<PAGE>
ANNUAL REPORT
1996
1996
1996
1996
1996
SMITH BARNEY
FUNDS, INC.
U.S. GOVERNMENT
SECURITIES PORTFOLIO
- --------------------
December 31, 1996
[LOGO] SMITH BARNEY MUTUAL FUNDS
Investing for your Future.
Every day.
- --------------------------------------------------------------------------------
U.S. Government Securities Portfolio
- --------------------------------------------------------------------------------
Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney Funds,
Inc. -- U.S. Government Securities Portfolio ("Portfolio") for the year ended
December 31, 1996. In this report, we summarize the period's prevailing economic
and market conditions and outline our portfolio strategy. A more detailed
summary of performance can be found in the appropriate sections that follow in
the report.
Portfolio Performance Update
For the year ended December 31, 1996, the Portfolio's Class A shares had a total
return of 3.97%, which was above its Lipper Analytical Services, Inc. peer group
total return average of 3.87%. (Lipper is an independent fund tracking
organization.) Moreover, over the past twelve months, the Portfolio distributed
dividends totaling $0.858 per share for Class A shares.
Market Update and Outlook
In our view, one of the most important events for the market in 1996 was the
unexpected strength of the U.S. economy during the first half of the year and
weaker economic growth during the second half. In addition to President
Clinton's re-election and Congress maintaining its Republican majority, other
significant market events in 1996 include the U.S. Treasury's plans to introduce
inflation-indexed securities, the Boskin Report that suggests inflation may be
roughly 1% lower than previously reported and Russian President Boris Yeltsin
surviving both medically and politically.
Looking ahead to 1997, we believe there may be some possible (although not
necessarily probable) market challenges on the horizon such as:
-- Data that indicates moderate to weaker economic growth
-- Continued ethics probes that negatively impact our political leaders
-- U.S. dollar coming under short-term pressure because of a failure to put
in place a credible fiscal plan
-- Renewed tension in the Middle East -- possibly oil related
-- Political problems resurfacing in Russia
In our opinion, the yield on the 30 Year U.S. Treasury bond should remain in a
broad range of 6%-7%. However, if any of the expected 1997 events outlined above
take place, the yield could temporarily rise above the 7% level. Ultimately, we
believe this would represent a buying opportunity because U.S.
economic fundamentals do not, in our view, warrant higher rates. The section
below shows how yields have changed during the reporting period.
Yields from U.S. Treasuries
12/31/95 12/31/96
-------- --------
2 Year U.S. Treasury Note 5.15% 5.87%
3 Year U.S. Treasury Note 5.21 6.01
5 Year U.S. Treasury Note 5.37 6.21
10 Year U.S. Treasury Bond 5.57 6.42
30 Year U.S. Treasury Bond 5.95 6.64
Portfolio's Investment Strategy
As interest rates rose during the first half of 1996, we slowly reduced the
Portfolio's weighting in mortgage-backed securities and increased our U.S.
Treasury holdings (specifically zero coupon Treasury strips and 10 Year
Treasuries). During September through November, these actions paid off as
interest rates declined. In early December, we sold the Portfolio's zero coupon
Treasury strips and 10 Year Treasuries and purchased 5 Year Treasuries and
mortgage-backed securities on the belief that interest rates had temporarily
declined as much as they would.
In closing, thank you for investing in the U.S. Government Securities Portfolio.
We look forward to continuing to help you achieve your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ James E. Conroy
Heath B. McLendon James E. Conroy
Chairman and Vice President
Chief Executive Officer
January 15, 1997
2
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Historical Performance -- Class A Shares
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<TABLE>
<CAPTION>
Net Asset Value
----------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
=============================================================================
<S> <C> <C> <C> <C> <C>
12/31/96 $13.59 $13.24 $ 0.86 $0.00 3.97%
- -----------------------------------------------------------------------------
12/31/95 12.50 13.59 0.92 0.00 16.52
- -----------------------------------------------------------------------------
12/31/94 13.66 12.50 0.91 0.05 (1.48)
- -----------------------------------------------------------------------------
12/31/93 13.87 13.66 0.98 0.11 6.40
- -----------------------------------------------------------------------------
12/31/92 14.10 13.87 1.08 0.08 6.85
- -----------------------------------------------------------------------------
12/31/91 13.22 14.10 1.13 0.05 16.29
- -----------------------------------------------------------------------------
12/31/90 13.17 13.22 1.18 0.00 9.95
- -----------------------------------------------------------------------------
12/31/89 12.56 13.17 1.21 0.00 15.11
- -----------------------------------------------------------------------------
12/31/88 12.68 12.56 1.20 0.00 8.72
- -----------------------------------------------------------------------------
12/31/87 13.89 12.68 1.31 0.24 2.67
=============================================================================
Total $10.78 $0.53
=============================================================================
</TABLE>
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Historical Performance -- Class B Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
===============================================================================
<S> <C> <C> <C> <C> <C>
12/31/96 $13.61 $13.26 $0.79 $0.00 3.44%
- -------------------------------------------------------------------------------
12/31/95 12.51 13.61 0.86 0.00 16.03
- -------------------------------------------------------------------------------
Inception*-12/31/94 12.47 12.51 0.21 0.00 2.04+
===============================================================================
Total $1.86 $0.00
===============================================================================
</TABLE>
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Historical Performance -- Class C Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
================================================================================
<S> <C> <C> <C> <C> <C>
12/31/96 $13.58 $13.23 $0.80 $0.00 3.49%
- --------------------------------------------------------------------------------
12/31/95 12.50 13.58 0.87 0.00 15.93
- --------------------------------------------------------------------------------
12/31/94 13.66 12.50 0.83 0.04 (2.11)
- --------------------------------------------------------------------------------
12/31/93 13.86 13.66 0.88 0.11 5.74
- --------------------------------------------------------------------------------
Inception*-12/31/92 14.01 13.86 0.30 0.00 1.07+
================================================================================
Total $3.68 $0.15
================================================================================
</TABLE>
3
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Historical Performance -- Class Y Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
===============================================================================
<S> <C> <C> <C> <C> <C>
12/31/96 $13.61 $13.27 $0.89 $0.00 4.30%
- -------------------------------------------------------------------------------
12/31/95 12.51 13.61 0.96 0.00 16.88
- -------------------------------------------------------------------------------
12/31/94 13.67 12.51 0.91 0.04 (1.53)
- -------------------------------------------------------------------------------
Inception*- 12/31/93 13.97 13.67 0.95 0.11 5.55+
===============================================================================
Total $3.71 $0.15
===============================================================================
</TABLE>
- --------------------------------------------------------------------------------
Historical Performance -- Class Z Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
---------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
================================================================================
<S> <C> <C> <C> <C> <C>
12/31/96 $13.60 $13.26 $0.89 $0.00 4.31%
- --------------------------------------------------------------------------------
12/31/95 12.50 13.60 0.95 0.00 16.89
- --------------------------------------------------------------------------------
Inception*-12/31/94 12.47 12.50 0.24 0.00 (2.15)+
================================================================================
Total $2.08 $0.00
================================================================================
</TABLE>
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS MONTHLY AND CAPITAL GAINS, IF
ANY, ANNUALLY.
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Without Sales Charge(1)
-------------------------------------------------
Class A Class B Class C Class Y Class Z
===============================================================================
<S> <C> <C> <C> <C> <C>
Year Ended 12/31/96 3.97% 3.44% 3.49% 4.30% 4.31%
- -------------------------------------------------------------------------------
Five Years Ended 12/31/96 6.29 N/A N/A N/A N/A
- -------------------------------------------------------------------------------
Ten Years Ended 12/31/96 8.35 N/A N/A N/A N/A
- -------------------------------------------------------------------------------
Inception* through 12/31/96 9.57 9.88 5.73 6.14 10.75
===============================================================================
<CAPTION>
Without Sales Charge(2)
-------------------------------------------------
Class A Class B Class C Class Y Class Z
===============================================================================
<S> <C> <C> <C> <C> <C>
Year Ended 12/31/96 (0.71)% (0.95)% 2.52% 4.30% 4.31%
- -------------------------------------------------------------------------------
Five Years Ended 12/31/96 5.33 N/A N/A N/A N/A
- -------------------------------------------------------------------------------
Ten Years Ended 12/31/96 7.85 N/A N/A N/A N/A
- -------------------------------------------------------------------------------
Inception* through 12/31/96 9.16 8.62 5.73 6.14 10.75
===============================================================================
</TABLE>
4
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Without Sales Charge(1)
================================================================================
<S> <C>
Class A (12/31/86 through 12/31/96) 122.92%
- --------------------------------------------------------------------------------
Class B (Inception* through 12/31/96) 22.47
- --------------------------------------------------------------------------------
Class C (Inception* through 12/31/96) 25.52
- --------------------------------------------------------------------------------
Class Y (Inception* through 12/31/96) 26.71
- --------------------------------------------------------------------------------
Class Z (Inception* through 12/31/96) 24.54
================================================================================
</TABLE>
(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 charges with respect to Class A shares or the contingent
deferred sales charges ("CDSC") with respect to Class B and C shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, Class A shares reflect the deduction
of the maximum initial sales charge of 4.50%; Class B shares reflect the
deduction of a 4.50% CDSC, which applies if shares are redeemed within one
year from initial purchase. This CDSC declines by 0.50% the first year
after purchase and thereafter by 1.00% per year until no CDSC is incurred.
Class C shares reflect the deduction of a 1.00% CDSC, which applies if
shares are redeemed within the first year of purchase.
* Inception dates for Class A, B, C, Y and Z shares are October 9, 1984,
November 7, 1994, December 2, 1992, January 12, 1993 and November 7, 1994,
respectively.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
5
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Class A Shares of the
U.S. Government Securities Portfolio vs.
Lehman Brothers GNMA Index+
- --------------------------------------------------------------------------------
December 1986 -- December 1996
[GRAPHIC]
<TABLE>
<CAPTION>
U.S. Government Lehman Brothers
Securities Portfolio GNMA Index
- --------------------------------------------------------------------------------
<S> <C> <C>
12/86 $ 9,599 $ 10,000
12/87 9,817 10,432
12/88 10,633 11,350
12/89 12,195 13,130
12/90 13,360 14,519
12/91 15,472 16,848
12/92 16,489 18,096
12/93 17,490 19,286
12/94 17,193 18,996
12/95 20,034 22,234
12/96 20,829 23,466
</TABLE>
+ Hypothetical illustration of $10,000 invested in Class A shares on December
31, 1986, assuming deduction of the maximum 4.00% sales charge in effect at
the time of investment and reinvestment of dividends (after deduction of
applicable sales charge through November 7, 1994, and thereafter at net asset
value) and capital gains, if any, at net asset value through December 31,
1996. The Lehman Brothers GNMA Index is composed of 15-year and 30-year fixed-
rate securities backed by mortgage pools of the Government National Mortgage
Association. The index is unmanaged and is not subject to the management and
trading expenses of a mutual fund. The performance of the Portfolio's other
classes may be greater or less than the Class A shares' performance indicated
on this chart, depending on whether greater or lesser sales charges and fees
were incurred by shareholders investing in other classes.
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
- --------------------------------------------------------------------------------
Schedule of Investments December 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
=============================================================================================
<S> <C> <C>
U.S. GOVERNMENT AND AGENCY OBLIGATIONS -- 96.3%
$18,000,000 U.S. Treasury Note, 5.875% due 11/30/01+ $ 17,746,560
13,000,000 U.S. Treasury Note, 5.875% due 2/15/04 12,663,950
50,900,000 U.S. Treasury Note, 6.500% due 10/15/06 51,186,058
63,757,000 U.S. Treasury Strips, zero coupon due 11/15/09 27,098,000
55,400,000 FNMA Principal Strips, zero coupon due 10/9/19 11,362,540
6,891,096 FNMA Certificates, 8.000% due 10/1/26++ 7,020,305
86,476,295 GNMA Certificates, 8.000% due 7/15/26++ 88,286,244
10,376,599 GNMA Certificates, 9.000% due 7/15/26++ 10,934,341
1,492,841 GNMA Certificates, 10.000% due 7/15/20++ 1,636,989
32,150,155 GNMA Certificates Platinum, 9.000% due 11/15/17 34,380,412
97,705,089 GNMA Certificates Platinum, 9.000% due 12/15/17+++ 104,482,890
928,254 GNMA II Certificates, 10.000% due 1/20/18++ 996,415
- ---------------------------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT AND
AGENCY OBLIGATIONS (Cost -- $367,634,711) 367,794,704
=============================================================================================
REPURCHASE AGREEMENTS -- 3.7%
292,000 Citibank, Inc., 6.900% due 1/2/97; Proceeds at maturity --
$292,112; (Fully collateralized by U.S. Treasury Notes,
5.750% due 12/31/98; Market value -- $297,849) 292,000
13,865,000 Morgan Stanley Group, Inc., 6.150% due 1/7/97; Proceeds at
maturity -- $13,881,580; (Fully collateralized by FNMA
Certificates, 6.085% due 12/1/33; Market value -- $14,142,088) 13,865,000
- ---------------------------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS
(Cost -- $14,157,000) 14,157,000
=============================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $381,791,711*) $381,951,704
=============================================================================================
</TABLE>
+ Security serves as collateral for the reverse repurchase agreement.
++ Maturity date shown represents the last in the range of maturity dates of
mortgage certificates owned.
+++ Security has been partially segregated by Custodian for reverse repurchase
agreements.
* Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
7
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities December 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS:
Investments, at value (Cost -- $381,791,711) $ 381,951,704
Cash 584
Receivable for Fund shares sold 69,573
Interest receivable 2,781,391
- ------------------------------------------------------------------------------
Total Assets 384,803,252
- ------------------------------------------------------------------------------
LIABILITIES:
Reverse repurchase agreements (Note 5) 17,865,000
Payable for Fund shares purchased 1,213,801
Management fees payable 177,100
Distribution fees payable 41,758
Accrued expenses 69,704
- ------------------------------------------------------------------------------
Total Liabilities 19,367,363
- ------------------------------------------------------------------------------
Total Net Assets $365,435,889
==============================================================================
NET ASSETS:
Par value of capital shares $ 275,899
Capital paid in excess of par value 368,628,571
Overdistributed net investment income (1,628)
Accumulated net realized loss from security transactions (3,626,946)
Net unrealized appreciation of investments 159,993
- ------------------------------------------------------------------------------
Total Net Assets $365,435,889
==============================================================================
Shares Outstanding:
Class A 23,547,951
- ------------------------------------------------------------------------------
Class B 845,510
- ------------------------------------------------------------------------------
Class C 1,303,489
- ------------------------------------------------------------------------------
Class Y 421,238
- ------------------------------------------------------------------------------
Class Z 1,471,678
- ------------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $13.24
- ------------------------------------------------------------------------------
Class B* $13.26
- ------------------------------------------------------------------------------
Class C** $13.23
- ------------------------------------------------------------------------------
Class Y (and redemption price) $13.27
- ------------------------------------------------------------------------------
Class Z (and redemption price) $13.26
- ------------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 4.71% of net asset value per share) $13.86
==============================================================================
</TABLE>
* Redemption price is NAV of Class B shares reduced by a 4.50% CDSC if shares
are redeemed within one year from initial purchase (See Note 2).
** Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
are redeemed within the first year of purchase.
See Notes to Financial Statements.
8
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended December 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest $ 29,553,889
Less: Interest expense (1,190,638)
- -----------------------------------------------------------------------
Total Investment Income 28,363,251
- -----------------------------------------------------------------------
EXPENSES:
Management fees (Note 2) 1,770,235
Distribution fees (Note 2) 1,069,472
Shareholder and system servicing fees 190,772
Shareholder communications 78,577
Registration fees 62,250
Custody 21,070
Audit and legal 15,655
Directors' fees 5,026
Other 7,132
- -----------------------------------------------------------------------
Total Expenses 3,220,189
- -----------------------------------------------------------------------
Net Investment Income 25,143,062
- -----------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS (NOTE 3):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 1,055,082,826
Cost of securities sold 1,054,125,646
- -----------------------------------------------------------------------
Net Realized Gain 957,180
- -----------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments:
Beginning of year 12,160,495
End of year 159,993
- -----------------------------------------------------------------------
Decrease in Net Unrealized Appreciation (12,000,502)
- -----------------------------------------------------------------------
Net Loss on Investments (11,043,322)
- -----------------------------------------------------------------------
Increase in Net Assets From Operations $ 14,099,740
=======================================================================
</TABLE>
See Notes to Financial Statements.
9
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended December 31,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
==========================================================================================
<S> <C> <C>
OPERATIONS:
Net investment income $ 25,143,062 $ 28,799,812
Net realized gain 957,180 9,369,017
Increase (decrease) in net unrealized appreciation (12,000,502) 26,284,851
- ------------------------------------------------------------------------------------------
Increase in Net Assets From Operations 14,099,740 64,453,680
- ------------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (25,585,330) (28,927,423)
- ------------------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (25,585,330) (28,927,423)
- ------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 7):
Net proceeds from sale of shares 12,294,423 29,154,430
Net asset value of shares issued in connection
with the transfer of Smith Barney Funds, Inc. --
Monthly Payment Government Portfolio's
net assets (Note 8) -- 42,151,893
Net asset value of shares issued for
reinvestment of dividends 14,678,816 17,079,838
Cost of shares reacquired (95,176,025) (92,097,436)
- ------------------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (68,202,786) (3,711,275)
- ------------------------------------------------------------------------------------------
Increase (Decrease) in Net Assets (79,688,376) 31,814,982
NET ASSETS:
Beginning of year 445,124,265 413,309,283
- ------------------------------------------------------------------------------------------
End of year* $365,435,889 $445,124,265
==========================================================================================
* Includes overdistributed net investment income of: $(1,628) $(100,007)
==========================================================================================
</TABLE>
See Notes to Financial Statements.
10
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
The U.S. Government Securities Portfolio ("Portfolio") is a separate
investment portfolio of the Smith Barney Funds, Inc. ("Fund"). The Fund, a
Maryland corporation, is registered under the Investment Company Act of 1940, as
amended, as a diversified, open-end management investment company. The Fund
consists of this Portfolio and three other separate investment portfolios:
Equity Income, Income Return Account and Short-Term U.S. Treasury Securities
Portfolios. The financial statements and financial highlights for the other
portfolios 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) U.S. Government
and Agency obligations are valued at the mean between the bid and asked prices;
(c) securities maturing within 60 days are valued at cost plus accreted
discount, or minus amortized premium, which approximates market value; (d)
interest income is recorded on the accrual basis; (e) gains or losses on the
sale of securities are calculated by using the specific identification method;
(f) direct expenses are charged to each class; management fees and general fund
expenses are allocated on the basis of relative net assets; (g) dividends and
distributions to shareholders are recorded on the ex-dividend date; (h) each
portfolio intends to comply with the applicable provisions of the Internal
Revenue Code of 1986, as amended, pertaining to regulated investment companies
to make distributions of taxable income sufficient to relieve it from
substantially all Federal income and excise taxes; (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
December 31, 1996, reclassifications were made to the capital accounts to
reflect permanent book/tax differences and income and gains available for
distribution under income tax regulations. Accordingly, a portion of accumulated
net realized loss and accumulated net investment loss amounting to $5,095,103
and $540,647, respectively, were reclassified to paid-in capital. Net investment
income, net realized gains and net assets were not affected by this change; 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.
11
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
2. Management Agreement and Transactions with Affiliated Persons
Smith Barney Mutual Funds Management Inc. ("SBMFM"), a subsidiary of Smith
Barney Holdings Inc. ("SBH"), acts as investment manager to the Fund. The
management fee for the U.S. Government Securities and Income Return Account
Portfolios is determined by aggregating the assets of each Portfolio and
applying a formula calculated at the annual rate of 0.50% on the first $200
million of the aggregate average daily net assets of the two Portfolios and
0.40% on the aggregate average daily net assets in excess of $200 million; this
total is then allocated to each Portfolio based on their relative average daily
net assets. These fees are calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SBH, acts as distributor of
Fund shares. For the year ended December 31, 1996, SB received sales charges of
approximately $135,000 on sales of the Portfolio's Class A shares.
There is a contingent deferred sales charge ("CDSC") of 4.50% on Class B
shares, which applies if redemption occurs within one year from initial
purchase. This CDSC declines by 0.50% the first year after purchase and
thereafter by 1.00% per year until no CDSC is incurred. Class C shares have a
1.00% CDSC, which applies if redemption occurs within the first year of
purchase. For the year ended December 31, 1996, CDSCs paid to SB for Class B
shares were approximately $40,000.
Pursuant to a Distribution Plan, the Portfolio pays a service fee with
respect to its Class A, B and C shares calculated at the annual rate of 0.25% of
the average daily net assets for each respective class. In addition, the
Portfolio also pays a distribution fee with respect to Class B and Class C
shares calculated at the annual rate of 0.50% and 0.45% of the average daily net
assets for each class, respectively. For the year ended December 31, 1996, total
Distribution Plan fees were as follows:
Class A Class B Class C
============================================================================
Distribution Plan Fees $851,122 $87,112 $131,238
============================================================================
All officers and three Directors of the Fund are employees of SB.
12
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
3. Investments
During the year ended December 31, 1996, the aggregate cost of purchases
and proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $1,049,799,630
- --------------------------------------------------------------------------------
Sales 1,055,082,826
================================================================================
At December 31, 1996, the aggregate gross unrealized appreciation and
depreciation of investments were as follows:
================================================================================
Gross unrealized appreciation $2,562,080 *
Gross unrealized depreciation (2,402,087)*
- --------------------------------------------------------------------------------
Net unrealized appreciation $ 159,993 *
================================================================================
*Substantially the same for Federal income tax purposes.
4. Repurchase Agreements
The Portfolio 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 Portfolio requires
continual maintenance of the market value of the collateral in amounts at least
equal to the repurchase price.
5. Reverse Repurchase Agreement
The Portfolio may enter into reverse repurchase agreement transactions for
leveraging purposes. A reverse repurchase agreement involves a sale by the
Portfolio of securities that it holds with an agreement by the Portfolio to
repurchase the same securities at an agreed upon price and date. A reverse
repurchase agreement involves the risk that the market value of the securities
sold by the Portfolio may decline below the repurchase price of the securities.
The Portfolio will establish a segregated account with its custodian, in which
the Portfolio will maintain cash, U.S. government securities or other liquid
high grade debt obligations equal in value to its obligations with respect to
the reverse repurchase agreement.
13
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
At December 31, 1996, the Portfolio had the following reverse repurchase
agreement outstanding:
FACE
AMOUNT SECURITY VALUE
==========================================================================
$17,865,000 Reverse Repurchase Agreement with Morgan
Stanley Group, Inc., dated 12/31/96 bearing
5.150% to be repurchased at $17,882,890
on 1/7/97, collateralized by U.S. Treasury
Note, 5.875% due 11/30/01 $17,865,000
==========================================================================
During the year ended December 31, 1996, the maximum and average amount of
reverse repurchase agreements outstanding were as follows:
==========================================================================
Maximum amount outstanding $49,779,660
- --------------------------------------------------------------------------
Average amount outstanding $35,231,411
==========================================================================
Interest rates earned on reverse repurchase agreements ranged from 1.375%
to 5.150% during the year. Total market value of the collateral for the reverse
repurchase agreement is $17,746,560.
For the year ended December 31, 1996, interest expense from reverse
repurchase agreements totalled $1,190,638.
6. Securities Traded on a To-Be-Announced Basis
The Portfolio may trade securities, particularly GNMAs, on a "to-be-
announced" ("TBA") basis. In a TBA transaction, the Portfolio commits to
purchasing or selling securities for which specific information is not yet known
at the time of the trade, particularly the face amount and maturity date.
Securities purchased on a TBA basis are not settled until they are delivered to
the Portfolio, normally 15 to 45 days later. These transactions are subject to
market fluctuations and their current value is determined in the same manner as
for other portfolio securities.
As of December 31, 1996, the Portfolio held no TBA securities.
14
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
7. Capital Shares
At December 31, 1996, the Fund had two billion shares of capital stock
authorized with a par value of $0.01 per share. The Portfolio has the ability to
issue multiple classes of shares. Each share of a class represents an identical
interest in the Portfolio and has the same rights, except that each class bears
certain expenses specifically related to the distribution of its shares.
At December 31, 1996, total paid-in capital amounted to the following for
each class:
<TABLE>
<CAPTION>
Class A Class B Class C Class Y Class Z
======================================================================================
<S> <C> <C> <C> <C> <C>
Total Paid-in Capital $316,152,585 $10,933,851 $17,910,433 $6,339,731 $17,567,870
======================================================================================
</TABLE>
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1996 December 31, 1995
-------------------- -----------------
Shares Amount Shares Amount
=====================================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 434,053 $ 5,765,143 993,281 $ 13,089,337
Net asset value of shares issued
in connection with the transfer
of Smith Barney Funds, Inc.
-- Monthly Payment
Government Portfolio's
net assets (Note 8) -- -- 2,887,733 38,637,744
Shares issued on reinvestment 913,861 12,031,692 1,073,322 14,209,870
Shares redeemed (6,089,171) (80,467,760) (5,309,396) (70,232,692)
- -----------------------------------------------------------------------------------------------------
Net Decrease (4,741,257) $(62,670,925) (355,060) $ (4,295,741)
=====================================================================================================
Class B
Shares sold 285,992 $ 3,778,340 759,232 $ 10,098,823
Net asset value of shares issued
in connection with the transfer
of Smith Barney Funds, Inc.
-- Monthly Payment
Government Portfolio's
net assets (Note 8) -- -- 40,956 548,705
Shares issued on reinvestment 36,148 476,041 23,845 318,309
Shares redeemed (293,500) (3,913,310) (129,358) (1,718,302)
- -----------------------------------------------------------------------------------------------------
Net Increase 28,640 $ 341,071 694,675 $ 9,247,535
=====================================================================================================
</TABLE>
15
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1996 December 31, 1995
-------------------- -------------------------
Shares Amount Shares Amount
================================================================================================
<S> <C> <C> <C> <C>
Class C
Shares sold 55,061 $ 725,736 236,768 $ 3,129,915
Net asset value of shares issued
in connection with the transfer
of Smith Barney Funds, Inc.
-- Monthly Payment
Government Portfolio's
net assets (Note 8) -- -- 221,615 2,965,444
Shares issued on reinvestment 50,186 660,064 69,690 921,823
Shares redeemed (388,960) (5,148,015) (641,755) (8,524,847)
- ------------------------------------------------------------------------------------------------
Net Decrease (283,713) $ (3,762,215) (113,682) $ (1,507,665)
================================================================================================
Class Y
Shares sold -- -- 3,330 $ 44,021
Shares issued on reinvestment 7,206 $ 95,184 12,500 165,457
Shares redeemed (99,666) (1,326,266) (613,583) (8,026,122)
- ------------------------------------------------------------------------------------------------
Net Decrease (92,460) $ (1,231,082) (597,753) $ (7,816,644)
================================================================================================
Class Z
Shares sold 152,496 $ 2,025,204 212,929 $ 2,792,334
Shares issued on reinvestment 107,482 1,415,835 110,569 1,464,379
Shares redeemed (326,769) (4,320,674) (271,382) (3,595,473)
- ------------------------------------------------------------------------------------------------
Net Increase (Decrease) (66,791) $ (879,635) 52,116 $ 661,240
================================================================================================
</TABLE>
8. Transfer of Net Assets
On October 13, 1995, the Portfolio acquired the assets and certain
liabilities of the Smith Barney Funds, Inc. -- Monthly Payment Government
Portfolio ("Monthly Payment") pursuant to a plan of reorganization approved by
the Monthly Payment shareholders on October 6, 1995. Total shares issued by the
Portfolio and the total net assets of Monthly Payment on the date of transfer
were:
Total Net
Shares Assets of Total Net
Issued by Monthly Assets of
Acquired Portfolio the Portfolio Payment the Portfolio
============================================================================
Monthly Payment 3,150,304 $42,151,893 $409,850,631
============================================================================
The total net assets of Monthly Payment before acquisition included
unrealized appreciation of $1,425,657 and a net realized loss of $2,370,573.
Total net assets of the Portfolio immediately after the transfer were
$452,002,524. The transaction was structured for tax purposes to qualify as a
tax-free reorganization under the Internal Revenue Code of 1986, as amended.
16
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
9. Capital Loss Carryforward
At December 31, 1996, the Portfolio had, for Federal income tax purposes,
approximately $3,627,000 of capital loss carryforwards available to offset
future realized gains. To the extent that these carryforward losses can be used
to offset net realized capital gains, such gains, if any, will not be
distributed.
The amount and date of expiration for each carryforward loss is indicated
below:
12/31/97 12/31/01 12/31/02
================================================================================
Carryforward Amounts $333,000 $430,000 $2,864,000
================================================================================
17
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
Class A Shares 1996 1995 1994 1993 1992
======================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 13.59 $ 12.50 $ 13.66 $ 13.87 $ 14.10
- ------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.84 0.92 0.91 0.98 1.06
Net realized and unrealized gain (loss) (0.33) 1.09 (1.11) (0.10) (0.13)
- ------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 0.51 2.01 (0.20) 0.88 0.93
- ------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.86) (0.92) (0.91) (0.98) (1.08)
Net realized gains -- -- (0.05)* (0.11)* (0.08)*
- ------------------------------------------------------------------------------------------------------
Total Distributions (0.86) (0.92) (0.96) (1.09) (1.16)
- ------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 13.24 $ 13.59 $ 12.50 $ 13.66 $ 13.87
- ------------------------------------------------------------------------------------------------------
Total Return 3.97% 16.52% (1.48)% 6.40% 6.85%
- ------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $311,875 $384,534 $ 358,045 $468,278 $459,380
- ------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.09% 0.79% 0.76%** 0.49% 0.50%
Net investment income 6.34 6.82 6.83 7.00 7.65
- ------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 265% 57% 40% 57% 26%
======================================================================================================
<CAPTION>
Class B Shares 1996 1995 1994(1)
==============================================================================
<S> <C> <C> <C>
Net Asset Value, Beginning of Year $13.61 $12.51 $12.47
- ------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.77 0.80 0.08
Net realized and unrealized gain (loss) (0.33) 1.16 0.17
- ------------------------------------------------------------------------------
Total Income From Operations 0.44 1.96 0.25
- ------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.79) (0.86) (0.21)
- ------------------------------------------------------------------------------
Total Distributions (0.79) (0.86) (0.21)
- ------------------------------------------------------------------------------
Net Asset Value, End of Year $13.26 $13.61 $12.51
- ------------------------------------------------------------------------------
Total Return 3.44% 16.03% 2.04%+++
- ------------------------------------------------------------------------------
Net Assets, End of Year (000s) $11,212 $11,116 $1,529
- ------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.58% 1.28% 1.21%+**
Net investment income 5.85 6.16 6.94+
- ------------------------------------------------------------------------------
Portfolio Turnover Rate 265% 57% 40%
==============================================================================
</TABLE>
(1) For the period from November 7, 1994 (inception date) to December 31, 1994.
* Represents distributions from paydown gains which are reported as ordinary
income for tax purposes.
** Amount has been restated from the December 31, 1994 annual report.
+++ Total return is not annualized, as it may not be representative of the total
return for the year.
+ Annualized.
18
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
Class C Shares 1996 1995 1994(1) 1993 1992(2)
====================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 13.58 $ 12.50 $ 13.66 $ 13.86 $14.01
- ----------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.78 0.86 0.82 0.89 0.15
Net realized and unrealized gain (loss) (0.33) 1.09 (1.11) (0.10) --
- ----------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 0.45 1.95 (0.29) 0.79 0.15
- ----------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.80) (0.87) (0.83) (0.88) (0.30)
Net realized gains -- -- (0.04)* (0.11)* --
- ----------------------------------------------------------------------------------------------------
Total Distributions (0.80) (0.87) (0.87) (0.99) (0.30)
- ----------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 13.23 $ 13.58 $ 12.50 $ 13.66 $13.86
- ----------------------------------------------------------------------------------------------------
Total Return 3.49% 15.93% (2.11)% 5.74% 1.07%+++
- ----------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $17,249 $21,559 $21,253 $ 19,938 $1,954
- ----------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.56% 1.25% 1.21% 1.21% 1.14%+
Net investment income 5.87 6.36 6.27 6.23 6.56+
- ----------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 265% 57% 40% 57% 26%
====================================================================================================
<CAPTION>
Class Y Shares 1996 1995 1994(3) 1993(4)
========================================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $13.61 $12.51 $13.67 $13.97
- ----------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.88 1.00 0.89 0.86
Net realized and unrealized gain (loss) (0.33) 1.06 (1.10) (0.10)
- ----------------------------------------------------------------------------------------
Total Income (Loss) From Operations 0.55 2.06 (0.21) 0.76
- ----------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.89) (0.96) (0.91) (0.95)
Net realized gains -- -- (0.04)* (0.11)*
- ----------------------------------------------------------------------------------------
Total Distributions (0.89) (0.96) (0.95) (1.06)
- ----------------------------------------------------------------------------------------
Net Asset Value, End of Year $13.27 $13.61 $12.51 $13.67
- ----------------------------------------------------------------------------------------
Total Return 4.30% 16.88% (1.53)% 5.55%+++
- ----------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $5,589 $6,992 $13,903 $14,118
- ----------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.80% 0.49% 0.61% 0.69%+
Net investment income 6.64 7.22 6.82 7.29+
- ----------------------------------------------------------------------------------------
Portfolio Turnover Rate 265% 57% 40% 57%
========================================================================================
</TABLE>
(1) On November 7, 1994, the former Class B shares were renamed Class C shares.
(2) For the period from December 2, 1992 (inception date) to December 31, 1992.
(3) On November 7, 1994, the former Class C shares were renamed Class Y shares.
(4) For the period from January 12, 1993 (inception date) to December 31, 1993.
* Represents distributions from paydown gains which are reported as ordinary
income for tax purposes.
+++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
19
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
Class Z Shares 1996 1995 1994(1)
===============================================================================
<S> <C> <C> <C>
Net Asset Value, Beginning of Year $13.60 $12.50 $12.47
- -------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.88 0.94 0.14
Net realized and unrealized gain (loss) (0.33) 1.11 0.13
- -------------------------------------------------------------------------------
Total Income From Operations 0.55 2.05 0.27
- -------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.89) (0.95) (0.24)
Net realized gains -- -- --
- -------------------------------------------------------------------------------
Total Distributions (0.89) (0.95) (0.24)
- -------------------------------------------------------------------------------
Net Asset Value, End of Year $13.26 $13.60 $12.50
- -------------------------------------------------------------------------------
Total Return 4.31% 16.89% (2.15)%+++
- -------------------------------------------------------------------------------
Net Assets, End of Year (000s) $19,511 $20,923 $18,580
- -------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.79% 0.50% 0.34%+
Net investment income 6.64 7.12 7.55+
- -------------------------------------------------------------------------------
Portfolio Turnover Rate 265% 57% 40%
===============================================================================
</TABLE>
(1) For the period from November 7, 1994 (inception date) to December 31, 1994.
+++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
A total of 24.8% of the ordinary income dividends paid by the Fund have
been derived from Federal obligations and may be exempt from taxation at the
state level.
20
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
The Shareholders and Board of Directors of
Smith Barney Funds, Inc.:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the U.S. Government Securities
Portfolio of Smith Barney Funds, Inc. as of December 31, 1996, 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 five-year period then ended.
These financial statements and financial highlights are the responsibility of
the Fund's management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1996, 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
U.S. Government Securities Portfolio of Smith Barney Funds, Inc. as of December
31, 1996, 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 five-year period then ended,
in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
February 7, 1997
21
SMITH BARNEY
FUNDS, INC.
DIRECTORS
Jessica M. Bibliowicz
Joseph H. Fleiss
Donald R. Foley
Paul Hardin
Francis P. Martin, M.D.
Heath B. McLendon, Chairman
Roderick C. Rasmussen
Bruce D. Sargent
John P. Toolan
OFFICERS
Heath B. McLendon
Chief Executive Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President
and Treasurer
Bruce D. Sargent
Vice President
Ayako Weissman
Vice President
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
SMITH BARNEY
- ---------------------------------
A Member of TravelersGroup [LOGO]
INVESTMENT MANAGER
Smith Barney Mutual Funds
Management Inc.
DISTRIBUTOR
Smith Barney Inc.
CUSTODIAN
PNC Bank, N.A.
SHAREHOLDER
SERVICING AGENT
First Data Investor Services Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for the general information of the shareholders of
Smith Barney Funds, Inc. -- U.S. Government Securities Portfolio. It is not
authorized for distribution to prospective investors unless accompanied or
preceded by a current Prospectus for the Portfolio, which contains information
concerning the Portfolio's investment policies and expenses as well as other
pertinent information.
SMITH BARNEY FUNDS, INC.
388 Greenwich Street
New York, New York 10013
FD01086 2/97
<PAGE>
ANNUAL REPORT
1996
1996
1996
1996
1996
SMITH BARNEY
FUNDS, INC.
INCOME RETURN
ACCOUNT PORTFOLIO
SHORT-TERM U.S.
TREASURY SECURITIES
PORTFOLIO
- -------------------
December 31, 1996
[LOGO] SMITH BARNEY MUTUAL FUNDS
Investing for your future.
Every day.
<PAGE>
- --------------------------------------------------------------------------------
INCOME RETURN ACCOUNT AND SHORT-TERM
U.S. TREASURY SECURITIES PORTFOLIOS
- --------------------------------------------------------------------------------
Dear Shareholder:
We are pleased to provide you with the annual report for the Smith Barney Funds,
Inc. -- Income Return Account Portfolio and Short-Term U.S. Treasury Securities
Portfolio ("Portfolios") for the year ended December 31, 1996. In this report,
we summarize the period's prevailing economic and market conditions and outline
our portfolio strategy. A more detailed summary of performance can be found in
the appropriate sections that follow.
Market Overview
In our view, one of the most important events for the market in 1996 was the
unexpected strength of the U.S. economy during the first half of the year and
weaker economic growth during the second half. In addition to President
Clinton's re-election and Congress maintaining its Republican majority, other
significant market events in 1996 include the U.S. Treasury's plans to introduce
inflation-indexed securities, the Boskin Report that suggests inflation may be
roughly 1% lower than previously reported, and Russian President Boris Yeltsin
surviving both medically and politically.
Income Return Account Portfolio
Performance and Investment Strategy
For the year ended December 31, 1996, the Income Return Account Portfolio's
Class A shares had a total return of 4.08% and underperformed versus the 5.67%
total return for the Salomon Brothers One-Year Treasury Index over the same
period. In addition, over the past twelve months, the Portfolio distributed
dividends totaling $0.47 per Class A share.
The Income Return Account invests in money market instruments to help provide
stability, and in longer-term securities (not to exceed five years for U.S.
Government securities, and three years for corporate debt obligations) to
provide enhanced return. For defensive purposes, the Portfolio also employs an
immunization strategy. (The Portfolio's immunization strategy involves the use
of proprietary technology that helps provide support to the manager in avoiding
negative quarterly returns.) While minor day-to-day price fluctuations are
unavoidable, this strategy should produce sufficient income during adverse
market conditions to offset any potential decline in the prices of the
Portfolio's longer term securities. In extremely uncertain or volatile periods
of interest rates, it is possible for the Portfolio to be fully invested in
short-term money market instruments. Unlike money market funds, which generally
seek to maintain a stable net asset value (NAV) of $1.00 per share, the Income
Return Account Portfolio's NAV does fluctuate with market conditions.
1
<PAGE>
Volatility in the market and the speed of that volatility has risen during the
reporting period. In our view, a primary factor behind this higher (and faster)
volatility has been the increasingly important market influence of hedge funds,
foreign investors and central banks. In this type of environment, the
Portfolio's immunization strategy, although challenged, has enabled the
Portfolio to avoid quarterly negative returns this past year.
Special Shareholder Notice
Assets have declined in the Income Return Account Portfolio over the last year
while its fixed costs have remained constant. As a result, the Portfolio's
investment style has been somewhat inhibited. After careful analysis of the
Portfolio's fee structure and recent performance, we will not allow purchases
into this Portfolio as of February 24, 1997 for new or existing shareholders.
In order to serve your investment needs, we encourage you to contact your Smith
Barney Financial Consultant or other qualified financial adviser to discuss
other Smith Barney Mutual Funds that may be appropriate in helping you to meet
your financial goals. He or she will be happy to discuss the wide range of
investment options available from Smith Barney Mutual Funds in greater detail.
You can, of course, exchange your shares in the Income Return Account Portfolio
to any other fund in the Smith Barney family of funds without the imposition of
any fees. We appreciate your continued support and look forward to helping serve
your investment needs in the future.
Short-Term U.S. Treasury Securities Portfolio
Performance and Investment Strategy
For the year ended December 31, 1996, the Short-Term U.S. Treasury Securities
Portfolio's Class A shares had a total return of 2.17%, which was below its
Lipper Analytical Services, Inc. peer group total return average of 3.76%.
(Lipper is an independent fund tracking organization.) In addition, over the
past twelve months, the Portfolio distributed dividends totaling $0.23 per Class
A share.
During the reporting period, we modestly extended the Portfolio's average
weighted maturity from 3.14 years to 5.23 years. Another key aspect of the
Portfolio's investment strategy was to "ladder" its maturities. By purchasing
bonds that mature at set intervals, the Portfolio will be diversified in case of
changes in interest rates.
2
<PAGE>
Market Outlook
Looking ahead to 1997, we believe there may be some possible (although not
necessarily probable) market challenges on the horizon such as:
-- Data that indicates moderate to weaker economic growth
-- Continued partisan ethics probes that negatively impact our political
leaders
-- U.S. dollar coming under short-term pressure because of a failure to
put in place a credible fiscal plan
-- Renewed tension in the Middle East -- possibly oil related
-- Political problems resurfacing in Russia
In our opinion, the yield on the 5 Year U.S. Treasury bond should remain in a
broad range of low 5% - high 5%. However, if any of the above expected 1997
events take place, the yield could temporarily rise above the 6% level.
Ultimately, we believe this would represent a buying opportunity because U.S.
economic fundamentals do not, in our view, warrant higher rates.
In closing, we would like to thank you for your investment in the Income Return
Account and Short-Term U.S. Treasury Securities Portfolios. We look forward to
continuing to help you achieve your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ James E. Conroy
Heath B. McLendon James E. Conroy
Chairman and Vice President
Chief Executive Officer
/s/ Patrick Sheehan
Patrick Sheehan
Vice President
January 15, 1997
3
<PAGE>
- --------------------------------------------------------------------------------
Income Return Account Portfolio
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Historical Performance -- Class A Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-------------------
Beginning End Income Capital Gain Return of Total
Year Ended of Year of Year Dividends Distributions Capital Returns(1)
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
12/31/96 $9.60 $9.48 $0.47 $0.00 $0.03 4.08%
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/95 9.34 9.60 0.51 0.00 0.00 8.43
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/94 9.59 9.34 0.45 0.00 0.00 2.14
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/93 9.68 9.59 0.47 0.00 0.00 4.00
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/92 9.65 9.68 0.52 0.00 0.00 5.85
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/91 9.38 9.65 0.73 0.00 0.00 11.06
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/90 9.31 9.38 0.74 0.00 0.00 9.10
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/89 9.12 9.31 0.75 0.00 0.00 10.67
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/88 9.26 9.12 0.72 0.00 0.00 6.48
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/87 9.43 9.26 0.60 0.06 0.00 5.36
====================================================================================================================================
Total $5.96 $0.06 $0.03
====================================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Historical Performance -- Class C Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-------------------
Beginning End Income Capital Gain Return of Total
Year Ended of Year of Year Dividends Distributions Capital Returns(1)
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
12/31/96 $9.60 $9.48 $0.44 $0.00 $0.03 3.72%
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/95 9.34 9.60 0.48 0.00 0.00 8.06
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/94 9.58 9.34 0.42 0.00 0.00 1.86
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/93 9.68 9.58 0.43 0.00 0.00 3.53
- ------------------------------------------------------------------------------------------------------------------------------------
Inception*-12/31/92 9.69 9.68 0.04 0.00 0.00 0.31+
====================================================================================================================================
Total $1.81 $0.00 $0.03
====================================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Historical Performance -- Class Y Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-------------------
Beginning End Income Capital Gain Return of Total
Year Ended of Year of Year Dividends Distributions Capital Returns(1)
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
12/31/96 $9.60 $9.48 $0.48 $0.00 $0.03 4.18%
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/95 9.34 9.60 0.51 0.00 0.00 8.43
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/94 9.59 9.34 0.44 0.00 0.00 2.01
- ------------------------------------------------------------------------------------------------------------------------------------
Inception*-12/31/93 9.72 9.59 0.42 0.00 0.00 3.01+
====================================================================================================================================
Total $1.85 $0.00 $0.03
====================================================================================================================================
</TABLE>
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS MONTHLY AND CAPITAL GAINS, IF
ANY, ANNUALLY.
4
<PAGE>
- --------------------------------------------------------------------------------
Income Return Account Portfolio
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Without Sales Charge(1)
---------------------------------------
Class A Class C Class Y
================================================================================
<S> <C> <C> <C>
Year Ended 12/31/96 4.08% 3.72% 4.18%
- -------------------------------------------------------------------------------
Five Years Ended 12/31/96 4.91 N/A N/A
- -------------------------------------------------------------------------------
Ten Years Ended 12/31/96 6.82 N/A N/A
- -------------------------------------------------------------------------------
Inception* through 12/31/96 7.17 4.30 4.48
================================================================================
</TABLE>
<TABLE>
<CAPTION>
Without Sales Charge(2)
---------------------------------------
Class A Class C Class Y
================================================================================
<S> <C> <C> <C>
Year Ended 12/31/96 1.95% 2.72% 4.18%
- -------------------------------------------------------------------------------
Five Years Ended 12/31/96 4.48 N/A N/A
- -------------------------------------------------------------------------------
Ten Years Ended 12/31/96 6.61 N/A N/A
- -------------------------------------------------------------------------------
Inception* through 12/31/96 6.99 4.30 4.48
================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Without
Sales Charge(1)
================================================================================
<S> <C>
Class A (12/31/86 through 12/31/96) 93.40%
- --------------------------------------------------------------------------------
Class C (Inception* through 12/31/96) 18.56
- --------------------------------------------------------------------------------
Class Y (Inception* through 12/31/96) 18.71
================================================================================
</TABLE>
(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 with respect to Class A shares or the applicable
contingent deferred sales charges ("CDSC") with respect to Class C shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, Class A shares reflect the deduction
of the maximum initial sales charge of 2.00% and Class C shares reflect the
deduction of a 1.00% CDSC, which applies if shares are redeemed within the
first year of purchase.
* Inception dates for Class A, C and Y shares are March 4, 1985, December 16,
1992, and February 1, 1993, respectively.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
5
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Class A Shares of
the Income Return Account Portfolio vs.
Salomon Brothers 1-Year Treasury Index+
- --------------------------------------------------------------------------------
December 1986 -- December 1996
[GRAPHIC]
<TABLE>
<CAPTION>
Income Return Salomon Brothers
Account Portfolio 1-Year
Treasury Index
------------- ----------------
<S> <C> <C>
12/86 $ 9,874 $ 10,000
12/87 10,343 10,574
12/88 11,014 11,220
12/89 12,188 12,350
12/90 13,262 13,452
12/91 14,863 14,634
12/92 15,732 15,337
12/93 16,361 15,925
12/94 16,703 16,343
12/95 18,112 17,664
12/96 18,851 18,776
</TABLE>
+ Hypothetical illustration of $10,000 invested in Class A shares on December
31, 1986, assuming deduction of the maximum 2.50% sales charge in effect at
the time of investment and the reinvestment of dividends (after deduction
of applicable sales charge through November 7, 1994, and thereafter at net
asset value) and capital gains, if any, at net asset value through December
31, 1996. The Salomon Brothers 1-Year Treasury Index is composed of the
most recently issued twelve month United States Treasury Bill which is used
to track the Treasury Bill's total return until its maturity. The index is
unmanaged and is not subject to the same management and trading expenses of
a mutual fund. The performance of the Portfolio's other classes may be
greater or less than the Class A shares' performance indicated on this
chart, depending on whether greater or lesser sales charges and fees were
incurred by shareholders investing in the other classes.
All figures represent past performance and are not a guarantee of future
results. Investment return and principal value will fluctuate and
redemption values 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>
- --------------------------------------------------------------------------------
Short-Term U.S. Treasury Securities Portfolio
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Historical Performance -- Class A Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-------------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
12/31/96 $4.19 $4.05 $0.23 $0.00 2.17%
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/95 3.91 4.19 0.22 0.00 13.16
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/94 4.16 3.91 0.18 0.00 (2.15)
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/93 4.12 4.16 0.18 0.02 6.01
- ------------------------------------------------------------------------------------------------------------------------------------
12/31/92 4.09 4.12 0.19 0.01 5.92
- ------------------------------------------------------------------------------------------------------------------------------------
Inception*-12/31/91 4.01 4.09 0.03 0.01 2.85+
====================================================================================================================================
Total $1.03 $0.04
====================================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Historical Performance-- Class Y Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value
-------------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
====================================================================================================================================
Inception*-12/31/96 $4.19 $4.05 $0.22 $0.00 2.08%+
====================================================================================================================================
</TABLE>
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS MONTHLY AND CAPITAL GAINS, IF
ANY, ANNUALLY.
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Without Sales Charge
-----------------------
Class A Class Y
================================================================================
<S> <C> <C>
Year Ended 12/31/96 2.17% N/A
- --------------------------------------------------------------------------------
Five Years Ended 12/31/96 5.04 N/A
- --------------------------------------------------------------------------------
Inception* through 12/31/96 5.47 2.08%+
================================================================================
</TABLE>
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Without Sales Charge
================================================================================
<S> <C>
Class A (Inception* through 12/31/96) 31.49%
- --------------------------------------------------------------------------------
Class Y (Inception* through 12/31/96) 2.08+
================================================================================
</TABLE>
* The inception dates for Class A and Y shares are November 11, 1991 and
February 7, 1996, respectively.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
7
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Class A Shares of
the Short-Term U.S. Treasury Securities Portfolio vs.
Salomon Brothers 3-Year Treasury Index+
- --------------------------------------------------------------------------------
November 1991 -- December 1996
[GRAPHIC]
<TABLE>
<CAPTION>
Short-Term Salomon Brothers
U.S. Treasury 3-Year Treasury Index
------------- ---------------------
<S> <C> <C>
11/11/91 $ 10000 $ 10000
12/91 10283 10230
12/92 10891 10902
12/93 11547 11653
12/94 11361 11471
12/95 12874 13004
12/96 13149 13674
</TABLE>
+ Hypothetical illustration of $10,000 invested in shares at inception on
November 11, 1991, assuming reinvestment of dividends and capital gains, if
any, at net asset value through December 31, 1996. The Salomon Brothers
3-Year Treasury Index is composed of the most recently issued 3-year United
States Treasury Note which is used to track the Note's total return until
its maturity. The index is unmanaged and is not subject to the same
management and trading expenses of a mutual fund.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption values may be more or less than the original cost. No adjustment
has been made for shareholder tax liability on dividends or capital gains.
8
<PAGE>
- --------------------------------------------------------------------------------
Schedules of Investments December 31, 1996
- --------------------------------------------------------------------------------
INCOME RETURN ACCOUNT PORTFOLIO
<TABLE>
<CAPTION>
FACE
AMOUNT SECURITY VALUE
================================================================================
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 100%
<C> <S> <C>
$ 3,020,000 U.S. Treasury Note, 5.625% due 10/31/97 $ 3,021,299
9,000,000 U.S. Treasury Note, 5.625% due 1/31/98 9,000,810
1,000,000 U.S. Treasury Note, 5.500% due 11/15/98 993,620
3,000,000 Federal Farm Credit Corp., 4.000% due 2/3/97 2,996,580
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $15,979,741*) $16,012,309
================================================================================
<CAPTION>
SHORT-TERM U.S. TREASURY SECURITIES PORTFOLIO
================================================================================
U.S. TREASURY OBLIGATIONS -- 97.2%
<C> <S> <C>
$10,500,000 U.S. Treasury Note, 6.500% due 4/30/99 $ 10,629,360
20,000,000 U.S. Treasury Note, 6.750% due 5/31/99 20,353,400
11,000,000 U.S. Treasury Note, 6.875% due 7/31/99 11,228,690
7,500,000 U.S. Treasury Note, 6.500% due 8/31/01 7,585,950
10,000,000 U.S. Treasury Note, 5.875% due 11/30/01 9,859,200
20,500,000 U.S. Treasury Note, 5.875% due 2/15/04 19,970,075
11,000,000 U.S. Treasury Note, 6.500% due 10/15/06 11,061,820
24,300,000 U.S. Treasury Strip, zero coupon due 2/15/00 20,176,776
- --------------------------------------------------------------------------------
TOTAL U.S. TREASURY OBLIGATIONS
(Cost -- $109,444,850) 110,865,271
================================================================================
REPURCHASE AGREEMENT -- 2.8%
3,215,000 Citibank, 6.893% due 1/2/97; Proceeds at
maturity -- $3,216,231; (Fully collateralized by
U.S. Treasury Notes, 5.750% due 12/31/98;
Market value -- $3,279,395)(Cost -- $3,215,000) 3,215,000
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost-- $112,659,850*) $114,080,271
================================================================================
</TABLE>
* Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
9
<PAGE>
================================================================================
Statements of Assets and Liabilities December 31, 1996
================================================================================
<TABLE>
<CAPTION>
Income Short-Term
Return U.S.Treasury
Account Securities
Portfolio Portfolio
====================================================================================================================================
<S> <C> <C>
ASSETS:
Investments, at value (Cost--$15,979,741
and $112,659,850, respectively) $ 16,012,309 $ 114,080,271
Cash 988,450 356
Receivable for securities sold 4,004,796 --
Receivable for Fund shares sold -- 232,887
Interest receivable 267,329 1,371,469
Other assets 56,853 81,573
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets 21,329,737 115,766,556
- ------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Payable for Fund shares purchased 3,624,777 137,081
Management fees payable 7,745 45,300
Distribution fees payable 645 9,290
Dividend payable -- 110,423
Accrued expenses 22,734 26,605
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 3,655,901 328,699
- ------------------------------------------------------------------------------------------------------------------------------------
Total Net Assets $ 17,673,836 $ 115,437,857
====================================================================================================================================
NET ASSETS:
Par value of capital shares $ 18,643 $ 285,355
Captial paid in excess of par value 18,390,454 122,775,426
Overdistributed net investment income (2,577) --
Accumulated net realized loss on
security transactions (765,252) (9,043,345)
Net unrealized appreciation of investments 32,568 1,420,421
- ------------------------------------------------------------------------------------------------------------------------------------
Total Net Assets $ 17,673,836 $ 115,437,857
====================================================================================================================================
Shares Outstanding:
Class A 1,576,712 20,597,691
----------------------------------------------------------------------------------------------------------------------------------
Class C 220,454 --
----------------------------------------------------------------------------------------------------------------------------------
Class Y 67,116 7,937,830
----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value:
----------------------------------------------------------------------------------------------------------------------------------
Class A (redemption price) $9.48 $4.05
----------------------------------------------------------------------------------------------------------------------------------
Class C* $9.48 --
----------------------------------------------------------------------------------------------------------------------------------
Class Y (redemption price) $9.48 $4.05
----------------------------------------------------------------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 2.04% of net asset value per
share for shares of the Income Return Account
Portfolio) $9.67 $4.05
====================================================================================================================================
</TABLE>
* Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
are redeemed within the first year of purchase (See Note 2).
See Notes to Financial Statements.
10
<PAGE>
================================================================================
Statements of Operations For the Year Ended December 31, 1996
================================================================================
<TABLE>
<CAPTION>
Income Short-Term
Return U.S.Treasury
Account Securities
Portfolio Portfolio
================================================================================
<S> <C> <C>
INVESTMENT INCOME:
Interest $ 1,391,081 $ 7,465,429
Less: Interest expense (Note 5) -- (429,694)
- --------------------------------------------------------------------------------
Total Investment Income 1,391,081 7,035,735
- --------------------------------------------------------------------------------
EXPENSES:
Management fees (Note 2) 107,484 479,559
Distribution fees (Note 2) 7,740 324,545
Registration fees 110,286 48,000
Shareholder and system servicing fees 20,499 64,112
Audit and legal 16,552 26,000
Shareholder communications 14,015 28,650
Directors' fees 3,500 3,111
Custody 1,003 4,798
Other 7,241 13,590
- --------------------------------------------------------------------------------
Total Expenses 288,320 992,365
- --------------------------------------------------------------------------------
Net Investment Income 1,102,761 6,043,370
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS (NOTE 3):
Realized Gain (Loss) From Securities
Transactions (excluding short-term
securities):
Proceeds from sales 28,213,633 137,344,453
Cost of securities sold 28,141,635 138,314,950
- --------------------------------------------------------------------------------
Net Realized Gain (Loss) 71,998 (970,497)
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation
of Investments:
Beginning of year 261,510 3,923,767
End of year 32,568 1,420,421
Decrease in Net Unrealized Appreciation (228,942) (2,503,346)
- --------------------------------------------------------------------------------
Net Loss on Investments (156,944) (3,473,843)
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 945,817 $ 2,569,527
================================================================================
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
================================================================================
Statements of Changes in Net Assets
================================================================================
<TABLE>
<CAPTION>
Years Ended
December 31,
---------------------------
Income Return Account Portfolio 1996 1995
================================================================================
<S> <C> <C>
OPERATIONS:
Net investment income $ 1,102,761 $ 1,513,388
Net realized gain 71,998 102,837
Increase (decrease) in net unrealized appreciation (228,942) 724,801
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 945,817 2,341,026
- --------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (1,192,442) (1,510,819)
Capital (54,765) --
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (1,247,207) (1,510,819)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
Net proceeds from sale of shares 2,637,826 2,507,895
Net asset value of shares issued for
reinvestment of dividends 1,046,263 1,263,875
Cost of shares reacquired (11,273,378) (11,328,757)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (7,589,289) (7,556,987)
- --------------------------------------------------------------------------------
Decrease in Net Assets (7,890,679) (6,726,780)
NET ASSETS:
Beginning of year 25,564,515 32,291,295
- --------------------------------------------------------------------------------
End of year* $ 17,673,836 $ 25,564,515
================================================================================
* Includes undistributed (overdistributed)
net investment income of: $(2,577) $17,808
================================================================================
</TABLE>
See Notes to Financial Statements
12
<PAGE>
================================================================================
Statements of Changes in Net Assets (continued)
================================================================================
<TABLE>
<CAPTION>
Years Ended
December 31,
-----------------------------------------
Short Term U.S. Treasury Securities Portfolio 1996 1995
====================================================================================================================================
<S> <C> <C>
OPERATIONS:
Net investment income $ 6,043,370 $ 4,746,932
Net realized loss (970,497) (1,124,138)
Increase (decrease) in net unrealized appreciation (2,503,346) 7,502,923
- ------------------------------------------------------------------------------------------------------------------------------------
Increase in Net Assets From Operations 2,569,527 11,125,717
- ------------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (6,043,370) (4,746,932)
- ------------------------------------------------------------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (6,043,370) (4,746,932)
- ------------------------------------------------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
Net proceeds from sale of shares 44,968,002 10,999,038
Net asset value of shares issued in
connection with the transfer of the
Smith Barney Income Trust--Smith
Barney Limited Maturity Treasury
Fund's net assets (Note 7) -- 53,909,184
Net asset value of shares issued for
reinvestment of dividends 4,448,261 3,983,544
Cost of shares reacquired (37,603,657) (56,878,050)
- ------------------------------------------------------------------------------------------------------------------------------------
Increase in Net Assets From
Fund Share Transactions 11,812,606 12,013,716
- ------------------------------------------------------------------------------------------------------------------------------------
Increase in Net Assets 8,338,763 18,392,501
NET ASSETS:
Beginning of year 107,099,094 88,706,593
- ------------------------------------------------------------------------------------------------------------------------------------
End of year $ 115,437,857 $ 107,099,094
====================================================================================================================================
</TABLE>
See Notes to Financial Statements.
13
<PAGE>
================================================================================
Notes to Financial Statements
================================================================================
1. Significant Accounting Policies
The Income Return Account Portfolio ("Income Return Account") and the
Short-Term U.S. Treasury Securities Portfolio ("Short-Term U.S. Treasury") are
separate investment portfolios ("Portfolios") of the Smith Barney Funds, Inc.
("Fund"). The Fund, a Maryland corporation, is registered under the Investment
Company Act of 1940, as amended, as a diversified, open-end management
investment company. The Fund consists of these Portfolios and two other separate
investment portfolios: Equity Income and U.S. Government Securities Portfolios.
The financial statements and financial highlights for the other portfolios are
presented in separate annual reports.
The significant accounting policies consistently followed by the Portfolios
are: (a) security transactions are accounted for on trade date; (b) U.S.
Government and Agency Obligations are valued at the mean between the bid and ask
prices; (c) securities that have a maturity of more than 60 days are valued at
prices based on market quotations for securities of similar type, yield and
maturity; (d) securities maturing within 60 days are valued at cost plus
accreted discount, or minus amortized premiums, which approximates market value;
(e) interest income is recorded on the accrual basis; (f) gains or losses on the
sale of securities are calculated by using the specific identification method;
(g) direct expenses are charged to each portfolio and each class; management
fees and general fund expenses are allocated on the basis of relative net
assets; (h) dividends and distributions to shareholders are recorded on the
ex-dividend date; (i) each Portfolio 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;
(j) 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 December 31, 1996, reclassifications were made to the
Fund's capital accounts to reflect permanent book/tax differences and income and
gains available for distributions under income tax regulations. Accordingly, a
portion of accumulated net realized losses and overdistributed net investment
income amounting to $876,134 and $69,296, respectively, were reclassified to
paid-in capital for Income Return Account. In addition, a portion of accumulated
net realized gains amounting to $18,822 was reclassified to paid-in capital for
Short-Term U.S. Treasury. Net investment income, net realized gains and net
assets for each Portfolio were not affected by these changes; 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.
14
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
2. Management Agreements
and Transactions with Affiliated Persons
Smith Barney Mutual Funds Management Inc. ("SBMFM"), a subsidiary of Smith
Barney Holdings Inc., acts as investment manager to the Fund. The management fee
for the Income Return Account and U.S. Government Securities Portfolios is
determined by aggregating the assets of each Portfolio and applying a formula
calculated at the annual rate of 0.50% on the first $200 million of the
aggregate average daily net assets of the two portfolios and 0.40% on the
aggregate average daily net assets in excess of $200 million; this total is then
allocated to each Portfolio based on their relative average daily net assets.
Short-Term U.S. Treasury pays SBMFM a management fee calculated at the annual
rate of 0.45% of the Portfolio's average daily net assets. These fees are
calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of Smith Barney Holdings Inc.,
acts as distributor of Fund shares. For the year ended December 31, 1996, SB
received sales charges of approximately $25,000 on sales of Income Return
Account Class A shares. There is a contingent deferred sales charge ("CDSC") of
1.00% on Income Return Account Class C shares if redemption occurs less than one
year from initial purchase. In addition, Income Return Account Class A shares
have a 1.00% CDSC, which applies if redemption occurs within the first year of
purchase. This CDSC only applies to those purchases of Class A shares, which,
when combined with current holdings of Class A shares equal or exceed $500,000
in the aggregate. These purchases do not incur an initial sales charge. For the
year ended December 31, 1996, CDSCs paid to SB were:
<TABLE>
<CAPTION>
Class A Class C
================================================================================
<S> <C> <C>
Income Return Account $2,000 $1,000
================================================================================
</TABLE>
Pursuant to a Distribution Plan, Income Return Account pays a distribution
fee and service fee with respect to its Class C shares calculated at an annual
rate of 0.20% and 0.15% of average daily net assets, respectively. Short-Term
U.S. Treasury pays a distribution fee and a service fee with respect to Class A
shares calculated at the annual rate of 0.10% and 0.25% of its average daily net
assets, respectively. For the year ended December 31, 1996, total Distribution
Plan fees were as follows:
<TABLE>
<CAPTION>
Class A Class C
================================================================================
<S> <C> <C>
Income Return Account -- $7,740
Short-Term U.S. Treasury $324,545 --
================================================================================
</TABLE>
15
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
All officers and three Directors of the Fund are employees of SB.
3. Investments
During the year ended December 31, 1996, the aggregate cost of purchases
and proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
<TABLE>
<CAPTION>
Income
Return Short-Term
Account U.S. Treasury
================================================================================
<S> <C> <C>
Purchases $ 25,129,112 $144,258,687
- --------------------------------------------------------------------------------
Sales 28,213,633 137,344,453
================================================================================
</TABLE>
At December 31, 1996, aggregate gross unrealized appreciation and
depreciation of investments were as follows:
<TABLE>
<CAPTION>
Income
Return Short-Term
Account U.S. Treasury
================================================================================
<S> <C> <C>
Gross unrealized appreciation* $ 33,109 $ 1,730,008
Gross unrealized depreciation* (541) (309,587)
- --------------------------------------------------------------------------------
Net unrealized appreciation* $ 32,568 $ 1,420,421
================================================================================
</TABLE>
*Substantially the same for Federal income tax purposes.
4. Repurchase Agreements
The Portfolios purchase (and their custodian take 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 Portfolios require
continual maintenance of the market value of the collateral in amounts at least
equal to the repurchase price.
5. Reverse Repurchase Agreement
A reverse repurchase agreement involves a sale by Short-Term U.S. Treasury
of securities that it holds with an agreement to repurchase the same securities
at an agreed upon price and date. A reverse repurchase agreement involves the
risk that the market value of the securities sold by the Portfolio may decline
below the repurchase price of the securities. The Portfolio will establish a
segregated account with its custodian, in which the Portfolio will maintain
16
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
cash, U.S. government securities or other liquid high grade debt obligations
equal in value to its obligations with respect the reverse repurchase
agreements.
At December 31, 1996, the Portfolio had no reverse repurchase agreements.
During the year ended December 31, 1996, the maximum and average amount of
reverse repurchase agreements outstanding were as follows:
<TABLE>
<CAPTION>
================================================================================
<S> <C>
Maximum amount outstanding $22,244,375
- --------------------------------------------------------------------------------
Average amount outstanding 19,746,400
================================================================================
</TABLE>
Interest rates on reverse repurchase agreements ranged from 1.375% to
5.050% during the year.
For the year ended December 31, 1996, interest expense on reverse
repurchase agreements totalled $429,694 for Short-Term U.S. Treasury.
6. Capital Shares
At December 31, 1996, the Fund had two billion shares of capital stock
authorized with a par value of $0.01 per share. Each Portfolio has the ability
to issue multiple classes of shares. Each share of a class represents an
identical interest in its respective Portfolio and has the same rights, except
that each class bears certain expenses specifically related to the distribution
of its shares. At December 31, 1996, total paid-in-capital amounted to the
following for each class and respective Portfolio:
<TABLE>
<CAPTION>
Class A Class C Class Y
================================================================================
<S> <C> <C> <C>
Income Return Account $15,472,817 $ 2,158,757 $ 777,523
- --------------------------------------------------------------------------------
Short-Term U.S. Treasury 91,111,731 -- 31,949,050
================================================================================
</TABLE>
17
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1996 December 31, 1995
------------------------------- -------------------------------
Income Return Account Shares Amount Shares Amount
====================================================================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 221,871 $ 2,115,137 225,444 $ 2,157,394
Shares issued on reinvestment 70,351 669,288 78,208 744,322
Shares redeemed (415,523) (4,034,655) (629,762) (5,998,609)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Decrease (123,301) $ (1,250,230) (326,110) $ (3,096,893)
====================================================================================================================================
Class C
Shares sold 54,931 $ 522,432 31,564 $ 300,875
Shares issued on reinvestment 7,212 68,623 10,399 98,935
Shares redeemed (104,148) (993,088) (106,686) (1,012,222)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Decrease (42,005) $ (402,033) (64,723) $ (612,412)
====================================================================================================================================
Class Y
Shares sold 1 $ 10 -- $ --
Shares issued on reinvestment 3,887 36,968 6,752 64,067
Shares redeemed (35,888) (341,958) (254,016) (2,404,236)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Decrease (32,000) $ (304,980) (247,264) $ (2,340,169)
====================================================================================================================================
Class Z*
Shares sold 26 $ 247 5,206 $ 49,626
Shares issued on reinvestment 28,488 271,384 37,427 356,551
Shares redeemed (628,796) (5,903,677) (200,256) (1,913,690)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Decrease (600,282) $ (5,632,046) (157,623) $ (1,507,513)
====================================================================================================================================
Short-Term U.S. Treasury
====================================================================================================================================
Class A
Shares sold 3,206,711 $ 13,018,952 2,680,304 $ 10,999,038
Net asset value of shares
issued in connection with the
transfer of Smith Barney
Income Trust - Smith
Barney Limited Maturity
Treasury Fund's net
assets (Note 7) -- -- 13,207,339 53,909,184
Shares issued on reinvestment 1,099,875 4,448,261 973,147 3,983,544
Shares redeemed (9,277,889) (37,603,657) (13,976,062) (56,878,050)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) (4,971,303) $(20,136,444) 2,884,728 $ 12,013,716
====================================================================================================================================
Class Y**
Shares sold 7,937,830 $ 31,949,050 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Net Increase 7,937,830 $ 31,949,050 -- --
====================================================================================================================================
</TABLE>
* As of December 31, 1996, Class Z Shares were fully redeemed.
** Transactions are for the period from February 7, 1996 (inception date) to
December 31, 1996.
18
<PAGE>
================================================================================
Notes to Financial Statements (continued)
================================================================================
7. Transfer of Net Assets
On August 11, 1995, Short-Term U.S. Treasury acquired the assets and
certain liabilities of the Smith Barney Income Trust--Smith Barney Limited
Maturity Treasury Fund ("Limited Maturity Treasury"), pursuant to a plan of
reorganization approved by shareholders on August 11, 1995. Total shares issued
by Short-Term U.S. Treasury and the total net assets of Limited Maturity
Treasury on the date of transfer were:
<TABLE>
<CAPTION>
Total Net
Shares Assets of Total Net
Issued by Acquired Assets of
Acquired Fund the Portfolio Fund the Portfolio
================================================================================
<S> <C> <C> <C>
Limited Maturity Treasury 13,207,339 $53,909,184 $64,271,771
================================================================================
</TABLE>
The total net assets of Limited Maturity Treasury before acquisition
included unrealized appreciation of $331,570 and a net realized loss of
$3,000,291. Total net assets of Short-Term U.S. Treasury immediately after the
transfer were $118,180,955. The transaction was structured for tax purposes to
qualify as a tax-free reorganization under the Internal Revenue Code of 1986, as
amended.
8. Capital Loss Carryforward
At December 31, 1996, Income Return Account and Short-Term U.S. Treasury
had for Federal income tax purposes approximately $765,000 and $9,043,000 of
capital loss carryforwards available to offset future realized gains. To the
extent that these capital carryforward losses are used to offset capital gains,
it is probable that the gains so offset will not be distributed. The amount and
year of expiration for each capital carryforward loss are indicated below:
<TABLE>
<CAPTION>
1997 2001 2002 2003 2004
=======================================================================================================
<S> <C> <C> <C> <C> <C>
Income Return Account $ 218,000 -- $ 547,000 -- --
Short-Term U.S. Treasury -- $1,477,000 5,471,000 $1,124,000 $ 971,000
=======================================================================================================
</TABLE>
19
<PAGE>
================================================================================
Financial Highlights
================================================================================
For a share of each class of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
Class A Shares
----------------------------------------------------------------------------
Income Return Account Portfolio 1996 1995 1994 1993 1992
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 9.60 $ 9.34 $ 9.59 $ 9.68 $ 9.65
- ------------------------------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.44 0.51 0.46 0.45 0.52
Net realized and unrealized gain (loss) (0.06) 0.26 (0.26) (0.07) 0.03
- ------------------------------------------------------------------------------------------------------------------------------------
Total Income From Operations 0.38 0.77 0.20 0.38 0.55
- ------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.47) (0.51) (0.45) (0.47) (0.52)
Capital (0.03) -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.50) (0.51) (0.45) (0.47) (0.52)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 9.48 $ 9.60 $ 9.34 $ 9.59 $ 9.68
- ------------------------------------------------------------------------------------------------------------------------------------
Total Return 4.08% 8.43% 2.14% 4.00% 5.85%
- ------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 14,948 $ 16,324 $ 18,918 $ 50,874 $ 48,538
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.26% 0.69% 0.56% 0.53% 0.50%
Net investment income 4.82 5.38 4.60 4.67 5.33
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 122% 107% 127% 152% 84%
====================================================================================================================================
<CAPTION>
Class C Shares
----------------------------------------------------------------------------
Income Return Account Portfolio 1996 1995 1994(1) 1993 1992(2)
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 9.60 $ 9.34 $ 9.58 $ 9.68 $ 9.69
- ------------------------------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.41 0.48 0.42 0.45 0.03
Net realized and unrealized gain(loss) (0.06) 0.26 (0.24) (0.12) --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Income From Operations 0.35 0.74 0.18 0.33 0.03
- ------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.44) (0.48) (0.42) (0.43) (0.04)
Capital (0.03) -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.47) (0.48) (0.42) (0.43) (0.04)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 9.48 $ 9.60 $ 9.34 $ 9.58 $ 9.68
- ------------------------------------------------------------------------------------------------------------------------------------
Total Return 3.72% 8.06% 1.86% 3.53% 0.31%+++
- ------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 2,090 $ 2,520 $ 3,055 $ 3,993 $ 10
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.60% 1.02% 0.94% 0.90% 0.86%+
Net investment income 4.46 4.89 4.40 4.25 5.71+
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 122% 107% 127% 152% 84%
====================================================================================================================================
</TABLE>
(1) On November 7, 1994, the former Class B shares were renamed Class C shares.
(2) For the period from December 16, 1992 (inception date) to December 31,
1992.
+++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
20
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
Class Y Shares
---------------------------------------------------------------
Income Return Account Portfolio 1996 1995 1994(1) 1993(2)
====================================================================================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 9.60 $ 9.34 $ 9.59 $ 9.72
- ------------------------------------------------------------------------------------------------------------------------------------
Income From Operations:
Net investment income 0.45 0.51 0.44 0.42
Net realized and unrealized gain (loss) (0.06) 0.26 (0.25) (0.13)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Income From Operations 0.39 0.77 0.19 0.29
- ------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.48) (0.51) (0.44) (0.42)
Capital (0.03) -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.51) (0.51) (0.44) (0.42)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 9.48 $ 9.60 $ 9.34 $ 9.59
- ------------------------------------------------------------------------------------------------------------------------------------
Total Return 4.18% 8.43% 2.01% 3.01%+++
- ------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 636 $ 952 $ 3,235 $ 5,412
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.17% 0.73% 0.69% 0.75%+
Net investment income 5.12 5.43 4.65 4.78+
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 122% 107% 127% 152%
====================================================================================================================================
</TABLE>
(1) On November 7, 1994, the former Class C shares were renamed Class Y shares.
(2) For the period from February 1, 1993 (inception date) to December 31, 1993.
+++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
21
<PAGE>
================================================================================
Financial Highlights (continued)
================================================================================
For a share of each class of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
Class A Shares
Short-Term U.S. Treasury ---------------------------------------------------------------------------
Securities Portfolio 1996 1995 1994 1993 1992
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 4.19 $ 3.91 $ 4.16 $ 4.12 $ 4.09
- ------------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.23 0.22 0.18 0.18 0.19
Net realized and unrealized gain (loss) (0.14) 0.28 (0.25) 0.06 0.04
- ------------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 0.09 0.50 (0.07) 0.24 0.23
- ------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.23) (0.22) (0.18) (0.18) (0.19)
Net realized gains -- -- -- (0.02) (0.01)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Distributions (0.23) (0.22) (0.18) (0.20) (0.20)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 4.05 $ 4.19 $ 3.91 $ 4.16 $ 4.12
- ------------------------------------------------------------------------------------------------------------------------------------
Total Return 2.17% 13.16% (2.15)% 6.01% 5.92%
- ------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 83,324 $ 107,099 $ 88,707 $ 205,758 $ 130,280
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
- ------------------------------------------------------------------------------------------------------------------------------------
Expenses 0.98% 0.98% 0.91% 0.88% 0.91%
Net investment income 5.62 5.29 4.54 4.40 4.76
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 130% 29% 25% 41% 45%
====================================================================================================================================
<CAPTION>
Class Y
Shares
--------
Short-Term U.S. Treasury Securities Portfolio 1996(1)
================================================================================
<S> <C>
Net Asset Value, Beginning of Year $ 4.19
- --------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.22
Net realized and unrealized loss (0.14)
- --------------------------------------------------------------------------------
Total Income From Operations 0.08
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.22)
- --------------------------------------------------------------------------------
Total Distributions (0.22)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $ 4.05
- --------------------------------------------------------------------------------
Total Return+++ 2.08%
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 32,114
- --------------------------------------------------------------------------------
Ratios to Average Net Assets+:
Expenses 0.58%
Net investment income 5.99
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 130%
================================================================================
</TABLE>
(1) For the period February 7, 1996 (inception date) through December 31, 1996.
+++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
22
<PAGE>
================================================================================
Independent Auditors' Report
================================================================================
The Shareholders and Board of Directors of
Smith Barney Funds Inc.
We have audited the accompanying statements of assets and liabilities,
including the schedules of investments, of Income Return Account and Short-Term
U.S. Treasury Securities Portfolios of Smith Barney Funds, Inc. as of December
31, 1996, the related statements of operations for the year then ended, the
statements of changes in net assets for each of the years in the two-year period
then ended and financial highlights for each of the years in the five-year
period then ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1996, 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
Income Return Account and Short-Term U.S. Treasury Securities Portfolios of
Smith Barney Funds, Inc. as of December 31, 1996, the results of their
operations for the year then ended, the changes in their net assets for each of
the years in the two-year period then ended and financial highlights for each of
the years in the five-year period then ended, in conformity with generally
accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
February 19, 1997
23
<PAGE>
================================================================================
Tax Information (unaudited)
================================================================================
A total of 87.48% and 91.59% of the ordinary income dividends paid by the Income
Return Account Portfolio and Short-Term U.S. Treasury Securities Portfolio,
respectively, have been derived from federal obligations and may be exempt from
taxation at the state level.
24
<PAGE>
SMITH BARNEY
FUNDS, INC.
DIRECTORS
Jessica M. Bibliowicz
Joseph H. Fleiss
Donald R. Foley
Paul Hardin
Francis P. Martin, M.D.
Heath B. McLendon, Chairman
Roderick C. Rasmussen
Bruce D. Sargent
John P. Toolan
OFFICERS
Heath B. McLendon
Chief Executive Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President
and Treasurer
James E. Conroy
Vice President
Bruce D. Sargent
Vice President
Patrick Sheehan
Vice President
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
SMITH BARNEY
- ----------------------------------
A Member of TravelersGroup [LOGO]
INVESTMENT MANAGER
Smith Barney Mutual Funds
Management Inc.
DISTRIBUTOR
Smith Barney Inc.
CUSTODIAN
PNC Bank, N.A.
SHAREHOLDER
SERVICING AGENT
First Data Investor
Services Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for the general information of the shareholders of
Smith Barney Funds, Inc.-- Income Return Account and Short-Term U.S. Treasury
Securities Portfolios. It is not authorized for distribution to prospective
investors unless accompanied or preceded by a current Prospectus for the
Portfolio, which contains information concerning the Portfolio's investment
policies and expenses as well as other pertinent information.
SMITH BARNEY FUNDS, INC.
388 Greenwich Street
New York, New York 10013
FD0854 2/97
<PAGE>
- --------------------------------------------------------------------------------
ANNUAL REPORT
- --------------------------------------------------------------------------------
1996
1996
1996
1996
1996 [STOCK PHOTOGRAPHY]
Smith Barney
Funds, Inc.
Equity Income
Portfolio
--------------------------
December 31, 1996
[Logo] Smith Barney Mutual Funds
Investing for your future.
Every day.
<PAGE>
- -----------------------
Equity Income Portfolio
- -----------------------
Dear Shareholder:
We are pleased to provide you with the annual report for Smith Barney Funds Inc.
- -- Equity Income Portfolio ("Portfolio") for the year ended December 31, 1996.
For your convenience, we summarize the period's prevailing economic conditions
and briefly report on the Portfolio's investment strategy. A detailed summary of
performance and current holdings can be found in the appropriate sections that
follow.
Portfolio Performance
and Investment Strategy
For the year ended December 31, 1996, the Equity Income Portfolio had a total
return of 16.06% for Class A shares versus the Standard & Poor's 500 total
return of 22.95% for the same period. (The Standard & Poor's 500 Index is a
capitalization weighted-index of 500 widely held common stocks.) In addition,
the Portfolio had a dividend yield of approximately 3.00% versus the roughly
2.00% yield of the S&P 500.
In selecting stocks for the Equity Income Portfolio, we typically choose
large-capitalization companies that have an above-market dividend yield and
assets that are undervalued by the marketplace. We look to find a fundamental
improvement underway, such as new product development or new management, the
positive effect of which has not yet been reflected in the stock price.
We employ a conservative, highly disciplined and bottom-up approach to
investing. This means that individual stock selection is more influential to the
overall performance of the Portfolio rather than the present or future condition
of the economy, the financial markets or the performance of particular market
sectors. Our approach involves visiting hundreds of companies every year and
meeting with their management teams to understand a company's business and
industry, identify outstanding management teams and target promising long-term
investment opportunities.
We strive to minimize risk in the Equity Income Portfolio in a number of ways.
As of December 31, 1996, the Portfolio owned 66 securities and no single
security made up more than 5% of the Portfolio. In addition to broad
diversification, the Portfolio's holdings tend to be highly liquid and the
dividends they generate help to cushion the Portfolio from the effects of
volatile markets. In fact, a key aspect of our investment strategy is that every
stock we own must provide at least the same or a higher dividend than the
average for the S&P 500.
1
<PAGE>
Market Update and Outlook
At the beginning of 1996, few market observers expected the stock market to
perform as well as it did, particularly considering it was up 37.40% in 1995 as
measured by the S&P 500. In 1996, the stock market, as measured by the S&P 500,
was up 22.95%. At the beginning of the year, the Equity Income Portfolio was
conservatively positioned and that hurt its relative performance versus the
benchmark during the reporting period. In particular, the Portfolio's holdings
in the utilities sector turned in a disappointing performance as expected
restructurings failed to materialize. On the other hand, the Portfolio's
holdings in financial services benefited its performance. In 1997, we expect
market returns to be more modest and in line with historical norms (i.e.,
roughly 10%) and we believe the Portfolio's emphasis on stocks with high
dividend yields should serve it well in the coming year.
During the spring and summer of 1996, concerns about the pace of economic growth
caused increased volatility in the financial markets. As a result, the upward
momentum in the stock market was interrupted in July when earnings
disappointments by a few prominent corporations caused some investors to believe
stock prices had become overvalued versus their earnings outlook. In retrospect,
those investor concerns proved unfounded which set the stage for the stock
market's current rally.
Looking ahead, we do not believe inflation is a problem and should remain
subdued. However, in our view, possible inflationary pressures will be the
driving force for market returns going forward. Therefore, we will continue to
closely monitor key economic data regarding wages and unemployment levels for
any signs of unsustainable growth.
Portfolio Update
During the reporting period, the Equity Income Portfolio's industry allocations
remained relatively unchanged. Two new additions to the Portfolio during the
reporting period that demonstrate its value approach to investing are
Bristol-Myers and Reynolds Metal. Considered a conservatively managed "sleeper"
in the drug industry with no new exciting drugs in the pipeline, Bristol-Myers
has a solid balance sheet and one of the highest-yielding stocks in the sector.
What initially caught our attention was the fact that the company's new
cost-conscious management team, which has been recently streamlined into three
separate divisions, had managed Bristol-Myers well despite intense competition
from generic drug makers and the patent expiration of Capoten (a blood pressure
control medication and one of Bristol-Myer's most popular and profitable
products). In addition, its drug Pravachol, used for treatment of high
cholesterol, appears to decrease significantly the chances of getting a first
heart attack. Bristol-Myers recently received FDA approval for this new use for
Pravachol. Since receiving approval from the FDA, sales have already
2
<PAGE>
increased dramatically. Moreover, Bristol-Myers owns non-core businesses in
other areas such as Clairol (a hair products company) and Nutritional & Medical
Devices Group. We believe that Bristol-Myers' senior management may eventually
restructure the company and sell some of these non-strategic, lower margin
assets, which may ultimately increase its long-term attractiveness.
Reynolds Metal, a manufacturer and distributor of aluminum and other metals, is
another new addition for the Equity Income Portfolio. Although the stock has
underperformed over the last ten years, the company recently promoted Jeremiah
Sheehan from within to replace retiring CEO Richard Holder. Mr. Sheehan has
publicly stated he would like to enhance shareholder value and has hired a major
Wall Street firm to closely analyze all of the company's different businesses
such as building products, mining operations, and aluminum manufacturing. In
addition, the company may possibly spin-off some non-strategic assets. If this
restructuring happens, shareholders should realize a much higher stock price.
In closing, no matter how turbulent market conditions may become, we remain
committed to our bottom up, value investment approach that seeks to find
out-of-favor companies with improving earnings outlooks. Thank you for investing
in the Equity Income Portfolio. We look forward to continuing to help you
achieve your financial goals.
Sincerely,
/s/ Heath B. McLendon /s/ Ayako Weissman
Heath B. McLendon Ayako Weissman
Chairman and Vice President
Chief Executive Officer
January 21, 1997
3
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance -- Class A Shares
- --------------------------------------------------------------------------------
Net Asset Value
------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
================================================================================
12/31/96 $14.59 $14.79 $0.36 $1.79 16.06%
- --------------------------------------------------------------------------------
12/31/95 12.18 14.59 0.39 1.18 33.05
- --------------------------------------------------------------------------------
12/31/94 13.31 12.18 0.42 0.14 (4.31)
- --------------------------------------------------------------------------------
12/31/93 12.48 13.31 0.46 0.73 16.38
- --------------------------------------------------------------------------------
12/31/92 12.51 12.48 0.51 0.40 7.23
- --------------------------------------------------------------------------------
12/31/91 10.54 12.51 0.73 0.05 26.57
- --------------------------------------------------------------------------------
12/31/90 12.69 10.54 0.70 0.25 (9.46)
- --------------------------------------------------------------------------------
12/31/89 11.00 12.69 0.70 0.31 25.11
- --------------------------------------------------------------------------------
12/31/88 10.05 11.00 0.63 0.17 17.67
- --------------------------------------------------------------------------------
12/31/87 11.40 10.05 0.50 0.63 (2.83)
================================================================================
Total $5.40 $5.65
================================================================================
- --------------------------------------------------------------------------------
Historical Performance -- Class B Shares
- --------------------------------------------------------------------------------
Net Asset Value
------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
================================================================================
12/31/96 $14.54 $14.74 $0.24 $1.79 15.22%
- --------------------------------------------------------------------------------
12/31/95 12.15 14.54 0.29 1.18 32.07
- --------------------------------------------------------------------------------
Inception*-12/31/94 12.54 12.15 0.09 0.14 (1.28)+
================================================================================
Total $0.62 $3.11
================================================================================
- --------------------------------------------------------------------------------
Historical Performance -- Class C Shares
- --------------------------------------------------------------------------------
Net Asset Value
------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
================================================================================
12/31/96 $14.57 $14.76 $0.24 $1.79 15.15%
- --------------------------------------------------------------------------------
12/31/95 12.18 14.57 0.29 1.18 32.01
- --------------------------------------------------------------------------------
12/31/94 13.30 12.18 0.34 0.14 (4.91)
- --------------------------------------------------------------------------------
12/31/93 12.48 13.30 0.36 0.73 15.46
- --------------------------------------------------------------------------------
Inception*-12/31/92 12.87 12.48 0.06 0.40 (0.57)+
================================================================================
Total $1.29 $4.24
================================================================================
4
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance -- Class Y Shares
- --------------------------------------------------------------------------------
Net Asset Value
------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
================================================================================
Inception*-12/31/96 $15.06 $14.80 $0.41 $1.79 12.86%+
================================================================================
- --------------------------------------------------------------------------------
Historical Performance -- Class Z Shares
- --------------------------------------------------------------------------------
Net Asset Value
------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
================================================================================
12/31/96 $14.61 $14.82 $0.41 $1.79 16.47%
- --------------------------------------------------------------------------------
12/31/95 12.19 14.61 0.42 1.18 33.41
- --------------------------------------------------------------------------------
Inception*-12/31/94 12.54 12.19 0.12 0.14 (0.73)+
================================================================================
Total $0.95 $3.11
================================================================================
It is the Fund's policy to distribute dividends quarterly and capital gains, if
any, annually.
- --------------------------------------------------------------------------------
Average Annual Total Return
- --------------------------------------------------------------------------------
Without Sales Charge(1)
--------------------------------------------------
Class A Class B Class C Class Y Class Z
================================================================================
Year Ended 12/31/96 16.06% 15.22% 15.15% N/A 16.47%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/96 13.02 N/A N/A N/A N/A
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/96 11.70 N/A N/A N/A N/A
- --------------------------------------------------------------------------------
Inception* through 12/31/96 8.03 20.83 13.52 12.86%+ 22.32
================================================================================
With Sales Charge(2)
--------------------------------------------------
Class A Class B Class C Class Y Class Z
================================================================================
Year Ended 12/31/96 10.25% 10.22% 14.15% N/A 16.47%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/96 11.86 N/A N/A N/A N/A
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/96 11.13 N/A N/A N/A N/A
- --------------------------------------------------------------------------------
Inception* through 12/31/96 7.80 19.70 13.52 12.86%+ 22.32
================================================================================
5
<PAGE>
- --------------------------------------------------------------------------------
Cumulative Total Return
- --------------------------------------------------------------------------------
Without Sales Charge(1)
================================================================================
Class A (12/31/86 through 12/31/96) 202.27%
- --------------------------------------------------------------------------------
Class B (Inception* through 12/31/96) 50.22
- --------------------------------------------------------------------------------
Class C (Inception* through 12/31/96) 67.82
- --------------------------------------------------------------------------------
Class Y (Inception* through 12/31/96) 12.86+
- --------------------------------------------------------------------------------
Class Z (Inception* through 12/31/96) 54.25
================================================================================
(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 charges with respect to Class A shares or the contingent
deferred sales charges ("CDSC") with respect to Class B and C shares.
(2) Assumes reinvestment of all dividends and capital gain distributions, if
any, at net asset value. In addition, Class A shares reflect the deduction
of the maximum initial sales charge of 5.00% and Class B shares reflect the
deduction of a 5.00% CDSC, which applies if shares are redeemed within one
year from initial purchase and declines thereafter by 1.00% per year until
no CDSC is incurred. Class C shares reflect the deduction of a 1.00% CDSC,
which applies if shares are redeemed within the first year of purchase.
* Inception dates for Class A, B, C, Y and Z shares are January 2, 1972,
November 7, 1994, December 2, 1992, February 6, 1996 and November 7, 1994,
respectively.
+ Total return is not annualized, as it may not be representative of the
total return for the year.
6
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Class A Shares of
the Equity Income Portfolio vs.
Standard & Poor's 500 Index+
- --------------------------------------------------------------------------------
December 1986 -- December 1996
[The following table was depicted as a line graph in the printed material.]
Equity Income Portfolio Standard & Poor's 500 Index
----------------------- ---------------------------
12/86 9422 10000
12/87 9132 10525
12/88 10546 12269
12/89 13358 16150
12/90 11770 15648
12/91 15250 20406
12/92 16354 21960
12/93 19033 24167
12/94 18212 24485
12/95 24231 33675
12/96 28123 37608
+ Hypothetical illustration of $10,000 invested in Class A shares on December
31, 1986, assuming deduction of the maximum 5.75% sales charge in effect at
the time of investment and reinvestment of dividends (after deduction of
applicable sales charge through March 1991, and thereafter at net asset value)
and capital gains, if any, at net asset value through December 31, 1996. 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 index is
unmanaged and is not subject to the same management and trading expenses of a
mutual fund. The performance of the Portfolio's other classes may be greater
or less than the Class A shares' performance indicated on this chart,
depending on whether greater or lesser sales charges and fees were incurred by
shareholders investing in the other classes.
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.
7
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
COMMON STOCKS -- 92.2%
================================================================================
Capital Goods -- 5.2%
150,000 Emerson Electric Co. $ 14,512,500
200,000 General Electric Co. 19,775,000
250,000 National Services Industries, Inc. 9,343,750
- --------------------------------------------------------------------------------
43,631,250
- --------------------------------------------------------------------------------
Conglomerates -- 7.2%
250,000 Minnesota Mining & Manufacturing Co. 20,718,750
200,000 Pitney Bowes Inc. 10,900,000
400,000 Tenneco, Inc. 18,050,000
150,000 United Technologies Corp. 9,900,000
- --------------------------------------------------------------------------------
59,568,750
- --------------------------------------------------------------------------------
Consumer Cyclicals -- 5.4%
20,000 Deluxe Corp. 655,000
250,000 Ford Motor Corp. 7,968,750
100,000 Knight-Ridder, Inc. 3,825,000
100,000 McGraw Hill Companies, Inc. 4,612,500
330,000 New York Times Co., Class A Shares 12,540,000
175,000 Sears, Roebuck & Co. 8,071,875
265,000 Stanley Works, Inc. 7,155,000
- --------------------------------------------------------------------------------
44,828,125
- --------------------------------------------------------------------------------
Consumer Staples -- 16.5%
100,000 Allegiance Corp. 2,762,500
375,000 American Home Products Corp. 21,984,375
520,000 Baxter International, Inc. 21,320,000
200,000 Bristol-Myers Squibb & Co. 21,750,000
225,000 Eli Lilly & Co. 16,425,000
325,000 Federal Mogul Corp. 7,150,000
425,000 H.J. Heinz & Co. 15,193,750
140,000 Tambrands, Inc. 5,722,500
140,000 Unilever, N.V. 24,535,000
- --------------------------------------------------------------------------------
136,843,125
- --------------------------------------------------------------------------------
Energy -- 14.4%
300,000 Ashland, Inc. 13,162,500
215,000 Chevron Corp. 13,975,000
325,000 Dresser Industries, Inc. 10,075,000
200,000 Enron Global Power & Pipelines, LLC. 5,400,000
190,000 Mobil Corp. 23,227,500
250,000 Panenergy Corp. 11,250,000
100,000 Royal Dutch Petroleum Co. 17,075,000
450,000 Unocal Corp. 18,281,250
250,000 Valero Energy Corp. 7,156,250
- --------------------------------------------------------------------------------
119,602,500
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
8
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Financial Services -- 15.2%
350,000 Allstate Corp. $ 20,256,250
70,000 Aon Corp. 4,348,750
200,000 Bankers Trust of New York Corp. 17,250,000
208,000 Chase Manhattan Corp. 18,564,000
300,000 Chubb Corp. 16,125,000
250,000 Fleet Financial Group 12,468,750
250,000 Great Western Financial Corp. 7,250,000
200,000 Household International, Inc. 18,450,000
200,000 St. Paul Companies, Inc. 11,725,000
- --------------------------------------------------------------------------------
126,437,750
- --------------------------------------------------------------------------------
Raw & Intermediate Materials -- 8.2%
250,000 International Paper Co. 10,093,750
200,000 Kimberly-Clark Corp. 19,050,000
225,000 Masco Corp. 8,100,000
150,000 Monsanto Co. 5,831,250
410,000 Olin Corp. 15,426,250
175,000 Reynolds Metals Co. 9,865,625
- --------------------------------------------------------------------------------
68,366,875
- --------------------------------------------------------------------------------
Technology -- 6.9%
300,000 Eastman Kodak Co. 24,075,000
110,000 Lockheed Martin Corp. 10,065,000
450,000 Xerox Corp. 23,681,250
- --------------------------------------------------------------------------------
57,821,250
- --------------------------------------------------------------------------------
Transportation -- 3.1%
80,000 Alexander Baldwin, Inc. 2,000,000
80,000 Newport News Shipbuilding 1,200,000
375,000 Union Pacific Corp. 22,546,875
- --------------------------------------------------------------------------------
25,746,875
- --------------------------------------------------------------------------------
Utilities -- 10.1%
220,000 Brooklyn Union Gas 6,627,500
250,000 Consolidated Natural Gas Co. 13,812,500
50,000 Deutsche Telekom ADR 1,018,750
37,200 El Paso Natural Gas 1,878,600
380,000 Entergy Corp. 10,545,000
400,000 GTE Corp. 18,200,000
400,000 Sprint Corp. 15,950,000
400,000 Texas Utilities Co. 16,300,000
- --------------------------------------------------------------------------------
84,332,350
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost -- $583,876,822) 767,178,850
================================================================================
See Notes to Financial Statements.
9
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
CONVERTIBLE PREFERRED STOCKS -- 1.6%
================================================================================
Financial Services -- 1.6%
60,000 Aetna, Inc., Preferred Class C, Exchangeable 6.25% $ 4,762,500
100,000 Banc One Corp., Series C, Exchangeable $3.50 8,300,000
- --------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(Cost -- $11,348,781) 13,062,500
================================================================================
FACE
AMOUNT SECURITY VALUE
================================================================================
CONVERTIBLE DEBENTURES -- 0.7%
================================================================================
Energy -- 0.7%
$5,800,000 Oryx Energy, 7.50% due 5/15/14
(Cost -- $5,547,625) 5,626,000
- --------------------------------------------------------------------------------
REPURCHASE AGREEMENTS -- 5.5%
6,137,000 Chase Manhattan Bank, 6.500% due 1/2/97;
Proceeds at maturity -- $6,139,215;
(Fully collateralized by U.S. Treasury Notes,
5.875% due 10/31/98; Market value -- $6,267,222) 6,137,000
40,000,000 CS First Boston Corp., 6.500% due 1/2/97;
Proceeds at maturity -- $40,014,435;
(Fully collateralized by U.S. Treasury Notes,
7.500% due 1/31/97; Market value -- $40,818,696) 40,000,000
- --------------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS
(Cost -- $46,137,000) 46,137,000
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $646,910,228*) $832,004,350
================================================================================
* Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
10
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities December 31, 1996
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost -- $646,910,228) $832,004,350
Cash 642
Receivable for Fund shares sold 4,556,726
Dividends and interest receivable 2,236,503
- --------------------------------------------------------------------------------
Total Assets 838,798,221
- --------------------------------------------------------------------------------
LIABILITIES:
Payable for Fund shares purchased 504,024
Management fees payable 414,487
Distribution fees payable 218,636
Accrued expenses 149,408
- --------------------------------------------------------------------------------
Total Liabilities 1,286,555
- --------------------------------------------------------------------------------
Total Net Assets $837,511,666
- --------------------------------------------------------------------------------
NET ASSETS:
Par value of capital shares $ 566,108
Capital paid in excess of par value 651,600,670
Undistributed net investment income 230,075
Accumulated net realized gain from security transactions 20,691
Net unrealized appreciation of investments 185,094,122
- --------------------------------------------------------------------------------
Total Net Assets $837,511,666
================================================================================
Shares Outstanding:
Class A 43,667,865
------------------------------------------------------------------------------
Class B 1,009,719
------------------------------------------------------------------------------
Class C 2,260,077
------------------------------------------------------------------------------
Class Y 2,038,995
------------------------------------------------------------------------------
Class Z 7,634,136
------------------------------------------------------------------------------
Net Asset Value:
Class A (and redemption price) $14.79
------------------------------------------------------------------------------
Class B* $14.74
------------------------------------------------------------------------------
Class C** $14.76
------------------------------------------------------------------------------
Class Y (and redemption price) $14.80
------------------------------------------------------------------------------
Class Z (and redemption price) $14.82
------------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
(net asset value plus 5.26% of net asset value per share) $15.57
================================================================================
* Redemption price is NAV of Class B shares reduced by a 5.00% CDSC if shares
are redeemed within one year from initial purchase (See Note 2).
** Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
are redeemed within the first year of purchase.
See Notes to Financial Statements.
11
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended December 31, 1996
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Dividends $ 20,840,817
Interest 5,075,103
Less: Foreign withholding tax (224,407)
- --------------------------------------------------------------------------------
Total Investment Income 25,691,513
- --------------------------------------------------------------------------------
EXPENSES:
Management fees (Note 2) 4,622,817
Distribution fees (Note 2) 2,003,957
Shareholder and system servicing fees 506,480
Registration fees 107,508
Shareholder communications 82,782
Custody 48,512
Audit and legal 27,549
Directors' fees 24,024
Other 42,025
- --------------------------------------------------------------------------------
Total Expenses 7,465,654
- --------------------------------------------------------------------------------
Net Investment Income 18,225,859
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS (NOTE 3):
Realized Gain From Security Transactions
(excluding short-term securities):
Proceeds from sales 377,538,258
Cost of securities sold 287,389,601
- --------------------------------------------------------------------------------
Net Realized Gain 90,148,657
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments:
Beginning of year 174,298,184
End of year 185,094,122
- --------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 10,795,938
- --------------------------------------------------------------------------------
Net Gain on Investments 100,944,595
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $ 119,170,454
================================================================================
See Notes to Financial Statements.
12
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended December 31,
- --------------------------------------------------------------------------------
1996 1995
================================================================================
OPERATIONS:
Net investment income $ 18,225,859 $ 19,447,507
Net realized gain 90,148,657 56,593,756
Increase in net unrealized appreciation 10,795,938 123,193,695
- --------------------------------------------------------------------------------
Increase In Net Assets From Operations 119,170,454 199,234,958
- --------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (18,560,723) (19,458,013)
Net realized gains (90,678,646) (56,277,355)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (109,239,369) (75,735,368)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net proceeds from sales of shares 77,117,814 35,334,789
Net asset value of shares issued for
reinvestment of dividends 98,396,742 70,023,680
Cost of shares reacquired (99,848,727) (129,386,207)
- --------------------------------------------------------------------------------
Increase (Decrease) in Net Assets From
Fund Share Transactions 75,665,829 (24,027,738)
- --------------------------------------------------------------------------------
Increase in Net Assets 85,596,914 99,471,852
NET ASSETS:
Beginning of year 751,914,752 652,442,900
- --------------------------------------------------------------------------------
End of year* $ 837,511,666 $ 751,914,752
================================================================================
* Includes undistributed net investment income of: $230,075 --
================================================================================
See Notes to Financial Statements.
13
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Equity Income Portfolio ("Portfolio"), is a separate investment
portfolio of the Smith Barney Funds, Inc. ("Fund"). The Fund, a Maryland
corporation, is registered under the Investment Company Act of 1940, as amended,
as a diversified, open-end management investment company and consists of this
Portfolio and three other separate investment portfolios: U.S. Government
Securities, Income Return Account and Short-Term U.S. Treasury Securities
Portfolios. The financial statements and financial highlights for the other
portfolios are presented in separate annual reports.
The significant accounting policies consistently followed by the Portfolio
are: (a) security transactions are accounted for on trade date; (b) securities
traded on national securities markets are valued at the closing prices on such
markets; securities for which no sales price was reported and U.S. Government
and Agency obligations are valued at the mean between the bid and ask prices;
(c) securities that have a maturity of more than 60 days are valued at prices
based on market quotations for securities of similar type, yield and maturity;
(d) securities maturing within 60 days or less are valued at cost plus accreted
discount, or minus amortized premium, which approximates market value; (e)
dividend income is recorded on the ex-dividend date and interest income is
recorded on the accrual basis; foreign dividends are recorded on the ex-dividend
date or as soon as practical after the Portfolio determines the existence of a
dividend declaration after exercising reasonable due diligence; (f) gains or
losses on the sale of securities are calculated by using the specific
identification method; (g) dividends and distributions to shareholders are
recorded on the ex-dividend date; (h) direct expenses are charged to each class;
management fees and general portfolio expenses are allocated on the basis of
relative net assets; (i) the accounting records are maintained in U.S. dollars.
All assets and liabilities denominated in foreign currencies are translated into
U.S. dollars based on the rate of exchange of such currencies against U.S.
dollars on the date of valuation. Purchases and sales of securities, and income
and expenses are translated at the rate of exchange quoted on the respective
date that such transactions are recorded. Differences between income and expense
amounts recorded and collected or paid are adjusted when reported by the
custodian bank; (j) the Portfolio 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;
(k) 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 December 31, 1996, reclassifications were made to the
Portfolio's capital accounts to reflect permanent book/tax
14
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
differences and income and gains available for distributions under income tax
regulations. Accordingly, a portion of accumulated realized loss amounting to
$178,747 and a portion of accumulated net investment loss amounting to $564,939
was reclassified to paid-in capital. Net investment income, net realized gains
and net assets were not affected by this change; and (l) 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. MANAGEMENT AGREEMENT AND OTHER TRANSACTIONS
Smith Barney Mutual Funds Management Inc. ("SBMFM"), a subsidiary of Smith
Barney Holdings Inc. ("SBH"), acts as investment manager of the Fund. The Equity
Income Portfolio pays SBMFM a management fee calculated at an annual rate of
0.60% on the Portfolio's average daily net assets up to $500 million, 0.55% on
the next $500 million and 0.50% on average daily net assets in excess of $1.0
billion. These fees are calculated daily and paid monthly.
Smith Barney Inc. ("SB"), another subsidiary of SBH, acts as distributor of
Fund shares and primary broker for its portfolio agency transactions. For the
year ended December 31, 1996, SB received brokerage commissions of $441,702 and
sales charges of approximately $529,000 on sales of the Portfolio's Class A
shares.
There is a contingent deferred sales charge ("CDSC") of 5.00% on Class B
shares, which applies if redemption occurs less than one year from initial
purchase and declines thereafter by 1.00% per year until no CDSC is incurred.
Class C shares have a 1.00% CDSC, which applies if redemption occurs within the
first year of purchase. In addition, Class A shares also have a 1.00% CDSC,
which applies if redemption occurs within the first year of purchase. This CDSC
only applies to those purchases of Class A shares, which when combined with
current holdings of Class A shares, equal or exceed $500,000 in the aggregate.
These purchases do not incur an initial sales charge. For the year ended
December 31, 1996, CDSCs paid to SB were:
Class A Class B Class C
================================================================================
CDSCs $1,000 $41,000 $3,000
================================================================================
Pursuant to a Distribution Plan, the Portfolio pays a service fee with
respect to its Class A, B and C shares calculated at the annual rate of 0.25% of
15
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
the average daily net assets of each respective class. In addition, the
Portfolio also pays a distribution fee with respect to Class B and C shares
calculated at the annual rate of 0.75% of the average daily net assets of each
class. For the year ended December 31, 1996, total Distribution Plan fees were
as follows:
Class A Class B Class C
================================================================================
Distribution Plan Fees $1,580,633 $107,017 $316,307
================================================================================
All officers and three Directors of the Fund are employees of SB.
3. INVESTMENTS
During the year ended December 31, 1996, the aggregate cost of purchases
and proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $355,806,455
- --------------------------------------------------------------------------------
Sales 377,538,258
================================================================================
At December 31, 1996, the aggregate gross unrealized appreciation and
depreciation of investments were as follows:
================================================================================
Gross unrealized appreciation $ 189,104,434*
Gross unrealized depreciation (4,010,312)*
- --------------------------------------------------------------------------------
Net unrealized appreciation $ 185,094,122*
================================================================================
* Substantially the same for Federal income tax purposes.
4. REPURCHASE AGREEMENTS
The Portfolio purchases (and its custodian take 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 Portfolio requires
continual maintenance of the market value of the collateral in amounts at least
equal to the repurchase price.
5. CAPITAL SHARES
At December 31, 1996, the Fund had two billion shares of capital stock
authorized with a par value of $0.01 per share. The Portfolio has the ability to
issue multiple classes of shares. Each share of a class represents an identical
interest in the Portfolio and has the same rights, except that each class bears
certain expenses specifically related to the distribution of its shares.
16
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
At December 31, 1996, total paid-in capital amounted to the following for
each class:
Class A Class B Class C Class Y Class Z
================================================================================
Total Paid-in
Capital $477,222,923 $14,931,337 $30,766,096 $31,621,332 $97,625,090
================================================================================
Transactions in shares of each class were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1996* December 31, 1995
------------------------- ---------------------------
Shares Amount Shares Amount
=========================================================================================
<S> <C> <C> <C> <C>
Class A
Shares sold 1,572,895 $ 23,892,544 1,257,466 $ 17,631,623
Shares issued on reinvestment 5,161,353 77,820,683 3,940,421 56,723,635
Shares redeemed (5,390,653) (83,086,170) (7,565,480) (103,786,681)
- -----------------------------------------------------------------------------------------
Net Increase (Decrease) 1,343,595 $ 18,627,057 (2,367,593) $ (29,431,423)
=========================================================================================
Class B
Shares sold 622,419 $ 9,553,511 383,746 $ 5,468,312
Shares issued on reinvestment 110,323 1,654,996 32,917 476,304
Shares redeemed (110,106) (2,171,232) (28,716) (399,167)
- -----------------------------------------------------------------------------------------
Net Increase 592,636 $ 9,037,275 387,947 $ 5,545,449
=========================================================================================
Class C
Shares sold 309,334 $ 4,772,481 240,559 $ 3,375,523
Shares issued on reinvestment 256,939 3,861,171 180,858 2,604,330
Shares redeemed (348,965) (5,369,299) (636,749) (8,570,732)
- -----------------------------------------------------------------------------------------
Net Increase (Decrease) 217,308 $ 3,264,353 (215,332) $ (2,590,879)
=========================================================================================
Class Y
Shares sold 2,038,995 $ 31,633,477 -- --
- -----------------------------------------------------------------------------------------
Net Increase 2,038,995 $ 31,633,477 -- --
=========================================================================================
Class Z
Shares sold 478,209 $ 7,265,801 665,866 $ 8,859,331
Shares issued on reinvestment 996,127 15,059,892 709,558 10,219,411
Shares redeemed (592,793) (9,222,026) (1,185,176) (16,629,627)
- -----------------------------------------------------------------------------------------
Net Increase 881,543 $ 13,103,667 190,248 $ 2,449,115
=========================================================================================
</TABLE>
* For Class Y shares, transactions are for the period from February 6, 1996
(inception date) to December 31, 1996.
17
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of each class of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
Class A Shares 1996 1995 1994(1) 1993 1992
==========================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 14.59 $ 12.18 $ 13.31 $ 12.48 $ 12.51
- ----------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.36 0.39 0.43 0.46 0.50
Net realized and unrealized gain (loss) 1.99 3.59 (1.00) 1.56 0.38
- ----------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 2.35 3.98 (0.57) 2.02 0.88
- ----------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.36) (0.39) (0.42) (0.46) (0.51)
Net realized gains(2) (1.79) (1.18) (0.14) (0.73) (0.40)
- ----------------------------------------------------------------------------------------------------------
Total Distributions (2.15) (1.57) (0.56) (1.19) (0.91)
- ----------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 14.79 $ 14.59 $ 12.18 $ 13.31 $ 12.48
- ----------------------------------------------------------------------------------------------------------
Total Return 16.06% 33.05% (4.31)% 16.38% 7.23%
- ----------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $645,935 $617,431 $544,572 $627,870 $573,085
- ----------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.95% 1.02% 0.96% 0.91% 0.92%
Net investment income 2.28 2.78 3.31 3.42 3.97
- ----------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 49% 51% 27% 46% 39%
- ----------------------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(3) $ 0.06 $ 0.06 -- -- --
==========================================================================================================
</TABLE>
(1) On October 10, 1994 the former Class C shares were exchanged into Class A
shares; therefore for the period from January 1, 1994 to October 9, 1994
the Class C share activity is included with the Class A share activity.
(2) Net short-term gains, if any, are included and reported as ordinary income
for income tax purposes.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
18
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of capital stock outstanding throughout each year:
Class B Shares 1996 1995 1994(1)
================================================================================
Net Asset Value, Beginning of Year $14.54 $12.15 $12.54
- --------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.25 0.24 0.03
Net realized and unrealized gain (loss) 1.98 3.62 (0.19)
- --------------------------------------------------------------------------------
Total Income (Loss) From Operations 2.23 3.86 (0.16)
- --------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.24) (0.29) (0.09)
Net realized gains(2) (1.79) (1.18) (0.14)
- --------------------------------------------------------------------------------
Total Distributions (2.03) (1.47) (0.23)
- --------------------------------------------------------------------------------
Net Asset Value, End of Year $14.74 $14.54 $12.15
- --------------------------------------------------------------------------------
Total Return 15.22% 32.07% (1.28)%++
- --------------------------------------------------------------------------------
Net Assets, End of Year (000s) $14,883 $6,065 $ 354
- --------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.71% 1.73% 1.59%+*
Net investment income 1.55 1.83 2.11+
- --------------------------------------------------------------------------------
Portfolio Turnover Rate 49% 51% 27%
- --------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(3) $ 0.06 $ 0.06 --
================================================================================
(1) For the period from November 7, 1994 (inception date) to December 31, 1994.
(2) Net short-term gains, if any, are included and reported as ordinary income
for income tax purposes.
(3) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
* Figure has been restated from December 31, 1994 annual report.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
19
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
Class C Shares 1996 1995 1994(1) 1993 1992(2)
====================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $14.57 $12.18 $13.30 $12.48 $12.87
- ----------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.24 0.27 0.31 0.38 0.17
Net realized and unrealized gain (loss) 1.98 3.59 (0.95) 1.53 (0.10)
- ----------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 2.22 3.86 (0.64) 1.91 0.07
- ----------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.24) (0.29) (0.34) (0.36) (0.06)
Net realized gains(3) (1.79) (1.18) (0.14) (0.73) (0.40)
- ----------------------------------------------------------------------------------------------------
Total Distributions (2.03) (1.47) (0.48) (1.09) (0.46)
- ----------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $14.76 $14.57 $12.18 $13.30 $12.48
- ----------------------------------------------------------------------------------------------------
Total Return 15.15% 32.01% (4.91)% 15.46% (0.57)%++
- ----------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $33,365 $29,758 $27,507 $15,408 $1,504
- ----------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.73% 1.79% 1.75% 1.65% 1.58%+
Net investment income 1.50 2.00 2.49 2.59 1.80+
- ----------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 49% 51% 27% 46% 39%
- ----------------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(4) $ 0.06 $ 0.06 -- -- --
====================================================================================================
</TABLE>
(1) On November 7, 1994, the former Class B shares were renamed Class C shares.
(2) For the period from December 2, 1992 (inception date) to December 31, 1992.
(3) Net short-term gains, if any, are included and reported as ordinary income
for income tax purposes.
(4) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
20
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
For a share of each class of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
Class Y Shares Class Z Shares
-------------- -----------------------------
1996(1)(2) 1996 1995 1994(3)
============================================================================================
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $15.06 $14.61 $12.19 $12.54
- --------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.36 0.42 0.43 0.07
Net realized and unrealized gain (loss) 1.58 1.99 3.59 (0.16)
- --------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 1.94 2.41 4.02 (0.09)
- --------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.41) (0.41) (0.42) (0.12)
Net realized gains(4) (1.79) (1.79) (1.18) (0.14)
- --------------------------------------------------------------------------------------------
Total Distributions (2.20) (2.20) (1.60) (0.26)
- --------------------------------------------------------------------------------------------
Net Asset Value, End of Year $14.80 $14.82 $14.61 $12.19
- --------------------------------------------------------------------------------------------
Total Return 12.86%++ 16.47% 33.41% (0.73)%++
- --------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $30,169 $113,160 $98,661 $80,010
- --------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 0.66%+ 0.62% 0.69% 0.42%+
Net investment income 3.02+ 2.62 3.11 3.88+
- --------------------------------------------------------------------------------------------
Portfolio Turnover Rate 49% 49% 51% 27%
- --------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(5) $ 0.06 $ 0.06 $ 0.06 --
============================================================================================
</TABLE>
(1) Per share amounts have been calculated using the monthly average shares
method, which more appropriately presents per share data for this year
since the use of the undistributed income method did not accord with
results of operations.
(2) For the period from February 6, 1996 (inception date) to December 31, 1996.
(3) For the period from November 7, 1994 (inception date) to December 31, 1994.
(4) Net short term gains, if any, are included and reported as ordinary income
for income tax purposes. (5) As of September 1995, the SEC instituted new
guidelines requiring the disclosure of average commissions per share.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
+ Annualized.
21
<PAGE>
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
To the Board of Directors and Shareholders of
Smith Barney Funds, Inc.:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Equity Income Portfolio of Smith
Barney Funds, Inc., as of December 31, 1996, 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 five-year period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1996, 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
Equity Income Portfolio of Smith Barney Funds, Inc. as of December 31, 1996, 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 five-year period then ended, in
conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
February 19, 1997
22
<PAGE>
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
A total of 79.25% of the ordinary income dividends paid by the Fund
qualified for the dividends received deduction available to corporate taxpayers.
The Fund paid distributions of $90,280,405 from long-term capital gains.
23
<PAGE>
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<PAGE>
Smith Barney SMITH BARNEY
Funds, Inc. ------------
A Member of TravelersGroup [Logo]
Directors
Jessica M. Bibliowicz
Joseph H. Fleiss
Donald R. Foley
Paul Hardin
Francis P. Martin, M.D.
Heath B. McLendon, Chairman
Roderick C. Rasmussen
Bruce D. Sargent
John P. Toolan
Officers
Heath B. McLendon
Chief Executive Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President
and Treasurer
Bruce D. Sargent
Vice President
Ayako Weissman
Vice President
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
Investment Manager
Smith Barney Mutual Funds
Management Inc.
Distributor
Smith Barney Inc.
Custodian
PNC Bank, N.A.
Shareholder
Servicing Agent
First Data Investor Services Group, Inc.
P.O. Box 9134
Boston, MA 02205-9134
This report is submitted for the general information of the shareholders of
Smith Barney Funds, Inc. -- Equity Income Portfolio. It is not authorized for
distribution to prospective investors unless accompanied or preceded by a
current Prospectus for the Portfolio, which contains information concerning the
Portfolio's investment policies and expenses as well as other pertinent
information.
Smith Barney Funds, Inc.
388 Greenwich Street
New York, New York 10013
FD0853 2/97
