UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-02365
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PROSPECT STREET(R) INCOME SHARES INC.
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(Exact name of registrant as specified in charter)
Two Galleria Tower
13455 Noel Road, Suite 800
DALLAS, TEXAS 75240
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(Address of principal executive offices) (Zip code)
James D. Dondero
Prospect Street(R) Income Shares, Inc.
Two Galleria Tower
13455 Noel Road, Suite 800
DALLAS, TEXAS 75240
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(Name and address of agent for service)
Registrant's telephone number, including area code: (877) 665-1287
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Date of fiscal year end: DECEMBER 31
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Date of reporting period: DECEMBER 31, 2006
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Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
PROSPECT STREET INCOME SHARES INC.
13455 Noel Road, Suite 800
Dallas, TX 75240
CNN-AR-1206
PROSPECT STREET(R)
INCOME SHARES, INC.
ANNUAL REPORT
DECEMBER 31, 2006
[GRAPHIC OMITTED]
PROSPECT STREET LOGO
CONTENTS
1 Privacy Policy
2 Letter to Stockholders
3 Portfolio Statistics
4 Schedule of Investments
8 Statement of Assets and Liabilities
9 Statement of Operations
10 Statement of Cash Flows
11 Statements of Changes in Net Assets
12 Financial Highlights
13 Notes to Financial Statements
19 Report of Independent Registered Public Accounting Firm
20 Additional Information
THIS REPORT HAS BEEN PREPARED FOR THE INFORMATION OF SHAREHOLDERS OF PROSPECT
STREET INCOME SHARES, INC.
PROSPECT STREET(R) FUNDS
PRIVACY POLICY
We recognize and respect your privacy expectations, whether you are a
visitor to our web site, a potential shareholder, a current shareholder or even
a former shareholder.
COLLECTION OF INFORMATION
We may collect nonpublic personal information about you from the following
sources:
o Account applications and other forms, which may include your name,
address and social security number, written and electronic
correspondence and telephone contacts;
o Web site information, including information captured through the use of
"cookies"; and
o Account history, including information about the transactions and
balances in your accounts with us or our affiliates.
DISCLOSURE OF INFORMATION
We may share the information we collect (described above) with our
affiliates. We may also disclose this information as otherwise permitted by law.
We do not sell your personal information to third parties for their independent
use.
CONFIDENTIALITY AND SECURITY OF INFORMATION
We restrict access to nonpublic personal information about you to our
employees who need to know such information to provide products or services to
you. We maintain physical, electronic and procedural safeguards that comply with
federal standards to guard your nonpublic personal information, although you
should be aware that data protection cannot be guaranteed.
NONPUBLIC PERSONAL INFORMATION OF CHILDREN
You must be at least 18 years of age in order to submit information on our
web site or through other means, because we do not collect information (such as
name, address, etc.) from persons under the age of 18.
1
LETTER TO STOCKHOLDERS
Dear Stockholders:
We are pleased to provide you with our report for Prospect Street Income
Shares, Inc. (the "Fund") for the year ended December 31, 2006. On December 31,
2006, the net asset value of the Fund was $6.59 per share, as compared to $6.40
on December 31, 2005. On December 31, 2006, the closing market price of the
Fund's shares on the New York Stock Exchange was $6.08 per share, as compared to
$5.45 on December 31, 2005. During the year ended December 31, 2006, the Fund
declared to common stock stockholders $0.4475 per share.
THE FUND'S INVESTMENTS:
The total return on the Fund's per share market price, assuming
reinvestment of dividends, for the year ended December 31, 2006, was 20.23%. The
total return on the Fund's net assets, was 10.97% for the year ended December
31, 2006. The variation in total returns is attributable to the increase in the
market price of the Fund's shares of 11.56% relative to an increase in the net
asset value of the Fund's shares of 2.97% during the period.
On December 8, 2006, the Board of Directors declared a quarterly dividend
of $0.11 per common share, payable on January 15, 2007.
Respectfully submitted,
/S/JAMES DONDERO
James Dondero
President
/S/MARK OKADA
Mark Okada
Executive Vice President
2
PROSPECT STREET INCOME SHARES, INC.
PORTFOLIO STATISTICS
AS OF DECEMBER 31, 2006
INVESTMENT TYPE BY MARKET VALUE
(AS A PERCENTAGE OF TOTAL INVESTMENTS)
Bonds and Notes 98.12%
Common Stocks 1.87%
Warrants and Preferred Stock 0.01%
3
PROSPECT STREET INCOME SHARES, INC.
SCHEDULE OF INVESTMENTS
AS OF DECEMBER 31, 2006
Ratings (g)
-------------------
Principal Standard & Value
Amount ($) Description Moody's Poor's (Note 1a) ($)
- ----------- ----------- --------- -------- ------------
BONDS AND NOTES - 135.61% (A)
AUTOMOBILE - 7.37%
3,000,000 American Tire Distributors Holdings, Inc., 11.62%,
04/01/2012 (b)....................................... Caa1 CCC+ 2,880,000
300,000 Ford Motor Co., 4.25%, 12/15/2036...................... Caa1 CCC+ 322,125
1,500,000 Penhall International, Corp., 12.00%, 08/01/2014 (c)... B3 CCC+ 1,627,500
------------
4,829,625
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BANKING - 3.20%
2,000,000 Washington Mutual Capital I, 8.38%, 06/01/2027......... Baa1 BBB 2,098,570
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2,098,570
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BROADCASTING AND ENTERTAINMENT - 12.67%
2,000,000 Belo Corp., 7.13%, 06/01/2007.......................... Baa3 BBB- 2,007,890
500,000 CCH I LLC, 11.00%, 10/01/2015.......................... Caa2 CCC- 515,625
2,000,000 Liberty Media Corp., 7.88%, 07/15/2009................. Ba2 BB+ 2,095,648
1,500,000 Time Warner Entertainment Co., LP, 10.15%, 05/01/2012.. Baa2 BBB+ 1,778,086
2,000,000 Young Broadcasting, Inc., 10.00%, 03/01/2011........... Caa1 CCC- 1,910,000
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8,307,249
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BUILDINGS AND REAL ESTATE - 1.75%
1,000,000 SUSA Partnership, LP, 7.45%, 07/01/2018................ Aaa AAA 1,148,332
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1,148,332
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CABLE AND OTHER PAY TELEVISION SERVICES - 1.80%
1,000,000 Tele Communications, Inc., 9.80%, 02/01/2012........... Baa2 BBB+ 1,180,404
------------
1,180,404
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CHEMICALS, PLASTICS AND RUBBER - 7.72%
2,000,000 Potash Corp. of Saskatchewan, Inc., 7.75%, 05/31/2011.. Baa1 BBB+ 2,181,108
2,000,000 Albemarle Corp., 5.10%, 02/01/2015..................... Baa3 BBB- 1,900,138
1,000,000 Solutia Inc., 10/15/2037 (d)........................... NR NR 978,750
------------
5,059,996
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CONTAINERS, PACKAGING AND GLASS - 5.54%
2,000,000 Sealed Air Corp., 5.63%, 07/15/2013 (c)................ Baa3 BBB 1,981,592
1,900,000 Solo Cup Co., 8.50%, 02/15/2014........................ Caa2 CCC- 1,653,000
------------
3,634,592
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ELECTRONICS - 8.01%
3,500,000 Freescale Semiconductor, 10.13%, 12/15/2016 (c)........ B2 B 3,521,875
2,000,000 MagnaChip Semiconductor, 8.61%, 12/15/2011 (b)......... B1 B+ 1,730,000
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5,251,875
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ENVIRONMENTAL SERVICES - 3.20%
2,000,000 Republic Services, Inc., 6.75%, 08/15/2011............. Baa2 BBB+ 2,098,430
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2,098,430
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See accompanying notes to the financial statements.
4
PROSPECT STREET INCOME SHARES, INC.
SCHEDULE OF INVESTMENTS (CONTINUED)
AS OF DECEMBER 31, 2006
Ratings (g)
-------------------
Principal Standard & Value
Amount ($) Description Moody's Poor's (Note 1a) ($)
- ----------- ----------- --------- -------- ------------
BONDS AND NOTES - (CONTINUED)
FINANCE - 4.76%
2,000,000 BankAmerica Institutional, Series A, 8.07%, 12/31/2026 (c) Aa3 A 2,082,556
1,000,000 BT Capital Trust, Series B1, 7.90%, 01/15/2027......... A2 A- 1,035,290
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3,117,846
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FOOD, BEVERAGE AND TOBACCO - 5.78%
2,000,000 Altria Group, Inc., 7.75%, 01/15/2027 (e).............. Baa1 BBB 2,432,476
1,000,000 Chiquita Brands International, Inc., 7.50%, 11/01/2014. Caa2 CCC+ 920,000
500,000 Land O' Lakes Capital Trust I, 7.45%, 03/15/2028 (c)... B2 B- 433,750
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3,786,226
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HEALTHCARE, EDUCATION AND CHILDCARE - 8.91%
2,000,000 HCA, Inc., 9.63%, 11/15/2016 (c)....................... B2 BB- 2,155,000
2,000,000 Manor Care, Inc., 6.25%, 05/01/2013.................... Baa3 BBB 2,019,324
1,576,250 Pharma IV, 12.00%, 06/30/2014.......................... NR NR 1,662,944
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5,837,268
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HOME AND OFFICE FURNISHINGS, HOUSEWARES, AND DURABLE CONSUMER - 2.06%
1,550,000 Spectrum Brands, Inc., 7.38%, 02/01/2015............... Caa2 CCC 1,348,500
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1,348,500
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HOTELS, MOTELS, INNS AND GAMING - 4.03%
3,000,000 Harrahs Operating Co., Inc., 5.38%, 12/15/2013......... Baa3 BB 2,644,041
------------
2,644,041
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LEISURE, AMUSEMENT, MOTION PICTURES, ENTERTAINMENT - 5.93%
4,000,000 Blockbuster Inc., 9.50%, 09/01/2012 (e)................ Caa2 CCC 3,890,000
------------
3,890,000
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OIL AND GAS - 10.04%
1,500,000 Secunda International, Ltd., 13.37%, 09/01/2012 (b).... B2 B- 1,554,375
2,000,000 Dominion Resources, Inc., 5.00%, 03/15/2013............ Baa2 BBB 1,949,678
2,000,000 Opti Canada, Inc., 8.25%, 12/15/2014 (c)............... B1 BB 2,065,000
1,000,000 SemGroup, LP, 8.75%, 11/15/2015 (c).................... B1 NR 1,010,000
------------
6,579,053
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PERSONAL TRANSPORTATION - 4.52%
3,000,000 Delta Air Lines, 12/15/2029 (d)........................ NR NR 2,025,000
1,000,000 Northwest Airlines, Inc., 06/01/2007 (d)............... NR D 940,000
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2,965,000
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See accompanying notes to the financial statements.
5
PROSPECT STREET INCOME SHARES, INC.
SCHEDULE OF INVESTMENTS (CONTINUED)
AS OF DECEMBER 31, 2006
Ratings (g)
-------------------
Principal Standard & Value
Amount ($) Description Moody's Poor's (Note 1a) ($)
- ----------- ----------- --------- -------- ------------
BONDS AND NOTES - (CONTINUED)
PRINTING AND PUBLISHING - 6.29%
2,000,000 Network Communications, Inc., 10.75%, 12/01/2013....... B2 B- 2,030,000
2,000,000 PRIMEDIA, Inc., 10.75%, 05/15/2010 (b)................. B2 B 2,090,000
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4,120,000
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RETAIL STORES - 7.14%
1,000,000 Linens `n Things, Inc., 11.00%, 01/15/2014 (b)......... B3 B 975,000
3,810,000 Wendy's International, Inc., 6.20%, 06/15/2014......... Ba2 BB+ 3,706,075
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4,681,075
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TELECOMMUNICATIONS - 11.94%
1,000,000 Nortel Networks Corp., 6.88%, 09/01/2023............... B3 B- 845,000
4,000,000 CenturyTel, Inc., 5.00%, 02/15/2015.................... Baa2 BBB 3,653,672
1,000,000 Grande Communications Holdings, Inc., 14.00%, 04/01/2011 Caa1 B- 1,097,500
2,000,000 ICO North America, 7.50%, 08/15/2009................... Ba2 BB+ 2,230,000
------------
7,826,172
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UTILITIES - 12.95%
2,500,000 Calpine Corp., 8.50%, 02/15/2011 (d)................... NR D 2,012,500
2,000,000 Constellation Energy Group, 7.00%, 04/01/2012.......... Baa1 BBB+ 2,146,084
2,000,000 Kiowa Power Partners LLC, 5.74%, 03/30/2021 (c)........ Baa3 BBB- 1,940,892
500,000 Southern Power Co., Series D, 4.88%, 07/15/2015........ Baa1 BBB+ 474,604
1,903,720 Tenaska Virginia Partners, LP, 6.12%, 03/30/2024 (c)... Baa3 BBB- 1,917,678
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8,491,758
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TOTAL BONDS AND NOTES (COST $86,486,459)............... 88,896,012
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See accompanying notes to the financial statements.
6
PROSPECT STREET INCOME SHARES, INC.
SCHEDULE OF INVESTMENTS (CONTINUED)
AS OF DECEMBER 31, 2006
Principal Value
Amount ($) Description (Note 1a) ($)
- ----------- ----------- ------------
COMMON STOCKS - 2.59% (A)
111,940 Motient Corp. (f)................................................. 1,108,206
19,723 Owens Corning, Inc. (f)........................................... 589,717
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TOTAL COMMON STOCKS (COST $2,204,624)............................. 1,697,923
------------
PREFERRED STOCK - 0.00% (A)
10,000 Adelphia Communications Corp., Series B (f)....................... 2,300
------------
TOTAL PREFERRED STOCK (COST $935,000)............................. 2,300
------------
WARRANTS - 0.01% (A)
1,000 Grande Communications 04/01/2011 (f).............................. 10
17,481 Pathmark Stores, Inc. 09/19/2010 (f).............................. 4,370
1,000 XM Satellite Radio, Inc., 03/15/2010 (f).......................... 0
------------
TOTAL WARRANTS (COST $140,010).................................... 4,380
------------
TOTAL INVESTMENTS - 138.21% (COST $89,766,093).................... 90,600,615
------------
OTHER ASSETS & LIABILITIES, NET - 7.55%........................... 4,951,640
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PREFERRED SHARES - (45.76)%....................................... (30,000,000)
------------
NET ASSETS APPLICABLE TO COMMON STOCK - 100.00%................... 65,552,255
============
<FN>
(a) Percentages are based on net assets applicable to common stock.
(b) Variable rate security. The interest rate shown reflects the rate in effect
at December 31, 2006.
(c) Rule 144A securities - Private placement securities issued under Rule 144A
are exempt from the registration requirement of the Securities Act of 1933,
as amended. These securities may only be resold, in transactions exempt from
registration, to qualified institutional buyers. At December 31, 2006, the
market value of these securities aggregated $18,735,843 or 28.6% of net
assets applicable to common stock. These securities have been determined by
the investment adviser to be liquid securities.
(d) The issuer is in default of certain debt covenants. Income is not being
accrued.
(e) Securities (or a portion of securities) on loan as of December 31, 2006. See
footnote 7.
(f) Non-income producing security.
(g) Ratings of issuers shown have not been audited.
</FN>
See accompanying notes to the financial statements.
7
PROSPECT STREET INCOME SHARES, INC.
STATEMENT OF ASSETS AND LIABILITIES
AS OF DECEMBER 31, 2006
($)
------------
ASSETS:
Investment in securities, at value ($89,766,093, at cost; see Schedule
of Investments and Note 1)....................................................... 90,600,615
Cash and cash equivalents........................................................... 3,604,305
Cash held as collateral for securities loaned (Note 7).............................. 4,917,173
Interest and dividend receivable.................................................... 1,654,997
Receivable for investments sold..................................................... 4,995,020
Prepaid assets...................................................................... 66,947
------------
Total assets..................................................................... 105,839,057
------------
LIABILITIES:
Payable upon return of securities loaned (Note 7)................................... 4,917,173
Payables:
Investment advisory fee payable..................................................... 119,240
Dividend payable.................................................................... 1,094,180
Payable for investments purchased................................................... 4,000,000
Preferred shares distribution payable............................................... 25,610
Other accounts payable.............................................................. 130,599
------------
Total liabilities................................................................ 10,286,802
------------
PREFERRED SHARES:
Preferred shares, $0.01 par value ($25,000 per share liquidation preference)
Authorized - 1,000,000 shares
Issued and outstanding - 1,200 Series T shares (Note 6)........................... 30,000,000
------------
Total preferred shares........................................................... 30,000,000
------------
NET ASSETS APPLICABLE TO COMMON STOCK:
Common stock, $1.00 par value --
Authorized - 15,000,000 shares
Issued and outstanding - 9,947,104 shares......................................... 9,947,104
Capital in excess of par value...................................................... 85,850,066
Accumulated net realized gain/(loss) from security transactions..................... (31,724,489)
Undistributed net investment income................................................. 645,052
Net unrealized appreciation/(depreciation) on investments........................... 834,522
------------
Net assets applicable to common stock............................................ 65,552,255
============
Net asset value per common stock outstanding..................................... 6.59
============
See accompanying notes to the financial statements.
8
PROSPECT STREET INCOME SHARES, INC.
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2006
($)
------------
INVESTMENT INCOME:
Interest income.................................................................... 7,220,239
Amortization of bond premiums...................................................... (65,908)
Dividend income.................................................................... 21,900
Securities lending income.......................................................... 88,255
------------
Total investment income...................................................... 7,264,486
------------
EXPENSES:
Investment advisory fee (Note 2)................................................... 470,503
Administration fee................................................................. 44,334
Printing expense................................................................... 48,463
Legal fees......................................................................... 31,808
Registration expenses.............................................................. 25,000
Professional fees.................................................................. 46,475
Insurance expenses................................................................. 101,206
Custody fee........................................................................ 21,493
Preferred shares broker expense.................................................... 75,291
Directors' fees and expenses (Note 4).............................................. 21,400
Texas franchise expense............................................................ 2,669
Miscellaneous expense.............................................................. 85,887
------------
Total expenses............................................................... 974,529
------------
Net investment income........................................................ 6,289,957
------------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
Net realized gain/(loss) on investments............................................ 1,790,114
Net change in unrealized appreciation/(depreciation) on investments................ (295,286)
------------
Net realized and unrealized gain/(loss) on investments:...................... 1,494,828
------------
DISTRIBUTIONS TO PREFERRED SHAREHOLDERS.............................................. (1,470,283)
------------
Net change in net assets resulting from operations........................... 6,314,502
============
See accompanying notes to the financial statements.
9
PROSPECT STREET INCOME SHARES, INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2006
($)
------------
CASH FLOW FROM OPERATING ACTIVITIES:
Interest received.................................................................. 7,349,320
Increase in cash held as collateral for securities loaned.......................... 4,917,173
Operating expenses paid............................................................ (952,717)
Preferred shares distributions..................................................... (1,459,608)
Purchase of portfolio securities................................................... (130,207,002)
Increase in payable upon receipt of securities loaned.............................. (4,917,173)
Sales and maturities of portfolio securities....................................... 131,597,690
------------
Net cash provided by operating activities....................................... 6,327,683
------------
CASH FLOW FROM FINANCING ACTIVITIES:
Common stock distributions paid from net investment income......................... (4,451,332)
------------
Net cash used by financing activities........................................... (4,451,332)
------------
NET CHANGE IN CASH.................................................................... 1,876,351
CASH, BEGINNING OF THE YEAR........................................................... 1,727,954
------------
CASH, END OF THE YEAR................................................................. 3,604,305
============
RECONCILIATION OF NET CHANGES IN NET ASSETS RESULTING FROM OPERATIONS TO NET
CASH PROVIDED BY OPERATING ACTIVITIES:
Net change in net assets resulting from operations................................. 6,314,502
Change in interest and dividends receivable........................................ 18,926
Change in investments.............................................................. 1,390,688
Change in prepaids................................................................. 12,977
Change in investment advisory fee payable.......................................... 38,747
Change in accrued expenses......................................................... (29,912)
Change in distributions payable.................................................... 10,675
Net realized gain/(loss) on investments............................................ (1,790,114)
Net change in unrealized appreciation/(depreciation) on investments................ 295,286
Amortization of bond premium....................................................... 65,908
------------
Net cash provided by operating activities....................................... 6,327,683
============
See accompanying notes to the financial statements.
10
PROSPECT STREET INCOME SHARES, INC.
STATEMENTS OF CHANGES IN NET ASSETS
Year Year
Ended Ended
December 31, 2006 December 31, 2005
($) ($)
----------------- ------------------
FROM OPERATIONS:
Net investment income............................................. 6,289,957 5,690,707
Net realized gain/(loss) on investments........................... 1,790,114 (388,928)
Net change in unrealized appreciation/(depreciation) on investments (295,286) (3,288,193)
Distributions to preferred shareholders........................... (1,470,283) (977,469)
----------------- ------------------
Net change in net assets resulting from operations........... 6,314,502 1,036,117
----------------- ------------------
FROM CAPITAL SHARE TRANSACTIONS:
Shares of common stock issued (0 and 148,375, respectively)
in capital share transactions................................... -- 1,004,504
----------------- ------------------
FROM DISTRIBUTIONS TO COMMON STOCKHOLDERS:
Distributions to common stockholders from net investment income
($0.45 and $0.46 per share, respectively)....................... (4,451,329) (4,534,911)
----------------- ------------------
Net decrease in net assets resulting from distributions...... (4,451,329) (4,534,911)
----------------- ------------------
Total change in net assets................................... 1,863,173 (2,494,290)
NET ASSETS APPLICABLE TO COMMON STOCK:
Beginning of year................................................. 63,689,082 66,183,372
----------------- ------------------
End of year (including undistributed net investment income of
$645,052 and $214,653, respectively)............................ 65,552,255 63,689,082
================= ==================
See accompanying notes to the financial statements.
11
PROSPECT STREET INCOME SHARES, INC.
FINANCIAL HIGHLIGHTS
SELECTED PER SHARE DATA AND RATIOS
FOR EACH SHARE OF COMMON STOCK OUTSTANDING THROUGHOUT THE YEARS PRESENTED
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
Net asset value, beginning of year............. $ 6.40 $ 6.75 $ 6.49 $ 5.90 $ 6.77
-------- -------- -------- -------- --------
Net investment income(a) $ 0.63 $ 0.58 $ 0.59 $ 0.60 $ 0.75
Net realized and unrealized gain/(loss)
on Investments............................. $ 0.16 $ (0.37) $ 0.29 $ 0.65 $ (0.74)
Distributions to preferred shareholders....... $ (0.15) $ (0.10) $ (0.05) $ (0.04) $ (0.05)
-------- -------- -------- -------- --------
Total from investment operations........... $ 0.64 $ 0.11 $ 0.83 $ 1.21 $ (0.04)
-------- -------- -------- -------- --------
Distributions:
Distributions from accumulated net
investment income to common stockholders... $ (0.45) $ (0.46) $ (0.55) $ (0.62) $ (0.83)
Distributions from tax return of capital to
common stockholders........................ -- -- (0.02) -- --
-------- -------- -------- -------- --------
Total distributions........................ $ (0.45) $ (0.46) $ (0.57) $ (0.62) $ (0.83)
-------- -------- -------- -------- --------
Net asset value, end of year................... $ 6.59 $ 6.40 $ 6.75 $ 6.49 $ 5.90
======== ======== ======== ======== ========
Market price per share, end of year............ $ 6.08 $ 5.45 $ 6.21 $ 6.33 $ 5.45
======== ======== ======== ======== ========
Total investment return(b)
Based on market price per share.............. 20.23% (5.28%) 7.63% 27.52% (2.48%)
======== ======== ======== ======== ========
Based on net asset value per share........... 10.97% 2.33% 14.11% 20.51% (0.59%)
======== ======== ======== ======== ========
Net assets, end of year(c)..................... $ 65,552 $ 63,689 $ 66,183 $ 63,529 $ 57,160
======== ======== ======== ======== ========
Preferred Shares outstanding, end of year(c)... $ 30,000 $ 30,000 $30,000 $30,000 $ 30,000
======== ======== ======== ======== ========
Asset Coverage:
Per preferred stock share(d)................. 319% 312% 321% 312% 291%
Ratio of operating expenses to average net
assets, applicable to common stock(e)...... 1.52% 1.40% 1.36% 1.55% 1.63%
Ratio of total expenses to average net assets,
applicable to common stock(e).............. 1.52% 1.40% 1.36% 1.55% 1.63%
Ratio of net investment income to average net
assets, applicable to common stock(e)...... 9.81% 8.79% 9.06% 9.73% 11.93%
Portfolio turnover rate........................ 146.23% 60.23% 41.32% 51.87% 26.71%
<FN>
(a) Per share net investment income or loss is calculated by dividing net
investment income by the average number of shares outstanding during the
period.
(b) Total investment return based on market value may result in substantially
different returns than investment return based on net asset value, because
market value can be significantly greater or less than the net asset value.
Investment return assumes reinvestment of dividends.
(c) Dollars in thousands.
(d) Calculated by subtracting the Fund's total liabilities (not including
senior securities) from the Fund's total assets and dividing such amount by
the liquidation preference of the outstanding shares of Series T preferred
stock.
(e) Ratios do not reflect the effect of dividend payments to preferred
shareholders.
</FN>
See accompanying notes to the financial statements.
12
PROSPECT STREET INCOME SHARES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
(1) SIGNIFICANT ACCOUNTING POLICIES:
Prospect Street Income Shares Inc. (the "Fund") is registered under the
Investment Company Act of 1940, as amended (the "1940 Act"), as a closed-end,
diversified management investment company. The following is a summary of
significant accounting policies consistently followed by the Fund. The policies
are in conformity with accounting principles generally accepted in the United
States of America.
(A) VALUATION OF INVESTMENTS
Investments in debt securities are valued at the mean of the bid and ask
prices on the last business day of the accounting period. Equity securities
traded on a national securities exchange are valued at the last reported sales
price on the last business day of the accounting period; equity securities
traded in the over-the-counter market and listed securities for which no sale
was reported on that date are valued at the closing bid price on that date.
Warrants are valued at the last reported sales price on the last business day of
the accounting period. Obligations with remaining maturities of 60 days or less
are valued at amortized cost, which approximates market value. Securities for
which market quotations are not readily available (which includes all restricted
securities) are valued at fair value as determined by, or under the direction
of, the Fund's Board of Directors; such values require the use of estimates.
Securities transactions are accounted for on the date the securities are
purchased or sold. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Interest income is recorded as earned.
(B) FEDERAL INCOME TAXES
It is the Fund's policy to comply with the requirements of the Internal
Revenue Code applicable to regulated investment companies and to distribute all
of its taxable income to its stockholders. Therefore, no Federal income tax
provision is required.
At December 31, 2006, the Fund had the following capital loss carryovers
available to offset future capital gains, if any, to the extent provided by
regulations:
CARRYOVER
AVAILABLE EXPIRATION DATE
------------ -------------------
$ 2,656,461 December 31, 2007
4,737,419 December 31, 2008
15,317,739 December 31, 2009
3,458,710 December 31, 2010
3,196,740 December 31, 2011
1,210,721 December 31, 2012
873,134 December 31, 2013
------------
$ 31,450,924
============
At December 31, 2006, the Fund has elected to defer recognition of $95,071 of
long-term capital losses incurred after October 31, 2006 until January 1,
2007.
13
PROSPECT STREET INCOME SHARES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
As of December 31, 2006, the cost and related gross unrealized appreciation
and depreciation and the components of distributable earnings on a tax basis are
as follows:
Cost of investments for tax purposes....................... $ 89,766,093
--------------
Gross investment unrealized appreciation for tax purposes.. $ 3,478,293
Gross investment unrealized depreciation for tax purposes.. (2,643,771)
--------------
Net unrealized appreciation on investments for tax purposes $ 834,522
==============
Undistributed ordinary income.............................. $ 582,998
--------------
Accumulated capital losses................................. $ 71,662,435
--------------
The amount of distributions are determined in accordance with federal income
tax regulations which may differ from accounting principles generally accepted
in the United States of America. These "book/tax" differences are either
considered temporary or permanent in nature. To the extent these differences are
permanent in nature, such amounts are reclassified within the capital accounts
based on their federal tax-basis treatment; temporary differences do not require
reclassification.
(C) CASH FLOW INFORMATION
The Fund invests primarily in corporate debt securities and distributes
dividends from net investment income, which are paid in cash or shares of common
stock of the Fund. These activities are reported in the accompanying statement
of changes in net assets, and additional information on cash receipts and cash
payments is presented in the accompanying statement of cash flows.
(D) CASH AND CASH EQUIVALENTS
The Fund considers all highly liquid investments purchased with initial
maturity equal to or less than three months to be cash equivalents.
(E) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
(F) NEW ACCOUNTING STANDARDS
On July 13, 2006, the Financial Accounting Standards Board (FASB) released
FASB Interpretation No. 48 (FIN 48) "ACCOUNTING FOR UNCERTAINTY IN INCOME
TAXES". FIN 48 provides guidance for how uncertain tax positions should be
recognized, measured, presented and disclosed in the financial statements. FIN
48 requires the evaluation of tax positions taken in the course of preparing the
Fund's tax returns to determine whether the tax positions are
"more-likely-than-not" of being sustained by the applicable tax authority. Tax
benefits of positions not deemed to meet the more-likely-than-not threshold
would be booked as a tax expense in the current year and would be recognized as:
a liability for unrecognized tax benefits; a reduction of an income tax refund
receivable; a reduction of deferred tax asset; an increase in deferred tax
liability; or a combination thereof. Adoption of FIN 48 is required for fiscal
years beginning after December 15, 2006.
In addition, in September 2006, Statement of Financial Accounting Standards
No. 157 FAIR VALUE MEASUREMENTS ("SFAS 157") was issued and is effective for
fiscal years beginning after November 15, 2007. SFAS 157 defines fair value,
14
PROSPECT STREET INCOME SHARES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
establishes a framework for measuring fair value and expands disclosures about
fair value measurements.
At this time, management is evaluating the implications of FIN 48 and SFAS
157 and its impact on the financial statements has not yet been determined.
(2) INVESTMENT ADVISORY AGREEMENT:
Highland Capital Management, L.P. ("Highland" or "the Investment Advisor")
earned $470,503 in investment advisory fees for the year ended December 31,
2006. Investment advisory fees paid by the Fund to Highland were calculated at
..5% (on an annual basis) of the average weekly net asset value, defined as total
assets of the Fund less accrued liabilities (excluding the principal amount of
any bank loan, notes and the liquidation preference of any preferred shares, and
including accrued and unpaid dividends on any preferred shares). On December 31,
2006, the fee payable to the Investment Advisor was $119,240, which is included
in the accompanying statement of assets and liabilities. The agreement between
the Fund and Highland, however, provides that if the costs and expenses
(excluding interest, advisory fee, taxes, brokerage charges and expenses and
extraordinary costs and expenses and expenses incident to the public offering of
shares other than those offered through the Dividend Reinvestment Plan) borne by
the Fund in any fiscal year exceed 1.5% of average net assets up to $30,000,000
plus 1% of average net assets over $30,000,000, the Investment Advisor is
obligated to reimburse the Fund for any excess pursuant to the investment
advisory agreement. As of December 31, 2006, no such expense reimbursement was
required.
Pursuant to a letter dated September 30, 2001, Highland entered into an
agreement, which expired on July 31, 2003, to waive its advisory fees on that
portion of the Fund's assets attributable to outstanding preferred stock.
(3) PURCHASES AND SALES OF SECURITIES:
For the year ended December 31, 2006, the aggregate cost of purchases and
proceeds from sales of investment securities, other than U.S. Government
obligations and short-term investments, was approximately $133,256,212 and
$136,082,016, respectively.
The Investment Advisor 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 Advisor to be
equitable to the Fund and such other accounts. The Investment Advisor also may
aggregate orders to purchase and sell securities for the Fund and such other
accounts. Although the Investment Advisor 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.
(4) CERTAIN TRANSACTIONS:
An officer of the Investment Advisor serves on the Board of Directors of the
Fund but receives no compensation in this capacity.
Directors who are not officers or employees of the Investment Advisor receive
fees of $5,000 per year, together with the reimbursement of actual out-of-pocket
expenses incurred relating to board meeting attendance. For the year ended
December 31, 2006, the Fund incurred Board of Directors' fees and expenses of
$21,400.
15
PROSPECT STREET INCOME SHARES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(5) DIVIDENDS AND DISTRIBUTIONS:
Distributions on the Funds 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 quarterly
distributions to holders of Common Stock ("Common Shareholders"). As a result of
market conditions or investment decisions, the amount of distributions may
exceed net investment income earned at certain times throughout the period. It
is anticipated that, on an annual basis, the amount of distributions to Common
Stockholders will not exceed net investment income (as defined) allocated to
Common Stockholders for income tax purposes.
For the year ended December 31, 2006, the tax character of distributions
declared on Common Stock by the Fund were as follows:
Distributions from net investment income............ $ 4,451,329
Distributions from paid in capital.................. 0
-----------------
$ 4,451,329
=================
For the year ended December 31, 2005, the tax character of distributions
declared on Common Stock by the Fund were as follows:
Distributions from net investment income............ $ 4,534,911
Distributions from paid in capital.................. 0
-----------------
$ 4,534,911
=================
(6) PREFERRED SHARES:
On July 23, 2001, the Fund issued 1,200 shares of Series T Auction Rate
Cumulative Preferred Shares (the "Preferred Shares"), $25,000 liquidation
preference, for a total issuance of $30,000,000. All such Preferred Shares were
outstanding as of December 31, 2006. The Fund may borrow amounts in the future
to increase its use of leverage within the limitations imposed by the 1940 Act.
Significant provisions regarding Preferred Shares are described below.
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 the failure to meet certain asset coverages, portfolio valuation 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 are set out in
a notice designating a special dividend period. The dividend rate of the
Preferred Shares at December 31, 2006 was 5.26%.
16
PROSPECT STREET INCOME SHARES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
In general, when the Fund has any Preferred Shares outstanding, the Fund may
not pay any dividend or distribution in respect of 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 certain 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 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 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 holders of
Preferred Shares of the full preferential amounts, the holders of Preferred
Shares will have no right or claim to any of the remaining assets of the Fund.
(7) 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
December 31, 2006, the market value of securities loaned by the Fund was
$4,802,297. The loans were secured with cash collateral of $4,917,173.
(8) DICLOSURES OF SIGNIFICANT RISK:
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.
17
PROSPECT STREET INCOME SHARES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(9) 2006 ANNUAL STOCKHOLDER MEETING (UNAUDITED):
On May 19, 2006, the Fund held its Annual Meeting of Stockholders.
Stockholders were asked to vote on the election of two Directors to the Board. A
quorum of the shares outstanding was present, and each nominee was elected with
a majority of those shares. The results were as follows:
Proposal -- Election of Directors
Shares With
Shares Voted Percentage of Authority Percentage of
Name For Shares Outstanding Withheld Shares Outstanding
-------------------------------- ---------------- ------------------ ------------ --------------------
Scott F. Kavanaugh (common vote) 7,208,935 72.47% 128,255 1.29%
Bryan A. Ward (preferred vote) 1,194 99.50% 6 0.50%
18
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
of Prospect Street Income Shares, Inc.
We have audited the accompanying statement of assets and liabilities of
Prospect Street Income Shares, Inc. (the "Fund"), including the schedule of
investments, as of December 31, 2006, 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 the 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 the 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 December 31, 2006, by correspondence with the
custodian and brokers; where replies were not received from brokers, we
performed other auditing procedures. 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 Income Shares, Inc. as of December 31, 2006 and 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 the accounting principles generally accepted in the United
States of America.
DELOITTE & TOUCHE LLP
February 12, 2007
Dallas, TX
19
PROSPECT STREET INCOME SHARES, INC.
ADDITIONAL INFORMATION (UNAUDITED)
DIVIDEND REINVESTMENT PLAN
If your Common Stock are registered directly with the Fund or if you hold
your Common Stock with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect by written notice to the Fund
to receive cash distributions, all dividends, including any capital gain
distributions, on your Common Stock will be automatically reinvested by PFPC
Inc. (the "Plan Agent"), in additional Common Stock under the Plan. If you elect
to receive cash distributions, you will receive all distributions in cash paid
by check mailed directly to you by PFPC Inc., as dividend paying agent.
If you decide to participate in the Plan, the number of shares of Common
Stock you will receive will be determined as follows:
(1) If the shares are trading at or above net asset value ("NAV") at the
time of valuation, the Fund will issue new shares at a price equal to
the greater of (i) NAV per share on that date or (ii) 95% of the market
price on that date.
(2) If these shares are trading below NAV at the time of valuation, the
Plan Agent will receive the dividend or distribution in cash and will
purchase Common Stock in the open market, on the American Stock
Exchange or elsewhere, for the participants' accounts. It is possible
that the market price for the Common Stock may increase before the Plan
Agent has completed its purchases. Therefore, the average purchase
price per share paid by the Plan Agent may exceed the market price at
the time of valuation, resulting in the purchase of fewer shares than
if the dividend or distribution had been paid in Common Stock issued by
the Fund. The Plan Agent will use all dividends and distributions
received in cash to purchase Common Stock in the open market within 30
days of the valuation date except where temporary curtailment or
suspension of purchases is necessary to comply with federal securities
laws. Interest will not be paid on any uninvested cash payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (800) 331-1710, in
accordance with such reasonable requirements as the Plan Agent and Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan, and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Stockholders' accounts in the Plan and
gives written confirmation of all transactions in the accounts, including
information you may need for tax records. Common Stock in your account will be
held by the Plan Agent in non-certificated form. The Plan Agent will forward to
each participant any proxy solicitation material and will vote any shares so
held only in accordance with proxies returned to the Fund. Any proxy you receive
will include all Common Stock you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or
distributions in Common Stock. However, all participants will pay a pro rata
share of brokerage commissions incurred by the Plan Agent when it makes open
market purchases.
Automatically reinvesting dividends and distributions does not mean that you
do not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized, although cash is not received by you.
Consult your financial advisor for more information.
If you hold your Common Stock with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment
of the Board of Trustees the change is warranted. There is no direct service
charge to participants in the Plan; however, the Fund reserves the right to
amend the Plan to include a service charge payable by the participants.
Additional information about the Plan may be obtained by writing PFPC Inc., 301
Bellevue Parkway, Wilmington, Delaware 19809.
20
PROSPECT STREET INCOME SHARES, INC.
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
DIRECTORS AND OFFICERS INFORMATION
The business and affairs of the Fund are managed under the direction of the
Fund's Board of Directors and the Fund's officers appointed by the Board of
Directors. The tables below list the Directors and officers of the Fund and
their ages and principal occupations for the last five years, as well as other
directorships held by the Directors. For the purposes hereof, the term `'Fund
Complex" means all of the registered companies advised by the Investment Advisor
as of the date of February 12, 2007. The business address of the Directors and
officers is c/o Highland Capital Management, L.P., Two Galleria Tower, 13455
Noel Road, Suite 800, Dallas, Texas, 75240.
NUMBER OF
PORTFOLIOS IN
YEAR FIRST FUND
POSITION(S) ELECTED OR COMPLEX
HELD WITH APPOINTED TO PRINCIPAL OCCUPATION(S) DURING OVERSEEN OTHER DIRECTORSHIPS
NAME AND AGES FUND OFFICE1 PAST FIVE YEARS BY DIRECTOR HELD BY DIRECTOR
- ------------------------ --------- ------------- ------------------------------ ------------- ---------------------
INDEPENDENT DIRECTORS
Timothy K. Hui Director 2000 Dean of Educational 10 None
(Age 58) Resources since July
2006; Assistant
Provost for Graduate
Education since July
2004; Assistant
Provost for
Educational
Resources, July 2001
to June 2004,
Philadelphia
Biblical University.
Scott F. Kavanaugh Director 2000 Private Investor since 10 None
(Age 46) February 2004; Sales
Representative at Round
Hill Securities, March
2003 to January 2004;
Executive at Provident
Funding Mortgage
Corporation, February
2003 to July 2003;
Executive Vice President,
Director and Treasurer,
Commercial Capital Bank,
January 2000 to February
2003; Managing Principal
and Chief Operating
Officer, Financial
Institutional Partners
Mortgage Company and the
Managing Principal and
President of Financial
Institutional Partners,
LLC (an investment
banking firm), April 1998
to February 2003.
James F. Leary Director 2000 Managing Director, Benefit 10 Board Member of
(Age 76) Capital Southwest, Inc. Capstone Series
(a financial consulting Fund, Inc.
firm), since January
1999.
Bryan A. Ward Director 2000 Senior Manager, Accenture, LLP 10 None
(Age 52) (a consulting firm) since
January 2002.
<FN>
1 Directors generally serve three-year terms or until their successors are
duly elected and qualified.
2 Mr. Dougherty is deemed to be an "interested person" of the Fund under the
1940 Act because of his position with the Investment Advisor.
3 Each officer also serves in the same capacity for each fund in the Fund
Complex.
</FN>
21
PROSPECT STREET INCOME SHARES, INC.
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
NUMBER OF
PORTFOLIOS IN
YEAR FIRST FUND
POSITION(S) ELECTED OR COMPLEX
HELD WITH APPOINTED TO PRINCIPAL OCCUPATION(S) DURING OVERSEEN OTHER DIRECTORSHIPS
NAME AND AGES FUND OFFICE1 PAST FIVE YEARS BY DIRECTOR HELD BY DIRECTOR
- ---------------------- ----------- ------------- ------------------------------ ------------- ---------------------
INTERESTED DIRECTOR2
R. Joseph Dougherty Director and 2000 Senior Portfolio Manager of 10 None
(Age 36) Chairman of the the Investment Advisor.
Board Trustee and Senior Vice
President of the funds in
the Fund Complex.
OFFICERS3
James D. Dondero Chief Executive 2000 President and Director of N/A N/A
(Age 44) Officer and Strand Advisors, Inc.,
President ("Strand") the general
partner of the Investment
Advisor. President of the
funds in the Fund
Complex.
R. Joseph Dougherty Senior Vice 2000 Senior Portfolio Manager of N/A N/A
(Age 36) President the Investment Advisor since
2000.
Mark Okada Executive Vice 2000 Executive Vice President N/A N/A
(Age 44) President of Strand and the funds
in the Fund Complex;
Chief Investment Officer
of the Investment
Advisor.
M. Jason Blackburn Secretary, 2003 Assistant Controller of the N/A N/A
(Age 30) Chief Investment Advisor since
Financial November 2001; Treasurer
Officer and Secretary of the
and Treasurer funds in the Fund
Complex.
<FN>
1 Directors generally serve three-year terms or until their successors are
duly elected and qualified.
2 Mr. Dougherty is deemed to be an "interested person" of the Fund under the
1940 Act because of his position with the Investment Advisor.
3 Each officer also serves in the same capacity for each fund in the Fund
Complex.
</FN>
22
PROSPECT STREET INCOME SHARES, INC.
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
NUMBER OF
PORTFOLIOS IN
YEAR FIRST FUND
POSITION(S) ELECTED OR COMPLEX
HELD WITH APPOINTED TO PRINCIPAL OCCUPATION(S) DURING OVERSEEN OTHER DIRECTORSHIPS
NAME AND AGES FUND OFFICE1 PAST FIVE YEARS BY DIRECTOR HELD BY DIRECTOR
- ------------------------ --------- ------------- ------------------------------ ------------- ---------------------
OFFICERS3 (CONTINUED)
Michael S. Minces Chief 2000 Chief Compliance Officer of N/A N/A
(Age 32) Compliance the Investment Advisor and
Officer the funds in the Fund
Complex since August
2004; Associate, Akin
Gump Strauss Hauer & Feld
LLP (law firm), October
2003 to August 2004;
Associate, Skadden, Arps,
Slate, Meagher & Flom LLP
(law firm), October 2000
to March 2003.
<FN>
1 Directors generally serve three-year terms or until their successors are
duly elected and qualified.
2 Mr. Dougherty is deemed to be an "interested person" of the Fund under the
1940 Act because of his position with the Investment Advisor.
3 Each officer also serves in the same capacity for each fund in the Fund
Complex.
</FN>
23
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24
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25
PROSPECT STREET INCOME SHARES, INC.
INVESTMENT ADVISOR LEGAL ADVISOR
Highland Capital Management, L.P. Skadden, Arps, Slate, Meagher & Flom LLP
13455 Noel Road Four Times Square
Suite 800 New York, NY 10036
Dallas, TX 75240
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
OFFICERS Deloitte & Touche LLP
James Dondero -- Chief Executive Officer and President JPMorgan Chase Tower
Mark Okada -- Executive Vice President 2200 Ross Avenue
R. Joseph Dougherty -- Senior Vice President Suite 1600
M. Jason Blackburn -- Secretary and Treasurer Dallas, TX 75201-6778
Michael Minces -- Chief Compliance Officer
TRANSFER AGENT AND SHAREHOLDERS' SERVICING AGENT
DIRECTORS PFPC Inc.
Joe Dougherty P.O. Box 43027
Timothy Hui Providence, RI 02940-3027
Scott Kavanaugh
James Leary CUSTODIAN
Bryan Ward PFPC Trust Company
8800 Tinicum Boulevard
Philadelphia, PA 19153
FACTS FOR SHAREHOLDERS:
Prospect Street Income Shares, Inc. is listed on the New York Stock Exchange
under the symbol "CNN". The Wall Street Journal and Wall Street Journal Online
publish Friday's closing net asset value of the Fund every Monday and lists the
market price of the Fund daily. They are also published in Barron's Market Week
every Saturday. Our website is www.prospectstreet.net. A description of the
policies and procedures that the Fund uses to determine how to vote proxies
relating to portfolio securities and the Fund's proxy voting record for the most
recent 12-month period ended June 30th, are available (1) without charge, by
calling 877-532-2834 and (2) on the Securities and Exchange Commission's website
at http://www.sec.gov.
The Fund files its complete schedule of portfolio holdings with the
Securities and Exchange Commission for the first and third quarters of each
fiscal year on Form N-Q. The Fund's Forms N-Q are available on the Commission's
website at http:/www.sec.gov and also may be reviewed and copied at the
Commission's Public Reference Room in Washington, DC. Information on the Public
Reference Room may be obtained by calling 1-800-SEC-0330.
The Statement of Additional Information includes additional information about
the Fund's Directors and is available upon request without charge by calling
1-877-532-2834.
The Fund mails one shareholder report to each shareholder address. If you
would like more than one report, please call shareholder services at
1-877-532-2834 and additional reports will be sent to you.
QUESTIONS REGARDING YOUR ACCOUNT: Please telephone PFPC Inc. at their toll
free number 1-800-331-1710 Monday through Friday from 9:00 a.m. to 5:00 p.m.
e.s.t.
WRITTEN CORRESPONDENCE REGARDING YOUR ACCOUNT: Please address all general
shareholder inquiries to PFPC Inc., P.O. Box 43027, Providence, RI 02940-3027.
ITEM 2. CODE OF ETHICS.
(a) The registrant, as of the end of the period covered by this report, has
adopted a code of ethics that applies to the registrant's principal
executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions,
regardless of whether these individuals are employed by the registrant
or a third party.
(b) Not applicable.
(c) There have been no amendments, during the period covered by this
report, to a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are employed
by the registrant or a third party, and that relates to any element of
the code of ethics description.
(d) The registrant has not granted any waivers, including an implicit
waiver, from a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are employed
by the registrant or a third party, that relates to one or more of the
items set forth in paragraph (b) of this item's instructions.
(e) Not applicable.
(f) The registrant's code of ethics is incorporated by reference to Exhibit
(a)(1) to the registrant's Form N-CSR filed with the Securities and
Exchange Commission on March 8, 2006 (Accession No.
0000950134-06-004550).
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
The Registrant's Board of Directors (the "Board") has determined that James
Leary, a member of the Audit Committee of the Board, is an audit committee
financial expert as defined by the Securities and Exchange Commission (the
"SEC"). Mr. Leary is "independent" as defined by the SEC for purposes of this
Item 3 of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
AUDIT FEES
(a) The aggregate fees billed for each of the last two fiscal years for
professional services rendered by the principal accountant for the
audit of the registrant's annual financial statements or services that
are normally provided by the accountant in connection with statutory
and regulatory filings or engagements for those fiscal years are
$36,000 for 2005 and $37,000 for 2006.
AUDIT-RELATED FEES
(b) The aggregate fees billed in each of the last two fiscal years for
assurance and related services by the principal accountant that are
reasonably related to the performance of the audit of the registrant's
financial statements and are not reported under paragraph (a) of this
Item are $26,200 for 2005 and $15,000 for 2006. These services
consisted of a review of quarterly regulatory filings.
TAX FEES
(c) The aggregate fees billed in each of the last two fiscal years for
professional services rendered by the principal accountant for tax
compliance, tax advice, and tax planning are $4,600 for 2005 and $5,000
for 2006. These services consisted of (i) review and/or preparation of
U.S. federal, state, local and excise tax returns; and (ii) U.S.
federal, state and local tax planning, advice and assistance regarding
statutory, regulatory or administrative developments.
ALL OTHER FEES
(d) The aggregate fees billed in each of the last two fiscal years for
products and services provided by the principal accountant, other than
the services reported in paragraphs (a) through (c) of this Item are
$17,200 for 2005 and $7,000 for 2006. These services consisted of
agreed-upon procedures related to compliance with rating agency
guidelines for the Registrant's outstanding Preferred Shares.
(e)(1) Disclose the audit committee's pre-approval policies and procedures
described in paragraph (c)(7) of Rule 2-01 of Regulation S-X.
The Audit Committee shall:
(a) have direct responsibility for the appointment, compensation,
retention and oversight of the Fund's independent auditors and,
in connection therewith, to review and evaluate matters
potentially affecting the independence and capabilities of the
auditors; and
(b) review and pre-approve (including associated fees) all audit and
other services to be provided by the independent auditors to the
Fund and all non-audit services to be provided by the
independent auditors to the Fund's investment adviser or any
entity controlling, controlled by or under common control with
the investment adviser (an "Adviser Affiliate") that provides
ongoing services to the Fund, if the engagement relates directly
to the operations and financial reporting of the Fund; and
(c) establish, to the extent permitted by law and deemed appropriate
by the Audit Committee, detailed pre-approval policies and
procedures for such services; and
(d) consider whether the independent auditors' provision of any
non-audit services to the Fund, the Fund's investment adviser or
an Adviser Affiliate not pre-approved by the Audit Committee are
compatible with maintaining the independence of the independent
auditors.
(e)(2) The percentage of services described in each of paragraphs (b) through
(d) of this Item that were approved by the audit committee pursuant to
paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X are as follows:
(b) 100%
(c) 100%
(d) N/A
(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most
recent fiscal year that were attributed to work performed by persons
other than the principal accountant's full-time, permanent employees
was less than fifty percent.
(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's
investment adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or overseen by
another investment adviser), and any entity controlling, controlled by,
or under common control with the adviser that provides ongoing services
to the registrant for each of the last two fiscal years of the
registrant was $0 for 2005 and $0 for 2006.
(h) The registrant's audit committee of the board of directors has
considered whether the provision of non-audit services that were
rendered to the registrant's investment adviser (not including any
sub-adviser whose role is primarily portfolio management and is
subcontracted with or overseen by another investment adviser), and any
entity controlling, controlled by, or under common control with the
investment adviser that provides ongoing services to the registrant
that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X is compatible with maintaining the principal
accountant's independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
The Registrant has a separately-designated standing audit committee established
in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934,
as amended. It is composed of the following Directors, each of who is not an
"interested person" as defined in the 1940 Act:
Timothy K. Hui
Scott F. Kavanaugh
James F. Leary
Bryan A. Ward
ITEM 6. SCHEDULE OF INVESTMENTS.
Schedule of Investments in securities of unaffiliated issuers as of the close of
the reporting period is included as part of the report to shareholders filed
under Item 1 of this form.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
Highland Capital Management, L.P. (the "Adviser") has adopted proxy voting
guidelines (the "Guidelines") that provide as follows:
o The Adviser votes proxies in respect of a client's securities in the
client's best economic interests and without regard to the interests of
the Adviser or any other client of the Adviser.
o Unless the Adviser otherwise determines (and documents the basis for
its decision) or as otherwise provided below, the Adviser votes proxies
in a manner consistent with the Guidelines.
o To avoid material conflicts of interest, the Adviser applies the
Guidelines in an objective and consistent manner across client
accounts. Where a material conflict of interest has been identified and
the matter is covered by the Guidelines, the Adviser votes in
accordance with the Guidelines. For clients that are registered
investment companies, where a conflict of interest has been identified
and the matter is not covered in the Guidelines, the Adviser will
disclose the conflict and the determination of the manner in which to
vote to the Fund's Board. For clients that are not investment
companies, where a conflict of interest has been identified and the
matter is not covered in the Guidelines, the Adviser will disclose the
conflict to the client and advise the client that its securities will
be voted only upon the client's written direction.
o The Adviser also may determine not to vote proxies in respect of
securities of any issuer if it determines it would be in its clients'
overall best interests not to vote.
The Adviser's Guidelines address how it will vote proxies on particular types of
matters such as changes in corporate government structures, adoption of options
plans and anti-takeover proposals. For example, the Adviser generally will:
o support management in most elections for directors, unless the board
gives evidence of acting contrary to the best economic interests of
shareholders;
o support option plans, if it believes that they provide for their
administration by disinterested parties and provide incentive to
directors, managers and other employees by aligning their economic
interests with those of the shareholders while limiting the transfer of
wealth out of the company; and
o oppose anti-takeover proposals unless they are structured in such a way
that they give shareholders the ultimate decision on any proposal or
offer.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
(A)(1) IDENTIFICATION OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS AND
DESCRIPTION OF ROLE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS
The Fund's portfolio is managed by a portfolio management team. As of
the date of this filing, the members of the team who are primarily responsible
for the day-to-day management of the Fund's portfolio are Mark Okada and R.
Joseph Dougherty.
MARK OKADA - Mr. Okada is a Founder and Chief Investment Officer at
Highland Capital Management, L.P. ("Highland"). He is responsible for overseeing
Highland's investment activities for its various funds and has over 19 years of
experience in the leveraged finance market. Before joining the Highland, Mr.
Okada served as Manager of Fixed Income for Protective Life's GIC subsidiary
from 1990 to 1993. He was primarily responsible for the bank loan portfolio and
other risk assets. Protective was one of the first non-bank entrants into the
syndicated loan market. From 1986 to 1990, he served as Vice President for
Hibernia National Bank, managing over U.S.$1 billion of high yield bank loans.
Mr. Okada is an honours graduate of the University of California Los Angeles
with degrees in Economics and Psychology. He completed his credit training at
Mitsui and has earned the right to use the Chartered Financial Analyst
designation. Mr. Okada is also Chairman of the Board of Directors of Common
Grace Ministries Inc.
R. JOSEPH DOUGHERTY - Mr. Dougherty is Head of Retail Products at
Highland Capital Management, L.P. ("Highland"). Prior to joining Highland in
June 1998, Mr. Dougherty served as an Investment Analyst with Sandera Capital
Management from 1997 to 1998. Formerly, he was a Business Development Manager at
Akzo Nobel from 1994 to 1996 and a Senior Accountant at Deloitte & Touche, LLP
from 1992 to 1994. Mr. Dougherty is a Senior Portfolio Manager and, as
previously mentioned, heads Highland's retail products business unit ("Highland
Funds"). He serves as Portfolio Manager, Senior Vice President, and/or Director
of the Firm's NYSE-listed funds and 1940 Act Registered Funds. He also serves as
Portfolio Manager for the Firm's sub-advised closed-end funds. In this capacity,
Mr. Dougherty oversees investment decisions for the retail funds, alongside
several other Portfolio Managers, and manages the team dedicated to their
day-to-day operations. Prior
to his current duties, Mr. Dougherty served as Portfolio Analyst for Highland
from 1998 to 1999. As a Portfolio Analyst, Mr. Dougherty helped follow companies
within the chemical, retail, supermarket, wireless and restaurant sectors. He
received a BS in Accounting from Villanova University and an MBA from Southern
Methodist University. Mr. Dougherty is a Certified Public Accountant and has
earned the right to use the Chartered Financial Analyst designation.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM
MEMBER AND POTENTIAL CONFLICTS OF INTEREST
OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT
TEAM MEMBER
The following tables provide information about funds and accounts,
other than the Fund, for which the Fund's portfolio managers are primarily
responsible for the day-to-day portfolio management as of December 31, 2006.
MARK OKADA
- ---------------------------------------------------------------------------------------------------------------------
Total # of Accounts Managed Total Assets with
# of Accounts Total Assets with Performance-Based Performance-Based
Type of Accounts Managed (millions) Advisory Fee Advisory Fee (millions)
- ---------------------------------------------------------------------------------------------------------------------
Registered Investment 11 $76 0 $0
Companies:
- ---------------------------------------------------------------------------------------------------------------------
Other Pooled Investment 28 $24,218 22 $14,814
Vehicles:
- ---------------------------------------------------------------------------------------------------------------------
Other Accounts: 0 $0 0 $0
- ---------------------------------------------------------------------------------------------------------------------
R. JOSEPH DOUGHERTY
- ---------------------------------------------------------------------------------------------------------------------
Type of Accounts Total Total Assets # of Accounts Managed Total Assets with
# of Accounts with Performance-Based Performance-Based
Managed (millions) Advisory Fee Advisory Fee (millions)
- ---------------------------------------------------------------------------------------------------------------------
Registered Investment 7 $76 0 $0
Companies:
- ---------------------------------------------------------------------------------------------------------------------
Other Pooled Investment 1 $6,578 0 $0
Vehicles:
- ---------------------------------------------------------------------------------------------------------------------
Other Accounts: 0 $0 0 $0
- ---------------------------------------------------------------------------------------------------------------------
POTENTIAL CONFLICTS OF INTERESTS
The Adviser has built a professional working environment, a firm-wide
compliance culture and compliance procedures and systems designed to protect
against potential incentives that may favor one account over another. Highland
has adopted policies and procedures that address the allocation of investment
opportunities, execution of portfolio transactions, personal trading by
employees and other potential conflicts of interest that are designed to ensure
that all client accounts are treated equitably over time. Nevertheless, the
Adviser furnishes advisory services to numerous clients in addition to the Fund,
and the Adviser may, consistent with applicable law, make investment
recommendations to other clients or accounts (including accounts that are hedge
funds or have performance or higher fees paid to the Adviser or in which
portfolio managers have a personal interest in the receipt of such fees) that
may be the same as or different from those made to the Fund. In addition, the
Adviser, its affiliates and any of their partners, directors, officers,
stockholders or employees may or may not have an interest in the securities
whose purchase and sale the Adviser recommends to the Fund. Actions with respect
to securities of the same kind may be the same as or different from the action
that the Adviser, or any of its affiliates, or any of their partners, directors,
officers, stockholders or employees or any member of their families may take
with respect to the same securities. Moreover, the Adviser may refrain from
rendering any advice or services concerning securities of companies of which any
of the Adviser's (or its affiliates') partners, directors, officers or employees
are directors or officers, or companies as to which the Adviser or any of its
affiliates or the partners, directors, officers and employees of any of them has
any substantial economic interest or possesses material non-public information.
In addition to its various policies and procedures designed to address these
issues, the Adviser includes disclosure regarding these matters to its clients
in both its Form ADV and investment advisory agreements.
The Adviser, its affiliates or their partners, directors, officers and
employees similarly serve or may similarly serve other entities that operate in
the same or related lines of business. Accordingly, these individuals may have
obligations to investors in those entities or funds or to other clients, the
fulfillment of which might not be in the best interests of the Fund. As a
result, the Adviser will face conflicts in the allocation of investment
opportunities to the Fund and other funds and clients. In order to enable such
affiliates to fulfill their fiduciary duties to each of the clients for which
they have responsibility, the Adviser will endeavor to allocate investment
opportunities in a fair and equitable manner which may, subject to applicable
regulatory constraints, involve pro rata co-investment by the Fund and such
other clients or may involve a rotation of opportunities among the Fund and such
other clients.
While the Adviser does not believe there will be frequent conflicts of
interest, if any, the Adviser and its affiliates have both subjective and
objective procedures and policies in place designed to manage the potential
conflicts of interest between the Adviser's fiduciary obligations to the Fund
and their similar fiduciary obligations to other clients so that, for example,
investment opportunities are allocated in a fair and equitable manner among the
Fund and such other clients. An investment opportunity that is suitable for
multiple clients of the Adviser and its affiliates may not be capable of being
shared among some or all of such clients due to the limited scale of the
opportunity or other factors, including regulatory restrictions imposed by the
1940 Act. There can be no assurance that the Adviser's or its affiliates'
efforts to allocate any particular investment opportunity fairly among all
clients for whom such opportunity is appropriate will result in an allocation of
all or part of such opportunity to the Fund. Not all conflicts of interest can
be expected to be resolved in favor of the Fund.
The Adviser expects to apply to the SEC for exemptive relief to enable
the Fund and registered investment companies advised by the Adviser to co-invest
with other accounts and funds managed by the Adviser and its affiliates in
certain privately-placed securities and other situations. There are no
assurances that the Adviser will receive the requested relief. If such relief is
not obtained and until it is obtained, the Adviser may be required to allocate
some investments solely to any of the Fund, a registered fund, or another
account or fund advised by the Adviser or its affiliates. This restriction could
preclude the Fund from investing in certain securities it would otherwise be
interested in and could adversely affect the speed at which the Fund is able to
invest its assets and, consequently, the performance of the Fund.
(A)(3) COMPENSATION STRUCTURE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM
MEMBERS
Highland's financial arrangements with its portfolio managers, its
competitive compensation and its career path emphasis at all levels reflect the
value senior management places on key resources. Compensation may include a
variety of components and may vary from year to year based on a number of
factors including the relative performance of a portfolio managers underlying
account, the combined performance of the portfolio managers underlying accounts,
and the relative performance of the portfolio managers underlying accounts
measured against other employees. The principal components of compensation
include a base salary, a discretionary bonus, various retirement benefits and
one or more of the incentive compensation programs established by Highland such
as the Option It Plan and the Long-Term Incentive Plan.
BASE COMPENSATION. Generally, portfolio managers receive base
compensation based on their seniority and/or their position with the firm, which
may include the amount of assets supervised and other management roles within
the firm.
DISCRETIONARY COMPENSATION. In addition to base compensation, portfolio
managers may receive discretionary compensation, which can be a substantial
portion of total compensation. Discretionary compensation can include a
discretionary cash bonus as well as one or more of the following:
OPTION IT PLAN. The purpose of the Plan is to attract and
retain the highest quality employees for positions of
substantial responsibility, and to provide additional
incentives to a select group of management or highly
compensated employees of the Fund so as to promote the success
of the Fund.
LONG TERM INCENTIVE PLAN. The purpose of the Plan is to create
positive morale and teamwork, to attract and retain key
talent, and to encourage the achievement of common goals. The
Plan seeks to reward participating employees based on the
increased value of Highland through the use of Long-term
Incentive Units.
Senior portfolio managers who perform additional management functions
may receive additional compensation in these other capacities.
Compensation is structured such that key professionals benefit from
remaining with the firm.
(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
The following table sets forth the dollar range of equity securities
beneficially owned by each portfolio manager in the Fund as of December 31,
2006.
-------------------------------------------------------------------------------
DOLLAR RANGES OF EQUITY SECURITIES BENEFICIALLY
NAME OF PORTFOLIO MANAGER OWNED BY PORTFOLIO MANAGER
-------------------------------------------------------------------------------
Mark Okada $100,001 - $500,000
-------------------------------------------------------------------------------
R. Joseph Dougherty $100,001 - $500,000
-------------------------------------------------------------------------------
(B) Not applicable.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
REGISTRANT PURCHASES OF EQUITY SECURITIES
- ------------------------------------------------------------------------------------------------------------
(C) TOTAL NUMBER OF (D) MAXIMUM NUMBER (OR
(A) TOTAL NUMBER (B) AVERAGE SHARES (OR UNITS) APPROXIMATE DOLLAR VALUE) OF
SHARES PRICE PAID PURCHASED AS PART OF SHARES (OR UNITS) THAT MAY
(OR UNITS) PER SHARE PUBLICLY ANNOUNCED YET BE PURCHASED UNDER THE
PERIOD PURCHASED (OR UNIT) PLANS OR PROGRAMS PLANS OR PROGRAMS
- ------------------------------------------------------------------------------------------------------------
July 1, 2006 to 30,923 $5.7921 30,923 9,947,104
July 31, 2006
- ------------------------------------------------------------------------------------------------------------
August 1, 2006 - - - 9,947,104
to August 31,
2006
- ------------------------------------------------------------------------------------------------------------
September 1, - - - 9,947,104
2006 to
September 30,
2006
- ------------------------------------------------------------------------------------------------------------
October 1, 2006 28,378 $5.9298 28,378 9,947,104
to October 31,
2006
- ------------------------------------------------------------------------------------------------------------
November 1, - - - 9,947,104
2006 to
November 30,
2006
- ------------------------------------------------------------------------------------------------------------
December 1, - - - 9,947,104
2006 to
December 31,
2006
- ------------------------------------------------------------------------------------------------------------
Total 59,301 $5.8580 59,301 9,947,104
- ------------------------------------------------------------------------------------------------------------
Note: all purchases were made in the open market.
a. The date each plan or program was announced: Purchases were made
pursuant to an Automatic Dividend Reinvestment Plan that was last filed
with the SEC on July 13, 2001.
b. The dollar amount (or share or unit amount) approved : NONE c. The
expiration date (if any) of each plan or program: NONE
d. Each plan or program that has expired during the period covered by the
table: NONE
e. Each plan or program the registrant has determined to terminate prior
to expiration, or under which the registrant does not intend to make
further purchases.: NONE
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these controls
and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR
270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities
Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17
CFR 270.30a-3(d)) that occurred during the registrant's second fiscal
quarter of the period covered by this report that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) The registrant's code of ethics is incorporated by reference to
Exhibit (a)(1) to the registrant's Form N-CSR filed with the
Securities and Exchange Commission on March 8, 2006 (Accession No.
0000950134-06-004550).
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) PROSPECT STREET(R) INCOME SHARES INC.
--------------------------------------------------------------------
By (Signature and Title)* /S/ JAMES D. DONDERO
--------------------------------------------------------
James D. Dondero, Chief Executive Officer
(principal executive officer)
Date MARCH 5, 2007
------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /S/ JAMES D. DONDERO
--------------------------------------------------------
James D. Dondero, Chief Executive Officer
(principal executive officer)
Date MARCH 5, 2007
------------------------------------------------
By (Signature and Title)* /S/ M. JASON BLACKBURN
--------------------------------------------------------
M. Jason Blackburn, Chief Financial Officer
(principal financial officer)
Date MARCH 5, 2007
------------------------------------------------
* Print the name and title of each signing officer under his or her signature.