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ANNUAL REPORT
- --------------------------------------------------------------------------------
1997
1997
1997
1997
1997
Smith Barney
Principal Return
Fund
Zeros and
Appreciation
Series 1998
--------------------------------------------------
November 30, 1997
[LOGO] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
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Zeros and Appreciation Series 1998
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Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney
Principal Return Fund -- Zeros and Appreciation Series 1998 ("Fund") for the
year ended November 30, 1997. For your convenience, we have summarized the
Fund's investment strategy over this time and discussed some of the Fund's
holdings in greater detail. A more comprehensive summary of performance and
current holdings can be found in the appropriate sections of this report. In
addition, a hypothetical analysis of an initial $10,000 investment in the Fund
from January 25, 1991 through November 30, 1997 appears after this letter.
Fund's Performance Update
The Fund seeks to return the principal amount of each shareholder's original
investment (including any sales charge paid) on or about August 31, 1998, by
investing a portion of its assets in zero coupon bonds. In addition, the Fund,
to the extent consistent with its objective, seeks to provide long-term capital
appreciation by investing the balance of its assets primarily in stocks. The
fiscal year ended November 30, 1997 was a strong one for most financial assets.
The stock market continued to advance sharply while the bond market posted more
modest gains. Overall, the strength of the stock market exceeded our
expectations, while the bond market performed as we had anticipated.
The total return of 11.60% posted by the Fund resulted primarily from the
appreciation of the stock portion of the Fund, which comprises roughly 38% of
total assets. In addition, over the last twelve months, the Fund distributed
income dividends totaling $0.01 per share and paid a capital gain distribution
of $0.52 per share. For the one-year period ended November 30, 1997, the stock
market, as measured by the Standard & Poor's 500 Composite Index,* had a total
return of 28.50%. Over the same time period, the bond market, as measured by the
Lehman Brothers Intermediate Term Government Bond Index,** generated a total
return of 6.28%.
Market Overview
The stock market continued its terrific climb in 1997. Large inflows of money
into mutual funds by domestic and international investors, strong corporate
profits and favorable interest rates produced another year of outsized returns.
However, increased volatility and significant sector rotation created many
potholes along the way for investors. The bond market, where rates have declined
markedly, has finally realized that inflation remains dormant due to
productivity gains along with worldwide competition and excess capacity.
- ----------
* The Standard & Poor's 500 Composite Index is a capitalization-weighted
measure of 500 widely held common stocks.
** The Lehman Brothers Intermediate Term Government Bond Index is comprised
of approximately 1,000 issues of U.S. government treasury and agency
securities.
1
<PAGE>
Fund's Investment Strategy
The core of the stock portion of the Fund's portfolio consists of high-quality
growth stocks with dominant market positions, global franchises, seasoned and
respected management teams and excellent balance sheets. Because of their
steadiness, these stocks can be comforting in periods of market excesses and
their long-term consistent growth in earnings is ultimately translated into
higher dividends and stock prices. Around this core, we continue to look for
special situations such as restructuring candidates or undervalued companies
that are more dependent on economic cycles.
The Fund's top-ten holdings have changed slightly during the reporting period.
Allstate Corp., a leading provider of auto and home insurance, remains the
Fund's single largest holding. In our opinion, the company continues to run its
business for the benefit of shareholders. Another key industry is
pharmaceuticals, which has been well represented in the Fund for some time.
Strong volume growth driven by new products made these companies significant
contributors to overall returns in 1997. Johnson & Johnson, Bristol Myers Squibb
Co. and Merck & Co., Inc. remain top ten holdings of the Fund. Energy stocks
such as Mobil Corp. and Amoco Corp., which we highlighted last year, also remain
top ten holdings.
Our biggest disappointment in the last year was Eastman Kodak Co., which despite
a huge restructuring, is facing heavy competition in its core film business,
while investing heavily for future growth in digital products. Fortunately, we
were able to reduce our position as the company began to experience problems.
Market Outlook
While the market continues to discount a near-perfect economic environment, we
think there are some cracks appearing in the foundation of the economy which
warrant a more conservative investment posture. Our main concern is that
valuation levels are at or near record levels. While it is virtually impossible
to time when valuations will peak, we do believe that high valuations signify a
greater level of market risk. Secondly, in our view, corporate profit
expectations for 1998 are too high and could be adjusted downward. Profit growth
should still be solid, just less than is currently projected. Finally, market
sentiment remains high and we continue to monitor investor psychology for
extremes.
On a more positive note, interest rates should continue to trend lower as growth
slows and inflation fears subside. Overall, we are approaching this market
selectively. We believe that the Fund's holdings in zero coupon U.S. Treasury
bonds and high-quality stocks should continue to reduce both its risk and
volatility while providing solid returns to investors before the Fund matures in
late 1998.
2
<PAGE>
In closing, thank you for investing in the Smith Barney Principal Return Fund --
Zeros and Appreciation Series 1998. We look forward to continuing to help you
pursue your financial goals in the future.
Sincerely,
/s/ Heath B. McLendon /s/ Harry D. Cohen
- ------------------------------- -------------------------------
Heath B. McLendon Harry D. Cohen
Chairman Vice President and
Investment Officer
December 9, 1997
3
<PAGE>
Hypothetical Analysis of a $10,000 Investment in Smith Barney
Principal Return Fund -- Zeros and Appreciation Series 1998
from January 25, 1991* through November 30, 1997
This table illustrates a hypothetical analysis of an initial investment in the
Smith Barney Principal Return Fund -- Zeros and Appreciation Series 1998. The
key factors behind this analysis are:
o Initial Investment on January 25, 1991 $10,000
o Maximum offering price per share including
5% sales charge at time of investment $ 8.00
o Initial Shares Purchased 1,250
Income/
Capital Gain Reinvest Additional Cumulative
Year Dividend NAV Shares Shares
---- ------------ -------- ---------- ----------
1991* 1,250.00
1991 $0.4300 $8.43 63.76 1,313.76
1992 0.5004 8.68 75.74 1,389.50
1993 1.3183 8.14 225.04 1,614.54
1994 0.8236 7.52** 189.79 1,804.33
1995 0.8247 7.83** 197.95 2,002.28
1996 0.8247 7.68** 220.55 2,222.83
1997 0.5300 7.83 150.46 2,373.29
* Commencement of operations.
** NAV represents an average of several distributions made during the period.
Please note that this hypothetical analysis assumes reinvestment of all
distributions and a full redemption from the Fund as of November 30, 1997 at a
net asset value of $7.86 per share. A shareholder's initial investment of
$10,000 at a maximum offering price per share of $8.00 would result in an ending
share balance of 2,373.29 shares at a value of $18,654.06. The $8,654.06
increase over the cost basis consists of $8,763.69 in dividends and capital gain
distributions received throughout the life of the investment, and a net capital
loss at the time of redemption of ($109.63) (representing a long-term loss of
($150.93) and a short-term gain of $41.30.) The cumulative total return,
including the deduction of the 5% sales charge, on this investment is 86.54%,
and the average annual total return is 9.53%. Past performance is not indicative
of future results.
4
<PAGE>
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Historical Performance
- --------------------------------------------------------------------------------
Net Asset Value
-----------------
Beginning End of Income Capital Gain Total
Year Ended of Year Year Dividends Distributions Returns(1)
================================================================================
11/30/97 $7.52 $7.86 $0.01 $0.52 11.60%
- --------------------------------------------------------------------------------
11/30/96 7.91 7.52 0.78 0.44 11.03
- --------------------------------------------------------------------------------
11/30/95 7.75 7.91 0.40 0.83 19.93
- --------------------------------------------------------------------------------
11/30/94 9.38 7.75 0.45 0.89 (3.69)
- --------------------------------------------------------------------------------
11/30/93 9.02 9.38 0.40 0.10 9.99
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11/30/92 8.40 9.02 0.43 0.00 12.86
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1/25/91*-11/30/91 7.60 8.40 0.00 0.00 10.53+
================================================================================
Total $2.47 $2.78
================================================================================
It is the Fund's policy to distribute dividends and capital gains, if any,
annually.
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
Without With
Sales Charge(1) Sales Charge(2)
================================================================================
Year Ended 11/30/97 11.60% 5.96%
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Five Years Ended 11/30/97 9.50 8.39
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1/25/91* through 11/30/97 10.35 9.53
================================================================================
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Cumulative Total Return
- --------------------------------------------------------------------------------
Without
Sales Charge(1)
================================================================================
1/25/91* through 11/30/97 96.36%
================================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable sales charge.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, shares reflect the deduction of the
maximum initial sales charge of 5.00%.
* Commencement of operations.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
5
<PAGE>
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Historical Performance (unaudited)
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Shares of the
Zeros and Appreciation Series 1998 vs. S&P 500 Index and
Lehman Brothers Intermediate Term Government Bond Index+
- --------------------------------------------------------------------------------
January 1991 -- November 1997
[GRAPHIC OMITTED]
+ Hypothetical illustration of $10,000 invested in shares of the Zeros and
Appreciation Series 1998 from January 25, 1991 (commencement of
operations), assuming deduction of the maximum 5.00% sales charge at the
time of investment and reinvestment of dividends and capital gains, if
any, at net asset value through November 30, 1997. The S&P 500 Index is an
index of widely held common stocks listed on the New York and American
Stock Exchanges and the over-the-counter markets. Figures for the S&P 500
Index include reinvestment of dividends. The Lehman Brothers Intermediate
Term Government Bond Index is comprised of approximately 1,000 issues of
U.S. government treasury and agency securities. The indexes are unmanaged
and are not subject to the same management and trading expenses of a
mutual fund.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital gains.
6
<PAGE>
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Portfolio Highlights (unaudited) November 30, 1997
- --------------------------------------------------------------------------------
Common Stock Industry Breakdown
(as a percentage of total common stocks)
[THE FOLLOWING TABLE WAS REPRESENTED AS A PIE CHART IN THE PRINTED MATERIAL]
Diversified
Conglomerates 2.3%
Basic Industries 5.3%
Consumer Services 11.5%
Telecommunications 5.0%
Consumer Durables 2.8%
Capital Goods 8.6%
Financial Services 22.0%
Health Care 12.3%
Consumer Non-Durables 6.7%
Technology 11.0%
Energy 11.5%
Transportation 1.0%
Top Ten Holdings
Percentage of
Total Investments
================================================================================
U.S. Treasury Strips 62.5%
Allstate Corp. 1.6
General Electric Co. 1.0
Johnson & Johnson 1.0
Mobil Corp. 0.9
Xerox Corp. 0.9
Amoco Corp. 0.8
Bristol-Myers Squibb Co. 0.8
Minnesota Mining and Manufacturing Co. 0.8
Merck & Co., Inc. 0.8
================================================================================
7
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments November 30, 1997
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
COMMON STOCKS -- 37.5%
================================================================================
Basic Industries -- 2.0%
2,000 Aluminum Co. of America $ 134,500
7,000 E.I. du Pont de Nemours & Co. 423,938
2,000 Hercules, Inc. 97,125
2,000 Mead Corp. 129,125
8,000 Olin Corp. 396,000
2,000 Raychem Corp. 189,125
3,500 St. Joe Co. 330,750
- --------------------------------------------------------------------------------
1,700,563
- --------------------------------------------------------------------------------
Capital Goods -- 3.2%
12,000 Allied Signal, Inc. 445,500
4,252 Boeing Co. 225,887
4,000 Emerson Electric Co. 220,000
12,000 General Electric Co. 885,000
4,000 Honeywell Inc. 262,000
3,000 Johnson Controls Inc. 137,438
2,000 Lockheed Martin Corp. 195,125
10,000 Tyco International Ltd. 392,500
- --------------------------------------------------------------------------------
2,763,450
- --------------------------------------------------------------------------------
Consumer Durables -- 1.0%
5,000 Chrysler Corp. 171,562
8,000 General Motors Corp. 488,000
3,000 Goodyear Tire & Rubber Co. 182,063
1,500 The Stanley Works 66,094
- --------------------------------------------------------------------------------
907,719
- --------------------------------------------------------------------------------
Consumer Non-Durables -- 2.5%
3,000 American Greetings Corp., Class A Shares 110,250
5,000 Conagra Inc. 179,688
3,300 CPC International, Inc. 341,137
4,500 Eastman Kodak Co. 272,812
2,000 Gillette Co. 184,625
8,000 Kimberly-Clark Corp. 416,500
2,000 Procter & Gamble Co. 152,625
9,000 Unilever NV 522,563
- --------------------------------------------------------------------------------
2,180,200
- --------------------------------------------------------------------------------
Consumer Services -- 4.3%
2,000 Dow Jones & Co., Inc. 101,125
10,000 Gannett, Inc. 580,625
7,000 J.C. Penney Co. 449,750
7,000 McDonald's Corp. 339,500
10,000 Meredith Corp. 348,750
1,000 New York Times Co., Class A Shares 59,375
8,000 Newell Co. 326,500
See Notes to Financial Statements.
8
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) November 30, 1997
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Consumer Services -- 4.3% (continued)
3,500 Scandinavian Broadcasting Systems SA $ 87,500
5,000 Time Warner, Inc. 291,250
3,000 Viacom, Inc. 105,000
11,500 Wal-Mart Stores, Inc. 459,281
6,000 Walt Disney Co. 569,625
- --------------------------------------------------------------------------------
3,718,281
- --------------------------------------------------------------------------------
Diversified Conglomerates -- 0.9%
7,000 Minnesota Mining and Manufacturing Co. 682,063
2,000 Republic Industries, Inc. 52,125
- --------------------------------------------------------------------------------
734,188
- --------------------------------------------------------------------------------
Energy -- 4.3%
4,000 Amerada Hess Corp. 224,000
8,000 Amoco Corp. 720,000
6,000 Ashland Inc. 280,125
4,000 Exxon Corp. 244,000
6,000 Halliburton Co. 323,625
11,000 Mobil Corp. 791,312
3,000 Noble Affiliates Inc. 111,375
4,500 Reading & Bates Corp. 172,688
8,000 Royal Dutch Petroleum Co. 421,500
4,000 Sonat, Inc. 174,250
2,000 Texaco Inc. 113,000
6,000 Union Pacific Resources Corp. 149,250
- --------------------------------------------------------------------------------
3,725,125
- --------------------------------------------------------------------------------
Financial Services -- 8.3%
16,500 Allstate Corp. 1,416,937
5,000 American Express Co. 394,375
4,500 American International Group, Inc. 453,656
5,000 Associates First Capital Corp. 321,250
2,000 Barnett Banks, Inc. 140,750
5,500 Chase Manhattan Corp. 597,438
6,500 Chubb Corp. 461,094
1,500 C.N.A. Financial Corp.+ 183,750
12,000 Fannie Mae 633,750
4,500 First Virginia Banks, Inc. 215,156
1,600 General Re Corp. 317,600
5,000 Household International Inc. 630,000
4,000 Leucadia National Corp. 138,250
4,000 National City Corp. 267,000
4,000 St. Paul Cos. 320,000
1,000 U.S. Bancorp 107,563
1,700 Wells Fargo & Co. 522,325
- --------------------------------------------------------------------------------
7,120,894
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
9
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) November 30, 1997
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Health Care - 4.6%
7,000 Abbott Laboratories $ 455,000
8,000 American Home Products Corp. 559,000
7,500 Bristol-Myers Squibb Co. 702,187
14,000 Johnson & Johnson 881,125
2,000 Lilly, Eli & Co. 126,125
7,000 Merck & Co., Inc. 661,937
3,000 Novartis AG ADR 239,625
2,000 Pfizer, Inc. 145,500
4,000 SmithKline Beecham PLC 198,500
- --------------------------------------------------------------------------------
3,968,999
- --------------------------------------------------------------------------------
Technology - 4.1%
3,000 Cisco Systems Inc. 258,750
6,000 Hewlett Packard Co. 366,375
7,000 Intel Corp. 543,375
4,000 International Business Machines Corp. 438,250
2,000 Lucent Technologies, Inc. 160,250
2,000 Microsoft Corp. 283,000
9,000 Texas Instruments, Inc. 443,250
8,000 Thermo Electron Corp. $294,500
10,000 Xerox Corp. 776,875
- --------------------------------------------------------------------------------
3,564,625
- --------------------------------------------------------------------------------
Telecommunications - 1.9%
6,000 Ameritech Corp. 462,375
6,000 Bell Atlantic Corp. 535,500
12,000 GTE Corp. 606,750
- --------------------------------------------------------------------------------
1,604,625
- --------------------------------------------------------------------------------
Transportation - .4%
2,000 AMR Corp 242,375
3,000 Wisconsin Central Transportation Corp. 90,375
332,750
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost - $18,092,289) 32,321,419
================================================================================
FACE
AMOUNT SECURITY VALUE
================================================================================
U. S. GOVERNMENT OBLIGATIONS - 62.5%
$56,000,000 U.S. Treasury Strips, zero Coupon
due 8/15/98
(Cost- $52,879,093) 53,830,000
================================================================================
TOTAL INVESTMENTS - 100%
(Cost - $70,971,374*) $86,151,419
================================================================================
+ Non-Income producing securities.
* Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
10
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) November 30, 1997
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost -- $70,971,374) $86,151,419
Dividends and interest receivable 66,356
- --------------------------------------------------------------------------------
Total Assets 86,217,775
- --------------------------------------------------------------------------------
LIABILITIES:
Payable to bank 32,525
Investment advisory fees payable 19,883
Distribution fees payable 13,863
Administration fees payable 13,004
Accrued expenses 41,786
- --------------------------------------------------------------------------------
Total Liabilities 121,061
- --------------------------------------------------------------------------------
Total Net Assets $86,096,714
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 10,958
Capital paid in excess of par value 67,221,562
Undistributed net investment income 3,901,491
Accumulated net realized loss from security transactions (217,342)
Net unrealized appreciation of investments 15,180,045
- --------------------------------------------------------------------------------
Total Net Assets $86,096,714
================================================================================
Shares Outstanding 10,957,991
- --------------------------------------------------------------------------------
Net Asset Value (and redemption price) $ 7.86
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
11
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended November 30, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $ 4,413,464
Dividends 598,006
Less: Foreign withholding tax (3,777)
- --------------------------------------------------------------------------------
Total Investment Income 5,007,693
- --------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2) 266,201
Distribution fees (Note 2) 221,835
Administration fees (Note 2) 177,468
Transfer agent fees 102,247
Audit and legal 23,207
Shareholder communications 17,852
Trustees' fees 12,894
Registration fees 9,917
Shareholder and system servicing fees 6,944
Custody 6,545
Other 914
- --------------------------------------------------------------------------------
Total Expenses 846,024
- --------------------------------------------------------------------------------
Net Investment Income 4,161,669
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS (NOTE 3):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 23,671,910
Cost of securities sold 18,592,334
- --------------------------------------------------------------------------------
Net Realized Gain 5,079,576
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments:
Beginning of year 14,743,051
End of year 15,180,045
- --------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 436,994
- --------------------------------------------------------------------------------
Net Gain on Investments 5,516,570
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 9,678,239
================================================================================
See Notes to Financial Statements.
12
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended November 30,
- --------------------------------------------------------------------------------
1997 1996
================================================================================
OPERATIONS:
Net investment income $ 4,161,669 $ 4,422,626
Net realized gain 5,079,576 4,226,911
Increase in net unrealized appreciation 436,994 1,204,551
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 9,678,239 9,854,088
- --------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (132,527) (9,107,488)
Net realized gains (5,346,896) (5,316,894)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (5,479,423) (14,424,382)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net asset value of shares issued for
reinvestment of dividends 5,324,889 14,078,633
Cost of shares reacquired (17,219,725) (14,228,216)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (11,894,836) (149,583)
- --------------------------------------------------------------------------------
Decrease in Net Assets (7,696,020) (4,719,877)
NET ASSETS:
Beginning of year 93,792,734 98,512,611
- --------------------------------------------------------------------------------
End of year* $ 86,096,714 $ 93,792,734
================================================================================
* Includes undistributed (overdistributed)
net investment income of: $ 3,901,491 $ (112,549)
================================================================================
See Notes to Financial Statements.
13
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Zeros and Appreciation Series 1998 ("Fund") is a separate investment
fund of the Smith Barney Principal Return Fund ("Trust"). The Trust, a
Massachusetts business trust, is registered under the Investment Company Act of
1940, as amended, as a diversified, open-end management investment company.
Shares of the Fund are not currently offered for sale to new investors. The
Trust consists of this Fund and two other funds: the Zeros Plus Emerging Growth
Series 2000 and the Security and Growth Fund. The financial statements and
financial highlights for the other funds are presented in separate annual
reports.
The significant accounting policies consistently followed by the Fund
are:(a) security transactions are accounted for on trade date; (b) securities
traded on a national securities exchange are valued at the last sale price on
that exchange or, if there were no sales, at the current quoted bid price;
over-the-counter securities and listed securities are valued at the bid price at
the close of business on each day; U.S. government securities (other than
short-term securities) are valued at the quoted bid price in the
over-the-counter market; investment in securities for which market quotations
are not available are valued at fair value as determined by the Board of
Trustees; (c) securities maturing within 60 days are valued at cost plus
accreted discount, or minus amortized premium, which approximates value; (d)
interest income, adjusted for amortization of premium and accretion of discount,
is recorded on an accrual basis; (e) dividend income is recorded on the
ex-dividend date; foreign dividend income is recorded on the ex-dividend date or
as soon as practical after the Fund determines the existence of a dividend
declaration after exercising reasonable due diligence; (f) the accounting
records of the Fund are maintained in U.S. dollars. All assets and liabilities
denominated in foreign currencies are translated into U.S. dollars based on the
rate of exchange of such currencies against U.S. dollars on the date of
valuation. Purchases and sales of securities, and income and expenses are
translated at the rate of exchange quoted on the respective date that such
transactions are recorded. Differences between income or expense amounts
recorded and collected or paid are adjusted when reported by the custodian bank;
(g) gains or losses on the sale of securities are calculated by using the
specific identification method; (h) dividends and distributions to shareholders
are recorded on the ex-dividend date; (i) the character of income and gains to
be distributed are determined in accordance with income tax regulations which
may differ from generally accepted accounting principles. At November 30, 1997,
reclassifications were made to the Fund's capital accounts to reflect permanent
book/tax differences and income and gains available for distributions under
income tax regulations. Net investment income, net realized gains and net assets
were not
14
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
affected by this change; (j) the Fund intends to comply with the applicable
provisions of the Internal Revenue Code of 1986, as amended, pertaining to
regulated investment companies and to make distributions of taxable income
sufficient to relieve it from substantially all Federal income and excise taxes;
and (k) estimates and assumptions are required to be made regarding assets,
liabilities and changes in net assets resulting from operations when financial
statements are prepared. Changes in the economic environment, financial markets
and any other parameters used in determining these estimates could cause actual
results to differ.
2. INVESTMENT ADVISORY AGREEMENT, ADMINISTRATION AGREEMENT AND OTHER
TRANSACTIONS
Mutual Management Corp. ("MMC"), formerly known as Smith Barney Mutual
Funds Management Inc., a subsidiary of Salomon Smith Barney Holdings Inc.
("SSBH"), acts as investment adviser of the Fund. The Fund pays MMC an
investment advisory fee calculated at an annual rate of 0.30% of the average
daily net assets. MMC also acts as the Fund's administrator for which the Fund
pays a fee calculated at an annual rate of 0.20% of the average daily net
assets. These fees are calculated daily and paid monthly.
Pursuant to a Distribution Plan, the Fund pays Smith Barney Inc. ("SB"),
another subsidiary of SSBH, a service fee calculated at an annual rate of 0.25%
of the average daily net assets.
All officers and one Trustee of the Trust are employees of SB.
3. INVESTMENTS
During the year ended November 30, 1997, the aggregate cost of purchases
and proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $ 9,874,403
- --------------------------------------------------------------------------------
Sales 23,671,910
================================================================================
At November 30, 1997, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were substantially
as follows:
================================================================================
Gross unrealized appreciation $15,272,063
================================================================================
Gross unrealized depreciation (92,018)
- --------------------------------------------------------------------------------
Net unrealized appreciation $15,180,045
================================================================================
15
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
4. REPURCHASE AGREEMENTS
The Fund purchases (and its custodian takes possession of) U.S. government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires continual maintenance
of the market value of the collateral in amounts at least equal to the
repurchase price.
5. SHARES OF BENEFICIAL INTEREST
At November 30, 1997, the Fund had an unlimited number of shares of
beneficial interest authorized with a par value of $0.001 per share. The Fund,
the Zeros Plus Emerging Growth Series 2000 and the Security and Growth Fund each
constitute a sub-trust under the Master Trust Agreement. Transactions in shares
of the Fund were as follows:
Year Ended Year Ended
November 30, 1997 November 30, 1996
================================================================================
Shares issued on reinvestment 675,747 1,838,422
Shares redeemed (2,184,506) (1,821,367)
- --------------------------------------------------------------------------------
Net Increase (Decrease) (1,508,759) 17,055
================================================================================
16
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of beneficial interest outstanding throughout each year:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 7.52 $ 7.91 $ 7.75 $ 9.38 $ 9.02
- ------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.38 0.38 0.36 0.41 0.38
Net realized and unrealized gain (loss) 0.49 0.45 1.03 (0.70) 0.48
- ------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 0.87 0.83 1.39 (0.29) 0.86
- ------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.01) (0.78) (0.40) (0.45) (0.40)
Net realized gains (0.52) (0.44) (0.83) (0.89) (0.10)
- ------------------------------------------------------------------------------------------------
Total Distributions (0.53) (1.22) (1.23) (1.34) (0.50)
- ------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 7.86 $ 7.52 $ 7.91 $ 7.75 $ 9.38
- ------------------------------------------------------------------------------------------------
Total Return 11.60% 11.03% 19.93% (3.69)% 9.99%
- ------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $86,097 $93,793 $98,513 $101,388 $136,576
- ------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.95% 0.95% 1.05% 1.01% 0.97%
Net investment income 4.66 4.67 4.59 4.47 4.15
- ------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 11% 12% 13% 10% 17%
================================================================================================
Average commissions per share
paid on equity transactions(1) $ 0.06 $ 0.06 $ 0.06 -- --
================================================================================================
</TABLE>
(1) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
17
<PAGE>
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
The Shareholders and Board of Trustees of
Smith Barney Principal Return Fund:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Zeros and Appreciation Series 1998
of Smith Barney Principal Return Fund as of November 30, 1997, the related
statement of operations for the year then ended, the statements of changes in
net assets for each of the years in the two-year period then ended and the
financial highlights for each of the years in the three-year period then ended.
These financial statements and financial highlights are the responsibility of
the Fund's management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audits. The financial
highlights for each of the years in the two-year period ended November 30, 1994,
were audited by other auditors whose report thereon, dated January 12, 1995,
expressed an unqualified opinion on those financial highlights.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
November 30, 1997, by correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of the
Zeros and Appreciation Series 1998 of Smith Barney Principal Return Fund as of
November 30, 1997, the results of its operations for the year then ended, the
changes in its net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the three-year
period then ended, in conformity with generally accepted accounting principles.
/S/ KPMG Peat Marwick LLP
New York, New York
January 15, 1998
18
<PAGE>
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
For Federal tax purposes the Fund hereby designates for the fiscal year
ended November 30, 1997:
o long-term capital gain distributions paid $4,752,668.
o 18.24% of the ordinary dividends paid as qualifying for the
corporate dividends received deduction.
A total of 16.05% of the ordinary dividends paid by the Fund has been
derived from the Federal obligations and may be exempt from taxation at the
state level.
19
<PAGE>
SMITH BARNEY
------------
Smith Barney
Principal Return Fund A Member of TravelersGroup[LOGO]
Trustees
Paul R. Ades
Herbert Barg
Dwight B. Crane
Frank Hubbard
Heath B. McLendon, Chairman
Jerome Miller
Ken Miller
John F. White
Allan R. Johnson, Emeritus
Officers
Heath B. McLendon
Chief Executive Officer
Lewis E. Daidone
Senior Vice President
and Treasurer
Harry D. Cohen
Vice President and
Investment Officer
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
Investment Adviser
Mutual Management Corp.
Distributor
Smith Barney Inc.
Custodian
PNC Bank, N.A.
This report is submitted for the general information of the shareholders of
Smith Barney Principal Return Fund -- Zeros and Appreciation Series 1998. It is
not authorized for distribution to prospective investors unless accompanied or
preceded by a current Prospectus for the Fund, which contains information
concerning the Fund's investment policies and expenses as well as other
pertinent information.
Smith Barney
Principal Return Fund
388 Greenwich Street
New York, New York 10013
www.smithbarney.com
FD0305 1/98
ANNUAL REPORT
1997
1997
1997
1997
1997
Smith Barney
Principal Return Fund
Zeros Plus
Emerging Growth
Series 2000
--------------------------------------------------------------
November 30,1997
[LOGO] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
- --------------------------------------------------------------------------------
Zeros Plus Emerging Growth Series 2000
- --------------------------------------------------------------------------------
Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney
Principal Return Fund Zeros Plus Emerging Growth Series 2000 ("Fund") for the
year ended November 30, 1997. For your convenience, we have summarized the
Fund's investment strategy during this period. A comprehensive summary of
performance and current holdings can be found in the appropriate sections that
follow.
Fund Performance Update
The Fund seeks to return the principal amount of each shareholder's original
investment (including any sales charges paid) on or about February 28, 2000, by
investing a portion of its assets in zero-coupon U.S. Treasury bonds. In
addition, the Fund, to the extent consistent with its objective, seeks to
provide long-term appreciation of capital by investing the balance of its assets
primarily in the equity securities issued by emerging growth companies. These
emerging growth companies are usually small- to medium-sized firms that we
believe will have significant profit potential in a relatively short period of
time.
For the one-year period ended November 30, 1997, the Fund posted a total return
of 12.28%. For the same period the Russell 2000 Index* and the Value Line
Composite Geometric Index**, two measures of performance which are more
representative of the equity portion of the portfolio, advanced 23.41% and
19.66%, respectively. The Lehman Brothers Intermediate Term Government Bond
Index*** advanced 6.28% for the one-year period ended November 30, 1997.
Emerging growth stocks currently comprise approximately 45% of the net assets of
the Fund with the remaining balance accounted for by zero coupon U.S. Treasury
strips. In addition, over the last 12 months, the Fund paid a capital gain
dividend of $1.23 per share.
Market Overview
For the past several years, investors have displayed a decided preference for
the shares of large-capitalization companies. A brief period of outperformance
for small- and mid-capitalization stocks occurred from May into September
following an approximate 10% advance in the Russell 2000 Index in May. In the
- ----------
* The Russell 2000 Index is made up of 2,000 smaller-capitalized U.S.-based
companies whose common stocks trade on either the New York, American or
Nasdaq stock exchanges.
** The Value Line Geometric Composite Index is composed of 1,700 stocks
tracked by the Value Line Investment Survey.
*** Lehman Brothers Intermediate Term Government Bond Index is comprised of
approximately 1,000 issues of U.S. Government Treasury and Agency
securities.
1
<PAGE>
summer, a series of earnings disappointments announced by several highly visible
blue-chip companies served to highlight the favorable valuation characteristics
enjoyed by many lesser known, smaller-sized companies. In addition, the strength
of the U.S. dollar versus other major currencies adversely affected the earnings
of the many large multinational companies. In fact, many smaller companies
derive a much greater percentage of their earnings from purely domestic
businesses and are thus insulated from exchange-rate pressures, unlike their
large-cap brethren.
While the U.S. economy has continued to perform almost flawlessly, characterized
by low rates of inflation, strong economic growth and strong corporate profits,
events in Asia began to cast an ominous pall over worldwide equity markets as
the summer drew to a close. Dramatic declines in many Asian currencies
contributed to sharp declines in their stock markets, fueling an overall decline
in wealth and contraction of economic activity in that region. The Asian
contagion has had a domino effect on other world stock markets with the
pervasive fear that companies that sell a portion of their goods to Asia would
witness a contraction in their own business.
For the first time since 1990, the U.S. stock market, as represented by the SAP
500, sustained more than a 10% correction. This was the fourth such correction
experienced by smaller company stocks since 1994. Following the stock market
lows in late October, the divergence in performance between large- and
small-company stocks returned with investors again displaying a preference for
larger stocks even though their earnings in many cases were more vulnerable to
the fallout from Asia than many domestic small-cap companies.
Investment Strategy and Market Outlook
In the Fund we continue to emphasize primarily young, innovative companies in
dynamic industries in the Fund that we think possess above-average growth in
earnings over the next few years. Moreover, the nearly 60% of the Fund invested
in U.S. Treasury securities can serve to cushion the downside during turbulent
markets such as the one which we have just experienced.
In 1998, U.S. economic growth may slow because of weaker exports to Asia.
However, slower growth may be mitigated by an increase in business with Europe
where economies seem to be firming. Despite a tight U.S. labor market and higher
employment cost, companies generally report an inability to raise prices because
of global competition. With the inflation outlook benign in 1998, we think that
long-term interest rates should remain low and the Federal Reserve Board should
maintain its steady monetary policy, especially given the precarious financial
condition of many Asian countries.
2
<PAGE>
We maintain significant Fund positions in health care-related equities whose
earnings are dependent on new product generation (i.e., Vertex Pharmaceuticals
and IDEC Pharmaceuticals), rather than a reliance on a strong global economy to
grow their earnings. We believe telecommunications suppliers such as California
Microwave and C-COR Electronics, which provide products that quickly transmit
data, voice and video, should be strong performers in the upcoming year given
the burgeoning growth in that market.
In sum, while overall corporate earnings may come under some pressure because of
weak business conditions in Asia, those companies that are able to report
favorable relative earnings will likely see their P/E ratios rise in a low
inflation and low interest rate environment. We believe the Fund is positioned
to benefit from these expected conditions.
In closing, thank you for your continued confidence in our investment-management
approach. We look forward to helping you pursue your financial goals in the
years ahead.
Sincerely,
/s/ Heath B. McLendon /s/ Richard A. Freeman
Heath B. McLendon Richard A. Freeman
Chairman Vice President and
Investment Officer
December 19, 1997
3
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance
- --------------------------------------------------------------------------------
Net Asset Value
------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
================================================================================
11/30/97 $8.63 $8.46 $0.00 $1.23 12.28%
- --------------------------------------------------------------------------------
11/30/96 9.28 8.63 0.57 0.22 1.55
- --------------------------------------------------------------------------------
11/30/95 8.15 9.28 0.27 0.35 22.17
- --------------------------------------------------------------------------------
11/30/94 9.00 8.15 0.34 0.50 (0.20)
- --------------------------------------------------------------------------------
11/30/93 8.16 9.00 0.29 0.09 15.72
- --------------------------------------------------------------------------------
11/30/92 7.57 8.16 0.10 0.00 9.15
- --------------------------------------------------------------------------------
8/30/91*-11/30/91 7.60 7.57 0.00 0.00 (0.39)+
================================================================================
Total $1.57 $2.39
================================================================================
It is the Fund's policy to distribute dividends and capital gains, if any,
annually.
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
Without With
Sales Charge(1) Sales Charge(2)
================================================================================
Year Ended 11/30/97 12.28% 6.72%
- --------------------------------------------------------------------------------
Five Years Ended 11/30/97 9.98 8.85
- --------------------------------------------------------------------------------
8/30/91* through 11/30/97 9.36 8.45
================================================================================
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Without
Sales Charge(1)
================================================================================
8/30/91* through 11/30/97 74.92%
================================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable sales charge.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, shares reflect the deduction of the
maximum initial sales charge of 5.00%.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
* Commencement of operations.
4
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Shares of the
Zeros Plus Emerging Growth Series 2000
vs. Value Line Composite Index and
Lehman Brothers Intermediate Term Government Bond Index+
- --------------------------------------------------------------------------------
August 1991 -- November 1997
[THE FOLLOWING TABLE WAS DEPICTED AS A LINE CHART IN THE PRINTED MATERIAL]
+ Hypothetical illustration of $10,000 invested in shares of the Zeros Plus
Emerging Growth Series 2000 from August 30, 1991 (commencement of
operations), assuming deduction of the maximum 5.00% sales charge at the
time of investment and reinvestment of dividends and capital gains, if
any, at net asset value through November 30, 1997. The Value Line
Composite Index - Geometric, composed of approximately 1,700 stocks, is a
geometric average of the daily price percentage change in each stock
covering both large and small capitalized companies. The Lehman Brothers
Intermediate Term Government Bond Index is comprised of approximately
1,000 issues of U.S. Government Treasury and Agency securities. These
indexes are unmanaged and are not subject to the same management and
trading expenses of a mutual fund.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital gains.
5
<PAGE>
- --------------------------------------------------------------------------------
Portfolio Highlights (unaudited) November 30, 1997
- --------------------------------------------------------------------------------
Common Stock Industry Breakdown
(as a percentage of total common stocks)
[THE FOLLOWING TABLE WAS DEPICTED AS A PIE CHART IN THE PRINTED MATERIAL]
Biotechnology 20.6%
Telecommunications 16.3%
Capital Goods 10.5%
Drug Delivery 2.8%
Technology 29.0%
Pharmaceuticals 20.8%
Top Ten Holdings
Percentage of
Total Investments
================================================================================
U.S. Treasury Strips 55.5%
Tyco International Ltd. 4.7
Genzyme Corp. - General Division 4.6
IDEC Pharmaceuticals Corp. 4.5
Quantum Corp. 4.3
C-COR Electronics, Inc. 4.0
Chiron Corp. 3.7
Tech-Sym Corp. 3.4
California Microwave, Inc. 3.3
Vertex Pharmaceuticals, Inc. 3.3
================================================================================
6
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments November 30, 1997
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
COMMON STOCKS -- 44.5%
================================================================================
Biotechnology -- 9.1%
120,000 Chiron Corp.+ $ 2,182,500
100,000 Gensia Sicor Inc.+ 506,250
100,000 Genzyme Corp. - General Division+ 2,681,250
3,000 Genzyme Corp. - Tissue Repair+ 22,875
- --------------------------------------------------------------------------------
5,392,875
- --------------------------------------------------------------------------------
Capital Goods -- 4.7%
70,000 Tyco International Ltd. 2,747,500
- --------------------------------------------------------------------------------
Drug Delivery -- 1.3%
100,000 Advanced Polymer Systems, Inc.+ 737,500
- --------------------------------------------------------------------------------
Pharmaceuticals -- 9.3%
20,000 Forest Laboratories Inc., Class A Shares+ 895,000
75,000 IDEC Pharmaceuticals Corp.+ 2,620,312
70,000 Vertex Pharmaceuticals, Inc.+ 1,938,125
- --------------------------------------------------------------------------------
5,453,437
- --------------------------------------------------------------------------------
Technology -- 12.9%
100,000 Excel Technology Inc.+ 1,262,500
95,000 Quantum Corp.+ 2,529,375
66,500 Tech-Sym Corp.+ 2,015,781
80,000 VLSI Technology, Inc.+ 1,800,000
- --------------------------------------------------------------------------------
7,607,656
- --------------------------------------------------------------------------------
Telecommunications -- 7.2%
104,500 California Microwave, Inc.+ 1,933,250
150,050 C-COR Electronics, Inc.+ 2,325,775
- --------------------------------------------------------------------------------
4,259,025
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost-- $14,681,008) 26,197,993
================================================================================
FACE
AMOUNT SECURITY VALUE
================================================================================
U.S. GOVERNMENT OBLIGATIONS -- 55.5%
$37,000,000 U.S. Treasury Strips, zero coupon due 2/15/00
(Cost -- $31,068,070) 32,629,930
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $45,749,078*) $58,827,923
================================================================================
+ Non-income producing security.
* Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
7
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities November 30, 1997
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost -- $45,749,078) $ 58,827,923
Receivable for securities sold 568,209
- --------------------------------------------------------------------------------
Total Assets 59,396,132
- --------------------------------------------------------------------------------
LIABILITIES:
Payable to bank 488,536
Investment advisory fees payable 17,688
Administration fees payable 8,844
Payable for Fund shares purchased 4,742
Distribution fees payable 2,071
Accrued expenses 36,490
- --------------------------------------------------------------------------------
Total Liabilities 558,371
- --------------------------------------------------------------------------------
Total Net Assets $58,837,761
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 6,957
Capital paid in excess of par value 43,654,764
Undistributed net investment income 1,930,992
Accumulated net realized gain on security transactions 166,203
Net unrealized appreciation of investments 13,078,845
- --------------------------------------------------------------------------------
Total Net Assets $58,837,761
================================================================================
Shares Outstanding 6,957,549
- --------------------------------------------------------------------------------
Net Asset Value (and redemption price) $8.46
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
8
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended November 30, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $ 2,629,530
Dividends 9,000
- --------------------------------------------------------------------------------
Total Investment Income 2,638,530
- --------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2) 249,071
Distribution fees (Note 2) 155,670
Administration fees (Note 2) 124,536
Shareholder and system servicing fees 68,551
Audit and Legal 23,475
Shareholder communications 17,063
Trustees' fees 9,159
Registration fees 4,863
Custody 2,906
Other 5,836
- --------------------------------------------------------------------------------
Total Expenses 661,130
- --------------------------------------------------------------------------------
Net Investment Income 1,977,400
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS (NOTE3):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 17,851,382
Cost of securities sold 10,541,806
- --------------------------------------------------------------------------------
Net Realized Gain 7,309,576
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments:
Beginning of year 15,177,124
End of year 13,078,845
- --------------------------------------------------------------------------------
Decrease in Net Unrealized Appreciation (2,098,279)
- --------------------------------------------------------------------------------
Net Gain on Investments 5,211,297
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $7,188,697
================================================================================
See Notes to Financial Statements.
9
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended November 30,
- --------------------------------------------------------------------------------
1997 1996
================================================================================
OPERATIONS:
Net investment income $1,977,400 $2,191,296
Net realized gain 7,309,576 1,363,972
Increase in net unrealized appreciation (2,098,279) (2,664,005)
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 7,188,697 891,263
- --------------------------------------------------------------------------------
DISTRIBUTION TO SHAREHOLDERS FROM:
Net investment income -- (4,363,626)
Net realized gains (7,551,121) (1,632,152)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (7,551,121) (5,995,778)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net asset value of shares issued for
reinvestment of dividends 7,366,972 5,862,983
Cost of shares reacquired (13,598,864) (11,889,570)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (6,231,892) (6,026,587)
- --------------------------------------------------------------------------------
Decrease in Net Assets (6,594,316) (11,131,102)
NET ASSETS:
Beginning of year 65,432,077 76,563,179
- --------------------------------------------------------------------------------
End of year* $58,837,761 $65,432,077
================================================================================
* Includes undistributed (overdistributed)
net investment income of: $1,930,992 $(46,408)
================================================================================
See Notes to Financial Statements.
10
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Zeros Plus Emerging Growth Series 2000 ("Fund") is a separate
investment fund of the Smith Barney Principal Return Fund ("Trust"). The Trust,
a Massachusetts business trust, is registered under the Investment Company Act
of 1940, as amended, as a diversified, open-end management investment company.
Shares of the Fund are not currently offered for sale to new investors. The
Trust consists of this Fund and two other funds: Zeros and Appreciation Series
1998 and Security and Growth Fund. The financial statements and financial
highlights for the other funds are presented in separate annual reports.
The significant accounting policies consistently followed by the Fund
are:(a) security transactions are accounted for on the trade date; (b)
securities traded on a national securities exchange are valued at the last sale
price on that exchange or, if there were no sales, at the current quoted bid
price; over-the-counter securities and listed securities are valued at the bid
price at the close of business on each day; U.S. government securities (other
than short-term securities) are valued at the quoted bid price in the
over-the-counter market; investment in securities for which market quotations
are not available are valued at fair value as determined by the Board of
Trustees; (c) securities maturing within 60 days are valued at cost plus
accreted discount, or minus amortized premium, which approximates value; (d)
interest income, adjusted for amortization of premium and accretion of discount,
is recorded on an accrual basis; (e) dividend income is recorded on the
ex-dividend date; foreign income dividends are recorded on the ex-dividend date
or as soon as practical after the Fund determines the existence of a dividend
declaration after exercising reasonable due diligence; (f) the accounting
records of the Fund are maintained in U.S. dollars. All assets and liabilities
denominated in foreign currencies are translated into U.S. dollars based on the
rate of exchange of such currencies against U.S. dollars on the date of
valuation. Purchases and sales of securities, and income and expenses are
translated at the rate of exchange quoted on the respective date that such
transactions are recorded. Differences between income and expense amounts
recorded and collected or paid are adjusted when reported by the custodian bank;
(g) gains or losses on the sale of securities are calculated by using the
specific identification method; (h) dividends and distributions to shareholders
are recorded on the ex-dividend date; (i) the character of income and gains to
be distributed are determined in accordance with income tax regulations which
may differ from generally accepted accounting principles; (j) the Fund intends
to comply with the applicable provisions of the Internal Revenue Code of 1986,
as amended,
11
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
pertaining to regulated investment companies and to make distributions of
taxable income sufficient to relieve it from substantially all Federal income
and excise taxes; and (k) estimates and assumptions are required to be made
regarding assets, liabilities and changes in net assets resulting from
operations when financial statements are prepared. Changes in the economic
environment, financial markets and any other parameters used in determining
these estimates could cause actual results to differ.
2. INVESTMENT ADVISORY AGREEMENT, ADMINISTRATION AGREEMENT AND OTHER
TRANSACTIONS
Mutual Management Corp. ("MMC"), formerly known as Smith Barney Mutual
Funds Management Inc., a subsidiary of Salomon Smith Barney Holdings Inc.
("SSBH"), acts as investment adviser of the Fund. The Fund pays MMC an
investment advisory fee calculated at an annual rate of 0.40% of the average
daily net assets. MMC also acts as the Fund's administrator for which the Fund
pays a fee calculated at an annual rate of 0.20% of the average daily net
assets. These fees are calculated daily and paid monthly.
Pursant to a Distribution Plan, the Fund pays Smith Barney Inc. ("SB"),
another subsidiary of SSBH, a service fee calculated at an annual rate of 0.25%
of the average daily net assets.
All officers and one Trustee of the Trust are employees of SB.
3. INVESTMENTS
During the year ended November 30, 1997, the aggregate cost of purchases
and proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $ 0
- --------------------------------------------------------------------------------
Sales 17,851,382
================================================================================
At November 30, 1997, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were substantially
as follows:
================================================================================
Gross unrealized appreciation $13,089,252
Gross unrealized depreciation (10,407)
- --------------------------------------------------------------------------------
Net unrealized appreciation $13,078,845
================================================================================
12
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
4. REPURCHASE AGREEMENTS
The Fund purchases (and its custodian takes possession of) U.S. government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires continual maintenance
of the market value of the collateral in amounts at least equal to the
repurchase price.
5. SHARES OF BENEFICIAL INTEREST
At November 30, 1997, the Fund had an unlimited number of shares of
beneficial interest authorized with a par value of $0.001 per share. The Fund,
Zeros and Appreciation Series 1998 and Security and Growth Fund each constitutes
a sub-trust under the Master Trust Agreement.
Transactions in shares of the Fund were as follows:
Year Ended Year Ended
November 30, 1997 November 30, 1996
================================================================================
Shares issued on reinvestment 854,637 662,288
Shares redeemed (1,476,738) (1,335,970)
- --------------------------------------------------------------------------------
Net Decrease (622,101) (673,682)
================================================================================
13
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of beneficial interest outstanding throughout each year:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
===================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $8.63 $9.28 $8.15 $9.00 $8.16
- ---------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.28 0.30 0.27 0.27 0.26
Net realized and unrealized gain (loss) 0.78 (0.16) 1.48 (0.28)
- ---------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 1.06 0.14 1.75 (0.01) 1.22
- ---------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income -- (0.57) (0.27) (0.34) (0.29)
Net realized gains (1.23) (0.22) (0.35) (0.50) (0.09)
- ---------------------------------------------------------------------------------------------------
Total Distributions (1.23) (0.79) (0.62) (0.84) (0.38)
- ---------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $8.46 $8.63 $9.28 $8.15 $9.00
- ---------------------------------------------------------------------------------------------------
Total Return 12.28% 1.55% 22.17% (0.20)% 15.72%
- ---------------------------------------------------------------------------------------------------
Net Assets, End of Year (millions) $59 $65 $77 $75 $97
- ---------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.05% 1.11% 1.17% 1.15% 1.10%
Net investment income 3.15 3.15 3.12 3.27 3.12
- ---------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 0% 0% 6% 1% 0%
- ---------------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(1) $0.06 $0.06 $0.06 -- --
===================================================================================================
</TABLE>
(1) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
14
<PAGE>
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
The Shareholders and Board of Trustees of
Smith Barney Principal Return Fund:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Zeros Plus Emerging Growth Series
2000 of Smith Barney Principal Return Fund as of November 30, 1997, and the
related statement of operations for the year then ended and the statements of
changes in net assets for each of the years in the two-year period then ended
and financial highlights for each of the years in the three-year period then
ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits. The financial highlights for each of the years in the two-year period
ended November 30, 1994, were audited by other auditors whose report thereon,
dated January 12, 1995 expressed an unqualified opinion on those financial
highlights.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
November 30, 1997, by correspondence with the custodian. As to securities sold
but not delivered, we performed other appropriate auditing procedures. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of the
Zeros Plus Emerging Growth Series 2000 of Smith Barney Principal Return Fund as
of November 30, 1997, and the results of its operations for the year then ended
and the changes in its net assets for each of the years in the two-year period
then ended and financial highlights for each of the years in the three-year
period then ended, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwich LLP
New York, New York
January 15,1998
15
<PAGE>
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
For Federal tax purposes the Fund hereby designates for the fiscal year
ended November 30, 1997:
o long-term capital gain distributions paid of $7,551,121.
16
<PAGE>
Smith Barney SMITH BARNEY
Principal Return Fund ------------
A Member of TravelersGroup[LOGO]
Trustees Investment Manager
Paul R. Ades Mutual Management Corp.
Herbert Barg
Dwight B. Crane Distributor
Frank Hubbard
Heath B. McLendon, Chairman Smith Barney Inc.
Jerome Miller
Ken Miller Custodian
John F. White
PNCBank, N.A.
Allan R. Johnson, Emeritus
Officers This report is submitted for the
general information of the
Heath B. McLendon shareholders of Smith Barney
President and Principal Return Fund -- Zeros
Chief Executive Officer Plus Emerging Growth Series
2000. It is not authorized for
Lewis E. Daidone distribution to prospective
Senior Vice President investors unless accompanied or
and Treasurer preceded by a current Prospectus
for the Fund, which contains
Richard Freeman information concerning the
Vice President and Fund's investment policies and
Investment Officer expenses as well as other
pertinent information.
Thomas M. Reynolds
Controller
Christina T. Sydor Smith Barney
Secretary Principal Return Fund
388 Greenwich Street
New York, New York 10013
www.smithbarney.com
FD0306 1/98
ANNUAL REPORT
1997
1997
1997
1997
1997
Smith Barney
Principal
Return Fund
Security and
Growth Fund
--------------------------------------
November 30, 1997
[LOGO] Smith Barney Mutual Funds
Investing for your future.
Every Day.
<PAGE>
- ------------------------
Security and Growth Fund
- ------------------------
Dear Shareholder:
We are pleased to provide the annual report for the Smith Barney Principal
Return Fund - Security and Growth Fund ("Fund") for the year ended November 30,
1997. In this report, we comment on how your Fund has performed as well as our
near term expectations for the financial markets. For your convenience, a
detailed summary of the historical performance as well as its current holdings
can be found in the appropriate sections that follow.
Fund Performance Update
For the year ended November 30, 1997, the Fund had a total return of 16.42%. The
zero coupon bonds held in the Fund rose 7.67%. The zero coupon bonds represent
about 50% of the Fund's total portfolio and at maturity will be sufficient to
return the investor's original capital. The stock component of the Fund
appreciated roughly 25%. The closest benchmark to the portfolio of stocks held
in the Fund is the Russell 2000 Index (a common benchmark of small
capitalization stocks), which appreciated about 23% during the last year. We
believe the Fund posted solid returns in a volatile market environment.
The primary factors affecting the performance of the Fund included:
o A strong bond market. The bond market turned in its best performance since
1995. The zero coupon bonds held in the Fund rallied to a yield of just
under 6% by fiscal year end after backing up almost a full percent from
December 1996 to April 1997.
o A strong technology sector. We entered the year "overweighting" technology
because we felt prospects for the companies in this sector were favorable.
Technology stocks represented approximately 31% of the stock and cash
component of the portfolio. This compares to an approximate weighting of
16% in the Russell 2000 Index. This overweighted sector performed very
well during the small-cap rally from May to October.
o A weak health-care/biotechnology sector. We entered the year with a
roughly 21% in health care versus an approximate 10% weighting in the
Russell 2000 Index. This overweighted sector was basically flat over the
year with some stocks performing well and others performing poorly.
Market Outlook
The recent events in Asia, which have included currency devaluations and
financing problems for companies and countries, undoubtedly will affect both the
U.S. economy and the U.S. stock market. One of the key assumptions behind the
robust U.S. stock market in recent years was that demand, and especially demand
from Asia and other fast-growing areas, would provide
1
<PAGE>
revenue and earnings momentum for many companies especially leading U.S.
multinational companies that dominate the S&P 500 Index. (The S&P 500 Index is a
capitalization-weighted measure of 500 widely held common stocks.)
The bull market of 1991-1997 now seems in transition. Interest rates in the U.S.
have fallen and long-term Treasury bond prices have risen in response to the
perceived deflationary effects of the Asian crisis. Earnings growth prospects
for 1998 have been revised downward, and there has been a flight to quality, in
both the bond and stock market. Large U.S. multinational companies will probably
have their earnings negatively affected in the coming quarters, but because of
their large size, liquidity, and quality, their share prices have not been
materially impacted. In recent months, many smaller- and medium-capitalization
companies have seen their share prices decline rather substantially. If the
company's prospects are economically sensitive, the declines have often been
pronounced. Although the larger-capitalization companies have held up well, they
represent historically high valuations, as measured by high P/E ratios and low
yields. (A P/E ratio shows the relationship between a stock's price and the
company's earnings for the last four quarters.) As indicated previously, these
companies, in our judgment, will not be immune from recent developments in Asia.
The transition market we are in will ultimately reward a preservation of capital
and an ability to pick stocks with attractive investment possibilities. At some
point in 1998, we believe the smaller capitalization companies, especially those
sensitive to the economy, should provide the greatest returns. We believe
unusually attractive valuations are in the process of being created in this area
of the market. In the meantime, our more than 50% holdings of zero coupon U.S.
Treasuries provides a good hedge against present uncertainties in what we have
described as a "transitional stock market."
Investment Strategy
The Fund limits itself to no more than 25 core stock positions. In recent
months, we elected to take profits in a number of issues that had appreciated
significantly and neared our price targets. The net result was that by the end
of the year we had raised our cash level from roughly 1% to about 11% of net
assets. This figure understates the actual amount of cash raised, because we
maintain almost half of the portfolio in bonds. Cash actually represents about
22% of the stock and cash component of the portfolio. Because of our positive
outlook for the bond market, since June of this year, we let the U.S. Treasury
component of the portfolio grow relative to the required amount needed to insure
principal return at maturity. We have intentionally raised our cash position to
enable us to be able to take advantage of the stock market's transition phase.
2
<PAGE>
We expect the new stock market leadership eventually will center in those
smaller-to-mid sized companies that are sensitive to the economy and have
substantially more operating leverage than classic growth stocks. Technology,
for example, will continue to be an area of opportunity for the Fund. Certain
economically sensitive industry groups where capacity is under control may also
be attractive. Aluminum, paper and chemical industries may be areas of future
interest.
Over the last six months, the Fund's sector allocation has changed modestly.
Please note that our technology weighting increased from about 17% to roughly
19%, largely due to positive performance of the stocks in this sector. Basic
materials increased from an estimated 7% to about 9% as existing positions were
added to a new positions were created. All other sector weightings decreased as
existing positions were sold or reduced.
Over the last six months, the Fund's top ten holdings have changed modestly. We
would like to highlight the following:
o RMI Titanium became the largest position in the Fund as we purchased
additional shares over the last six months. RMI Titanium is a leader in
designing and fabricating titanium for aerospace, energy and power
applications. The company's shares came under pressure during the last six
months as one of their competitors signed a large contract with RMI's
largest customer, Boeing. This arrangement may limit the upside potential
of RMI business with Boeing. Our analysis indicates that emerging
opportunities in energy coupled with new military applications will more
than offset any potential slowing in Boeing business. RMI currently has a
substantial backlog with visibility through 1998. At seven times 1998
projected earnings of $3.05, two times book value, and 1.3 times sales, we
believe RMI has limited downside risk and substantial upside potential if
these new opportunities materialize.
o Quantum dropped from our largest position as we reduced our exposure by
about 42% over the last six months. Quantum is a leading manufacturer of
disk drives and back-up tape drives for personal computers and servers.
Quantum's second fiscal quarter release (October 21, 1997) revealed that
its execution was slightly ahead of our expectations as they reported
operating margins at 10.1% and earnings of $0.62 cents per share, fully
diluted. In our opinion, the stock market had anticipated these strong
results as Quantum's price per share had risen towards $40 prior to the
release. Although the longer term prospects for Quantum remain strong, its
share price had approached our near term target of 12 times forward 12
month earnings, and we elected to reduce our position.
3
<PAGE>
o Geoworks is a new addition to the top ten as well as new addition the
Fund's portfolio over the last six months. It is a leading supplier of
operating systems and application software to the portable
telecommunications industry. This emerging market is poised for rapid
growth in the next few years. Geoworks had licensed its technology to
major handset providers Nokia, Toshiba, Ericsson, NEC and Mitsubishi as
well as major service providers worldwide. Our position was established
when the market capitalization of the company was about $110 million with
about $30 million of this comprising cash. We were effectively paying $80
million for a company that could generate $500 million in revenues in the
next five years and whose business model is patterned after Microsoft.
o Other significant changes to the Fund's portfolio included the sale of
Adflex and Home Shopping Network that had reached our long-term price
target. Lone Star Steakhouse was added to the portfolio, and the position
of Asia Pacific Resources was increased.
We thank you for your investment in the Smith Barney Principal Return Fund
Security and Growth Fund. We are pleased with its progress and believe the Fund
is well positioned to take advantage of the opportunities we see developing in
today's market.
Sincerely,
/s/ Heath B. McLendon /s/ John G. Goode
Heath B. McLendon John G. Goode
Chairman Vice President and
Investment Officer
December 31, 1997
4
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance
- --------------------------------------------------------------------------------
Net Asset Value
-------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
================================================================================
11/30/97 $10.22 $10.12 $0.03 $1.75 16.42%
- --------------------------------------------------------------------------------
11/30/96 10.68 10.22 0.62 0.99 11.15
- --------------------------------------------------------------------------------
3/30/95* - 11/30/95 9.60 10.68 0.00 0.14 12.70+
================================================================================
Total $0.65 $2.88
================================================================================
It is the Fund's policy to distribute dividends and capital gains, if any,
annually.
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
Without With
Sales Charge(1) Sales Charge(2)
================================================================================
Year Ended 11/30/97 16.42% 11.72%
- --------------------------------------------------------------------------------
3/30/95* through 11/30/97 15.15 13.41
================================================================================
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Without
Sales Charge(1)
================================================================================
3/30/95* through 11/30/97 45.83%
================================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value and does not reflect the deduction of the
applicable sales charge.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, shares reflect the deduction of the
maximum initial sales charge of 4.00%.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
* Commencement of operations.
5
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Shares of the
Security and Growth Fund vs. Standard & Poor's 500 Index,
Lehman Brothers Intermediate Term Government Bond Index and
Russell 2000 Index+
- --------------------------------------------------------------------------------
March 1995 -- November 1997
[The following table was represented as a line graph in the printed material.]
Lehman Bros.
S&P 500 Intermediate Term Russell 2000
SGF Index Gov't Index Index
- --------------------------------------------------------------------------------
3/30/95 9,600 10,000 10,000 10,000
5/95 10,170 10,653 10,401 10,398
11/95 10,819 12,237 10,877 11,963
5/96 12,030 13,679 10,873 14,131
11/96 12,026 15,644 11,493 13,938
5/97 12,131 17,706 11,647 15,115
11/30/97 14,000 20,104 12,214 17,201
+ Hypothetical illustration of $10,000 invested in shares of the Security
and Growth Fund from March 30, 1995 (commencement of operations), assuming
deduction of the maximum 4.00% sales charge at the time of investment and
reinvestment of dividends and capital gains, if any, at net asset value
through November 30, 1997. The Standard & Poor's 500 Index is an index of
widely held common stocks listed on the New York and American Stock
Exchanges and the over-the-counter markets. Figures for the index include
reinvestment of dividends. The Lehman Brothers Intermediate Term
Government Bond Index is comprised of approximately 1,000 issues of U.S.
Government Treasury and Agency Securities. The Russell 2000 Index is a
capitalization weighted total return index which is comprised of 2,000 of
the smallest capitalized U.S. domiciled companies with less than average
growth orientation whose common stock is traded in the United States on
the New York Stock Exchange, American Stock Exchange and NASDAQ. The
indexes are unmanaged and are not subject to the same management and
trading expenses of a mutual fund.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital gains.
6
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments November 30, 1997
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
COMMON STOCKS -- 41.8%
================================================================================
Computer Peripheral -- 4.6%
350,000 Quantum Corp. $ 9,318,750
- --------------------------------------------------------------------------------
Computer Software -- 8.3%
200,000 Adobe Systems Inc. 8,400,000
425,000 Geoworks Corp.* 5,445,313
250,000 Infinium Software Inc.* 3,250,000
667 Siebel Systems, Inc.* 27,750
- --------------------------------------------------------------------------------
17,123,063
- --------------------------------------------------------------------------------
Electronics Semiconductor -- 2.6%
326,000 California Micro Devices Corp.* 1,996,750
100,000 Peak International Ltd.* 2,212,500
301,500 SEEQ Technology Inc. 1,055,250
- --------------------------------------------------------------------------------
5,264,500
- --------------------------------------------------------------------------------
Forest Products & Paper -- 1.8%
1,000,000 Asia Pacific Resource Inc., Class A Shares* 3,625,000
- --------------------------------------------------------------------------------
Manufacturing - Special -- 4.0%
400,000 Optical Coating Laboratory Inc. 6,025,000
2,727,272 Power Spectra Inc.*+ 1,534,090
2,000,000 Power Spectra Inc.*++@ 562,500
- --------------------------------------------------------------------------------
8,121,590
- --------------------------------------------------------------------------------
Medical Biotechnology -- 6.6%
370,000 Alteon Inc.* 2,104,375
181,500 Aphton Corp.*# 2,132,626
450,000 Neurex Corp.* 7,031,250
300,000 Onyx Pharmaceuticals Inc.* 2,175,000
- --------------------------------------------------------------------------------
13,443,251
- --------------------------------------------------------------------------------
Medical Supplies -- 1.7%
965,000 Metra Bio Systems Inc.* 3,558,438
- --------------------------------------------------------------------------------
Metals Diversified -- 7.2%
200,000 Alyn Corp.* 2,687,500
150,000 Commonwealth Industries Inc. 2,493,750
400,000 RMI Titanium Co.* 9,500,000
- --------------------------------------------------------------------------------
14,681,250
- --------------------------------------------------------------------------------
Oil & Gas - Domestic -- 1.4%
1,200,000 Abacan Resource Corp.* 2,775,000
- --------------------------------------------------------------------------------
Restaurants -- 3.6%
200,000 Lonestar Steakhouse* 3,725,000
700,000 Taco Cabana Inc., Class A Shares* 3,675,000
- --------------------------------------------------------------------------------
7,400,000
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
7
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) November 30, 1997
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Telecommunications -- 0.0%
5,800 Electric Lightwave Inc., Class A Shares* $ 92,800
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost -- $76,805,115) 85,403,642
================================================================================
FOREIGN STOCK -- 1.1%
296,000 Canadian Fracmaster Installment Receipts
(Cost -- $2,123,450) 2,287,320
================================================================================
FACE
AMOUNT SECURITY VALUE
================================================================================
U.S. TREASURY STRIPS -- 52.3%
$168,000,000 U.S. Treasury Strips, zero coupon due 8/15/05
(Cost -- $96,210,346) 107,088,240
================================================================================
REPURCHASE AGREEMENT -- 4.8%
9,832,000 Chase Manhattan Bank, 5.65% due 12/1/97; Proceeds at
maturity -- $9,836,627; (Fully collateralized by U.S.
Treasury Note, 5.00% due 1/31/99; Market value --
$10,028,692) (Cost -- $9,832,000) 9,832,000
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $184,970,911**) $204,611,202
================================================================================
* Non-income producing security.
+ Security issued with 2,727,272 warrants which are exercisable under
certain conditions and have a current value of $0 and a cost of $0.
++ Security is exempt from registration under Rule 144A of the Securities Act
of 1933. This security may be resold in transactions that are exempt from
registration, normally to qualified institutional buyers.
@ Security is valued by the Fund's Board of Directors (See Note 6).
# Security issued with 125,000 warrants which are exercisable under certain
conditions and have a current value of $0 and a cost of $0.
** Aggregate cost of Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
8
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities November 30, 1997
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost -- $184,970,911) $204,611,202
Cash 404
Receivable for securities sold 757,429
Dividends and interest receivable 28,628
- --------------------------------------------------------------------------------
Total Assets 205,397,663
- --------------------------------------------------------------------------------
LIABILITIES:
Payable for securities purchased 624,050
Distribution fees payable 201,916
Payable for Fund shares sold 25,590
Management fees payable 83,211
Accrued expenses 104,460
- --------------------------------------------------------------------------------
Total Liabilities 1,039,227
- --------------------------------------------------------------------------------
Total Net Assets $204,358,436
================================================================================
NET ASSETS:
Par value of shares of beneficial interest $ 20,198
Capital paid in excess of par value 178,388,874
Undistributed net investment income 4,947,372
Accumulated net realized gain from security transactions and
options 1,372,771
Net unrealized appreciation of investments and foreign
currencies 19,629,221
- --------------------------------------------------------------------------------
Total Net Assets $204,358,436
================================================================================
Shares Outstanding 20,197,849
- --------------------------------------------------------------------------------
Net Asset Value (and redemption price) $ 10.12
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
9
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended November 30, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $ 7,428,873
Dividends 165,667
- --------------------------------------------------------------------------------
Total Investment Income 7,594,540
- --------------------------------------------------------------------------------
EXPENSES:
Management fees (Note 2) 1,077,814
Distribution fees (Note 2) 538,907
Shareholder and system servicing fees 247,956
Shareholder communications 37,719
Audit and legal 25,835
Trustees' fees 20,640
Custody 11,607
Registration fees 4,204
Other 5,027
- --------------------------------------------------------------------------------
Total Expenses 1,969,709
- --------------------------------------------------------------------------------
Net Investment Income 5,624,831
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS,
FOREIGN CURRENCIES AND OPTIONS (NOTES 3 AND 5):
Realized Gain From:
Security transactions (excluding short-term securities) 29,756,644
Options written 158,677
- --------------------------------------------------------------------------------
Net Realized Gain 29,915,321
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments
and Foreign Currencies:
Beginning of year 23,964,662
End of year 19,629,221
- --------------------------------------------------------------------------------
Decrease in Net Unrealized Appreciation (4,335,441)
- --------------------------------------------------------------------------------
Net Gain on Investments, Foreign Currencies and Options 25,579,880
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 31,204,711
================================================================================
See Notes to Financial Statements.
10
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended November 30,
- --------------------------------------------------------------------------------
1997 1996
================================================================================
OPERATIONS:
Net investment income $ 5,624,831 $ 7,787,828
Net realized gain 29,915,321 23,428,478
Decrease in net unrealized appreciation (4,335,441) (2,101,994)
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 31,204,711 29,114,312
- --------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (497,465) (16,260,991)
Net realized gains (30,380,974) (21,493,619)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (30,878,439) (37,754,610)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 7):
Net asset value of shares issued
for reinvestment of dividends 30,210,679 36,941,093
Cost of shares reacquired (70,185,118) (94,116,308)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (39,974,439) (57,175,215)
- --------------------------------------------------------------------------------
Decrease in Net Assets (39,648,167) (65,815,513)
NET ASSETS:
Beginning of year 244,006,603 309,822,116
- --------------------------------------------------------------------------------
End of year* $ 204,358,436 $ 244,006,603
================================================================================
* Includes undistributed (overdistributed)
net investment income of: $ 4,947,372 $ (192,371)
================================================================================
See Notes to Financial Statements.
11
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Security and Growth Fund ("Fund") is a separate investment fund of the
Smith Barney Principal Return Fund ("Trust"). The Trust, a Massachusetts
business trust, is registered under the Investment Company Act of 1940, as
amended, as a diversified, open-end management investment company. Shares of the
Fund are not currently offered for sale to new investors. The Trust consists of
this Fund and two other funds: the Zeros and Appreciation Series 1998 and the
Zeros Plus Emerging Growth Series 2000. The financial statements and financial
highlights for the other funds are presented in separate annual reports.
The significant accounting policies consistently followed by the Fund
are: (a) security transactions are accounted for on the trade date; (b)
securities traded on a national securities exchange are valued at the last sale
price on that exchange or, if there were no sales, at the current quoted bid
price; over-the-counter securities and listed securities are valued at the bid
price at the close of business on each day; U.S. government securities are
valued at the quoted bid price in the over-the-counter market; investment in
securities for which market quotations are not available are valued at fair
value as determined by the Board of Trustees; (c) securities maturing within 60
days are valued at cost plus accreted discount, or minus amortized premium,
which approximates value; (d) interest income is recorded on the accrual basis
and dividend income is recorded on the ex-dividend date; foreign dividends are
recorded on the ex-dividend date or as soon as practical after the Fund
determines the existence of a dividend declaration after exercising reasonable
due diligence; (e) the accounting records of the Fund are maintained in U.S.
dollars. All assets and liabilities denominated in foreign currencies are
translated into U.S. dollars based on the rate of exchange of such currencies
against U.S. dollars on the date of valuation. Purchases and sales of
securities, and income and expenses are translated at the rate of exchange
quoted on the respective date that such transactions are recorded. Differences
between income and expense amounts recorded and collected or paid are adjusted
when reported by the custodian bank; (f) gains or losses on the sale of
securities are calculated by using the specific identification method; (g)
dividends and distributions to shareholders are recorded by the Fund on the
ex-dividend date; (h) the character of income and gains to be distributed are
determined in accordance with income tax regulations which may differ from
generally accepted accounting principles; (i) the Fund intends to comply with
the applicable provisions of the Internal Revenue Code of 1986, as amended,
pertaining to regulated investment companies and to make distributions of
taxable income sufficient to relieve it from substantially all Federal income
and excise taxes; and (j) estimates and assumptions are required to be made
regarding assets, liabilities and changes in net assets resulting from
operations when financial statements are prepared. Changes in the economic
environment, financial markets and any other parameters used in determining
these estimates could cause actual results to differ.
12
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
2. MANAGEMENT AGREEMENT AND OTHER TRANSACTIONS
Mutual Management Corp. ("MMC"), formerly known as Smith Barney Mutual
Funds Management Inc., a subsidiary of Salomon Smith Barney Holdings Inc.
("SSBH"), through its Davis Skaggs Investment Management division, acts as
investment manager of the Fund. The Fund pays MMC a management fee calculated at
an annual rate of 0.50% of the average daily net assets. This fee is calculated
daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SSBH, acts as distributor
of Trust shares.
Pursuant to a Distribution Plan, the Fund pays SB a service fee calculated
at an annual rate of 0.25% of the average daily net assets.
All officers and one Trustee of the Trust are employees of SB.
3. INVESTMENTS
During the year ended November 30, 1997, the aggregate cost of purchases
and proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $ 42,440,747
- --------------------------------------------------------------------------------
Sales 123,331,663
================================================================================
At November 30, 1997, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were substantially
as follows:
================================================================================
Gross unrealized appreciation $ 32,075,608
Gross unrealized depreciation (12,435,317)
- --------------------------------------------------------------------------------
Net unrealized appreciation $ 19,640,291
================================================================================
4. REPURCHASE AGREEMENTS
The Fund purchases (and its custodian takes possession of) U.S. government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires continual maintenance
of the market value of the collateral in amounts at least equal to the
repurchase price.
13
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
5. OPTION CONTRACTS
Premiums paid when put or call options are purchased by the Fund,
represent investments, which are marked-to-market daily. When a purchased option
expires, the Fund will realize a loss in the amount of the premium paid. When
the Fund enters into a closing sales transaction, the Fund will realize a gain
or loss depending on whether the proceeds from the closing sales transaction are
greater or less than the premium paid for the option. When the Fund exercises a
put option, they will realize a gain or loss from the sale of the underlying
security and the proceeds from such sale will be decreased by the premium
originally paid. When the Fund exercises a call option, the cost of the security
which the Fund purchases upon exercise will be increased by the premium
originally paid.
At November 30, 1997, the Fund held no purchased call or put options.
When the Fund writes a call or put option, an amount equal to the premium
received by the Fund is recorded as a liability, the value of which is
marked-to-market daily. When a written option expires, the Fund realizes a gain
equal to the amount of the premium received. When the Fund enters into a closing
purchase transaction, the Fund realizes a gain (or loss if the cost of the
closing purchase transaction exceeds the premium received when the option was
sold) without regard to any unrealized gain or loss on the underlying security,
and the liability related to such option is eliminated. When a written call
option is exercised the cost of the security sold will be decreased by the
premium originally received. When a written put option is exercised, the amount
of the premium originally received will reduce the cost of the security which
the Fund purchased upon exercise. When written index options are exercised,
settlement is made in cash.
The risk associated with purchasing options is limited to the premium
originally paid. The Fund enters into options for hedging purposes. The risk in
writing a call option is that the Fund gives up the opportunity to participate
in any increase in the price of the underlying security beyond the exercise
price. The risk in writing a put option is that the Fund is exposed to the risk
of loss if the market price of the underlying security declines.
The following covered call option transactions occurred during the year
ended November 30, 1997:
Number of
Premium Contracts
================================================================================
Options written, outstanding at November 30, 1996 $ 188,681 1,500
Options written during the year ended November 30, 1997 270,491 1,500
Options cancelled in closing purchase transactions (262,179) (2,000)
Options expired (196,993) (1,000)
- --------------------------------------------------------------------------------
Options written, outstanding at November 30, 1997 $ 0 0
================================================================================
14
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
6. SECURITY VALUED BY THE FUND'S BOARD OF DIRECTORS
The following security held by the Fund on November 30, 1997, is illiquid
and valued at fair value in good faith by, or under the direction of, the Fund's
Board of Directors taking into consideration the appropriate economic, financial
and other pertinent available information pertaining to this security.
Value Percentage
Acquisition Per Fair of Total
Security Date Shares Unit Value Net Assets Cost
================================================================================
Power Spectra Inc. 4/10/97 2,000,000 $0.28 $562,500 0.28% $500,000
================================================================================
7. SHARES OF BENEFICIAL INTEREST
At November 30, 1997, the Fund had an unlimited number of shares of
beneficial interest authorized with a par value of $0.001 per share. The Fund,
the Zeros and Appreciation Series 1998 and the Zeros Plus Emerging Growth Series
2000 each constitute a sub-trust under the Master Trust Agreement.
Transactions in shares of the Fund were as follows:
Year Ended Year Ended
November 30, 1997 November 30, 1996
================================================================================
Shares issued on reinvestment 2,947,383 3,534,156
Shares redeemed (6,617,924) (8,683,354)
- --------------------------------------------------------------------------------
Net Decrease (3,670,541) (5,149,198)
================================================================================
15
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of beneficial interest outstanding throughout each year:
1997 1996 1995(1)
================================================================================
Net Asset Value, Beginning of Year $ 10.22 $ 10.68 $ 9.60
- --------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.28 0.33 0.28
Net realized and unrealized gain 1.40 0.82 0.94
- --------------------------------------------------------------------------------
Total Income From Operations 1.68 1.15 1.22
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.03) (0.62) --
Net realized gains (1.75) (0.99) (0.14)
- --------------------------------------------------------------------------------
Total Distributions (1.78) (1.61) (0.14)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 10.12 $ 10.22 $ 10.68
- --------------------------------------------------------------------------------
Total Return 16.42% 11.15% 12.70%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 204,358 $ 244,007 $ 309,822
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.92% 0.99% 1.02%+
Net investment income 2.62 2.88 4.07+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 20% 43% 26%
- --------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions $ 0.04 $ 0.05 $ 0.06
================================================================================
(1) For the period from March 30, 1995 (commencement of operations) to
November 30, 1995.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
For Federal tax purposes the Fund hereby designates for the fiscal year
ended November 30, 1997:
o long term capital gain distributions paid of $11,275,834.
A total of 2.48% of the ordinary dividends paid by the Fund has been
derived from Federal obligations and may be exempt from taxation at the state
level.
16
<PAGE>
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
The Shareholders and Board of Trustees of
Smith Barney Principal Return Fund:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Security and Growth Fund of Smith
Barney Principal Return Fund as of November 30, 1997, and the related statement
of operations for the year then ended, the statements of changes in net assets
for each of the years in the two-year period then ended and financial highlights
for each of the years in the two-year period then ended and for the period from
March 30, 1995 (commencement of operations) to November 30, 1995. 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 securities owned as of
November 30, 1997, by correspondence with the custodian. As to securities
purchased or sold but not received or delivered, we performed other appropriate
auditing procedures. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of the
Security and Growth Fund of Smith Barney Principal Return Fund as of November
30, 1997, and the results of its operations for the year then ended, the changes
in its net assets for each of the years in the two-year period then ended and
financial highlights for each of the years in the two-year period then ended and
for the period from March 30, 1995 to November 30, 1995, in conformity with
generally accepted accounting principles.
/s/ KPMG Peat Marwich LLP
New York, New York
January 15, 1998
17
<PAGE>
SMITH BARNEY
A Member of TravelersGroup[LOGO]
Smith Barney
Principal Return Fund
Trustees
Paul R. Ades
Herbert Barg
Dwight B. Crane
Frank Hubbard
Heath B. McLendon, Chairman
Jerome Miller
Ken Miller
John F. White
Allan R. Johnson, Emeritus
Officers
Heath B. McLendon
President and
Chief Executive Officer
Lewis E. Daidone
Senior Vice President
and Treasurer
John G. Goode
Vice President and
Investment Officer
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
Investment Manager
Mutual Management Corp.
Distributor
Smith Barney Inc.
Custodian
PNC Bank, N.A.
This report is submitted for the general information of the shareholders of
Smith Barney Principal Return Fund -- Security and Growth Fund. It is not
authorized for distribution to prospective investors unless accompanied or
preceded by a current Prospectus for the Fund, which contains information
concerning the Fund's investment policies and expenses as well as other
pertinent information.
Smith Barney
Principal Return Fund
388 Greenwich Street
New York, New York 10013
www.smithbarney.com
FD01052 1/98
