PROSPECT STREET HIGH INCOME PORTFOLIO, INC.
NOTES TO FINANCIAL STATEMENTS (continued)
requires entities to display
the fair value of the selected assets and liabilities on the face of the
balance sheet. FAS 159 does not eliminate disclosure requirements of other
accounting standards, including fair value measurement disclosures in FAS 157.
FAS 159 is effective as of the beginning of an entity’s first fiscal year
beginning after November 15, 2007.
At
this time, management is evaluating the implications of FIN 48, FAS 157 and FAS
159 and their impact on the financial statements has not yet been determined.
(3) Investment Advisory
Agreement:
Highland
earned $953,801 in management fees for the year ended October 31, 2007.
Management fees paid by the Fund to Highland were calculated at 0.65% (on an
annual basis) of the Fund’s average weekly net asset value, defined as total
assets of the Fund less accrued liabilities (excluding the principal amount of
any bank loan, notes and the liquidation preference of any preferred shares,
and including accrued and unpaid dividends on any preferred shares), up to and
including $175,000,000 of net assets, 0.55% on the next $50,000,000 of net
assets and 0.50% of the excess of net assets over $225,000,000.
(4) Purchases and Sales of
Securities:
For
the year ended October 31, 2007, the aggregate cost of purchases and proceeds
from sales of investment securities other than U.S. government obligations and
short-term investments was approximately $300,732,101 and $300,624,835,
respectively. There were no purchases or sales of U.S. government obligations
for the year ended October 31, 2007.
The
Investment Adviser and its affiliates manage other accounts, including
registered and private funds and individual accounts that also invest in high
yield fixed-income securities. Although investment decisions for the Fund are
made independently from those of such other accounts, investments of the type
the Fund may make may also be made on behalf of such other accounts. When the
Fund and one or more of such other accounts is prepared to invest in, or
desires to dispose of, the same security, available investments or
opportunities for each will be allocated in a manner believed by the Investment
Adviser to be equitable to the Fund and such other accounts. The Investment
Adviser also may aggregate orders to purchase and sell securities for the Fund
and such other accounts. Although the Investment Adviser believes that, over
time, the potential benefits of participating in volume transactions and
negotiating lower transaction costs should benefit all accounts including the
Fund, in some cases these activities may adversely affect the price paid or
received by the Fund or the size of the position obtained or disposed of by the
Fund.
(5) Certain Transactions:
An
officer of the Investment Adviser serves on the Board of Directors but receives
no compensation in this capacity.
17
PROSPECT STREET HIGH INCOME PORTFOLIO, INC.
NOTES TO FINANCIAL STATEMENTS (continued)
Directors
who are not officers or employees of the Investment Adviser receive fees of
$15,000 per year, together with the reimbursement of actual out-of-pocket expenses
incurred relating to attendance at Board of Directors’ meetings. For the year
ended October 31, 2007, the Fund incurred Board of Directors’ fees and expenses
of $45,897.
(6) Distributions:
Distributions
on the Fund’s common stock (“Common Stock”) are declared based on annual
projections of the Fund’s net investment income (defined as dividends and
interest income, net of Fund expenses). The Fund plans to pay monthly
distributions to holders of Common Stock (“Common Stockholders”). As a result
of market conditions or investment decisions, the amount of distributions may
exceed net investment income earned at certain times throughout the period.
For
the year ended October 31, 2007, the tax character of distributions paid by the
Fund to Common Stockholders were as follows:
|
|
|
|
|
|
|
Distributions from net
investment income
|
|
$
|
8,629,480
|
|
|
Distributions from paid in
capital
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
$
|
8,629,480
|
|
|
|
|
|
|
|
For the year ended October
31, 2006, the tax character of distributions paid by the Fund to Common
Stockholders were as follows:
|
|
|
|
|
|
|
Distributions from net
investment income
|
|
$
|
8,166,360
|
|
|
Distributions from paid in
capital
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
$
|
8,166,360
|
|
|
|
|
|
|
|
The
following is the history of the Fund’s calendar year distributions and their
composition to common stockholders in calendar years 2002 through 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions to Common Stockholders
|
|
$
|
0.27
|
|
$
|
0.28
|
|
$
|
0.33
|
|
$
|
0.31
|
|
$
|
0.72
|
|
|
Composition of Distributions*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ordinary Income
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
58
|
%
|
|
Return of Capital
|
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
42
|
%
|
|
Capital Gains
|
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ordinary Income
|
|
$
|
0.27
|
|
$
|
0.28
|
|
$
|
0.33
|
|
$
|
0.31
|
|
$
|
0.42
|
|
|
Return of Capital
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
0.30
|
|
|
Capital Gains
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
0.27
|
|
$
|
0.28
|
|
$
|
0.33
|
|
$
|
0.31
|
|
$
|
0.72
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
Distributions and their composition may differ for Common Stockholders who
bought or sold shares mid-year.
(7) Preferred Shares:
On
March 16, 2001, the Fund issued 3,000 shares of Series W Auction Rate
Cumulative Preferred Shares (the “Preferred Shares”) with $0.01 par value,
$25,000 liquidation preference, for a total issuance of $75,000,000. As of
October 31, 2007, 1,600 Preferred Shares were outstanding. The Fund may
reborrow amounts in the future to increase its use of leverage within the
limitations imposed by the 1940 Act. Significant provisions regarding the
Preferred Shares are described below.
18
PROSPECT STREET HIGH INCOME PORTFOLIO, INC.
NOTES TO FINANCIAL STATEMENTS (continued)
Redemption
The
Preferred Shares are not subject to any sinking fund, but are subject to
mandatory redemption under certain circumstances. If the Fund does not timely
cure a failure to meet certain asset coverages or timely filing requirements,
the Preferred Shares are subject to mandatory redemption out of funds legally
available in accordance with the Fund’s charter and applicable law, at a
redemption price of $25,000 per Preferred Share plus an amount equal to
accumulated but unpaid dividends thereon, whether or not earned or declared to
the date fixed for redemption. In addition, the Fund at its option may redeem
Preferred Shares having a dividend period of one year or less at this same
redemption price to the extent permitted under the 1940 Act and Maryland law.
Any Preferred Shares repurchased or redeemed by the Fund will be classified as
authorized but unissued Preferred Shares. The Preferred Shares have no
preemptive, exchange or conversion rights. The Fund will not issue any class of
stock senior to or on a parity with the Preferred Shares.
Dividends
The
Preferred Shares pay dividends based on a rate set at auctions, normally held
every seven days. In most instances, dividends are payable every seven days, on
the first business day following the end of the dividend period. The dividend
payment date for special dividend periods of more than seven days is set forth
in the notice designating a special dividend period. At October 31, 2007, the
rate on the Preferred Shares was 4.69%. In general, when the Fund has any
Preferred Shares outstanding, the Fund may not pay any distribution in respect
of its common stock unless the Fund has paid all cumulative dividends on
Preferred Shares.
Voting
Rights
The
Fund’s Preferred Shares and Common Stock have equal voting rights of one vote
per share and vote together as a single class, except they vote as separate
classes on other matters as required under the Fund’s charter, the 1940 Act and
Maryland law.
Liquidation
In
the event of a liquidation of the Fund, whether voluntary or involuntary, the
holders of the Preferred Shares (“Preferred Shareholders”) are entitled to
receive, prior to and in preference to any distribution of any of the assets of
the Fund available for distribution to the Common Stockholders, a liquidation
preference in the amount of $25,000 for each Preferred Share outstanding plus
an amount equal to all dividends thereon, whether or not earned or declared,
accumulated but unpaid to and including the date of final distribution. After
the payment to the Preferred Shareholders of the full preferential amounts, the
Preferred Shareholders will have no right or claim to any of the remaining
assets of the Fund.
(8) Securities Loans:
The
Fund may make secured loans of its portfolio securities amounting to not more
than one-third of the value of its total assets, thereby realizing additional
income. The risks in lending portfolio securities, as with other extensions of
credit, consist of possible delays in recovery of the securities or possible
loss of rights in the collateral should the borrower fail financially. As a
matter of policy, securities loans are made to unaffiliated broker-dealers
pursuant to agreements requiring that loans be continuously secured by
collateral in cash or short-term debt obligations at least equal at all times
to the value of the securities subject to the loan. The borrower pays to the
Fund an amount equal to any interest or dividends received on securities
subject to the loan. The Fund retains all or a portion of the interest received
on investment of the cash collateral or receives a fee from the borrower. As of
October 31, 2007, the market value of securities loaned by the Fund was
$46,719,984. The loans were secured with cash collateral of $49,315,481.
19
PROSPECT STREET HIGH INCOME PORTFOLIO, INC.
NOTES TO FINANCIAL STATEMENTS (continued)
(9) Unfunded Loan Commitments:
As
of October 31, 2007, the Portfolio had an unfunded loan commitment of $16,779,
which could be extended at the option of the borrower, pursuant to loan
agreements with the following borrower:
|
|
|
|
|
|
|
Borrower
|
|
Unfunded
Loan Commitment
|
|
|
|
|
|
|
Univision Communications,
Inc.
|
|
$
|
16,779
|
|
|
|
|
|
|
|
(10) Disclosure of Significant Risks:
Credit
Risk
Credit
risk is the risk that the issuer of a security owned by the Fund will be unable
to pay the interest or principal when due. The degree of credit risk depends on
both the financial condition of the issuer and the terms of the obligation.
Interest
Rate Risk
Interest
rate risk is the risk that prices of securities owned by the Fund generally
increase when interest rates decline and decrease when interest rates increase.
Foreign
Currency Risk
Foreign
currencies, investments and other assets and liabilities are translated into
U.S. dollars at the exchange rates using the current 4:00 p.m. London Time Spot
Rate. Fluctuations in the value of the foreign currencies and other assets and
liabilities resulting from changes in exchange rates, between trade and
settlement dates on securities transactions and between the accrual and payment
dates on dividends, interest income and foreign withholding taxes, are recorded
as unrealized foreign currency gains (losses). Realized gains (losses) and
unrealized appreciation (depreciation) on investment securities and income and
expenses are translated on the respective dates of such transactions.
20
Report of
Independent Registered Public Accounting Firm
To the Stockholders and Board
of Directors
of Prospect Street High Income Portfolio, Inc.
We have audited the
accompanying statement of assets and liabilities of Prospect Street High Income
Portfolio, Inc. (the “Fund”), including the schedule of investments, as of October
31, 2007, and the related statements of operations and cash flows for the year
then ended, the statements of changes in net assets for each of the two years
in the period then ended, and the financial highlights for each of the five
years in the 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 the standards of the Public Company Accounting Oversight Board
(United States). 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. The Fund is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Fund’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. Our procedures included confirmation of
securities owned as of October 31, 2007, by correspondence with the custodian
and brokers. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial
statements and financial highlights referred to above present fairly, in all
material respects, the financial position of Prospect Street High Income
Portfolio, Inc. as of October 31, 2007, the results of its operations and its
cash flows for the year then ended, the changes in its net assets for each of
the two years in the period then ended, and the financial highlights for each
of the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
December 19, 2007
Dallas, Texas
21
PROSPECT STREET HIGH INCOME PORTFOLIO, INC.
ADDITIONAL INFORMATION (unaudited)
Stockholder
Voting Results
On
May 25, 2007, at an Annual Meeting of the stockholders of the Fund (the “Meeting”),
the stockholders of the Fund’s Common Stock and Series W Auction Rate
Cumulative Preferred Shares were asked to elect R. Joseph Dougherty as the
Class I Director of the Fund, to serve for a three-year term expiring at the
2010 Annual Meeting and until his successor is duly elected and qualified (the
“Proposal”). On March 16, 2007, the Record Date of the Meeting, the Fund had
the following shares issued and outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
30,874,699
|
|
|
|
|
|
|
|
Series W Auction Rate Cumulative
Preferred Shares
|
|
|
1,600
|
|
|
|
|
|
|
On
May 25, 2007, the date of the Meeting, a majority of the total number of
outstanding shares of the Fund entitled to vote was represented at the Meeting
and the Fund’s quorum requirement was met. On May 25, 2007, the Proposal was
voted on and was approved by the stockholders of the Fund present at the
Meeting. The results on the Proposals of the voting on May 25, 2007 were as
follows:
With
respect to the election of R. Joseph Dougherty as Class I Director of the Fund
for the Common Stock:
|
|
|
|
|
|
|
|
|
|
|
|
For:
|
|
|
25,299,609
|
|
|
|
|
|
|
|
Withheld:
|
|
|
895,631
|
|
|
|
|
|
|
With
respect to the election of R. Joseph Dougherty as Class I Director of the Fund
for the Series W Auction Rate Cumulative Preferred Shares: