<PAGE>
 
================================================================================
                                  ANNUAL REPORT
================================================================================

          1997
          1997
          1997
          1997
          1997


                              Smith Barney
                              Funds, Inc.
                              U.S. Government
                              Securities Fund
                              --------------------------------------------------
                              December 31, 1997


                      [LOGO]  Smith Barney Mutual Funds
                              Investing for your future.
                              Every day.

--------------------------------------------------------------------------------
<PAGE>
 
===============================
U.S. Government Securities Fund
===============================

Dear Shareholder:

We are pleased to provide the annual report for the Smith Barney Funds, Inc. --
U.S. Government Securities Fund ("Portfolio") for the year ended December 31,
1997. In this report, we summarize the period's prevailing economic and market
conditions and outline our portfolio strategy. A more detailed summary of
performance can be found in the appropriate sections that follow in the report.

Performance Update

For the year ended December 31, 1997, the Portfolio's Class A shares had a total
return of 9.67%, which was above its Lipper Analytical Services, Inc. ("Lipper")
peer group total return average of 8.84%. (Lipper is a major independent
fund-tracking organization.) Moreover, over the past twelve months, the
Portfolio distributed income dividends totaling $0.86 per Class A share.

Investment Strategy

The Portfolio seeks high current income, liquidity and security of principal by
investing in obligations of the U.S. Government, its agencies or its
instrumentalities and related repurchase and reverse repurchase agreements. Our
investment style emphasizes total return. We seek income from the standpoint of
paying dividends to shareholders, but our overriding concern is preserving asset
values in all market conditions. For example, if interest rates are expected to
decline, we are not going to defy the market and buy high-income coupon
securities that maximize income but typically do not perform well when interest
rates are going down. Rather, we would buy securities that perform better in an
anticipated lower interest rate environment.

In the first four months of the reporting period, we emphasized mortgage-backed
securities in the Portfolio. However, as the year unfolded, U.S. Treasurys
became our primary focus. In addition, in the last six weeks of the calendar
year, approximately 36% of the Portfolio was invested in Treasurys and about 64%
was in mortgage-backed securities.

Market Update and Outlook

In our view, one of the most important events for the market in 1997 was the
widely publicized currency and economic turmoil in Asia, specifically in Korea,
Japan and Indonesia. As these currencies were devalued, the U.S. dollar was
clearly a beneficiary. Other notable events during the year include:

     o    As a result of the unexpected strength in the U.S. economy, the
          Federal Reserve Board ("Fed") raised the federal-funds rate by 25
          basis points,


                                                                               1
<PAGE>
 
          or 0.25%, at its March 1997 meeting. (The federal-funds rate is the
          interest rate banks charge each other for overnight loans and is a
          closely watched indicator of the direction of interest rates.)

     o    The not-so-successful introduction of inflation-indexed bonds by the
          U.S. Treasury.

     o    The drastic reduction in the U.S. budget deficit. According to the
          latest report by the Congressional Budget Office, the deficit will go
          down to $5 billion in fiscal 1998 and may actually run annual
          surpluses in 1999 if present policies continue.

     o    As a result of lower rates, mortgage refinancing has increased.

     o    The drive toward the European Monetary Union continues to be on target
          for 1999.

As you can see from the chart below, interest rates declined during the year.

   Yields from U.S. Treasurys:

<TABLE>
<CAPTION>
                                                      12/31/97        12/31/96
                                                      --------        --------
<S>                                                    <C>             <C>   
    2-Year U.S. Treasury Note                          5.642%          5.868%
    3-Year U.S. Treasury Note                          5.669           6.010
    5-Year U.S. Treasury Note                          5.705           6.206
   10-Year U.S. Treasury Bond                          5.741           6.418
   30-Year U.S. Treasury Bond                          5.924           6.641
</TABLE>

Looking ahead to 1998, we anticipate the following events to have an impact on
the bond market:

     o    The turmoil in Asia may end up being worse than what is being
          reported. Therefore, the troubles in Asia will depress U.S. economic
          activity even more than current consensus expectations.

     o    The Fed will probably ease monetary policy and lower rates. In fact,
          several Fed Governors have recently shifted to a more "dovish" view
          regarding interest rates.

     o    U.S economic growth should be modestly weaker.

     o    Interest rates will be lower and the yield on the 30-Year U.S.
          Treasury bond should trend toward 5 1/2%.



2
<PAGE>
 
Moderate economic growth, combined with historically low inflation and the
threat of financial and economic turmoil in Southeast Asia, should provide more
than enough ammunition for rates to go lower. While non-believers would suggest
rates are too low, there is no compelling evidence to warrant a reversal of the
present trend. High real rates, a lesser supply of U.S. Treasurys and a strong
U.S. dollar are just some of the reasons why we remain bullish on bonds.

On a more somber note, we are saddened by the loss of an outstanding physician
and Director of the Portfolio, Dr. Francis P. Martin. His knowledge and wisdom
will be missed.

In closing, thank you for investing in the Smith Barney Funds, Inc. -- U.S.
Government Securities Fund. We look forward to continuing to help you pursue
your financial goals.

Sincerely,


/s/ Heath B. McLendon                       /s/ James E. Conroy


Heath B. McLendon                           James E. Conroy
Chairman                                    Vice President

February 20, 1998



                                                                               3
<PAGE>
 
<TABLE>
<CAPTION>
====================================================================================
Historical Performance -- Class A Shares
====================================================================================

                        Net Asset Value
                     --------------------
                     Beginning      End         Income     Capital Gain     Total
Year Ended            of Year      of Year     Dividends   Distributions  Returns(1)
====================================================================================
<S>                    <C>         <C>           <C>          <C>           <C>  
12/31/97               $13.24      $13.61       $ 0.86        $0.00         9.67%
------------------------------------------------------------------------------------
12/31/96                13.59       13.24         0.86         0.00         3.97
------------------------------------------------------------------------------------
12/31/95                12.50       13.59         0.92         0.00        16.52
------------------------------------------------------------------------------------
12/31/94                13.66       12.50         0.91         0.05        (1.48)
------------------------------------------------------------------------------------
12/31/93                13.87       13.66         0.98         0.11         6.40
------------------------------------------------------------------------------------
12/31/92                14.10       13.87         1.08         0.08         6.85
------------------------------------------------------------------------------------
12/31/91                13.22       14.10         1.13         0.05        16.29
------------------------------------------------------------------------------------
12/31/90                13.17       13.22         1.18         0.00         9.95
------------------------------------------------------------------------------------
12/31/89                12.56       13.17         1.21         0.00        15.11
------------------------------------------------------------------------------------
12/31/88                12.68       12.56         1.20         0.00         8.72
------------------------------------------------------------------------------------
12/31/87                13.89       12.68         1.31         0.24         2.67
====================================================================================
Total                                           $11.64        $0.53
====================================================================================
</TABLE>             

<TABLE>
<CAPTION>
====================================================================================
Historical Performance -- Class B Shares
====================================================================================

                        Net Asset Value
                     --------------------
                     Beginning      End         Income     Capital Gain     Total
Year Ended            of Year      of Year     Dividends   Distributions  Returns(1)
====================================================================================
<S>                    <C>         <C>           <C>          <C>           <C>  
12/31/97               $13.26      $13.63        $0.80        $0.00          9.12%
------------------------------------------------------------------------------------
12/31/96                13.61       13.26         0.79         0.00          3.44
------------------------------------------------------------------------------------
12/31/95                12.51       13.61         0.86         0.00         16.03
------------------------------------------------------------------------------------
Inception*-12/31/94     12.47       12.51         0.21         0.00          2.04+
====================================================================================
Total                                            $2.66        $0.00
====================================================================================
</TABLE>


<TABLE>
<CAPTION>
====================================================================================
Historical Performance -- Class C Shares
====================================================================================

                        Net Asset Value
                     --------------------
                     Beginning      End         Income     Capital Gain     Total
Year Ended            of Year      of Year     Dividends   Distributions  Returns(1)
====================================================================================
<S>                    <C>         <C>           <C>          <C>           <C>  
12/31/97               $13.23      $13.60        $0.80        $0.00          9.18%
------------------------------------------------------------------------------------
12/31/96                13.58       13.23         0.80         0.00          3.49
------------------------------------------------------------------------------------
12/31/95                12.50       13.58         0.87         0.00         15.93
------------------------------------------------------------------------------------
12/31/94                13.66       12.50         0.83         0.04         (2.11)
------------------------------------------------------------------------------------
12/31/93                13.86       13.66         0.88         0.11          5.74
------------------------------------------------------------------------------------
Inception*-12/31/92     14.01       13.86         0.30         0.00          1.07+
====================================================================================
Total                                            $4.48        $0.15
====================================================================================
</TABLE>



4
<PAGE>
 
<TABLE>
<CAPTION>
====================================================================================
Historical Performance -- Class Y Shares
====================================================================================

                        Net Asset Value
                     --------------------
                     Beginning      End         Income     Capital Gain     Total
Year Ended            of Year      of Year     Dividends   Distributions  Returns(1)
====================================================================================
<S>                    <C>         <C>           <C>          <C>           <C>  
12/31/97               $13.27      $13.64        $0.90        $0.00         10.00%
------------------------------------------------------------------------------------
12/31/96                13.61       13.27         0.89         0.00          4.30
------------------------------------------------------------------------------------
12/31/95                12.51       13.61         0.96         0.00         16.88
------------------------------------------------------------------------------------
12/31/94                13.67       12.51         0.91         0.04         (1.53)
------------------------------------------------------------------------------------
Inception*-12/31/93     13.97       13.67         0.95         0.11          5.55+
====================================================================================
Total                                            $4.61        $0.15
====================================================================================
</TABLE>

<TABLE>
<CAPTION>
====================================================================================
Historical Performance -- Class Z Shares
====================================================================================

                        Net Asset Value
                     --------------------
                     Beginning      End         Income     Capital Gain     Total
Year Ended            of Year      of Year     Dividends   Distributions  Returns(1)
====================================================================================
<S>                    <C>         <C>           <C>          <C>           <C>  
12/31/97               $13.26      $13.63        $0.90        $0.00          9.98%
------------------------------------------------------------------------------------
12/31/96                13.60       13.26         0.89         0.00          4.31
------------------------------------------------------------------------------------
12/31/95                12.50       13.60         0.95         0.00         16.89
------------------------------------------------------------------------------------
Inception*-12/31/94     12.47       12.50         0.24         0.00          2.15+
====================================================================================
Total                                            $2.98        $0.00
====================================================================================
</TABLE>

It is the Fund's policy to distribute dividends monthly and capital gains, if
any, annually.


                                                                               5
<PAGE>
 
================================================================================
Average Annual Total Return
================================================================================
<TABLE>
<CAPTION>
                                           Without Sales Charge(1)
                                ------------------------------------------------
                                Class A    Class B   Class C   Class Y   Class Z
================================================================================
<S>                               <C>       <C>       <C>      <C>        <C>  
Year Ended 12/31/97               9.67%     9.12%     9.18%    10.00%     9.98%
--------------------------------------------------------------------------------
Five Years Ended 12/31/97         6.85       N/A      6.28       N/A       N/A
--------------------------------------------------------------------------------
Ten Years Ended 12/31/97          9.06       N/A       N/A       N/A       N/A
--------------------------------------------------------------------------------
Inception* through 12/31/97       9.58      9.64      6.40      6.91     10.50
================================================================================

<CAPTION>
                                               With Sales Charge(2)
                                ------------------------------------------------
                                Class A    Class B   Class C   Class Y   Class Z
================================================================================
<S>                               <C>       <C>       <C>      <C>        <C>  
Year Ended 12/31/97               4.77%     4.62%     8.18%    10.00%     9.98%
--------------------------------------------------------------------------------
Five Years Ended 12/31/97         5.88       N/A      6.28       N/A       N/A
--------------------------------------------------------------------------------
Ten Years Ended 12/31/97          8.56       N/A       N/A       N/A       N/A
--------------------------------------------------------------------------------
Inception* through 12/31/97       9.20      9.12      6.40      6.91     10.50
================================================================================
</TABLE>

================================================================================
Cumulative Total Return
================================================================================
<TABLE>
<CAPTION>
                                                       Without Sales Charge(1)
================================================================================
<S>                                                            <C>    
Class A (12/31/87 through 12/31/97)                            138.12%
--------------------------------------------------------------------------------
Class B (Inception* through 12/31/97)                           33.64
--------------------------------------------------------------------------------
Class C (Inception* through 12/31/97)                           37.05
--------------------------------------------------------------------------------
Class Y (Inception* through 12/31/97)                           39.38
--------------------------------------------------------------------------------
Class Z (Inception* through 12/31/97)                           36.98
================================================================================
</TABLE>

(1)  Assumes reinvestment of all dividends and capital gain distributions, if
     any, at net asset value and does not reflect the deduction of the
     applicable sales charges with respect to Class A shares or the applicable
     contingent deferred sales charges ("CDSC") with respect to Class B and C
     shares.
(2)  Assumes reinvestment of all dividends and capital gain distributions, if
     any, at net asset value. In addition, Class A shares reflect the deduction
     of the maximum initial sales charge of 4.50%; Class B shares reflect the
     deduction of a 4.50% CDSC, which applies if shares are redeemed within one
     year from initial purchase. This CDSC declines by 0.50% the first year
     after purchase and thereafter by 1.00% per year until no CDSC is incurred.
     Class C shares reflect the deduction of a 1.00% CDSC, which applies if
     shares are redeemed within the first year of purchase.
*    Inception dates for Class A, B, C, Y and Z shares are October 9, 1984,
     November 7, 1994, December 2, 1992, January 12, 1993 and November 7, 1994,
     respectively.
+    Total return is not annualized, as it may not be representative of the
     total return for the year.



6
<PAGE>
 
================================================================================
Historical Performance (unaudited)
================================================================================

               Growth of $10,000 Invested in Class A Shares of the
                       U.S. Government Securities Fund vs.
            Lehman Brothers GNMA Index and Lehman Brothers MBS Index+

--------------------------------------------------------------------------------
                         December 1987 -- December 1997

 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.]

<TABLE>
<CAPTION>
               U.S. Government       Lehman Brothers     Lehman Brothers
               Securities Fund          GNMA Index          MBS Index
               ---------------          ----------          ---------
<S>                  <C>                  <C>                <C>   
12/87                9,599                10,000             10,000
12/88               10,397                10,879             10,871
12/89               11,924                12,586             12,539
12/90               13,063                13,918             13,884
12/91               15,140                16,150             16,067
12/92               16,124                17,347             17,185
12/93               17,102                18,487             18,360
12/94               16,812                18,209             18,065
12/95               19,590                21,313             21,102
12/96               20,367                22,494             22,230
12/97               22,338                24,648             24,340
</TABLE>

+    Hypothetical illustration of $10,000 invested in Class A shares on December
     31, 1987, assuming deduction of the maximum 4.50% sales charge in effect at
     the time of investment and reinvestment of dividends (after deduction of
     applicable sales charge through November 7, 1994, and thereafter at net
     asset value) and capital gains, if any, at net asset value through December
     31, 1997. The Lehman Brothers GNMA Index is composed of 15-year and 30-year
     fixed-rate securities backed by mortgage pools of the Government National
     Mortgage Association. The Lehman Brothers MBS Index is composed of about
     600 15-year to 30-year fixed-rate mortgage-backed pools of Government
     National Mortgage Association, Federal National Mortgage Association and
     Federal Home Loan Mortgage Corp. The indexes are unmanaged and are not
     subject to the management and trading expenses of a mutual fund. The
     performance of the Portfolio's other classes may be greater or less than
     the Class A shares' performance indicated on this chart, depending on
     whether greater or lesser sales charges and fees were incurred by
     shareholders investing in other classes.
++   It is the opinion of management that the Lehman Brothers MBS Index more
     accurately reflects the composition of the U.S. Government Securities Fund
     than the Lehman Brothers GNMA Index. In future reporting, the Lehman
     Brothers MBS Index will be used as a basis of comparison of total return
     performance rather than the Lehman Brothers GNMA Index.
     All figures represent past performance and are not a guarantee of future
     results. Investment returns and principal value will fluctuate, and
     redemption value may be more or less than the original cost. No adjustment
     has been made for shareholder tax liability on dividends or capital gains.



                                                                               7
<PAGE>
 
<TABLE>
<CAPTION>
================================================================================================
Schedule of Investments                                                        December 31, 1997
================================================================================================

    FACE
   AMOUNT                            SECURITY                                           VALUE
================================================================================================
<S>                                                                                 <C>         
U.S. TREASURY OBLIGATIONS -- 35.9%
$57,000,000   U.S. Treasury Note, 5.750% due 11/15/00                               $ 57,092,930
 13,000,000   U.S. Treasury Note, 5.875% due 2/15/04                                  13,121,810
 48,000,000   U.S. Treasury Strips, zero coupon due 11/15/04                          32,515,680
 51,000,000   U.S. Treasury Strips, zero coupon due 11/15/21                          12,170,880
------------------------------------------------------------------------------------------------
              TOTAL U.S. TREASURY OBLIGATIONS
              (Cost -- $114,278,071)                                                 114,901,300
================================================================================================
U.S. GOVERNMENT AGENCIES -- 64.0%
 90,000,000   Federal National Mortgage Association Principal Strips,
                zero coupon due 7/5/14                                                32,473,389
 23,750,000   Federal National Mortgage Association Principal Strips,
                zero coupon due 10/9/19                                                6,193,763
 17,000,000   Government National Mortgage Association,
                7.000% due 8/14/00@                                                   17,148,750
  1,136,694   Government National Mortgage Association Certificates,
                10.000% due 7/15/20+                                                   1,238,996
 15,463,461   Government National Mortgage Association Certificates,
                8.000% due 7/15/26+                                                   16,043,341
  8,173,541   Government National Mortgage Association Certificates,
                9.000% due 7/15/26+                                                    8,745,690
  5,445,000   Government National Mortgage Association Certificates,
                7.000% due 12/15/27+                                                   5,492,644
 26,754,874   Government National Mortgage Association Certificates Platinum,
                9.000% due 11/15/17                                                   29,037,333
 80,711,459   Government National Mortgage Association Certificates Platinum,
                9.000% due 12/15/17                                                   87,596,954
    902,254   Government National Mortgage Association II Certificates,
                10.000% due 1/20/18+                                                     974,435
------------------------------------------------------------------------------------------------
              TOTAL U.S. GOVERNMENT AGENCIES
              (Cost-- $199,778,590)                                                  204,945,295
================================================================================================
REPURCHASE AGREEMENT -- 0.1%
    516,000   Goldman, Sachs & Co., 6.350% due 1/2/98; Proceeds
              at maturity -- $516,182; (Fully collateralized by
              U.S. Treasury Note, 5.625% due 12/31/99;
              Market value -- $526,547) (Cost -- $516,000)                               516,000
================================================================================================
              TOTAL INVESTMENTS -- 100%
              (Cost -- $314,572,661*)                                               $320,362,595
================================================================================================
</TABLE>

@    Security is traded on a "to-be-announced" basis (See Note 6).
+    Maturity date shown  represents  the last in the range of maturity dates of
     mortgage certificates owned.
*    Aggregate cost for Federal income tax purposes is  substantially  the same.



                       See Notes to Financial Statements.


8
<PAGE>
 
================================================================================
Statement of Assets and Liabilities                            December 31, 1997
================================================================================
<TABLE>
<S>                                                                <C>         
ASSETS:
  Investments, at value (Cost -- $314,572,661)                     $320,362,595
  Cash                                                                      801
  Receivable for securities sold                                    158,491,265
  Receivable for Fund shares sold                                       214,913
  Interest receivable                                                 2,044,013
--------------------------------------------------------------------------------
  Total Assets                                                      481,113,587
--------------------------------------------------------------------------------
LIABILITIES:
  Payable for securities purchased                                  154,299,090
  Management fees payable                                               170,942
  Payable for Fund shares purchased                                     101,052
  Distribution fees payable                                              37,285
  Accrued expenses                                                       38,828
--------------------------------------------------------------------------------
  Total Liabilities                                                 154,647,197
--------------------------------------------------------------------------------
Total Net Assets                                                   $326,466,390
================================================================================
NET ASSETS:
  Par value of capital shares                                         $ 239,773
  Capital paid in excess of par value                               320,442,160
  Overdistributed net investment income                                  (5,477)
  Net unrealized appreciation of investments                          5,789,934
--------------------------------------------------------------------------------
Total Net Assets                                                   $326,466,390
--------------------------------------------------------------------------------
Shares Outstanding:
  Class A                                                            19,961,936
  -----------------------------------------------------------------------------
  Class B                                                               897,819
  -----------------------------------------------------------------------------
  Class C                                                             1,063,457
  -----------------------------------------------------------------------------
  Class Y                                                               379,959
  -----------------------------------------------------------------------------
  Class Z                                                             1,674,139
  -----------------------------------------------------------------------------
Net Asset Value:
  Class A (and redemption price)                                        $13.61
  -----------------------------------------------------------------------------
  Class B*                                                              $13.63
  -----------------------------------------------------------------------------
  Class C**                                                             $13.60
  -----------------------------------------------------------------------------
  Class Y (and redemption price)                                        $13.64
  -----------------------------------------------------------------------------
  Class Z (and redemption price)                                        $13.63
  -----------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
  (net asset value plus 4.71% of net asset value per share)             $14.25
================================================================================
</TABLE>

*    Redemption price is NAV of Class B shares reduced by a 4.50% CDSC if shares
     are redeemed within the first year of purchase (See Note 2).
**   Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
     are redeemed within the first year of purchase (See Note 2).


                       See Notes to Financial Statements.


                                                                               9
<PAGE>
 
================================================================================
Statement of Operations                                        December 31, 1997
================================================================================
<TABLE>
<S>                                                                 <C>        
INVESTMENT INCOME:
  Interest                                                          $24,984,542
  Less: Interest expense (Note 5)                                      (542,073)
--------------------------------------------------------------------------------
  Total Investment Income                                            24,442,469
--------------------------------------------------------------------------------
EXPENSES:
  Management fees (Note 2)                                            1,571,535
  Distribution fees (Note 2)                                            914,915
  Shareholder and system servicing fees                                 141,273
  Registration fees                                                      70,000
  Shareholder communications                                             46,200
  Audit and legal                                                        16,801
  Custody                                                                16,002
  Directors' fees                                                         5,000
  Other                                                                  10,000
--------------------------------------------------------------------------------
  Total Expenses                                                      2,791,726
--------------------------------------------------------------------------------
Net Investment Income                                                21,650,743
--------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS AND FUTURES CONTRACTS
(NOTES 3 AND 7):
Realized Gain (Loss) From:
  Security transactions (excluding short-term securities)             9,509,242
  Futures contracts                                                  (5,770,736)
--------------------------------------------------------------------------------
  Net Realized Gain                                                   3,738,506
--------------------------------------------------------------------------------
  Change in Net Unrealized Appreciation of Investments:
    Beginning of year                                                   159,993
    End of year                                                       5,789,934
--------------------------------------------------------------------------------
  Increase in Net Unrealized Appreciation                             5,629,941
--------------------------------------------------------------------------------
Net Gain on Investments and Futures Contracts                         9,368,447
--------------------------------------------------------------------------------
Increase in Net Assets From Operations                              $31,019,190
================================================================================
</TABLE>


                       See Notes to Financial Statements.


10
<PAGE>
 
<TABLE>
<CAPTION>
===========================================================================================
Statements of Changes in Net Assets                        For the Years Ended December 31,
===========================================================================================

                                                              1997                1996
===========================================================================================
<S>                                                      <C>                  <C>          
OPERATIONS:                                                                   
  Net investment income                                  $  21,650,743        $  25,143,062
  Net realized gain                                          3,738,506              957,180
  Increase (decrease) in net unrealized appreciation         5,629,941          (12,000,502)
-------------------------------------------------------------------------------------------
  Increase in Net Assets From Operations                    31,019,190           14,099,740
-------------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:                                           
  Net investment income                                    (21,829,158)         (25,585,330)
  Net realized gains                                          (111,560)                  --
-------------------------------------------------------------------------------------------
  Decrease in Net Assets From                                                 
    Distributions to Shareholders                          (21,940,718)         (25,585,330)
-------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 8):                                             
  Net proceeds from sale of shares                          17,054,286           12,294,423
  Net asset value of shares issued for                                        
    reinvestment of dividends                               12,732,904           14,678,816
  Cost of shares reacquired                                (77,835,161)         (95,176,025)
-------------------------------------------------------------------------------------------
  Decrease in Net Assets                                                      
    From Fund Share Transactions                           (48,047,971)         (68,202,786)
-------------------------------------------------------------------------------------------
Decrease in Net Assets                                     (38,969,499)         (79,688,376)
NET ASSETS:                                                                   
  Beginning of year                                        365,435,889          445,124,265
-------------------------------------------------------------------------------------------
  End of year*                                           $ 326,466,390        $ 365,435,889
===========================================================================================
* Includes overdistributed net investment income of:           $(5,477)             $(1,628)
===========================================================================================
</TABLE>


                       See Notes to Financial Statements.



                                                                              11
<PAGE>
 
================================================================================
Notes to Financial Statements
================================================================================

     1. SIGNIFICANT ACCOUNTING POLICIES

     The U.S. Government Securities Fund ("Portfolio"), formerly known as U.S.
Government Securities Portfolio, is a separate investment portfolio of the Smith
Barney Funds, Inc. ("Fund"). The Fund, a Maryland corporation, is registered
under the Investment Company Act of 1940, as amended, as a diversified, open-end
management investment company. The Fund consists of this Portfolio and two other
separate investment portfolios: Large Cap Value Fund and Short-Term U.S.
Treasury Securities Fund. The financial statements and financial highlights for
the other portfolios are presented in separate annual reports.

     The significant accounting policies consistently followed by the Portfolio
are: (a) security transactions are accounted for on trade date; (b) U.S.
government agencies and obligations are valued at the mean between the bid and
ask prices; (c) securities maturing within 60 days are valued at cost plus
accreted discount, or minus amortized premium, which approximates value; (d)
interest income is recorded on an accrual basis; (e) gains or losses on the sale
of securities are calculated by using the specific identification method; (f)
direct expenses are charged to each class; management fees and general fund
expenses are allocated on the basis of relative net assets; (g) dividends and
distributions to shareholders are recorded on the ex-dividend date; (h) the
portfolio intends to comply with the applicable provisions of the Internal
Revenue Code of 1986, as amended, pertaining to regulated investment companies
to make distributions of taxable income sufficient to relieve it from
substantially all Federal income and excise taxes; (i) the character of income
and gains to be distributed are determined in accordance with income tax
regulations which may differ from generally accepted accounting principles. At
December 31, 1997, reclassifications were made to the Portfolio's capital
accounts to reflect permanent book/tax differences and income and gains
available for distribution under income tax regulations. Accordingly, a portion
of overdistributed net investment income amounting to $174,566 was reclassified
to paid-in capital. Net investment income, net realized gains and net assets
were not affected by this change; and (j) estimates and assumptions are required
to be made regarding assets, liabilities and changes in net assets resulting
from operations when financial statements are prepared. Changes in the economic
environment, financial markets and any other parameters used in determining
these estimates could cause actual results to differ.



12
<PAGE>
 
================================================================================
Notes to Financial Statements (continued)
================================================================================

     2.  MANAGEMENT AGREEMENT AND TRANSACTIONS
         WITH AFFILIATED PERSONS

     Mutual Management Corp. ("MMC"), formerly known as Smith Barney Mutual
Funds Management Inc., a subsidiary of Salomon Smith Barney Holdings Inc.
("SSBH"), acts as investment manager for the Fund. The Portfolio pays MMC an
investment advisory fee calculated at an annual rate of 0.50% of the first $200
million of the average daily net assets, and 0.40% of the average daily net
assets of the Portfolio in excess of $200 million. This fee is calculated daily
and paid monthly.

     Smith Barney Inc. ("SB"), another subsidiary of SSBH, acts as distributor
of Fund shares. For the year ended December 31, 1997, SB received sales charges
of approximately $105,000 on sales of the Portfolio's Class A shares.

     There is a contingent deferred sales charge ("CDSC") of 4.50% on Class B
shares, which applies if redemption occurs within one year from initial
purchase. This CDSC declines by 0.50% the first year after purchase and
thereafter by 1.00% per year until no CDSC is incurred. Class C shares have a
1.00% CDSC, which applies if redemption occurs within the first year of
purchase. For the year ended December 31, 1997, CDSCs paid to SB were
approximately:

<TABLE>
<CAPTION>
                                                           Class B     Class C
================================================================================
<S>                                                        <C>         <C>   
CDSCs                                                      $29,000     $1,000
================================================================================
</TABLE>

     Pursuant to a Distribution Plan, the Portfolio pays a service fee with
respect to its Class A, B and C shares calculated at an annual rate of 0.25% of
the average daily net assets for each respective class. In addition, the
Portfolio also pays a distribution fee with respect to Class B and C shares
calculated at the annual rate of 0.50% and 0.45% of the average daily net assets
for each class, respectively. For the year ended December 31, 1997, total
Distribution Plan fees were as follows:

<TABLE>
<CAPTION>
                                              Class A      Class B     Class C
================================================================================
<S>                                          <C>           <C>        <C>     
Distribution Plan Fees                       $720,768      $88,018    $106,129
================================================================================
</TABLE>


     All officers and two Directors of the Fund are employees of SB.


                                                                              13
<PAGE>
 
================================================================================
Notes to Financial Statements (continued)
================================================================================

     3.  INVESTMENTS

     During the year ended December 31, 1997, the aggregate cost of purchases
and proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:

<TABLE>
--------------------------------------------------------------------------------
<S>                                                                <C>         
Purchases                                                          $484,837,865
--------------------------------------------------------------------------------
Sales                                                               464,946,272
================================================================================
</TABLE>

     At December 31, 1997, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were substantially
as follows:

<TABLE>
================================================================================
<S>                                                                  <C>       
Gross unrealized appreciation                                        $6,331,247
Gross unrealized depreciation                                          (541,313)
--------------------------------------------------------------------------------
Net unrealized appreciation                                          $5,789,934
================================================================================
</TABLE>

     4.  REPURCHASE AGREEMENTS

     The Portfolio purchases (and its custodian takes possession of) U.S.
government securities from banks and securities dealers subject to agreements to
resell the securities to the sellers at a future date (generally, the next
business day) at an agreed-upon higher repurchase price. The Portfolio requires
continual maintenance of the market value of the collateral in amounts at least
equal to the repurchase price.

     5.  REVERSE REPURCHASE AGREEMENT

     The Portfolio may enter into reverse repurchase agreement transactions for
leveraging purposes. A reverse repurchase agreement involves a sale by the
Portfolio of securities that it holds with an agreement by the Portfolio to
repurchase the same securities at an agreed upon price and date. A reverse
repurchase agreement involves the risk that the market value of the securities
sold by the Portfolio may decline below the repurchase price of the securities.
The Portfolio will establish a segregated account with its custodian, in which
the Portfolio will maintain cash, U.S. government securities or other liquid
high grade debt obligations equal in value to its obligations with respect to
the reverse repurchase agreement.

     During the year ended December 31, 1997, the maximum and average amounts of
reverse repurchase agreements outstanding were as follows:

<TABLE>
--------------------------------------------------------------------------------
<S>                                                                 <C>        
Maximum amount outstanding                                          $36,208,125
--------------------------------------------------------------------------------
Average amount outstanding                                          $17,607,992
================================================================================
</TABLE>



14
<PAGE>
 
================================================================================
Notes to Financial Statements (continued)
================================================================================

     Interest rates earned on reverse repurchase agreements ranged from 1.10% to
5.45% during the year. For the year ended December 31, 1997, interest expense
from reverse repurchase agreements totalled $542,073 and the Portfolio had no
open reverse repurchase agreements at December 31, 1997.

     6.  SECURITIES TRADED ON A TO-BE-ANNOUNCED BASIS

     The Portfolio may trade securities, particularly GNMAs, on a
"to-be-announced" ("TBA") basis. In a TBA transaction, the Portfolio commits to
purchasing or selling securities for which specific information is not yet known
at the time of the trade, particularly the face amount and maturity date.
Securities purchased on a TBA basis are not settled until they are delivered to
the Portfolio, normally 15 to 45 days later. These transactions are subject to
market fluctuations and their current value is determined in the same manner as
for other portfolio securities.

     At December 31, 1997, the Portfolio held one TBA security with a cost of
$17,042,963.

     7.  FUTURES CONTRACTS

     Initial margin deposits made upon entering into futures contracts are
recognized as assets. Securities equal to the initial margin amount are
segregated by the custodian in the name of the broker. Additional securities are
also segregated up to the current market value of the futures contracts. During
the period the futures contract is open, changes in the value of the contract
are recognized as unrealized gains or losses by "marking to market" on a daily
basis to reflect the market value of the contract at the end of each day's
trading. Variation margin payments are made or received and recognized as assets
due from or liabilities due to broker, depending upon whether unrealized gains
or losses are incurred. When the contract is closed, the Portfolio records a
realized gain or loss equal to the difference between the proceeds from (or cost
of) the closing transactions and the Portfolio's basis in the contract.

     The Portfolio enters into such contracts to hedge a portion of its
portfolio. The Portfolio bears the market risk that arises from changes in the
value of the financial instruments and securities indices (futures contracts).

     At December 31, 1997, the Portfolio had no open futures contracts.



                                                                              15
<PAGE>
 
================================================================================
Notes to Financial Statements (continued)
================================================================================

     8.  CAPITAL SHARES

     At December 31, 1997, the Fund had two billion shares of capital stock
authorized with a par value of $0.01 per share. The Portfolio has the ability to
issue multiple classes of shares. Each share of a class represents an identical
interest in the Portfolio and has the same rights. Each class bears certain
expenses specifically related to the distribution of its shares.

     At December 31, 1997, total paid-in capital amounted to the following for
each class:

<TABLE>
<CAPTION>
                            Class A          Class B         Class C        Class Y        Class Z
=====================================================================================================
<S>                       <C>              <C>             <C>             <C>            <C>        
Total Paid-in Capital     $268,267,184     $11,626,283     $14,720,635     $5,783,393     $20,284,438
=====================================================================================================
</TABLE>

     Transactions in shares of each class were as follows:

<TABLE>
<CAPTION>
                                                     Year Ended                               Year Ended
                                                  December 31, 1997                        December 31, 1996
                                            ------------------------------           -------------------------------
                                             Shares             Amount                Shares               Amount
====================================================================================================================
<S>                                        <C>                <C>                    <C>                <C>          
Class A
Shares sold                                   622,981         $  8,299,404              434,053         $  5,765,143
Shares issued on reinvestment                 774,295           10,292,016              913,861           12,031,692
Shares redeemed                            (4,983,291)         (66,329,135)          (6,089,171)         (80,467,760)
--------------------------------------------------------------------------------------------------------------------
Net Decrease                               (3,586,015)        $(47,737,715)          (4,741,257)        $(62,670,925)
====================================================================================================================

Class B
Shares sold                                   244,954         $  3,269,526              285,992         $  3,778,340
Shares issued on reinvestment                  35,495              472,688               36,148              476,041
Shares redeemed                              (228,140)          (3,043,767)            (293,500)          (3,913,310)
--------------------------------------------------------------------------------------------------------------------
Net Increase                                   52,309         $    698,447               28,640         $    341,071
====================================================================================================================

Class C
Shares sold                                    76,583         $  1,020,293               55,061         $    725,736
Shares issued on reinvestment                  39,216              520,622               50,186              660,064
Shares redeemed                              (355,831)          (4,722,947)            (388,960)          (5,148,015)
--------------------------------------------------------------------------------------------------------------------
Net Decrease                                 (240,032)        $ (3,182,032)            (283,713)        $ (3,762,215)
====================================================================================================================

Class Y
Shares sold                                     3,928         $     53,575                   --                   --
Shares issued on reinvestment                   5,590               74,202                7,206         $     95,184
Shares redeemed                               (50,797)            (681,381)             (99,666)          (1,326,266)
--------------------------------------------------------------------------------------------------------------------
Net Decrease                                  (41,279)        $   (553,604)             (92,460)        $ (1,231,082)
====================================================================================================================

Class Z
Shares sold                                   329,314         $  4,411,488              152,496         $  2,025,204
Shares issued on reinvestment                 103,114            1,373,376              107,482            1,415,835
Shares redeemed                              (229,967)          (3,057,931)            (326,769)          (4,320,674)
--------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease)                       202,461         $  2,726,933              (66,791)        $   (879,635)
====================================================================================================================
</TABLE>


16
<PAGE>
 
================================================================================
Financial Highlights
================================================================================

For a share of each class of capital stock outstanding throughout each year:

<TABLE>
<CAPTION>
Class A Shares                                            1997            1996              1995            1994            1993
==================================================================================================================================
<S>                                                     <C>             <C>               <C>             <C>             <C>     
Net Asset Value, Beginning of Year                        $13.24          $13.59            $12.50          $13.66          $13.87
----------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
   Net investment income                                    0.85            0.84              0.92            0.91            0.98
   Net realized and unrealized gain (loss)                  0.38           (0.33)             1.09           (1.11)          (0.10)
----------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations                         1.23            0.51              2.01           (0.20)           0.88
----------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
   Net investment income                                   (0.86)          (0.86)            (0.92)          (0.91)          (0.98)
   Net realized gains                                      (0.00)#            --                --           (0.05)*         (0.11)*

----------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                        (0.86)          (0.86)            (0.92)          (0.96)          (1.09)
----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                              $13.61          $13.24            $13.59          $12.50          $13.66
Total Return                                                9.67%           3.97%            16.52%          (1.48)%          6.40%
----------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                          $271,767        $311,875          $384,534        $358,045        $468,278
----------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
   Expenses                                                 0.80%           0.79%**           0.79%         0.76%@            0.49%
   Net investment income                                    6.37            6.34              6.82            6.83            7.00
----------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                      130%            265%               57%             40%             57%
==================================================================================================================================

<CAPTION>
Class B Shares                                                           1997              1996            1995            1994(1)
==================================================================================================================================
<S>                                                                     <C>               <C>             <C>              <C>     
Net Asset Value, Beginning of Year                                       $13.26            $13.61          $12.51          $12.47
----------------------------------------------------------------------------------------------------------------------------------
Income From Operations:                                                 
   Net investment income                                                   0.79              0.77            0.80            0.08
   Net realized and unrealized gain (loss)                                 0.38             (0.33)           1.16            0.17
----------------------------------------------------------------------------------------------------------------------------------
Total Income From Operations                                               1.17              0.44            1.96            0.25
----------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:                                                
   Net investment income                                                  (0.80)            (0.79)          (0.86)          (0.21)
   Net realized gains                                                     (0.00)#              --              --              --
----------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                                       (0.80)            (0.79)          (0.86)          (0.21)
----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                                             $13.63            $13.26          $13.61          $12.51
----------------------------------------------------------------------------------------------------------------------------------
Total Return                                                               9.12%             3.44%          16.03%           2.04%++

----------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                                          $12,238           $11,212         $11,116          $1,529
----------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:                                           
   Expenses                                                                1.31%             1.28%**         1.28%           1.21%+@

   Net investment income                                                   5.85              5.85            6.16            6.94+
----------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                                     130%              265%             57%             40%
==================================================================================================================================
</TABLE>

(1)  For the period from November 7, 1994 (inception date) to December 31, 1994.
#    Amount represents less than $0.01.
*    Represents distributions from paydown gains which are reported as ordinary
     income for tax purposes. 
**   Amount has been restated from the December 31, 1996 annual report.
@    Amount has been restated from the December 31, 1994 annual report.
++   Total return is not annualized, as it may not be representative of the
     total return for the year.
+    Annualized.


                                                                              17
<PAGE>
 
================================================================================
Financial Highlights (continued)
================================================================================

For a share of each class of capital stock outstanding throughout each year:

<TABLE>
<CAPTION>
Class C Shares                                           1997            1996              1995          1994(1)          1993
================================================================================================================================
<S>                                                    <C>             <C>               <C>             <C>             <C>    
Net Asset Value, Beginning of Year                      $13.23          $13.58            $12.50          $13.66          $13.86
--------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
  Net investment income                                   0.77            0.78              0.86            0.82            0.89
  Net realized and unrealized gain (loss)                 0.40           (0.33)             1.09           (1.11)          (0.10)
--------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations                       1.17            0.45              1.95           (0.29)           0.79
--------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                                  (0.80)          (0.80)            (0.87)          (0.83)          (0.88)
  Net realized gains                                     (0.00)#            --                --           (0.04)*         (0.11)*
--------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                      (0.80)          (0.80)            (0.87)          (0.87)          (0.99)
--------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                            $13.60          $13.23            $13.58          $12.50          $13.66
--------------------------------------------------------------------------------------------------------------------------------
Total Return                                              9.18%           3.49%            15.93%          (2.11)%          5.74%
--------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                         $14,464         $17,249           $21,559         $21,253         $19,938
--------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                                1.27%           1.26%**           1.25%           1.21%           1.21%
  Net investment income                                   5.91            5.87              6.36            6.27            6.23
--------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                    130%            265%               57%             40%             57%
================================================================================================================================

<CAPTION>
Class Y Shares                                          1997            1996              1995           1994(2)         1993(3)
================================================================================================================================
<S>                                                    <C>             <C>               <C>             <C>             <C>    
Net Asset Value, Beginning of Year                      $13.27          $13.61            $12.51          $13.67          $13.97
--------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
  Net investment income                                   0.88            0.88              1.00            0.89            0.86
  Net realized and unrealized gain (loss)                 0.39           (0.33)             1.06           (1.10)          (0.10)
--------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations                       1.27            0.55              2.06           (0.21)           0.76
--------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                                  (0.90)          (0.89)            (0.96)          (0.91)          (0.95)
  Net realized gains                                     (0.00)#            --                --           (0.04)*         (0.11)*
--------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                      (0.90)          (0.89)            (0.96)          (0.95)          (1.06)
--------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                            $13.64          $13.27            $13.61          $12.51          $13.67
--------------------------------------------------------------------------------------------------------------------------------
Total Return                                             10.00%           4.30%            16.88%          (1.53)%          5.55%++
--------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                          $5,182          $5,589            $6,992         $13,903         $14,118
--------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                                0.51%           0.50%**           0.49%           0.61%           0.69%+
  Net investment income                                   6.65            6.64              7.22            6.82            7.29+
--------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                    130%            265%               57%             40%             57%
================================================================================================================================
</TABLE>

(1)  On November 7, 1994, the former Class B shares were renamed Class C shares.
(2)  On November 7, 1994, the former Class C shares were renamed Class Y shares.
(3)  For the period from January 12, 1993 (inception date) to December 31, 1993.
#    Amount represents less than $0.01.
*    Represents distributions from paydown gains which are reported as ordinary
     income for tax purposes. 
**   Amount has been restated from the December 31, 1996 annual report.
++   Total return is not annualized, as it may not be representative of the
     total return for the year.
+    Annualized.


18
<PAGE>
 
================================================================================
Financial Highlights (continued)
================================================================================

For a share of each class of capital stock outstanding throughout each year:

<TABLE>
<CAPTION>
Class Z Shares                                         1997               1996               1995              1994(1)
======================================================================================================================
<S>                                                   <C>                <C>                <C>                <C>    
Net Asset Value, Beginning of Year                     $13.26             $13.60             $12.50             $12.47
----------------------------------------------------------------------------------------------------------------------
Income From Operations:
  Net investment income                                  0.89               0.88               0.94               0.14
  Net realized and unrealized gain (loss)                0.38              (0.33)              1.11               0.13
----------------------------------------------------------------------------------------------------------------------
Total Income From Operations                             1.27               0.55               2.05               0.27
----------------------------------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                                 (0.90)             (0.89)             (0.95)             (0.24)
  Net realized gains                                    (0.00)#               --                 --                 --
----------------------------------------------------------------------------------------------------------------------
Total Distributions                                     (0.90)             (0.89)             (0.95)             (0.24)
----------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                           $13.63             $13.26             $13.60             $12.50
----------------------------------------------------------------------------------------------------------------------
Total Return                                             9.98%              4.31%             16.89%              2.15%++
----------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                        $22,815            $19,511            $20,923            $18,580
----------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                               0.51%              0.49%              0.50%              0.34%+
  Net investment income                                  6.64               6.64               7.12               7.55+
----------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                   130%               265%                57%                40%
======================================================================================================================
</TABLE>

(1)  For the period from November 7, 1994 (inception date) to December 31, 1994.
 #   Amount represents less than $0.01.
++   Total return is not annualized, as it may not be representative of the
     total return for the year.
 +   Annualized.


================================================================================
Tax Information (unaudited)
================================================================================

     A total of 27.74% of the ordinary income dividends paid by the Portfolio
have been derived from federal obligations and may be exempt from taxation at
the state level.


                                                                              19
<PAGE>
 
================================================================================
Independent Auditors' Report
================================================================================

The Shareholders and Board of Directors of
Smith Barney Funds, Inc.:

     We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the U.S. Government Securities
Portfolio of Smith Barney Funds, Inc. as of December 31, 1997, the related
statement of operations for the year then ended, the statements of changes in
net assets for each of the years in the two-year period then ended and the
financial highlights for each of the years in the five-year period then ended.
These financial statements and financial highlights are the responsibility of
the Fund's management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audits.

     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1997, by correspondence with the custodian. As to securities
purchased or sold but not yet received or delivered, we performed other
appropriate auditing procedures. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

     In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
U.S. Government Securities Portfolio of Smith Barney Funds, Inc. as of December
31, 1997, the results of its operations for the year then ended, the changes in
its net assets for each of the years in the two-year period then ended and the
financial highlights for each of the years in the five-year period then ended,
in conformity with generally accepted accounting principles.


                                        /s/ KPMG Peat Marwick LLP


New York, New York
February 10, 1998



20
<PAGE>
 
Smith Barney                                                        SMITH BARNEY
Funds, Inc.                                                         ------------
                                                A Member of TravelersGroup[LOGO]


Directors                             Investment Manager                        
Donald R. Foley                       Mutual Management Corp.                   
Paul Hardin                                                                     
Heath B. McLendon, Chairman           Distributor                               
Roderick C. Rasmussen                 Smith Barney Inc.                         
Bruce D. Sargent                                                                
John P. Toolan                        Custodian                                 
                                      PNC Bank, N.A.                            
Joseph H. Fleiss, Emeritus                                                      
C. Richard Youngdahl, Emeritus        Shareholder                               
                                      Servicing Agent                           
Officers                              First Data Investor Services Group, Inc.  
Heath B. McLendon                     P.O. Box 9134                             
President and                         Boston, MA 02205-9134                     
Chief Executive Officer                                                         
                                                                                
Lewis E. Daidone                                                                
Senior Vice President                 This report is submitted for the general  
and Treasurer                         information of the shareholders of        
                                      Smith Barney Funds, Inc. -- U.S.          
James E. Conroy                       Government Securities Fund. It is not     
Vice President                        authorized for distribution to prospective
                                      investors unless accompanied or           
Bruce D. Sargent                      preceded by a current Prospectus for the  
Vice President                        Portfolio, which contains information     
                                      concerning the Portfolio's investment     
Thomas M. Reynolds                    policies and expenses as well as other    
Controller                            pertinent information.                    
                                                                                
Christina T. Sydor                                                              
Secretary                                                                       
                                                                                
                                      Smith Barney Funds, Inc.                  
                                      388 Greenwich Street                      
                                      New York, New York 10013                  
                                      www.smithbarney.com                       
                                                                                
                                                                                
                                                                                
                                                                                
                                      FD01086 2/98                              


<PAGE>
 
================================================================================
                                  ANNUAL REPORT
================================================================================


          1997
          1997
          1997
          1997
          1997


                                  Smith Barney
                                  Funds, Inc.
                                  Short-Term U.S.
                                  Treasury Securities
                                  Fund
                                  ----------------------------------------------
                                  December 31, 1997

                           [LOGO] Smith Barney Mutual Funds
                                  Investing for your future.
                                  Every day.

--------------------------------------------------------------------------------
<PAGE>
 
========================================
Short-Term U.S. Treasury Securities Fund
========================================

Dear Shareholder:

We are pleased to provide the annual report for the Smith Barney Funds, Inc. --
Short-Term U.S. Treasury Securities Fund ("Portfolio") for the year ended
December 31, 1997. In this report, we summarize the period's prevailing economic
and market conditions and outline our portfolio strategy. A more detailed
summary of performance can be found in the appropriate sections that follow.

Performance Update

For the year ended December 31, 1997, the Portfolio's Class A shares had a total
return of 6.73%, which was above its Lipper Analytical Services, Inc. ("Lipper")
peer group total return average of 6.30%. (Lipper is a major independent
fund-tracking organization.) Moreover, over the past twelve months, the
Portfolio's Class A shares distributed income dividends totaling $0.22 per
share.

Investment Strategy

The Portfolio seeks current income, preservation of capital and liquidity. We
seek income from the standpoint of paying dividends to shareholders, but our
overriding concern is preserving asset values in all market conditions. For
example, if interest rates are expected to lower, we are not going to defy the
market and buy high-income coupon securities that maximize income but typically
do not perform well when interest rates are going down. Rather, we would buy
securities that perform better in a lower interest-rate environment.

Market Update and Outlook

In our view, one of the most important events for the market in 1997 was the
widely publicized currency and economic turmoil in Asia, specifically in Korea,
Japan and Indonesia. As these currencies were devalued, the U.S. dollar was
clearly a beneficiary. Other notable events during the reporting period include:

     o    As a result of the unexpected strength in the U.S. economy, the
          Federal Reserve Board ("Fed") raised the federal-funds rate by 25
          basis points, or 0.25%, at its March 1997 meeting. (The federal-funds
          rate is the interest rate banks charge each other for overnight loans
          and is a closely watched indicator of the direction of interest
          rates.)

     o    The not-so-successful introduction of inflation-indexed bonds by the
          U.S. Treasury.


                                                                               1
<PAGE>
 
     o    The drastic reduction in the U.S. budget deficit. According to the
          latest report by the Congressional Budget Office, the deficit will go
          down to $5 billion in fiscal 1998 and may actually run annual
          surpluses in 2001 if present policies continue.

     o    As a result of lower rates, mortgage refinancing has increased.

     o    The drive toward the European Monetary Union continues to be on target
          for 1999.

As you can see from the chart below, interest rates declined during the year.

   Yields from U.S. Treasurys:

<TABLE>
<CAPTION>
                                           12/31/97               12/31/96
                                           --------               --------
<S>                                         <C>                    <C>   
    2-Year U.S. Treasury Note               5.642%                 5.868%
    3-Year U.S. Treasury Note               5.669                  6.010
    5-Year U.S. Treasury Note               5.705                  6.206
   10-Year U.S. Treasury Bond               5.741                  6.418
   30-Year U.S. Treasury Bond               5.924                  6.641
</TABLE>

Looking ahead to 1998, we anticipate the following events to have an impact on
the bond market:

     o    The turmoil in Asia may end up worse than what is being reported.
          Therefore, the troubles in Asia will depress U.S. economic activity
          even more than current consensus expectations.

     o    The Fed will probably ease monetary policy and lower rates. In fact,
          several Fed Governors have recently shifted to a more "dovish" view
          regarding interest rates.

     o    Interest rates will be lower and the yield on the 30-Year U.S.
          Treasury bond should trend toward 5 1/2%.

Moderate economic growth, combined with historically low inflation and the
threat of financial and economic turmoil in Southeast Asia, should provide more
than enough ammunition for rates to go lower. While non-believers would suggest
rates are too low, there is no compelling evidence to warrant a reversal of the
present trend. High real rates, a lesser supply of U.S. Treasurys and a strong
dollar are just some of the reasons why we remain bullish on bonds.

On a more somber note, we are saddened by the loss of an outstanding physician
and Director of the Portfolio, Dr. Francis P. Martin. His knowledge and wisdom
will be missed.



2
<PAGE>
 
In closing, thank you for investing in the Smith Barney Funds, Inc. --
Short-Term U.S. Treasury Securities Fund. We look forward to continuing to help
you pursue your financial goals.

Sincerely,


/s/ Heath B. McLendon                    /s/ James E. Conroy

Heath B. McLendon                        James E. Conroy
Chairman                                 Vice President

February 20, 1998


                                                                               3
<PAGE>
 
================================================================================
Historical Performance -- Class A Shares
================================================================================

<TABLE>
<CAPTION>
                      Net Asset Value
                    -------------------
                    Beginning     End      Income     Capital Gain      Total
Year Ended           of Year    of Year   Dividends   Distributions    Returns
================================================================================
<S>                   <C>        <C>        <C>          <C>            <C>  
12/31/97              $4.05      $4.09      $0.22        $0.00           6.73%
--------------------------------------------------------------------------------
12/31/96               4.19       4.05       0.23         0.00           2.17
--------------------------------------------------------------------------------
12/31/95               3.91       4.19       0.22         0.00          13.16
--------------------------------------------------------------------------------
12/31/94               4.16       3.91       0.18         0.00          (2.15)
--------------------------------------------------------------------------------
12/31/93               4.12       4.16       0.18         0.02           6.01
--------------------------------------------------------------------------------
12/31/92               4.09       4.12       0.19         0.01           5.92
--------------------------------------------------------------------------------
Inception*-12/31/91    4.01       4.09       0.03         0.01           2.85+
================================================================================
Total                                       $1.25        $0.04
================================================================================
</TABLE>

================================================================================
Historical Performance -- Class Y Shares
================================================================================
<TABLE>
<CAPTION>
                      Net Asset Value
                    -------------------
                    Beginning     End      Income     Capital Gain     Total
Year Ended           of Year    of Year   Dividends   Distributions   Returns
================================================================================
<S>                   <C>        <C>        <C>          <C>            <C>  
12/31/97              $4.05      $4.09      $0.24        $0.00          7.20%
--------------------------------------------------------------------------------
Inception*-12/31/96    4.19       4.05       0.22         0.00          2.08+
================================================================================
Total                                       $0.46        $0.00
================================================================================
</TABLE>
                   
It is the Fund's policy to distribute dividends monthly and capital gains, if
any, annually.

================================================================================
Average Annual Total Return
================================================================================
<TABLE>
<CAPTION>
                                                     Without Sales Charge
                                                   -------------------------
                                                   Class A          Class Y
================================================================================
<S>                                                 <C>              <C>  
Year Ended 12/31/97                                 6.73%            7.20%
--------------------------------------------------------------------------------
Five Years Ended 12/31/97                           5.20              N/A
--------------------------------------------------------------------------------
Inception* through 12/31/97                         5.67             4.87
================================================================================
</TABLE>

================================================================================
Cumulative Total Return
================================================================================
<TABLE>
<CAPTION>
                                                           Without Sales Charge
================================================================================
<S>                                                              <C>   
Class A (Inception* through 12/31/97)                            40.34%
--------------------------------------------------------------------------------
Class Y (Inception* through 12/31/97)                             9.44
================================================================================
</TABLE>

*    The inception dates for Class A and Y shares are November 11, 1991 and
     February 7, 1996, respectively.
+    Total return is not annualized, as it may not be representative of the
     total return for the year.


4
<PAGE>
 
================================================================================
Historical Performance (unaudited)
================================================================================

                 Growth of $10,000 Invested in Class A Shares of
                the Short-Term U.S. Treasury Securities Fund vs.
                 Salomon Smith Barney 3-Year Treasury Index and
                    Lehman Brothers 1-3 Years Treasury Index+

--------------------------------------------------------------------------------
                         November 1991 -- December 1997


 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.]

<TABLE>
<CAPTION>
                     Short-Term           Salomon Smith Barney     Lehman Brothers 1-3 
                   U.S. Treasury          3-Year Treasury Index    Years Treasury Index
                   -------------          ---------------------    --------------------
<S>                    <C>                       <C>                     <C>   
11/11/91               10,000                    10,000                  10,000
   12/91               10,283                    10,230                  10,230
   12/92               10,891                    10,902                  11,902
   12/93               11,547                    11,653                  11,653
   12/94               11,361                    11,471                  11,770
   12/95               12,874                    13,004                  13,265
   12/96               13,149                    13,674                  13,905
12/31/97               14,034                    14,673                  14,808
</TABLE>

+    Hypothetical illustration of $10,000 invested in shares at inception on
     November 11, 1991, assuming reinvestment of dividends and capital gains, if
     any, at net asset value through December 31, 1997. The Salomon Smith Barney
     3-Year Treasury Index is composed of the most recently issued 3-year United
     States Treasury Notes which are used to track the index total return. The
     Lehman Brothers 1-3 Years Treasury Index is composed of fixed-rate U.S.
     Treasury securities that have one year to three years final maturity and at
     least $100 million par amount outstanding. The indexes are unmanaged and
     are not subject to the same management and trading expenses of a mutual
     fund. The performance of the Portfolio's other classes may be greater or
     less than the Class A shares' performance indicated on this chart,
     depending on whether greater or lesser fees were incurred by shareholders
     investing in the other classes.
++   It is the opinion of management that the Lehman Brothers 1-3 Years Treasury
     Index more accurately reflects the composition of the Short-Term U.S.
     Treasury Securities Fund than the Salomon Smith Barney 3-Year Treasury
     Index. In future reporting, the Lehman Brothers 1-3 Years Treasury Index
     will be used as a basis of comparison of total return performance rather
     than the Salomon Smith Barney 3-Year Treasury Index.
     All figures represent past performance and are not a guarantee of future
     results. Investment returns and principal value will fluctuate, and
     redemption values may be more or less than the original cost. No adjustment
     has been made for shareholder tax liability on dividends or capital gains.



                                                                               5
<PAGE>
 
<TABLE>
<CAPTION>
========================================================================================
Schedule of Investments                                                December 31, 1997
========================================================================================

    FACE
   AMOUNT                          SECURITY                                     VALUE
========================================================================================
<S>                                                                         <C>         
U.S. GOVERNMENT OBLIGATIONS -- 99.2%
$5,300,000    U.S. Treasury Note, 5.125% due 11/30/98                       $  5,278,535
10,300,000    U.S. Treasury Note, 6.500% due 4/30/99                          10,414,536
11,000,000    U.S. Treasury Note, 6.250% due 5/31/99                          11,090,750
19,600,000    U.S. Treasury Note, 6.750% due 5/31/99                          19,893,020
21,500,000    U.S. Treasury Note, 6.000% due 8/15/00                          21,663,400
18,500,000    U.S. Treasury Note, 5.875% due 11/30/01                         18,578,625
12,300,000    U.S. Treasury Note, 5.875% due 9/30/02                          12,371,832
----------------------------------------------------------------------------------------

              TOTAL U.S. GOVERNMENT OBLIGATIONS
              (Cost-- $98,544,380)                                            99,290,698
========================================================================================

REPURCHASE AGREEMENT -- 0.8%
  797,000     Goldman, Sachs & Co., 6.348% due 1/2/98;
              Proceeds at maturity -- $797,281; (Fully collateralized
              by U.S. Treasury Note, 5.625% due 12/31/99;
              Market value -- $813,291) (Cost -- $797,000)                       797,000
========================================================================================

              TOTAL INVESTMENTS -- 100%
              (Cost -- $99,341,380*)                                        $100,087,698
========================================================================================
</TABLE>

*    Aggregate cost for Federal income tax purposes is substantially the same.




                       See Notes to Financial Statements.


6
<PAGE>
 
================================================================================
Statement of Assets and Liabilities                            December 31, 1997
================================================================================
<TABLE>
<S>                                                                <C>         
ASSETS:
  Investments, at value (Cost $99,341,380)                         $100,087,698
  Cash                                                                      725
  Interest receivable                                                 1,098,872
  Receivable for Fund shares sold                                       198,073
  Other assets                                                           39,741
--------------------------------------------------------------------------------
  Total Assets                                                      101,425,109
--------------------------------------------------------------------------------
LIABILITIES:
  Dividends payable                                                     107,076
  Payable for Fund shares purchased                                      92,883
  Management fees payable                                                39,352
  Distribution fees payable                                               8,484
  Accrued expenses                                                       30,474
--------------------------------------------------------------------------------
  Total Liabilities                                                     278,269
--------------------------------------------------------------------------------
Total Net Assets                                                   $101,146,840
================================================================================
NET ASSETS:
  Par value of capital shares                                      $    247,046
  Capital paid in excess of par value                               107,055,542
  Accumulated net realized loss on security transactions             (6,902,066)
  Net unrealized appreciation of investments                            746,318
--------------------------------------------------------------------------------
Total Net Assets                                                   $101,146,840
================================================================================
Shares Outstanding:
  Class A                                                            17,428,313
  ------------------------------------------------------------------------------
  Class Y                                                             7,276,295
  ------------------------------------------------------------------------------
Net Asset Value:
  Class A (and redemption price)                                          $4.09
  ------------------------------------------------------------------------------
  Class Y (and redemption price)                                          $4.09
  ------------------------------------------------------------------------------
</TABLE>




                       See Notes to Financial Statements.


                                                                               7
<PAGE>
 
================================================================================
Statement of Operations                     For the Year Ended December 31, 1997
================================================================================
<TABLE>
<S>                                                               <C>          
INVESTMENT INCOME:
  Interest                                                        $   7,769,414
  Less: Interest expense (Note 5)                                       (10,326)
--------------------------------------------------------------------------------
  Total Investment Income                                             7,759,088
--------------------------------------------------------------------------------

EXPENSES:
  Management fees (Note 2)                                              538,831
  Distribution fees (Note 2)                                            272,848
  Shareholder and system servicing fees                                  59,316
  Shareholder communications                                             28,833
  Audit and legal                                                        25,997
  Registration fees                                                      17,644
  Custody                                                                 4,798
  Directors' fees                                                         3,111
  Other                                                                   1,204
--------------------------------------------------------------------------------
  Total Expenses                                                        952,582
--------------------------------------------------------------------------------
Net Investment Income                                                 6,806,506
--------------------------------------------------------------------------------

REALIZED AND UNREALIZED GAIN
ON INVESTMENTS (NOTE 3):
  Realized Gain From Security Transactions
  (excluding short-term securities):
    Proceeds from sales                                             179,923,247
    Cost of securities sold                                         177,781,968
--------------------------------------------------------------------------------
  Net Realized Gain                                                   2,141,279
--------------------------------------------------------------------------------
  Change in Net Unrealized Appreciation
  of Investments:
    Beginning of year                                                 1,420,421
    End of year                                                         746,318
--------------------------------------------------------------------------------
  Decrease in Net Unrealized Appreciation                              (674,103)
--------------------------------------------------------------------------------
Net Gain on Investments                                               1,467,176
--------------------------------------------------------------------------------
Increase in Net Assets From Operations                            $   8,273,682
================================================================================
</TABLE>



                       See Notes to Financial Statements.


8
<PAGE>
 
================================================================================
Statements of Changes in Net Assets             For the Years Ended December 31,
================================================================================
<TABLE>
<CAPTION>
                                                      1997            1996
================================================================================
<S>                                              <C>              <C>          
OPERATIONS:
   Net investment income                         $   6,806,506    $   6,043,370
   Net realized gain (loss)                          2,141,279         (970,497)
   Decrease in net unrealized appreciation            (674,103)      (2,503,346)
--------------------------------------------------------------------------------
   Increase in Net Assets From Operations            8,273,682        2,569,527
--------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
   Net investment income                            (6,806,506)      (6,043,370)
--------------------------------------------------------------------------------
   Decrease in Net Assets From
     Distributions to Shareholders                  (6,806,506)      (6,043,370)
--------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
   Net proceeds from sale of shares                 52,065,590       44,968,002
   Net asset value of shares issued for
     reinvestment of dividends                       3,694,867        4,448,261
   Cost of shares reacquired                       (71,518,650)     (37,603,657)
--------------------------------------------------------------------------------
   Increase (Decrease) in Net Assets From
     Fund Share Transactions                       (15,758,193)      11,812,606
--------------------------------------------------------------------------------
Increase (Decrease) in Net Assets                  (14,291,017)       8,338,763
NET ASSETS:
   Beginning of year                               115,437,857      107,099,094
--------------------------------------------------------------------------------
   End of year                                   $ 101,146,840    $ 115,437,857
================================================================================
</TABLE>




                       See Notes to Financial Statements.


                                                                               9
<PAGE>
 
================================================================================
Notes to Financial Statements
================================================================================

     1. SIGNIFICANT ACCOUNTING POLICIES

     The Short-Term U.S. Treasury Securities Fund ("Portfolio"), formerly known
as Short-Term U.S. Treasury Securities Portfolio, a separate investment
portfolio of the Smith Barney Funds, Inc. ("Fund"), a Maryland corporation, is
registered under the Investment Company Act of 1940, as amended, as a
diversified, open-end management investment company. The Fund consists of the
Portfolio and two other separate investment portfolios: Large Cap Value Fund and
U.S. Government Securities Fund. The financial statements and financial
highlights for the other portfolios are presented in separate annual reports.

     The significant accounting policies consistently followed by the Portfolio
are: (a) security transactions are accounted for on trade date; (b) U.S.
government agencies and obligations are valued at the mean between the bid and
ask prices; (c) securities that have a maturity of more than 60 days are valued
at prices based on market quotations for securities of similar type, yield and
maturity; (d) securities maturing within 60 days are valued at cost plus
accreted discount, or minus amortized premium, which approximates value; (e)
interest income is recorded on an accrual basis; (f) gains or losses on the sale
of securities are calculated by using the specific identification method; (g)
direct expenses are charged to each class; management fees and general fund
expenses are allocated on the basis of relative net assets;(h) dividends and
distributions to shareholders are recorded on the ex-dividend date; (i) the
Portfolio intends to comply with the applicable provisions of the Internal
Revenue Code of 1986, as amended, pertaining to regulated investment companies
and to make distributions of taxable income sufficient to relieve it from
substantially all Federal income and excise taxes; and (j) estimates and
assumptions are required to be made regarding assets, liabilities and changes in
net assets resulting from operations when financial statements are prepared.
Changes in the economic environment, financial markets and any other parameters
used in determining these estimates could cause actual results to differ.

     2. MANAGEMENT AGREEMENTS 
        AND TRANSACTIONS WITH AFFILIATED PERSONS

     Mutual Management Corp. ("MMC"), formerly known as Smith Barney Mutual
Funds Management Inc., a subsidiary of Salomon Smith Barney Holdings Inc.
("SSBH"), acts as investment manager to the Fund. The Portfolio pays MMC a
management fee calculated at an annual rate of 0.45% of the Portfolio's average
daily net assets. This fee is calculated daily and paid monthly.


10
<PAGE>
 
================================================================================
Notes to Financial Statements (continued)
================================================================================

     Smith Barney Inc. ("SB"), another subsidiary of SSBH, acts as distributor
of Fund shares. Pursuant to a Distribution Plan, the Portfolio pays a
distribution fee and a service fee with respect to Class A shares calculated at
the annual rate of 0.10% and 0.25% of its average daily net assets,
respectively. For the year ended December 31, 1997, total Distribution Plan fees
incurred was $272,848.

     All officers and two Directors of the Fund are employees of SB.

     3. INVESTMENTS

     During the year ended December 31, 1997, the aggregate cost of purchases
and proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:

<TABLE>
================================================================================
<S>                                                                <C>         
Purchases                                                          $165,220,875
--------------------------------------------------------------------------------
Sales                                                               179,923,247
================================================================================
</TABLE>

     At December 31, 1997, aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were substantially
as follows:

<TABLE>
================================================================================
<S>                                                                    <C>     
Gross unrealized appreciation                                          $746,896
Gross unrealized depreciation                                              (578)
--------------------------------------------------------------------------------
Net unrealized appreciation                                            $746,318
================================================================================
</TABLE>

     4. REPURCHASE AGREEMENTS

     The Portfolio purchases (and its custodian takes possession of) U.S.
government securities from banks and securities dealers subject to agreements to
resell the securities to the sellers at a future date (generally, the next
business day) at an agreed-upon higher repurchase price. The Portfolio requires
continual maintenance of the market value of the collateral in amounts at least
equal to the repurchase price.

     5. REVERSE REPURCHASE AGREEMENT

     A reverse repurchase agreement involves a sale by the Portfolio of
securities that it holds with an agreement to repurchase the same securities at
an agreed upon price and date. A reverse repurchase agreement involves the risk
that the market value of the securities sold by the Portfolio may decline below
the repurchase price of the securities. The Portfolio will 



                                                                              11
<PAGE>
 
================================================================================
Notes to Financial Statements (continued)
================================================================================

establish a segregated account with its custodian, in which the Portfolio will
maintain cash, U.S. government securities or other liquid high grade debt
obligations equal in value to its obligations with respect to the reverse
repurchase agreements.

     During the year ended December 31, 1997 the Portfolio had entered into one
reverse repurchase agreement. The total market value of the reverse repurchase
agreement was $10,793,750 and had an interest rate of 4.92% which incurred
interest expense of $10,326.

     At December 31, 1997, the Portfolio had no open reverse repurchase
agreements.

     6. CAPITAL SHARES

     At December 31, 1997, the Fund had two billion shares of capital stock
authorized with a par value of $0.01 per share. The Portfolio has the ability to
issue multiple classes of shares. Each share of a class represents an identical
interest in the Portfolio and has the same rights, except that each class bears
certain expenses specifically related to the distribution of its shares.

     At December 31, 1997, total paid-in-capital amounted to the following for
each class:

<TABLE>
<CAPTION>
                                                      Class A         Class Y
================================================================================
<S>                                                 <C>             <C>        
Total Paid-in Capital                               $78,306,127     $28,996,461
================================================================================
</TABLE>

     Transactions in shares of each class were as follows:

<TABLE>
<CAPTION>
                                         Year Ended                       Year Ended
                                      December 31, 1997               December 31, 1996
                                 ----------------------------     --------------------------
                                    Shares         Amount           Shares         Amount
============================================================================================
<S>                              <C>            <C>               <C>           <C>         
Class A
Shares sold                        6,333,523    $ 25,620,854       3,206,711    $ 13,018,952
Shares issued on reinvestment        914,485       3,694,867       1,099,875       4,448,261
Shares redeemed                  (10,417,386)    (42,121,325)     (9,277,889)    (37,603,657)
--------------------------------------------------------------------------------------------
Net Decrease                      (3,169,378)   $(12,805,604)     (4,971,303)   $(20,136,444)
============================================================================================

Class Y
Shares sold                        6,558,594    $ 26,444,736       7,937,830    $ 31,949,050
Shares redeemed                   (7,220,129)    (29,397,325)             --              --
--------------------------------------------------------------------------------------------
Net Increase (Decrease)             (661,535)   $ (2,952,589)      7,937,830    $ 31,949,050
============================================================================================
</TABLE>



12
<PAGE>
 
================================================================================
Notes to Financial Statements (continued)
================================================================================

     7. CAPITAL LOSS CARRYFORWARD

     At December 31, 1997, the Portfolio had for Federal income tax purposes
approximately $6,900,000, of capital loss carryforwards available to offset
future realized gains. To the extent that these capital carryforward losses are
used to offset capital gains, it is probable that the gains so offset will not
be distributed.

     The amount and expiration of the carryforwards are indicated below.
Expiration occurs on December 31 of the year indicated:

<TABLE>
<CAPTION>
                                             2002           2003          2004
================================================================================
<S>                                       <C>            <C>            <C>     
Carryforward amounts                      $4,805,000     $1,124,000     $971,000
================================================================================
</TABLE>


                                                                              13
<PAGE>
 
================================================================================
Financial Highlights
================================================================================

For a share of each class of capital stock outstanding throughout each year:

<TABLE>
<CAPTION>
Class A Shares                                             1997               1996           1995            1994           1993
===================================================================================================================================
<S>                                                      <C>                 <C>           <C>              <C>          <C>     
Net Asset Value, Beginning of Year                         $4.05               $4.19          $3.91           $4.16         $4.12
-----------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
  Net investment income                                     0.22                0.23           0.22            0.18          0.18
  Net realized and unrealized gain (loss)                   0.04               (0.14)          0.28           (0.25)         0.06
-----------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations                         0.26                0.09           0.50           (0.07)         0.24
-----------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                                    (0.22)              (0.23)         (0.22)          (0.18)        (0.18)
  Net realized gains                                          --                  --             --              --         (0.02)
-----------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                        (0.22)              (0.23)         (0.22)          (0.18)        (0.20)
-----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                               $4.09               $4.05          $4.19           $3.91         $4.16
-----------------------------------------------------------------------------------------------------------------------------------
Total Return                                                6.73%               2.17%         13.16%          (2.15)%        6.01%
-----------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                           $71,361             $83,324       $107,099         $88,707      $205,758
-----------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                                  0.95%               0.98%          0.98%           0.91%         0.88%
  Net investment income                                     5.53                5.62           5.29            4.54          4.40
-----------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                      145%                130%            29%             25%           41%
===================================================================================================================================

<CAPTION>
Class Y Shares                                                                                                1997        1996(1)
===================================================================================================================================
<S>                                                                                                         <C>          <C>     
Net Asset Value, Beginning of Year                                                                            $4.05         $4.19
-----------------------------------------------------------------------------------------------------------------------------------
Income From Operations:
  Net investment income                                                                                        0.24          0.22
  Net realized and unrealized gain (loss)                                                                      0.04         (0.14)
-----------------------------------------------------------------------------------------------------------------------------------
Total Income From Operations                                                                                   0.28          0.08
-----------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                                                                                       (0.24)        (0.22)
-----------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                                                                           (0.24)        (0.22)
-----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                                                                                  $4.09         $4.05
-----------------------------------------------------------------------------------------------------------------------------------
Total Return                                                                                                   7.20%         2.08%++

-----------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                                                                              $29,786       $32,114
-----------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                                                                                     0.50%         0.58%+
  Net investment income                                                                                        6.00          5.99+
-----------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                                                                         145%          130%
===================================================================================================================================
</TABLE>

(1)  For the period from February 7, 1996 (inception date) through December 31,
     1996.
++   Total return is not annualized, as it may not be representative of the
     total return for the year.
+    Annualized.



14
<PAGE>
 
================================================================================
Independent Auditors' Report
================================================================================

The Shareholders and Board of Directors of
Smith Barney Funds, Inc.:

     We have audited the accompanying statements of assets and liabilities,
including the schedule of investments, of Short-Term U.S. Treasury Securities
Portfolio of Smith Barney Funds, Inc. as of December 31, 1997, the related
statement of operations for the year then ended, the statements of changes in
net assets for each of the years in the two-year period then ended and financial
highlights for each of the years in the five-year period then ended. These
financial statements and financial highlights are the responsibility of the
Fund's management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audits.

     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1997, by correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Short-Term U.S. Treasury Securities Portfolio of Smith Barney Funds, Inc. as of
December 31, 1997, the results of its operations for the year then ended, the
changes in its net assets for each of the years in the two-year period then
ended and financial highlights for each of the years in the five-year period
then ended, in conformity with generally accepted accounting principles.


                                            /s/ KPMG Peat Marwick LLP


New York, New York
February 10, 1998


                                                                              15
<PAGE>
 
================================================================================
Tax Information (unaudited)
================================================================================

     A total of 97.89% of the ordinary income dividends paid by the Portfolio
have been derived from federal obligations and may be exempt from taxation at
the state level.




16
<PAGE>
 
Smith Barney                                                        SMITH BARNEY
Funds, Inc.                                                         ------------
                                               A Member of TravelersGroup [LOGO]

Directors                               Investment Manager                      
Donald R. Foley                         Mutual Management Corp.                 
Paul Hardin                                                                     
Heath B. McLendon, Chairman             Distributor                             
Roderick C. Rasmussen                   Smith Barney Inc.                       
Bruce  D. Sargent                                                               
John P. Toolan                          Custodian                               
                                        PNC Bank, N.A.                          
Joseph H. Fleiss, Emeritus                                                      
C. Richard Youngdahl, Emeritus          Shareholder                             
                                        Servicing Agent                         
Officers                                First Data Investor Services Group, Inc.
Heath B. McLendon                       P.O. Box 9134                           
President and                           Boston, MA 02205-9134                   
Chief Executive Officer                                                         
                                                                                
Lewis E. Daidone                                                                
Senior Vice President                                                           
and Treasurer                           This report is submitted for the        
                                        general information of the shareholders 
James E. Conroy                         of Smith Barney Funds, Inc. --          
Vice President                          Short-Term U.S. Treasury Securities     
                                        Fund. It is not authorized for          
Bruce D. Sargent                        distribution to prospective investors   
Vice President                          unless accompanied or preceded by a     
                                        current Prospectus for the Portfolio,   
Thomas M. Reynolds                      which contains information concerning   
Controller                              the Portfolio's investment policies and 
                                        expenses as well as other pertinent     
Christina T. Sydor                      information.                            
Secretary                                                                       
                                                                                
                                        Smith Barney Funds, Inc.                
                                        388 Greenwich Street                    
                                        New York, New York 10013                
                                        www.smithbarney.com                     
                                                                                
                                        FD0854 2/98                             


<PAGE>
 
---------
1967-1997
---------

                                      30th
                                  Anniversary
================================================================================
                                   [GRAPHIC]


                                        Smith Barney Funds, Inc. 
                                        Large Cap
                                        Value Fund
[GRAPHIC]
                                        ANNUAL REPORT

                                        December 31, 1997

                                 [LOGO] Smith Barney Mutual Funds 
                                        Investing for your future.
                                        Every day.(SM)
================================================================================
<PAGE>
 
Smith Barney Funds, Inc.
Large Cap Value Fund
================================================================================

================================================================================
The Large Cap Value Fund ("Fund"), formerly known as the Equity Income
Portfolio, seeks current income and long-term growth of income and capital
primarily through investments in common stocks.


Smith Barney Funds, Inc.
Large Cap Value Fund's
Average Annual Total Returns Ended
December 31, 1997

<TABLE>
<CAPTION>
                                                  Without Sales Charges*
                                           -------------------------------------
                                           Class A        Class B       Class C
================================================================================
<S>                                         <C>            <C>            <C>   
One-Year                                    27.86%         26.83%         26.85%
--------------------------------------------------------------------------------
Five-Year                                   17.07            N/A          16.18
--------------------------------------------------------------------------------
Ten-Year                                    14.80            N/A            N/A
--------------------------------------------------------------------------------
Since Inception+                            11.72          22.70          16.02
================================================================================
<CAPTION>
                                                   With Sales Charges**
                                           -------------------------------------
                                           Class A        Class B       Class C
================================================================================
<S>                                         <C>            <C>            <C>   
One-Year                                    21.45%         21.83%         25.85%
--------------------------------------------------------------------------------
Five-Year                                   15.87            N/A          16.18
--------------------------------------------------------------------------------
Ten-Year                                    14.22            N/A           N/A
--------------------------------------------------------------------------------
Since Inception+                            11.53          22.29         16.02
================================================================================
</TABLE>

*    Assumes reinvestment of all dividends and capital gain distributions, if
     any, at net asset value and does not reflect the deduction of the
     applicable sales charges with respect to Class A shares or the applicable
     contingent deferred sales charges ("CDSC") with respect to Class B and C
     shares.
**   Assumes reinvestment of all dividends and capital gain distributions, if
     any, at net asset value. In addition, Class A shares reflect the deduction
     of the maximum initial sales charge of 5.00% and Class B shares reflect the
     deduction of a 5.00% CDSC, which applies if shares are redeemed within one
     year from purchase. Thereafter, the CDSC declines by 1.00% per year until
     no CDSC is incurred. Class C shares reflect the deduction of a 1.00% CDSC
     which applies if shares are redeemed within the first year of purchase. 
     All figures represent past performance and are not a guarantee of future
     results. Investment returns and principal value will fluctuate, and
     redemption value may be more or less than the original cost.
+    Inception dates for Class A, B and C shares are May 18, 1967, November 7,
     1994 and December 2, 1992, respectively.

================================================================================
A PROUD HISTORY...
================================================================================

This year we proudly celebrate the 30th anniversary of the Large Cap Value Fund.
Since it began in May 1967, the Fund has delivered consistently competitive
returns through two wars, seven administrations and a number of market downturns
as well as the current historic bull market.



================================================================================
NASDAQ SYMBOL
================================================================================

           Class A                      SBCIX
           Class B                      SBCCX
           Class C                      SBGCX


================================================================================
WHAT'S INSIDE
================================================================================
<TABLE>
<S>                                                                           <C>
Shareholder Letter ........................................................    1

Historical Performance ....................................................    4

Schedule of Investments ...................................................    8

Statement of Assets and Liabilities .......................................   11

Statement of Operations ...................................................   12

Statements of Changes in Net Assets .......................................   13

Notes to Financial Statements .............................................   14

Financial Highlights ......................................................   18

Independent Auditors' Report ..............................................   23

Tax Information ...........................................................   24
</TABLE>
<PAGE>
 
================================================================================
Shareholder Letter
================================================================================


[PHOTO]                                 [PHOTO]


HEATH B.                                BRUCE D.
MCLENDON                                SARGENT, CFA

Chairman                                Vice President

Dear Shareholder:

It is with pleasure that we provide the annual report for the Smith Barney
Funds, Inc. -- Large Cap Value Fund ("Fund"), formerly known as the Equity
Income Portfolio, for the year ended December 31, 1997. In this report, we
summarize the period's prevailing economic conditions and briefly outline the
Fund's investment strategy. A detailed summary of performance and current
holdings can be found in the appropriate sections that follow.

As you can see, your Fund's name was changed from the Equity Income Portfolio to
the Large Cap Value Fund. However, the Fund's investment style has remained
unchanged and the portfolio managers will continue to follow a highly
disciplined bottom-up approach to investing. In selecting stocks for the Fund,
the managers will search for undervalued stocks of established well-recognized,
yet temporarily out-of-favor companies or ones that offer potential
opportunities yet unrecognized by the broader marketplace. Typically, these are
companies that may have performed poorly in the past, yet, in the view of the
managers, are poised to turn around because of a new management team, new
product or new business strategy. In addition, the managers will look at the
dividend level and the company's ability to increase their dividends over time.

Celebrating 30 Years of Solid Performance

We are proud to celebrate the 30th anniversary of the Large Cap Value Fund.
Since it began in May 1967, the Fund has delivered consistently competitive
returns through two wars, seven administrations and a number of market downturns
as well as the current historic bull market. Over the years, the Fund has grown
to serve approximately 36,000 shareholders and now has more than $1 billion in
assets under management as of December 31, 1997.

Portfolio Performance and Investment Strategy

For the year ended December 31, 1997, the Fund generated a total return of
27.86%, 26.83% and 26.85% for its Class A, B and C shares without sales charges,
respectively. In comparison, the Lipper Analytical Services, Inc. peer group
average was 27.44% for the same period. (Lipper is an independent fund-tracking
organization.)

Since its inception, the Fund has maintained a consistent investment strategy.
The Fund seeks to provide shareholders with current income and long-term growth
of capital by investing primarily in large-capitalization companies that tend to
be familiar household names. Our approach involves visiting hundreds of
companies each year and meeting regularly with management to understand a
company's business and industry, identifying outstanding management teams and
targeting promising long-term investment opportunities.

--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -- Large Cap Value Fund                               1
<PAGE>
 
We strive to minimize risk in the Fund in a number of ways. As of December 31,
1997, the Fund owned 61 securities and no single security made up more than 5%
in the Fund. In addition to this broad diversification, the Fund's holdings tend
to be highly liquid and the dividends they generate help to cushion the Fund
from the effects of volatile markets. In fact, a principal aspect of our
management strategy is that every stock we own must provide a dividend that is
greater than or equal to the average for the Standard & Poor's 500 Stock Index
("S&P 500"), an index composed of widely held common stocks.

Market Update and Outlook

During 1997 the stock market continued the impressive returns of the past few
years. The S&P 500 has never before reported three consecutive years of 20%+
growth. The reasons behind these returns center on a specific confluence of
events that have occurred over recent years. Company earnings have been very
robust, and returns on assets and capital have been enhanced by an increased
emphasis on cost cutting and efficient use of capital. Simultaneously, interest
rates have declined over the past two years. As governments restrained public
spending worldwide and competitive forces placed a lid on price increases, the
yield on bonds fell in the major markets. The combination of these events made
stocks more attractive.

Looking ahead at 1998, we believe the main risk to the stock market is the
potential reduction in corporate earnings. With worldwide price inflation low,
especially given the recent events in Southeast Asia, the margin for error is
small. The restructurings that many domestic companies have undergone since the
beginning of the decade have kept costs under control and will be important
going forward as margins come under more pressure.

Our investment emphasis on dividend-paying companies should help cushion
disappointments. With stock price performance expected to return to more
historical levels, the dividend component will become a more critical part of
the total return. However, the U.S. economy continues to report low inflation,
moderate growth and productivity increases. We think these factors bode well for
stocks over the medium to longer term.

Fund's Portfolio Update

During the reporting period, we invested in Dow Jones & Company Inc., a
multi-national media company specializing in business news. Early in the year,
Dow Jones announced its intention to invest roughly $650 million in Dow Jones
Markets Service (formerly Telerate). Many investment professionals thought the
better course of action would be to sell off this chronically underperforming
division. Yet, we believe the asset value of Dow Jones alone made it a good
value despite the drag of Dow Jones Markets Service. If there's a positive
catalyst in the coming year, we expect the upside potential to Dow Jones to be
significant.

Our pharmaceutical holdings helped the Fund's performance during the period
under review. Drug companies such as Bristol-Meyers Squibb Co. and Eli Lilly &
Co., which were earlier undervalued by the marketplace, came out with exciting
new products and investors began to view these stocks much more favorably. In
addition, the Fund also benefited from its holdings in financial services
companies and electric utilities.

However, the Fund's performance was negatively impacted by its cyclical stock
holdings even though their valuations appeared to be inexpensive when we first
identified them. A slowdown in domestic economic growth and the turmoil in Asia
had an

--------------------------------------------------------------------------------
2                 Special 30th Anniversary -- 1997 Annual Report to Shareholders
<PAGE>
 
adverse affect on the earnings of most cyclicals. Another disappointment for the
Fund during the reporting period was Eastman Kodak. The company became
aggressive and competitor Fuji responded in kind. In our view, Eastman Kodak
painted themselves into a corner when its competitive strategy backfired and the
company was forced to cut prices.

In closing, thank you for your investment in the Smith Barney Funds, Inc. --
Large Cap Value Fund. We at Smith Barney look forward to continuing to help you
pursue your financial goals.

Sincerely,


/s/ Heath B. McLendon           /s/ Bruce Sargent

Heath B. McLendon               Bruce Sargent, CFA
Chairman                        Vice President

February 20, 1998

================================================================================
Top Ten Holdings*                                        As of December 31, 1997
================================================================================

<TABLE>
<S>                                                                        <C>
 1.  Bristol-Myers Squibb Co.                                               3.7%
--------------------------------------------------------------------------------
 2.  Unilever, N.V                                                          3.4
--------------------------------------------------------------------------------
 3.  Sprint Corp.                                                           3.2
--------------------------------------------------------------------------------
 4.  Chubb Corp.                                                            3.0
--------------------------------------------------------------------------------
 5.  Xerox Corp.                                                            2.9
--------------------------------------------------------------------------------
 6.  American Home Products Corp.                                           2.8
--------------------------------------------------------------------------------
 7.  Eli Lilly & Co.                                                        2.7
--------------------------------------------------------------------------------
 8.  Mobil Corp.                                                            2.7
--------------------------------------------------------------------------------
 9.  Baxter International, Inc.                                             2.6
--------------------------------------------------------------------------------
10.  General Electric Co.                                                   2.5
--------------------------------------------------------------------------------
</TABLE>

* As a percentage of total common stocks.


--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -- Large Cap Value Fund                               3
<PAGE>
 
<TABLE>
<CAPTION>
===========================================================================================================================
Historical Performance -- Class A Shares
===========================================================================================================================

                                                   Net Asset Value
                                              -------------------------
                                              Beginning           End             Income        Capital Gain       Total
Year Ended                                     of Year          of Year          Dividends      Distributions    Returns(1)
===========================================================================================================================
<S>                                            <C>              <C>               <C>               <C>            <C>   
12/31/97                                       $14.79           $17.09            $0.29             $1.50          27.86%
---------------------------------------------------------------------------------------------------------------------------
12/31/96                                        14.59            14.79             0.36              1.79           16.06
---------------------------------------------------------------------------------------------------------------------------
12/31/95                                        12.18            14.59             0.39              1.18           33.05
---------------------------------------------------------------------------------------------------------------------------
12/31/94                                        13.31            12.18             0.42              0.14           (4.31)
---------------------------------------------------------------------------------------------------------------------------
12/31/93                                        12.48            13.31             0.46              0.73           16.38
---------------------------------------------------------------------------------------------------------------------------
12/31/92                                        12.51            12.48             0.51              0.40            7.23
---------------------------------------------------------------------------------------------------------------------------
12/31/91                                        10.54            12.51             0.73              0.05           26.57
---------------------------------------------------------------------------------------------------------------------------
12/31/90                                        12.69            10.54             0.70              0.25           (9.46)
---------------------------------------------------------------------------------------------------------------------------
12/31/89                                        11.00            12.69             0.70              0.31           25.11
---------------------------------------------------------------------------------------------------------------------------
12/31/88                                        10.05            11.00             0.63              0.17           17.67
===========================================================================================================================
   Total                                                                          $5.19             $6.52
===========================================================================================================================

<CAPTION>
===========================================================================================================================
Historical Performance -- Class B Shares
===========================================================================================================================

                                                   Net Asset Value
                                              -------------------------
                                              Beginning           End             Income        Capital Gain       Total
Year Ended                                     of Year          of Year          Dividends      Distributions    Returns(1)
===========================================================================================================================
<S>                                            <C>              <C>               <C>               <C>            <C>   
12/31/97                                       $14.74           $17.03            $0.15             $1.50          26.83%
---------------------------------------------------------------------------------------------------------------------------
12/31/96                                        14.54            14.74             0.24              1.79           15.22
---------------------------------------------------------------------------------------------------------------------------
12/31/95                                        12.15            14.54             0.29              1.18           32.07
---------------------------------------------------------------------------------------------------------------------------
Inception*-- 12/31/94                           12.54            12.15             0.09              0.14           (1.28)+
===========================================================================================================================
   Total                                                                          $0.77             $4.61
===========================================================================================================================

<CAPTION>
===========================================================================================================================
Historical Performance -- Class C Shares
==========================================================================================================================

                                                   Net Asset Value
                                              -------------------------
                                              Beginning           End             Income        Capital Gain       Total
Year Ended                                     of Year          of Year          Dividends      Distributions    Returns(1)
===========================================================================================================================
<S>                                            <C>              <C>               <C>               <C>            <C>   
12/31/97                                       $14.76           $17.05            $0.16             $1.50          26.85%
---------------------------------------------------------------------------------------------------------------------------
12/31/96                                        14.57            14.76             0.24              1.79           15.15
---------------------------------------------------------------------------------------------------------------------------
12/31/95                                        12.18            14.57             0.29              1.18           32.01
---------------------------------------------------------------------------------------------------------------------------
12/31/94                                        13.30            12.18             0.34              0.14           (4.91)
---------------------------------------------------------------------------------------------------------------------------
12/31/93                                        12.48            13.30             0.36              0.73           15.46
---------------------------------------------------------------------------------------------------------------------------
Inception*-- 12/31/92                           12.87            12.48             0.06              0.40           (0.57)+
===========================================================================================================================
   Total                                                                          $1.45             $5.74
===========================================================================================================================

===========================================================================================================================
 Historical Performance -- Class Y Shares
===========================================================================================================================
                                                   Net Asset Value
                                              -------------------------
                                              Beginning           End             Income        Capital Gain       Total
Year Ended                                     of Year          of Year          Dividends      Distributions    Returns(1)
===========================================================================================================================
<S>                                            <C>              <C>               <C>               <C>            <C>   
12/31/97                                       $14.80           $17.09            $0.35             $1.50          28.21%
---------------------------------------------------------------------------------------------------------------------------
Inception*-- 12/31/96                           15.06            14.80             0.41              1.79          12.86+
===========================================================================================================================
   Total                                                                          $0.76             $3.29
===========================================================================================================================
</TABLE>

--------------------------------------------------------------------------------
4                 Special 30th Anniversary -- 1997 Annual Report to Shareholders
<PAGE>
 
<TABLE>
<CAPTION>
===========================================================================================================================
Historical Performance -- Class Z Shares
===========================================================================================================================

                                                   Net Asset Value
                                              -------------------------
                                              Beginning           End             Income        Capital Gain       Total
Year Ended                                     of Year          of Year          Dividends      Distributions    Returns(1)
===========================================================================================================================
<S>                                            <C>              <C>               <C>               <C>            <C>   
12/31/97                                       $14.82           $17.12            $0.35             $1.50          28.27%
---------------------------------------------------------------------------------------------------------------------------
12/31/96                                        14.61            14.82             0.41              1.79           16.47
---------------------------------------------------------------------------------------------------------------------------
12/31/95                                        12.19            14.61             0.42              1.18           33.41
---------------------------------------------------------------------------------------------------------------------------
Inception*-- 12/31/94                           12.54            12.19             0.12              0.14           (0.73)+
===========================================================================================================================
   Total                                                                          $1.30             $4.61
===========================================================================================================================
</TABLE>

IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS QUARTERLY AND CAPITAL GAINS, IF
ANY, ANNUALLY.

<TABLE>
<CAPTION>
===========================================================================================================================
Average Annual Total Return
===========================================================================================================================

                                                                       Without Sales Charge(1)
                                              -----------------------------------------------------------------------------
                                              Class A          Class B           Class C           Class Y        Class Z
===========================================================================================================================
<S>                                            <C>              <C>               <C>               <C>            <C>   
Year Ended 12/31/97                            27.86%           26.83%            26.85%            28.21%         28.27%
---------------------------------------------------------------------------------------------------------------------------
Five Years Ended 12/31/97                      17.07              N/A             16.18               N/A            N/A
---------------------------------------------------------------------------------------------------------------------------
Ten Years Ended 12/31/97                       14.80              N/A               N/A               N/A            N/A
---------------------------------------------------------------------------------------------------------------------------
Inception* through 12/31/97                    11.72            22.70             16.02             21.48          24.18
===========================================================================================================================

<CAPTION>
                                                                            With Sales Charge(2)
                                              -----------------------------------------------------------------------------
                                              Class A          Class B           Class C           Class Y        Class Z
===========================================================================================================================
<S>                                            <C>              <C>               <C>               <C>            <C>   
Year Ended 12/31/97                            21.45%           21.83%            25.85%            28.21%         28.27%
---------------------------------------------------------------------------------------------------------------------------
Five Years Ended 12/31/97                      15.87              N/A             16.18               N/A            N/A
---------------------------------------------------------------------------------------------------------------------------
Ten Years Ended 12/31/97                       14.22              N/A               N/A               N/A            N/A
---------------------------------------------------------------------------------------------------------------------------
Inception* through 12/31/97                    11.53            22.29             16.02             21.48          24.18
===========================================================================================================================
</TABLE>


================================================================================
Cumulative Total Return
================================================================================

<TABLE>
<CAPTION>
                                                    Without Sales Charge(1)
===============================================================================
<S>                                                     <C>    
Class A (12/31/87 through 12/31/97)                         297.73%
-------------------------------------------------------------------------------
Class A (Inception* through 12/31/97)                    2,881.22
-------------------------------------------------------------------------------
Class B (Inception* through 12/31/97)                       90.53
-------------------------------------------------------------------------------
Class C (Inception* through 12/31/97)                      112.84
-------------------------------------------------------------------------------
Class Y (Inception* through 12/31/97)                       44.70
-------------------------------------------------------------------------------
Class Z (Inception* through 12/31/97)                       97.85
===============================================================================
</TABLE>

(1)  Assumes reinvestment of all dividends and capital gain distributions, if
     any, at net asset value and does not reflect the deduction of the
     applicable sales charges with respect to Class A shares or the contingent
     deferred sales charges ("CDSC") with respect to Class B and C shares.

(2)  Assumes reinvestment of all dividends and capital gain distributions, if
     any, at net asset value. In addition, Class A shares reflect the deduction
     of the maximum initial sales charge of 5.00% and Class B shares reflect the
     deduction of a 5.00% CDSC, which applies if shares are redeemed within one
     year from purchase. Thereafter the CDSC declines by 1.00% per year until no
     CDSC is incurred. Class C shares reflect the deduction of a 1.00% CDSC,
     which applies if shares are redeemed within the first year of purchase.

+    Total return is not annualized, as it may not be representative of the
     total return for the year.

*    Inception dates for Class A, B, C, Y and Z shares are May 18, 1967,
     November 7, 1994, December 2, 1992, February 6, 1996 and November 7, 1994,
     respectively.

--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -- Large Cap Value Fund                               5
<PAGE>
 
Smith Barney Funds, Inc.
Large Cap Value Fund

Growth of $10,000 invested in Class A Shares
of the Smith Barney Funds, Inc. -- Large Cap Value Fund
vs. the Standard & Poor's 500 Stock Index*
(unaudited)

May 18, 1967 -- December 31, 1997

 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.]

<TABLE>
<CAPTION>
                                                        Smith Barney Funds, Inc.             S&P 500 
Date                                                     Large Cap Value Fund                 Index
----                                                     --------------------                -------
<S>         <C>                                               <C>                            <C>   
  5/18/67                                                        9,427                         10,000
12/31/67                                                        9,670                         11,031
12/31/68    Assassination of Martin Luther King, Jr.           11,945                         12,252 
12/31/69    United States puts the first man on the moon       10,636                         11,218
12/31/70    War in Cambodia escalates                          10,887                         11,661
12/31/71    Freeze on wages and prices                         12,073                         13,329
            NASDAQ introduced                                
               [ARROW] SMITH BARNEY                          
                       ------------                          
                       February 1972 --                      
                       An affiliate of Smith Barney          
                       assumes management of                 
                       Large Cap Value Fund                  
12/31/72    Watergate break-in                                 12,652                         15,861
            Nixon visits China                               
12/31/73    OPEC oil embargo                                   10,134                         13,531
12/31/74    Nixon resigns as President                          8,357                          9,949
12/31/75    U.S. involvement in Vietnam ends                   11,282                         13,654
12/31/76    Bicentennial celebration                           15,461                         16,921
12/31/77    U.S. energy crisis                                 15,709                         15,709
12/31/78    Genocide in Cambodia                               15,997                         16,743
            Camp David accords                               
12/31/79    Three Mile island disaster                         19,370                         19,857
            Iran hostage crisis begins                       
12/31/80    Reagan elected President in landslide              25,639                         26,311
12/31/81    Assassination attempts on Reagan and Pope          28,703                         25,016
            First space shuttle launch                       
</TABLE>                                                  
 
*    Hypothetical illustration of $10,000 invested in Class A shares on May 18,
     1967, assuming deduction of the maximum 5.00% sales charge at the time of
     investment and reinvestment of dividends and capital gains, if any, at net
     asset value through December 31, 1997. The Standard & Poor's 500 Stock
     Index ("S&P 500") is an index composed of widely held common stocks listed
     on the New York Stock Exchange, American Stock Exchange and the Nasdaq
     Stock market. Figures for the index include reinvestment of dividends. The
     index is unmanaged and is not subject to the same management and trading
     expenses as a mutual fund. The performance of the Portfolio's other classes
     may be greater or less than the Class A shares' performance indicated on
     this chart, depending on whether greater or lesser sales charges and fees
     were incurred by shareholders investing in other classes. All figures
     represent past performance and are not a guarantee of future results.
     Investment returns and principal value will fluctuate, and redemption value
     may be more or less than the original cost. No adjustment has been made for
     shareholder tax liability on dividends or capital gains.

--------------------------------------------------------------------------------
6                 Special 30th Anniversary -- 1997 Annual Report to Shareholders
<PAGE>
 
Large Cap Value Fund...
For more than 30 years, a solid Fund with a sturdy track record

 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.]

<TABLE>
<CAPTION>
                                                        Smith Barney Funds, Inc.             S&P 500 
Date                                                     Large Cap Value Fund                 Index
----                                                     --------------------                -------
<S>         <C>                                                <C>                            <C>   
12/31/82    Worst U.S. recession in 40 years                    36,575                         30,407
12/31/83    Beirut bombing                                      42,934                         37,267
12/31/84    Iran/Iraq conflict                                  47,195                         39,604
12/31/85    U.S. becomes debtor nation                          60,077                         52,170
            Gramm-Rudman Act                                   
12/31/86    Tax reform                                          72,719                         61,905 
            Bombing of Libya                                    
12/31/87    Market correction                                   70,663                         65,156
12/31/88    RJR Nabisco buyout                                  83,150                         75,945
12/31/89    Collapse of high-yield bond market                 104,029                         99,967
            Beruit Wall falls                                  
12/31/90    Iraq invasion of Kuwait                             94,188                         96,858
12/31/91    U.S. recession                                     119,208                        126,303
12/31/92    Riots in Los Angeles                               127,818                        135,914
12/31/93    World Trade Center terrorist bombing               148,760                        149,587
            Passage of NAFTA                                   
12/31/94    Orange County bankruptcy                           142,341                        151,547 
12/31/95    Dow rises above 4000, then 5000                    189,386                        208,422 
12/31/96    Dow rises above 6500                               219,811                        256,255 
12/31/97    Dow rises above 7000                               281,046                        341,741 
</TABLE>                                                       
    
--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -- Large Cap Value Fund                               7
<PAGE>
 
<TABLE>
<CAPTION>
===================================================================================================================================
 Schedule of Investments                                                                                          December 31, 1997
===================================================================================================================================

            SHARES                                                 SECURITY                                             VALUE
===================================================================================================================================
<S>          <C>           <C>                                                                                         <C>      
COMMON STOCK -- 93.5%
Aerospace -- 0.0%
               9,565       Raytheon Co., Class A Shares                                                                $   471,699
-----------------------------------------------------------------------------------------------------------------------------------
Automotive -- 2.0%
             250,000       Ford Motor Corp.                                                                             12,171,875
             150,000       General Motors                                                                                9,093,750
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        21,265,625
-----------------------------------------------------------------------------------------------------------------------------------
Capital Goods -- 6.0%
             400,000       Emerson Electric Co.                                                                         22,575,000
             350,000       General Electric Co.                                                                         25,681,250
             350,000       National Services Industries, Inc.                                                           17,346,875
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        65,603,125
-----------------------------------------------------------------------------------------------------------------------------------
Chemicals -- 2.1%
             350,000       Imperial Chemical Industries ADR+                                                            22,728,125
-----------------------------------------------------------------------------------------------------------------------------------
Conglomerates -- 1.9%
             200,000       Pitney Bowes Inc.                                                                            17,987,500
             100,000       Seagram Co., Ltd.                                                                             3,231,250
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        21,218,750
-----------------------------------------------------------------------------------------------------------------------------------
Consumer Cyclicals -- 2.9%
             100,000       McGraw Hill Cos., Inc.                                                                        7,400,000
             500,000       Stanley Works, Inc.                                                                          23,593,750
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        30,993,750
-----------------------------------------------------------------------------------------------------------------------------------
Consumer Staples -- 17.6%
             375,000       American Home Products Corp.                                                                 28,687,500
             520,000       Baxter International, Inc.                                                                   26,227,500
             400,000       Bristol-Myers Squibb Co.                                                                     37,850,000
             400,000       Eli Lilly & Co.                                                                              27,850,000
             350,000       Federal Mogul Corp.+                                                                         14,175,000
             450,000       H.J. Heinz & Co.                                                                             22,865,625
             560,000       Unilever, N.V.+                                                                              34,965,000
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                       192,620,625
-----------------------------------------------------------------------------------------------------------------------------------
Energy -- 7.6%
             200,000       AMP Inc.                                                                                      8,400,000
             350,000       Ashland, Inc.                                                                                18,790,625
             325,000       Dresser Industries, Inc.                                                                     13,629,688
             400,000       Duke Energy Corp.                                                                            22,150,000
              91,890       Enron Corp.                                                                                   3,819,178
             450,000       Keyspan Energy Corp.                                                                         16,565,625
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        83,355,116
-----------------------------------------------------------------------------------------------------------------------------------
Financial Services -- 16.8%
             150,000       American General Corp.+                                                                       8,109,375
             105,000       Aon Corp.                                                                                     6,155,625
             208,000       Chase Manhattan Corp.                                                                        22,776,000
             400,000       Chubb Corp.                                                                                  30,250,000
             400,000       Dow Jones & Co.+                                                                             21,475,000
             300,000       First Chicago NBD Corp.                                                                      25,050,000
</TABLE>

                       See Notes to Financial Statements.

--------------------------------------------------------------------------------
8               Special 30th Anniversary -- 1997 Annual Report to Shareholders
<PAGE>
 
<TABLE>
<CAPTION>
===================================================================================================================================
 Schedule of Investments (continued)                                                                               December 31, 1997
===================================================================================================================================

            SHARES                                                 SECURITY                                             VALUE
===================================================================================================================================
<S>          <C>           <C>                                                                                       <C>      
Financial Services -- 16.8% (continued)
             150,000       Fleet Financial Group                                                                     $  11,240,625
             200,000       Marsh & McLennan Cos., Inc.                                                                  14,912,500
             300,000       St. Paul Companies, Inc.                                                                     24,618,750
             300,000       Washington Mutual Inc.                                                                       19,143,750
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                       183,731,625
-----------------------------------------------------------------------------------------------------------------------------------
Food Processing -- 2.2%
             250,000       Quaker Oats Corp.                                                                            13,187,500
             200,000       Sara Lee Corp.                                                                               11,262,500
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        24,450,000
-----------------------------------------------------------------------------------------------------------------------------------
Oil Integrated -- 7.6%
             250,000       Chevron Corp.                                                                                19,250,000
             240,000       Exxon Corp.                                                                                  14,685,000
             380,000       Mobil Corp.                                                                                  27,431,250
             400,000       Royal Dutch Petroleum Co., ADR                                                               21,675,000
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        83,041,250
-----------------------------------------------------------------------------------------------------------------------------------
Natural Gas -- 1.0%
             400,000       William Cos.+                                                                                11,350,000
-----------------------------------------------------------------------------------------------------------------------------------
Raw & Intermediate Materials -- 5.5%
             350,000       International Paper Co.                                                                      15,093,750
             350,000       Kimberly-Clark Corp.                                                                         17,259,373
             300,000       Masco Corp.+                                                                                 15,262,500
             200,000       Reynolds Metals Co.                                                                          12,000,000
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        59,615,623
-----------------------------------------------------------------------------------------------------------------------------------
Retail - Specialty Apparel -- 1.9%
             800,000       Limited, Ltd.                                                                                20,400,000
-----------------------------------------------------------------------------------------------------------------------------------
Technology -- 5.2%
             100,000       Eastman Kodak Co.                                                                             6,081,250
             220,000       Lockheed Martin Corp.                                                                        21,670,000
             400,000       Xerox Corp.+                                                                                 29,525,000
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        57,276,250
-----------------------------------------------------------------------------------------------------------------------------------
Telephone -- 7.8%
             250,000       American Telephone & Telegraph                                                               15,312,500
             300,000       Bellsouth Corp.                                                                              16,893,750
             400,000       GTE Corp.                                                                                    20,900,000
             550,000       Sprint Corp.                                                                                 32,243,750
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        85,350,000
-----------------------------------------------------------------------------------------------------------------------------------
Transportation -- 2.3%
              80,000       Alexander Baldwin, Inc.                                                                       2,185,000
             375,000       Union Pacific Corp.                                                                          23,414,064
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        25,599,064
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                       See Notes to Financial Statements.

--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -- Large Cap Value Fund                               9
<PAGE>
 
<TABLE>
<CAPTION>
===================================================================================================================================
 Schedule of Investments (continued)                                                                              December 31, 1997
===================================================================================================================================

            SHARES                                                 SECURITY                                             VALUE
===================================================================================================================================
<S>       <C>              <C>                                                                                       <C>      
Utilities -- 3.1%
             250,000       Boston Edison Co.                                                                         $   9,468,750
             300,000       El Paso Natural Gas                                                                          19,950,000
             100,000       NIPSCO Industries Inc.                                                                        4,943,750
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                        34,362,500
-----------------------------------------------------------------------------------------------------------------------------------
                           TOTAL COMMON STOCK
                           (Cost -- $715,355,095)                                                                   1,023,433,127
===================================================================================================================================
CONVERTIBLE PREFERRED STOCK -- 1.0%
Financial Services -- 1.0%
             100,000       Banc One Corp., Series C, Exchangeable $3.50
                           (Cost -- $6,830,625)                                                                        10,512,500
===================================================================================================================================

<CAPTION>
          FACE
         AMOUNT                                                 SECURITY                                                  VALUE
===================================================================================================================================
<S>      <C>               <C>                                                                                      <C>      
CONVERTIBLE DEBENTURE -- 0.5%
Energy -- 0.5%
         $ 5,800,000       Oryx Energy, 7.50% due 5/15/14
                           (Cost -- $5,547,625)                                                                         5,865,250
===================================================================================================================================
REPURCHASE AGREEMENT -- 5.0%
          53,818,000       Goldman, Sachs & Co., 6.348% due 1/2/98; Proceeds at
                           maturity -- $53,836,980; (Fully collateralized by
                           U.S. Treasury Notes, 5.625% due 12/31/99;
                           Market value -- $54,918,060) (Cost -- $53,818,000)                                           53,818,000
===================================================================================================================================
                           TOTAL INVESTMENTS -- 100%
                           (Cost -- $781,551,345*)                                                                  $1,093,628,877
===================================================================================================================================
</TABLE>

+    A portion of the security is on loan (See Note 5).
*    Aggregate cost for Federal income tax purposes is substantially the same.


                       See Notes to Financial Statements.

--------------------------------------------------------------------------------
10                 Special 30th Anniversary - 1997 Annual Report to Shareholders
<PAGE>
 
<TABLE>
<CAPTION>
================================================================================
Statement of Assets and Liabilities                            December 31, 1997
================================================================================
<S>                                                              <C>            
ASSETS:
     Investments, at value (Cost -- $781,551,345)                $ 1,093,628,877
     Cash                                                                     90
     Collateral for securities loaned (Note 5)                        80,477,361
     Receivable for Fund shares sold                                   4,726,791
     Dividends and interest receivable                                 2,177,346
--------------------------------------------------------------------------------
     Total Assets                                                  1,181,010,465
--------------------------------------------------------------------------------
LIABILITIES:
     Payable for securities loaned (Note 5)                           80,477,361
     Dividends payable                                                13,958,215
     Payable for Fund shares purchased                                   606,550
     Management fees payable                                             525,280
     Distribution fees payable                                           308,164
     Accrued expenses                                                     88,933
--------------------------------------------------------------------------------
     Total Liabilities                                                95,964,503
--------------------------------------------------------------------------------
Total Net Assets                                                 $ 1,085,045,962
================================================================================
NET ASSETS:
     Par value of capital shares                                 $       634,963
     Capital paid in excess of par value                             772,256,081
     Overdistributed net investment income                                (7,476)
     Accumulated net realized gain on security transactions               84,862
     Net unrealized appreciation of investments                      312,077,532
--------------------------------------------------------------------------------
Total Net Assets                                                 $ 1,085,045,962
================================================================================
Shares Outstanding:
     Class A                                                          44,402,107
     ---------------------------------------------------------------------------
     Class B                                                           1,675,167
     ---------------------------------------------------------------------------
     Class C                                                           2,469,984
     ---------------------------------------------------------------------------
     Class Y                                                           6,535,999
     ---------------------------------------------------------------------------
     Class Z                                                           8,413,016
     ---------------------------------------------------------------------------
Net Asset Value:
     Class A (and redemption price)                                       $17.09
     ---------------------------------------------------------------------------
     Class B*                                                             $17.03
     ---------------------------------------------------------------------------
     Class C**                                                            $17.05
     ---------------------------------------------------------------------------
     Class Y (and redemption price)                                       $17.09
     ---------------------------------------------------------------------------
     Class Z (and redemption price)                                       $17.12
     ---------------------------------------------------------------------------
Class A Maximum Public Offering Price Per Share
     (net asset value plus 5.26% of net asset value per share)            $17.99
================================================================================
</TABLE>

*    Redemption price is NAV of Class B shares reduced by a 5.00% CDSC if shares
     are redeemed within one year from initial purchase (See Note 2).

**   Redemption price is NAV of Class C shares reduced by a 1.00% CDSC if shares
     are redeemed within the first year of purchase.


                       See Notes to Financial Statements.

--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -  Large Cap Value Fund                              11
<PAGE>
 
<TABLE>
<CAPTION>
================================================================================
Statement of Operations                     For the Year Ended December 31, 1997
================================================================================
<S>                                                               <C>          
INVESTMENT INCOME:
     Dividends                                                    $  21,375,288
     Interest                                                         4,127,189
     Less: Foreign withholding tax                                     (174,166)
-------------------------------------------------------------------------------
     Total Investment Income                                         25,328,311
-------------------------------------------------------------------------------
EXPENSES:
     Management fees (Note 2)                                         5,536,984
     Distribution fees (Note 2)                                       2,372,282
     Shareholder and system servicing fees                              544,255
     Registration fees                                                   93,449
     Shareholder communications                                          85,206
     Custody                                                             37,011
     Audit and legal                                                     29,375
     Directors' fees                                                     23,959
     Other                                                               10,080
-------------------------------------------------------------------------------
     Total Expenses                                                   8,732,601
-------------------------------------------------------------------------------
Net Investment Income                                                16,595,710
-------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS (NOTE 3):
     Realized Gain From Security Transactions
     (excluding short-term securities):
        Proceeds from sales                                         355,950,030
        Cost of securities sold                                     267,493,115
-------------------------------------------------------------------------------
     Net Realized Gain                                               88,456,915
-------------------------------------------------------------------------------
     Change in Net Unrealized Appreciation of Investments:
        Beginning of year                                           185,094,122
        End of year                                                 312,077,532
-------------------------------------------------------------------------------
     Increase in Net Unrealized Appreciation                        126,983,410
-------------------------------------------------------------------------------
Net Gain on Investments                                             215,440,325
-------------------------------------------------------------------------------
Increase in Net Assets From Operations                            $ 232,036,035
===============================================================================
</TABLE>


                       See Notes to Financial Statements.

--------------------------------------------------------------------------------
12                 Special 30th Anniversary - 1997 Annual Report to Shareholders
<PAGE>
 
<TABLE>
<CAPTION>
========================================================================================================
Statements of Changes in Net Assets                                      For the Year Ended December 31,
========================================================================================================
                                                                             1997               1996
========================================================================================================
<S>                                                                   <C>                <C>            
OPERATIONS:
     Net investment income                                            $    16,595,710    $    18,225,859
     Net realized gain                                                     88,456,915         90,148,657
     Increase in net unrealized appreciation                              126,983,410         10,795,938
--------------------------------------------------------------------------------------------------------
     Increase in Net Assets From Operations                               232,036,035        119,170,454
--------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
     Net investment income                                                (16,833,261)       (18,560,723)
     Net realized gains                                                   (88,392,744)       (90,678,646)
--------------------------------------------------------------------------------------------------------
     Decrease in Net Assets From
        Distributions to Shareholders                                    (105,226,005)      (109,239,369)
--------------------------------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 6):
     Net proceeds from sales of shares                                    164,777,053         77,117,814
     Net asset value of shares issued for
        reinvestment of dividends                                          88,143,626         98,396,742
     Cost of shares reacquired                                           (132,196,413)       (99,848,727)
--------------------------------------------------------------------------------------------------------
     Increase in Net Assets From
        Fund Share Transactions                                           120,724,266         75,665,829
--------------------------------------------------------------------------------------------------------
Increase in Net Assets                                                    247,534,296         85,596,914
NET ASSETS:
     Beginning of year                                                    837,511,666        751,914,752
--------------------------------------------------------------------------------------------------------
     End of year*                                                     $ 1,085,045,962    $   837,511,666
========================================================================================================
*  Includes undistributed (overdistributed) net investment income of:         $(7,476)          $230,075
========================================================================================================
</TABLE>

                       See Notes to Financial Statements.

--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -  Large Cap Value Fund                              13
<PAGE>
 
================================================================================
 Notes to Financial Statements
================================================================================

1. Significant Accounting Policies

The Large Cap Value Fund ("Portfolio"), formerly known as Equity Income
Portfolio, is a separate investment portfolio of the Smith Barney Funds, Inc.
("Fund"). The Fund, a Maryland corporation, is registered under the Investment
Company Act of 1940, as amended, as a diversified, open-end management
investment company and consists of this Portfolio and two other separate
investment portfolios: U.S. Government Securities and Short-Term U.S. Treasury
Securities Portfolios. The financial statements and financial highlights for the
other portfolios are presented in separate annual reports.

The significant accounting policies consistently followed by the Portfolio are:
(a) security transactions are accounted for on trade date; (b) securities traded
on national securities markets are valued at the closing prices on such markets;
securities for which no sales price was reported and U.S. government and agency
obligations are valued at the mean between the bid and ask prices; (c)
securities that have a maturity of more than 60 days are valued at prices based
on market quotations for securities of similar type, yield and maturity; (d)
securities maturing within 60 days or less are valued at cost plus accreted
discount, or minus amortized premium, which approximates value; (e) dividend
income is recorded on the ex-dividend date and interest income is recorded on
the accrual basis; foreign dividends are recorded on the ex-dividend date or as
soon as practical after the Portfolio determines the existence of a dividend
declaration after exercising reasonable due diligence; (f) gains or losses on
the sale of securities are calculated by using the specific identification
method; (g) dividends and distributions to shareholders are recorded on the
ex-dividend date; (h) direct expenses are charged to each class; management fees
and general portfolio expenses are allocated on the basis of relative net assets
by class; (i) the accounting records are maintained in U.S. dollars. All assets
and liabilities denominated in foreign currencies are translated into U.S.
dollars based on the rate of exchange of such currencies against U.S. dollars on
the date of valuation. Purchases and sales of securities, and income and
expenses are translated at the rate of exchange quoted on the respective date
that such transactions are recorded. Differences between income and expense
amounts recorded and collected or paid are adjusted when reported by the
custodian bank; (j) the Portfolio intends to comply with the applicable
provisions of the Internal Revenue Code of 1986, as amended, pertaining to
regulated investment companies and to make distributions of taxable income
sufficient to relieve it from substantially all Federal income and excise taxes;
(k) the character of income and gains to be distributed are determined in
accordance with income tax regulations which may differ from generally accepted
accounting principles. At December 31, 1997, reclassifications were made to the
capital accounts of the Fund to reflect permanent book/tax differences and
income and gains available for distributions under income tax regulations. Net
investment income, net realized gains and net assets were not affected by this
change; and (l) estimates and assumptions are required to be made regarding
assets, liabilities and changes in net assets resulting from operations when
financial statements are prepared. Changes in the economic environment,
financial markets and any other parameters used in determining these estimates
could cause actual results to differ.

2. Management Agreement and Other Transactions

Mutual Management Corp. ("MMC"), formerly known as Smith Barney Mutual Funds
Management Inc., a subsidiary of Salomon Smith Barney Holdings Inc. ("SSBH"),
acts as investment manager of the Fund. The Portfolio pays MMC a management fee
calculated at an annual rate of 0.60% on the Portfolio's average daily net
assets up to $500 million, 0.55% on the next $500 million

--------------------------------------------------------------------------------
14               Sprecial 30th Anniversary -- 1997 Annual Report to Shareholders
<PAGE>
 
================================================================================
 Notes to Financial Statements (contined)
================================================================================

and 0.50% on average daily net assets in excess of $1.0 billion. These fees are
calculated daily and paid monthly.

Smith Barney Inc. ("SB"), another subsidiary of SSBH, acts as distributor of
Fund shares and primary broker for its portfolio agency transactions. For the
year ended December 31, 1997, SB received brokerage commissions of $276,012 and
sales charges of approximately $458,000 on sales of the Portfolio's Class A
shares.

There is a contingent deferred sales charge ("CDSC") of 5.00% on Class B shares,
which applies if redemption occurs less than one year from purchase and declines
thereafter by 1.00% per year until no CDSC is incurred. Class C shares have a
1.00% CDSC, which applies if redemption occurs within the first year of
purchase. For the year ended December 31, 1997, CDSCs paid to SB were
approximately:

<TABLE>
<CAPTION>
                                                           Class B      Class C
================================================================================
<S>                                                        <C>          <C>   
CDSCs                                                      $43,000      $2,000
================================================================================
</TABLE>

Pursuant to a Distribution Plan, the Portfolio pays a service fee with respect
to its Class A, B and C shares calculated at the annual rate of 0.25% of the
average daily net assets of each respective class. In addition, the Portfolio
also pays a distribution fee with respect to Class B and C shares calculated at
the annual rate of 0.75% of the average daily net assets of each class. For the
year ended December 31, 1997, total Distribution Plan fees were as follows:

<TABLE>
<CAPTION>
                                           Class A        Class B      Class C
================================================================================
<S>                                       <C>            <C>          <C>     
Distribution Plan Fees                    $1,785,010     $212,156     $375,116
================================================================================
</TABLE>

All officers and two Directors of the Fund are employees of SB.

3. Investments

During the year ended December 31, 1997, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:

<TABLE>
================================================================================
<S>                                                               <C>         
Purchases                                                         $394,453,233
--------------------------------------------------------------------------------
Sales                                                              355,950,030
================================================================================
</TABLE>

At December 31, 1997, the aggregate gross unrealized appreciation and
depreciation of investments for Federal income tax purposes were substantially
as follows:

<TABLE>
================================================================================
<S>                                                               <C>         
Gross unrealized appreciation                                     $315,532,987
Gross unrealized depreciation                                       (3,455,455)
--------------------------------------------------------------------------------
Net unrealized appreciation                                       $312,077,532
================================================================================
</TABLE>

4. Repurchase Agreements

The Portfolio purchases (and its custodian take possession of) U.S. government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Portfolio requires continual
maintenance of the market value of the collateral in amounts at least equal to
the repurchase price.

5. Lending of Portfolio Securities

The Fund has an agreement with its custodian whereby the custodian may lend
securities owned by the Fund to brokers, dealers and other financial
organizations. Fees earned by the Fund on securities lending are recorded in
interest income. Loans of securities by the Fund are collateralized by cash,
U.S. government securities or high quality money market instruments that are
maintained at all times in an amount at least equal to the current market value
of the loaned securities, plus a margin which may vary depending on the type of
securities loaned. The custodian establishes and maintains the collateral in a
segregated account. The Fund maintains exposure for the risk of any losses in
the investment of amounts received as collateral.

--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -- Large Cap Value Fund                              15
<PAGE>
 
================================================================================
 Notes to Financial Statements (contined)
================================================================================

At December 31, 1997, the Fund loaned stocks having a value of approximately
$78,978,552 and holds the following collateral for loaned securities.

<TABLE>
<CAPTION>
Security Description                                                     Value
================================================================================
<S>                                                                  <C>        
Time Deposits:
   Bank of Tokyo, 10.000% due 1/2/98                                 $ 4,940,898
   Instituto Bancario San Paolo, 7.000% due 1/2/98                    13,834,514
   Keycorp Bank, N.A., 4.000% due 1/2/98                               3,157,889

Repurchase Agreements:
   Goldman, Sachs & Co., 6.800% due 1/2/98                            49,156,355
   Merrill Lynch, 7.000% due 1/2/98                                    9,387,705
--------------------------------------------------------------------------------
Total                                                                $80,477,361
================================================================================
</TABLE>

6. Capital Shares

At December 31, 1997, the Fund had two billion shares of capital stock
authorized with a par value of $0.01 per share. The Portfolio has the ability to
issue multiple classes of shares. Each share of a class represents an identical
interest in the Portfolio and has the same rights, except that each class bears
certain expenses specifically related to the distribution of its shares.

At December 31, 1997, total paid-in capital amounted to the following for each
class:

<TABLE>
<CAPTION>
                                       Class A              Class B              Class C             Class Y            Class Z
====================================================================================================================================
<S>                                 <C>                   <C>                  <C>                <C>                <C>         
Total Paid-in Capital               $490,735,469          $26,367,929          $34,544,842        $110,545,054       $110,697,750
====================================================================================================================================
</TABLE>

Transactions in shares of each class were as follows:

<TABLE>
<CAPTION>
                                                             Year Ended                                      Year Ended
                                                          December 31, 1997                               December 31, 1996
                                                 -----------------------------------             ---------------------------------
                                                  Shares                   Amount                 Shares                  Amount
====================================================================================================================================
<S>                                             <C>                    <C>                      <C>                   <C>         
Class A
Shares sold                                      1,441,479             $  24,457,765             1,572,895            $ 23,892,544
Shares issued on reinvestment                    3,970,126                67,884,054             5,161,353              77,820,683
Shares redeemed                                 (4,677,363)              (78,829,273)           (5,390,653)            (83,086,170)
------------------------------------------------------------------------------------------------------------------------------------
Net Increase                                       734,242             $  13,512,546             1,343,595            $ 18,627,057
====================================================================================================================================
Class B
Shares sold                                        731,383             $  12,514,579               622,419            $  9,553,511
Shares issued on reinvestment                      135,875                 2,316,326               110,323               1,654,996
Shares redeemed                                   (201,810)               (3,394,313)             (110,106)             (2,171,232)
------------------------------------------------------------------------------------------------------------------------------------
Net Increase                                       665,448             $  11,436,592               592,636            $  9,037,275
====================================================================================================================================
</TABLE>

--------------------------------------------------------------------------------
16               Sprecial 30th Anniversary -- 1997 Annual Report to Shareholders
<PAGE>
 
================================================================================
 Notes to Financial Statements (contined)
================================================================================

<TABLE>
<CAPTION>
                                                             Year Ended                                      Year Ended
                                                          December 31, 1997                               December 31, 1996
                                                 -----------------------------------             ---------------------------------
                                                  Shares                   Amount                 Shares                  Amount
====================================================================================================================================
<S>                                             <C>                    <C>                       <C>                  <C>         
Class C
Shares sold                                        324,275             $   5,556,018               309,334            $  4,772,481
Shares issued on reinvestment                      208,453                 3,556,014               256,939               3,861,171
Shares redeemed                                   (322,821)               (5,333,286)             (348,965)             (5,369,299)
------------------------------------------------------------------------------------------------------------------------------------
Net Increase                                       209,907             $   3,778,746               217,308            $  3,264,353
====================================================================================================================================
Class Y
Shares sold                                      6,479,279             $ 114,285,256             2,038,995            $ 31,633,477
Shares redeemed                                 (1,982,275)              (35,361,534)                   --                      --
------------------------------------------------------------------------------------------------------------------------------------
Net Increase                                     4,497,004             $  78,923,722             2,038,995            $ 31,633,477
====================================================================================================================================
Class Z
Shares sold                                        484,651             $   7,963,435               478,209            $  7,265,801
Shares issued on reinvestment                      839,710                14,387,232               996,127              15,059,892
Shares redeemed                                   (545,481)               (9,278,007)             (592,793)             (9,222,026)
------------------------------------------------------------------------------------------------------------------------------------
Net Increase                                       778,880             $  13,072,660               881,543            $ 13,103,667
====================================================================================================================================
</TABLE>

*    For Class Y shares, transactions are for the period from February 6, 1996
     (inception date) to December 31, 1996.

--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -- Large Cap Value Fund                              17
<PAGE>
 
================================================================================
 Financial Highlights
================================================================================

For a share of each class of capital stock outstanding throughout each year:

<TABLE>
<CAPTION>
Class A Shares                                                     1997          1996           1995         1994(1)        1993
====================================================================================================================================
<S>                                                             <C>           <C>            <C>           <C>           <C>   
Net Asset Value, Beginning of Year                                $14.79        $14.59         $12.18        $13.31        $12.48
------------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
   Net investment income                                            0.29          0.36           0.39          0.43          0.46
   Net realized and unrealized gain (loss)                          3.80          1.99           3.59         (1.00)         1.56
------------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations                                 4.09          2.35           3.98         (0.57)         2.02
------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
   Net investment income                                           (0.29)        (0.36)         (0.39)        (0.42)        (0.46)
   Net realized gains(2)                                           (1.50)        (1.79)         (1.18)        (0.14)        (0.73)
------------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                                (1.79)        (2.15)         (1.57)        (0.56)        (1.19)
------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                                      $17.09        $14.79         $14.59        $12.18        $13.31
------------------------------------------------------------------------------------------------------------------------------------
Total Return                                                       27.86%        16.06%         33.05%        (4.31)%       16.38%
------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                                  $758,708      $645,935       $617,431      $544,572      $627,870
------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
   Expenses                                                         0.92%         0.95%          1.02%         0.96%         0.91%
   Net investment income                                            1.71          2.28           2.78          3.31          3.42
------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                               40%           49%            51%           27%           46%
------------------------------------------------------------------------------------------------------------------------------------
Average commissions per share
   paid on equity transactions(3)                                  $0.06         $0.06          $0.06         --            --
====================================================================================================================================
</TABLE>

(1)  On October 10, 1994 the former Class C shares were exchanged into Class A
     shares; therefore for the period from January 1, 1994 to October 9, 1994
     the Class C share activity is included with the Class A share activity.
(2)  Net short-term gains, if any, are included and reported as ordinary income
     for income tax purposes.
(3)  As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.

--------------------------------------------------------------------------------
18                 Special 30th Anniversary - 1997 Annual Report to Shareholders
<PAGE>
 
================================================================================
 Financial Highlights (continued)
================================================================================

For a share of each class of capital stock outstanding throughout each year:

<TABLE>
<CAPTION>
Class B Shares                                                                 1997           1996          1995         1994(1)
====================================================================================================================================
<S>                                                                           <C>            <C>           <C>           <C>   
Net Asset Value, Beginning of Year                                            $14.74         $14.54        $12.15        $12.54
------------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
   Net investment income                                                        0.16           0.25          0.24          0.03
   Net realized and unrealized gain (loss)                                      3.78           1.98          3.62         (0.19)
------------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations                                             3.94           2.23          3.86         (0.16)
------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
   Net investment income                                                       (0.15)         (0.24)        (0.29)        (0.09)
   Net realized gains(2)                                                       (1.50)         (1.79)        (1.18)        (0.14)
------------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                                            (1.65)         (2.03)        (1.47)        (0.23)
------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                                                  $17.03         $14.74        $14.54        $12.15
Total Return                                                                   26.83%         15.22%        32.07%        (1.28)%++
------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                                               $28,525        $14,883        $6,065          $354
------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
   Expenses                                                                     1.71%          1.71%         1.73%         1.59%+*
   Net investment income                                                        0.92           1.55          1.83          2.11+
------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                                           40%            49%           51%           27%
------------------------------------------------------------------------------------------------------------------------------------
Average commissions per share
   paid on equity transactions(3)                                              $0.06          $0.06         $0.06         --
====================================================================================================================================
</TABLE>

(1)  For the period from November 7, 1994 (inception date) to December 31, 1994.
(2)  Net short-term gains, if any, are included and reported as ordinary income
     for income tax purposes.
(3)  As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.
*    Figure has been restated from December 31, 1994 annual report.
++   Total return is not annualized, as it may not be representative of the
     total return for the year.
+    Annualized.

--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -- Large Cap Value Fund                              19
<PAGE>
 
================================================================================
 Financial Highlights (continued)
================================================================================

For a share of each class of capital stock outstanding throughout each year:


<TABLE>
<CAPTION>
Class C Shares                                                     1997          1996           1995         1994(1)        1993
====================================================================================================================================
<S>                                                               <C>           <C>            <C>           <C>           <C>   
Net Asset Value, Beginning of Year                                $14.76        $14.57         $12.18        $13.30        $12.48
------------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
   Net investment income                                            0.16          0.24           0.27          0.31          0.38
   Net realized and unrealized gain (loss)                          3.79          1.98           3.59         (0.95)         1.53
------------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations                                 3.95          2.22           3.86         (0.64)         1.91
------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
   Net investment income                                           (0.16)        (0.24)         (0.29)        (0.34)        (0.36)
   Net realized gains(2)                                           (1.50)        (1.79)         (1.18)        (0.14)        (0.73)
------------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                                (1.66)        (2.03)         (1.47)        (0.48)        (1.09)
------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                                      $17.05        $14.76         $14.57        $12.18        $13.30
------------------------------------------------------------------------------------------------------------------------------------
Total Return                                                       26.85%        15.15%         32.01%        (4.91)%       15.46%
------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                                   $42,115       $33,365        $29,758       $27,507       $15,408
------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
   Expenses                                                         1.69%         1.73%          1.79%         1.75%         1.65%
   Net investment income                                            0.93          1.50           2.00          2.49          2.59
------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                               40%           49%            51%           27%           46%
------------------------------------------------------------------------------------------------------------------------------------
Average commissions per share
   paid on equity transactions(3)                                  $0.06         $0.06          $0.06            --            --
====================================================================================================================================
</TABLE>

(1)  On November 7, 1994, the former Class B shares were renamed Class C shares.
(2)  Net short-term gains, if any, are included and reported as ordinary income
     for income tax purposes.
(3)  As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.



--------------------------------------------------------------------------------
20                Special 30th Anniversary -- 1997 Annual Report to Shareholders
<PAGE>
 
================================================================================
 Financial Highlights (continued)
================================================================================

For a share of each class of capital stock outstanding throughout each year:

<TABLE>
<CAPTION>
Class Y Shares                                          1997          1996(1)(2)
================================================================================
<S>                                                  <C>              <C>    
Net Asset Value, Beginning of Year                     $14.80          $15.06
--------------------------------------------------------------------------------
Income From Operations:
   Net investment income                                 0.38            0.36
   Net realized and unrealized gain                      3.76            1.58
--------------------------------------------------------------------------------
Total Income From Operations                             4.14            1.94
--------------------------------------------------------------------------------
Less Distributions From:
   Net investment income                                (0.35)          (0.41)
   Net realized gains(3)                                (1.50)          (1.79)
--------------------------------------------------------------------------------
Total Distributions                                     (1.85)          (2.20)
--------------------------------------------------------------------------------
Net Asset Value, End of Year                           $17.09          $14.80
--------------------------------------------------------------------------------
Total Return                                            28.21%          12.86%++
--------------------------------------------------------------------------------
Net Assets, End of Year (000s)                       $111,690         $30,169
--------------------------------------------------------------------------------
Ratios to Average Net Assets:
   Expenses                                              0.60%           0.66%+
   Net investment income                                 2.06            3.02+
--------------------------------------------------------------------------------
Portfolio Turnover Rate                                    40%             49%
--------------------------------------------------------------------------------
Average commissions per share
   paid on equity transactions(4)                       $0.06           $0.06
================================================================================
</TABLE>

(1)  Per share amounts have been calculated using the monthly average shares
     method, rather than the undistributed net investment income method, because
     it more accurately reflects the per share data for the period.
(2)  For the period from February 6, 1996 (inception date) to December 31, 1996.
(3)  Net short term gains, if any, are included and reported as ordinary income
     for income tax purposes. 
(4)  As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.
++   Total return is not annualized, as it may not be representative of the
     total return for the year.
+    Annualized.

--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -  Large Cap Value Fund                              21
<PAGE>
 
================================================================================
 Financial Highlights (continued)
================================================================================

For a share of each class of capital stock outstanding throughout each year:


<TABLE>
<CAPTION>
Class Z Shares                                                             1997            1996           1995          1994(1)
====================================================================================================================================
<S>                                                                       <C>             <C>            <C>            <C>   
Net Asset Value, Beginning of Year                                        $14.82          $14.61         $12.19         $12.54
------------------------------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
   Net investment income                                                    0.35            0.42           0.43           0.07
   Net realized and unrealized gain (loss)                                  3.80            1.99           3.59          (0.16)
------------------------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations                                         4.15            2.41           4.02          (0.09)
------------------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
   Net investment income                                                   (0.35)          (0.41)         (0.42)         (0.12)
   Net realized gains(2)                                                   (1.50)          (1.79)         (1.18)         (0.14)
------------------------------------------------------------------------------------------------------------------------------------
Total Distributions                                                        (1.85)          (2.20)         (1.60)         (0.26)
------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year                                              $17.12          $14.82         $14.61         $12.19
------------------------------------------------------------------------------------------------------------------------------------
Total Return                                                               28.27%          16.47%         33.41%          (0.73)%++
------------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)                                          $144,008        $113,160        $98,661        $80,010
------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
   Expenses                                                                 0.60%           0.62%          0.69%          0.42%+
   Net investment income                                                    2.03            2.62           3.11           3.88+
------------------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                                       40%             49%            51%            27%
------------------------------------------------------------------------------------------------------------------------------------
Average commissions per share
   paid on equity transactions(3)                                          $0.06           $0.06          $0.06             --
====================================================================================================================================
</TABLE>

(1)  For the period from November 7, 1994 (inception date) to December 31, 1994.
(2)  Net short term gains, if any, are included and reported as ordinary income
     for income tax purposes.
(3)  As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.
++   Total return is not annualized, as it may not be representative of the
     total return for the year.
+    Annualized.

--------------------------------------------------------------------------------
22                 Special 30th Anniversary - 1997 Annual Report to Shareholders
<PAGE>
 
================================================================================
 Independent Auditors' Report
================================================================================

To the Board of Directors and Shareholders of
Smith Barney Funds, Inc.:

     We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of the Large Cap Value Fund of Smith
Barney Funds, Inc., as of December 31, 1997, the related statement of operations
for the year then ended, the statements of changes in net assets for each of the
years in the two-year period then ended and financial highlights for each of the
years in the five-year period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.

     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1997, by correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of the
Large Cap Value Fund of Smith Barney Funds, Inc. as of December 31, 1997, the
results of its operations for the year then ended, the changes in its net assets
for each of the years in the two-year period then ended and the financial
highlights for each of the years in the five-year period then ended, in
conformity with generally accepted accounting principles.




                                                       /s/ KPMG Peat Marwick LLP

New York, New York
February 10, 1998



--------------------------------------------------------------------------------
Smith Barney Funds, Inc. -  Large Cap Value Fund                              23
<PAGE>
 
================================================================================
 Tax Information (unaudited)
================================================================================

For Federal tax purposes the Fund hereby designates for the fiscal year ended
December 31, 1997:

     o    70.20% of the ordinary dividends paid as qualifying for the corporate
          dividends received deduction.

     o    The Taxpayer Relief Act of 1997 enacted differing rates of tax on
          various long-term capital gain transactions. As a result, the Fund
          designates:

          o    Total long-term capital gain distributions paid $77,728,759.
                    $36,493,229 are considered "28 percent rate gains".
                    $41,235,530 are considered "20 percent rate gains".









--------------------------------------------------------------------------------
24                Special 30th Anniversary -- 1997 Annual Report to Shareholders
<PAGE>
 
Smith Barney
Funds, Inc.

<TABLE>
<S>                                       <C>
Directors                                 Investment Adviser                           
Donald R. Foley                           Mutual Management Corp.                      
Paul Hardin                                                                            
Heath B. McLendon, Chairman                                                            
Roderick C. Rasmussen                     Distributor                                  
Bruce D. Sargent                          Smith Barney Inc.                            
John P. Toolan                                                                         
                                                                                       
Joseph H. Fleiss, Emeritus                Custodian                                    
C. Richard Youngdahl, Emeritus            PNC Bank, N.A.                               
                                                                                       
                                                                                       
Officers                                  Shareholder Servicing Agent                  
Heath B. McLendon                         First Data Investor Services Group, Inc.     
President and Chief Executive Officer     P.O. Box 9134                                
                                          Boston, MA 02205-9134                        
Lewis E. Daidone                                                                       
Senior Vice President and Treasurer                                                    
                                                                                       
Bruce D. Sargent, CFA                     This report is submitted for the general     
Vice President                            information of the shareholders of Smith     
                                          Barney Funds, Inc. -- Large Cap Value Fund.  
Thomas M. Reynolds                        It is not for distribution to prospective    
Controller                                investors unless accompanied by an effective 
                                          Prospectus for the Fund, which contains      
Christina T. Sydor                        information concerning the Fund's investment 
Secretary                                 policies and expenses as well as other       
                                          pertinent information.                       
                                                                                       
                                                                                       
                                                                                       
                                          SMITH BARNEY                                  
                                          --------------------------------------
                                               A Member of TravelersGroup [LOGO]
                                                                                       
                                                                                       
                                                                                       
                                          Smith Barney Funds, Inc.                     
                                          Smith Barney Mutual Funds                    
                                          388 Greenwich Street                         
                                          New York, New York 10013                     
                                          www.smithbarney.com                          
                                                                                       
                                                                                       
                                          FD0853 2/98                                  




</TABLE>