<PAGE>
PROSPECT STREET(R)
HIGH INCOME PORTFOLIO INC.
ANNUAL
REPORT
OCTOBER 31, 1998
[LOGO]
<PAGE>
December 21, 1998
LETTER TO SHAREHOLDERS
Dear Shareholders:
On October 31, 1998, the net asset value of the Fund was $7.97, as
compared to $11.64 on April 30, 1998. As of December 18, 1998 the Fund's net
asset value had recovered to $8.30 (unaudited). During the fiscal year ended
October 31, 1998, the Fund paid dividends to shareholders on the common stock
in the amount of $1.26 per share. Total dividends for the calendar year ending
December 31, 1998, will be $1.26.
THE HIGH YIELD MARKET
During 1998 the capital market exhibited extreme volatility and the high
yield corporate bonds were no exception. The high yield market as measured by
the DLJ High Yield Index generated a total return of negative 2.65% for the
twelve-month period ending October 31, 1998, and a negative 4.42% for the
calendar period ended October 31, 1998. However, the middle and lower tiers of
the high yield market generated declines of 4.74% to 27.12% for the twelve-
month period ending October 31, 1998. The Fund's holdings are weighted more
heavily in the middle and lower tiers of the market with very little in the
upper tier.
At October 31, 1998, the spread between high yield securities and
comparable U.S. Government securities stood at 735 basis points compared to
377 basis points at April 30, 1998 and 381 basis points at October 31, 1997.
Total new issue volume for the year ending October 31, 1998, was $119.8
billion. However, the months of August, September, and October saw new issue
volume drop to annual rates of $24 to $30 billion, a significant decline from
earlier in the year. The average price for a cash paying high yield security
was $92.85 with an average coupon of 9.91%.
The flow of new funds into high yield mutual funds year-to-date totaled
$10.2 billion, which is down substantially from 1997.
THE FUND'S INVESTMENTS
As of October 31, 1998, the Fund held 157 issues representing 29 industry
groups. Cash and short-term investments represented 4.2% of our holdings. The
average price of the Fund's high yield securities was $76.63, with an average
coupon of 11%. The Fund had an outstanding bank borrowing of $40.0 million
under a $50.0 million revolving line of credit at an interest rate of 6.3%. At
October 31, 1998, the Fund was generating monthly income of approximately
$0.105 per common share.
INVESTMENT OUTLOOK
The world has changed substantially since our last shareholder report in
April. As always, there are positive factors and negative factors affecting
our market. Some of the positive factors that could benefit the high yield
market are:
1. The Federal Reserve has demonstrated a willingness to provide liquidity
to the system to moderate credit problems and maintain the capital
markets.
2. The most recent decline in interest rates, while precipitated by
deteriorating financial conditions in both the bond and equity markets,
could be followed by further interest rate declines in 1999.
3. Turmoil in the foreign market continues to make the U.S. capital market
an attractive investment opportunity for foreign investors.
4. The yields available in the high yield market today appear compelling
and have not been this attractive since 1990.
5. The strong economy, together with consumer willingness to spend has
been a major factor supporting the very recent rebound in many high
yield issues.
Some of the factors that could negatively impact the high yield market are:
1. South East Asia continues to be in turmoil and we may see further
weakening of the larger economies in the region. The impact on the U.S.
economy and capital markets could be harmful.
2. Corporate profits could be much weaker in 1999 than consensus
forecasters now expect, resulting in more stress for all corporate
issuers.
3. The introduction of the new single currency in Europe could contribute
to weakness in the U.S. dollar resulting in funds being pulled out of
the U.S. capital markets.
4. A weaker economy, particularly if accompanied by a weak stock market,
could precipitate a rise in credit problems for many issuers of high
yield debt, resulting in high default rates.
LEVERAGE
On May 15, 1998, the Fund redeemed all of its Taxable Auction Rate
Preferred Stock at an aggregate redemption price of $20 million and on July
24, 1998, the Fund redeemed all of its outstanding senior notes at an
aggregate redemption price of $20 million. Funds required to redeem the
preferred stock and the senior notes were borrowed by the Fund under a new
floating rate, $50 million revolving credit facility with BankBoston, N.A., as
lender and agent. At October 31, 1998, the Fund had an outstanding borrowing
of $40 million under such facility at an interest rate of 6.3%.
YEAR 2000 PROBLEM
Many computer systems were designed using only two digits to signify the
year (i.e. 98 for 1998). On January 1, 2000, if these systems are not
corrected, they may incorrectly interpret 00 as 1900 instead of 2000, leading
to computer shutdowns or errors. To the extent these systems conduct forward-
looking calculations, the computer problems may occur prior to January 1,
2000. Like other investment companies and financial and business
organizations, the Fund could be adversely affected in its ability to process
securities trades, price securities, provide shareholder account services and
otherwise conduct normal business operations if the computer systems used by
the Adviser or other Fund service providers do not adequately address this
problem in a timely manner. The Adviser does not anticipate that the
transition to the Year 2000 will have any material impact on its ability to
continue to service the Fund at current levels. In addition, the Adviser has
sought assurances from the other Fund service providers that they are taking
the steps necessary to deal with the problem. The cost of any systems
remediation by persons other than the Fund or the Adviser will not be borne by
the Fund. However, no assurance can be given that the actions taken by the
Adviser or the Fund's other service providers will be sufficient to avoid any
adverse effect on the Fund.
PROPOSED RIGHTS OFFERING
On December 18, 1998, the Fund filed a Registration Statement with the
Securities and Exchange Commission for a transferable rights offering to
shareholders. PaineWebber and Gruntal & Co. are the Dealer Managers. The
Offering will be made only pursuant to a prospectus upon the effectiveness of
the Registration Statement.
CONCLUSION
The past six to twelve months have been very volatile in the high yield
market and we expect this volatility to continue, but in a more subdued
manner. Our strategy in the current environment will therefore be defensive
with an emphasis on preservation of capital.
The recent adverse market conditions may well lead to a significant buying
opportunity, particularly if the U.S. economy is able to overcome the
continuing global weakness.
Management continues to review the Fund's investments, seeking to maximize
the Fund's income while conserving principal.
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, 1998
<TABLE>
<CAPTION>
FIXED INCOME -- 84.92%
Ratings
----------------
Par Standard Value
Value Description & Poor's Moody's (Note 2)
----- ----------- -------- ------- --------
<S> <C> <C> <C> <C>
AUTOMOBILE/AUTO PARTS/TRUCK MANUFACTURING - 2.48%
$ 375,000 Aftermarket Technology Corp., 12%, sr. sub. notes, series B, 08/01/04 ........... B B2 $ 337,500
6,443,000 Iochpe-Maxion SA, 12 3/8%, notes, 11/08/02 ...................................... NR NR 3,865,800
2,000,000 Localiza Rent a Car, 10 1/4%, sr. notes, 10/01/05 ............................... BB- B2 800,000
------------
5,003,300
------------
BANKS/SAVINGS AND LOANS/FINANCE COMPANIES/CONSUMER CREDIT - 4.04%
1,000,000 Bank Plus Corp.,12%, sr. notes, 07/18/07 ........................................ NR NR 1,010,000
2,533,000 Cityscape Financial Corp., 12 3/4%, sr. notes, series A, 06/01/04(b)* ........... D Ca 481,270
3,500,000 Emergent Group Inc., 10 3/4%, sr. notes, series B, 09/15/04 ..................... CCC Caa2 1,645,000
4,500,060 Federal Home Loan Mortgage, 4.10%, interest only stripped security, 12/15/22 (c) A1+ AAA 28,125
1,500,000 Life Federal Savings Bank, 13 1/2%, sub. debs, 03/15/04 ......................... NR NR 1,500,000
500,000 Local Financial Corp., 11%, sr. notes, 09/05/04, 144A ........................... NR NR 505,000
1,875,000 Mego Mortgage, 12 1/2%, sr. sub. notes, 12/01/01 ................................ NR Ca 1,500,000
1,000,000 Ocwen Federal Bank, 12%, sub. debs., 06/15/05 ................................... BB- B1 760,000
3,300,000 Southern Pacific Funding Corp., 11 1/2%, sr. notes, 11/01/04(b)* ................ D Caa3 726,000
------------
8,155,395
------------
BROADCASTING - TV/CABLE/RADIO/PUBLISHING - 12.95%
7,000,000 AMSC Acquisition Co., Inc., 12 1/4%, sr. notes, 04/01/08 ........................ NR NR 3,360,000
17,107 Australis Media Ltd., 0%, gtd. sr. secd. disc. notes, 05/15/03(b) ............... D C 214
1,000,000 Australis Media Ltd., 0%, sr. secd. disc. notes, 05/15/03(b) .................... D C 12,500
7,742,168 CAI Wireless System Inc., 0%, sr. notes, 10/14/04 ............................... NR NR 1,703,277
9,000,000 CS Wireless Systems Inc., 0%, sr. disc. notes, series B, 03/01/06 ............... C Ca 1,800,000
8,404,000 DIVA Systems Corp., 0%, sub. disc. notes, 03/01/08, 144A ........................ NR NR 2,773,320
1,000,000 Echostar DBS Corp., 12 1/2%, sr. secd. notes, 07/01/02 .......................... B- Caa1 1,005,000
500,000 Galaxy Telecom, L.P., 12 3/8%, sr. sub. notes, 10/01/05 ......................... B- B3 530,000
1,000,000 Goss Graphic Systems Inc., 12%, sr. sub. notes, 10/15/06 ........................ CCC+ B2 880,000
3,500,000 Net Sat Services, 12 3/4%, sr. notes, 08/05/04 .................................. B B3 2,100,000
2,000,000 One Point Communications Co., 14 1/2%, units, 06/01/08, 144A .................... NR NR 920,000
2,000,000 Optel Inc., 13%, sr. notes, series B, 02/15/05 .................................. B- B3 1,940,000
1,000,000 Park n View Inc., 13%, units, 05/15/08 .......................................... B- B3 850,000
700,000 RBS Participaco, 14%, notes, 12/15/03(f) ........................................ BB- NR 682,500
4,000,000 Source Media Inc., 12%, sr. secd. notes, 11/01/04 ............................... B- B3 3,000,000
2,000,000 Spanish Broadcasting System Inc., 12 1/2%, sr. notes, 06/15/02 .................. B B2 2,160,000
1,000,000 Star Choice Communications, 13%, sr. secd. notes, 12/15/05 ...................... B B3 912,500
1,000,000 Vialog Corporation, 12 3/4%, sr. notes, series B, 11/15/01 ...................... B- Caa3 800,000
4,500,000 Wireless One Inc., 13%, sr. disc. notes, 10/15/03 ............................... CCC+ Ca 742,500
------------
26,171,811
------------
DIVERSIFIED/CONGLOMERATE MANUFACTURING - 4.59%
1,000,000 AXIA Inc., 10 3/4%, sr. sub. notes, 07/15/08, 144A .............................. B- B3 930,000
500,000 Amtrol Acquisition Inc., 10 5/8%, sr. sub. notes, 12/31/06 ...................... B- B3 466,250
1,500,000 Chatwins Group Inc., 13%, sr. exch. notes, 05/01/03 ............................. B- B2 1,455,000
1,000,000 Genmar Holdings Inc., 13 1/2%, sr. sub. notes, series A, 07/15/01 ............... NR Caa2 1,022,500
1,000,000 Haynes International Inc., 11 5/8%, sr. notes, 09/01/04 ......................... B- B3 950,000
1,000,000 Key Components LLC, 10 1/2%, sr. notes, 06/01/08, 144A .......................... B- B3 940,000
500,000 MVE Inc., 12 1/2%, sr. secd. notes, 02/15/02 .................................... B B3 470,000
3,000,000 Phase Metrica Inc., 10 3/4%, sr. notes, 02/01/05, 144A .......................... NR Caa1 2,100,000
500,000 Selmer Inc., 11%, sr. sub. notes, 05/15/05 ...................................... B B2 513,750
500,000 Spinnaker Industries Inc., 10 3/4%, sr. secd. notes, 10/15/06 ................... B B3 425,000
------------
9,272,500
------------
DIVERSIFIED/CONGLOMERATE SERVICES - 1.02%
550,000 Coinmach Corp., 11 3/4%, sr. notes, series D, 11/15/05 .......................... B+ B2 572,000
1,000,000 Production Resource Group, 11 1/2%, sr. sub. notes, 01/15/08 .................... B- Caa2 930,000
1,500,000 Young America Corp., 11 5/8%, sr. sub. notes, series B, 02/15/06 ................ CCC+ B3 570,000
------------
2,072,000
------------
ELECTRICAL EQUIPMENT/ELECTRONICS/COMPUTERS - 1.77%
500,000 Decision Holdings Corp., 0%, sr. disc. debs., 08/01/08 .......................... B- NR 135,000
3,000,000 EV International Inc., 11%, sr. sub. notes, series A, 03/15/07 .................. B B3 2,235,000
500,000 International Wire Group Inc., 11 3/4%, sr. sub. notes, 06/01/05 ................ B- B3 495,000
1,300,000 Sharp Do Brasil, 9 5/8%, notes, 10/30/05 ........................................ NR NR 715,000
------------
3,580,000
------------
FINANCIAL SERVICES - 2.18%
1,000,000 Beal Financial Corp., 12 3/4%, sr. notes, 08/15/00 .............................. B- B2 1,030,000
425,000 First Federal Financial Corp., 11 3/4%, notes, 10/01/04 ......................... B+ B2 436,687
500,000 Hawthorne Financial Corporation, 12 1/2%, sr. notes, 12/31/04 ................... NR NR 490,000
500,000 Ocwen Financial Corp., 11 7/8%, notes, 10/01/03 ................................. BB- B1 420,000
1,500,000 Resource America Inc., 12%, sr. notes, 08/01/04 ................................. B- Caa1 1,230,000
2,000,000 Wilshire Financial Services Group Inc., 13%, notes, 01/01/04 .................... NR NR 800,000
------------
4,406,687
------------
FOOD/TOBACCO - 5.90%
3,105,000 American Rice Inc., 13%, mtg. notes, 07/31/02(d)* ............................... D Ca 1,707,750
250,000 AmeriKing Inc., 10 3/4%, sr. notes, 12/01/06 .................................... B- B3 252,500
3,228,442 Cafeteria Operators L.P., 12%, sr. secd. notes, 12/31/01 ........................ NR NR 3,228,442
1,000,000 Gorges Quik to Fix Foods Inc., 11 1/2%, sr. sub. notes, series B, 12/01/06 ...... CCC CCC2 350,000
250,000 Liggett Group Inc., 16 1/2%, notes, 02/01/99 .................................... NR NR 185,000
4,050,000 Liggett Group Inc., 11 1/2%, gtd. sr. secd. notes, series B, 02/01/99 ........... NR NR 2,875,500
200,000 Liggett Group Inc., 19 3/4%, gtd. sr. secd. notes, series C, 02/01/99 ........... NR NR 148,000
1,000,000 North Atlantic Trading Inc., 11%, sr. notes, 06/15/04 ........................... B B3 940,000
3,000,000 Specialty Foods Corp., 11 1/4%, sr. sub. notes, series B, 08/15/03 .............. CCC Caa3 1,200,000
1,000,000 Sun World International Inc., 11 1/4%, 1st. mtg. notes, series B, 04/15/04 ...... B B2 1,030,000
------------
11,917,192
------------
GENERAL & SPECIALTY RETAIL - 1.50%
1,000,000 Big 5 Corp., 10 7/8%, sr. notes, series B, 11/15/07 ............................. B- B2 950,000
1,000,000 Mothers Work Inc., 12 5/8%, sr. notes, 08/01/05 ................................. B B3 1,089,400
1,000,000 SRI Receivable Pure Inc., 12 1/2%, tr. ctf. backed notes, series B, 12/15/00 .... NR NR 1,000,000
------------
3,039,400
------------
GROCERY/CONVENIENCE FOOD STORES - 2.16%
2,000,000 Homeland Stores Inc., 10%, sr. notes, 08/01/03 .................................. NR NR 1,800,000
3,750,000 P&C Food Markets Inc., 11 1/2%, sr. notes, 10/15/01 ............................. B Caa2 2,212,500
351,000 Pantry Inc., 12%, sr. notes, series B, 11/15/00 ................................. B+ B2 351,000
------------
4,363,500
------------
HEALTHCARE/DRUGS/HOSPITAL SUPPLIES - 3.12%
1,785,000 Complete Management Inc., 8%, conv. sub. deb., 08/15/03 ......................... NR NR 370,387
3,906,000 Complete Management Inc., 8%, conv. sub. deb., 12/15/03 ......................... NR NR 810,495
3,000,000 Global Health Sciences Inc., 11%, sr. notes, 05/01/08 ........................... B+ Caa1 2,550,000
300,000 National Patent Developers, 5%, conv. notes, 08/31/99 ........................... NR NR 219,375
5,000,000 PHP Healthcare Corp., 6 1/2%, conv. sub. deb., 12/15/02(b)* ..................... D C 450,000
1,000,000 Sun Healthcare Group Inc., 6%, conv. sub. notes, 03/01/04, 144A ................. NR B3 550,000
2,695,000 Uromed Corp., 6%, conv. sub. notes, 10/15/03 .................................... NR NR 1,347,500
------------
6,297,757
------------
HOME FURNISHINGS/DURABLE CONSUMER PRODUCTS - 2.02%
5,000,000 Converse Inc., 7%, conv. sub. notes, 06/01/04 ................................... NR NR 2,000,000
1,000,000 Gothic Products Corp., 11 1/8%, sr. secd. notes, 05/01/05 ....................... CCC+ B3 650,000
1,000,000 Simmons Co., 10 3/4%, sr. sub. notes, 04/15/06 .................................. NR NR 1,040,000
500,000 Syratech Corp., 11%, sr. notes, 04/15/07 ........................................ B- B3 390,000
------------
4,080,000
------------
HOTEL/GAMING - 1.12%
1,000,000 Bluegreen Corp., 10 1/2%, sr. secd. notes, series B, 04/01/08 ................... B B3 860,000
500,000 Courtyard By Mariott II Ltd., 10 3/4%, sr. secd. notes,
series B, 02/01/08 ............................................................ B- NR 505,000
1,000,000 Epic Resorts LLC, 13%, sr. secd. notes, 06/15/05, 144A .......................... B- NR 900,000
------------
2,265,000
------------
INSURANCE COMPANIES - 0.46%
1,000,000 Superior National Insurance Group Inc., 10 3/4%, pfd. Trust notes, 12/01/17 ..... BB B1 920,000
------------
LEISURE/AMUSEMENT/MOTION PICTURES - 4.37%
4,200,000 Booth Creek Ski Holdings Inc., 12 1/2%, sr. notes, series B, 03/15/07 ........... B- Caa1 3,906,000
750,000 Discovery Zone Inc., 13 1/2%, sr. secd. notes, 08/01/02 ......................... NR NR 262,500
175,000 Discovery Zone Inc., 13 1/2%, units, 05/01/02 ................................... NR NR 175,000
20,125,000 Marvel Holdings Inc., 0%, sr. secd. disc. notes, series B, 04/15/98(b)* ......... D NR 805,000
4,000,000 Planet Hollywood International Inc., 12%, sr. sub. notes, 04/01/05 .............. CCC B3 2,000,000
2,000,000 Premier Cruise Ltd., 11%, sr. notes, 03/15/08, 144A ............................. CCC Caa2 1,220,000
500,000 SFX Entertainment Inc., 9 1/8%, sr. notes, 02/01/08 ............................. CCC+ B3 457,500
------------
8,826,000
------------
MACHINERY - 1.52%
1,000,000 Central Tractor Farm Country, 10 5/8%, sr. notes, 04/01/07 ...................... B+ B2 950,000
3,250,000 Willcox & Gibbs Inc., 12 1/4%, sr. notes, series B, 12/15/03 .................... B+ B3 2,112,500
------------
3,062,500
------------
METALS/MINING - 5.09%
1,500,000 Continental Global Group Inc., 11%, sr. notes, series B, 04/01/07 ............... B B2 1,230,000
1,000,000 Doe Run Corp., 11 1/4%, sr. notes, series B, 03/15/05 ........................... B+ B3 750,000
750,000 GS Technologies Inc., 12%, gtd. sr. notes, 09/01/04 ............................. B B2 622,500
1,500,000 IVACO Inc., 11 1/2%, sr. notes, 09/15/05 ........................................ B+ B1 1,455,000
500,000 International Knife and Saw, 11 3/8%, sr. sub. notes, 11/15/06 .................. B- B3 490,000
4,500,000 NSM Steel Inc., 12%, sr. mtg. notes, 02/01/06, 144A ............................. B- Caa3 1,125,000
3,000,000 PT Alatief Freeport, 9 3/4%, gtd. sr. notes, 04/15/01 ........................... CCC+ B3 2,850,000
1,000,000 Recycling Industries Inc., 13%, sub. notes, 12/05/05, 144A ...................... NR B3 900,000
1,500,000 TVX Gold Inc., 5%, conv. notes, 03/28/02 ........................................ NR NR 870,000
------------
10,292,500
------------
NON-AGRICULTURAL CHEMICALS/PLASTICS - 1.74%
1,000,000 RBX Corp., 12%, sr. secd. notes, series B, 01/15/03 ............................. B+ B3 783,750
3,500,000 Sterling Chemicals Inc., 11 3/4%, sr. sub. notes, 08/15/06 ...................... B+ B3 2,730,000
------------
3,513,750
------------
OIL/NATURAL GAS/OIL SERVICES - 1.59%
750,000 First Wave Marine Inc., 11%, sr. notes, 02/01/08 ................................ B- B3 703,125
5,000,000 Hurricane Hydrocarbons Ltd., 11 3/4%, sr. notes, 11/01/04 ....................... B- B3 2,500,000
------------
3,203,125
------------
PACKAGING/CONTAINERS - 2.35%
3,250,000 Crown Packaging Ltd., 10 3/4%, sr. secd. notes, series B, 11/01/00 .............. NR Caa2 2,210,000
500,000 Portola Packaging Inc., 10 3/4%, sr. notes, 10/01/05 ............................ B B2 492,500
2,000,000 Tekni-Plex Inc., 11 1/4%, sr. sub. notes, series B, 04/01/07 .................... B- B3 2,050,000
------------
4,752,500
------------
PAPER/FOREST PRODUCTS/PRINTING - 0.50%
800,000 Advanced Argo Publishing Co. Ltd., 13%, notes, 11/15/07, 144A ................... CCC B3 824,000
1,000,000 FSW International Finance Co., 12 1/2%, gtd. sub. notes, 11/01/06(d)* ........... D Caa3 195,000
------------
1,019,000
------------
PERSONAL & MISCELLANEOUS SERVICES - 0.72%
500,000 Anchor Advanced Products Inc., 11 3/4%, sr. notes, series B, 04/01/04 ........... BB- B1 510,000
1,000,000 Styling Technology Corp., 10 7/8%, sr. sub. notes, 07/01/08, 144A ............... B- B3 940,000
------------
1,450,000
------------
POLLUTION CONTROL/WASTE REMOVAL - 0.24%
500,000 GNI Group Inc., 10 7/8%, sr. notes, 07/15/05, 144A .............................. B+ B2 491,250
------------
PUBLIC UTILITY/ELECTRIC POWER/HYDRO POWER - 0.57%
2,000,000 Panda Global Energy Co., 12 1/2%, sr. secd. notes, 04/15/04 ..................... B- B2 1,160,000
------------
RAIL/TRUCKING/OVERNIGHT DELIVERY - 0.37%
750,000 Johnstown America Industries Inc., 11 3/4%, sr. sub. notes, series C, 08/15/05 .. B NR 746,250
------------
REAL ESTATE DEVELOPMENT/REITS/BUILDING/CONSTRUCTION - 1.36%
1,000,000 American Architecture, 11 3/4%, sr. notes, 12/01/07 ............................. B Caa1 860,000
290,820 Bramalea Limited, 11 1/8%, 03/22/98(b)* ......................................... NR NR 0
750,000 Peters, J.M., Inc., 12 3/4%, sr. notes, 05/01/02 ................................ B- B3 751,875
1,375,000 Presley Companies, 12 1/2%, sr. notes, 07/01/01 ................................. CCC Caa3 1,127,500
------------
2,739,375
------------
TELEPHONE/COMMUNICATIONS - 12.56%
500,000 Alvey Systems, Inc., 11 3/8%, sr. sub. notes, 01/31/03 .......................... B- B3 525,000
3,286,000 American Telecasting Inc., 0%, sr. disc. notes, series B, 08/15/05 .............. CCC Ca 722,920
2,000,000 Cell Net Data System Inc., 0%, sr. disc. notes, series B, 10/01/07 .............. NR NR 600,000
1,000,000 Consorcio Ecuatoriano de Telecomunicationes SA, 14%, notes, series B, 05/01/02 .. NR NR 350,000
1,000,000 Conecel Holdings Ltd., 14%, units, 10/01/00, 144A ............................... NR Caa1 350,000
500,000 Econophone Inc., 13 1/2%, sr. notes, 07/15/07 ................................... NR NR 523,750
2,000,000 Globix Corp., 13%, sr. notes, 05/01/05 .......................................... NR NR 1,560,000
3,000,000 Hyperion Telecommunications Inc., 12 1/4%, sr. secd. notes, series B, 09/01/04 .. B+ B3 2,850,000
2,000,000 In Flight Phone Corp., 14%, sr. disc. notes, series B, 05/15/02(b)* ............. NR C 180,000
2,000,000 Innova S De R.L., 12 7/8%, sr. exch. notes, 04/01/07 ............................ B- B2 1,060,000
4,000,000 Innova S De R.L., 12 7/8%, reg. sr. notes, 04/01/07 ............................. B- B2 2,400,000
3,500,000 Ionica PLC, 13 1/2%, sr. notes, 08/15/06(e) ..................................... NR Ca 1,225,000
2,000,000 Ionica PLC, 0%, sr. disc. notes, 05/01/07(e) .................................... NR Ca 60,000
750,000 Iridium Operations LLC, 10 7/8%, gtd. sr. notes, series D, 07/15/05 ............. B- B3 525,000
1,000,000 Knology Holdings Inc., 0%, sr. disc. notes, 10/15/07 ............................ NR NR 450,000
4,000,000 MGC Communications Inc., 13%, sr. secd. notes, series B, 10/01/04 ............... NR Caa2 2,960,000
1,000,000 Occidente Y Caribe Cellular, 0%, sr. disc. notes, series B, 03/15/04 ............ B B3 780,000
1,500,000 Orbcomm Global L.P., 14%, sr. notes, 08/15/04 ................................... B- B3 1,350,000
3,750,000 Teletrac Inc., 14%, sr. notes, series B, 08/01/07 ............................... CCC+ Caa2 2,212,500
2,000,000 Total Access Communication Ltd., 7 5/8%, bonds, 11/04/01, 144A .................. BB- B2 1,640,000
2,000,000 USN Communications Inc., 0%, sr. disc. notes, series B, 08/15/04 ................ CCC+ Ca 800,000
500,000 Verio Inc., 10 3/4%, sr. notes, 04/01/05 ........................................ B- B3 487,500
2,000,000 Viatel Inc., 11 1/4%, sr. notes, 04/15/08 ....................................... NR Caa1 1,760,000
------------
25,371,670
------------
TEXTILES/OTHER MANUFACTURING/APPAREL - 0.50%
150,000 GPO Synkro SA, 12%, bonds, 04/01/02 ............................................. NR NR 90,000
1,000,000 Glenoit Corp., 11%, sr. sub. notes, 04/15/07 .................................... B- B3 930,000
------------
1,020,000
------------
TRANSPORTATION/AIRLINES/BUS - 6.13%
1,000,000 Cenargo International Ltd., 9 3/4%, 1st mtg. notes, 06/15/08, 144A .............. BB- Ba3 860,000
2,500,000 Global Ocean Carriers Ltd., 10 1/4%, sr. notes, 07/15/07 ........................ B- B3 1,550,000
2,250,000 Golden Ocean Group Ltd., 10%, sr. notes, 08/31/01 ............................... CCC+ B3 787,500
1,000,000 MC Shipping Inc., 11 1/4%, sr. notes, series B, 03/01/08 ........................ B+ B1 750,000
1,418,031 Mexico City Toluca Toll, 11%, notes, 05/19/02, 144A ............................. NR NR 992,622
2,000,000 Sabreliner Corp., 11%, sr. notes, 06/15/08, 144A ................................ B B3 1,700,000
500,000 TBS Shipping International Ltd., 10%, 1st mtg. notes, 05/01/05 .................. B+ B3 335,000
1,850,000 TRISM Inc., 10 3/4%, gtd. sr. sub. notes, 12/15/00 .............................. B- Caa2 1,054,500
2,000,000 Trans World Airlines Inc., 11 1/2%, sr. secd. notes, 12/15/04 ................... CCC B2 1,720,000
1,000,000 Trans World Airlines Inc., 11 3/8%, sr. notes, 03/01/06 ......................... CC Caa1 780,000
2,000,000 Trans World Airlines Inc., 12%, sr. secd. notes, 04/01/02 ....................... NR B2 1,860,000
------------
12,389,622
------------
Total Fixed Income (cost $234,687,850).................................. $171,582,084
------------
COMMON STOCK AND WARRANTS -- 5.50%
<CAPTION>
Value
Units Description (Note 2)
----- ----------- --------
<S> <C> <C>
10,000 American Capital Strategies ........................................................................ $ 132,500
7,000 American Mobile Satellite, warrants, 144A* ......................................................... 33,845
2,000 American Telecasting Inc., warrants* ............................................................... 20
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 ..................................................................... 75,625
50,000 Annaly Mortgage Management Inc. .................................................................... 350,000
50,000 Anthracite Capital Corp. ........................................................................... 287,500
5,806 Apartment Investment & Management Co. .............................................................. 202,847
2,000 Bell Technology Group Ltd., warrants* .............................................................. 0
12,888 Brooke Group Ltd. .................................................................................. 116,798
496,364 CAI Wireless Systems Inc.* ......................................................................... 248,182
550 CS Wireless Systems Inc., 144A* .................................................................... 0
50,000 Capital Automotive, REIT ........................................................................... 706,250
5,925 Capital Pac Holdings Inc., warrants, 144A* ......................................................... 593
2,000 Cell Net Data System Inc., warrants, 144A* ......................................................... 40,000
1,000 Central Rents Inc., 144A* .......................................................................... 30,500
170,000 Chastain Capital Corp. ............................................................................. 850,000
4,392 Chattem Inc.* ...................................................................................... 121,878
100,000 Commodore Separation Technology, warrants* ......................................................... 3,125
100,000 Commodore Separation Technology, sr. conv. preferred ............................................... 25,000
7,887 Cort Business Services Corp.* ...................................................................... 154,782
500 County Seat Holdings Inc., warrants* ............................................................... 72
750 Discovery Zone Inc., warrants, 144A* ............................................................... 0
6,000 DIVA Systems Corp., warrants* ...................................................................... 0
500 Econophone Inc., warrants, 144A* ................................................................... 4,000
1,000 Epic Resorts LLC, warrants, 144A* .................................................................. 10
20,000 Excel Legacy Corp.* ................................................................................ 55,000
25,000 FBR Asset Investment Corp., 144A ................................................................... 500,000
2,000 Globalstar Telecommunications, warrants, 144A* ..................................................... 270
1,500 Golden Ocean Group Ltd., warrants* ................................................................. 7,688
28,000 Gothic Energy Corp., warrants* ..................................................................... 31,500
9,533 Gothic Energy Corp., warrants* ..................................................................... 0
500 HDA Management Corp., warrants* .................................................................... 20,062
20,000 HRPT Properties Trust .............................................................................. 318,750
11,000 HarCor Energy Inc., warrants* ...................................................................... 6,864
1,500 Heartland Wireless Communications, warrants, 144A* ................................................. 202
10,000 Hospitality Properties Trust ....................................................................... 265,000
14,400 ICF Kaiser International Inc., warrants* ........................................................... 5,400
750 IHF Capital Inc., warrants, 144A* .................................................................. 7,594
15,000 Imperial Credit Commercial Mortgage Investments Corp. .............................................. 125,625
750 Intermedia Communications of Florida Inc., warrants, 144A* ......................................... 87,938
1,000 Knology Holdings Inc., warrants, 144A* ............................................................. 0
25,000 Local Financial Corp., 144A* ....................................................................... 187,500
2,000 Loral Orion Network Systems Inc., warrants* ........................................................ 20,000
3,000 MGC Communications Inc., warrants, 144A* ........................................................... 165,000
1,851,500 Marvel Entertainment Group Inc.* ................................................................... 277,725
625,000 Mego Mortgage Corp., pfd, series A* ................................................................ 560,367
500 Motels of America Inc., 144A* ...................................................................... 4,125
291 Mothers Work Inc.* ................................................................................. 2,437
750 NS Group Inc., warrants* ........................................................................... 90,000
20,000 National Propane Partners L.P. ..................................................................... 167,500
24,000 New Plan Excel Realty Trust Inc. ................................................................... 546,000
4,000 Occidente Y Caribe Cellular, warrants, 144A* ....................................................... 68,500
3,500 Optel Inc.* ........................................................................................ 140,000
125,449 Prime Retail Inc. .................................................................................. 1,215,290
4,094 Prime Retail Inc. conv. pfd., series B ............................................................. 72,668
33,333 Resource Asset Investment Trust .................................................................... 408,329
100 SF Holdings Group Inc., pfd., 144A* ................................................................ 900,000
1,000 Sabreliner Corp., warrants* ........................................................................ 1,000
3,750 Sheffield Steel Corp., warrants* ................................................................... 38
500 Signature Brands Inc., warrants* ................................................................... 0
500 Spanish Broadcasting Corp., warrants* .............................................................. 31,250
11,580 Star Choice Communications, warrants* .............................................................. 0
3,750 Teletrac Holdings Inc., warrants, 144A* ............................................................ 112,500
4,000 Terex Corp., rights* ............................................................................... 56,500
5,133 Trans World Airlines Inc.* ......................................................................... 25,665
2,000 Trans World Airlines Inc., warrants* ............................................................... 300,000
25,000 Ugly Duckling Corp. * .............................................................................. 128,125
1,000 Unifi Communications Inc., warrants, 144A* ......................................................... 0
9,800 Uniroyal Technology Corp., warrants* ............................................................... 58,800
1,000 Vialog Corporation, warrants* ...................................................................... 0
992 Viatel Inc., pfd., series A* ....................................................................... 59,768
1,500 WHX Corp., preferred ............................................................................... 64,125
20,000 Walden Residential Properties, conv. preferred, series B ........................................... 512,500
40,000 Wilshire Real Estate Investments ................................................................... 120,000
1,500 Wireless One Inc., warrants* ....................................................................... 15
------------
TOTAL COMMON STOCK AND WARRANTS (cost $14,014,809) ................................................. 11,111,147
------------
TOTAL INVESTMENTS IN SECURITIES (cost $248,702,659) ................................................ 182,693,231
------------
SHORT-TERM INVESTMENTS -- 3.62%
Par
Value
-----
COMMERCIAL PAPER:
$7,324,000 Western Pennsylvania Power, 5.30%, 11/02/98, A1/P1 ................................................. 7,321,843
------------
TOTAL SHORT-TERM INVESTMENTS (cost $7,321,843) ..................................................... 7,321,843
------------
TOTAL INVESTMENTS - 94.04% (COST $256,024,502) ..................................................... 190,015,074
------------
OTHER ASSETS - 5.96% ............................................................................... 12,044,811
------------
TOTAL ASSETS - 100% ................................................................................ $202,059,885
============
(a) Percentages indicated are based on total assets.
(b) Denotes company has filed for bankruptcy.
(c) Variable rate security. Coupon rate disclosed is that which is in effect at October 31, 1998.
(d) Denotes company currently in default.
(e) Security currently in receivership.
(f) A put option has been exercised on this security effective December 15, 1998.
NR denotes not rated.
* Non-income producing security.
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
BALANCE SHEET
October 31, 1998
ASSETS
Investments in securities at value (identified cost $256,024,502;
see Schedule of Investments and Note 2) ...................... $190,015,074
Cash ........................................................... 599,730
Receivables:
Investment securities sold ................................... 4,337,139
Interest and dividends ....................................... 6,908,185
Prepaid insurance .............................................. 180,135
Other assets ................................................... 19,622
------------
Total assets ........................................... $202,059,885
------------
LIABILITIES
Payables:
Investment securities purchased .............................. $ 3,694,537
Accrued expenses (Note 3) ...................................... 564,894
Bank loan (Note 14) ............................................ 40,000,000
------------
Total liabilities ...................................... $ 44,259,431
------------
Net Assets:
Common stock, $.03 par value --
Authorized -- 100,000,000 shares
Issued and outstanding -- 19,805,323 shares ................ $ 594,160
Capital in excess of par value (Notes 2 and 5) ............... 247,586,022
Accumulated undistributed net investment income (Note 2) ..... 3,682,152
Accumulated net realized loss from security transactions ..... (28,052,452)
Net unrealized depreciation of investments ................... (66,009,428)
------------
Total net assets (equivalent to $7.97 per share, based on
19,805,323 shares outstanding) ......................... $157,800,454
============
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, 1998
INVESTMENT INCOME (Note 2):
Interest income .............................................. $ 27,183,822
Dividend income .............................................. 1,126,225
Accretion of discount ........................................ 1,742,564
------------
Total investment income ................................ $ 30,052,611
------------
EXPENSES:
Interest expense ............................................. $ 2,485,678
Investment advisory fee (Note 3) ............................. 1,582,842
Custodian and transfer agent fees ............................ 239,041
Professional fees ............................................ 184,724
Amortization of prepaid surety bond premiums (Note 7) ........ 80,001
Directors' fees .............................................. 95,077
Insurance expense ............................................ 74,595
Amortization of deferred auction agent fees (Note 6) ......... 27,003
Excise tax expense ........................................... 155,012
Miscellaneous expenses ....................................... 579,981
------------
Total expenses ......................................... $ 5,503,954
------------
Net investment income .................................. $ 24,548,657
------------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized loss on investments sold ........................ $ (5,007,628)
Change in net unrealized appreciation of investments (Note 2) (69,126,156)
------------
Net realized and unrealized loss on investments ........ $(74,133,784)
------------
Net decrease in net assets resulting from operations ... (49,585,127)
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS ($3,144 per share) ..... (628,030)
------------
Net decrease in net assets applicable to common
stockholders ............................................ $(50,213,157)
============
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, 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest and dividends received ......................... $ 26,736,956
Operating expenses paid ................................. (7,507,449)
-------------
Net cash provided by operating activities ......... $ 19,229,507
-------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of portfolio securities ....................... $(428,103,749)
Sales and maturities of portfolio securities ............ 378,030,602
-------------
Net cash used in investing activities ............. $ (50,073,147)
-------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from common stock rights offering and sale
of common stock ....................................... $ 53,422,039
Proceeds from bank loan ................................. 40,000,000
Redemption of senior notes .............................. (20,000,000)
Redemption of taxable auction rate preferred stock ..... (20,000,000)
Preferred stock dividends paid .......................... (661,339)
Common stock dividends paid from operations ............. (21,317,330)
-------------
Net cash provided by financing activities ......... $ 31,443,370
-------------
NET INCREASE IN CASH ...................................... $ 599,730
CASH, BEGINNING OF PERIOD ................................. --
-------------
CASH, END OF PERIOD ....................................... $ 599,730
=============
RECONCILIATION OF NET DECREASE IN NET ASSETS RESULTING
FROM OPERATIONS TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Net decrease in net assets resulting from operations .. $ (49,585,127)
Increase in interest and dividend receivables ......... (1,843,345)
Amortization of Fidelity Bond and other deferred assets 32,000
Increase in other assets .............................. (84,276)
Decrease in accrued expenses and other payables ....... (1,951,219)
Net realized loss on investments sold ................. 5,007,628
Change in net unrealized appreciation of investments .. 69,126,156
Accretion of bond discount ............................ (1,472,310)
-------------
Net cash provided by operating activities ......... $ 19,229,507
=============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest ................ $ 3,280,081
Cash paid during the period for excise taxes ............ 114,557
=============
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<TABLE>
STATEMENT OF CHANGES IN NET ASSETS
<CAPTION>
Fiscal Year Ended Fiscal Year Ended
October 31, October 31,
1998 1997
----------------- -----------------
<S> <C> <C>
FROM OPERATIONS:
Net investment income ................................ $ 24,548,657 $ 17,862,020
Net realized gain (loss) on investments sold ......... (5,007,628) 4,773,501
Change in net unrealized appreciation (depreciation)
of investments ..................................... (69,126,156) 4,499,052
------------ ------------
Net increase (decrease) in net assets resulting
from operations .............................. $(49,585,127) $ 27,134,573
------------ ------------
FROM FUND SHARE TRANSACTIONS:
Shares issued (175,689 shares and 96,957 shares,
respectively) to common stockholders for
reinvestment of dividends .......................... $ 1,995,745 $ 1,146,681
Net proceeds from sale of common stock issued
(4,914,203 and 4,306,031 shares, respectively, after
deducting $2,599,872 and $2,167,500 of soliciting
fees and other expenses, respectively) ............. 53,422,039 44,208,450
Redemption of taxable auction rate preferred stock
(200 shares at $100,000 liquidation preference) .... (20,000,000) --
------------ ------------
Increase in net assets resulting from fund share
transactions ................................. $ 35,417,784 $ 45,355,131
------------ ------------
DISTRIBUTIONS TO STOCKHOLDERS:
Preferred dividends ($3,144 and $5,456 per share,
respectively) ...................................... $ (628,030) $ (1,091,099)
Common dividends ($1.26 and $1.26 per share,
respectively) from operations ...................... (23,313,075) (16,200,344)
------------ ------------
Decrease in net assets resulting from
distributions to stockholders ................ (23,941,105) (17,291,443)
------------ ------------
Total net increase (decrease) in net assets .... $(38,108,448) $ 55,198,261
NET ASSETS:
Beginning of period .................................. 195,908,902 140,710,641
------------ ------------
End of period (including $3,682,152 and $2,845,247 of
undistributed net investment income as of October
31, 1998 and October 31, 1997, respectively) ....... $157,800,454 $195,908,902
============ ============
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
SELECTED PER SHARE DATA AND RATIOS
FOR EACH SHARE OF COMMON STOCK OUTSTANDING THROUGHOUT THE PERIODS PRESENTED
<CAPTION>
For the Years Ended October 31,
--------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994 1993
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of
period ..................... $ 11.94 $ 11.70 $ 11.10 $ 11.07 $ 12.75 $ 12.09
-------- -------- -------- -------- -------- --------
Net investment income ........ 1.30# 1.38# 1.50# 1.35 1.44# 1.89#
Net realized and unrealized
gain (loss) on investments.. (3.76)# .72# .60# .09 (1.14)# 1.17#
-------- -------- -------- -------- -------- --------
Total from investment
operations ......... $ (2.46) $ 2.10 $ 2.10 $ 1.44 $ .30 $ 3.06
-------- -------- -------- -------- -------- --------
Distributions:
Dividends from accumulated net
investment income
To preferred stockholders (.03) (.09) (.12) (.15) (.09) (.18)
To common stockholders ... (1.26) (1.26) (1.26) (1.26) (1.35) (1.86)
-------- -------- -------- -------- -------- --------
Total distributions .. $ (1.29) $ (1.35) $ (1.38) $ (1.41) $ (1.44) $ (2.04)
-------- -------- -------- -------- -------- --------
Effect of sale of common stock
and related expenses from
rights offering ............ $ (.22) $ (.51) $ (.12) $ -- $ (.54) $ (.36)
-------- -------- -------- -------- -------- --------
Net asset value, end of period $ 7.97 $ 11.94 $ 11.70 $ 11.10 $ 11.07 $ 12.75
======== ======== ======== ======== ======== =========
Per share market value, end of
period ..................... $ 10.25 $ 12.39 $ 12.00 $ 11.64 $ 10.50 $ 12.75
======== ======== ======== ======== ======== =========
Total investment return ...... (7.63)% 14.82% 15.29% 28.57% (7.78)% 23.25%
======== ======== ======== ======== ======== =========
Net assets, end of period,
applicable to
common stock (a) ........... $157,800 $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) $157,800 $195,909 $140,711 $113,309 $112,072 $ 99,438
======== ======== ======== ======== ======== =========
Ratio of operating expenses to
average net assets,
applicable to common stock . 2.67% 2.30% 3.06% 3.27% 3.27% 3.10%
Ratio of net investment income
to average net assets,
applicable to common stock . 11.92% 11.94% 13.20% 13.47% 12.25% 13.49%
Ratio of operating expenses to
average net assets** ....... 2.18%+ 1.81%+ 2.21%+ 2.28%+ 2.30%+ 2.13%+
Ratio of net investment income
to average net assets** .... 9.72% 9.42% 9.51% 9.39% 8.64% 9.26%
Portfolio turnover rate ...... 156.48% 176.04% 108.33% 80.71% 72.00% 117.20%
(a) Dollars in thousands.
(b) The selected per share data and ratios have been restated, where applicable, for all periods to give effect for the
one-for-three reverse stock split in April of 1998. (Note 10).
** 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 bank loans and 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 1.20%, 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>
INFORMATION REGARDING SENIOR SECURITIES
<CAPTION>
As of October 31,
------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994 1993
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Total Amount Outstanding:
Notes & Loans $40,000,000 $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) 495% 1,080% 804% 667% 660% 597%
Per preferred stock
share (b) n/a 540% 402% 333% 330% 299%
Involuntary Liquidation Preference:
Per preferred stock
share (c) n/a $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000
Approximate Market Value:
Per note n/a $ 1,003.80 $ 990.00 $ 987.50 $ 937.10 $ 997.50
Per preferred stock share n/a 100,000 100,000 100,000 100,000 100,000
(a) Calculated by subtracting the Fund's total liabilities (not including bank loans and 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 bank loans and 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 FIANCIAL STATEMENT
OCTOBER 31, 1998S
(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.
Gains and losses on sales of investments are calculated on the identified
cost method for both financial reporting and federal income tax purposes. It
is the Fund's practice to first select for sale those securities that have the
highest cost and also qualify for long-term capital gain or loss treatment for
tax purposes.
Settlements from litigation and class action suits are recognized when the
Fund acquires an enforceable right to such awards. Included in net realized
loss from investments is $3,273,015 attributable to class action settlements
received by the Fund during the year ended October 31, 1998.
(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 $235,013 from paid in capital to accumulated
undistributed net investment income, $37,564,886 from paid in capital to
accumulated net realized loss from security transactions and $5,660 from
accumulated undistributed net investment income to accumulated 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, 1998, the cost of investments in securities for federal
income tax purposes was $256,261,835. Aggregate gross unrealized gains on
securities in which there was an excess of market value over tax cost was
$3,620,256. Aggregate gross unrealized losses on securities in which there was
an excess of tax cost over market value was $69,867,017. The net unrealized
loss on securities held by the Fund was $66,246,761 for federal income tax
purposes.
At October 31, 1998, 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
$(18,529,051) October 31, 1999
(808,396) October 31, 2002
(3,703,531) October 31, 2003
(4,698,150) October 31, 2006
------------
$(27,739,128)
============
(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 had been
deferred and amortized on a straight-line basis over a period of five years.
The senior notes were redeemed (see Note 4) and the remaining deferred balance
was written-off during the year ended October 31, 1998.
(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 $1,582,842 in management fees for the year ended October 31,
1998. 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 bank loan, 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,
1998, the fee payable to the Investment Adviser was $196,249, which was
included in accrued expenses in the accompanying balance sheet.
(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 would mature,
if not previously redeemed, on December 1, 1998. The Fund was required to
maintain certain asset coverages with respect to the Senior Notes, as defined
in the Note Purchase Agreement, and the Senior Notes were subject to mandatory
redemption if the Fund fails to maintain these asset coverages. Interest on
the Senior Notes was at the rate of 6.53% per annum through November 30, 1998
and was due every June 1 and December 1, commencing December 1, 1993.
The Senior Notes were redeemable, in whole or in part, by the Fund at
certain times and under certain circumstances, as defined in the Note Purchase
Agreement.
On July 24, 1998 the Fund redeemed all of its Senior Notes at an aggregate
redemption price of $20 million, plus accrued interest. The funds required to
redeem the Senior Notes were borrowed under a new $50 million credit facility
discussed in Note 14.
(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 were cumulative at a rate that was established at the
offering of the preferred stock and which was reset every 30 days thereafter
by an auction. Dividend rates ranged from 5.52% to 5.89% of the liquidation
preference during the year ended October 31, 1998. The remaining 200 shares of
preferred stock were 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 was also subject to mandatory
redemption at a redemption price equal to $100,250 per share, plus accumulated
and unpaid dividends, if the Fund was 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 voted together as a single
class, except that the holders of the preferred stock, as a separate class,
voted to elect two members of the Board of Directors, and separate class votes
were required on certain matters that affected the respective interests of the
preferred stock and common stock. The preferred stock had a liquidation
preference of $100,000 per share, plus accumulated and unpaid dividends. The
Fund was 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.
On May 15, 1998 the Fund redeemed all of its Taxable Auction Rate Preferred
Stock at an aggregate redemption price of $20 million. The funds required to
redeem the preferred stock were borrowed under a new credit facility discussed
in Note 14.
(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, 1998 was
$27,003.
(7) SURETY BOND
The Fund had entered into an insurance agreement, dated as of December 1,
1988, with Financial Security Assurance, Inc. (FSA), pursuant to which FSA had
issued a surety bond. Under the terms of the surety bond, FSA unconditionally
and irrevocably guaranteed dividend, redemption and liquidation payments to
preferred shareholders upon failure of the Fund to do so, and the Fund would
then have been 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 paid an annual
premium of 0.40% on the maximum aggregate liquidation preference of the
preferred stock. In connection with the redemption of the preferred stock the
surety bond expired on May 15, 1998.
The Fund executed an amendment to the insurance agreement on April 11, 1990,
which provided 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, 1998, the aggregate cost of purchases and
proceeds from sales of investment securities other than U.S. Government
obligations and short-term investments aggregated $422,037,061 and
$375,637,342, respectively. There were no purchases or sales of U.S.
Government obligations during the year ended October 31, 1998.
(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 $.105 per share,
giving effect to the April 1998 one for three reverse stock split. Dividends
were payable on November 28 and December 31, 1997, and January 30, February
27, March 31, April 30, May 29, June 30, July 31, August 31, September 30, and
October 30, 1998.
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, 1998, the fair value
of the bank term loan was $40,000,000.
(12) REVERSE STOCK SPLIT
In March of 1998, the shareholders of the Fund approved a one-for-three
reverse stock split which became effective on April 1, 1998. Certain per share
amounts included in the accompanying financial statements have been restated
to give effect for this reverse stock split.
(13) RIGHTS OFFERING
On December 24, 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 4,914,203
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 rate of one share of common stock for every three rights held. The
subscription period for the rights offering expired on January 23, 1998 and
the Fund issued, on a post-split basis, 4,914,203 shares of common stock at
$11.40 per share. Proceeds to the Fund amounted to $53,422,039, net of
soliciting fees and offering expenses of $2,599,872.
(14) BANK LOAN
On April 30, 1998 the Fund entered into a credit agreement ("the Agreement")
with a lending institution and borrowed the maximum amount of $30 million
under a revolving credit facility. The Fund's ability to utilize this facility
extends until April 30, 2001, though there are provisions in the Agreement
which allow for its modification prior to April 30, 2001, including extension,
termination and reduction of the facility amount. The Fund has the option to
choose the applicable interest rate on its borrowing with such rates being
based upon either the higher of the lending institution's base lending rate or
one half percent above the Federal funds rate, or, LIBOR plus 0.55%. On July
24, 1998 the Fund entered into an amended agreement to increase the available
line of credit to $50 million. Under the terms of the loan agreement the Fund
is required to maintain certain debt covenants, which include that the Fund's
total liabilities plus, without duplication, the aggregate amount of its debt,
may not exceed 25% of its total assets. The weighted average loan balance and
interest rate for the year ended October 31, 1998 was approximately
$21,364,000 and 6.33%, respectively. The outstanding loan balance at October
31, 1998 was $40 million, with an interest rate on the outstanding loans of
6.30%. The Agreement also provides for commitment fees at a rate of 0.09% per
year on the daily amount by which the aggregate amount of the commitment
amount of 50 million exceeds the aggregate outstanding principal of the bank
loans.
<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, 1998, 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, 1998 and 1997 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, 1998 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, 1998, 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 14, 1998
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
INVESTMENT ADVISER LEGAL ADVISER
Prospect Street Investment Management Olshan Grundman Frome & Rosenzweig LLP
Co., Inc. New York, NY
60 State Street, Suite 3750
Boston, MA 02109 AUDITORS
Arthur Andersen LLP
OFFICERS Boston, MA
Richard E. Omohundro, Jr. -- President
John A. Frabotta -- Vice President, TRANSFER AND SHAREHOLDERS' SERVICING
Treasurer and AGENT
Chief Investment State Street Bank and Trust Company
Officer P.O. Box 8200
Karen J. Thelen -- Secretary Boston, MA 02266
(800) 426-5523
DIRECTORS
John S. Albanese CUSTODIAN
C. William Carey State Street Bank and Trust Company
Joseph G. Cote Boston, MA
John A. Frabotta
Richard E. Omohundro, Jr.
Harlan D. Platt
Christopher E. Roshier
<PAGE>
FACTS FOR SHAREHOLDERS:
Prospect Street High Income Portfolio Inc. has a website at http://
www.prospectstreet.net and 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
