 $17.29 $13.98 $0.49 $4.98 12.89%
- -----------------------------------------------------------------------------------------------------
12/31/97 14.69 17.29 0.10 1.38 28.11
- -----------------------------------------------------------------------------------------------------
12/31/96 15.24 14.69 0.56 3.24 21.02
- -----------------------------------------------------------------------------------------------------
12/31/95 13.05 15.24 0.44 0.94 27.56
- -----------------------------------------------------------------------------------------------------
12/31/94 14.93 13.05 0.39 1.02 (3.12)
- -----------------------------------------------------------------------------------------------------
12/31/93 14.36 14.93 0.57 1.45 18.61
- -----------------------------------------------------------------------------------------------------
12/31/92 13.76 14.36 0.50 0.48 11.48
- -----------------------------------------------------------------------------------------------------
12/31/91 10.93 13.76 0.58 0.00 31.34
- -----------------------------------------------------------------------------------------------------
12/31/90 12.66 10.93 0.66 0.00 (8.37)
- -----------------------------------------------------------------------------------------------------
Inception* to 12/31/89 12.50 12.66 0.18 0.00 2.68(2)
- -----------------------------------------------------------------------------------------------------
Total $4.47 $13.49
- -----------------------------------------------------------------------------------------------------
</TABLE>
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS AND CAPITAL GAINS, IF ANY,
ANNUALLY.
Average Annual Total Return(1)
- --------------------------------------------------------------------------------
Year Ended 12/31/98 12.89%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 16.65
- --------------------------------------------------------------------------------
Inception* to 12/31/98 14.27
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Inception* to 12/31/98 252.86%
- --------------------------------------------------------------------------------
(1) Assumes reinvestment of all dividends and capital gain distributions.
(2) Total return is not annualized, as it may not be respresentative of the
total return for the year.
* The inception date for the Income and Growth Portfolio is July 20, 1989.
<PAGE>
Historical Performance (Unaudited)
GROWTH OF $10,000 INVESTED IN SHARES OF
THE INCOME AND GROWTH PORTFOLIO
VS. STANDARD & POOR'S 500 INDEX*
July 1989 -- December 1998
[GRAPH APPEARS HERE]
INCOME &
GROWTH S&P 500
DATE PORTFOLIO INDEX
-------- ------------- ------------
7/20/89 10,000 10,000
12/89 10,268 10,362 $45,824
12/90 9,408 10,040 $35,286
12/91 12,357 13,092
12/92 13,776 14,088
12/93 16,340 15,581
12/94 15,831 15,786
12/95 20,160 21,709
12/98 35,286 45,824
*Hypothetical illustration of $10,000 invested in shares at inception
on July 20, 1989, assuming reinvestment of dividends and capital
gains, if any, at net asset value through December 31, 1998. The
Standard & Poor's 500 Index is an index of widely held common stocks
traded on the New York Stock Exchange, American Stock Exchange and
Nasqaq Market. Figures for the index include reinvestment of
dividends. The index is unmanaged and is not subject to the same
management and trading expenses as a mutual fund.
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.
<PAGE>
U.S. Government/High Quality Securities Portfolio
Historical Performance
<TABLE>
<CAPTION>
Net Asset Value
-------------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distribution Returns(1)
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
12/31/98 $12.66 $10.40 $1.06 $1.23 0.22%
- -----------------------------------------------------------------------------------------------------
12/31/97 12.90 12.66 0.04 0.90 5.43
- -----------------------------------------------------------------------------------------------------
12/31/96 13.66 12.90 1.22 0.00 3.34
- -----------------------------------------------------------------------------------------------------
12/31/95 12.46 13.66 0.94 0.00 17.20
- -----------------------------------------------------------------------------------------------------
12/31/94 13.35 12.46 0.84 0.00 (0.35)
- -----------------------------------------------------------------------------------------------------
12/31/93 13.44 13.35 0.87 0.02 5.91
- -----------------------------------------------------------------------------------------------------
12/31/92 13.45 13.44 0.89 0.05 6.91
- -----------------------------------------------------------------------------------------------------
12/31/91 12.74 13.45 0.87 0.02 12.58
- -----------------------------------------------------------------------------------------------------
12/31/90 12.54 12.74 0.82 0.00 8.11
- -----------------------------------------------------------------------------------------------------
Inception* to 12/31/89 12.50 12.54 0.34 0.00 3.01(2)
- -----------------------------------------------------------------------------------------------------
Total $7.89 $2.22
- -----------------------------------------------------------------------------------------------------
</TABLE>
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS AND CAPITAL GAINS, IF ANY,
ANNUALLY.
Average Annual Total Return(1)
- --------------------------------------------------------------------------------
Year Ended 12/31/98 0.22%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 4.98
- --------------------------------------------------------------------------------
Inception* to 12/31/98 6.50
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Inception* to 12/31/98 81.02%
- --------------------------------------------------------------------------------
(1) Assumes reinvestment of all dividends and capital gain distributions.
(2) Total return is not annualized, as it may not be respresentative of the
total return for the year.
* The inception date for the U.S. Government/High Quality Securities
Portfolio is July 31, 1989.
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (Unaudited)
- --------------------------------------------------------------------------------
GROWTH OF $10,000 INVESTED IN SHARES OF
THE U.S. GOVERNMENT/HIGH QUALITY SECURITIES PORTFOLIO
VS. LEHMAN BROTHERS GNMA INDEX*
================================================================================
July 1989 -- December 31, 1998
[GRAPH APPEARS HERE]
U.S. Government/ Lehman
High Quality GNMA
Date Securities Portfolio Index
-------------------------------------------------
7/31/89 10,000 10,000
12/89 10,301 10,354
12/90 11,136 11,449
12/91 12,537 11,633
12/92 13,404 12,495
12/93 14,196 13,317
12/94 14,146 13,118
12/95 16,579 15,353
12/96 17,132 16,858
6/97 17,610 16,858
12/97 18,062 17,748
12/98 18,102 18,915
* Hypothetical illustration of $10,000 invested in shares at
inception on July 31, 1989, assuming reinvestment of dividends
and capital gains, if any, at net asset value through December
31, 1998. The Lehman Brothers GNMA Index is composed of 15-year
and 30-year fixed-rate securities backed by mortgage pools of
the Government National Mortgage Association. The index is
unmanaged and is not subject to the same management and trading
expenses of a mutual fund.
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.
<PAGE>
RESERVE ACCOUNT PORTFOLIO
Historical Performance
<TABLE>
<CAPTION>
Net Asset Value
--------------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distribution Returns(1)
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
12/31/98 $ 7.70 $ 7.36 $0.27 $0.00 (0.89)%
- -----------------------------------------------------------------------------------------------------
12/31/97 10.99 7.70 0.25 3.19 1.36
- -----------------------------------------------------------------------------------------------------
12/31/96 12.71 10.99 1.92 0.00 1.57
- -----------------------------------------------------------------------------------------------------
12/31/95 12.39 12.71 0.74 0.05 8.83
- -----------------------------------------------------------------------------------------------------
12/31/94 12.75 12.39 0.58 0.03 1.99
- -----------------------------------------------------------------------------------------------------
12/31/93 12.86 12.75 0.69 0.01 4.59
- -----------------------------------------------------------------------------------------------------
12/31/92 13.08 12.86 0.78 0.07 4.82
- -----------------------------------------------------------------------------------------------------
12/31/91 12.66 13.08 0.89 0.03 10.64
- -----------------------------------------------------------------------------------------------------
12/31/90 12.55 12.66 0.93 0.00 8.30
- -----------------------------------------------------------------------------------------------------
Inception* to 12/31/89 12.50 12.55 0.36 0.00 3.26(2)
- -----------------------------------------------------------------------------------------------------
Total $7.41 $3.38
- -----------------------------------------------------------------------------------------------------
</TABLE>
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS AND CAPITAL GAINS, IF ANY,
ANNUALLY.
Average Annual Total Return(1)
- --------------------------------------------------------------------------------
Year Ended 12/31/98 (0.89)%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 2.52
- --------------------------------------------------------------------------------
Inception* to 12/31/98 4.66
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Inception* to 12/31/98 53.61%
- --------------------------------------------------------------------------------
(1) Assumes reinvestment of all dividends and capital gain distributions.
(2) Total return is not annualized, as it may not be representative of
the total return for the year.
* The inception date for the Reserve Account Portfolio is August 2, 1989.
<PAGE>
Historical Performance (unaudited)
GROWTH OF $10,000 INVESTED IN SHARES OF
THE RESERVE ACCOUNT PORTFOLIO
VS. SALOMON SMITH BARNEY 1-YEAR TREASURY INDEX*
================================================================================
August 1989 -- December 1998
[GRAPH APPEARS HERE]
RESERVE SALOMON BROTHERS
DATE ACCOUNT PORTFOLIO 1-YEAR TREASURY
8/2/89 10,000 10,000
12/89 10,326 10,331
12/90 11,183 11,254
12/91 12,373 12,238
12/92 12,969 12,828
12/93 13,563 13,319
12/94 13,833 13,670
12/95 15,054 14,776
12/98 15,361 17,545
* Hypothetical illustration of $10,000 invested in shares at
inception on August 2, 1989, assuming reinvestment of dividends
and capital gains, if any, at net asset value through December
31, 1998. The Salomon Smith Barney 1-Year Treasury Index is
composed of one 1-Year United States Treasury Bond whose return
is tracked until its maturity. The index is unmanaged and is
not subject to the same management and trading expenses as a
mutual fund.
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.
<PAGE>
- --------------------------------------------------------------------------------
Schedules of Investments December 31, 1998
- --------------------------------------------------------------------------------
INCOME AND GROWTH PORTFOLIO
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
COMMON STOCK - 98.8%
- ---------------------------------------------------------------------------------------------------
AEROSPACE/DEFENSE - 0.9%
1,500 Lockheed Martin Corp. $127,125
- ---------------------------------------------------------------------------------------------------
AUTO-CARS/LIGHT TRUCKS - 3.2%
5,000 Ford Motor Co. 293,437
2,000 General Motors Corp. 143,125
- ---------------------------------------------------------------------------------------------------
436,562
- ---------------------------------------------------------------------------------------------------
BANKING - 8.5%
4,500 BankAmerica Corp. 270,563
6,000 Chase Manhattan Corp. 408,375
6,000 First Union Corp. 364,875
1,800 Mellon Bank Corp. 123,750
- ---------------------------------------------------------------------------------------------------
1,167,563
- ---------------------------------------------------------------------------------------------------
CONGLOMERATES - 1.5%
2,000 General Electric Co. 204,125
- ---------------------------------------------------------------------------------------------------
CONSUMER PRODUCTS - 5.4%
8,000 Masco Corp. 230,000
3,500 Unilever NV 290,281
4,000 Whirlpool Corp. 221,500
- ---------------------------------------------------------------------------------------------------
741,781
- ---------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES - 7.2%
6,000 CMS Energy Corp. 290,625
8,000 Duke Energy Corp. 512,500
5,000 Unicom Corp. 192,813
- ---------------------------------------------------------------------------------------------------
995,938
- ---------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT - 2.7%
6,000 Emerson Electric Co. 375,375
- ---------------------------------------------------------------------------------------------------
ENERGY OIL INTEGRATED - INTERNATIONAL - 10.2%
5,000 Chevron Corp. 414,688
1,000 Exxon Corp. 73,125
7,000 Mobil Corp. 609,875
10,000 Williams Cos., Inc. 311,875
- ---------------------------------------------------------------------------------------------------
1,409,563
- ---------------------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
Schedules of Investments December 31, 1998
- --------------------------------------------------------------------------------
INCOME AND GROWTH PORTFOLIO
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
ENERGY-REFINING AND MARKETING - 5.2%
5,000 E.I. du Pont Nemours & Co. $265,312
8,000 Enron Corp. 456,500
- ---------------------------------------------------------------------------------------------------
721,812
- ---------------------------------------------------------------------------------------------------
FOOD PROCESSING - 6.5%
8,000 ConAgra, Inc. 252,000
4,000 PepsiCo, Inc. 163,750
8,000 Quaker Oats Co. 476,000
- ---------------------------------------------------------------------------------------------------
891,750
- ---------------------------------------------------------------------------------------------------
INSURANCE: MULTI-LINE - 4.4%
2,500 American General Corp. 195,000
2,500 CIGNA Corp. 193,281
4,000 Hartford Financial Services Group, Inc. 219,500
- ---------------------------------------------------------------------------------------------------
607,781
- ---------------------------------------------------------------------------------------------------
MACHINE TOOLS - 0.4%
2,000 Stanley Works 55,500
- ---------------------------------------------------------------------------------------------------
MEDICAL PRODUCTS - 4.3%
6,000 Abbott Laboratories 294,000
2,000 Merck & Co., Inc. 295,375
- ---------------------------------------------------------------------------------------------------
589,375
- ---------------------------------------------------------------------------------------------------
NATURAL-GAS PIPELINE - 2.0%
8,000 El Paso Natural Gas Co. 278,500
- ---------------------------------------------------------------------------------------------------
OFFICE AUTOMATION & EQUIPMENT - 3.4%
2,000 Pitney Bowes, Inc. 132,125
3,000 Xerox Corp. 354,000
- ---------------------------------------------------------------------------------------------------
486,125
- ---------------------------------------------------------------------------------------------------
OIL WELL EQUIPMENT & SERVICES - 1.5%
10,000 Conoco Inc., Class A Shares* 208,750
- ---------------------------------------------------------------------------------------------------
PHARMACEUTICALS - 11.7%
10,000 American Home Products Corp. 563,125
4,500 Bristol-Myers Squibb Co. 602,156
5,000 Eli Lilly & Co. 444,375
- ---------------------------------------------------------------------------------------------------
1,609,656
- ---------------------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
Schedules of Investments December 31, 1998
- --------------------------------------------------------------------------------
INCOME AND GROWTH PORTFOLIO
<TABLE>
<CAPTION>
SHARES SECURITY VALUE
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
PUBLISHING - 1.8%
5,000 Dow Jones & Co., Inc. $ 240,625
- ---------------------------------------------------------------------------------------------------
TELEPHONE - 17.9%
2000 Ameritech Corp. 126,750
4,000 AT&T Corp. 301,000
14,000 Bellsouth Corp. 698,250
10,000 GTE Corp. 674,375
8,000 Sprint Corp. 673,000
- ---------------------------------------------------------------------------------------------------
2,473,375
- ---------------------------------------------------------------------------------------------------
TOTAL COMMON STOCK
(Cost - $9,620,336) 13,621,281
- ---------------------------------------------------------------------------------------------------
FACE
AMOUNT SECURITY VALUE
- ---------------------------------------------------------------------------------------------------
REPURCHASE AGREEMENT - 1.2%
$161,000 Morgan Stanley & Co., 4.65% due 1/4/99; Proceeds at
maturity - $161,083; (Fully collateralized by U.S. Treasury
Notes, 6.00% to 6.50% due 7/15/99 to 8/15/27;
Market value - $164,970) (Cost - $161,000) 161,000
- ---------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS - 100%
(Cost - $9,781,336**) $13,782,281
- ---------------------------------------------------------------------------------------------------
</TABLE>
* Non-income producing security.
** Aggregate cost for Federal income tax purposes is substantially the same.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
Schedules of Investment (continued) December 31, 1998
U.S. GOVERNMENT/HIGH QUALITY SECURITIES PORTFOLIO
FACE
AMOUNT SECURITY VALUE
- --------------------------------------------------------------------------------
REPURCHASE AGREEMENT - 100.0%
$220,000 Morgan Stanley & Co., 4.65% due 1/4/99;
Proceeds at maturity - $220,114; (Fully
collateralized by U.S. Treasury Notes, 6.00% to
6.50% due 7/15/99 to 8/15/27; Market value -
$225,425) (Cost - $220,000*) $220,000
- --------------------------------------------------------------------------------
* Aggregate cost for Federal income tax purposes is substantially the same.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
Statements of Assets and Liabilities December 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
U.S. GOV'T./
INCOME AND HIGH QUALITY RESERVE
GROWTH SECURITIES ACCOUNT
PORTFOLIO PORTFOLIO PORTFOLIO
============================================================================================================
<S> <C> <C> <C>
ASSETS:
Investments, at value (Cost --- $9,781,336
$220,000 and $ ---, respectively) $ 13,782,281 $ 220,000 ---
Cash 290 740,247 $ 3,840
Dividends and interest receivable 17,863 --- ---
Receivable from investment manager --- 25,312 58,442
Other assets --- 72 38
- -----------------------------------------------------------------------------------------------------------
TOTAL ASSETS 13,800,434 985,631 62,320
- -----------------------------------------------------------------------------------------------------------
LIABILITIES:
Management fees payable 6,945 --- ---
Payable for Fund shares purchased 485 35 2
Accrued expenses 14,571 12,596 5,906
- -----------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 22,001 12,631 5,908
- -----------------------------------------------------------------------------------------------------------
TOTAL NET ASSETS $ 13,778,433 $ 973,000 $56,412
===========================================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 985 $ 94 $ 7
Capital paid in excess of par value 7,163,109 972,196 58,538
Undistributed (overdistributed) net investment 220,184 710 (2,133)
Accumulated net realized gain from security transactions 2,393,210 --- ---
Net unrealized appreciation of investments 4,000,945 --- ---
- -----------------------------------------------------------------------------------------------------------
TOTAL NET ASSETS $ 13,778,433 $ 973,000 $56,412
===========================================================================================================
SHARES OUTSTANDING 985,475 93,570 7,669
- -----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, PER SHARE $ 13.98 $ 10.40 $ 7.36
- -----------------------------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
Statements of Operations For the Year Ended December 31,1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
U.S. GOV'T./
INCOME AND HIGH QUALITY RESERVE
GROWTH SECURITIES ACCOUNT
PORTFOLIO PORTFOLIO PORTFOLIO
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INVESTMENT INCOME:
Interest $ 15,884 $ 14,274 $ ---
Dividends 324,537 --- ---
Less: Foreign withholding tax (1,221) --- ---
- -----------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT INCOME 339,200 14,274 ---
- -----------------------------------------------------------------------------------------------------------
EXPENSES:
Management fees (Note 2) 88,984 5,279 361
Audit and legal 13,134 9,280 9,280
Shareholder and system servicing fees 7,191 1,424 1,424
Custody 1,470 75 ---
Trustees' fees 1,362 2,050 1,950
Other 745 3,735 3,700
- -----------------------------------------------------------------------------------------------------------
TOTAL EXPENSES 112,886 21,843 16,715
Less: Management fee waiver and
expense reimbursement (Note 2) --- (10,111) (15,913)
- -----------------------------------------------------------------------------------------------------------
NET EXPENSES 112,886 11,732 802
- -----------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME (LOSS) 226,314 2,542 (802)
- -----------------------------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS (NOTE 3):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 10,795,968 --- ---
Cost of securities sold 8,407,576 --- ---
- -----------------------------------------------------------------------------------------------------------
NET REALIZED GAIN 2,388,392 --- ---
- -----------------------------------------------------------------------------------------------------------
Change in Net Unrealized Appreciation
of Investments:
Beginning of year 4,851,884 --- ---
End of year 4,000,945 --- ---
- -----------------------------------------------------------------------------------------------------------
DECREASE IN NET UNREALIZED APPRECIATION (850,939) --- ---
- -----------------------------------------------------------------------------------------------------------
NET GAIN ON INVESTMENTS 1,537,453 --- ---
- -----------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS $1,763,767 $ 2,542 $ (802)
===========================================================================================================
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
Statements of changes in Net Assets For the Years Ended December 31,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INCOME AND GROWTH PORTFOLIO 1998 1997
===========================================================================================================
<S> <C> <C>
OPERATIONS:
Net investment income $ 226,314 $ 398,213
Net realized gain 2,388,392 4,040,732
Increase (decrease) in net unrealized appreciation (850,939) 114,008
- -----------------------------------------------------------------------------------------------------------
INCREASE IN NET ASSETS FROM OPERATIONS 1,763,767 4,552,953
- -----------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (396,112) (90,206)
Net realized gains (4,050,110) (1,210,791)
- -----------------------------------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM DISTRIBUTIONS TO SHAREHOLDERS (4,446,222) (1,300,997)
- -----------------------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net proceeds from sale of shares 358,924 203,497
Net asset value of shares issued for reinvestment of dividends 4,446,222 1,300,997
Cost of shares reacquired (4,580,223) (9,332,290)
- -----------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS FROM FUND SHARE TRANSACTION 224,923 (7,827,796)
- -----------------------------------------------------------------------------------------------------------
DECREASE IN NET ASSETS (2,457,532) (4,575,840)
NET ASSETS:
Beginning of year 16,235,965 20,811,805
- -----------------------------------------------------------------------------------------------------------
END OF YEAR* $ 13,778,433 $ 16,235,965
===========================================================================================================
* Includes undistributed net investment income of: $ 220,184 $ 405,947
===========================================================================================================
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets (continued) For the Years Ended December 31
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
U.S. GOVERNMENT/HIGH QUALITY SECURITIES PORTFOLIO 1998 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Net investment income $ 2,542 $ 90,449
Net realized gain --- 104,975
Decrease in net unrealized appreciation --- (83,469)
- -----------------------------------------------------------------------------------------------------------
INCREASE IN NET ASSETS FROM OPERATIONS 2,542 111,955
- -----------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (90,126) (4,758)
Net realized gains (104,745) (107,054)
- -----------------------------------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM DISTRIBUTIONS TO SHAREHOLDERS (194,871) (111,812)
- -----------------------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net proceeds from sale of shares 231,508 275,159
Net asset value of shares issued for reinvestment of dividends 194,871 111,812
Cost of shares reacquired (878,215) (1,646,129)
- -----------------------------------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM FUND SHARE TRANSACTIONS (451,836) (1,259,158)
- -----------------------------------------------------------------------------------------------------------
DECREASE IN NET ASSETS (644,165) (1,259,015)
NET ASSETS:
Beginning of year 1,617,165 2,876,180
- -----------------------------------------------------------------------------------------------------------
END OF YEAR* $ 973,000 $ 1,617,165
- -----------------------------------------------------------------------------------------------------------
* Includes undistributed net investment income of: $ 710 $ 88,295
- -----------------------------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets (continued) For the Years Ended December 31
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
RESERVE ACCOUNT PORTFOLIO 1998 1997
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Net investment income (loss) $ (802) $ 3,025
Net realized gain --- ---
Increase in net unrealized appreciation --- ---
- ----------------------------------------------------------------------------------------------------------
INCREASE IN NET ASSETS FROM OPERATIONS (802) 3,025
- ----------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (2,677) (2,236)
Net realized gains --- (27,718)
- ----------------------------------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM DISTRIBUTIONS TO SHAREHOLDERS (2,677) (29,954)
- ----------------------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net proceeds from sale of shares 1,997 2,064
Net asset value of shares issued for reinvestment of dividends 2,677 29,954
Cost of shares reacquired (41,761) (342,651)
- ----------------------------------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM FUND SHARE TRANSACTIONS (37,087) (310,633)
- ----------------------------------------------------------------------------------------------------------
DECREASE IN NET ASSETS (40,566) (337,562)
NET ASSETS:
Beginning of year 96,978 434,540
- ----------------------------------------------------------------------------------------------------------
END OF YEAR* $ 56,412 $ 96,978
- ----------------------------------------------------------------------------------------------------------
* Includes undistributed (overdistributed) net investment income of: $ (2,133) $ 857
- ----------------------------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
Notes to Financial Statements
1. SIGNIFICANT ACCOUNTING POLICIES
Smith Barney Variable Account Funds ("Fund"), a Massachusetts business
trust, is registered under the Investment Company Act of 1940, as amended, as a
diversified, open-end management investment company. The Fund is sold
exclusively for use with variable annuity contracts. The Fund consists of three
separate investment portfolios ("Portfolios"): Income and Growth, U.S.
Government/High Quality Securities and Reserve Account Portfolios. Shares of the
Fund are offered only to insurance company separate accounts that fund certain
annuity and variable life insurance contracts.
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 prices on such markets;
securities for which no sales price was reported and U.S government and agency
obligations are valued at the mean between bid and ask prices; (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
the 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; (e) interest
income, adjusted for accretion of original issue discount, is recorded on the
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 and expense amounts recorded and collected
or paid are adjusted when reported by the custodian bank; (i) the character of
income and gains distributed are determined in accordance with income tax
regulations which may differ from generally accepted accounting principles. At
December 31, 1998, 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, for the Income & Growth
and Reserve Portfolios a portion of undistributed (overdistributed) net
investment income amounting to $1,965 and ($489) was reclassified to paid-in
capital, respectively. Moreover, for the Income & Growth and U.S.
Government/High Quality Securities Portfolios a portion of accumulated net
realized gain (loss) amounting to $32 and ($2) was reclassified to paid-in
capital, respectively. Net investment income, net realized gains and net assets
were not affected by this change; (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.
<PAGE>
Notes to Financial Statements (continued)
2. MANAGEMENT AGREEMENT AND TRANSACTIONS WITH AFFILIATED PERSONS
Mutual Management Corp. ("MMC"), a subsidiary of Salomon Smith Barney
Holdings Inc. ("SSBH"), acts as investments manager of the Fund. The Income and
Growth, U.S. Government/High Quality Securities and Reserve Account Portfolios
pay MMC a management fee calculated at the annual rates of 0.60%, 0.45% and
0.45%, respectively, on average daily net assets. These fees are calculated
daily and paid monthly. For the year ended December 31, 1998, MMC waived all of
its management fees and reimbursed expenses of $4,832 and $15,552 for the U.S.
Government/High Quality Securities and Reserve Account Portfolios, respectively.
On October 8, 1998, CFBDS, Inc. became the Fund's distributor. Prior to that
date Salomon Smith Barney Inc. ("SSB"), another subsidiary of SSBH, was the
Fund's distributor. For the year ended December 31, 1998, SSB received brokerage
commissions of $10,449.
All officers and one Trustee of the Fund are employees of SSB.
3. INVESTMENTS
During the year ended December 31, 1998, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
<TABLE>
<CAPTION>
U.S. GOVT./
INCOME AND HIGH QUALITY RESERVE
GROWTH SECURITIES ACCOUNT
PORTFOLIO PORTFOLIO PORTFOLIO
=========================================================================
<S> <C> <C> <C>
Purchases $7,185,144 --- ---
- -------------------------------------------------------------------------
Sales 10,795,968 --- ---
=========================================================================
</TABLE>
At December 31, 1998, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were substantially
as follows:
<TABLE>
<CAPTION>
U.S. GOVT./
INCOME AND HIGH QUALITY RESERVE
GROWTH SECURITIES ACCOUNT
PORTFOLIO PORTFOLIO PORTFOLIO
===============================================================================
<S> <C> <C> <C>
Gross unrealized appreciation $4,282,510 --- ---
Gross unrealized depreciation (281,565) --- ---
- -------------------------------------------------------------------------------
Net unrealized appreciation $4,000,945 --- ---
===============================================================================
</TABLE>
<PAGE>
Notes to Financial Statements (continued)
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 seller at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires maintenance of the
market value of the collateral in amounts at least equal to the repurchase
price.
5. SHARES OF BENEFICIAL INTEREST
At December 31, 1998, the Fund had an unlimited number of shares of
beneficial interest authorized with a par value of $0.001 per share. Each share
represents an equal proportionate interest and has an equal entitlement to any
dividends and distributions made by the Portfolio.
Transactions in shares of each Portfolio were as follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997
===============================================================================
<S> <C> <C>
INCOME AND GROWTH PORTFOLIO
Shares sold 23,858 12,756
Shares issued on 321,957 77,718
reinvestment
Shares redeemed (299,350) (568,198)
- -------------------------------------------------------------------------------
Net Increase (Decrease) 46,465 (477,724)
===============================================================================
U.S. GOV'T./HIGH QUALITY SECURITIES
PORTFOLIO
Shares sold 19,525 20,551
Shares issued on 18,756 8,832
reinvestment
Shares redeemed (72,448) (124,615)
- -------------------------------------------------------------------------------
Net Decrease (34,167) (95,232)
===============================================================================
RESERVE ACCOUNT
PORTFOLIO
Shares sold 271 185
Shares issued on 362 3,890
reinvestment
Shares redeemed (5,557) (31,011)
- -------------------------------------------------------------------------------
Net Decrease (4,924) (26,936)
===============================================================================
</TABLE>
<PAGE>
Financial Highlights
For a share of beneficial interest outstanding throughout each year ended
December 31:
<TABLE>
<CAPTION>
INCOME AND GROWTH PORTFOLIO 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $ 17.29 $ 14.69 $ 15.24 $ 13.05 $ 14.93
- -----------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS:
Net investment income 0.29 0.47 0.57 0.45 0.39
Net realized and unrealized gain (loss) 1.87 3.61 2.68 3.12 (0.86)
- -----------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 2.16 4.08 3.25 3.57 (0.47)
- -----------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
Net investment income (0.49) (0.10) (0.56) (0.44) (0.39)
Net realized gains (4.98) (1.38) (3.24) (0.94) (1.02)
- -----------------------------------------------------------------------------------------------------
Total Distributions (5.47) (1.48) (3.80) (1.38) (1.41)
- -----------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 13.98 $ 17.29 $ 14.69 $ 15.24 $ 13.05
- -----------------------------------------------------------------------------------------------------
TOTAL RETURN 12.89% 28.11% 21.02% 27.56% (3.12)%
- -----------------------------------------------------------------------------------------------------
NET ASSETS, END OF YEAR (000S) $13,778 $16,236 $20,812 $29,782 27,484
- -----------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses 0.76% 0.77% 0.74% 0.77% 0.75%
Net investment income 1.53 2.18 2.39 2.77 2.49
- -----------------------------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE 49% 38% 30% 46% 40%
=====================================================================================================
</TABLE>
<PAGE>
Financial Highlights (continued)
For a share of beneficial interest outstanding throughout each year ended
December 31:
<TABLE>
<CAPTION>
U.S. GOVERNMENT/HIGH
QUALITY SECURITIES PORTFOLIO 1998(1) 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $12.66 $12.90 $13.66 $12.46 $13.35
- -----------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS:
Net investment income (2) 0.03 0.72 1.22 0.94 0.84
Net realized and unrealized gain (loss) --- (0.02) (0.76) 1.20 (0.89)
- -----------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 0.03 0.70 (0.46) 2.14 (0.05)
- -----------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
Net investment income (1.06) (0.04) (1.22) (0.94) (0.84)
Net realized gains (1.23) (0.90) --- --- ---
- -----------------------------------------------------------------------------------------------------
Total Distributions (2.29) (0.94) (1.22) (0.94) (0.84)
- -----------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $10.40 $12.66 $12.90 $13.66 $12.46
- -----------------------------------------------------------------------------------------------------
TOTAL RETURN 0.22% 5.43% 3.34% 17.20% (0.35)%
- -----------------------------------------------------------------------------------------------------
NET ASSETS, END OF YEAR (000S) $ 973 $1,617 $2,876 $4,856 $4,838
- -----------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses (2) 1.00% 1.00% 0.98% 0.87% 0.76%
Net investment income 0.22 4.33 6.30 6.36 5.87
- -----------------------------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE 0% 43% 13% 0% 36%
- -----------------------------------------------------------------------------------------------------
</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) Under a voluntary fee waiver whereby the aggregate expenses of the
Portfolio may not exceed 1.00% of the average daily net assets for any
year, the investment manager waived all or a a portion of its fees in the
amount of $0.05 per share (0.45% of average net assets) in 1998 and and
$0.08 per share (0.49% of average net assets) in 1997. The investment
manager also reimbursed the Portfolio for $4,832 and $719 in expenses for
the years ended December 31, 1998 and 1997, respectively.
If such fees were not waived and expenses reimbursed, the net investment
income (loss) per share would have been ($0.07) and $0.64 and the expense
ratio would have been 1.86% and 1.49%, for the year ended December 31,
1998 and 1997, respectively.
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
FOR A SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
<TABLE>
<CAPTION>
RESERVE ACCOUNT PORTFOLIO 1998(1) 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $7.70 $10.99 $12.71 $12.39 $12.75
- -----------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS:
Net investment income (loss) (2) (0.07) 0.15 1.92 0.73 0.59
Net realized and unrealized gain (loss) --- --- (1.72) 0.38 (0.34)
- -----------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations (0.07) 0.15 0.20 1.11 0.25
- -----------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
Net investment income (0.27) (0.25) (1.92) (0.74) (0.58)
Net realized gains --- (3.19) --- (0.05) (0.03)
- -----------------------------------------------------------------------------------------------------
Total Distributions (0.27) (3.44) (1.92) (0.79) (0.61)
- -----------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $7.36 $ 7.70 $10.99 $12.71 $12.39
- -----------------------------------------------------------------------------------------------------
TOTAL RETURN (0.89)% 1.36% 1.57% 8.83% 1.99%
- -----------------------------------------------------------------------------------------------------
NET ASSETS, END OF YEAR (000S) $ 56 $ 97 $ 435 $2,315 $2,528
- -----------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses (2) 1.00% 1.00% 1.00% 0.97% 0.86%
Net investment income (1.00) 1.59 4.98 5.30 4.77
- -----------------------------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE 0% 0% 0% 17% 81%
====================================================================================================
</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) Under a voluntary fee waiver whereby the aggregate expenses of the
Portfolio may not exceed 1.00% of the average daily net assets for any
year, the investment manager waived all or a portion of its fees in the
amount of $0.03 per share (0.45% of average net assets) in 1998, $1.61 per
share (10.65% of average net assets) in 1997 and $0.15 per share (0.45% of
average net assets) in 1996. The investment manager also reimbursed the
Portfolio for $15,552, $19,395 and $19,891 in expenses fror the years
ended December 31, 1998, 1997 and 1996, respectively.
If such fees were not waived and expenses reimbursed, the net investment
income (loss) per share would have been $(1.56), $(1.76) and $1.27 and the
expense ratio would have been 20.81%, 11.65% and 2.79%, for the year ended
December 31, 1998, 1997 and 1996, respectively.
<PAGE>
[LOGO OF KPMG]
345 Park Avenue
New York, NY 10154
The Shareholders and Board of Trustees of
Smith Barney Variable Account Funds:
We have audited the accompanying statements of assets and liabilities, including
the schedules of investments, of the Income and Growth Portfolio, U.S.
Government/High Quality Securities Portfolio and Reserve Account Portfolio of
Smith Barney Variable Account Funds as of December 31, 1998, the related
statements 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 five 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.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1998, 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 aspects, the financial positions of the
Income and Growth Portfolio, U.S. Government/High Quality Securities Portfolio
and Reserve Account Portfolio of Smith Barney Variable Account Funds as of
December 31, 1998, the results of their operations for the year then ended, the
changes in their 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 five year period
then ended, in conformity with generally accepted accounting principles.
KPMG LLP
New York, New York
February 8, 1999
<PAGE>
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
For Federal tax purposes the Smith Barney Variable Account Funds hereby
designates for the fiscal year ended December 31, 1998:
. Percentage of ordinary dividends paid as qualifying for the
corporate dividends received deduction:
Income & Growth Portfolio 81.21%
. Total long-term capital gain distributions paid:
Income & Growth Portfolio $3,940,912
U.S. Government/High Quality Securities Portfolio 94,448
<PAGE>
[LOGO OF KPMG APPEARS HERE]
