<PAGE>
- --------------------------------------------------------------------------------
PROSPECT STREET(R)
HIGH INCOME PORTFOLIO INC.
ANNUAL
REPORT
OCTOBER 31, 1999
[graphic omitted]
- --------------------------------------------------------------------------------
<PAGE>
December 22, 1999
LETTER TO SHAREHOLDERS
Dear Shareholders:
On October 29, 1999, the net asset value of the Fund was $6.98, as compared
to $7.97 on October 31, 1998. During the fiscal period ended October 31, 1999
the Fund paid dividends to common stock shareholders in the amount of $1.26 per
share; the total dividends paid for the trailing twelve month period were $1.26
per share.
1999 SPECIAL STOCKHOLDERS' MEETING:
At the Special Meeting of Stockholders held on December 17, 1999 the
stockholders elected six additional Directors of the Fund and approved a new
Advisory Agreement between the Fund and Highland Capital Management LLP., both
of which will become effective upon the sale of certain of the assets and
goodwill of Prospect Street Investment Management Co., Inc. to Highland (the
"Transaction"), which is scheduled for January 21, 2000. The transaction remains
subject to the refinancing by the Fund of its outstanding $50 million senior
loan facility and certain other conditions.
RIGHTS OFFERING:
The Fund completed a transferable rights offering to shareholders of record
on January 26, 1999. The Fund raised net proceeds of approximately $55 million.
The Fund issued 6,630,663 new common shares, increasing the total shares
outstanding to 26,468,651. The offering was accretive to shareholders as the
subscription price for new shares exceeded the then net asset value. The net
proceeds were invested during the month of April at yields roughly equal to the
Fund's then current yield.
THE HIGH YIELD MARKET:
The high yield market continued to be impacted by structural changes by both
buy side participants and sell side participants. Reduced willingness to provide
capital to trading secondary issues, continued aversion to risk, as well as
increased credit rating downgrades and defaults resulted in a substantial
widening of spreads in the high yield corporate bond market as compared with the
high grade corporate market and the US Treasury market. Also, the same narrowing
of outperforming issues and industries we see in the equity markets has
prevailed in the high yield bond market.
The buy side participants, particularly the high yield mutual funds have
seen their cash inflows shrink resulting in net outflows of $(663) million from
January 1, 1999 to October 31, 1999. Also, continued loss of market value has
resulted in a reduced willingness to invest in all but the most liquid issues.
The newest participants to the high yield market, the Collateralized Bond
Obligation (CBO) funds, were stressed during 1999 due to rising default levels
and rating downgrades. These twin events resulted in substantial portfolio
adjustments by the CBO's at a time of reduced liquidity in the market
contributing to substantially more price volatility and resulting in lower
prices to clear the market.
The high yield index as measured by the DLJ High Yield Index generated a
total return of 6.09% for the twelve month period ended October 31, 1999. The
Index for the B3/B- sector of the high yield market, which is more reflective of
the Fund's holdings generated a 7.74% total return for the twelve months ended
October 31, 1999. At October 31, 1999, the spread between high yield securities
and comparable U.S. Government securities stood at 609 basis points compared to
735 basis points at October 31, 1998.
THE FUND'S INVESTMENTS:
The total return on the Fund's net assets for the twelve months ended
October 31, 1999, assuming reinvestment of dividends, was approximately 2.6%.
The total investment return on the Fund's per share market price was (11.78%)
for the twelve months ended October 31, 1999. The variation from the total
return on net assets is attributable to the decline in the per share market
value premium from 28.5% to14.0% during the period.
Factors contributing to this performance were lower valuations of many of
the Fund's investments for some of the reasons discussed above, including
generally prevailing adverse market conditions, attributable to higher interest
rates, higher default rates and diminished liquidity in the high-yield sector;
and defaulted interest payments and related non-accrual of investment income
with respect to a number of the Fund's investments.
As of October 31, 1999, the Fund held 148 issues representing 29 industry
groups. Cash and short-term investments represented approximately 1% of our
holdings. The average market price of the Fund's high yield securities was
$57.88 with an average coupon of 10.8%.
DIVIDEND REDUCTION:
On December 10, 1999, the Board of Directors voted to reduce the monthly
dividend rate to $0.095 per share from $0.105 per share. The first such dividend
is payable December 31, 1999 to stockholders of record on December 21, 1999.
Distributions on common stock are declared based on annual projections of the
Fund's taxable net income.
INVESTMENT OUTLOOK:
The high yield market has undergone significant changes in the past twelve
to eighteen months. Some of the positive factors benefiting the high yield
corporate market, are:
1. The U.S. domestic economy continues to exhibit strength. However, this
factor has provided less support for the high yield market than
historically and this may continue to be the case in 2000.
2. Many foreign economies have performed better than anticipated during 1999
putting less pressure on global financial markets as we enter 2000.
3. New money in the form of CBO's and foreign capital seeking higher risk
adjusted returns are expected to create continued demand for high yield
securities in the year 2000.
4. The absolute yield available to high yield investors and the spread
advantage to other fixed income investments appears historically
attractive as we enter 2000.
Some of the factors that could continue to negatively impact the high yield
market are:
1. Problems with the changeover at year-end from 1999 to 2000 could result
in disruption to economic activity with resulting turmoil in the capital
market which would impact the price and valuation of securities.
2. Defaults have risen during 1999 and the continued increase in both the
percentage of defaulted issues outstanding as well as their absolute
dollar amount would continue to negatively impact the high yield market.
Also, continued credit rating downgrades by the major rating agencies
would also be a negative factor for the market.
3. Federal Reserve policy changes could have more impact on the high yield
market as less and less issuers have access to the market and would
become more dependent on availability of credit from commercial banks.
4. The size of the high yield market, approximately $650 billion, makes any
diminution of available capital a cause of concern. A prolonged period of
depressed market valuations could begin to further reduce the flow of
money to the high yield sector.
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 21st century 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, including a material
adverse impact. The Adviser cannot assure the Fund that certain of the companies
in which it has invested (or in which it may hereafter invest) may be adversely
affected, directly or indirectly, by Year 2000-related problems, which could
impact the value of such investments.
CONCLUSION:
The high yield market has grown substantially in the past five years and
offers investors attractive returns.
Management continues to evaluate the Fund's investments, seeking to generate
a high current income and maximize the Fund's total return.
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
/s/ C. William Carey
C. William Carey
Chairman of the Board of Directors
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1999
<TABLE>
<CAPTION>
FIXED INCOME -- 90.44%
Ratings
------------------
Par Standard Value
Value Description & Poor's Moody's (Note 2)
- ----- ----------- -------- ------- --------
<C> <S> <C> <C> <C>
AGRICULTURAL CHEMICALS/FARMING -- 0.63%
$ 5,000,000 LaRoche Industries Inc., 9 1/2%, sr. sub.
notes, series B, 09/15/07 .............. B Caa2 $ 1,500,000
------------
AUTOMOBILE/AUTO PARTS/TRUCK MANUFACTURING
-- 1.76%
375,000 Aftermarket Technology Corp., 12%, sr.
sub. notes, series B, 08/01/04 B- B2 376,875
2,000,000 Collins & Aikman Products Co., 11 1/2%,
gtd. sr. sub. notes, 04/15/06 B B2 1,930,000
2,000,000 Holley Performance Products, 12 1/4%, sr.
notes, 09/15/07, 144A .................. B+ B2 1,880,000
------------
4,186,875
------------
BANKS/SAVINGS AND LOANS/FINANCE COMPANIES/
CONSUMER CREDIT -- 3.76%
2,625,000 Altiva Financial Corp.,12 1/2%, sub.
notes, 12/01/01 ........................ B- Ca 1,397,812
1,000,000 Bank Plus Corp.,12%, sr. notes, 07/18/07 . NR NR 847,500
1,000,000 Imperial Credit Industries Inc., 9 7/8%,
sr. notes, series B, 01/15/07* ......... B- B3 760,000
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
2,000,000 Metris Companies Inc., 10 1/8%, sr. notes,
07/15/06, 144A ......................... B+ Ba3 1,810,000
2,000,000 Nationwide Credit Inc., 10 1/4%, sr.
notes, 01/15/08 ........................ B- B3 1,200,000
1,000,000 Ocwen Federal Bank FSB, 12%, sub. debs.,
06/15/05 ............................... B+ B1 950,000
------------
8,970,312
------------
BROADCASTING - TV/CABLE/RADIO/
PUBLISHING -- 12.42%
7,480,000 AMSC Acquisition Co., Inc., 12 1/4%, gtd.
sr. notes, 04/01/08 .................... NR NR 5,610,000
17,107 Australis Media Ltd., 0%, gtd. sr. secd.
disc. notes, 05/15/03 (b)* ............. D NR 0
1,000,000 Australis Media Ltd., 0%, sr. secd. disc.
notes, 05/15/03 (b)* ................... D NR 0
3,400,000 CIA Latino Americano, 12%, sr. notes,
06/01/04 ............................... B+ NR 2,108,000
8,404,000 DIVA Systems Corp., 0%, sr. disc. notes,
series B, 03/01/08 ..................... NR NR 2,101,000
3,350,000 Globalstar L.P., 11 3/8%, sr. notes,
02/15/04 ............................... B Caa1 2,244,500
2,000,000 Net Sat Services, 12 3/4%, sr. notes,
08/05/04 ............................... B- Caa1 1,820,000
2,000,000 Optel Inc., 11 1/2%, sr. notes, 07/01/08 . D Caa3 980,000
1,000,000 Park n View Inc., 13%, sr. notes, series
B, 05/15/08 ............................ CCC+ B3 750,000
200,000 RBS Participaco, 14%, notes, 12/15/03 .... B+ NR 195,000
2,000,000 Spanish Broadcasting System Inc., 12 1/2%,
sr. notes, 06/15/02 .................... B- B2 2,290,000
1,000,000 Star Choice Communications, 13%, sr. secd.
notes, 12/15/05 ........................ B B3 995,000
14,300,000 Supercanal Holdings S. A., 11 1/2%, sr.
notes, 05/15/05 (e) .................... D Caa3 7,150,000
4,500,000 Vialog Corporation, 12 3/4%, sr. notes,
series B, 11/15/01 ..................... B- Caa3 3,375,000
------------
29,618,500
------------
DIVERSIFIED/CONGLOMERATE MANUFACTURING -- 4.38%
1,000,000 AXIA Inc., 10 3/4%, gtd. sr. sub. notes,
07/15/08 ............................... B- B3 920,000
500,000 Amtrol Acquisition Inc., 10 5/8%, sr. sub.
notes, 12/31/06 ........................ B- B3 475,625
2,000,000 Chatwins Group Inc., 13%, sr. exch. notes,
05/01/03 ............................... B- B2 1,700,000
1,500,000 Clark Material Handling Corp., 10 3/4%,
sr. notes, series D, 11/15/06 .......... B- Caa1 990,000
2,000,000 Haynes International Inc., 11 5/8%, sr.
notes, 09/01/04 ........................ B- B3 1,757,500
1,000,000 Key Components LLC, 10 1/2%, gtd. sr.
notes, 06/01/08 ........................ B- B3 950,000
4,000,000 Pentacon Inc., 12 1/4%, sr. sub. notes,
04/01/09 ............................... B- B3 3,640,000
------------
10,433,125
------------
DIVERSIFIED/CONGLOMERATE SERVICES -- 0.24%
550,000 Coinmach Corp., 11 3/4%, sr. notes, series
D, 11/15/05 ............................ B B2 569,250
------------
ELECTRICAL EQUIPMENT/ELECTRONICS/COMPUTERS
-- 4.36%
1,000,000 Amkor Technology Inc., 10 1/2%, sr. sub.
notes, 05/01/09, 144A .................. B B2 957,500
500,000 Decision Holdings Corp., 0%, units,
08/01/08 (e)* .......................... C C 1,250
3,000,000 EV International Inc., 11%, sr. sub.
notes, series A, 03/15/07 .............. CCC+ B3 2,100,000
1,000,000 Instron Corporation, 13 1/4%, units, 09/
15/09 .................................. B- B3 1,000,000
2,000,000 Knowles Electronics Inc., 13 1/8%, sr.
sub. notes, 10/15/09, 144A ............. B- B3 1,960,000
3,000,000 Phase Metrics Inc., 10 3/4%, sr. notes,
02/01/05 ............................... NR B- 450,000
2,000,000 Precise Technology Inc., 11 1/8%, sr. sub.
notes, series B, 06/15/07 .............. B- B3 1,860,000
1,300,000 Sharp Do Brasil, 9 5/8%, notes, 10/30/05 . NR NR 390,000
2,000,000 Special Devices Inc., 11 3/8%, sr. sub.
notes, 12/15/08 ........................ B- B3 1,670,000
------------
10,388,750
------------
FINANCIAL SERVICES -- 3.00%
1,000,000 Beal Financial Corp., 12 3/4%, sr. notes,
08/15/00 ............................... B B2 1,022,500
425,000 First Federal Financial Corp., 11 3/4%,
notes, 10/01/04 ........................ B+ B2 429,250
500,000 Hawthorne Financial Corporation, 12 1/2%,
sr. notes, 12/31/04 .................... NR NR 470,000
750,000 Indah Kiat International Finance Co.,
12 1/2%, gtd. secd. notes, 06/15/06 .... CCC+ Caa1 540,000
2,000,000 Provident CBO I Inc., 10 5/8%, sr. secd.
notes,
class C, 12/09/10, 144A ................ NR NR 1,780,000
3,500,000 Resource America Inc., 12%, sr. notes,
08/01/04 ............................... B- Caa1 2,905,000
------------
7,146,750
------------
FOOD/TOBACCO -- 2.57%
1,000,000 Advantica Restaurant Group, 11 1/4%, sr.
notes, 01/15/08 ........................ B B2 775,000
3,105,000 American Rice Inc., 13%, mtg. notes,
07/31/02 (b)* .......................... NR Ca 1,242,000
1,000,000 North Atlantic Trading Inc., 11%, sr.
notes, 06/15/04 ........................ B B3 930,000
2,600,000 RAB Enterprises, 10 1/2%, sr. notes,
05/01/05 ............................... CCC+ B3 1,612,000
1,000,000 Sun World International Inc., 11 1/4%,
1st. mtg. notes, series B, 04/15/04 .... B B2 1,003,750
4,000,000 Sunbeam Corp., 0%, conv. sr. sub. debs,
03/25/18 ............................... NR Caa2 560,000
------------
6,122,750
------------
GENERAL & SPECIALTY RETAIL -- 1.69%
1,000,000 Mothers Work Inc., 12 5/8%, sr. notes,
08/01/05 ............................... B B3 1,098,400
1,000,000 SRI Receivable Pure Inc., 12 1/2%, tr.
ctf. backed notes, series B, 12/15/00 .. NR NR 1,000,000
2,250,000 Wickes Inc, 11 5/8%, sr. sub. notes,
12/15/03 ............................... CCC+ Caa1 1,918,125
------------
4,016,525
------------
GROCERY/CONVENIENCE FOOD STORES -- 0.62%
2,000,000 Homeland Stores Inc., 10%, sr. notes,
08/01/03 ............................... NR NR 1,480,000
------------
HEALTHCARE/DRUGS/HOSPITAL SUPPLIES -- 3.09%
$ 3,715,000 Complete Management Inc., 8%, conv. sub.
deb., 08/15/03 (e)* .................... NR NR 185,750
5,006,000 Complete Management Inc., 8%, conv. sub.
deb., 12/15/03 (e)* .................... NR NR 250,300
2,000,000 Global Health Sciences Inc., 11%, sr.
notes, 05/01/08 ........................ B+ Caa1 1,040,000
1,000,000 Omnicare Inc., 5%, conv. sub. deb.,
12/01/07 ............................... BBB- Ba3 625,000
5,000,000 PHP Healthcare Corp., 6 1/2%, conv. sub.
deb., 12/15/02 (b)* .................... NR C 250,000
1,500,000 Rite Aid, 7 1/8%, sr. notes, 01/15/07 .... BB Ba2 1,005,000
3,500,000 Total Renal Care Holdings Inc., 7%, conv.
sub. notes, 05/15/09, 144A ............. B B1 2,218,125
2,000,000 Uromed Corp., 6%, conv. sub. notes,
10/15/03 ............................... NR NR 1,140,000
2,000,000 Vista Eyecare Inc., 12 3/4%, sr. notes,
10/15/05 ............................... CCC+ Caa1 640,000
------------
7,354,175
------------
HOME FURNISHINGS/DURABLE CONSUMER PRODUCTS -- 3.06%
2,000,000 Derby Cycle Corp., 10%, sr. notes,
05/15/08 ............................... CCC+ Caa1 1,140,000
2,000,000 Indesco International Inc., 9 3/4%, sr.
sub. notes, 04/15/08 ................... B- Caa2 1,000,000
500,000 Remington Products Co., LLC, 11%, sr. sub.
notes, series B, 05/15/06 CCC+ B3 375,000
2,000,000 Syratech Corp., 11%, sr. notes, 04/15/07 . CCC+ Caa1 1,405,000
3,500,000 Winsloew Furniture Inc., 12 3/4%, units,
08/15/07 ............................... B- B2 3,377,500
------------
7,297,500
------------
HOTEL/GAMING -- 0.72%
2,000,000 Epic Resorts LLC, 13%, gtd., sr. secd.
notes, series B, 06/15/05 .............. B- B3 1,722,500
------------
INSURANCE COMPANIES -- 0.25%
1,000,000 Superior National Insurance Group Inc.,
10 3/4%, pfd. trust notes, 12/01/17 ..... BB B1 600,000
------------
LEISURE/AMUSEMENT/MOTION PICTURES -- 3.44%
4,200,000 Booth Creek Ski Holdings Inc., 12 1/2%,
sr. notes, series B, 03/15/07 .......... CCC+ Caa1 3,066,000
20,125,000 Marvel Holdings Inc., 0%, sr. secd. disc.
notes, series B, 04/15/98 (b)* ......... NR NR 201,250
2,000,000 Premier Cruise Ltd., 11%, sr. notes,
03/15/08, 144A (e)* .................... D B3 67,500
5,000,000 Silver Cinemas International Inc.,
10 1/2%, sr. sub. notes, 04/15/05 ...... C Ca 2,500,000
2,000,000 United Artists Theater Co., 9 3/4%, sr.
sub. notes, 04/15/08 ................... CCC Caa3 300,000
6,600,000 V2 Music Holdings PLC., 0%, sr. disc.
notes, 04/15/08, 144A .................. NR NR 2,079,000
------------
8,213,750
------------
MACHINERY -- 0.05%
3,250,000 Willcox & Gibbs Inc., 12 1/4%, sr. notes,
series B, 12/15/03 (b)* ................ NR NR 130,000
------------
METALS/MINING -- 6.21%
5,600,000 Anker Coal Group Inc., 14 1/4%, sr. notes,
series B, 09/01/07, 144A ............... NR NR 4,760,000
1,000,000 Better Minerals & Aggregates Co., 13%, sr.
sub. notes, 09/15/09, 144A ............. B- B3 990,000
1,500,000 Continental Global Group Inc., 11%, sr.
notes, series B, 04/01/07 .............. B- B3 856,875
5,390,000 IMPSA Industrias Metalurgy, 9 1/2%, sr.
notes, 05/31/02 ........................ B+ B2 3,287,900
1,500,000 International Knife and Saw, 11 3/8%, sr.
sub. notes, 11/15/06 ................... CCC+ Caa1 1,125,000
3,000,000 PT Alatief Freeport, 9 3/4%, gtd. sr.
notes, 04/15/01 ........................ CCC+ B3 2,640,000
1,000,000 Recycling Industries Inc., 13%, sub.
notes, 12/05/05, 144A (b)* ............. NR NR 10,000
1,500,000 TVX Gold Inc., 5%, conv. notes, 03/28/02 . NR NR 1,140,000
------------
14,809,775
------------
NON-AGRICULTURAL CHEMICALS/PLASTICS -- 2.41%
1,000,000 RBX Corp., 12%, sr. secd. notes, series B,
01/15/03 ............................... B+ B3 780,000
2,500,000 Sterling Chemicals Inc., 11 3/4%, sr. sub.
notes, 08/15/06 ........................ B Caa3 1,725,000
2,000,000 Sweetheart Cup Inc., 9 5/8%, sr. secd.
notes, 09/01/00 ........................ B+ B2 1,940,000
1,500,000 Sweetheart Cup Inc., 10 1/2%, sr. secd.
notes, 09/01/03 ........................ B- Caa1 1,305,000
------------
5,750,000
------------
OIL/NATURAL GAS/OIL SERVICES -- 7.83%
3,000,000 Abraxas Petroleum Corp., 12 7/8%, sr.
secd. notes, 03/15/03 .................. NR B3 3,030,000
3,125,000 Belden & Blake Corp., 9 7/8%, sr. sub.
notes, series B, 06/15/07 .............. CCC- Caa1 1,906,250
1,000,000 Eott Energy Partners LP, 11%, sr. notes,
10/01/09 ............................... BB Ba2 1,022,500
3,750,000 First Wave Marine Inc., 11%, sr. notes,
02/01/08 ............................... B- B3 2,737,500
3,706,000 Kelley Oil & Gas Corp., 14%, sr. secd.
notes, 04/15/03 ........................ B- B3 3,631,880
3,435,000 Northern Offshore, 10%, sr. notes,
05/15/05 ............................... B- Caa2 2,095,350
5,930,000 Southwest Royalties Inc., 10 1/2%, sr.
notes, series B, 10/15/04 .............. CCC- Caa2 2,861,225
2,050,000 United Refining Co., 10 3/4%, sr. notes,
series B, 06/15/07 ..................... B- B3 1,378,625
------------
18,663,330
------------
PACKAGING/CONTAINERS -- 1.09%
500,000 Portola Packaging Inc., 10 3/4%, sr.
notes, 10/01/05 ........................ B B2 507,500
2,000,000 Tekni-Plex Inc., 11 1/4%, sr. sub. notes,
series B, 04/01/07 ..................... B- B3 2,100,000
------------
2,607,500
------------
PAPER/FOREST PRODUCTS/PRINTING -- 0.11%
1,000,000 FSW International Finance Co., 12 1/2%,
gtd. sub. notes, 11/01/06 (e)* ......... D Ca 257,500
------------
PERSONAL & MISCELLANEOUS SERVICES -- 0.63%
2,400,000 AAI Foster Grant Inc., 10 3/4%, sr. notes,
07/15/06 ............................... CCC+ Caa3 840,000
1,000,000 Styling Technology Corp., 10 7/8%, gtd.
sr. sub. notes, 07/01/08 ............... CCC+ B3 650,000
------------
1,490,000
------------
POLLUTION CONTROL/WASTE REMOVAL -- 0.09%
500,000 GNI Group Inc., 10 7/8%, gtd. sr. notes,
07/15/05 ............................... B B2 208,750
------------
PUBLIC UTILITY/ELECTRIC POWER/HYDRO
POWER -- 0.73%
3,000,000 Aqua Chem Inc., 11 1/4%, sr. sub. notes,
07/01/08 ............................... CCC+ B3 1,732,500
------------
REAL ESTATE DEVELOPMENT/REITS/BUILDING/
CONSTRUCTION -- 1.98%
1,000,000 American Architectural Products, 11 3/4%,
gtd. sr. notes, 12/01/07 ............... CCC+ Caa1 300,000
290,820 Bramalea Limited, 11 1/8%, 03/22/98 (b)* . NR NR 0
2,000,000 Fortress Group Inc., 13 3/4%, sr. notes,
05/15/03 ............................... NR B3 1,200,000
750,000 Peters, J.M., Inc., 12 3/4%, sr. notes,
05/01/02 ............................... B- B3 630,000
3,375,000 Presley Companies, 12 1/2%, sr. notes,
07/01/01 ............................... CCC B3 2,581,875
------------
4,711,875
------------
TELEPHONE/COMMUNICATIONS -- 18.50%
348,000 Alvey Systems, Inc., 11 3/8%, sr. sub.
notes, 01/31/03 ........................ B- B3 354,960
3,250,000 Arch Escrow Corp., 13 3/4%, sr. notes,
04/15/08, .............................. B- B3 2,632,500
4,000,000 COVAD Communications Group, 12 1/2%, sr.
disc. notes, 02/15/09 .................. B- B3 4,120,000
1,500,000 Consorcio Ecuatoriano de
Telecomunicationes SA, 14%, notes,
series B, 05/01/02 ..................... NR NR 450,000
1,400,000 Conecel Holdings Ltd., 14%, units,
10/01/00 ............................... NR NR 140,000
500,000 Conecel Holdings Ltd., 14%, units,
10/01/00 ............................... NR NR 50,000
4,000,000 Dolphin Telecom PLC., 0%, sr. disc. notes,
05/15/09, 144A ......................... CCC+ Caa1 1,800,000
500,000 Econophone Inc., 13 1/2%, sr. notes,
07/15/07 .................................. NR NR 522,500
2,000,000 First World Communications, 0%, sr. notes,
04/15/08 ............................... NR NR 1,070,000
2,000,000 Globix Corp., 13%, sr. notes, 05/01/05 ... NR NR 1,740,000
2,000,000 Innova S De R.L., 12 7/8%, sr. exch.
notes, 04/01/07 ........................ B- B3 1,640,000
8,200,000 Innova S De R.L., 12 7/8%, reg. sr. notes,
04/01/07 ............................... B- B3 6,642,000
2,000,000 Ionica PLC, 0%, sr. disc. notes, 05/01/07
(d) .................................... NR Ca 60,000
1,000,000 Knology Holdings Inc., 0%, sr. disc.
notes, 10/15/07 ........................ NR NR 570,000
5,835,000 MGC Communications Inc., 13%, sr. secd.
notes, series B, 10/01/04 .............. B- Caa2 5,718,300
3,000,000 Orbital Imaging Corp., 11 5/8%, sr. notes,
series D, 03/01/05 ..................... CCC+ NR 1,950,000
5,000,000 Splitrock Services Inc., 11 3/4%, sr.
notes, series B, 07/15/08 .............. NR NR 4,612,500
1,500,000 Telehub Communications Corp., 0%, sr.
disc. notes, 07/31/05 .................. NR NR 150,000
6,000,000 Telesystem International Wireless Inc.,
0%, sr. disc. notes, series C, 11/01/07 CCC+ Caa1 2,820,000
2,000,000 Total Access Communication Ltd., 7 5/8%,
bonds, 11/04/01, 144A .................. BB- B2 1,660,000
3,000,000 USA Mobile Communications Inc., 9 1/2%,
sr. notes, 02/01/04 .................... B- B3 2,280,000
2,000,000 Viatel Inc., 11 1/4%, sr. notes, 04/15/08 NR B- 1,880,000
2,000,000 Viatel Inc., 0%, sr. disc. notes, 04/15/08 B- B3 1,240,000
------------
44,102,760
------------
TEXTILES/OTHER MANUFACTURING/APPAREL -- 1.20%
5,000,000 Converse Inc., 7%, conv. sub. notes,
06/01/04 ............................... NR NR 525,000
150,000 GPO Synkro SA, 12%, bonds, 04/01/02 ...... NR NR 112,500
1,000,000 Glenoit Corp., 11%, sr. sub. notes,
04/15/07 ............................... CCC+ B3 660,000
1,000,000 Norton McNaughton Inc., 12 1/2%, sr.
notes, 06/01/05 ........................ B B2 850,000
2,000,000 Pillowtex Corp., 10%, sr. sub. notes,
04/15/06 ............................... CCC+ B2 720,000
------------
2,867,500
------------
TRANSPORTATION/AIRLINES/BUS -- 3.62%
1,000,000 Cenargo International Ltd., 9 3/4%, 1st
mtg. notes, 06/15/08 ................... B+ Ba3 850,000
1,418,031 Mexico City Toluca Toll, 11%, notes,
05/19/02, 144A ......................... NR NR 992,622
3,000,000 Sabreliner Corp., 11%, sr. notes,
06/15/08, 144A ......................... B Ca 2,040,000
6,910,000 TRISM Inc., 10 3/4%, gtd. sr. sub. notes,
12/15/00 (e) ........................... D Caa3 1,658,400
2,000,000 Trans World Airlines Inc., 11 1/2%, sr.
secd. notes, 12/15/04 .................. CCC B2 1,420,000
2,000,000 Trans World Airlines Inc., 12%, sr. secd.
notes, 04/01/02 ........................ NR B2 1,660,000
------------
8,621,022
------------
TOTAL FIXED INCOME (cost $264,669,725)........................... $215,573,274
------------
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
COMMON STOCK, PREFERRED STOCK AND WARRANTS -- 5.09%
Value
Value
Units Description (Note 2)
- ----- ----------- --------
<C> <S> <C>
62,031 AMC Financial Inc.* ..................................... $ 341,171
41,668 Altiva Finanacial Corp.* ................................ 145,838
10,000 American Capital Strategies ............................. 209,375
7,480 American Mobile Satellite, warrants, 144A* .............. 112,200
2,000 American Telecasting Inc., warrants* .................... 20
185,900 Ames Department Stores Inc., excess cash flow pmt.,
series A* ............................................. 0
131 Anker Coal Group Inc.* .................................. 1
43,800 Annaly Mortgage Management Inc. ......................... 377,775
50,000 Anthracite Capital Inc. ................................. 340,625
5,806 Apartment Investment & Management, class A* ............. 218,451
2,000 Bell Technology Group Ltd., warrants* ................... 0
13,532 Brooke Group Ltd. ....................................... 207,209
550 CS Wireless Systems Inc., 144A* ......................... 1
50,000 Capital Automotive, REIT ................................ 637,500
5,925 Capital Pac Holdings Inc., warrants, 144A* .............. 5,925
100,000 Commodore Separation Technology, warrants* .............. 9,000
100,000 Commodore Separation Technology, sr. conv. pfd. ......... 31,300
7,887 Cort Business Services Corp.* ........................... 160,205
6,000 DIVA Systems Corp., warrants, 144A* ..................... 712,020
25,212 DIVA Systems Corp., warrants* ........................... 201,696
500 Econophone Inc., warrants, 144A* ........................ 40,000
1,000 Epic Resorts LLC., warrants, 144A* ...................... 1,000
8,862 Equus Gaming Co. L.P.* .................................. 12,185
20,000 Excel Legacy Corp.* ..................................... 83,750
25,000 FBR Asset Investment Corp., 144A* ....................... 275,000
2,000 First World Communications, warrants, 144A* ............. 160,000
10,000 GIGA Information Group Inc.* ............................ 33,125
17,251 GP Strategies Corp.* .................................... 202,699
2,000 Global Star L.P.* ....................................... 270
28,000 Gothic Energy Corp., warrants* .......................... 32,200
9,533 Gothic Energy Corp., warrants, 144A* .................... 95
20,000 HRPT Properties Trust ................................... 183,750
11,000 HarCor Energy Inc., warrants* ........................... 6,864
10,000 Hospitality Properties Trust ............................ 211,250
750 IHF Capital Inc., warrants, 144A* ....................... 7,594
40,000 Imperial Credit Industries, Inc.* ....................... 1,000,000
750 Intermedia Communications of Florida Inc., warrants,
144A* ................................................. 13,350
1,000 Knology Holdings Inc., warrants, 144A* .................. 0
25,000 Local Financial Corp., 144A* ............................ 250,000
2,000 Loral Orion Network Systems Inc., warrants* ............. 24,250
300 MGC Communications Inc.* ................................ 8,250
51,960 Marvel Enterprise Inc., Class A, warrants* .............. 35,722
87,999 Marvel Enterprise Inc., Class C, warrants* .............. 22,000
500 Motels of America Inc., 144A* ........................... 125
291 Mothers Work Inc.* ...................................... 3,055
8,774 NS Group Inc.* .......................................... 88,837
24,000 New Plan Excel Realty Trust Inc. ........................ 415,500
1,500 Nucentrix Broadband Network, warrants* .................. 0
3,500 Optel Inc.* ............................................. 35,000
1,000 Park & View Inc., warrants, 144A* ....................... 0
125,449 Prime Retail Inc. ....................................... 995,753
4,094 Prime Retail Inc., conv. pfd., series B ................. 50,663
33,333 Resource Asset Investment Trust ......................... 354,163
19,240 SF Holdings Group Inc., class C, 144A* .................. 48,100
105 SF Holdings Group Inc., exch. pfd., 144A ................ 367,500
520 SF Holdings Group Inc., exch. pfd., series B ............ 1,820,000
1,000 Sabreliner Corp., warrants* ............................. 1,000
2,000 Senior Housing Property Trust ........................... 24,500
3,750 Sheffield Steel Corp., warrants* ........................ 3,750
500 Signature Brands, Inc.,warrants* ........................ 0
28,744 Splitrock Services Inc.* ................................ 628,775
1,500 Telehub Communications Corp., warrants, 144A* ........... 937
2,000 Trans World Airlines Inc.* .............................. 168,000
25,000 Ugly Duckling Corp.* .................................... 221,875
1,000 Unifi Communications Inc., warrants, 144A* .............. 135
9,800 Uniroyal Technology Corp., warrants* .................... 58,800
6,600 V2 Music Holdings PLC, warrants* ........................ 66
4,500 Vialog Corporation, warrants* ........................... 202,500
1,500 WHX Corp., pfd. ......................................... 53,906
104,563 Wilshire Financial Services Group Inc. .................. 150,309
40,000 Wilshire Real Estate Investments* ....................... 116,250
1,500 Wireless One Inc., warrants* ............................ 15
------------
TOTAL COMMON STOCK, PREFERRED STOCK, AND WARRANTS (cost
$15,215,910) ............................................ 12,123,180
------------
TOTAL INVESTMENTS IN SECURITIES (cost $279,885,635) ..... $227,696,454
------------
SHORT-TERM INVESTMENTS -- 0.82%
Par
Value
COMMERCIAL PAPER:
$1,963,000 Case Credit, 5.30%, 11/01/99, A2/P2 ..................... 1,962,422
------------
TOTAL SHORT-TERM INVESTMENTS (cost $1,962,422) .......... 1,962,422
------------
TOTAL INVESTMENTS -- 96.35% (COST $281,848,057) ......... 229,658,876
------------
OTHER ASSETS -- 3.65% ................................... 8,709,239
------------
TOTAL ASSETS -- 100% .................................... $238,368,115
=== ============
(a) Percentages indicated are based on total assets.
(b) Denotes company has filed for bankruptcy.
(c) When issued security.
(d) Denotes security is in receivorship.
(e) Denotes security currently in default.
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, 1999
ASSETS
Investments in securities at value (identified cost $281,848,057;
see Schedule of Investments and Note 2) ...................... $229,658,876
Cash ........................................................... 25,996
Receivables:
Investment securities sold ................................... 1,701,979
Interest and dividends ....................................... 6,902,283
Prepaid insurance .............................................. 75,135
Other assets ................................................... 3,846
------------
Total assets ........................................... $238,368,115
------------
LIABILITIES
Payables:
Investment securities purchased .............................. $ 1,820,812
Accrued expenses (Note 3) ...................................... 380,493
Bank loan (Note 12) ............................................ 50,000,000
------------
Total liabilities ...................................... $ 52,201,305
------------
Net Assets:
Common stock, $.03 par value --
Authorized -- 100,000,000 shares
Issued and outstanding -- 26,673,903 shares ................ $ 800,217
Capital in excess of par value (Notes 2 and 5) ............... 285,819,239
Distributions in excess of accumulated net investment
income (Note 2) ............................................ (119,650)
Accumulated net realized loss from security transactions ..... (48,143,815)
Net unrealized depreciation of investments ................... (52,189,181)
------------
Total net assets (equivalent to $6.98 per share, based
on 26,673,903 shares outstanding) ................... $186,166,810
============
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, 1999
INVESTMENT INCOME (Note 2):
Interest income .............................................. $ 24,565,750
Dividend income .............................................. 807,546
Accretion of discount ........................................ 6,765,130
------------
Total investment income ................................ $ 32,138,426
------------
EXPENSES:
Interest expense ............................................. $ 2,903,210
Investment advisory fee (Note 3) ............................. 1,465,527
Custodian and transfer agent fees ............................ 169,999
Professional fees ............................................ 191,473
Directors' fees .............................................. 89,672
Insurance expense ............................................ 107,595
Excise tax expense ........................................... 83,536
Miscellaneous expenses ....................................... 226,001
------------
Total expenses ......................................... $ 5,237,013
------------
Net investment income .................................. $ 26,901,413
------------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized loss on investments sold ........................ $(38,743,202)
Change in net unrealized depreciation of investments (Note 2) 13,820,247
------------
Net realized and unrealized loss on investments ........ $(24,922,955)
------------
Net increase in net assets resulting from operations ... $ 1,978,458
============
The accompanying notes are an integral part of the financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
STATEMENT OF CASH FLOWS
For the year ended October 31, 1999
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest and dividends received ............................ $ 25,379,198
Operating expenses paid .................................... (5,300,157)
-------------
Net cash provided by operating activities ............ $ 20,079,041
-------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of portfolio securities .......................... $(345,491,851)
Sales and maturities of portfolio securities ............... 288,451,178
-------------
Net cash used in investing activities ................ $ (57,040,673)
-------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from common stock rights offering
and sale of common stock ................................. $ 54,955,507
Proceeds from bank loan .................................... 10,000,000
Common stock dividends paid from operations ................ (28,607,609)
-------------
Net cash provided by financing activities ............ $ 36,387,898
-------------
NET (DECREASE) IN CASH ....................................... $ (573,734)
CASH, BEGINNING OF PERIOD .................................... 599,730
-------------
CASH, END OF PERIOD .......................................... $ 25,996
=============
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 ....... $ 1,978,458
Decrease in interest and dividend receivables .............. 5,902
Amortization of deferred assets ............................ 7,053
Decrease in other assets ................................... 114,204
Decrease in accrued expenses and other payables ............ (184,401)
Net realized loss on investments sold ...................... 38,743,202
Change in net unrealized depreciation of investments ....... (13,820,247)
Accretion of bond discount ................................. (6,765,130)
-------------
Net cash provided by operating activities ............ $ 20,079,041
=============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest ................... $ 2,997,599
Cash paid during the period for excise taxes ............... 123,991
=============
The accompanying notes are an integral part of the financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended October 31,
--------------------------------
1999 1998
------------- -------------
<S> <C> <C>
FROM OPERATIONS:
Net investment income .................................. $ 26,901,413 $ 24,548,657
Net realized loss on investments sold .................. (38,743,202) (5,007,628)
Change in net unrealized appreciation (depreciation) of
investments .......................................... 13,820,247 (69,126,156)
------------- -------------
Net increase (decrease) in net assets resulting
from operations ................................. $ 1,978,458 $ (49,585,127)
------------- -------------
FROM FUND SHARE TRANSACTIONS:
Shares issued (237,917 shares and 175,689 shares,
respectively) to common stockholders for reinvestment
of dividends ......................................... $ 2,063,366 $ 1,995,745
Net proceeds from sale of common stock issued (6,630,663
and 4,914,203 shares, respectively, after deducting
$2,691,261 and $2,599,872 of soliciting fees and other
expenses, respectively) .............................. 54,995,507 53,422,039
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 .................................. $ 57,058,873 $ 35,417,784
------------- -------------
DISTRIBUTIONS TO STOCKHOLDERS:
Preferred dividends ($0 and $3,144 per share,
respectively) ............................................ $ 0 $ (628,030)
Common dividends ($1.26 and $1.26 per share,
respectively) from accumulated net investment income . (30,583,565) (23,313,075)
Common dividends ($0 and $0 per share, respectively) in
excess of accumulated net investment income .......... (87,410) --
------------- -------------
Decrease in net assets resulting from
distributions to stockholders ............................ $ (30,670,975) $ (23,941,105)
------------- -------------
Total net increase (decrease) in net assets ...... $ 28,366,356 $ (38,108,448)
NET ASSETS:
Beginning of period .................................... 157,800,454 195,908,902
------------- -------------
End of period (including $(119,650) and $3,682,152 of accumulated
undistributed (distributions in excess of) net investment income as of
October 31, 1999 and
October 31, 1998, respectively) ...................... $ 186,166,810 $ 157,800,454
============= =============
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
FINANCIAL HIGHLIGHTS
SELECTED PER SHARE DATA AND RATIOS
FOR EACH SHARE OF COMMON STOCK OUTSTANDING THROUGHOUT THE PERIODS PRESENTED
<TABLE>
<CAPTION>
For the Years Ended October 31, (b)
----------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of
period ..................... $ 7.97 $ 11.94 $ 11.70 $ 11.10 $ 11.07 $ 12.75
----------- ----------- ----------- ----------- ----------- ----------
Net investment income ........ $ 1.08# $ 1.30# $ 1.38# $ 1.50# $ 1.35 $ 1.44#
Net realized and unrealized
gain (loss) on investments.. (1.00)# (3.76)# .72# .60# .09 (1.14)#
----------- ----------- ----------- ----------- ----------- ----------
Total from investment
operations ......... $ .08 $ (2.46) $ 2.10 $ 2.10 $ 1.44 $ .30
----------- ----------- ----------- ----------- ----------- ----------
Distributions:
Dividends from accumulated net
investment income
To preferred stockholders $ -- $ (.03) $ (.09) $ (.12) $ (.15) $ (.09)
To common stockholders ... (1.26) (1.26) (1.26) (1.26) (1.26) (1.35)
----------- ----------- ----------- ----------- ----------- ----------
Total distributions .. $ (1.26) $ (1.29) $ (1.35) $ (1.38) $ (1.41) $ (1.44)
----------- ----------- ----------- ----------- ----------- ----------
Effect of sale of common stock
and related expenses from
rights offerings ........... $ .19 $ (.22) $ (.51) $ (.12) $ -- $ (.54)
----------- ----------- ----------- ----------- ----------- ----------
Net asset value, end of period $ 6.98 $ 7.97 $ 11.94 $ 11.70 $ 11.10 $ 11.07
=========== =========== =========== =========== =========== ==========
Per share market value, end of
period ..................... $ 7.94 $ 10.25 $ 12.39 $ 12.00 $ 11.64 $ 10.50
=========== =========== =========== =========== =========== ==========
Total investment return ...... (11.78)% (7.63)% 14.82% 15.29% 28.57% (7.78)%
=========== =========== =========== =========== =========== ==========
Net assets, end of period,
applicable to common
stock (a) .................. $ 186,167 $ 157,800 $ 175,909 $ 120,711 $ 93,309 $ 92,072
=========== =========== =========== =========== =========== ==========
Net assets, end of period,
applicable to
preferred stock (a) ........ $ -- $ -- $ 20,000 $ 20,000 $ 20,000 $ 20,000
=========== =========== =========== =========== =========== ==========
Net assets, end of period (a) $ $186,167 $ 157,800 $ 195,909 $ 140,711 $ 113,309 $ 112,072
=========== =========== =========== =========== =========== ==========
Ratio of operating expenses to
average net assets,
applicable to common stock . 2.67% 2.67% 2.30% 3.06% 3.27% 3.27%
Ratio of net investment income
to average net assets,
applicable to common stock . 13.72% 11.92% 11.94% 13.20% 13.47% 12.25%
Ratio of operating expenses to
average net assets** ....... 2.14%+ 2.18%+ 1.81%+ 2.21%+ 2.28%+ 2.30%+
Ratio of net investment income
to average net assets** .... 11.01% 9.72% 9.42% 9.51% 9.39% 8.64%
Portfolio turnover rate ...... 126.45% 156.48% 176.04% 108.33% 80.71% 72.00%
(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 relative to average net assets (total assets
less accrued liabilities (excluding bank loans and senior notes)).
+ Excluding interest expense, the ratio of operating expenses to average net assets (total assets less accrued liabilities
(excluding bank loans and senior notes)) is .95%, 1.20%, 1.13%, 1.30%, 1.29% and 1.32%, 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.
INFORMATION REGARDING SENIOR SECURITIES
<TABLE>
<CAPTION>
As of October 31,
------------------------------------------------------------------------------------
1999 1998 1997 1996 1995 1994
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Total Amount
Outstanding:
Indebtedness $50,000,000 $40,000,000 $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
Asset Coverage:
Per Indebtedness(a) 472% 495% 1,080% 804% 667% 660%
Per preferred stock share (b) N/A N/A 540% 402% 333% 330%
Involuntary Liquidation Preference:
Per preferred stock share (c) N/A N/A $ 100,000 $ 100,000 $ 100,000 $ 100,000
Approximate Market Value:
Per note N/A N/A $ 1,003.80 $ 990.00 $ 987.50 $ 937.10
Per preferred stock share N/A N/A 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.
</TABLE>
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1999
(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, which comprise the major portion of the Fund's portfolio
holdings, are primarily non-investment-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. These investments are stated at fair
value on the basis of subjective valuations furnished by an independent pricing
service or broker dealers, subject to review and 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 pursuant to 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.
(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. It is the
Fund's policy to place securities on non-accrual status when collection of
interest is doubtful.
(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 $90,548 from paid in capital to distributions in
excess of accumulated net investment income, $18,529,051 from paid in capital to
accumulated net realized loss from security transactions and $122,788 from
distributions in excess of accumulated 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, 1999, the cost of investments in securities for federal income
tax purposes was $283,445,581. Aggregate gross unrealized gains on securities in
which there was an excess of market value over tax cost was $6,503,232.
Aggregate gross unrealized losses on securities in which there was an excess of
tax cost over market value was $60,289,937. The net unrealized loss on
securities held by the Fund was $(53,786,705) for federal income tax purposes.
At October 31, 1999, 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
$ (808,396) October 31, 2002
(3,703,531) October 31, 2003
(4,688,248) October 31, 2006
(37,346,116) October 31, 2007
-----------
$(46,546,291)
============
(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 $1,465,527 in management fees for the year ended October 31,
1999. Management fees paid by the Fund to the Investment Adviser were calculated
at .65% (on an annual basis) of the average weekly net asset value defined as,
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,
1999, the fee payable to the Investment Adviser was $169,404, which was included
in accrued expenses in the accompanying balance sheet.
(4) DEBT
The Fund issued $20,000,000 of 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.
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 12.
(5) REDEEMABLE PREFERRED STOCK
Dividends on the 200 shares of preferred stock outstanding at October 31,
1994, 1995, 1996 and 1997 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. These 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. 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 12.
(6) PURCHASES AND SALES OF SECURITIES
For the year ended October 31, 1999, the aggregate cost of purchases and
proceeds from sales of investment securities other than U.S. Government
obligations and short-term investments aggregated $348,977,066 and $285,816,018,
respectively. There were no purchases or sales of U.S. Government obligations
during the year ended October 31, 1999.
(7) 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.
(8) DIVIDENDS AND DISTRIBUTIONS
The Board of Directors of the Fund declared regular dividends on the common
stock of $.105 per share payable on November 30 and December 31, 1998, and
January 29, February 26, March 31, April 30, May 28, June 30, July 30, August
31, September 30, and October 29, 1999.
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 participants in the Dividend Reinvestment Plan (the
"Plan") unless they elect otherwise. Under the Plan, when the market price of
common stock is equal to or exceeds the net asset value on the record date for a
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 the 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.
(9) 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, 1999, the fair value
of the bank term loan was $50,000,000.
(10) 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 to this reverse stock split.
(11) RIGHTS OFFERING
On January 26, 1999, the Fund commenced a rights offering whereby the Fund
issued to its shareholders of record, as of that date, nontransferable rights
entitling the holders thereof to subscribe for an aggregate of 6,630,663 shares
of the Fund's common stock. Each record date shareholder received 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 February 19, 1999 and the Fund issued, on a post-split basis,
6,630,663 shares of common stock at $8.70 per share. Proceeds to the Fund
amounted to $54,995,507, net of soliciting fees and offering expenses of
$2,691,261.
(12) BANK LOAN
The Fund has entered into a $50 million credit agreement ("the Agreement")
with a lending institution. 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%. 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,
1999 was approximately $48,288,000 and 5.86%, respectively. The outstanding loan
balance at October 31, 1999 was $50 million, with an average interest rate on
the outstanding loans of 5.97%. 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.
(13) SUBSEQUENT EVENT
On October 4, 1999, the Fund announced that Prospect Street Investment
Management Co., Inc. (PSIM) had entered into an agreement to sell certain of its
assets and goodwill relating to the management of the Fund to Highland Capital
Management, L.P. ("Highland") of Dallas, Texas. At the Special Meeting of
Stockholders held on December 17, 1999 the stockholders elected six additional
Directors of the Fund and approved the new Advisory Agreement between the Fund
and Highland, both of which will become effective only upon the sale of certain
of the assets and goodwill of PSIM to Highland (the "Transaction"), which is
scheduled for January 21, 2000. The Transaction remains subject to the
refinancing by the Fund of its outstanding $50 million senior loan facility and
certain other conditions.
<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,
1999, 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,
1999 and 1998 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, 1999 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, 1999, 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 17, 1999
<PAGE>
<TABLE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<S> <C>
INVESTMENT ADVISER AUDITORS
Prospect Street Investment Management Co., Inc. Arthur Andersen LLP
60 State Street, Suite 3750 Boston, MA
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 Chief Investment (800) 426-5523
Officer
Karen J. Thelen -- Secretary CUSTODIAN
State Street Bank and Trust Company
DIRECTORS Boston, MA
John S. Albanese
C. William Carey, Chairman Listed: NYSE
Joseph G. Cote Symbol: PHY
John A. Frabotta
Richard E. Omohundro, Jr.
Harlan D. Platt
Christopher E. Roshier
LEGAL ADVISER
Olshan Grundman Frome Rosenzweig &
Wolosky LLP
New York, NY
</TABLE>
<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 and Wall Street Journal
Online publish Friday's closing net asset value of the Fund every Monday and
lists the market price of the Fund daily. They are also published in Barron's
Market Week every Saturday. Our website is prospectstreet.net.
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
