<PAGE>
PROSPECT STREET(R)
HIGH INCOME PORTFOLIO INC.
ANNUAL
REPORT
OCTOBER 31, 1997
[LOGO]
<PAGE>
December 22, 1997
LETTER TO SHAREHOLDERS
Dear Shareholders:
On October 31, 1997, the net asset value of the Fund was $3.98, as compared
to $3.76 on April 30, 1997 and $3.90 on October 31, 1996. During the fiscal year
ended October 31, 1997, the Fund paid dividends to shareholders on the common
stock in the amount of $0.42 per share. Total dividends paid for the calendar
year ending December 31, 1997 will be $0.42.
THE HIGH YIELD MARKET:
The high yield market as measured by the CS First Boston Index generated an
annualized total return of 14.75% for the twelve-month period ended October 31,
1997. At October 31, 1997, the spread between high yield securities and
comparable US Government Securities stood at 381 basis points, compared to 352
basis points at April 30, 1997 and 404 basis point at October 31, 1996. Total
new issue volume through October 31, 1997 approximated $114.6 billion, heavily
weighted toward Rule 144A issues. The average price for a cash paying high yield
security was $100.83 with an average coupon of 10.40%.
The flow of new funds into high yield mutual funds continued at a high level
for the 4 month period ended October 31, 1997, averaging approximately $400
million per week. Total assets in high yield mutual funds exceeded $96 billion
at October 31, 1997 compared to $82 billion at April 30, 1997.
THE FUND'S INVESTMENTS:
The total return on the Fund's Net Assets for the twelve months ended
October 31, 1997, assuming investment of dividends and adjusted for the March
1997 rights offering, was 14.82%. As of October 31, 1997 the Fund held 165
issues representing 31 industry groups. Currently the Fund is generating monthly
net investment income of approximately $0.035 per month.
INVESTMENT OUTLOOK:
The high yield market has performed well since October of 1996. Factors that
would be expected to extend a favorable outlook for high yield securities are:
1. Money continues to flow into High Yield Mutual Funds seeking the high
interest rate yields that sector of the Bond market offers.
2. Below investment grade credits continue to have access to funds in both
the public and private markets. This access has contributed to the low
default rate experienced in 1997 for High Yield bond issues and currently
is expected to continue in 1998.
3. The continuing decline in interest rates forces income oriented investors
to seek high yield investments.
4. The turmoil in Asia and Japan would appear to give the Federal Reserve
more discretion to maintain an accommodating monetary policy.
Some of the factors that could negatively impact the high yield market are:
1. The current turmoil in Asia and Japan could have a significant impact on
both the U.S. capital markets as well as the economy. Japan continues to
experience problems in its financial sector, and its equity market
valuations could contribute to on-going turmoil, the consequences of
which are difficult to determine.
2. Corporate profit for U.S. companies in 1998 could be impacted negatively
if the recent foreign currency devaluation results in a rising volume of
low cost imports coming into the U.S. economy.
3. The economic cycle has been a major contributor to improvement in the
credit position of many below investment grade credits. A significant
weakening of the business cycle could result in substantial increases in
problem credits and a widening of the interest rate spread between
investment grade and non-investment grade credits.
PROPOSED RIGHTS OFFERING
On November 21, 1997 the Fund filed a registration statement for a
transferable rights offering to shareholders. PaineWebber and Tucker Anthony are
the dealer managers. The offering will be made only pursuant to a prospectus
upon the effectiveness of the registration statement.
CONCLUSION:
The fiscal year ended October 31, 1997 has been a period of strength in the
high yield market. There continues to be a strong demand for high yielding
securities. While the current expectation for the high yield market is positive
the degree of certainty is becoming more suspect.
Management continues to review the Fund's investments, eliminating issues
that appear fully priced or vulnerable to either interest rate risk or
disappointing financial results.
Respectfully submitted,
/s/ Richard E. Omohundro, Jr.
Richard E. Omohundro, Jr.
President
/s/ John A. Frabotta
John A. Frabotta
Vice President and
Chief Investment Officer
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1997
<TABLE>
<CAPTION>
FIXED INCOME -- 90.51%
Ratings
--------------------
Par Standard Value
Value Description & Poor's Moody's (Note 2)
----- ----------- -------- ------- --------
<S> <C> <C> <C> <C>
AEROSPACE AND DEFENSE - 0.23%
$ 500,000 Burke Industries Inc. 10%, sr. notes,
08/15/07, 144A ......................... B+ B2 $ 517,500
------------
AGRICULTURAL CHEMICALS/FARMING - 0.97%
500,000 Calmar Spraying Systems Inc., 11 1/2%, sr.
sub. notes, series B, 08/15/05 .......... B- B3 532,500
500,000 Hines Horticulture Inc., 11 3/4%, sr. sub.
notes, series B, 10/15/05 .............. CCC+ B3 550,000
1,000,000 Iridium Capital Corp., 14%, sr. notes,
series B, 07/15/05 ..................... B- B3 1,060,000
------------
2,142,500
------------
AUTOMOBILE/AUTO PARTS/TRUCK MANUFACTURING
- 5.80%
1,000,000 Aetna Industries Inc., 11 7/8%, sr. notes,
10/01/06 ............................... B- B3 1,015,000
2,500,000 Chatwins Group Inc., 13%, sr. exch. notes,
05/01/03 ............................... B- B2 2,625,000
500,000 Chief Auto Parts Inc., 10 1/2%, sr. notes,
05/15/05 ............................... B B2 487,500
4,500,000 Highway Master Communication, 13 3/4%, sr.
notes, 09/15/05 ........................ B Caa 4,432,500
1,250,000 Iochpe-Maxion SA, 12 3/8%, notes, 11/08/02 NR NR 1,225,000
1,000,000 Localiza Rent a Car, 10 1/4%, sr. notes,
10/01/05, 144A ......................... BB- B2 900,000
500,000 Motors & Gears Inc., 10 3/4%, sr. notes,
series B, 11/15/06 ..................... B B3 530,000
750,000 Simula Inc., 8%, conv. sr. sub. notes,
05/01/04 ............................... NR NR 821,250
781,000 Venture Holdings Trust, 9 3/4%, sr. sub.
notes, 04/01/04 ........................ B- B3 781,000
------------
12,817,250
------------
BANKS/SAVINGS AND LOANS/FINANCE COMPANIES/
CONSUMER CREDIT - 2.60%
1,000,000 Bank Plus Corp.,12%, sr. notes, 07/18/07 . NR NR 1,120,000
500,000 Emergent Group Inc., 10 3/4%, sr. notes,
09/15/04, 144A ......................... B- B3 485,000
1,500,000 Life Federal Savings Bank,13 1/2%, sub.
debs, 03/15/04 ......................... NR NR 1,515,000
500,000 Local Financial Corp., 11%, sr. notes,
09/05/04, 144A ......................... NR NR 525,000
1,000,000 Mego Mortgage, 12 1/2%, sr. sub. notes,
12/01/01 ............................... B Caa 1,000,000
1,000,000 Ocwen Federal Bank, 12%, sub. debs.,
06/15/05 ............................... B+ B1 1,090,000
------------
5,735,000
------------
BROADCASTING - TV/CABLE/RADIO/PUBLISHING -
14.13%
8,858 Australis Media Ltd., 0%, gtd. sr. secd.
disc. notes, 05/15/03 .................. NR Caa 6,466
1,000,000 Australis Media Ltd., 0%, sr. secd. disc.
notes, 05/15/03 ........................ NR Caa 750,000
500,000 Busse Broadcasting Corp., 11 5/8%, sr.
secd. notes, 10/15/00 .................. NR B3 533,750
10,000,000 CAI Wireless System Inc., 12 1/4%, sr.
disc. notes, 09/15/02 .................. CCC+ Caa 3,100,000
9,000,000 CS Wireless Systems Inc., 0%, sr. disc.
notes, series B, 03/01/06 .............. CCC+ Caa 2,565,000
6,000,000 DIVA Systems Corp., 0%, sub. disc. notes,
05/15/06, 144A ......................... NR NR 5,190,000
750,000 Emerson Radio Corp., 8 1/2%, conv. sr.
sub. deb, 08/15/02, 144A ............... NR NR 435,000
750,000 Emerson Radio Corp., 8 1/2%, conv. sr.
sub. deb, 08/15/02 ..................... NR NR 472,500
500,000 Galaxy Telecom, L.P., 12 3/8%, sr. sub.
notes, 10/01/05 ........................ B- B3 553,750
1,000,000 Global Star L.P., 11 1/4%, sr. notes,
06/15/04, 144A ......................... B B3 985,000
3,000,000 Global Star L.P., 10 3/4%, sr. notes,
11/01/04, 144A ......................... B B3 2,857,500
1,250,000 Heartland Wireless, 14%, sr. notes, series
B, 10/15/04 ............................ B B3 587,500
1,000,000 Katz Media Corp., 10 1/2%, sr. sub. notes,
series B, 01/15/07 ..................... B B2 1,085,000
1,000,000 Net Sat Services, 12 3/4%, sr. notes,
08/05/04 ............................... B B2 1,030,000
3,500,000 Optel Inc., 13%, sr. notes, series B,
02/15/05 ............................... B- B3 3,587,500
1,750,000 Paxson Communications Corp., 11 5/8%, sr.
sub. notes, 10/01/02 ................... B- B3 1,907,500
500,000 Radio One, Inc., 7%, sr. sub. notes,
05/15/04, 144A ......................... NR NR 481,250
500,000 RBS Participaco, 14%, notes, 12/15/03 .... BB- NR 575,000
2,000,000 Source Media Inc., 12%, sr. secd. notes,
11/01/04, 144A ......................... B- B3 2,000,000
2,000,000 Spanish Broadcasting System Inc., 12 1/2%,
sr. notes, 06/15/02 .................... B B2 2,270,000
500,000 Wireless One Inc., 13%, sr. disc. notes,
10/15/03 ............................... B- B3 240,000
------------
31,212,716
------------
DIVERSIFIED/CONGLOMERATE MANUFACTURING -
2.05%
500,000 Amtrol Acquisition Inc., 10 5/8%, sr. sub.
notes, 12/31/06 ........................ B- B3 506,250
1,000,000 Genmar Holdings Inc., 13 1/2%, sr. sub.
notes, series A, 07/15/01 .............. CCC- Caa 1,027,500
1,000,000 Haynes International Inc., 11 5/8%, sr.
notes, 09/01/04 ........................ B- B3 1,160,000
500,000 MVE Inc., 12 1/2%, sr. secd. notes,
02/15/02 ............................... B+ B3 500,000
500,000 Selmer Inc., 11%, sr. sub. notes, 05/15/05 B B3 550,000
500,000 Spinnaker Industries Inc., 10 3/4%, sr.
secd. notes, 10/15/06 .................. B B3 515,000
250,000 Therma Wave Inc., 10 5/8%, sr. notes,
series B, 05/15/04 ..................... B B2 266,250
------------
4,525,000
------------
DIVERSIFIED/CONGLOMERATE SERVICES - 0.27%
550,000 Coinmach Corp., 11 3/4%, sr. notes, series
B, 11/15/05 ............................ B+ B2 599,500
------------
ELECTRICAL EQUIPMENT/ELECTRONICS/COMPUTERS
- 1.40%
1,750,000 Computervision Corp., 11 3/8%, sr. sub.
notes, 08/15/99 ........................ B- B3 1,050,000
500,000 International Wire Group Inc., 11 3/4%,
sr. sub. notes, 06/01/05 ............... B- B3 545,000
990,000 Real Time Data Inc., 0%, sub. disc. notes,
08/15/06, 144A ......................... NR NR 564,300
1,000,000 Unifi Communications Inc., 14%, sr. notes,
03/01/04 ............................... NR NR 940,000
------------
3,099,300
------------
FINANCIAL SERVICES - 1.88%
1,000,000 Beal Financial Corp., 12 3/4%, sr. notes,
08/15/00 ............................... B- B2 1,070,000
425,000 First Federal Financial Corp., 11 3/4%,
notes, 10/01/04 ........................ B+ B2 467,500
500,000 Ocwen Financial Corp., 11 7/8%, notes,
10/01/03 ............................... B+ B1 560,000
2,000,000 Wilshire Financial Services Group Inc.,
13%, notes, 01/01/04 ................... NR NR 2,065,000
------------
4,162,500
------------
FOOD/TOBACCO - 10.41%
346,978 American Restaurant Group Inc., 13%,
series 92, sr. secd. notes, 09/15/98 ... B- Caa 340,038
2,500,000 American Rice Inc., 13%, mtg. notes,
07/31/02 ............................... B- Caa 2,500,000
250,000 AmeriKing Inc., 10 3/4%, sr. notes,
12/01/06 ............................... B- B3 265,000
3,228,442 Cafeteria Operators L.P., 12%, sr. secd.
notes, 12/31/01 ........................ NR NR 3,309,154
1,000,000 Doane Products Co., 10 5/8%, sr. notes,
03/01/06 ............................... B B3 1,065,000
500,000 Envirodyne Industries Inc., 10 1/4%, sr.
notes, 12/01/01 ........................ B- B3 493,750
1,000,000 Gorges Quik to Fix Foods Inc., 11 1/2%,
sr. sub. notes, series B, 12/01/06 ..... B- B3 1,035,000
500,000 International Home Foods Inc., 10 3/8%,
sr. sub. notes, 11/01/06 ............... B- B2 530,000
1,000,000 Krystal Company, 10 1/4%, sr. notes,
10/01/07 ............................... B+ B1 1,003,750
250,000 Liggett Group Inc., 16 1/2%, notes,
02/01/99 ............................... NR NR 175,000
3,070,000 Liggett Group Inc., 11 1/2%, gtd. sr.
secd. notes, series B, 02/01/99 ........ NR NR 1,964,800
500,000 North Atlantic Trading Inc., 11%, sr.
notes, 06/15/04, 144A .................. B B3 512,500
3,750,000 P&C Food Markets Inc., 11 1/2%, sr. notes,
10/15/01 ............................... B B3 3,543,750
3,000,000 Specialty Foods Corp., 11 1/4%, sr. sub.
notes, series B, 08/15/03 .............. CCC Caa 2,865,000
1,000,000 Sun World International Inc., 11 1/4%,
1st. mtg. notes, 04/15/04, 144A ........ B B2 1,055,000
1,000,000 Toms Foods Inc., 10 1/2%, sr. secd. notes,
11/01/04, 144A ......................... B B3 1,000,000
500,000 Unicco Service Co., 9 7/8%, sr. sub.
notes, 10/15/07, 144A .................. B- B3 495,000
750,000 Van De Kamps Inc., 12%, sr. sub. notes,
09/15/05 ............................... B- B2 832,500
------------
22,985,242
------------
GENERAL & SPECIALTY RETAIL - 1.65%
750,000 Hills Stores Co., 12 1/2%, sr. notes,
series B, 07/01/03 ..................... B- B2 562,500
1,000,000 Mothers Work Inc., 12 5/8%, sr. notes,
08/01/05 ............................... B B3 1,060,000
1,000,000 SRI Receivable Pure Inc., 12 1/2%, tr.
ctf. backed notes, series B, 12/15/00 .. NR NR 1,030,000
1,000,000 Wilsons Leather Experts Inc., 11 1/4%, sr.
notes, 08/15/04, 144A .................. B+ B3 990,000
------------
3,642,500
------------
GROCERY/CONVENIENCE FOOD STORES - 0.18%
351,000 Pantry Inc., 12%, sr. notes, series B,
11/15/00 ............................... B+ B2 386,100
------------
HEALTHCARE/DRUGS/HOSPITAL SUPPLIES - 3.62%
750,000 Complete Management Inc., 8%, conv. sub.
debs., 08/15/03 ........................ NR NR 937,500
500,000 Complete Management Inc., 8%, conv. sub.
debs., 12/15/03 ........................ NR NR 540,000
3,000,000 Phar Mor Inc., 11.72%, notes, 09/11/02 ... B- B3 3,150,000
500,000 Signature Brands, Inc., 13%, sr. sub.
notes, 08/15/02 ........................ B- B3 495,000
3,000,000 Urohealth System Inc., 12 1/2%, sr. sub.
notes, 04/01/04 ........................ B- B3 2,880,000
------------
8,002,500
------------
HOME FURNISHINGS/DURABLE CONSUMER PRODUCTS
- 1.31%
1,000,000 E&S Holdings Corp., 10 3/8%, sr. sub.
notes, 10/01/06 ........................ B- B3 845,000
500,000 Omega Cabinets Ltd., 10 1/2%, sr. sub.
notes, 06/15/07, 144A .................. B- B3 520,000
1,000,000 Simmons Co., 10 3/4%, sr. sub. notes,
04/15/06 ............................... B B2 1,040,000
500,000 Syratech Corp., 11%, sr. notes, 04/15/07 . B B1 480,000
------------
2,885,000
------------
HOTEL/GAMING - 0.36%
500,000 Courtyard By Mariott II Ltd., 10 3/4%, sr.
secd. notes, series B, 02/01/08 ........ B- NR 540,000
295,842 U.S. Trails Inc., 12%, sr. sub. pik notes,
07/15/03(b) ............................ NR NR 266,258
------------
806,258
------------
INSURANCE COMPANIES - 0.70%
1,500,000 Resource America Inc., 12%, sr. notes,
08/01/04, 144A ......................... NR Caa 1,556,250
------------
LEISURE/AMUSEMENT/MOTION PICTURES - 1.28%
1,000,000 Cobblestone Golf Group Inc., 11 1/2%, sr.
notes, series B, 06/01/03 .............. B B2 1,045,000
750,000 Discovery Zone Inc., 13 1/2%, sr. secd.
notes, 08/01/02 ........................ NR NR 791,250
1,500,000 Jumbo Sports Inc., 4 1/4%, conv. sub.
notes, 11/01/00 ........................ B- Caa 982,500
------------
2,818,750
------------
MACHINERY - 1.91%
1,000,000 Central Tractor Farm Country, 10 5/8%, sr.
notes, 04/01/07 ........................ B+ B2 1,030,000
3,250,000 Willcox & Gibbs Inc., 12 1/4%, sr. notes,
series B, 12/15/03 ..................... B+ B2 3,185,000
------------
4,215,000
------------
METALS/MINING - 5.54%
1,500,000 Algoma Steel Inc., 12 3/8%, 1st. mtg.
notes, 07/15/05 ........................ B B1 1,725,000
1,000,000 Anker Coal Group Inc., 9 3/4%, sr. notes,
10/01/07, 144A ......................... B B3 1,015,000
1,500,000 Continental Global Group Inc., 11%, sr.
notes, series B, 04/01/07 .............. B B2 1,590,000
750,000 GS Technologies Inc., 12%, gtd. sr. notes,
09/01/04 ............................... B B2 815,625
1,000,000 Gulf States Steel, 13 1/2%, 1st mtg.
notes, series, B, 04/15/03 ............. B- B1 1,030,000
500,000 International Knife and Saw, 11 3/8%, sr.
sub. notes, 11/15/06 ................... B- B3 535,000
2,000,000 IVACO Inc., 11 1/2%, sr. notes, 09/15/05 . B+ B1 2,210,000
1,000,000 Maxxam Group Inc., 11 1/4%, sr. secd.
notes, 08/01/03 ........................ CCC+ B3 1,055,000
450,000 NS Group Inc., 13 1/2%, sr. secd. notes,
07/15/03 ............................... B- B3 515,250
500,000 Royal Oak Mines Inc., 11%, sr. sub. notes,
series B, 08/15/06 ..................... B- B3 470,000
500,000 Sheffield Steel Corp., 12%, 1st. mtg.
notes, 11/01/01 ........................ B- Caa 515,000
750,000 Sheffield Steel Corp., 12%, 1st. mtg.
notes, 11/01/01 ........................ B- Caa 772,500
------------
12,248,375
------------
NON-AGRICULTURAL CHEMICALS/PLASTICS -
0.49%
1,000,000 Plastic Specialties & Technologies Inc.,
11 1/4%, bonds, 12/01/03 ............... NR B3 1,082,500
------------
OIL/NATURAL GAS/OIL SERVICES - 1.64%
436,000 HarCor Energy Inc., 14 7/8%, sr. secd.
notes, series B, 07/15/02 .............. B- B3 510,120
3,000,000 United Refining Co., 10 3/4%, sr. notes,
06/15/07, 144A ......................... B- B2 3,105,000
------------
3,615,120
------------
PACKAGING/CONTAINERS - 2.59%
3,250,000 Crown Packaging Ltd., 10 3/4%, sr. secd.
notes, series B, 11/01/00 .............. NR Caa 3,022,500
500,000 Portola Packaging Inc., 10 3/4%, sr.
notes, 10/01/05 ........................ B B2 520,000
2,000,000 Tekni-Plex Inc., 11 1/4%, sr. sub. notes,
series B, 04/01/07 ..................... B- B3 2,185,000
------------
5,727,500
------------
PAPER/FOREST PRODUCTS/PRINTING - 1.67%
325,000 American Pad & Paper Company, 13%,
sr. sub. notes, series B, 11/15/05 ..... B- B3 377,812
500,000 Day International Group, Inc., 11 1/8%,
sr. sub. notes, series B, 06/01/05 ..... B- B3 532,500
2,000,000 Fonda Group Inc., 9 1/2%, sr. sub. notes,
series B, 03/01/07 ..................... B- B3 1,900,000
1,000,000 FSW International Finance Co., 12 1/2%,
gtd. sub. notes, 11/01/06 .............. B+ B1 880,000
------------
3,690,312
------------
PERSONAL & MISCELLANEOUS SERVICES - 1.94%
500,000 Anchor Advanced Products Inc., 11 3/4%,
sr. notes, series B, 04/01/04 .......... B+ B3 530,000
750,000 ICON Health & Fitness Inc., 13%, sr. sub.
notes, series B, 07/15/02 .............. CCC+ NR 840,000
3,000,000 T/SF Communications Corp., 10 3/8%, sr.
sub. notes, 11/01/07, 144A ............. B- B3 2,910,000
------------
4,280,000
------------
POLLUTION CONTROL/WASTE REMOVAL - 0.12%
250,000 Compania de Infraes & Services, 11 5/8%,
gtd. sr. notes, 06/01/04, 144A ......... BB NR 263,750
-----------
PUBLIC UTILITY/ELECTRIC POWER/HYDRO POWER - 1.18%
2,000,000 Gothic Energy Corp., 12 1/4%, sr. notes,
09/01/04 ............................... NR NR 2,080,000
500,000 Texas New Mexico Power Co., 12 1/2%,
debs., 01/15/99 ........................ BB- Ba3 532,500
------------
2,612,500
------------
RAIL/TRUCKING/OVERNIGHT DELIVERY - 1.69%
375,000 Aftermarket Technology Corp., 12%, sr.
sub. notes, series B, 08/01/04 ......... NR B3 416,250
1,500,000 Golden Ocean Group Ltd., 10%, sr. notes,
08/31/01 ............................... CCC+ B3 1,237,500
750,000 Johnstown America Industries Inc.,
11 3/4%, sr. sub. notes,
series B, 08/15/05, 144A ............... B B3 810,000
667,000 Terex Corp., 13 1/4%, sr. secd. notes,
05/15/02 ............................... B- Caa 763,715
500,000 TFM, 10 1/4%, sr. notes, 06/15/07, 144A .. B+ B2 500,000
------------
3,727,465
------------
REAL ESTATE DEVELOPMENT/REITS/BUILDING/
CONSTRUCTION - 1.79%
290,820 Bramalea Limited, 11 1/8%, 03/22/98 ...... NR NR 72,705
1,000,000 ICF Kaiser International Inc., 13%, sr.
sub. notes, 12/31/03 ................... B- B3 1,030,000
2,000,000 ICF Kaiser International Inc., 12%, sr.
sub. notes, 12/31/03 ................... B- B3 2,070,000
750,000 Peters, J.M., Inc., 12 3/4%, sr. notes,
05/01/02 ............................... B- B3 772,500
------------
3,945,205
------------
TELEPHONE/COMMUNICATIONS - 13.97%
500,000 Alvey Systems, Inc., 11 3/8%, sr. sub.
notes, 01/31/03 ........................ B- B3 515,000
1,750,000 American Communications Services, Inc.,
13 3/4%, sr. notes, 07/15/07, 144A ..... NR NR 1,977,500
1,000,000 BTI Telecom Corp., 10 1/2%, sr. notes,
09/15/07, 144A ......................... B+ B2 975,000
2,000,000 Cell Net Data System Inc., 0%, sr. disc.
notes, 10/01/07, 144A .................. NR NR 1,010,000
1,000,000 Echostar DBS Corp., 12 1/2%, sr. secd.
notes, 07/01/02, 144A .................. B- NR 1,057,500
500,000 Econophone Inc., 13 1/2%, sr. notes,
07/15/07, 144A ......................... NR NR 540,000
4,000,000 Hyperion Telecommunications Inc., 12 1/4%,
sr. secd. notes, 09/01/04, 144A ........ B NR 4,240,000
1,000,000 Innova S. De R. L., 12 7/8%, sr. notes,
04/01/07 ............................... B- B2 1,025,000
2,000,000 Ionica PLC, 0%, sr. disc. notes, 05/01/07 NR B3 1,090,000
1,000,000 Knology Holdings Inc., 0%, sr. disc.
notes, 10/15/07 ........................ NR NR 520,000
5,000,000 MGC Communications Inc., 13%, sr. secd.
notes, 10/01/04, 144A .................. B Caa 4,950,000
1,000,000 Occidente Y Caribe Cellular, 0%, sr. disc.
notes, series B, 03/15/04 .............. B B3 750,000
4,500,000 Orbcomm Global L.P., 14%, sr. notes,
08/15/04 ............................... NR B3 4,713,750
2,750,000 Phonetel Technologies Inc., 12%, sr.
notes, 12/15/06 ........................ B- B2 2,811,875
500,000 Powertel Inc., 11 1/8%, sr. notes,
06/01/07 ............................... B B2 525,000
1,450,000 Telemundo Group Inc., 7%, sr. notes,
02/15/06 ............................... B B1 1,392,000
1,000,000 Tevecap SA, 12 5/8%, sr. notes, 11/26/04 . B B2 1,010,000
650,000 Winstar Communications Inc., 14%, sr.
disc. notes, 10/15/05 .................. NR NR 487,500
325,000 Winstar Communications Inc., 0%, conv. sr.
disc. notes, 10/15/05, 144A ............ NR NR 230,750
1,000,000 Winstar Equipment Corp., 12 1/2%, gtd. sr.
secd. exch. notes, 03/15/04 ............ CCC+ B3 1,042,500
------------
30,863,375
------------
TEXTILES/OTHER MANUFACTURING/APPAREL -
2.34%
2,000,000 Brazos Sportswear Inc., 10 1/2%, sr.
notes, 07/01/07 ........................ B+ B2 1,970,000
1,000,000 Glenoit Corp., 11%, sr. sub. notes,
04/15/07, 144A ......................... B- B2 1,055,000
2,000,000 Hosiery Corporation of America Inc.,
13 3/4%, sr. sub. notes, 08/01/02 ...... B- B3 2,140,000
542 JPS Cap Corp., 0%, contingent pay. notes,
09/10/98 ............................... NR NR 466
------------
5,165,466
------------
TRANSPORTATION/AIRLINES/BUS - 4.80%
1,000,000 CHC Helicopter Corp., 11 1/2%, sr. sub.
notes, 07/15/02 ........................ B- B3 1,065,000
1,000,000 Global Ocean Carriers Ltd., 10 1/4%, sr.
notes, 07/15/07, 144A .................. B+ B2 975,000
1,460,949 Mexico City Toluca Toll, 11%, notes,
05/19/02, 144A ......................... NR NR 1,417,120
1,000,000 Sabreliner Corp., 12 1/2%, sr. notes,
series B, 04/15/03 ..................... B B2 1,010,000
2,000,000 Trans World Airlines Inc., 12%, sr. secd.
notes, 04/01/02 ........................ NR NR 2,480,000
985,583 Tribasa Toll Road Trust, 10 1/2%, notes,
12/01/11 ............................... NR NR 827,890
985,583 Tribasa Toll Road Trust, 10 1/2%, notes,
series A, 12/01/11, 144A ............... NR NR 827,890
2,000,000 Valujet Airlines Inc., 10 1/2%, sr. secd.
notes, 04/15/01, 144A .................. NR NR 2,005,000
------------
10,607,900
------------
TOTAL FIXED INCOME (cost $198,461,345) .......................... $199,938,334
------------
COMMON STOCK AND WARRANTS -- 5.56%
<CAPTION>
Value
Units Description (Note 2)
----- ----------- --------
<S> <C> <C>
10,500 Ambassador Apartments Inc. ...................................... $ 225,094
10,000 American Capital Strategies ..................................... 180,000
13,550 American Communications Services, Inc.* ......................... 1,422,750
500,000 American Communications Services, Inc.* ......................... 470,250
2,000 American Telecasting Inc., warrants* ............................ 5,000
185,900 Ames Department Stores Inc., excess cash flow pmt., series A .... 0
594,876 Ames Department Stores Inc., lit. trust units ................... 0
10,000 Annaly Mortgage Management Inc .................................. 118,750
50,000 Annaly Mortgage Management Inc. ................................. 550,000
5,925 Capital Pac Holdings Inc., warrants, 144A* ...................... 22
1,000 Central Rents Inc., 144A ........................................ 60,000
750 Chattem Inc., warrants* ......................................... 3,000
100,000 Commodore Separation Technology, sr. conv. preferred ............ 775,000
100,000 Commodore Separation Technology ................................. 87,500
33,000 Cort Business Services Corp., warrants* ......................... 132,000
500 County Seat Holdings Inc., warrants* ............................ 0
20,000 Criimi Mae Inc., conv. preferred, series B ...................... 725,000
4,000 Crown America Realty Trust ...................................... 217,000
550 CS Wireless Systems Inc., 144A* ................................. 17,050
20,000 Engel General Developers Ltd.* .................................. 166,250
20,000 Excel Realty Trust Inc. ......................................... 602,500
2,000 Globalstar Telecommunications, warrants, 144A* .................. 0
1,500 Golden Ocean Group Ltd. ......................................... 123,750
11,000 HarCor Energy Inc., warrants* ................................... 0
500 HDA Management Corp., warrants* ................................. 0
20,000 Health & Retirement Properties Trust ............................ 375,000
1,500 Heartland Wireless Communications, warrants, 144A* .............. 1,500
10,000 Hospitality Properties Trust .................................... 355,625
4,800 ICF Kaiser International Inc., warrants* ........................ 0
750 IHF Capital Inc., warrants, 144A* ............................... 45,000
15,000 Imperial Credit Commercial Mortgage Investments Corp.* .......... 247,500
750 Intermedia Communications of Florida Inc., warrants, 144A* ...... 74,250
2,000 Ionica PLC, warrants* ........................................... 0
49,970 JPS Textile Group, Inc.* ........................................ 674,595
25,000 Local Financial Corp., 144A ..................................... 281,250
500 Motels of America Inc., 144A* ................................... 500
20,000 National Propane Partners L.P. .................................. 440,000
750 NS Group Inc.* .................................................. 0
4,000 Occidente Y Caribe Cellular, warrants, 144A* .................... 0
3,500 Optel Inc.* ..................................................... 35
2,000 Orion Network Systems Inc. ...................................... 35,000
125,449 Prime Retail Inc. ............................................... 1,873,894
1,000 Sabreliner Corp., warrants* ..................................... 0
500 Spanish Broadcasting Corp., warrants* ........................... 175,000
15,000 Supermarkets General Holdings Corp., exchangeable preferred ..... 345,000
4,000 Terex Corp., rights* ............................................ 80,000
5,133 Trans World Airlines Inc.* ...................................... 38,177
2,000 Trans World Airlines Inc., warrants* ............................ 0
25,000 Ugly Duckling Corp.* ............................................ 296,875
1,000 Unifi Communications Inc., warrants, 144A* ...................... 0
9,800 Uniroyal Technology Corp., warrants* ............................ 9,800
20,000 Walden Residential Properties, conv. preferred, series B ........ 560,000
5,000 WBK Strypes Trust ............................................... 155,000
7,000 WHX Corp., preferred* ........................................... 344,750
1,500 Wireless One Inc., warrants* .................................... 0
------------
TOTAL COMMON STOCK AND WARRANTS (cost $10,649,928) .............. 12,289,667
------------
TOTAL INVESTMENTS IN SECURITIES (cost $209,111,273) ............. 212,228,001
------------
OTHER ASSETS - 3.93% ............................................ 8,669,705
------------
TOTAL ASSETS - 100% ............................................. $220,897,706
============
* Non-income producing security.
(a) Percentages indicated are based on total assets.
(b) Pay in kind.
NR denotes not rated.
</TABLE>
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
BALANCE SHEET
October 31, 1997
ASSETS
Investments in securities at value (identified cost $209,111,273;
see Schedule of Investments and Note 2) ....................... $212,228,001
Receivables:
Investment securities sold .................................... 3,457,384
Interest and dividends ........................................ 5,064,840
Deferred debt issuance costs (Note 2) ........................... 4,997
Deferred auction agent fees (Note 6) ............................ 27,003
Prepaid surety bond premiums (Note 7) ........................... 7,012
Prepaid insurance ............................................... 83,174
Other assets .................................................... 25,295
------------
Total assets ............................................ $220,897,706
------------
LIABILITIES
Payables:
Investment securities purchased ............................... $ 2,439,382
Due to bank ................................................... 1,591,286
Accrued expenses (Note 3) ....................................... 958,136
Senior notes (Note 4) ........................................... 20,000,000
------------
Total liabilities ....................................... $ 24,988,804
------------
Net Assets:
Taxable auction rate preferred stock, no par value --
Authorized -- 1,000 shares
Issued -- 200 shares, liquidation preference of $100,000 per
share (Notes 5 and 7) ..................................... $ 20,000,000
------------
Common stock, $.01 par value --
Authorized -- 100,000,000 shares
Issued and outstanding -- 44,146,293 shares ................. $ 441,463
Capital in excess of par value (Notes 2 and 5) ................ 230,120,834
Accumulated undistributed net investment income (Note 2) ...... 2,845,247
Accumulated net realized loss from security transactions ...... (60,615,370)
Net unrealized appreciation of investments .................... 3,116,728
------------
Net assets applicable to common stock (equivalent to
$3.98 per share, based on 44,146,293 shares outstanding) $175,908,902
------------
Total net assets .................................... $195,908,902
============
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
STATEMENT OF OPERATIONS
For the year ended October 31, 1997
INVESTMENT INCOME (Note 2):
Interest income ............................................... $18,589,675
Dividend income ............................................... 645,812
Accretion of discount ......................................... 1,999,323
Other income .................................................. 66,032
-----------
Total investment income ................................. $21,300,842
===========
EXPENSES:
Interest expense .............................................. $ 1,305,999
Investment advisory fee (Note 3) .............................. 1,146,665
Custodian and transfer agent fees ............................. 169,999
Preferred dividend auction costs .............................. 125,290
Professional fees ............................................. 159,002
Miscellaneous expenses ........................................ 156,047
Amortization of prepaid surety bond premiums (Note 7) ......... 80,001
Directors' fees ............................................... 91,165
Insurance expense ............................................. 107,595
Amortization of deferred auction agent fees (Note 6) .......... 26,999
Excise tax expense ............................................ 70,060
-----------
Total expenses .......................................... $ 3,438,822
-----------
Net investment income ................................... $17,862,020
-----------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized gain on investments sold ......................... $ 4,773,501
Change in net unrealized depreciation of investments (Note 2) . 4,499,052
----------
Net realized and unrealized gain on investments ......... $ 9,272,553
----------
Net increase in net assets resulting from operations .... $27,134,573
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS ($5,456 per share) ...... (1,091,099)
-----------
Net increase in net assets applicable to common
stockholders .......................................... $26,043,474
===========
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
STATEMENT OF CASH FLOWS
For the year ended October 31, 1997
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest and dividends received .......................... $ 19,053,136
Operating expenses paid .................................. (1,807,203)
-------------
Net cash provided by operating activities .......... $ 17,245,933
-------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of portfolio securities ........................ $(370,804,113)
Sales and maturities of portfolio securities ............. 323,702,189
-------------
Net cash used in investing activities .............. $ (47,101,924)
-------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from common stock rights offering and sale
of common stock ........................................ 44,499,053
Preferred stock dividends paid ........................... (1,091,099)
Common stock dividends paid from operations .............. (15,053,657)
-------------
Net cash provided by financing activities .......... $ 28,354,297
-------------
NET DECREASE IN CASH ....................................... $ (1,501,694)
CASH, BEGINNING OF PERIOD .................................. 1,501,694
-------------
CASH, END OF PERIOD ........................................ $ --
=============
RECONCILIATION OF NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Net increase in net assets resulting from operations ... $ 27,134,573
Increase in interest and dividend receivables .......... (409,580)
Amortization of Fidelity Bond and other deferred assets 32,000
Increase in other assets ............................... (74,567)
Increase in accrued expenses and other payables ........ 1,674,186
Net realized gain on investments sold .................. (4,773,501)
Change in net unrealized depreciation of investments ... (4,499,052)
Accretion of bond discount ............................. (1,838,126)
-------------
Net cash provided by operating activities .......... $ 17,245,933
=============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest ................... $ 1,305,999
Cash paid during the year for excise taxes ............... 70,060
=============
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<TABLE>
<CAPTION>
STATEMENT OF CHANGES IN NET ASSETS
Fiscal Year Ended Fiscal Year Ended
October 31, October 31,
1997 1996
------------ ------------
<S> <C> <C>
FROM OPERATIONS:
Net investment income ................................ $ 17,862,020 $ 13,628,745
Net realized gain on investments sold ................ 4,773,501 351,405
Change in net unrealized depreciation of investments . 4,499,052 5,074,470
------------ ------------
Net increase in net assets resulting from
operations ................................... $ 27,134,573 $ 19,054,620
------------ ------------
FROM FUND SHARE TRANSACTIONS:
Shares issued (290,871 shares and 353,455 shares,
respectively) to common stockholders for
reinvestment of dividends .......................... $ 1,146,681 $ 1,333,077
Net proceeds from sale of common stock issued
(12,918,092 and 5,393,885 shares, after deducting
$2,167,500 and $996,862 of soliciting fees and other
expenses), respectively ............................ 44,208,450 19,553,840
------------ ------------
Increase in net assets resulting from fund share
transactions ................................. $ 45,355,131 $ 20,886,917
------------ ------------
DISTRIBUTIONS TO STOCKHOLDERS:
Preferred dividends ($5,456 and $5,679 per share,
respectively) ...................................... $(1,091,099) $ (1,135,736)
Common dividends ($.42 and $.42 per share,
respectively) from operations ...................... (16,200,344) (11,404,136)
------------ ------------
Decrease in net assets resulting from
distributions to stockholders ................ (17,291,443) (12,539,872)
------------ ------------
Total net increase in net assets ............... $ 55,198,261 $ 27,401,665
NET ASSETS:
Beginning of period .................................. 140,710,641 113,308,976
------------ ------------
End of period (including $2,845,247 and $2,018,708 of
undistributed net investment income as of October
31, 1997 and 1996, respectively) ................... $195,908,902 $140,710,641
============ ============
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
SELECTED PER SHARE DATA AND RATIOS
FOR EACH SHARE OF COMMON STOCK OUTSTANDING THROUGHOUT THE PERIODS PRESENTED
For the Years Ended October 31,
--------------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period ... $ 3.90 $ 3.70 $ 3.69 $ 4.25 $ 4.03
-------- -------- -------- -------- --------
Net investment income .................. .46# .50# .45 .48# .63#
Net realized and unrealized gain (loss)
on investments........................ .24# .20# .03 (.38)# .39#
-------- -------- -------- -------- --------
Total from investment operations $ .70 $ .70 $ .48 $ .10 $ 1.02
-------- -------- -------- -------- --------
Distributions:
Dividends from accumulated net
investment income
To preferred stockholders .......... (.03) (.04) (.05) (.03) (.06)
To common stockholders ............. (.42) (.42) (.42) (.45) (.62)
-------- -------- -------- -------- --------
Total distributions ............ $ (.45) $ (.46) $ (.47) $ (.48) $ (.68)
-------- -------- -------- -------- --------
Effect of sale of common stock and
related expenses from rights offering $ (.17) $ (.04) $ -- $ (.18) $ (.12)
-------- -------- -------- -------- --------
Net asset value, end of period ......... $ 3.98 $ 3.90 $ 3.70 $ 3.69 $ 4.25
======== ======== ======== ======== ========
Per share market value, end of period .. $ 4.13 $ 4.00 $ 3.88 $ 3.50 $ 4.25
======== ======== ======== ======== ========
Total investment return ................ 14.82% 15.29% 28.57% (7.78)% 23.25%
======== ======== ======== ======== ========
Net assets, end of period, applicable to
common stock (a) ..................... $175,909 $120,711 $ 93,309 $ 92,072 $ 79,438
======== ======== ======== ======== ========
Net assets, end of period, applicable to
preferred stock (a) .................. $ 20,000 $ 20,000 $ 20,000 $ 20,000 $ 20,000
======== ======== ======== ======== ========
Net assets, end of period (a) .......... $195,909 $140,711 $113,309 $112,072 $ 99,438
======== ======== ======== ======== ========
Ratio of operating expenses to average
net assets, applicable to common stock 2.30% 3.06% 3.27% 3.27% 3.10%
Ratio of net investment income to average
net assets, applicable to common stock 11.94% 13.20% 13.47% 12.25% 13.49%
Ratio of operating expenses to average
net assets** ......................... 1.81%+ 2.21%+ 2.28%+ 2.30%+ 2.13%+
Ratio of net investment income to
average net assets** 9.42% 9.51% 9.39% 8.64% 9.26%
Portfolio turnover rate ................ 176.04% 108.33% 80.71% 72.00% 117.20%
(a) Dollars in thousands.
** Ratios calculated on the basis of expenses and net investment income applicable to both the common and preferred shares
relative to the average net assets (total assets less accrued liabilities (excluding senior notes)) of both the common and
preferred shareholders.
+ Excluding interest expense, the ratio of operating expenses to average net assets, applicable to common stock and preferred
stock, is 1.13%, 1.30%, 1.29%, 1.32% and 1.50%, respectively.
# Calculation is based on average shares outstanding during the indicated period due to the per share effect of the Fund's
rights offerings.
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<TABLE>
<CAPTION>
INFORMATION REGARDING SENIOR SECURITIES
As of October 31,
-------------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total Amount Outstanding:
Notes $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000
Preferred stock 20,000,000 20,000,000 20,000,000 20,000,000 20,000,000
Asset Coverage:
Per note (a) 1,080% 804% 667% 660% 597%
Per preferred stock share (b) 540% 402% 333% 330% 299%
Involuntary Liquidation Preference:
Per preferred stock share (c) $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000
Approximate Market Value:
Per note $ 1,003.80 $ 990.00 $ 987.50 $ 937.10 $ 997.50
Per preferred stock share 100,000 100,000 100,000 100,000 100,000
(a) Calculated by subtracting the Fund's total liabilities (not including senior securities) from the Fund's total
assets and dividing such amount by the principal amount of the debt outstanding.
(b) Calculated by subtracting the Fund's total liabilities (not including senior securities) from the Fund's total
assets and dividing such amount by the principal amount of the debt outstanding and aggregate liquidation
preference of the outstanding shares of Taxable Auction Rate Preferred Stock.
(c) Plus accumulated and unpaid dividends.
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1997
(1) ORGANIZATION AND OPERATIONS
Prospect Street High Income Portfolio Inc. (the "Fund") was organized as a
corporation in the state of Maryland on May 13, 1988 and is registered with the
Securities and Exchange Commission as a diversified, closed-end, management
investment company under the Investment Company Act of 1940. The Fund commenced
operations on December 5, 1988. The Fund's financial statements have been
prepared in conformity with generally accepted accounting principles, which
requires the management of the Fund to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expenses during the reporting periods. Actual
results could differ from those estimates. The following is a summary of
significant accounting policies consistently followed by the Fund, which are in
conformity with those generally accepted in the investment company industry.
The Fund invests primarily in securities of fixed-maturity, corporate debt
securities and in redeemable preferred stocks that are rated less than
investment grade. Risk of loss upon default by the issuer is significantly
greater with respect to such securities compared to investment-grade securities
because these securities are generally unsecured and are often subordinated to
other creditors of the issuer, and because these issuers usually have high
levels of indebtedness and are more sensitive to adverse economic conditions,
such as a recession, than are investment-grade issuers. In some cases, the
collection of principal and timely receipt of interest is dependent upon the
issuer attaining improved operating results, selling assets or obtaining
additional financing.
See the schedule of investments for information on individual securities, as
well as industry diversification and credit quality ratings.
(2) SIGNIFICANT ACCOUNTING POLICIES
(a) VALUATION OF INVESTMENTS
Investments for which listed market quotations are readily available are
stated at market value, which is determined using the last reported sale price
or, if no sales are reported, as in the case of some securities traded
over-the-counter, the last reported bid price. Short-term investments having
remaining maturities of 60 days or less are stated at amortized cost, which
approximates market.
Other investments, primarily noninvestment-grade corporate debt securities for
which market quotations are not readily available due to a thinly traded market
with a limited number of market makers, are stated at fair value on the basis of
valuations furnished by an independent pricing service, subject to adjustment by
the investment adviser based upon quotations obtained from market makers. The
independent pricing service determines value based primarily on quotations from
dealers and brokers, market transactions, accessing data from quotation
services, offering sheets obtained from dealers and various relationships
between securities. The independent pricing service utilizes the last sales
price based on odd-lot trades, if available. If such price is not available, the
price furnished is based on round-lot or institutional size trades. These
procedures have been approved by the Board of Directors.
The fair value of restricted securities is determined by the investment
adviser following procedures approved by the Board of Directors.
(b) SECURITY TRANSACTIONS AND RELATED INVESTMENT INCOME
Realized gains and losses on investments sold are recorded on the
identified-cost basis. Interest income and accretion of discounts are recorded
on the accrual basis.
(c) FEDERAL INCOME TAXES
It is the Fund's policy to comply with the requirements of the Internal
Revenue Code of 1986, as amended, applicable to regulated investment companies,
and to distribute substantially all of its investment company taxable income to
its stockholders each year. Accordingly, no federal income tax provision is
required.
The Fund has reclassified $262,889 from paid in capital to undistributed net
investment income and $6,927 from undistributed net investment income to
undistributed net realized loss from security transactions. These
reclassifications have no impact on the net asset value of the Fund and are
designed to present the Fund's capital accounts on a tax basis.
At October 31, 1997, the cost of investments in securities for federal income
tax purposes was $209,111,273. Aggregate gross unrealized gains on securities in
which there was an excess of market value over tax cost was $10,968,585.
Aggregate gross unrealized losses on securities in which there was an excess of
tax cost over market value was $7,851,857. The net unrealized gain on securities
held by the Fund was $3,116,728 for federal income tax purposes.
At October 31, 1997, the Fund had the following capital loss carryovers
available to offset future capital gains, if any, to the extent provided by
regulations:
CARRYOVER
AVAILABLE EXPIRATION DATE
$(37,564,886) October 31, 1998
(18,529,051) October 31, 1999
(808,396) October 31, 2002
(3,703,531) October 31, 2003
------------
$(60,605,864)
============
(D) COMMON STOCK AND TAXABLE AUCTION RATE PREFERRED STOCK (PREFERRED STOCK),
OFFERING AND DEFERRED DEBT ISSUANCE COSTS
The costs incurred by the Fund in connection with the initial sale of the
common and preferred stock as well as the common stock rights offerings have
been recorded as a reduction of the common stock proceeds. The costs incurred by
the Fund in connection with the issuance of the senior notes have been deferred
and are being amortized on a straight-line basis over a period of five years.
(E) CASH FLOW INFORMATION
The Fund invests primarily in corporate debt securities and distributes
dividends from net investment income, which are paid in cash or shares of common
stock of the Fund. These activities are reported in the accompanying statement
of changes in net assets, and additional information on cash receipts and cash
payments is presented in the accompanying statement of cash flows.
(3) INVESTMENT ADVISORY AGREEMENT
Prospect Street Investment Management Co., Inc., the Fund's Investment
Adviser, earned $1,146,665 in management fees for the year ended October 31,
1997. Management fees paid by the Fund to the Investment Adviser were calculated
at .65% (on an annual basis) of the average weekly value of total assets of the
Fund less accrued liabilities (excluding the principal amount of the notes and
the liquidation preference of the preferred stock and including accrued and
unpaid dividends on the preferred stock) up to and including $175,000,000 of net
assets, .55% on the next $50,000,000 of net assets and .50% of the excess of net
assets over $225,000,000. At October 31, 1997, the fee payable to the Investment
Adviser was $169,638, which was included in accrued expenses in the accompanying
balance sheet. However, for a period of one year commencing on the expiration
date of the May 1996 rights offering, the Adviser waived its advisory fee with
respect to any increase in the Fund's net assets resulting from the exercise of
any rights pursuant to that Offering.
(4) DEBT
In July 1993, the Fund repurchased the remaining $5,000,000 (principal amount)
of its senior extendible notes (the Notes), which carried an annual interest
rate through November 30, 1993 of 10.28%. The Fund simultaneously issued
$20,000,000 of new Senior Notes (the Senior Notes) that will mature, if not
previously redeemed, on December 1, 1998. The Fund is required to maintain
certain asset coverages with respect to the Senior Notes, as defined in the Note
Purchase Agreement, and the Senior Notes are subject to mandatory redemption if
the Fund fails to maintain these asset coverages. The Senior Notes bear interest
at the rate of 6.53% per annum through November 30, 1998. Interest on the Senior
Notes is due every June 1 and December 1, commencing December 1, 1993.
The Senior Notes are redeemable, in whole or in part, by the Fund at certain
times and under certain circumstances, as defined in the Note Purchase
Agreement.
(5) REDEEMABLE PREFERRED STOCK
In July 1993, the Fund redeemed 100 of the 300 shares of preferred stock that
were issued concurrently with the issuance of the Senior Extendible Notes.
Dividends are cumulative at a rate that was established at the offering of the
preferred stock and which has and will continue to be reset every 30 days
thereafter by an auction. Dividend rates ranged from 5.30% to 5.65% of the
liquidation preference during the year ended October 31, 1997. The remaining 200
shares of preferred stock are redeemable, at the option of the Fund, at a
redemption price equal to $100,000 per share, plus accumulated and unpaid
dividends, on any dividend payment date. The preferred stock is also subject to
mandatory redemption at a redemption price equal to $100,250 per share, plus
accumulated and unpaid dividends, if the Fund is in default of its surety asset
coverage requirements with respect to the preferred stock (see Note 7). In
general, the holders of the preferred stock and the common stock vote together
as a single class, except that the holders of the preferred stock, as a separate
class, vote to elect two members of the Board of Directors, and separate class
votes are required on certain matters that affect the respective interests of
the preferred stock and common stock. The preferred stock has a liquidation
preference of $100,000 per share, plus accumulated and unpaid dividends. The
Fund is required to maintain certain asset coverages with respect to the
preferred stock, as defined in the Fund's Note Purchase Agreement and Surety
Bond Agreement.
(6) AUCTION AGENT
The Fund amended and extended the auction agent agreement with Bear Stearns &
Co. Inc. on October 26, 1993 (which was originally dated May 7, 1990) to provide
for an extension to December 4, 1998. The Fund incurred additional costs of
$135,000 related to extending this agreement. These costs are being amortized on
a straight-line basis over the remaining life of the extended agreement.
Amortization expense for the year ended October 31, 1997 was $26,999.
(7) SURETY BOND
The Fund has entered into an insurance agreement, dated as of December 1,
1988, with Financial Security Assurance, Inc. (FSA), pursuant to which FSA has
issued a surety bond. Under the terms of the surety bond, FSA has
unconditionally and irrevocably guaranteed dividend, redemption and liquidation
payments to preferred shareholders upon failure of the Fund to do so, and the
Fund is then obligated to reimburse FSA for any amounts paid under the surety
bond. The surety bond had an initial term of five years and was scheduled to
expire on December 5, 1993. On July 15, 1993, the Fund extended the terms of the
surety bond from December 5, 1993 to December 5, 1998. The Fund will pay an
annual premium of 0.40% on the maximum aggregate liquidation preference of the
preferred stock.
The Fund executed an amendment to the insurance agreement on April 11, 1990,
which provides that the Fund must redeem or repurchase all of the then
outstanding shares of preferred stock in the event that the dividend rate on the
preferred stock for the period next succeeding the auction in September 1998 is
the maximum applicable rate (as defined) payable on the Fund's preferred stock.
(8) PURCHASES AND SALES OF SECURITIES
For the year ended October 31, 1997, the aggregate cost of purchases and
proceeds from sales of investment securities other than U.S. Government
obligations and short-term investments aggregated $371,447,873 and $324,868,108,
respectively. There were no purchases or sales of U.S. Government obligations
during the year ended October 31, 1997.
(9) CERTAIN TRANSACTIONS
Certain officers of the Investment Adviser serve on the Board of Directors of
the Fund. They receive no compensation in this capacity.
Directors who are not officers or employees of the Investment Adviser receive
a fee of $10,000 per year plus $2,000 per Directors' meetings attended, together
with actual out-of-pocket expenses relating to attendance at such meetings and
$1,000 per telephone meeting. In addition, members of the Fund's audit
committee, which consists of certain of the Fund's noninterested Directors,
receive $1,000 per audit committee meeting attended, together with actual
out-of-pocket expenses relating to attendance at such meeting.
(10) DIVIDENDS AND DISTRIBUTIONS
The Board of Directors of the Fund declared regular dividends on the common
stock of $.035 per share payable on November 29 and December 30, 1996, and
January 31, February 28, March 31, April 30, May 30, June 30, July 31, August
29, September 30 and October 31, 1997.
Distributions on common stock are declared based on annual projections of the
Fund's net investment income (defined as dividends and interest income, net of
Fund expenses, less distributions on the preferred stock). The Fund plans to pay
monthly distributions to common shareholders. Meanwhile, as a result of market
conditions or investment decisions, the amount of distributions may exceed net
investment income earned at certain times throughout the period. It is
anticipated that, on an annual basis, the amount of distributions to common
shareholders will not exceed net investment income (as defined) applicable to
common shareholders on a tax basis. All shareholders of the Fund are
automatically considered a participant in the Dividend Reinvestment Plan (the
"Plan") unless otherwise elected. Under the Plan, when the market price of
common stock shares is equal to or exceeds the net asset value on record date
for distribution, participants will receive all dividends and distributions in
full and fractional shares of the Fund at the most recently determined net asset
value but in no event less than 95% of market price. If on record date for
distributions the net asset value of the common stock exceeds its market price,
or if the Fund shall declare a dividend or capital gains distribution payable
only in cash, the dividend-paying agent will buy common stock in the open market
for the participants' accounts. Participants are not charged a service fee for
the Plan but are subject to a pro rata share of brokerage fees incurred with
respect to open market purchases of common stock.
(11) FAIR VALUE OF LONG-TERM DEBT
The fair value of the Fund's long-term debt is estimated based on the quoted
market prices for the same issues or on the current rates offered to the Fund
for debt of the same remaining securities. At October 31, 1997, the fair value
of the Senior Notes was $20,076,400.
(12) RIGHTS OFFERING
On February 28, 1997 the Fund commenced a rights offering whereby the Fund
issued to its shareholders of record, as of that date, non-transferable rights
entitling the holders thereof to subscribe for an aggregate of 12,918,092 shares
of the Fund's common stock. Each record date shareholder had the ability to
receive one right for each whole share of common stock held. The rights allowed
the rights holder to subscribe for shares of common stock at the right of one
share of common stock for every three rights held. The subscription period for
the rights offering expired on March 25, 1997 and the Fund issued 12,918,092
shares of common stock at $3.59 per share. Proceeds to the Fund amounted to
$44,208,450, net of soliciting fees and offering expenses of $2,167,500.
On November 21, 1997 the Fund filed a registration statement for a
transferable rights offering to shareholders. Such rights, if exercised, will
entitle the holders thereof to subscribe for an aggregate of 14,718,295 shares
of the Fund's common stock. The expected offering date is December 1997 with a
closing date near the end of January 1998.
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
Prospect Street High Income Portfolio Inc.:
We have audited the accompanying balance sheet of PROSPECT STREET HIGH
INCOME PORTFOLIO INC., including the schedule of investments, as of October 31,
1997, the related statements of operations and cash flows for the year then
ended, the statements of changes in net assets for the years ended October 31,
1997 and 1996 and the financial highlights for the periods presented. 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 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 investments owned as of
October 31, 1997 by correspondence with the custodian and brokers. 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
Prospect Street High Income Portfolio Inc. as of October 31, 1997, and the
results of its operations, the changes in its net assets, its cash flows and the
financial highlights for the periods presented, in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
December 5, 1997
<PAGE>
PROSPECT
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
INVESTMENT ADVISER AUDITORS
Prospect Street Investment Management Arthur Andersen LLP
Co., Inc. Boston, MA
60 State Street, Suite 3750
Boston, MA 02109 TRANSFER AND SHAREHOLDERS' SERVICING
AGENT
OFFICERS State Street Bank and Trust Company
Richard E. Omohundro, Jr. -- President P.O. Box 8200
John A. Frabotta -- Vice President, Boston, MA 02266
Treasurer and (800) 426-5523
Chief Investment
Officer CUSTODIAN
Karen J. Thelen -- Secretary State Street Bank and Trust Company
Boston, MA
DIRECTORS
John S. Albanese PAYING AGENT (PREFERRED)
C. William Carey Bankers Trust Company
Joseph G. Cote New York, NY
John A. Frabotta
Richard E. Omohundro, Jr. Listed: NYSE
Harlan D. Platt Symbol: PHY
Christopher E. Roshier
LEGAL ADVISER
Olshan Grundman Frome & Rosenzweig
New York, NY
<PAGE>
FACTS FOR SHAREHOLDERS:
Prospect Street High Income Portfolio Inc. is listed on the New York Stock
Exchange under the symbol "PHY". The Wall Street Journal publishes Friday's
closing net asset value of the Fund every Monday and lists the market price of
the Fund daily.
QUESTIONS REGARDING YOUR ACCOUNT: Please telephone State Street Bank & Trust
Company at their toll free number 1-800-426-5523 Monday through Friday from
9:00 a.m. to 5:00 p.m.
WRITTEN CORRESPONDENCE REGARDING YOUR ACCOUNT: Please mail all correspondence
directly to Prospect Street High Income Portfolio Inc., c/o State Street Bank &
Trust Company, P.O. Box 8200, Boston, MA 02266. For express mail the address is
Prospect Street High Income Portfolio Inc., c/o State Street Bank & Trust
Company, 2 Heritage Drive, Corporate Stock Transfer -- 4th Floor, North Quincy,
MA 02171.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
60 State Street, Suite 3750
Boston, MA 02109
