HSF Hartford Income Shares Fund, Inc.

Notes to Financial Statements

January 31, 2008 (Unaudited)

($000’s Omitted)

 

 

Indemnifications:  Under the Fund’s organizational documents, the Fund shall indemnify its officers and directors to the full extent required or permitted under Maryland Corporate Law and the federal securities law. In addition, the Fund enters into contracts that contain a variety of indemnifications. The Fund’s maximum exposure under these arrangements is unknown. However, the Fund has not had any prior claims or losses pursuant to these contracts and expects the risk of loss to be remote.

 

 

a) Security Transactions and Related Investment Income  — Security transactions are accounted for on trade date (the date the order to buy or sell is executed). Interest income, including level-yield amortization of premium and discount, is recorded on the accrual basis. Realized security gains and losses are determined on the basis of identified cost.

 

For the six-month period ended January 31, 2008, the cost of purchases and proceeds from sales of securities (including maturities but excluding short-term securities) were as follows:

 

 

b) Security Valuation and Investment Income  — The Fund generally uses market prices in valuing portfolio securities. If market quotations are not readily available or are deemed unreliable, the Fund will use the fair value of the security as determined in good faith under policies and procedures established by and under the supervision of the Fund’s Board of Directors. Market prices may be deemed unreliable, for example, if a security is thinly traded or if an event has occurred after the close of the exchange on which a portfolio security is principally traded but before the close of the New York Stock Exchange (the “Exchange”) (normally 4:00 p.m. Eastern Time, referred to as the “Valuation Time”) that is expected to affect the value of the portfolio security. The circumstances in which the Fund may use fair value pricing include, among others: (i) the occurrence of events that are significant to a particular issuer, such as mergers, restructuring or defaults; (ii) the occurrence of events that are significant to an entire market, such as natural disasters in a particular region or governmental actions; (iii) trading restrictions on securities; (iv) thinly traded securities; and (v) market events such as trading halts and early market closings. In addition, with respect to the valuation of securities principally traded on foreign markets, the Fund uses a fair value pricing service approved by the Fund’s Board of Directors which employs quantitative models to adjust for “stale” prices caused by the movement of other markets and other factors occurring after the close of the foreign markets but before the close of the Exchange. Securities that are primarily traded on foreign markets may trade on days that are not business days of the Fund. Because the Net Asset Value (“NAV”) of the Fund’s shares is determined only on business days of the Fund, the value of the portfolio securities of the Fund’s investments in foreign securities may change on days when a shareholder will not be able to purchase or redeem shares of the Fund. Fair value pricing is subjective in nature and the use of fair value pricing by the Fund may cause the NAV of the respective shares to differ significantly from the NAV that would have been calculated using prevailing market prices at the close of the exchange on which a portfolio is primarily traded but before the close of the Exchange. There can be no assurance that the Fund could obtain the fair value assigned to a security if the Fund were to sell the security at approximately the time at which the Fund determines its NAV per share.

 

Debt securities (other than short-term investments) held by the Fund are valued on the basis of valuations furnished by an unaffiliated pricing service which determines valuations for normal institutional size trading units of debt securities. Securities for which prices are not available from an independent pricing service, but where an active market exists, are valued using market quotations obtained from one or more dealers that make markets in securities or from a widely-used quotation system in accordance with procedures established by the Fund’s Board of Directors. Generally, the Fund may use fair valuation in regards to debt securities when the Fund holds defaulted or distressed securities or securities in a company in which a reorganization is pending. Short term investments with a maturity of more than 60 days when purchased are valued based on market quotations until the remaining days to maturity become less than 61 days. Investments that mature in 60 days or less are valued at amortized cost, which approximates market value.

 

Futures contracts shall be valued at the final settlement price reported by an exchange on which they are principally traded. If there were no trades as of the valuation day, then the contract shall be valued at the mean of the closing bid/ask price as of the Valuation Time.

Notes to Financial Statements

January 31, 2008 (Unaudited)

($000’s Omitted)

 

c) Repurchase Agreements  — A repurchase agreement is an agreement by which the seller of a security agrees to repurchase the security sold at a mutually agreed upon time and price. At the time the Fund enters into a repurchase agreement, the value of the underlying collateral security(ies), including accrued interest, will be equal to or exceed the value of the repurchase agreement. Securities that serve to collateralize the repurchase agreement are held by the Fund’s custodian in book entry or physical form in the custodial account of the Fund or in a third party custodial account. Repurchase agreements are valued at cost plus accrued interest receivable. As of January 31, 2008, there were no outstanding repurchase agreements.

 

d) Futures and Options Transactions  — The Fund may invest in futures contracts and options contracts in order to gain exposure to or protect against changes in the market. A futures contract is an agreement between two parties to buy and sell a security at a set price on a future date. When the Fund enters into futures contracts, it is required to deposit with a futures commission merchant an amount of “initial margin” of cash, commercial paper or U.S. Treasury Bills. Subsequent payments, called maintenance margin, to and from the broker, are made on a daily basis as the price of the underlying security fluctuates, making the long and short positions in the futures contract more or less valuable (i.e., mark-to-market), which results in an unrealized gain or loss to the Fund.

 

At any time prior to the expiration of the futures contract, the Fund may close the position by taking an opposite position, which would effectively terminate the position in the futures contract. A final determination of maintenance margin is then made, additional cash is required to be paid by or released to the Fund and the Fund realizes a gain or loss.

 

The use of futures contracts involve elements of market risk, which may exceed the amounts recognized in the Statement of Assets and Liabilities. Changes in the value of the futures contracts may decrease the effectiveness of the Fund’s strategies and potentially result in loss. The Fund, as shown on the Schedule of Investments, had outstanding futures contracts as of January 31, 2008.

 

The premium paid by the Fund for the purchase of a call or put option is included in the Fund’s Statement of Assets and Liabilities as an investment and subsequently “marked-to-market” through net unrealized appreciation (depreciation) of options to reflect the current market value of the option as of the end of the reporting period.

 

The Fund may write covered options. “Covered” means that so long as the Fund is obligated as the writer of an option, it will own either the underlying securities or currency or an option to purchase or sell the same underlying securities or currency having an expiration date of the covered option and an exercise price equal to or less than the exercise price of the covered option, or will establish or maintain with its custodian for the term of the option a “segregated account” consisting of cash or other liquid securities having a value equal to or greater than the fluctuating market value of the option securities or currencies. The Fund receives a premium for writing a call or put option, which is recorded on the Fund’s Statement of Assets and Liabilities and subsequently “marked-to-market” through net unrealized appreciation (depreciation) of options. There is a risk of a loss from a change in the value of such options, which may exceed the related premiums received. During the six-month period ended January 31, 2008, the Fund had no transactions involving written options contracts.

 

e) Federal Income Taxes  — For federal income tax purposes, the Fund intends to continue to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code by distributing substantially all of its taxable net investment income and net realized capital gains to its shareholders and otherwise complying with the requirements of regulated investment companies. The Fund has distributed substantially all of its income and capital gains in prior years and intends to distribute substantially all of its income and capital gains in this fiscal year. Accordingly, no provision for federal income taxes has been made in the accompanying financial statements. On a calendar year basis, the Fund is subject to a 4% federal excise tax to the extent it does not distribute substantially all of its net investment income and realized gains, if any. Distributions from short-term capital gains are treated as ordinary income distributions for federal income tax purposes.

 

Net investment income and net realized gains differ for financial statement and tax purposes. The character of distributions made during the year from net investment income or net realized gains may therefore differ from their ultimate characterization for federal income tax purposes. Also, due to the timing of dividend distributions, the fiscal year in which amounts are distributed may differ from the year that the income or realized gains (losses) were recorded by the Fund.

 

The tax character of distributions paid for the fiscal years ended July 31, 2007 and 2006, were ordinary income in the amounts of $7,191 and $7,160, respectively.

 

As of July 31, 2007, the components of distributable earnings on a tax basis were as follows:

 

 

Notes to Financial Statements

January 31, 2008 (Unaudited)

($000’s Omitted)

 

 

 

For federal income tax purposes, the Fund had capital loss carryovers of $21,740 at July 31, 2007, which, if not offset by subsequent capital gains, will expire in 2008 through 2014 as follows:

 

 

f) Financial Accounting Standards Board Interpretation No. 48  — On July 13, 2006, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements. Management has evaluated the implications of FIN 48 for all open tax years (tax years ended 2005 - 2007) and has determined there is no impact on the Fund’s financial statements.

 

g) Dividend Reinvestment Plan  — The Fund has a dividend reinvestment plan (the “Plan”), which is open to all registered holders of the Fund’s common stock (the “Common Stock”). Common shareholders who participate in the Plan will have his or her dividend and capital gain distributions reinvested in additional whole or fractional shares of the Fund by Hartford Administrative Services Company (“HASCO”); HASCO has delegated certain of its duties as plan agent to DST Systems, Inc. (“DST”), the Fund’s sub-transfer agent (HASCO and DST are collectively referred to herein as the “Plan Agent”). Such distributions are recorded as of the ex-dividend date. Shareholders will automatically receive their dividends and capital gains distributions in cash, unless they inform the Plan Agent (see page 20) in writing 15 days prior to the record date of a dividend payment in order for such dividend payment to be included in the Plan. Shareholders whose common shares are held in the name of a broker or nominee should contact the broker or nominee to determine whether and how they may participate in the Plan.

 

Under the Plan the number of shares participants will receive as a shareholder of the Common Stock when the Fund’s Board of Directors declares a dividend or capital gain distribution is as follows:

 

 

The Plan Agent will maintain all shareholders’ accounts in the Plan and supply written confirmation of all transactions in the account, including information needed for tax records. Shares in the account of each Plan participant will be held by the Plan Agent in non-certificate form. Any proxy you receive as a shareholder will include all shares of Common Stock you have purchased or received under the Plan.

 

Automatically reinvesting dividends and distributions does not mean that you do not have to pay income taxes due (or required to be withheld) upon receiving dividends and distributions.

 

Participants may withdraw from the Plan by giving written notice to the Plan Agent. Notice to withdraw from the Plan must be received by the Plan Agent 15 days prior to the dividend date for which it is to become effective; otherwise, it will be effective for all subsequent distributions. Upon termination of the Plan, participants will receive certificates for whole common shares and a cash payment for all fractional shares credited to his or her account.

 

There is no charge for reinvestment of your dividends or distributions. However, all participants will pay a pro rata share of brokerage commissions incurred with respect to the Plan Agent’s open market purchases, when applicable.

 

The Fund reserves the right to amend or terminate the Plan. All correspondence concerning the plan should be directed to the Plan Agent (see page 20).

Notes to Financial Statements

January 31, 2008 (Unaudited)

($000’s Omitted)

 

h) Illiquid and Restricted Securities  — “Illiquid Securities” are those that may not be sold or disposed of in the ordinary course of business within seven days, at approximately the price used to determine the Fund’s NAV per share. The Fund may not be able to sell illiquid securities or other investments when its sub-adviser considers it desirable to do so or may have to sell such securities or investments at a price that is lower than the price that could be obtained if the securities or investments were more liquid. A sale of illiquid securities or other investments may require more time and may result in higher dealer discounts and other selling expenses than does the sale of those that are liquid. Illiquid securities and investments also may be more difficult to value, due to the unavailability of reliable market quotations for such securities or investments, and investments in them may have an adverse impact on NAV. The Fund may also purchase certain restricted securities, commonly known as Rule 144A securities, that can be resold to institutions and which may be determined to be liquid pursuant to policies and guidelines established by the Fund’s Board of Directors.

 

i) Securities Purchased on a When-Issued or Delayed-Delivery Basis  — Delivery and payment for securities that have been purchased by the Fund on a when-issued or delayed-delivery basis can take place a month or more after the transaction date. During this period, such securities are subject to market fluctuations and the Fund will identify securities segregated in its records with values at least equal to the amount of the commitment. As of January 31, 2008, there were no outstanding when-issued or delayed-delivery purchase commitments.

 

j) Credit Risk  — Credit risk depends largely on the perceived financial health of bond issuers. In general, lower rated bonds have higher credit risk. High yield bond prices can fall on bad news about the economy, an industry or a company. The share price, yield and total return of a fund which holds securities with higher credit risk may fluctuate more than with less aggressive bond funds.

 

k) Use of Estimates  — The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of income and expenses during the period. Operating results in the future could vary from the amounts derived from management’s estimates.

 

m) Financial Accounting Standards Board Financial Accounting Standards No. 157  — In September 2006, FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“FAS 157”). This standard clarifies the definition of fair value for financial reporting, establishes a framework for measuring fair value and requires additional disclosures about the use of fair value measurements. FAS 157 is effective for the Fund’s financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Management has evaluated the impact of the standard and does not believe the adoption of FAS 157 will impact the amounts reported in the financial statements; however, additional disclosures will be required about the inputs used to develop the measurements of fair value and the effect of certain measurements reported in the Statement of Operations for a fiscal period.

 

3. Expenses:

 

(a) Payments to Related Parties  — Hartford Investment Financial Services, LLC (“HIFSCO”) is the investment manager for the Fund. Investment advisory and management fees are computed at the annual rate of 0.45% for the first $100 million of average monthly net assets and at the annual rate of 0.40% of average monthly net assets over $100 million, plus 2% of investment income.

 

As investment manager for the Fund, HIFSCO has retained Hartford Investment Management Company (“Hartford Investment Management”) to provide investment advice and, in general, to conduct the management investment program of the Fund, subject to the general control of HIFSCO and the Fund’s Board of Directors. Pursuant to the sub-advisory agreement, Hartford Investment Management will regularly provide the Fund with investment research, advice and supervision and furnish an investment program consistent with the Fund’s investment objectives and policies, including the purchase, retention and disposition of securities.

 

The Hartford Financial Services Group, Inc. (“The Hartford”) and its subsidiaries provide facilities and office equipment and perform certain services for the Fund, including Fund accounting and financial reporting. Certain officers of the Fund are directors and/or officers of HIFSCO, Hartford Investment Management and/or The Hartford or its subsidiaries. For the six-month period ended January 31, 2008, a portion of the Fund’s Chief Compliance Officer’s salary was paid by the Fund. The amount paid was less than five hundred dollars and rounds to zero for this report. HASCO, a subsidiary of The Hartford, provides transfer agent services to the Fund. Transfer agent fees are paid by HIFSCO.

 

b) Expense Offset  — The Fund’s custodian bank has agreed to reduce its fees when the Fund maintains cash on deposit in the non-interest-bearing custody account. For the six-month period ended January 31, 2008, the custodian fee offset arrangement reduced expenses by $6. The total expense reduction represents an effective annual rate of 0.006% of the Fund’s average daily net assets.