As filed with the Securities and Exchange Commission on October 9, 2003
Securities Act File No. 333-107928
Investment Company Act File No. 811-05397
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM N-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Pre-Effective Amendment No. 1 [X]
Post-Effective Amendment No. [ ]
and/or
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940
Amendment No. 12 [X]
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Royce Focus Trust, Inc.
(Exact Name of Registrant as Specified In Charter)
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1414 Avenue of the Americas, New York, New York 10019
(Address of Principal Executive Offices)
(800) 221-4268
(Registrant's Telephone Number, including Area Code)
Charles M. Royce, President
Royce Focus Trust, Inc.
1414 Avenue of the Americas
New York, New York 10019
(Name and Address of Agent for Service)
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Copies to:
Frank P. Bruno, Esq. John E. Denneen, Esq. Cynthia G. Cobden, Esq.
Sidley Austin Brown & Wood LLP Royce Focus Trust, Inc. Simpson Thacher & Bartlett LLP
787 Seventh Avenue 1414 Avenue of the Americas 425 Lexington Avenue
New York, New York 10019 New York, New York 10019 New York, New York 10017
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Approximate Date of Proposed Public Offering:
As soon as practicable after the effective date of this Registration Statement.
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If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), other than securities offered only in
connection with dividend or interest reinvestment plans, check the following
box. [ ]
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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Proposed
Proposed Maximum Amount
Amount Maximum Aggregate of
Being Offering Price Offering Registration
Title of Securities Being Registered Registered (1) Per Unit (1) Price(1) Fee(2)
----------------------------------------------------- ------------------- ---------------- -------------------- -------------------
__% Cumulative Preferred Stock ($.001 par value).... 1,000,000 shares $25.00 $25,000,000 $2,023
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(1) Estimated solely for the purpose of calculating the registration fee.
(2) $81 was previously paid in connection with the Registrant's initial
registration statement filed with the Securities and Exchange Commission (the
"Commission") on August 13, 2003. $1,942 was transmitted to the Commission's
designated lockbox at Mellon Bank in Pittsburgh, PA. in connection with this
filing.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE
OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE
REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES
THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN
ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL
THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS
THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
The information in this Prospectus is not complete and may be changed. These
securities may not be sold until the registration statement filed with the
Securities and Exchange Commission is effective. This Prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state or other jurisdictions where the offer or sale is not
permitted.
SUBJECT TO COMPLETION, DATED OCTOBER 9, 2003
PROSPECTUS
1,000,000 SHARES
ROYCE FOCUS TRUST, INC.
% CUMULATIVE PREFERRED STOCK
LIQUIDATION PREFERENCE $25.00 PER SHARE
-----------------
The % Cumulative Preferred Stock initial liquidation preference $25.00
per share (the "Cumulative Preferred Stock") is being offered by Royce Focus
Trust, Inc. (the "Fund"). The Fund is a closed-end diversified management
investment company. The Fund's investment goal is long-term capital growth. The
Fund normally invests at least 75% of its assets in equity securities. The
Fund's address is 1414 Avenue of the Americas, New York, New York 10019, and its
telephone number is (212) 355-7311. Royce & Associates, LLC ("Royce") is the
Fund's investment adviser.
Dividends on the Cumulative Preferred Stock offered hereby, at the
annual rate of % of the initial liquidation preference of $25.00 per share, are
cumulative from the Date of Original Issue thereof and are payable quarterly on
March 23, June 23, September 23 and December 23, commencing on December 23,
2003.
(Continued on following page)
-----------------
INVESTING IN THE CUMULATIVE PREFERRED STOCK INVOLVES RISKS. SEE
"PROSPECTUS SUMMARY -- SPECIAL CONSIDERATIONS AND RISK FACTORS" BEGINNING ON
PAGE 9 AND "INVESTMENT GOAL, POLICIES AND RISKS" BEGINNING ON PAGE 22.
-----------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or passed upon the
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
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Per Share Total
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Public Offering Price (1) $25.00 $25,000,000
Underwriting Discount (2) $ $
Proceeds to the Fund (before expenses)(3) $ $
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(1) Plus accumulated dividends, if any, from October , 2003.
(2) The Fund and Royce have agreed to indemnify the Underwriters against
certain liabilities, including liabilities under the Securities Act of
1933, as amended.
(3) Offering expenses payable by the Fund are estimated at $196,525.
-----------------
The shares of Cumulative Preferred Stock offered hereby are offered by
the Underwriters listed in this Prospectus, subject to receipt and acceptance by
them and subject to their right to reject any order in whole or in part. It is
expected that delivery of the Cumulative Preferred Stock will be made in
book-entry form only through the facilities of The Depository Trust Company
("DTC") in New York, New York on or about October , 2003, which is the
business day following the date of this Prospectus, against payment therefore
in immediately available funds.
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Joint Book-Running Managers
CITIGROUP UBS INVESTMENT BANK
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LEGG MASON WOOD WALKER
Incorporated
October , 2003
(Continued from cover page)
Application will be made to list the Cumulative Preferred Stock on the
New York Stock Exchange (the "NYSE"). If approved, trading of the Cumulative
Preferred Stock on the NYSE is expected to commence within 30 days of the date
of this Prospectus. Prior to this offering, there has been no public market for
the Cumulative Preferred Stock. See "Underwriting".
Distributions paid on the Cumulative Preferred Stock will consist of:
(i) long-term capital gains, (ii) qualified dividend income, (iii) other
ordinary income and/or (iv) returns of capital. The Jobs and Growth Tax Relief
Reconciliation Act of 2003 (the "2003 Tax Act") reduced the individual Federal
income tax rate on long-term capital gains and qualified dividend income to a
maximum of 15%. Under the 2003 Tax Act, the maximum individual Federal income
tax rate on other ordinary income is 35%. These tax rates are scheduled to apply
through 2008. Assuming the 2003 Tax Act had been in effect during the past one,
three and five years ended December 31, 2002, approximately 94%, 78% and 75% of
the distributions paid by the Fund would have consisted of less highly taxed
long-term capital gains and qualified dividend income. It is currently expected
that dividends paid on the Cumulative Preferred Stock will consist primarily of
such long-term capital gains and qualified dividend income, which are taxed at
lower rates for individuals than other ordinary income. See "Tax Attributes of
Preferred Stock Dividends" and "Taxation". No assurance can be given, however,
as to what percentage, if any, of the dividends paid on the Cumulative Preferred
Stock will consist of long-term capital gains and qualified dividend income.
It is a condition to the issuance of the Cumulative Preferred Stock
that it be rated Aaa by Moody's Investors Service, Inc. ("Moody's"). In
connection with the receipt of such rating, the Fund will be required to
maintain a discounted asset coverage with respect to the Cumulative Preferred
Stock reflecting guidelines established by Moody's. See "Rating Agency
Guidelines".
The Cumulative Preferred Stock is subject to mandatory redemption, in
whole or in part, by the Fund for cash at a price equal to $25.00 per share plus
accumulated but unpaid dividends (whether or not earned or declared) through the
date of redemption (the "Redemption Price") if the Fund fails to maintain a
quarterly asset coverage of at least 200% or fails to maintain the discounted
asset coverage required by Moody's. Commencing October , 2008 and thereafter,
the Fund at its option may redeem the Cumulative Preferred Stock, in whole or in
part, for cash at a price equal to the Redemption Price. Prior to October ,
2008, the Cumulative Preferred Stock will be redeemable, at the option of the
Fund, for cash at a price equal to the Redemption Price, only to the extent
necessary for the Fund to continue to qualify for tax treatment as a regulated
investment company. See "Description of Cumulative Preferred Stock --
Redemption".
If the Fund voluntarily terminates compliance with the Moody's
guidelines, the Fund will no longer be required to maintain the discounted asset
coverage required by Moody's. However, at the time of such termination, the
Cumulative Preferred Stock must have received a rating from at least one
nationally recognized statistical rating organization that is at least
comparable to the then current rating from Moody's. The Fund will then be
required to comply with the guidelines established by such successor rating
organization. See "Rating Agency Guidelines" and "Description of Cumulative
Preferred Stock -- Termination of Rating Agency Guidelines".
This Prospectus concisely sets forth certain information an investor
should know before investing and should be retained for future reference.
A Statement of Additional Information dated October , 2003 has been
filed with the Securities and Exchange Commission and is incorporated by
reference in this Prospectus. The table of contents of the Statement of
Additional Information appears on page 48 of this Prospectus. A copy of the
Statement of Additional Information may be obtained without charge by writing to
the Fund at its address at 1414 Avenue of the Americas, New York, New York
10019, or by calling the Fund toll-free at (800) 221-4268.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR
EFFECT TRANSACTIONS WHICH STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE MARKET
PRICE OF THE CUMULATIVE PREFERRED STOCK, INCLUDING THE ENTRY OF STABILIZING
BIDS, SYNDICATE COVERING TRANSACTIONS OR THE IMPOSITION OF PENALTY BIDS. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING".
YOU SHOULD RELY ON THE INFORMATION CONTAINED IN OR INCORPORATED BY
REFERENCE INTO THIS PROSPECTUS. NEITHER THE FUND NOR THE UNDERWRITERS HAVE
AUTHORIZED ANY OTHER PERSON TO PROVIDE YOU WITH DIFFERENT INFORMATION. IF ANYONE
PROVIDES YOU WITH DIFFERENT OR INCONSISTENT INFORMATION, YOU SHOULD NOT RELY ON
IT. NEITHER THE FUND NOR THE UNDERWRITERS ARE MAKING AN OFFER TO SELL THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. YOU
SHOULD ASSUME THAT THE INFORMATION APPEARING IN THIS PROSPECTUS IS ACCURATE AS
OF THE DATE ON THE FRONT COVER OF THIS PROSPECTUS ONLY.
----------------------
TABLE OF CONTENTS
PAGE
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PROSPECTUS SUMMARY.............................................................4
FINANCIAL HIGHLIGHTS..........................................................15
TAX ATTRIBUTES OF PREFERRED STOCK DIVIDENDS...................................18
THE FUND......................................................................20
USE OF PROCEEDS...............................................................20
CAPITALIZATION................................................................21
PORTFOLIO COMPOSITION.........................................................22
INVESTMENT GOAL, POLICIES AND RISKS...........................................22
RATINGS AGENCY GUIDELINES.....................................................29
INVESTMENT ADVISORY AND OTHER SERVICES........................................30
DESCRIPTION OF CUMULATIVE PREFERRED STOCK.....................................32
DESCRIPTION OF CAPITAL STOCK..................................................40
TAXATION......................................................................42
CUSTODIAN, DIVIDEND-PAYING AGENT, TRANSFER AGENT AND REGISTRAR................44
UNDERWRITING..................................................................44
LEGAL MATTERS.................................................................46
EXPERTS.......................................................................46
ADDITIONAL INFORMATION........................................................47
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS.............................47
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION......................48
GLOSSARY......................................................................49
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PROSPECTUS SUMMARY
This is only a summary. You should review the more detailed information
included elsewhere in this Prospectus and the Statement of Additional
Information. Capitalized terms not otherwise defined in this Summary are defined
in the Glossary that appears at the end of this Prospectus.
THE FUND............... Royce Focus Trust, Inc. (the "Fund") has been engaged in
business as a closed-end diversified management
investment company since its initial offering in March
1988. Since November 1, 1996, when Royce & Associates,
LLC ("Royce") became its investment adviser, the Fund's
investment goal has been long-term capital growth. Royce
normally invests at least 75% of the Fund's assets in
equity securities. Royce uses a value approach to invest
the Fund's assets in a limited number of domestic and
foreign companies. While the Fund is not restricted as
to stock market capitalization, Royce focuses the Fund's
investments primarily in small-cap companies (companies
with stock market capitalizations below $2 billion) with
significant business activities in the United States.
See "Investment Goal, Policies and Risks".
THE OFFERING........... The Fund is offering 1,000,000 shares of %
Cumulative Preferred Stock, par value $.001 per share,
initial liquidation preference $25.00 per share (the
"Cumulative Preferred Stock"), at a purchase price of
$25.00 per share.
USE OF PROCEEDS........ The Fund will use a substantial portion of the net
proceeds from the offering of the Cumulative Preferred
Stock to redeem the issued and outstanding shares of
7.45% Cumulative Preferred Stock, par value $.001 per
share, of the Fund (the "7.45% Preferred"). In order for
the Fund to redeem the 7.45% Preferred, the Fund must
pay the 7.45% Preferred's aggregate initial liquidation
preference of $20,000,000, plus an amount equal to
accumulated and unpaid dividends (whether or not earned
or declared) on the 7.45% Preferred through the
redemption date. Royce expects to use any proceeds
remaining after the redemption of the 7.45% Preferred to
purchase additional portfolio securities in accordance
with the Fund's investment goal and policies. See "Use
of Proceeds".
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DIVIDENDS.............. Dividends on the Cumulative Preferred Stock, at the
annual rate of % of the initial liquidation preference
of $25.00 per share, are cumulative from the Date of
Original Issue and are payable, when, as and if
authorized by the Board of Directors and declared by the
Fund, out of funds legally available therefor, quarterly
on March 23, June 23, September 23, and December 23,
commencing on December 23, 2003, to the holders of
record on the preceding March 6, June 6, September 6 and
December 6, respectively. See "Description of Cumulative
Preferred Stock-- Dividends".
LONG-TERM CAPITAL GAINS
AND QUALIFIED DIVIDEND
INCOME................. The Jobs and Growth Tax Relief Reconciliation Act of
2003 (the "2003 Tax Act") reduced the individual Federal
income tax rate on long-term capital gains and qualified
dividend income to a maximum of 15%. Long-term capital
gains and qualified dividend income included in
distributions of a regulated investment company (such as
the Fund) to its stockholders are generally passed
through to such stockholders, including preferred
stockholders, and taxed at the related rates. See "Tax
Attributes of Preferred Stock Dividends" and "Taxation".
The 15% income tax rate applicable to capital gains and
qualified dividend income is scheduled to expire after
December 31, 2008. After this date, absent extension or
modification of the relevant legislative provisions,
long-term capital gains distributions paid by the Fund
generally will be taxable at the previously applicable
maximum 20% rate, and distributions attributable to
qualified dividend income will be taxed to the
stockholder at his or her marginal Federal income tax
rate (which generally will be higher than 15%).
TAX ATTRIBUTES OF
PREFERRED STOCK
DIVIDENDS.............. The distributions paid on the Cumulative Preferred Stock
will, for Federal income tax purposes, consist of
varying proportions of long-term capital gains,
qualified dividend income, other ordinary income
(including short-term capital gain and interest income
and non-qualified dividend income), and/or returns of
capital. Ordinary income, other than qualified dividend
income but including short-term capital gains, interest
income and non-qualified dividend income, is referred to
in this
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Prospectus as "Other Ordinary Income". The Fund is
required to allocate long-term capital gains, qualified
dividend income and/or Other Ordinary Income
proportionately among holders of shares of its Common
Stock and the Cumulative Preferred Stock offered hereby.
Assuming the 2003 Tax Act had been in effect during the
past one, three and five years ended December 31, 2002,
the distributions of taxable income by the Fund would
have consisted of approximately 94%, 78% and 75%
long-term capital gains and qualified dividend income
and approximately 6%, 22% and 25% Other Ordinary Income.
Certain investors in the Cumulative Preferred Stock may
realize a tax benefit to the extent that Fund
distributions are composed of long-term capital gains
and qualified dividend income rather than more highly
taxed Other Ordinary Income. See "Tax Attributes of
Preferred Stock Dividends". No assurance can be given,
however, as to what percentage, if any, of the
distributions to be paid on the Cumulative Preferred
Stock will consist of long-term capital gains and/or
qualified dividend income. To the extent that such
distributions do not consist of long-term capital gains
and qualified dividend income, they will be paid from
Other Ordinary Income taxable at higher Federal income
tax rates, or will represent a return of capital.
Subject to statutory limitations, investors may also be
entitled to offset the long-term capital gains portion
of a Cumulative Preferred Stock dividend with capital
losses incurred by such investors. See "Taxation".
RATING................. It is a condition to its issuance that the Cumulative
Preferred Stock be issued with a rating of Aaa from
Moody's Investors Service, Inc. ("Moody's"). The
Articles Supplementary creating and fixing the rights
and preferences of the Cumulative Preferred Stock (the
"Articles Supplementary") contain certain provisions
which reflect guidelines established by Moody's (the
"Rating Agency Guidelines") in order to obtain such
rating on the Cumulative Preferred Stock on the Date of
Original Issue. Although it is the Fund's present
intention to continue to comply with the Rating Agency
Guidelines, the Board of Directors of the Fund may
determine that it is not in the best interest of the
Fund to continue to comply with the Rating Agency
Guidelines. If the Fund voluntarily terminates
compliance with the
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Rating Agency Guidelines, the Fund will no longer be
required to maintain the discounted asset coverage
required by Moody's. However, at the time of such
termination, the Cumulative Preferred Stock must have
received a rating from at least one nationally
recognized statistical rating organization ("NRSRO")
that is at least comparable to the then current rating
from Moody's. The Fund will then be required to comply
with the guidelines established by such successor NRSRO.
See "Description of Cumulative Preferred Stock--
Termination of Rating Agency Guidelines".
ASSET MAINTENANCE...... The Fund will be required to maintain, as of the last
Business Day of March, June, September and December of
each year, Asset Coverage of at least 200% with respect
to the Cumulative Preferred Stock. Assuming the Fund had
issued and sold the Cumulative Preferred Stock and
redeemed the 7.45% Preferred as of June 30, 2003, the
Asset Coverage would have been 371%. See "Description of
Cumulative Preferred Stock-- Asset Maintenance-- Asset
Coverage".
Also, pursuant to the Rating Agency Guidelines, the Fund
will be required to maintain, as of each Valuation Date,
a Portfolio Calculation for Moody's at least equal to
the Basic Maintenance Amount. The discount factors and
guidelines for determining the Portfolio Calculation
have been established by Moody's in connection with the
Fund's receipt from Moody's of a rating on the
Cumulative Preferred Stock on the Date of Original Issue
of Aaa. See "Description of Cumulative Preferred Stock
-- Asset Maintenance -- Basic Maintenance Amount" and
"Rating Agency Guidelines".
VOTING RIGHTS.......... At all times, holders of shares of Cumulative Preferred
Stock and any other Preferred Stock will elect two
members of the Fund's Board of Directors, and holders of
shares of Cumulative Preferred Stock, any other
Preferred Stock and Common Stock, voting as a single
class, will elect the remaining directors. However, upon
a failure by the Fund to pay dividends on the Cumulative
Preferred Stock and/or any other Preferred Stock in an
amount equal to two full years' dividends, holders of
Cumulative Preferred Stock, voting as a separate class
together with the holders of any other Preferred Stock,
will have the right to elect the smallest number of
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7
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directors that would constitute a majority of the
directors until cumulative dividends have been paid or
provided for. Holders of Cumulative Preferred Stock and
any other Preferred Stock will vote separately as a
class on certain other matters, as required under the
Articles Supplementary and the Investment Company Act of
1940, as amended (the "1940 Act").
Except as otherwise indicated in this Prospectus and as
otherwise required by applicable law, holders of
Cumulative Preferred Stock will be entitled to one vote
per share on each matter submitted to a vote of
stockholders and will vote together with holders of
shares of Common Stock and any other Preferred Stock as
a single class. See "Description of Cumulative Preferred
Stock -- Voting Rights".
MANDATORY REDEMPTION... The Cumulative Preferred Stock is subject to mandatory
redemption, in whole or in part, by the Fund in the
event that the Fund fails to: (i) maintain the quarterly
Asset Coverage, or (ii) maintain a Portfolio Calculation
at least equal to the Basic Maintenance Amount required
by Moody's and does not cure such failure by the
applicable cure date. Any such redemption will be made
for cash at a price equal to $25.00 per share plus
accumulated and unpaid dividends (whether or not earned
or declared) through the redemption date (the
"Redemption Price"). In the event that shares of
Cumulative Preferred Stock are redeemed due to a failure
to maintain the quarterly Asset Coverage, the Fund may
redeem a sufficient number of shares of Cumulative
Preferred Stock so that the asset coverage, as defined
in the 1940 Act, of the remaining outstanding shares of
Cumulative Preferred Stock and any other Preferred Stock
after such redemption is up to 275%. In the event that
shares of Cumulative Preferred Stock are redeemed due to
a failure to maintain a Portfolio Calculation at least
equal to the Basic Maintenance Amount, the Fund may
redeem a sufficient number of shares of Cumulative
Preferred Stock and any other Preferred Stock so that
the Portfolio Calculation exceeds the Basic Maintenance
Amount of the remaining outstanding shares of Cumulative
Preferred Stock and any other Preferred Stock by up to
10%. See "Description of Cumulative Preferred Stock--
Redemption-- Mandatory Redemption".
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OPTIONAL REDEMPTION.... Commencing October , 2008 and thereafter, the Fund at
its option may redeem the Cumulative Preferred Stock, in
whole or in part, for cash at a price equal to the
Redemption Price. Prior to October , 2008, the
Cumulative Preferred Stock will be redeemable at the
option of the Fund at the Redemption Price, only to the
extent necessary for the Fund to continue to qualify for
tax treatment as a regulated investment company. See
"Description of Cumulative Preferred Stock - Redemption
- Optional Redemption".
LIQUIDATION PREFERENCE. The liquidation preference of each share of Cumulative
Preferred Stock is $25.00 plus an amount equal to all
unpaid dividends accumulated to and including the date
fixed for such distribution or payment (whether or not
earned or declared but excluding interest thereon). The
initial liquidation preference is $25.00 per share. See
"Description of Cumulative Preferred Stock --
Liquidation Rights".
LISTING................ Prior to this offering, there has been no public market
for the Cumulative Preferred Stock. Application will be
made to list the shares of Cumulative Preferred Stock on
the New York Stock Exchange (the "NYSE"). However,
during an initial period, which is not expected to
exceed 30 days from the date of this Prospectus, the
Cumulative Preferred Stock will not be listed on any
securities exchange. During such period, the
Underwriters intend to make a market in the Cumulative
Preferred Stock; however, they have no obligation to do
so. Consequently, an investment in the Cumulative
Preferred Stock may be illiquid during such period.
SPECIAL CONSIDERATIONS
AND RISK FACTORS....... General. The market price for the Cumulative Preferred
Stock will be influenced by changes in interest rates,
the perceived credit quality of the Cumulative Preferred
Stock and other factors.
Liquidity. During an initial period which is not
expected to exceed 30 days after the date of issuance,
the Cumulative Preferred Stock will not be listed on any
securities exchange. During such period, the
Underwriters intend to make a market in the Cumulative
Preferred Stock; however, they have no obligation to do
so. Consequently, the Cumulative Preferred Stock may be
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illiquid during such period. No assurance can be
provided that listing on any securities exchange or
market making by the Underwriters will result in the
market for Cumulative Preferred Stock being liquid at
any time.
Credit Rating. The credit rating on the Cumulative
Preferred Stock could be reduced or withdrawn by Moody's
or a successor NRSRO, if any, while an investor holds
shares of Cumulative Preferred Stock, either as a result
of the Fund's termination of compliance with the Rating
Agency Guidelines or otherwise. The credit rating does
not eliminate or mitigate the risks of investing in the
Cumulative Preferred Stock. A reduction or withdrawal of
the credit rating by Moody's or a successor NRSRO, if
any, may have an adverse effect on the liquidity and
market value of the Cumulative Preferred Stock. See
"Description of Cumulative Preferred Stock --
Termination of Rating Agency Guidelines".
Market, Selection and Style Risk. As with any investment
company that invests in common stocks, the value of the
Fund's portfolio may decline. For example, if an issuer
of a common stock in which the Fund invests experiences
financial difficulties, defaults on its senior
securities, has the credit rating on its senior
securities reduced or withdrawn, or otherwise is
affected by adverse market factors, the Fund's portfolio
will be negatively impacted. In particular, the prices
of small-cap companies are generally more volatile and
their markets are generally less liquid relative to
larger-cap companies. Therefore, an investment in the
Fund may involve more risk of loss than funds investing
in larger-cap companies or other asset classes. See
"Investment Goal, Policies and Risks -- Risk Factors -
Investing in Small-Cap Companies". In addition,
different types of investment styles tend to shift into
and out of favor with stock market investors, depending
on market and economic conditions. The performance of
funds that invest in value-style stocks may at times be
better or worse than the performance of stock funds that
focus on other types of stocks or have a broader
investment style.
Declines in the value of the Fund's portfolio may reduce
the asset coverage for the Cumulative Preferred Stock or
the Fund's income. As indicated above, the Cumulative
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Preferred Stock is subject to redemption under specified
circumstances. To the extent that the Fund experiences a
substantial decline in the value of its net assets, it
may be required to redeem Cumulative Preferred Stock to
restore compliance with the applicable asset maintenance
requirements. See "Description of Cumulative Preferred
Stock -- Redemption -- Mandatory Redemption".
Sufficiently sharp declines in the value of the Fund's
assets could leave the Fund with insufficient assets to
redeem all of the Cumulative Preferred Stock for the
full redemption price.
Investing in a Limited Number of Companies. Because the
Fund invests in a limited number of companies,
developments affecting an individual issuer are likely
to have a greater impact on the Fund's net asset value
and the market price of its Common Stock.
Foreign Investments. The Fund invests a portion of its
assets in securities of foreign issuers. Foreign
investments involve certain additional risks, such as
political or economic instability of the issuer or of
the country of issue, fluctuating exchange rates, less
government regulation of foreign securities markets and
the possibility of imposition of exchange controls,
nationalization or expropriation of assets and more
difficulty obtaining information on the foreign
companies.
Indebtedness and Other Preferred Stock. Payments to the
holders of Cumulative Preferred Stock of dividends or
upon redemption or in liquidation will be subject to the
prior payments of interest and repayment of principal
then due on any outstanding indebtedness of the Fund and
the contemporaneous payment to holders of any other
outstanding Preferred Stock of dividends, upon
redemption or in liquidation. Assuming the Fund had
issued and sold the Cumulative Preferred Stock and
redeemed the 7.45% Preferred as of June 30, 2003, the
Fund would have had no outstanding indebtedness and no
Preferred Stock ranking on parity with the Cumulative
Preferred Stock offered hereby as to dividends and
payment upon liquidation. See "Investment Goal, Policies
and Risks -- Borrowing Money and Issuing Senior
Securities". The Fund may issue additional Preferred
Stock under the circumstances set forth under
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"Description of Cumulative Preferred Stock-- Limitations
on Issuance of Additional Preferred Stock".
Leverage and Borrowing. The Fund is authorized to borrow
money. So long as the Cumulative Preferred Stock is
rated by Moody's, however, the Fund cannot borrow for
investment leverage purposes. Borrowings create an
opportunity for greater capital appreciation with
respect to the Fund's investment portfolio, but at the
same time such borrowing is speculative in that it will
increase the Fund's exposure to capital risk. In
additional, borrowed funds are subject to interest costs
that my offset or exceed the return earned on the
borrowed funds.
Restrictions on Dividends and Other Distributions. The
Fund has qualified, and intends to remain qualified for
Federal income tax purposes, as a regulated investment
company. Qualification requires, among other things,
compliance by the Fund with certain distribution
requirements. If the Fund does not meet the asset
coverage requirements set forth in the 1940 Act or the
Articles Supplementary, the Fund will be required to
suspend distributions to holders of its Common Stock
until such asset coverage is restored. See "Description
of Cumulative Preferred Stock -- Dividends". Such a
limitation on distributions could jeopardize the Fund's
ability to meet the above-referenced distribution
requirements. Although the Fund presently intends, to
the extent possible, to purchase or redeem Cumulative
Preferred Stock and/or any other Preferred Stock to
maintain its qualification as a regulated investment
company, no assurance can be given that such actions can
be effected in time to meet the above-referenced
distribution requirements.
Redemption. As set forth above, the Cumulative Preferred
Stock is subject to both mandatory and optional
redemption under specified circumstances at a redemption
price equal to $25.00 per share plus accumulated and
unpaid dividends (whether or not earned or declared)
through the redemption date. Upon redemption,
stockholders may not be able to reinvest the proceeds
received from the redemption in an investment providing
the same or a better rate than that of the Cumulative
Preferred Stock.
--------------------------------------------------------------------------------
12
--------------------------------------------------------------------------------
Certain Corporate Governance Provisions. Certain
provisions of the Fund's Charter and Bylaws may have the
effect of maintaining the continuity of management and
may make it more difficult for the Fund's stockholders
to change the majority of the Board of Directors. See
"Description of Capital Stock -- Certain Corporate
Governance Provisions".
FEDERAL INCOME TAX
CONSIDERATIONS......... As set forth above, the Fund has qualified, and intends
to remain qualified for Federal income tax purposes, as
a regulated investment company. Qualification requires,
among other things, compliance by the Fund with certain
distribution requirements. Limitations on distributions
if the Fund failed to satisfy the Asset Coverage or
Portfolio Calculation requirements could jeopardize the
Fund's ability to meet tax-related distribution
requirements. The Fund presently intends, however, to
the extent possible, to purchase or redeem Cumulative
Preferred Stock and/or any other Preferred Stock if
necessary in order to maintain compliance with such
distribution requirements. See "Taxation" for a more
complete discussion of these and other Federal income
tax considerations.
INVESTMENT ADVISER..... Royce has served as the investment adviser to the Fund
since November 1, 1996. Royce also serves as investment
adviser to other registered management investment
companies, privately offered funds and institutional
accounts. As of September 30, 2003, Royce managed
approximately $12.6 billion in assets for the Fund and
other client accounts.
Charles M. Royce is Royce's President and Chief
Investment Officer. Royce's investment staff also
includes three other Senior Portfolio Managers: W.
Whitney George, Managing Director and Vice President, is
the Fund's portfolio manager; Boniface A. Zaino,
Managing Director; and Charles R. Dreifus, Principal.
Royce's investment staff is assisted by Jack E. Fockler,
Jr., Managing Director and Vice President. See
"Investment Advisory and Other Services -- Portfolio
Management" herein and "Directors and Officers" in the
Statement of Additional Information.
--------------------------------------------------------------------------------
13
--------------------------------------------------------------------------------
As compensation for its services under the Investment
Advisory Agreement, Royce is entitled to receive a
monthly fee equal to 1/12 of 1% (1% on an annualized
basis) of the Fund's average net assets (including
assets obtained from the sale of Preferred Stock) for
each month during the term of such Agreement.
Royce has volunteered to waive the portion of its
investment advisory fee attributable to the liquidation
preference of the 7.45% Preferred and the Cumulative
Preferred Stock (net of the liquidation preference of
the 7.45% Preferred) for any month when the Fund's net
asset value average annual total return since the
initial issuance of the 7.45% Preferred or the
Cumulative Preferred Stock fails to exceed the blended
dividend rate on those assets. See "Investment Advisory
and Other Services -- Advisory Fee"
CUSTODIAN, DIVIDEND-
PAYING AGENT, TRANSFER
AGENT AND REGISTRAR.... State Street Bank and Trust Company, acts as custodian
of the cash and other assets of the Fund. Equiserve
Trust Company, N.A. acts as transfer agent,
dividend-paying agent and registrar for the Fund's
shares and as agent to provide notice of redemption and
certain voting rights for the Cumulative Preferred
Stock. See "Custodian, Dividend-Paying Agent, Transfer
Agent and Registrar".
--------------------------------------------------------------------------------
14
FINANCIAL HIGHLIGHTS
The financial highlights table is intended to help you understand the
Fund's financial performance for the periods presented and reflects financial
results for a single share of the Fund's Common Stock. The total returns in the
table represent the rate that an investor would have earned on an investment in
the Fund's Common Stock (assuming reinvestment of all dividends and
distributions). The information for the six months ended June 30, 2003 has not
been audited and is included in the Statement of Additional Information, which
is available upon request. The information for each of the five years in the
period ended December 31, 2002 has been audited by Tait, Weller & Baker, whose
report, along with the Fund's financial statements, is included in the Statement
of Additional Information, which is available upon request.
15
Six months
ended Years ended December 31,
June 30, 2003 --------------------------------------------------------------------------------
(unaudited) 2002 2001 2000 1999 1998 1997 1996+ 1995 1994 1993
--------------- ------- ------ ------- ------- ------ ------ -------- ------- ------ -------
NET ASSET VALUE, BEGINNING
OF PERIOD......................... $6.27 $7.28 $6.77 $5.94 $5.63 $6.04 $5.52 $5.09 $4.70 $5.24 $4.99
--------------- ------- ------ ------- ------- ------ ------ -------- ------- ------ -------
INVESTMENT OPERATIONS:
Net investment income (loss)... 0.02 (0.01) 0.05 0.12 0.08 0.12 0.08 0.06 0.13 0.19 0.04
Net realized and unrealized
gain (loss) on investments and
foreign currency............... 1.23 (0.74) 0.79 1.26 0.58 (0.35) 1.12 0.35 0.36 (0.62) 0.46
------------------------------------------------------------------------------------------------
Total investment operations... 1.25 (0.75) 0.84 1.38 0.66 (0.23) 1.20 0.41 0.49 (0.43) 0.50
------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED
STOCKHOLDERS:
Net investment income.......... - (0.03) (0.04) (0.03) (0.01) (0.16) - - - - -
Net realized gain on
investments.................... - (0.13) (0.13) (0.14) (0.17) (0.02) (0.01) - - - -
Quarterly distributions*....... (0.08) - - - - - - - - - -
------------------------------------------------------------------------------------------------
Total distributions to
Preferred Stockholders........ (0.08) (0.16) (0.17) (0.17) (0.18) (0.18) (0.01) - - - -
------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET
ASSETS APPLICABLE TO COMMON
STOCKHOLDERS RESULTING FROM
INVESTMENT OPERATIONS............. 1.17 (0.91) 0.67 1.21 0.48 (0.41) 1.19 0.41 0.49 (0.43) 0.50
------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO COMMON
STOCKHOLDERS:
Net investment income.......... - (0.02) (0.03) (0.06) (0.01) - (0.12) - (0.16) (0.11) (0.03)
Net realized gain on
investments and foreign
currency..................... - (0.07) (0.11) (0.28) (0.14) - (0.41) - (0.01) - (0.22)
------------------------------------------------------------------------------------------------
Total distributions to
Common Stockholders`.......... - (0.09) (0.14) (0.34) (0.15) - (0.53) - (0.17) (0.11) (0.25)
------------------------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Effect of reinvestment of
distributions by Common
Stockholders................... - (0.01) (0.02) (0.04) (0.02) - (0.04) - - - -
Effect of Preferred Stock
Offering....................... - - - - - - (0.10) - - - -
Other Sources ................. - - - - - - - 0.02 0.07 - -
------------------------------------------------------------------------------------------------
Total capital stock
transactions.................. - (0.01) (0.02) (0.04) (0.02) - (0.14) 0.02 0.07 - -
================================================================================================
NET ASSET VALUE, END OF PERIOD $7.44 $6.27 $7.28 $6.77 $5.94 $5.63 $6.04 $5.52 $5.09 $4.70 $5.24
================================================================================================
MARKET VALUE, END OF PERIOD $6.77 $5.56 $6.65 $5.69 $4.72 $4.88 $5.06 $4.59 $4.19 $3.56 $4.31
================================================================================================
TOTAL RETURN(a):
Market Value...................... 21.8%*** (15.1)% 19.7% 27.9% (0.3)% (3.7)% 21.3% 9.6% 22.3% (17.4)% 9.3%
Net Asset Value................... 18.7%*** (12.5)% 10.0% 20.9% 8.7% (6.8)% 20.5% - - - -
RATIOS BASED ON AVERAGE
NET ASSETS APPLICABLE TO
COMMON STOCKHOLDERS:
Total expenses (b,c).............. 1.48%** 1.88% 1.47% 1.44% 1.51% 1.62% 0.94% 1.91% 2.14% 2.27% 2.43%
Management fee expense......... 1.00%** 1.13% 1.11% 1.00% 1.00% 1.14% 0.39% 0.83% 1.00% 1.00% 1.00%
Other operating expenses....... 0.48%** 0.75% 0.36% 0.44% 0.51% 0.48% 0.55% 1.08% 1.14% 1.27% 1.43%
Net investment income (loss)...... 0.57%** (0.16)% 0.70% 1.93% 1.47% 1.95% 1.35% 1.80% 2.80% 3.81% 0.74%
SUPPLEMENTAL DATA:
Net Assets Applicable to
Common Stockholders; End of
Period (in thousands)............. $68,730 $57,956 $66,654 $60,933 $51,003 $47,457 $50,893 $44,154 $41,385 $41,106 $45,839
Liquidation Value of
Preferred Stock; End of
Period (in thousands)............. $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 - - - -
Portfolio Turnover Rate........... 34% 61% 54% 69% 60% 90% 74% 159% 76% 483% 445%
Average Commission Rate
Paid (d).......................... $0.0463 $0.0482 $0.0517 $0.0597 $0.060 $0.0620 $0.0610 $0.0396
PREFERRED STOCK:
Total shares outstanding.......... 800,000 800,000 800,000 800,000 800,000 800,000 800,000 - - - -
Asset coverage per share.......... $110.91 $97.44 $108.32 $101.17 $88.75 $84.32 $88.62 - - - -
Liquidation preference per share.. $25.00 $25.00 $25.00 $25.00 $25.00 $25.00 $25.00 - - - -
Average market value per share(e). $25.62 $25.64 $25.09 $22.23 $24.00 $25.16 $25.25 - - - -
16
+ Royce has served as the investment adviser to the Fund since November 1,
1996.
(a) The Market Value Total Return is calculated assuming a purchase of Common
Stock on the opening of the first business day and a sale on the closing
of the last business day of each period reported. Dividends and
distributions, if any, are assumed for the purposes of this calculation,
to be reinvested at prices obtained under the Fund's Distribution
Reinvestment and Cash Purchase Plan. Net Asset Value Total Return is
calculated on the same basis, except that the Fund's net asset value is
used on the purchase and sale dates instead of market value. For years
prior to 1997, the Net Asset Value Total Return is not available.
(b) Expense ratios based on total average net assets including liquidation
value of Preferred Stock were 1.10%, 1.43%, 1.11%, 1.05%, 1.06%, 1.16%,
0.90%, 1.91%, 2.14%, 2.27%, and 2.43% for the six months ended June 30,
2003 and for the years ended December 31, 2002, 2001, 2000, 1999, 1998,
1997, 1996, 1995, 1994 and 1993, respectively.
(c) Expense ratios based on average net assets applicable to Common
Stockholders before waiver of fees by the investment adviser would have
been 1.82%, 2.06%, 1.69%, 1.81%, 1.93%, 1.88%, 1.60% and 2.08% for the
six months ended June 30, 2003 and for the years ended December 31, 2002,
2001, 2000, 1999, 1998, 1997 and 1996, respectively.
(d) For fiscal years beginning after October 1, 1995, the Fund is required to
disclose its average commission rate paid per share for purchases and
sales of investments.
(e) The average of month-end market values during the period.
* To be allocated to net investment income and capital gains at year-end.
** Annualized.
*** Not annualized.
17
TAX ATTRIBUTES OF PREFERRED STOCK DIVIDENDS
The Fund intends to distribute to its stockholders substantially all of
its long-term capital gains, qualified dividend income, and Other Ordinary
Income. The Fund is a regulated investment company ("RIC"), and a RIC's
distributions generally retain their character as long-term capital gains,
qualified dividend income, or Other Ordinary Income when received by its
preferred and common stockholders. Thus, distributions paid by the Fund to
holders of the Cumulative Preferred Stock will, for Federal income tax purposes,
consist of varying proportions of long-term capital gains, qualified dividend
income, described below, Other Ordinary Income, and/or returns of capital.
The 2003 Tax Act reduced the individual Federal income tax rate on
long-term capital gains and qualified dividend income to a maximum of 15%.
Qualified dividend income consists of dividends paid by domestic corporations
and certain foreign corporations. Under the 2003 Tax Act, the maximum individual
Federal income tax rate on Other Ordinary Income is 35%. These tax rates are
scheduled to apply through 2008. Assuming the 2003 Tax Act had been in effect
during the past one, three and five years ended December 31, 2002, the
distributions of taxable income by the Fund would have consisted of
approximately 94%, 78% and 75% long-term capital gains and qualified dividend
income and approximately 6%, 22% and 25% Other Ordinary Income. No assurance can
be given, however, as to what percentage, if any, of the dividends paid on the
Cumulative Preferred Stock will consist of long-term capital gains and qualified
dividend income, which are taxed at lower rates for individuals than Other
Ordinary Income.
Although the Fund is not managed utilizing a tax-focused investment
strategy and does not seek to achieve any particular distribution composition,
its primary investment goal is long-term capital growth. Accordingly, certain
individual investors in the Cumulative Preferred Stock would, under current
Federal income tax law, also realize a tax advantage on their investment to the
extent that Fund distributions continue to consist primarily of long-term
capital gains and qualified dividend income rather than more highly taxed Other
Ordinary Income. The Federal income tax characteristics of the Fund and the
taxation of its stockholders are described more fully under "Taxation".
ASSUMPTIONS
The following table shows examples of the pure Other Ordinary Income
equivalent yield that would be generated by the indicated dividend rate on the
Cumulative Preferred Stock, assuming distributions consisting of three different
proportions of long-term capital gains, qualified dividend income and Other
Ordinary Income for an individual investor in the 35% Federal marginal income
tax bracket. In reading these tables, prospective investors should understand
that a number of factors could affect the actual composition for Federal income
tax purposes of the Fund's distributions each year. Such factors include (i) the
Fund's investment performance for any particular year, which may result in
varying proportions of long-term capital gains, qualified dividend income, Other
Ordinary Income and/or return of capital in the year's distribution and (ii) the
timing of the realization of gains and losses during the Fund's taxable year.
18
THESE TABLES ARE FOR ILLUSTRATIVE PURPOSES ONLY AND CANNOT BE TAKEN AS
AN INDICATION OF THE ACTUAL COMPOSITION FOR FEDERAL INCOME TAX PURPOSES OF THE
FUND'S FUTURE DISTRIBUTIONS.
PERCENTAGE OF CUMULATIVE PREFERRED STOCK A CUMULATIVE PREFERRED STOCK
ANNUAL DIVIDEND COMPOSED OF ANNUAL DIVIDEND RATE OF
------------------------------------------------------ ------------------------------------------------------
5.50% 5.75% 6.00%
LONG-TERM CAPITAL GAINS AND
QUALIFIED DIVIDEND INCOME** OTHER ORDINARY INCOME IS EQUIVALENT TO AN OTHER ORDINARY INCOME YIELD OF
---------------------------- ------------------------- ------------------------------------------------------
90% 10% 7.02% 7.34% 7.66%
75% 25% 6.77% 7.08% 7.38%
50% 50% 6.35% 6.63% 6.92%
Assuming that long-term capital gains and qualified dividend income
comprise 90% of a stated Cumulative Preferred Stock dividend and that Other
Ordinary Income comprises the remaining 10% of that Cumulative Preferred Stock
dividend, the following table shows the pure Other Ordinary Income equivalent
yields that would be generated at the stated dividend rate for taxpayers in the
indicated tax brackets.
A CUMULATIVE PREFERRED STOCK
ANNUAL DIVIDEND RATE OF
--------------------------------------------------------
5.50% 5.75% 6.00%
2003 FEDERAL MARGINAL INCOME TAX BRACKET* IS EQUIVALENT TO AN OTHER ORDINARY INCOME YIELD OF
------------------------------------------------------------ --------------------------------------------------------
35.0%................................................... 7.02% 7.34% 7.66%
33.0%................................................... 6.83% 7.14% 7.45%
28.0%................................................... 6.39% 6.68% 6.98%
25.0%**................................................. 6.16% 6.44% 6.72%
--------------
* Annual taxable income levels corresponding to the 2003 Federal marginal
tax brackets are as follows: 35.0% -- over $311,950 for both single and joint
returns; 33.0% -- $143,501 - $311,950 for single returns, $174,701 - $311,950
for joint returns; 28.0% -- $68,801 - $143,500 for single returns, $114,651 -
$174,700 for joint returns; and 25.0% -- $28,401 - $68,800 for single returns,
$56,801 - $114,650 for joint returns. An investor's Federal marginal income tax
rates may exceed the rates shown in the above table due to the reduction, or
possible elimination, of the personal exemption deduction for high-income
taxpayers and an overall limit on itemized deductions. Income also may be
subject to certain state, local and foreign taxes. For investors who pay
alternative minimum tax, equivalent yields may be lower than those shown above.
The tax rates shown above do not apply to corporate taxpayers.
** Assumes that such individuals are taxed at a 15% rate on long-term
capital gains and qualified dividend income received from the Fund.
19
THE FUND
The Fund is a closed-end diversified management investment company. It
was incorporated under the name "America's All Season Fund, Inc." under the laws
of the State of Maryland on October 30, 1987 and registered under the 1940 Act.
The Fund commenced operations in March 1988. Assuming the Fund had issued and
sold the Cumulative Preferred Stock and redeemed the 7.45% Preferred as of June
30, 2003, the Fund would have had 9,241,025 shares of Common Stock issued and
outstanding, with an aggregate net asset value of $67,746,470, and 1,000,000
shares of Cumulative Preferred Stock issued and outstanding, with an aggregate
initial liquidation preference of $25,000,000. The Fund's principal office is
located at 1414 Avenue of the Americas, New York, New York 10019, and its
telephone number is (800) 221-4268.
Since November 1, 1996, when Royce became its investment adviser, the
Fund's investment goal has been long-term capital growth. Royce normally invests
at least 75% of the Fund's assets in equity securities. An investment in the
Fund is not appropriate for all investors. No assurance can be given that the
Fund's investment goal will be realized. See "Investment Goal, Policies and
Risks".
USE OF PROCEEDS
The net proceeds from the offering of the Cumulative Preferred Stock
are estimated at $24,015,975, after deduction of the underwriting discounts and
estimated offering expenses payable by the Fund. The Fund will use a substantial
portion of the net proceeds from the offering of the Cumulative Preferred Stock
to redeem the 7.45% Preferred. In order for the Fund to redeem the 7.45%
Preferred, the Fund must pay the 7.45% Preferred's aggregate initial liquidation
preference of $20,000,000, plus an amount equal to accumulated and unpaid
dividends (whether or not earned or declared) on the 7.45% Preferred through the
redemption date. Royce expects to invest any proceeds remaining after the
redemption of the 7.45% Preferred in accordance with the Fund's investment goal
and policies within approximately six months from the completion of the
offering, depending on market conditions for the types of securities in which
the Fund principally invests. Pending any such investment, the proceeds will be
held in high quality short-term debt securities and instruments and money market
mutual funds. Any delay by Royce in investing such remaining proceeds may hinder
the Fund's ability to achieve its investment goal.
20
CAPITALIZATION
The following table sets forth the capitalization of the Fund as of
June 30, 2003, and as adjusted to give effect to the issuance of the Cumulative
Preferred Stock and the redemption of the 7.45% Preferred.
OUTSTANDING AS ADJUSTED
----------- -----------
Preferred stock, $.001 par value per share:
7.45% Cumulative Preferred Stock, authorized 5,000,000 shares,
issued and outstanding 800,000 shares...................... $ 20,000,000 $ -
% Cumulative Preferred Stock, as adjusted, authorized
1,000,000 shares, issued and outstanding 1,000,000 shares.. - 25,000,000
---------------- ----------------
$ 20,000,000 $ 25,000,000
================ ================
Common stock, $.001 par value per share:
Initially authorized 100,000,000 shares, issued and
outstanding 9,241,025 shares............................... $ 9,241 $ 9,241
Additional paid-in capital...................................... 45,713,027 44,729,002(1)
Undistributed net investment income............................. 165,852 165,852
Accumulated net realized gain on investments.................... 5,356,492 5,356,492
Net unrealized appreciation on investments...................... 18,263,995 18,263,995
Quarterly and accrued distributions............................. (778,112) (778,112)
---------------- ----------------
Net assets applicable to outstanding common stock............... $ 68,730,495 $ 67,746,470
================ ================
-------------
(1) After deducting underwriting discounts and estimated costs of this
offering of $984,025.
21
PORTFOLIO COMPOSITION
The following tables set forth certain information with respect to the
Fund's investment portfolio as of June 30, 2003.
VALUE PERCENTAGE
----- ----------
Common stocks......................................... $66,458,817 75.3%
Corporate bonds....................................... 2,940,000 3.3%
Government bonds...................................... 5,025,385 5.7%
U.S. Treasury obligations............................. 5,344,725 6.1%
Repurchase agreement.................................. 8,442,000 9.6%
------------- -----------
Total investments.............................. $88,210,927 100.0%
============= ===========
SECTOR WEIGHTINGS IN COMMON STOCK PORTFOLIO
Technology............................................ $12,186,378 13.8%
Natural Resources..................................... 10,806,126 12.3%
Health................................................ 9,245,672 10.5%
Financial Intermediaries.............................. 8,243,290 9.3%
Industrial Products................................... 8,056,806 9.1%
Industrial Services................................... 6,323,000 7.2%
Consumer Products..................................... 5,492,950 6.2%
Consumer Services..................................... 4,577,676 5.2%
Financial Services.................................... 1,526,919 1.7%
------------- -----------
Total common stocks............................ $ 66,458,817 75.3%
============= ===========
OTHER INFORMATION REGARDING COMMON STOCK INVESTMENTS
Number of issuers.................................... 50
Median market capitalization......................... $812 million
INVESTMENT GOAL, POLICIES AND RISKS
INVESTMENT GOAL
The Fund's investment goal and one of its fundamental policies is
long-term capital growth. Royce normally invests at least 75% of the Fund's
assets in equity securities. Royce uses a value approach to invest the Fund's
assets in a limited number of domestic and foreign companies. While the Fund is
not restricted as to stock market capitalization, Royce focuses the Fund's
investments primarily in small-cap companies (companies with stock market
capitalizations below $2 billion) with significant business activities in the
United States. Stock market capitalization is calculated by multiplying the
total number of common shares issued and outstanding by the per share market
price of the common stock.
The Fund may invest up to 25% of its assets in direct obligations of
the U.S. Government or its agencies and in the non-convertible preferred stocks
and debt securities of domestic and foreign companies.
There are market risks inherent in any investment, and no assurance can
be given that the Fund's primary investment goal will be achieved.
22
INVESTMENT POLICIES
Royce invests the Fund's assets primarily in a limited number of
companies selected using a value approach. While it does not limit the stock
market capitalizations of the companies in which the Fund may invest, Royce has
historically focused on small-cap equity securities (companies with stock market
capitalizations below $2 billion).
Royce uses a value method in managing the Fund's assets. In selecting
securities for the Fund, Royce evaluates the quality of a company's balance
sheet, the level of its cash flows and various measures of a company's
profitability. Royce then uses these factors to assess the company's current
worth, basing this assessment on either what it believes a knowledgeable buyer
might pay to acquire the entire company or what it thinks the value of the
company should be in the stock market. This analysis takes a number of factors
into consideration, including the company's future growth prospects and current
financial condition.
Royce invests in securities of companies that are trading significantly
below its estimate of the company's "current worth" in an attempt to reduce the
risk of overpaying for such companies. Royce's value approach strives to reduce
some of the other risks of investing in small-cap companies (for the Fund's
portfolio taken as a whole) by evaluating various other risk factors. Royce
attempts to lessen financial risk by buying companies that combine strong
balance sheets with low leverage. While no assurance can be given that this
risk-averse value approach will be successful, Royce believes that it can reduce
some of the risks of investing in the securities of small-cap companies, which
are inherently fragile in nature and whose securities have substantially greater
market price volatility. Although Royce's approach to security selection seeks
to reduce downside risk to the Fund's portfolio, especially during periods of
broad small-cap market declines, it may also potentially have the effect of
limiting gains in strong small-cap up markets.
Foreign Investments. The Fund invests a portion of its assets in
securities of foreign issuers. In most instances, investments will be made in
companies principally based, or whose securities are traded in, the United
States or the other developed countries of North America, Europe, Asia,
Australia and New Zealand and not in emerging markets countries. Royce intends
to invest primarily in American Depository Receipts ("ADRs"), in U.S.
exchange-listed securities and in Nasdaq National Market System securities.
Foreign investments involve certain risks which typically are not
present in securities of domestic issuers. There may be less information
available about a foreign company than a domestic company; foreign companies may
not be subject to accounting, auditing and reporting standards and requirements
comparable to those applicable to domestic companies; and foreign markets,
brokers and issuers are generally subject to less extensive government
regulation than their domestic counterparts. Foreign securities may be less
liquid and may be subject to greater price volatility than domestic securities.
Foreign investments also may be subject to local economic and political risks
which might adversely affect the Fund's ability to realize on its investment in
such securities. No assurance can be given that Royce will be able to anticipate
these potential events or counter their effects.
23
The Fund does not expect to purchase or sell foreign currencies to
hedge against declines in the U.S. dollar or to lock in the value of the foreign
securities it purchases, and its foreign investments may be adversely affected
by changes in foreign currency rates. Consequently, the risks associated with
such investments may be greater than if the Fund did engage in foreign currency
transactions for hedging purposes.
Income earned or received by the Fund from sources within foreign
countries may be subject to withholding and other taxes imposed by such
countries. See "Taxation" below and in the Statement of Additional Information.
Depositary Receipts. The Fund may invest in the securities of foreign
issuers in the form of sponsored or unsponsored ADRs, European Depositary
Receipts ("EDRs") and Global Depositary Receipts ("GDRs") (collectively,
"Depositary Receipts") or other securities convertible into securities of
foreign issuers. Depositary Receipts may not necessarily be denominated in the
same currency as the underlying securities into which they may be converted.
ADRs are receipts typically issued by an American bank or trust company that
evidence ownership of underlying securities issued by a foreign corporation.
EDRs are receipts issued in Europe that evidence a similar ownership
arrangement. GDRs are receipts issued throughout the world that evidence a
similar arrangement. Generally, ADRs, in registered form, are designed for use
in the U.S. securities markets, and EDRs, in bearer form, are designed for use
in European securities markets. GDRs are tradeable both in the U.S. and in
Europe and are designed for use throughout the world. Depositary Receipts are
alternatives to the purchase of the underlying foreign securities in their
national markets and currencies. The Fund may invest in unsponsored Depositary
Receipts. The issuers of unsponsored Depositary Receipts are not obligated to
disclose material information in the United States and, therefore, there may be
less information available regarding such issuers and there may not be a
correlation between such information and the market value of the Depositary
Receipts. Depositary Receipts also involve the risks associated with other
investments in foreign securities, as discussed above.
Fixed Income Securities. Up to 25% of the Fund's assets may be invested
in direct obligations of the U.S. Government or its agencies and in
non-convertible preferred stocks and debt securities of various domestic and
foreign issuers, including up to 5% of its assets in below investment-grade debt
securities, also known as high-yield/high-risk securities. There are no limits
on the maturity or duration of the fixed income securities in which the Fund may
invest.
Two of the main risks of investing in fixed income securities are
credit risk and interest rate risk. Below investment-grade debt securities may
be in the lowest-rated categories of recognized rating agencies (C in the case
of Moody's or D in the case of S&P) or may be unrated. Such high-yield/high-risk
investments are primarily speculative and may entail substantial risk of loss of
principal and non-payment of interest, but may also produce above-average
returns for the Fund. Debt securities rated C or D may be in default as to the
payment of interest or repayment of principal. As of the date of this
Prospectus, interest rates are near historical lows which makes it more likely
that they will increase in the future which could, in turn, result in a decline
in the market value of the fixed income securities held by the Fund.
Warrants, Rights or Options. The Fund may invest up to 5% of its assets
in warrants, rights or options. A warrant, right or call option entitles the
holder to purchase a given security
24
within a specified period for a specified price and does not represent an
ownership interest in the underlying security. A put option gives the holder the
right to sell a particular security at a specified price during the term of the
option. These securities have no voting rights, pay no dividends and have no
liquidation rights. In addition, market prices of warrants, rights or call
options do not necessarily move parallel to the market prices of the underlying
securities; market prices of put options tend to move inversely to the market
prices of the underlying securities.
Securities Lending. The Fund may lend up to 25% of its assets to
brokers, dealers and other financial institutions. However, under the Rating
Agency Guidelines, the Fund may not lend portfolio securities in excess of 15%
of its total assets. The Rating Agency Guidelines may in the future be amended
to permit the Fund to lend a greater percentage of its total assets. Securities
lending allows the Fund to retain ownership of the securities loaned and, at the
same time, to earn additional income. Since there may be delays in the recovery
of loaned securities or even a loss of rights in collateral supplied should the
borrower fail financially, loans will be made only to parties that participate
in a global securities lending program organized and monitored by the Fund's
custodian and who are deemed by it to be of good standing. Furthermore, such
loans will be made only if, in Royce's judgment, the consideration to be earned
from such loans would justify the risk.
The current view of the staff of the Securities and Exchange Commission
(the "Commission") is that a fund may engage in such loan transactions only
under the following conditions: (i) the fund must receive 100% collateral in the
form of cash or cash equivalents (e.g., U.S. Treasury bills or notes) from the
borrower; (ii) the borrower must increase the collateral whenever the market
value of the securities loaned (determined on a daily basis at the close of
regular trading) rises above the value of the collateral; (iii) after giving
notice, the fund must be able to terminate the loan at any time; (iv) the fund
must receive reasonable interest on the loan or a flat fee from the borrower, as
well as amounts equivalent to any dividends, interest or other distributions on
the securities loaned; (v) the fund may pay only reasonable custodian fees in
connection with the loan; and (vi) the fund must be able to vote proxies on the
securities loaned, either by terminating the loan or by entering into an
alternative arrangement with the borrower.
Reverse Repurchase Agreements. The Fund is also authorized to enter
into reverse repurchase agreements. However, the Rating Agency Guidelines
prohibit such transactions. Such agreements involve the sale of securities held
by the Fund pursuant to an agreement to repurchase the securities at an
agreed-upon price, date and interest payment. When effecting reverse repurchase
transactions, liquid securities of a dollar amount equal in value to the
securities subject to the agreement are required to be maintained in a
segregated account with the Fund's custodian bank, and the reverse repurchase
agreement is required to be marked to market each day.
25
Temporary Investments. The assets of the Fund are normally invested as
described above. However, for temporary defensive purposes (i.e., when Royce
determines that market conditions warrant) or when it has uncommitted cash
balances, the Fund may also invest in U.S. Treasury bills, domestic bank
certificates of deposit, repurchase agreements with its custodian bank covering
U.S. Treasury and agency obligations having a term of not more than one week,
high-quality commercial paper and money market funds registered under the 1940
Act or retain all or part of its assets in cash. Accordingly, the composition of
the Fund's portfolio may vary from time to time.
Repurchase agreements are in effect loans by the Fund to its custodian,
and the agreements for such transactions require the custodian to maintain
securities having a value at least equal to the amount loaned as collateral.
Repurchase agreements could involve certain risks if the custodian defaults or
becomes insolvent, including possible delays or restrictions upon the Fund's
ability to dispose of collateral.
CHANGES IN INVESTMENT GOAL AND POLICIES
The Fund's investment goal of long-term capital growth is a fundamental
policy of the Fund and may not be changed without approvals of the holders of a
majority of the Fund's outstanding shares of Common Stock and Cumulative
Preferred Stock and any other Preferred Stock, voting together as a single
class, and a majority of the Cumulative Preferred Stock and any other Preferred
Stock, voting as a separate class (which for this purpose and under the 1940 Act
means the lesser of (i) 67% or more of the relevant shares of capital stock of
the Fund present or represented at a meeting of stockholders, at which the
holders of more than 50% of the outstanding relevant shares of capital stock are
present or represented, or (ii) more than 50% of the outstanding relevant shares
of capital stock of the Fund). Except as indicated under "Investment
Restrictions" in the Statement of Additional Information, the Fund does not
consider its other policies to be fundamental, and such policies may be changed
by the Board of Directors without stockholder approval or prior notice to
stockholders.
The Fund's investment policies are subject to certain restrictions. See
"Investment Restrictions" in the Statement of Additional Information.
RISK FACTORS - INVESTING IN SMALL-CAP COMPANIES
While the Fund is not restricted as to stock market capitalization,
Royce focuses the Fund's investments primarily in small-cap companies (companies
with stock market capitalizations below $2 billion) with significant business
activities in the United States.
The securities of small-cap companies offer investment opportunities
and additional risks. They may not be well known to the investing public, may
not be significantly owned by institutional investors, and may not have steady
earnings growth. In addition, the securities of such companies may be more
volatile in price, have wider spreads between their bid and ask prices and have
significantly lower trading volumes than larger capitalization stocks. As a
result, the purchase or sale of more than a limited number of shares of a
small-cap security may affect its market price. Royce may need a considerable
amount of time to purchase or sell its positions in these securities,
particularly when other accounts managed by Royce or other investors are
26
also seeking to purchase or sell them. Accordingly, Royce's investment focus on
small-cap companies generally requires it to have a long-term (at least three
years) investment outlook for a portfolio security.
RISK FACTORS - RISK OF INVESTING IN A LIMITED NUMBER OF COMPANIES
Because the Fund invests in a limited number of companies, developments
affecting an individual issuer are likely to have a greater impact on the Fund's
net asset value and the market price of its Common Stock.
RISK FACTORS - LIQUIDITY RISK
During an initial period which is not expected to exceed 30 days after
the date of issuance, the Cumulative Preferred Stock will not be listed on any
securities exchange. During such period, the Underwriters intend to make a
market in the Cumulative Preferred Stock; however, they have no obligation to do
so. Consequently, the Cumulative Preferred Stock may be illiquid during such
period. No assurance can be provided that listing on any securities exchange or
market making by the Underwriters will result in the market for Cumulative
Preferred Stock being liquid at any time.
RISK FACTORS - CREDIT RATING RISK
The credit rating on the Cumulative Preferred Stock could be reduced or
withdrawn by Moody's or a successor NRSRO, if any, while an investor holds
shares of Cumulative Preferred Stock, either as a result of the Fund's
termination of compliance with the Rating Agency Guidelines or otherwise. The
credit rating does not eliminate or mitigate the risks of investing in the
Cumulative Preferred Stock. A reduction or withdrawal of the credit rating by
Moody's or a successor NRSRO, if any, may have an adverse effect on the
liquidity and market value of the Cumulative Preferred Stock. See "Description
of Cumulative Preferred Stock -- Termination of Rating Agency Guidelines".
RISK FACTORS - LEVERAGE AND BORROWING
The Fund is authorized to borrow money. So long as the Cumulative
Preferred Stock is rated by Moody's, however, the Fund cannot borrow for
investment leverage purposes. Borrowings create an opportunity for greater
capital appreciation with respect to the Fund's investment portfolio, but at the
same time such borrowing is speculative in that it will increase the Fund's
exposure to capital risk. In addition, borrowed funds are subject to interest
costs that may offset or exceed the return earned on the borrowed funds.
RISK FACTORS - RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS
The Fund has qualified, and intends to remain qualified for Federal
income tax purposes, as a regulated investment company. Qualification requires,
among other things, compliance by the Fund with certain distribution
requirements. If the Fund does not meet the asset coverage requirements set
forth in the 1940 Act or the Articles Supplementary, the Fund will be required
to suspend distributions to holders of its Common Stock until such asset
coverage is restored. See "Description of Cumulative Preferred Stock --
Dividends". Such a limitation on
27
distributions could jeopardize the Fund's ability to meet the above-referenced
distribution requirements. Although the Fund presently intends, to the extent
possible, to purchase or redeem Cumulative Preferred Stock and/or any other
Preferred Stock to maintain its qualification as a regulated investment company,
no assurance can be given that such actions can be effected in time to meet the
above-referenced distribution requirements. See "Taxation" in this Prospectus
and the Statement of Additional Information.
RISK FACTORS - REDEMPTION
The Cumulative Preferred Stock is subject to both mandatory and
optional redemption under specified circumstances at a redemption price equal to
$25.00 per share plus accumulated and unpaid dividends (whether or not earned or
declared) through the redemption date. Upon redemption, stockholders may not be
able to reinvest the proceeds received from the redemption in an investment
providing the same or a better rate than that of the Cumulative Preferred Stock.
For a description of the circumstances in which shares of Cumulative Preferred
Stock may be redeemed, see "Description of Cumulative Preferred Stock --
Redemption" in this Prospectus.
BORROWING MONEY AND ISSUING SENIOR SECURITIES
The 1940 Act and the Fund's fundamental investment policies and
restrictions (see "Investment Restrictions" in the Statement of Additional
Information) permit the Fund to borrow money from banks and certain other
lenders and to issue and sell senior securities (as defined by the 1940 Act)
representing other forms of indebtedness or consisting of Preferred Stock if
various requirements are met. Such requirements include initial asset coverage
tests of 300% for indebtedness and 200% for Preferred Stock and restrictive
provisions concerning Common Stock dividend payments and other distributions,
Preferred Stock dividend payments and other distributions (if indebtedness is
incurred), stock repurchases and maintenance of asset coverage and giving senior
securityholders the right to elect directors in the event specified asset
coverage tests are not met or dividends are not paid. While the issuance and
sale of senior securities allows the Fund to raise additional cash for
investments, it is a speculative investment technique, involving the risk
considerations of leverage, potential dilution and increased share price
volatility for the Fund's Common Stock. In addition, the Fund may be required to
sell investments in order to make required payments to senior securityholders
when it may be disadvantageous to do so.
The Cumulative Preferred Stock offered hereby is a senior security, as
defined by the 1940 Act, of the Fund, which means, among other things, it is
senior in priority to the Fund's Common Stock; however, it will rank junior to
any future indebtedness of the Fund. See "Description of Cumulative Preferred
Stock". Payments to the holders of Cumulative Preferred Stock of dividends or
upon redemption or in liquidation will be subject to the prior payment of
interest and repayment of principal then due on any outstanding indebtedness of
the Fund.
Assuming the Fund had issued and sold the Cumulative Preferred Stock
and redeemed the 7.45% Preferred as of June 30, 2003, the Fund would have had
9,241,025 shares of Common Stock issued and outstanding, with an aggregate net
asset value of $67,746,470, and 1,000,000 shares of Cumulative Preferred Stock,
par value $.001 per share, with an aggregate initial liquidation preference of
$25,000,000, issued and outstanding, and no outstanding indebtedness.
28
Accordingly, assuming the Fund had issued and sold the Cumulative Preferred
Stock and redeemed the 7.45% Preferred as of such date, the Fund could have,
under its investment policies and restrictions, issued and sold senior
securities representing indebtedness of up to approximately $46 million or
additional shares of Preferred Stock having an aggregate involuntary liquidation
preference of up to approximately $43 million or various combinations of lesser
amounts of both securities representing indebtedness and Preferred Stock.
RATINGS AGENCY GUIDELINES
Certain of the capitalized terms used herein are defined in the
Glossary that appears at the end of this Prospectus.
Moody's has established guidelines in connection with the Fund's
receipt from Moody's of a rating of Aaa for the Cumulative Preferred Stock on
the Date of Original Issue. Moody's, an NRSRO, issues ratings for various
securities reflecting the perceived creditworthiness of such securities. The
guidelines have been developed by Moody's in connection with issuances of
asset-backed and similar securities, including debt obligations and various
auction rate preferred stocks, generally on a case-by-case basis through
discussions with the issuers of these securities. The guidelines are designed to
ensure that assets underlying outstanding debt or preferred stock will be
sufficiently varied and will be of sufficient quality and amount to justify
investment-grade ratings. The guidelines do not have the force of law, but are
being adopted by the Fund in order to satisfy current requirements necessary for
Moody's to issue the above-described rating for the Cumulative Preferred Stock.
The guidelines provide a set of tests for portfolio composition and discounted
asset coverage that supplement (and in some cases are more restrictive than) the
applicable requirements of Section 18 of the 1940 Act. The Moody's guidelines
are included in the Articles Supplementary and are referred to in this
Prospectus as the "Rating Agency Guidelines".
The Fund intends to maintain a Portfolio Calculation at least equal to
the Basic Maintenance Amount. If the Fund fails to meet such requirement and
such failure is not cured by the applicable cure date, the Fund will be required
to redeem some or all of the Cumulative Preferred Stock. See "Description of
Cumulative Preferred Stock -- Redemption -- Mandatory Redemption". The Rating
Agency Guidelines also: (i) exclude certain types of securities in which the
Fund may invest from Moody's Eligible Assets and, therefore, from the Portfolio
Calculation, (ii) prohibit the Fund's acquisition of futures contracts or
options on futures contracts, (iii) prohibit reverse repurchase agreements, (iv)
limit the writing of options on portfolio securities and (v) limit the lending
of portfolio securities to 15% of the Fund's total assets. Royce does not
believe that compliance with the Rating Agency Guidelines will have an adverse
effect on its management of the Fund's portfolio or on the achievement of the
Fund's investment goal. For a further discussion of the Rating Agency
Guidelines, see "Description of Cumulative Preferred Stock".
The Fund may, but is not required to, adopt any modifications to the
Rating Agency Guidelines that may hereafter be established by Moody's. Failure
to adopt such modifications, however, may result in a change in the Moody's
rating or a withdrawal of a rating altogether. In addition, Moody's may, at any
time, change or withdraw such rating. The terms of the
29
Cumulative Preferred Stock provide that the interpretation or applicability of
any or all of the Rating Agency Guidelines may from time to time be modified by
the Board of Directors of the Fund in its sole discretion based on a
determination by the Board of Directors that such action is necessary or
appropriate with respect to the Cumulative Preferred Stock; provided, however,
that the Board of Directors receives written confirmation from Moody's that any
such modification would not impair the then current rating assigned to the
Cumulative Preferred Stock by Moody's. Furthermore, under certain circumstances,
the Board of Directors of the Fund may determine that it is not in the best
interests of the Fund to continue to comply with the Rating Agency Guidelines.
If the Fund terminates compliance with the Rating Agency Guidelines, it is
likely that Moody's will change its rating on the Cumulative Preferred Stock or
withdraw its rating altogether. However, at the time of such termination, the
Cumulative Preferred Stock must have received a rating from at least one NRSRO
that is at least comparable to the then current rating from Moody's. The Fund
will then be required to comply with the guidelines established by such
successor NRSRO. It is the Fund's present intention to continue to comply with
the Rating Agency Guidelines.
As recently described by Moody's, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The rating on the Cumulative Preferred Stock is not a
recommendation to purchase, hold or sell such shares, inasmuch as the rating
does not comment as to market price or suitability for a particular investor.
Moreover, the Rating Agency Guidelines do not address the likelihood that a
holder of Cumulative Preferred Stock will be able to sell such shares. The
rating is based on current information furnished to Moody's by the Fund and
Royce and information obtained from other sources. The rating may be changed,
suspended or withdrawn as a result of changes in, or the unavailability of, such
information.
INVESTMENT ADVISORY AND OTHER SERVICES
Royce & Associates, LLC (which term as used in this Prospectus includes
its corporate predecessor) ("Royce"), a Delaware limited liability company, is
an investment advisory firm whose predecessor was organized in February 1967.
Royce is registered as an investment adviser under the Investment Advisers Act
of 1940, as amended. Royce became investment adviser of the Fund in November
1996. Royce also serves as investment adviser to other management investment
companies and institutional accounts. As of September 30, 2003, Royce managed
approximately $12.6 billion in assets for the Fund and other client accounts.
Royce's principal business address is 1414 Avenue of the Americas, New York, New
York 10019.
On October 1, 2001, Royce became an indirect wholly-owned subsidiary of
Legg Mason, Inc. ("Legg Mason"). On March 31, 2002, Royce's corporate
predecessor was merged into Royce Holdings, LLC (a wholly-owned subsidiary of
Legg Mason), which then changed its name to Royce & Associates, LLC. As a result
of this merger, Royce & Associates, LLC became the Fund's investment adviser and
a direct wholly-owned subsidiary of Legg Mason. Founded in 1899, Legg Mason is a
publicly-held financial services company primarily engaged in providing asset
management, securities brokerage, investment banking and related financial
services through its subsidiaries. As of June 30, 2003, Legg Mason's asset
management subsidiaries had aggregate assets under management of approximately
$215.4 billion.
30
Under the Fund's Articles of Incorporation, as amended and supplemented
(the "Charter"), and Maryland law, the Fund's business and affairs are managed
under the direction of its Board of Directors. Investment decisions for the Fund
are made by Royce, subject to any direction it may receive from the Fund's Board
of Directors, which periodically reviews the Fund's investment performance.
PORTFOLIO MANAGEMENT
Royce is responsible for the management of the Fund's assets. Royce has
been investing in small-cap companies with a value approach for more than 25
years. Its offices are located at 1414 Avenue of the Americas, New York, NY
10019. Charles M. Royce has been the firm's President and Chief Investment
Officer during this period.
Royce's investment staff also includes three other Senior Portfolio
Managers: W. Whitney George, Managing Director and Vice President, is the Fund's
portfolio manager; Boniface A. Zaino, Managing Director; and Charles R. Dreifus,
Principal. Royce's investment staff is assisted by Jack E. Fockler, Jr.,
Managing Director and Vice President. Mr. George has been a Portfolio Manager at
Royce since 2000, and prior thereto was a Senior Analyst. He has been employed
by Royce since 1991. Mr. Zaino joined Royce in April 1998 as a Senior Portfolio
Manager and previously was a Portfolio Manager and Group Managing Director at
Trust Company of the West (since 1984). Mr. Dreifus joined Royce in February
1998 as a Senior Portfolio Manager and previously was a Portfolio Manager and
Managing Director (since June 1995) and General Partner (from 1983 until June
1995) of Lazard Freres & Co. LLC. Mr. Fockler has been employed by Royce since
1989 as its Director of Marketing.
INVESTMENT ADVISORY AGREEMENT
Under the Investment Advisory Agreement between the Fund and Royce
dated October 1, 2001 (the "Investment Advisory Agreement"), Royce determines
the composition of the Fund's portfolio, the nature and timing of the changes in
it and the manner of implementing such changes; provides the Fund with
investment advisory, research and related services for the investment of its
assets; and pays all expenses incurred in performing its investment advisory
duties under the Investment Advisory Agreement.
The Fund pays all of its own administrative and other costs and
expenses attributable to its operations and transactions (except those set forth
above), including, without limitation, registrar, transfer agent and custodian
fees; legal, administrative and clerical services; rent for its office space and
facilities; auditing; preparation, printing and distribution of its proxy
statements, stockholder reports and notices; Federal and state registration
fees; listing fees and expenses; Federal, state and local taxes; non-affiliated
Directors fees; interest on its borrowings; brokerage commissions; and the cost
of issue, sale and repurchase of its shares. Thus, unlike most other investment
companies, the Fund is required to pay substantially all of its expenses, and
Royce does not incur substantial fixed expenses.
ADVISORY FEE
As compensation for its services under the Investment Advisory
Agreement, Royce is entitled to receive a monthly fee equal to 1/12 of 1% (1% on
an annualized basis) of the average
31
of the net assets of the Fund (including assets obtained from the sale of
Preferred Stock) for each month during the term of the agreement. Because the
fee is computed based on the Fund's net assets and not on its total assets,
Royce will not receive any fee in respect of those assets of the Fund equal to
the aggregate unpaid principal amount of any indebtedness of the Fund. However,
because Preferred Stock is a form of equity for these purposes, Royce will
receive a fee in respect of any assets of the Fund equal to the liquidation
preference of and any potential redemption premium for any Preferred Stock that
may be issued and sold by the Fund, including the Cumulative Preferred Stock.
Royce has volunteered to waive the portion of its investment advisory
fee attributable to the liquidation preference of the 7.45% Preferred and the
Cumulative Preferred Stock (net of the liquidation preference of the 7.45%
Preferred) for any month when the Fund's net asset value average annual total
return since the initial issuance of the 7.45% Preferred or the Cumulative
Preferred Stock fails to exceed the blended dividend rate on those assets.
Because Royce's fee is partially based on the average net assets of the
Fund (including assets obtained from the sale of the Cumulative Preferred Stock
and other Preferred Stock), Royce has generally benefited from the Fund's
issuance of Preferred Stock.
CODE OF ETHICS
The Fund's Board of Directors approved a Code of Ethics under Rule
17j-1 of the 1940 Act that covers the Fund and Royce. The Code of Ethics
establishes procedures for personal investing and restricts certain
transactions. Employees subject to the Code of Ethics may invest in securities
for their personal investment accounts, including, in certain cases, securities
that may be purchased or held by the Fund. See "Code of Ethics and Related
Matters" in the Statement of Additional Information.
DESCRIPTION OF CUMULATIVE PREFERRED STOCK
The following is a brief description of the terms of the Cumulative
Preferred Stock. This description does not purport to be complete and is
qualified by reference to the Charter, including the Articles Supplementary, the
form of which is filed as an exhibit to the Fund's Registration Statement, and
the Bylaws. Certain of the capitalized terms used herein are defined in the
Glossary that appears at the end of this Prospectus.
GENERAL
The Cumulative Preferred Stock offered hereby is a senior security, as
defined by the 1940 Act, of the Fund, which means, among other things, it is
senior in priority to the Fund's Common Stock; however, it will rank junior to
any future indebtedness of the Fund. Under the terms of the Cumulative Preferred
Stock, the Fund is initially authorized to issue up to 1,000,000 shares of
Cumulative Preferred Stock. No fractional shares of Cumulative Preferred Stock
will be issued. The Board of Directors reserves the right to issue additional
shares of Cumulative Preferred Stock or other Preferred Stock from time to time,
subject to the restrictions in the Charter and the 1940 Act. The shares of
Cumulative Preferred Stock will, upon issuance, be fully paid and nonassessable
and will have no appraisal, preemptive, exchange or conversion
32
rights. Any shares of Cumulative Preferred Stock repurchased or redeemed by the
Fund will be returned to the status of authorized but unissued Common Stock. The
Fund will not issue any class of stock senior to the shares of Cumulative
Preferred Stock.
DIVIDENDS
Holders of shares of Cumulative Preferred Stock will be entitled to
receive, when, as and if authorized by the Board of Directors and declared by
the Fund out of funds legally available therefor, cumulative cash dividends at
the annual rate of % per share (computed on the basis of a 360-day year
consisting of twelve 30-day months) of the initial liquidation preference of
$25.00 per share, payable quarterly on March 23, June 23, September 23 and
December 23 (each, a "Dividend Payment Date"), commencing on December 23, 2003
(or, if any such day is not a Business Day, then on the next succeeding Business
Day), to the persons in whose names the shares of Cumulative Preferred Stock are
registered at the close of business on the preceding March 6, June 6, September
6 and December 6 (or, if any such day is not a Business Day, then on the next
succeeding Business Day), respectively.
Dividends on the shares of Cumulative Preferred Stock will accumulate
from the date on which such shares are originally issued (the "Date of Original
Issue").
No dividends will be declared or paid or set apart for payment on
shares of Cumulative Preferred Stock for any dividend period or part thereof
unless full cumulative dividends have been or contemporaneously are declared and
paid on all outstanding shares of Cumulative Preferred Stock through the most
recent Dividend Payment Date thereof. If full cumulative dividends are not paid
on the Cumulative Preferred Stock, all dividends on the shares of Cumulative
Preferred Stock will be paid pro rata to the holders of the shares of Cumulative
Preferred Stock. Holders of Cumulative Preferred Stock will not be entitled to
any dividends, whether payable in cash, property or stock, in excess of full
cumulative dividends. No interest, or sum of money in lieu of interest, will be
payable in respect of any dividend payment that may be in arrears.
For so long as any shares of Cumulative Preferred Stock are
outstanding, the Fund will not declare, pay or set apart for payment any
dividend or other distribution (other than a dividend or distribution paid in
shares of, or options, warrants or rights to subscribe for or purchase shares
of, Common Stock or other stock, if any, ranking junior to the Cumulative
Preferred Stock as to dividends or payment upon liquidation) in respect of the
Common Stock or any other stock of the Fund ranking junior to or on a parity
with the Cumulative Preferred Stock as to dividends or payment upon liquidation,
or call for redemption, redeem, purchase or otherwise acquire for consideration
any shares of its Common Stock or any other junior stock (except by conversion
into or exchange for stock of the Fund ranking junior to or on a parity with the
Cumulative Preferred Stock as to dividends or payment upon liquidation), unless,
in each case, (i) immediately after such transaction, the Fund will have a
Portfolio Calculation for Moody's at least equal to the Basic Maintenance Amount
and the Fund will maintain the Asset Coverage (see "-- Asset Maintenance" and
"-- Redemption" below), (ii) full cumulative dividends on shares of Cumulative
Preferred Stock due on or prior to the date of the transaction have been
declared and paid (or sufficient Deposit Securities to cover such payment have
been deposited with the Paying Agent) and (iii) the Fund has redeemed the full
number of shares of Cumulative
33
Preferred Stock required to be redeemed by any provision for mandatory
redemption contained in the Charter.
If the Fund fails to pay dividends for two years or more, holders of
the Cumulative Preferred Stock will acquire certain additional voting rights.
See "-- Voting Rights" below. Such rights will be their exclusive remedy for any
such failure.
ASSET MAINTENANCE
The Fund will be required to satisfy two separate asset maintenance
requirements under the terms of the Cumulative Preferred Stock. These
requirements are summarized below.
Asset Coverage. For so long as any shares of Cumulative Preferred Stock
are outstanding, the Fund will be required to maintain as of the last Business
Day of each March, June, September and December of each year, an "asset
coverage" (as defined by the 1940 Act) of at least 200% (or such higher
percentage as may be required under the 1940 Act) with respect to all
outstanding senior securities of the Fund which are stock, including the
Cumulative Preferred Stock (the "Asset Coverage"). If the Fund fails to maintain
the Asset Coverage on such dates and such failure is not cured in 60 days, the
Fund will be required under certain circumstances to redeem certain of the
shares of Cumulative Preferred Stock. See "-- Redemption -- Mandatory
Redemption" below.
Assuming the Fund had issued and sold the Cumulative Preferred Stock
and redeemed the 7.45% Preferred as of June 30, 2003, the Asset Coverage
immediately following such issuance and sale of the Cumulative Preferred Stock
and such redemption of the 7.45% Preferred (after giving effect to the deduction
of the underwriting discounts and estimated offering expenses for such shares),
would have been computed as follows:
Value of Fund assets less
liabilities not constituting senior securities $92,746,470
---------------------------------------------------------------- = ------------------ = 371%
Senior securities representing indebtedness plus $25,000,000
aggregate liquidation preference of
the Cumulative Preferred Stock
Basic Maintenance Amount. For so long as any shares of Cumulative
Preferred Stock are outstanding, the Fund will be required to maintain, as of
each Valuation Date, portfolio holdings meeting specified guidelines of Moody's,
as described under "Rating Agency Guidelines", having an aggregate discounted
value (a "Portfolio Calculation") at least equal to the Basic Maintenance
Amount, which is in general the sum of the aggregate liquidation preferences of
the Cumulative Preferred Stock and any other Preferred Stock, any indebtedness
for borrowed money and current liabilities and dividends. If the Fund fails to
meet such requirement as to any Valuation Date and such failure is not cured
within 14 days after such Valuation Date, the Fund will be required to redeem
certain of the shares of Cumulative Preferred Stock. See "-- Redemption --
Mandatory Redemption" below.
Any security not in compliance with the Rating Agency Guidelines will
be excluded from the Portfolio Calculation.
34
The Moody's Discount Factors and guidelines for determining the market
value of the Fund's portfolio holdings have been based on criteria established
in connection with the rating of the Cumulative Preferred Stock. These factors
include, but are not limited to, the sensitivity of the market value of the
relevant asset to changes in interest rates, the liquidity and depth of the
market for the relevant asset, the credit quality of the relevant asset (for
example, the lower the rating of a corporate debt obligation, the higher the
related discount factor) and the frequency with which the relevant asset is
marked to market. The Moody's Discount Factor relating to any asset of the Fund
and the Basic Maintenance Amount, the assets eligible for inclusion in the
calculation of the discounted value of the Fund's portfolio and certain
definitions and methods of calculation relating thereto may be changed from time
to time by the Board of Directors, provided that, among other things, such
changes will not impair the rating then assigned to the Cumulative Preferred
Stock by Moody's.
On or before the third Business Day after each Quarterly Valuation
Date, the Fund is required to deliver to Moody's a Basic Maintenance Report
("Basic Maintenance Report"). Within ten Business Days after delivery of such
report relating to the Quarterly Valuation Date of the Fund's fiscal year, the
Fund will deliver a letter prepared by the Fund's independent accountants
regarding the accuracy of the calculations made by the Fund in such a Basic
Maintenance Report. If any such letter prepared by the Fund's independent
accountants shows that an error was made in the most recent Basic Maintenance
Report, the calculation or determination made by the Fund's independent
accountants will be conclusive and binding on the Fund.
REDEMPTION
Mandatory Redemption. The Fund will be required to redeem, at a
redemption price equal to $25.00 per share plus accumulated and unpaid dividends
through the date of redemption (whether or not earned or declared) (the
"Redemption Price"), certain of the shares of Cumulative Preferred Stock (to the
extent permitted under the 1940 Act, Maryland law and any agreement in respect
of indebtedness of the Fund to which it may be a party or by which it may be
bound) in the event that:
(i) the Fund fails to maintain the quarterly Asset Coverage
and such failure is not cured on or before 60 days following such
failure (a "Cure Date"); or
(ii) for so long as the Fund is complying with the Rating
Agency Guidelines, the Fund fails to maintain a Portfolio Calculation
at least equal to the Basic Maintenance Amount as of any Valuation
Date, and such failure is not cured on or before the 14th day after
such Valuation Date (also, a "Cure Date").
The amount of such mandatory redemption will equal the minimum number
of outstanding shares of Cumulative Preferred Stock and/or any other Preferred
Stock the redemption of which, if such redemption had occurred immediately prior
to the opening of business on a Cure Date, would have resulted in the Asset
Coverage having been satisfied or the Fund having a Portfolio Calculation for
Moody's equal to or greater than the Basic Maintenance Amount on such Cure Date
or, if the Asset Coverage or a Portfolio Calculation for Moody's equal to or
greater than the Basic Maintenance Amount, as the case may be, cannot be so
35
restored, all of the shares of Cumulative Preferred Stock, at the Redemption
Price. In the event that shares of Cumulative Preferred Stock are redeemed due
to the occurrence of (i) above, the Fund may, but is not required to, redeem a
sufficient number of shares of Cumulative Preferred Stock in order to increase
the "asset coverage" (as defined in the 1940 Act) of the remaining outstanding
shares of Cumulative Preferred Stock and any other Preferred Stock after
redemption up to 275%. In the event that shares of Cumulative Preferred Stock
and/or any other Preferred Stock are redeemed due to the occurrence of (ii)
above, the Fund may, but is not required to, redeem a sufficient number of
shares of Cumulative Preferred Stock so that the Portfolio Calculation exceeds
the Basic Maintenance Amount of the remaining outstanding shares of Cumulative
Preferred Stock and any other Preferred Stock remaining after redemption by up
to 10%.
If the Fund does not have funds legally available for the redemption
of, or is otherwise unable to redeem, all the shares of Cumulative Preferred
Stock to be redeemed on any redemption date, the Fund is required to redeem on
such redemption date that number of shares for which it has legally available
funds and is otherwise able to redeem, pro rata from each holder whose shares
are to be redeemed, and the remainder of the shares required to be redeemed will
be redeemed on the earliest practicable date on which the Fund will have funds
legally available for the redemption of, or is otherwise able to redeem, such
shares upon written notice of redemption ("Notice of Redemption").
If fewer than all shares of Cumulative Preferred Stock are to be
redeemed, such redemption will be made pro rata from each holder of shares in
accordance with the respective number of shares held by each such holder on the
record date for such redemption. If fewer than all shares of Cumulative
Preferred Stock held by any holder are to be redeemed, the Notice of Redemption
mailed to such holder will specify the number of shares to be redeemed from such
holder. Unless all accumulated and unpaid dividends for all past dividend
periods will have been or are contemporaneously paid or declared and Deposit
Securities for the payment thereof deposited with the Paying Agent, no
redemptions of Cumulative Preferred Stock or any other Preferred Stock may be
made.
Optional Redemption. Prior to October , 2008, the shares of Cumulative
Preferred Stock are not subject to any optional redemption by the Fund unless
such redemption is necessary, in the judgment of the Board of Directors of the
Fund, to maintain the Fund's status as a RIC under the Code. Commencing October
, 2008 and thereafter, the Fund may at its option redeem shares of Cumulative
Preferred Stock at any time in whole or in part at the Redemption Price. Such
redemptions are subject to the limitations of the 1940 Act, Maryland law and any
agreement in respect of indebtedness of the Fund to which it may be a party or
by which it may be bound.
Redemption Procedures. A Notice of Redemption will be given to the
holders of record of Cumulative Preferred Stock to be redeemed not less than 30
or more than 45 days prior to the date fixed for the redemption. Each Notice of
Redemption will state: (i) the redemption date, (ii) the number of shares of
Cumulative Preferred Stock to be redeemed, (iii) the CUSIP number(s) of such
shares, (iv) the Redemption Price, (v) that dividends on the shares to be
redeemed will cease to accumulate on such redemption date and (vi) the provision
of the Charter under which the redemption is being made. No defect in the Notice
of Redemption or in the
36
mailing thereof will affect the validity of the redemption proceedings, except
as required by applicable law.
LIQUIDATION RIGHTS
Upon a liquidation, dissolution or winding up of the affairs of the
Fund (whether voluntary or involuntary), holders of shares of Cumulative
Preferred Stock then outstanding will be entitled to receive out of the assets
of the Fund available for distribution to stockholders, after satisfying claims
of creditors but before any distribution or payment of assets is made to holders
of the Common Stock or any other class of stock of the Fund ranking junior to
the Cumulative Preferred Stock as to liquidation payments, a liquidation
distribution in the amount of $25.00 per share plus an amount equal to all
unpaid dividends accumulated to and including the date fixed for such
distribution or payment (whether or not earned or declared by the Fund, but
excluding interest thereon) (the "Liquidation Preference"), and such holders
will be entitled to no further participation in any distribution or payment in
connection with any such liquidation, dissolution or winding up. If, upon any
liquidation, dissolution or winding up of the affairs of the Fund, whether
voluntary or involuntary, the assets of the Fund available for distribution
among the holders of all outstanding shares of Cumulative Preferred Stock and
any other outstanding class or series of Preferred Stock of the Fund ranking on
a parity with the Cumulative Preferred Stock as to payment upon liquidation,
will be insufficient to permit the payment in full to such holders of Cumulative
Preferred Stock of the Liquidation Preference and the amounts due upon
liquidation with respect to such other Preferred Stock, then such available
assets will be distributed among the holders of Cumulative Preferred Stock and
such other Preferred Stock ratably in proportion to the respective preferential
amounts to which they are entitled. Unless and until the Liquidation Preference
has been paid in full to the holders of Cumulative Preferred Stock, no dividends
or distributions will be made to holders of the Common Stock or any other stock
of the Fund ranking junior to the Cumulative Preferred Stock as to liquidation.
Upon any liquidation, the holders of the Common Stock, after required
payments to the holders of Preferred Stock, will be entitled to participate
equally and ratably in the remaining assets of the Fund.
VOTING RIGHTS
Except as otherwise stated in this Prospectus and as otherwise required
by applicable law, holders of shares of Cumulative Preferred Stock and any other
Preferred Stock will be entitled to one vote per share on each matter submitted
to a vote of stockholders and will vote together with holders of shares of
Common Stock as a single class. Also, except as otherwise required by the 1940
Act, (i) holders of outstanding shares of the Cumulative Preferred Stock will be
entitled as a series, to the exclusion of the holders of all other securities,
including other Preferred Stock, Common Stock and other classes of capital stock
of the Fund, to vote on matters affecting the Cumulative Preferred Stock that do
not materially adversely affect any of the contract rights of holders of such
other securities, including other Preferred Stock, Common Stock and other
classes of capital stock, as expressly set forth in the Fund's Charter, and (ii)
holders of outstanding shares of Cumulative Preferred Stock will not be entitled
to vote on matters affecting any other Preferred Stock that do not materially
adversely affect any of the contract rights of holders of the Cumulative
Preferred Stock, as expressly set forth in the Charter. The foregoing
37
voting provisions will not apply to any shares of Cumulative Preferred Stock if,
at or prior to the time when the act with respect to which such vote otherwise
would be required will be effected, such shares will have been (i) redeemed or
(ii) called for redemption and sufficient Deposit Securities provided to the
Paying Agent to effect such redemption.
In connection with the election of the Fund's directors, holders of
shares of Cumulative Preferred Stock and any other Preferred Stock, voting as a
separate class, will be entitled at all times to elect two of the Fund's
directors, and the remaining directors will be elected by holders of shares of
Common Stock and holders of shares of Cumulative Preferred Stock and any other
Preferred Stock, voting together as single class. In addition, if at any time
dividends on outstanding shares of Cumulative Preferred Stock and/or any other
Preferred Stock are unpaid in an amount equal to at least two full years'
dividends thereon and sufficient Deposit Securities shall not have been
deposited with the Paying Agent for the payment of such accumulated dividends,
or if at any time holders of any shares of Preferred Stock are entitled,
together with the holders of shares of Cumulative Preferred Stock, to elect a
majority of the directors of the Fund under the 1940 Act, then the number of
directors constituting the Board of Directors will automatically increase by the
smallest number that, when added to the two directors elected exclusively by the
holders of shares of Cumulative Preferred Stock and any other Preferred Stock as
described above, would constitute a majority of the Board of Directors as so
increased by such smallest number. Such additional directors will be elected at
a special meeting of stockholders which will be called and held as soon as
practicable, and at all subsequent meetings at which directors are to be
elected, the holders of shares of Cumulative Preferred Stock and any other
Preferred Stock, voting as a separate class, will be entitled to elect the
smallest number of additional directors that, together with the two directors
which such holders in any event will be entitled to elect, constitutes a
majority of the total number of directors of the Fund as so increased. The terms
of office of the persons who are directors at the time of that election will
continue. If the Fund thereafter pays, or declares and sets apart for payment in
full, all dividends payable on all outstanding shares of Cumulative Preferred
Stock and any other Preferred Stock for all past dividend periods, the
additional voting rights of the holders of shares of Cumulative Preferred Stock
and any other Preferred Stock as described above will cease, and the terms of
office of all of the additional directors elected by the holders of shares of
Cumulative Preferred Stock and any other Preferred Stock (but not of the
directors with respect to whose election the holders of shares of Common Stock
were entitled to vote or the two directors the holders of shares of Cumulative
Preferred Stock and any other Preferred Stock have the right to elect in any
event) will terminate and the number of directors constituting the Board of
Directors will automatically decrease accordingly.
So long as shares of the Cumulative Preferred Stock are outstanding,
the Fund will not, without the affirmative vote of the holders of a majority of
the shares of Cumulative Preferred Stock outstanding at the time, voting
separately as one class, amend, alter or repeal the provisions of the Charter,
whether by merger, consolidation or otherwise, so as to materially adversely
affect any of the contract rights expressly set forth in the Charter of holders
of shares of the Cumulative Preferred Stock. Under Maryland law, the terms of
stock may be made dependent on facts ascertainable outside of the charter of a
corporation, including an action or determination of the board of directors.
Accordingly, the interpretation or applicability of any or all of the Rating
Agency Guidelines may from time to time be modified by the Board of Directors in
its sole discretion based on a determination by the Board of Directors that such
38
action is necessary or appropriate with respect to the Cumulative Preferred
Stock; provided, however, that the Board of Directors receives written
confirmation from Moody's that any such modification would not impair the then
current rating assigned to the Cumulative Preferred Stock by Moody's.
Furthermore, under certain circumstances, without the vote of stockholders, the
Board of Directors of the Fund may determine that it is not in the best
interests of the Fund to continue to comply with the Rating Agency Guidelines.
See "-- Termination of Rating Agency Guidelines" below. The affirmative vote of
a majority of the votes entitled to be cast by holders of outstanding shares of
the Cumulative Preferred Stock and any other Preferred Stock, voting as a
separate class, will be required to approve any plan of reorganization adversely
affecting such shares or any action requiring a vote of security holders under
Section 13(a) of the 1940 Act, including, among other things, changes in the
Fund's primary investment goal or changes in the investment restrictions
described as fundamental policies under "Investment Restrictions" in the
Statement of Additional Information. The class vote of holders of shares of the
Cumulative Preferred Stock and any other Preferred Stock described above in each
case will be in addition to a separate vote of the requisite percentage of
shares of Common Stock and Cumulative Preferred Stock and any other Preferred
Stock, voting together as a single class, necessary to authorize the action in
question. See "Description of Capital Stock -- Certain Corporate Governance
Provisions".
TERMINATION OF RATING AGENCY GUIDELINES
The terms of the Cumulative Preferred Stock provide that if the Board
of Directors of the Fund determines that it is not in the best interests of the
Fund to continue to comply with the Rating Agency Guidelines, the Fund will no
longer be required to comply with such guidelines, provided that (i) the Fund
has given the Paying Agent, Moody's and holders of the Cumulative Preferred
Stock at least 20 calendar days written notice of such termination of
compliance, (ii) the Fund is in compliance with the Rating Agency Guidelines at
the time the notice required in clause (i) above is given and at the time of
termination of compliance with the Rating Agency Guidelines, (iii) at the time
the notice required in clause (i) above is given and at the time of termination
of compliance with the Rating Agency Guidelines, the Cumulative Preferred Stock
is listed on the NYSE or on another exchange registered with the Commission as a
national securities exchange and (iv) at the time of termination of compliance
with the Rating Agency Guidelines, the Cumulative Preferred Stock must have
received a rating from at least one NRSRO that is at least comparable to the
then current rating from Moody's.
If the Fund voluntarily terminates compliance with the Rating Agency
Guidelines, Moody's may change its rating on the Cumulative Preferred Stock or
withdraw its rating altogether. However, the Fund will then be required to
comply with the guidelines established by the successor NRSRO. It is the Fund's
present intention to continue to comply with the Rating Agency Guidelines.
LIMITATION ON ISSUANCE OF ADDITIONAL PREFERRED STOCK
So long as any shares of Cumulative Preferred Stock are outstanding,
the Charter provides that the Fund may issue and sell shares of one or more
other series of Preferred Stock, provided that (i) immediately after giving
effect to the issuance and sale of such additional Preferred Stock and to the
Fund's receipt and application of the proceeds thereof, the Fund will
39
maintain the Asset Coverage of the shares of Cumulative Preferred Stock and all
other Preferred Stock of the Fund then outstanding, and (ii) no such additional
Preferred Stock will have any preference or priority over any other Preferred
Stock of the Fund upon the distribution of the assets of the Fund or in respect
of the payment of dividends.
BOARD'S ABILITY TO MODIFY ARTICLES SUPPLEMENTARY
The terms of the Cumulative Preferred Stock provide that, to the extent
permitted by law, the Board of Directors may modify or interpret the terms of
the Cumulative Preferred Stock to resolve any inconsistency or ambiguity or
remedy any formal defect so long as such modification or interpretation does not
materially adversely affect any of the contract rights expressly set forth in
the Charter of holders of shares of the Cumulative Preferred Stock or any other
capital stock of the Fund or adversely affect the then current rating on the
Cumulative Preferred Stock by Moody's or any successor NRSRO.
REPURCHASE OF CUMULATIVE PREFERRED STOCK
The Fund is a closed-end investment company and, as such, holders of
Cumulative Preferred Stock do not, and will not, have the right to redeem their
shares of the Fund. Redemption of the Cumulative Preferred Stock is subject to
the terms of the Articles Supplementary. The Fund may, however, repurchase
shares of the Cumulative Preferred Stock and/or any other Preferred Stock when
it is deemed advisable by the Board of Directors in compliance with the
requirements of the 1940 Act and the rules and regulations thereunder and
Maryland law.
BOOK-ENTRY
Shares of Cumulative Preferred Stock will initially be held in the name
of Cede & Co. ("Cede"), as nominee for The Depository Trust Company ("DTC"). The
Fund will treat Cede as the holder of record of the Cumulative Preferred Stock
for all purposes. In accordance with the procedures of DTC, however, purchasers
of Cumulative Preferred Stock will be deemed the beneficial owners of shares
purchased for purposes of dividends, voting and liquidation rights. The
Cumulative Preferred Stock will be held in book-entry only form. Shares of
Cumulative Preferred Stock will not be delivered in certificated form to
individual purchasers thereof. The laws of some jurisdictions require that
certain purchasers of Cumulative Preferred Stock take physical delivery of such
securities in certificated form. Such limits and laws may impair the ability to
transfer beneficial interests in shares of Cumulative Preferred Stock. See
"Book-Entry System" in the Statement of Additional Information for more
information about DTC and its procedures.
DESCRIPTION OF CAPITAL STOCK
COMMON STOCK
The Fund is initially authorized to issue 100,000,000 shares of Common
Stock, par value $.001 per share, certain shares of which have been classified
and designated in series of Preferred Stock, as discussed below. Each share of
Common Stock has equal voting, dividend,
40
distribution and liquidation rights. The shares of Common Stock outstanding are
fully paid and non-assessable. The shares of Common Stock are not redeemable and
have no preemptive, exchange, conversion or cumulative voting rights. Under
Maryland law and the rules of the Nasdaq National Market System, the Fund
generally is required to hold annual meetings of its stockholders.
PREFERRED STOCK
The Fund's Board of Directors has authority to classify and reclassify
any authorized but unissued shares of stock into other classes or series of
stock, including Preferred Stock, and to cause the Fund to issue such shares.
The terms of such Preferred Stock would be fixed by the Board of Directors and
would materially limit and/or qualify the rights of the holders of the Fund's
Common Stock. In this regard, the Board of Directors has classified and
designated 1,000,000 shares of Common Stock as the Cumulative Preferred Stock,
all of which are being offered hereby. See "Description of Cumulative Preferred
Stock". The Board of Directors previously classified and designated 5,000,000
shares of Common Stock as 7.45% Preferred, 800,000 of which are issued and
outstanding. The terms of the 7.45% Preferred are substantially similar to the
terms of the Cumulative Preferred Stock. The Fund will use a substantial portion
of the net proceeds from the issuance and sale of the Cumulative Preferred Stock
to redeem the 7.45% Preferred.
------------------------
The following table shows as of July 31, 2003 the number of shares of:
(i) capital stock authorized, (ii) capital stock held by the Fund for its own
account and (iii) capital stock outstanding for each class of authorized
securities of the Fund.
AMOUNT
OUTSTANDING
(EXCLUSIVE OF
AMOUNT HELD BY FUND AMOUNT HELD BY FUND
TITLE OF CLASS AMOUNT AUTHORIZED FOR ITS OWN ACCOUNT FOR ITS OWN ACCOUNT)
----------------------- --------------------- ---------------------
Common Stock..................................... 95,000,000 0 9,241,025
7.45% Preferred ................................. 5,000,000 0 800,000
CERTAIN CORPORATE GOVERNANCE PROVISIONS
The six Fund Directors who are elected by the holders of Common Stock
and Preferred Stock voting together are divided into three classes, each serving
a staggered term of three years and until a successor is elected and qualifies.
The two Directors elected only by the holders of Preferred Stock stand for
election at each annual meeting of stockholders. Accordingly, it likely would
take a number of years for stockholders to change a majority of the Board of
Directors. Vacancies on the Board of Directors for one or more of the six
classified positions may be filled by the remaining Directors for the balance of
the term of the class and until a successor is elected and qualifies.
The Fund's Bylaws permit stockholders to call a special meeting of
stockholders only if certain procedural requirements are met and the request is
made by stockholders entitled to cast
41
at least a majority of the votes entitled to be cast at such a meeting. The
Bylaws also require that advance notice be given to the Fund in the event a
stockholder desires to nominate a person for election to the Board of Directors
or to transact any other business at an annual meeting of stockholders. With
respect to an annual meeting of stockholders, notice of any such nomination or
business must be delivered to or received at the principal executive offices of
the Fund not less than 90 calendar days nor more than 120 calendar days prior to
the anniversary of the date of mailing of the notice for the preceding year's
annual meeting (subject to certain exceptions). Any advance notice by a
stockholder must be accompanied by certain information as provided in the
Bylaws. The Bylaws contain similar advance notice provisions with respect to
special meetings of stockholders.
Certain provisions of the 1940 Act and the Charter require a separate
additional vote of the holders of Preferred Stock to approve certain
transactions, including certain mergers, asset dispositions and conversion of
the Fund to open-end status.
These provisions may have the effect of maintaining the continuity of
management and thus may make it more difficult for the Fund's stockholders to
change the majority of Directors.
TAXATION
The Fund intends to continue to qualify for the special tax treatment
afforded RICs under the Internal Revenue Code of 1986, as amended (the "Code").
As long as it so qualifies, in any taxable year in which it distributes at least
90% of its investment company taxable income ("ICTI") (as that term is defined
in the Code without regard to the deduction for dividends paid) for such taxable
year, the Fund will not be subject to Federal income tax on the part of its ICTI
and net capital gains (i.e., the excess of the Fund's net realized long-term
capital gains over its net realized short-term capital losses), if any, that it
distributes to its stockholders in each taxable year. The Fund intends to
distribute substantially all of such income.
Under the 2003 Tax Act, Fund distributions comprised of dividends from
domestic corporations and certain foreign corporations (generally, corporations
incorporated in a possession of the United States, some corporations eligible
for treaty benefits under a treaty with the United States and corporations whose
stock is readily tradable on an established securities market in the United
States) are eligible for taxation at a maximum tax rate of 15% also applicable
to capital gains in the hands of individual shareholders. Capital gain dividends
likewise, are taxed at the reduced maximum rate of 15% for non-corporate
taxpayers. These tax rates are scheduled to apply through 2008. Not later than
60 days after the close of its taxable year, the Fund will provide its
stockholders with a written notice designating the amounts of any long-term
capital gains, qualified dividend income and Other Ordinary Income.
If the Fund does not meet the asset coverage requirements of the 1940
Act or the Articles Supplementary, the Fund will be required to suspend
distributions to holders of its Common Stock until the asset coverage is
restored. See "Description of Cumulative Preferred Stock -- Dividends". Such a
suspension of distributions might prevent the Fund from distributing 90% of its
ICTI, as is required in order to avoid Fund-level taxation of such income. Upon
any failure to meet the asset coverage requirements of the 1940 Act or the
Articles Supplementary, the Fund
42
may, and in certain circumstances will be required to, partially redeem shares
of its Cumulative Preferred Stock in order to maintain or restore the requisite
asset coverage and avoid the adverse consequences to the Fund and its
stockholders of failing to qualify as a RIC. If asset coverage were restored,
the Fund would again be able to pay dividends and might be able to avoid
Fund-level taxation of its income.
The Internal Revenue Service (the "IRS") currently requires that a RIC
that has two or more classes of stock allocate to each class proportionate
amounts of each type of its income (e.g., capital gains, qualified dividend
income and Other Ordinary Income). Accordingly, the Fund intends to designate
dividends paid to holders of Cumulative Preferred Stock as comprised of capital
gains, qualified dividend income and/or Other Ordinary Income, as applicable, in
proportion to the Cumulative Preferred Stock's share of total dividends paid
during the year.
If the Fund pays a dividend in January which was declared in the
previous October, November or December to stockholders of record on a specified
date in one of such months, then such dividend will be treated for tax purposes
as being paid by the Fund and received by its stockholders on December 31 of the
year in which such dividend was declared.
Stockholders may be entitled to offset their capital gain dividends
with capital losses. There are a number of statutory provisions affecting when
capital losses may be offset against capital gains, and limiting the use of
losses from certain investments and activities. Accordingly, stockholders with
capital losses are urged to consult their tax advisers.
In the opinion of Sidley Austin Brown & Wood LLP, the shares of
Cumulative Preferred Stock will be treated as stock of the Fund for Federal
income tax purposes and distributions with respect to such shares (other than
distributions in redemption of the Cumulative Preferred Stock under section
302(b) of the Code) will constitute dividends to the extent of the Fund's
current and accumulated earnings and profits, as calculated for Federal income
tax purposes. Nevertheless, the IRS might take a contrary position, asserting,
for example, that the shares of Cumulative Preferred Stock constitute debt of
the Fund. The Fund believes this position, if asserted, would be unlikely to
prevail. If this position were upheld, however, the discussion of the treatment
of distributions herein, and in the Statement of Additional Information, would
not apply. Instead, distributions by the Fund to holders of shares of Cumulative
Preferred Stock would constitute taxable interest income, whether or not they
exceeded the earnings and profits of the Fund. In such event, the designations
of particular types of income, such as capital gains and qualified dividend
income, would not be effective.
Ordinary income dividends (but not capital gain dividends) paid to
stockholders who are non-resident aliens or foreign entities generally will be
subject to a 30% United States withholding tax unless a lower treaty rate
applies.
Dividends and interest received by the Fund may give rise to
withholding and other taxes imposed by foreign countries. Tax conventions
between certain countries and the United States may reduce or eliminate such
taxes. Stockholders may be able to claim a credit or take a deduction for
foreign taxes paid by the Fund if certain requirements are met.
43
By law, unless you qualify for an exemption from backup withholding
(for instance, if you are a corporation), your dividends and redemption proceeds
will be subject to a backup withholding tax (currently 28%) if you have not
provided a tax identification number or social security number or if the number
you have provided is incorrect.
This section summarizes some of the consequences under Federal tax law
of an investment in Cumulative Preferred Stock of the Fund. It is not a
substitute for personal tax advice. Consult your personal tax adviser about the
potential tax consequences of purchasing and holding Cumulative Preferred Stock
in the Fund under all applicable tax laws. For additional tax discussion, see
"Taxation" in the Statement of Additional Information.
CUSTODIAN, DIVIDEND-PAYING AGENT, TRANSFER AGENT AND REGISTRAR
State Street Bank and Trust Company, Two Heritage Drive, North Quincy,
Massachusetts 02171, acts as custodian of the cash and other assets of the Fund.
Equiserve Trust Company, N.A., PO Box 43011, Providence, RI 02940-3011, acts as
transfer agent, dividend-paying agent and registrar for the Fund's shares and as
agent to provide notice of redemption and certain voting rights for the
Cumulative Preferred Stock. Stockholder inquiries should be directed to P.O. Box
8200, Boston, Massachusetts 02266-8200 (Tel. No. (800) 426-5523).
UNDERWRITING
Citigroup Global Markets Inc. and UBS Securities LLC are acting as
representatives of the several Underwriters in this offering. Subject to the
terms and conditions stated in the Fund's underwriting agreement dated
October , 2003 (the "Underwriting Agreement"), each Underwriter named below has
severally agreed to purchase, and the Fund has agreed to sell to such
Underwriter, the number of shares of Cumulative Preferred Stock set forth
opposite the name of such Underwriter.
NUMBER OF SHARES OF
UNDERWRITER CUMULATIVE PREFERRED STOCK
----------- ---------------------------
Citigroup Global Markets Inc...........................................
UBS Securities LLC.....................................................
Legg Mason Wood Walker, Incorporated...................................
===========
Total 800,000
===========
The Underwriting Agreement provides that the obligations of the
Underwriters to purchase the Cumulative Preferred Stock included in this
offering are subject to approval of legal matters by counsel and to other
conditions. The Underwriters are obligated to purchase all the Cumulative
Preferred Stock if they purchase any such shares.
44
The Underwriters propose to offer some of the Cumulative Preferred
Stock directly to the public at the public offering price set forth on the cover
page of this Prospectus and some of the Cumulative Preferred Stock to dealers at
the public offering price less a concession not to exceed $ per share of
Cumulative Preferred Stock. The sales load or underwriting discount the Fund
will pay of $ per share of Cumulative Preferred Stock is equal to % of
the initial offering price. The Underwriters may allow, and such dealers may
reallow, a concession not to exceed $ per share on sales to certain other
dealers. After the initial public offering, the Underwriters may change the
public offering price and other selling terms. Investors must pay for any
Cumulative Preferred Stock purchased on or before October , 2003.
It is expected that delivery of the Cumulative Preferred Stock will be
made against payment therefore on or about October , 2003 which is the
business day after the date hereof. Under Rule 15c6-1 of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), trades in the secondary market
generally are required to settle in three business days, unless the parties to
any such trade expressly agree otherwise. Accordingly, purchasers who wish to
trade the Cumulative Preferred Stock on the date hereof or the next succeeding
business days will be required, by virtue of the fact that the Cumulative
Preferred Stock initially will not settle in T+3, to specify an alternative
settlement cycle at the time of any such trade to prevent a failed settlement
and should consult their own advisor.
In the Underwriting Agreement, the Fund and Royce have each agreed to
indemnify the several Underwriters or contribute to losses arising out of
certain liabilities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act").
The Fund anticipates that from time to time the representatives of the
Underwriters and certain other Underwriters may act as brokers or dealers in
connection with the execution of the Fund's portfolio transactions after they
have ceased to be Underwriters and, subject to certain restrictions, may act as
brokers while they are Underwriters. Citigroup Global Markets Inc. and UBS
Securities LLC acted as financial advisers to Royce in connection with its
acquisition by Legg Mason on October 1, 2001. Royce and Legg Mason Wood Walker,
Incorporated, one of the Underwriters in this offering, are affiliates because
they are under the common control of Legg Mason. In addition, certain of the
Underwriters have in the past and may in the future act as financial advisers to
Royce or have other investment banking relationships with Royce.
Prior to the offering, there has been no public market for the
Cumulative Preferred Stock. Application will be made to list the Cumulative
Preferred Stock on the NYSE. However, during an initial period which is not
expected to exceed 30 days after the date of this Prospectus, the Cumulative
Preferred Stock will not be listed on any securities exchange. During such
period, the Underwriters intend to make a market in the Cumulative Preferred
Stock; however, they have no obligation to do so. Consequently, an investment in
the Cumulative Preferred Stock may be illiquid during such period.
In connection with the offering, the Underwriters may purchase and sell
shares of Cumulative Preferred Stock in the open market. These transactions may
include short sales and stabilizing transactions. Short sales involve syndicate
sales of shares in excess of the number of shares to be purchased by the
Underwriters in the offering, which creates a syndicate short
45
position. Stabilizing transactions consist of bids for or purchases of shares in
the open market while the offering is in progress.
The Underwriters may also impose a penalty bid. Penalty bids permit the
Underwriters to reclaim a selling concession from a syndicate member when the
Underwriters repurchase shares originally sold by that syndicate member in order
to cover syndicate short positions or make stabilizing purchases.
Any of these activities may have the effect of preventing or retarding
a decline in the market price of the stock. They may also cause the price of the
Cumulative Preferred Stock to be higher than the price that would otherwise
exist in the open market in the absence of these transactions. The Underwriters
may conduct these transactions on the NYSE or in the over-the-counter market, or
otherwise. If the Underwriters commence any of these transactions, they may
discontinue them at any time.
The principal business address of Citigroup Global Markets Inc. is 388
Greenwich Street, New York, NY 10013. The principal business address of UBS
Securities LLC is 299 Park Avenue, New York, NY 10171.
LEGAL MATTERS
Certain matters concerning the legality under Maryland law of the
Cumulative Preferred Stock will be passed on by Venable LLP, Baltimore,
Maryland. Certain legal matters will be passed on by Sidley Austin Brown & Wood
LLP, New York, New York, special counsel to the Fund, and by Simpson Thacher &
Bartlett LLP, counsel to the Underwriters. Sidley Austin Brown & Wood LLP and
Simpson Thacher & Bartlett LLP will each rely as to matters of Maryland law on
the opinion of Venable LLP.
EXPERTS
Tait, Weller & Baker, independent auditors, are the independent
auditors of the Fund. The audited financial statements of the Fund and certain
of the information appearing under the caption "Financial Highlights" included
in this Prospectus and under the caption "Financial Statements" included in the
Statement of Additional Information have been audited by Tait, Weller & Baker
for the periods indicated in its report with respect thereto which is included
in the Statement of Additional Information. Such financial statements and
information are included in this Prospectus and in the Statement of Additional
Information in reliance upon such reports and upon the authority of such firm as
experts in accounting and auditing. Tait, Weller & Baker has an office at 1818
Market Street, Suite 2400, Philadelphia, Pennsylvania 19103, and also performs
tax and other professional services for the Fund.
ADDITIONAL INFORMATION
The Fund is subject to the informational requirements of the Exchange
Act and the 1940 Act and, in accordance therewith, files reports and other
information with the Commission.
46
Reports, proxy statements and other information filed by the Fund with the
Commission pursuant to the informational requirements of such Acts can be
inspected and copied at the public reference facilities maintained by the
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. The Commission
maintains a Web site at http://www.sec.gov. containing reports, proxy and
information statements and other information regarding registrants, including
the Fund, that file electronically with the Commission.
This Prospectus constitutes part of a Registration Statement filed by
the Fund with the Commission under the Securities Act and the 1940 Act. This
Prospectus omits certain of the information contained in the Registration
Statement, and reference is hereby made to the Registration Statement and
related exhibits for further information with respect to the Fund and the
Cumulative Preferred Stock offered hereby. Any statements contained herein
concerning the provisions of any document are not necessarily complete and, in
each instance, reference is made to the copy of such document filed as an
exhibit to the Registration Statement or otherwise filed with the Commission.
Each such statement is qualified in its entirety by such reference. The complete
Registration Statement may be obtained from the Commission upon payment of the
fee prescribed by its rules and regulations or free of charge through the
Commission's web site (http://www.sec.gov).
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Prospectus constitute forward-looking
statements, which involve known and unknown risks, uncertainties and other
factors that may cause the actual results, levels of activity, performance or
achievements of the Fund to be materially different from any future results,
levels of activity, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, those listed
under "Risk Factors and Special Considerations" in the Statement of Additional
Information and elsewhere in this Prospectus. As a result of the foregoing and
other factors, no assurance can be given as to the future results, levels of
activity or achievements, and neither the Fund nor any other person assumes
responsibility for the accuracy and completeness of such statements.
47
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
A Statement of Additional Information dated October , 2003 has been
filed with the Commission and is incorporated by reference in this Prospectus. A
copy of the Statement of Additional Information may be obtained without charge
by writing to the Fund at its address at 1414 Avenue of the Americas, New York,
New York 10019, or by calling the Fund toll-free at (800) 221-4268. The Table of
Contents of the Statement of Additional Information is as follows:
PAGE
----
Risk Factors and Special Considerations....................................... 2
Investment Restrictions....................................................... 6
Taxation...................................................................... 8
Principal Stockholders........................................................15
Directors and Officers........................................................16
Code of Ethics and Related Matters............................................22
Investment Advisory and Other Services........................................23
Brokerage Allocation and Other Practices......................................24
Proxy Voting Policies and Procedures..........................................25
Net Asset Value...............................................................26
Book-Entry System.............................................................26
Financial Statements..........................................................27
No person has been authorized to give any information or to make any
representation in connection with this offering other than those contained in
this Prospectus in connection with the offer contained herein, and, if given or
made, such other information or representations must not be relied upon as
having been authorized by the Fund, Royce or the Underwriters. Neither the
delivery of this Prospectus nor any sale made hereunder will, under any
circumstances, create any implication that there has been no change in the
affairs of the Fund since the date hereof or that the information contained
herein is correct as of any time subsequent to its date. This Prospectus does
not constitute an offer to sell or the solicitation of an offer to buy such
securities in any circumstance in which such an offer or solicitation is
unlawful.
48
GLOSSARY
"Articles Supplementary" means the Fund's Articles Supplementary
creating and fixing the rights of the Cumulative Preferred Stock.
"Asset Coverage" means asset coverage, as defined in Section 18(h) of
the 1940 Act, of at least 200%, or such higher percentage as may be required
under the 1940 Act, with respect to all outstanding senior securities (as
defined by the 1940 Act) of the Fund which are stock, including all outstanding
shares of Cumulative Preferred Stock.
"Basic Maintenance Amount" means, as of any Valuation Date, the dollar
amount equal to (i) the sum of (A) the product of the number of shares of
Cumulative Preferred Stock outstanding on such Valuation Date multiplied by the
Liquidation Preference; (B) to the extent not included in (A), the aggregate
amount of cash dividends (whether or not earned or declared) that will have
accumulated for each outstanding share of Cumulative Preferred Stock from the
most recent Dividend Payment Date to which dividends have been paid or duly
provided for (or, in the event the Basic Maintenance Amount is calculated on a
date prior to the initial Dividend Payment Date with respect to the Cumulative
Preferred Stock, then from the Date of Original Issue) through the Valuation
Date plus all dividends to accumulate on the Cumulative Preferred Stock then
outstanding during the 70 days following such Valuation Date; (C) the Fund's
other liabilities due and payable as of such Valuation Date (except that
dividends and other distributions payable by the Fund by the issuance of Common
Stock shall not be included as a liability) and such liabilities projected to
become due and payable by the Fund during the 90 days following such Valuation
Date (excluding liabilities for investments to be purchased and for dividends
and other distributions not declared as of such Valuation Date); (D) any current
liabilities of the Fund as of such Valuation Date to the extent not reflected in
any of (i)(A) through (i)(C) (including, without limitation, and immediately
upon determination, any amounts due and payable by the Fund pursuant to reverse
repurchase agreements and any payables for assets purchased as of such Valuation
Date) less (ii) (A) the Discounted Value of any of the Fund's assets and/or (B)
the face value of any of the Fund's assets if, in the case of both (ii)(A) and
(ii)(B), such assets are either cash or securities which mature prior to or on
the date of redemption or repurchase of Cumulative Preferred Stock or payment of
another liability and are either U.S. Government Obligations or securities which
have a rating assigned by Moody's of at least Aaa, P-1, VMIG-1 or MIG-1 or by
S&P of at least AAA, SP-1+ or A-1+, in both cases irrevocably held by the Fund's
custodian bank in a segregated account or deposited by the Fund with the Paying
Agent for the payment of the amounts needed to redeem or repurchase Cumulative
Preferred Stock subject to redemption or repurchase or, without duplication, any
of (i)(B) through (i)(D) and provided that in the event the Fund has repurchased
Cumulative Preferred Stock at a price of less than the Liquidation Preference
thereof and irrevocably segregated or deposited assets as described above with
its custodian bank or the Paying Agent for the payment of the repurchase price
the Fund may deduct 100% of the Liquidation Preference of such Cumulative
Preferred Stock to be repurchased from (i) above.
"Business Day" means a day on which the New York Stock Exchange is open
for trading and that is neither a Saturday, Sunday nor any other day on which
banks in the City of New York are authorized by law to close.
49
"Charter" means the Articles of Incorporation, as amended and
supplemented (including the Articles Supplementary), of the Fund on file in the
State Department of Assessments and Taxation of Maryland.
"Common Stock" means the Common Stock, par value $.001 per share, of
the Fund.
"Cumulative Preferred Stock" means the % Cumulative Preferred
Stock, par value $.001 per share, of the Fund.
"Date of Original Issue" means the date on which shares of Cumulative
Preferred Stock are originally issued.
"Deposit Securities" means cash, Short-Term Money Instruments and U.S.
Government Obligations. Except for determining whether the Fund has a Portfolio
Calculation equal to or greater than the Basic Maintenance Amount, each Deposit
Security will be deemed to have a value equal to its principal or face amount
payable at maturity plus any interest payable thereon after delivery of such
Deposit Security but only if payable on or prior to the applicable payment date
in advance of which the relevant deposit is made.
"Discounted Value" means, with respect to a Moody's Eligible Asset, the
quotient of (A) in the case of non-convertible fixed income securities, the
lower of the principal amount and the market value thereof, or (B) in the case
of any other Moody's Eligible Assets, the market value thereof, divided by the
applicable Moody's Discount Factor.
"Dividend Payment Date" means each March 23, June 23, September 23 and
December 23.
"Fitch" means Fitch Ratings or its successor.
"Fund" means Royce Focus Trust, Inc., a Maryland corporation.
"Lien" means any material lien, mortgage, pledge, security interest or
security agreement of any kind.
"Liquidation Preference" means $25.00 per share of Cumulative Preferred
Stock plus an amount equal to all unpaid dividends accumulated to and including
the date fixed for such distribution or payment (whether or not earned or
declared by the Fund, but excluding interest thereon).
"Moody's" means Moody's Investors Service, Inc., or its successor.
"Moody's Discount Factor" means, for purposes of determining the
Discounted Value of any Moody's Eligible Asset, the percentage determined as
follows:
(i) Preferred securities (non-convertible): The percentage
determined by reference to the rating on such asset with
reference to whether such asset pays cumulative or
non-cumulative dividends, in accordance with the table set
forth below.
50
Rating Category (1) Cumulative Non-Cumulative
------------------- ---------- --------------
Aaa 150% 165%
Aa 155 171
A 160 176
Baa 165 182
Ba 196 216
B 216 238
Below B and Unrated 250 275
------------
(1) Unless conclusions regarding liquidity risk as well as estimates of both the
probability and severity of default for the Fund's assets can be derived from
other sources as well as combined with a number of sources as presented by the
Fund to Moody's, securities rated below B3 by Moody's and unrated securities,
which are securities rated by neither Moody's, S&P nor Fitch, are limited to 10%
of Moody's Eligible Assets. If a non-convertible preferred security is unrated
by Moody's, S&P or Fitch, the Fund will use the percentage set forth opposite
"Below B and Unrated" in this table. Ratings assigned by S&P or Fitch are
generally accepted by Moody's at face value. However, adjustments to face value
may be made by Moody's to particular categories of credits for which the S&P
and/or Fitch rating does not seem to approximate a Moody's rating equivalent.
Split rated securities assigned by S&P and Fitch will be accepted by Moody's at
the lower of the two ratings.
The Moody's Discount Factor applied to non-convertible preferred securities that
are Rule 144A Securities will equal the sum of the Moody's Discount Factor which
would apply if such securities were registered under the Securities Act plus
20%.
(ii) Corporate debt securities (non-convertible): The
percentage determined by reference to the rating on such asset
with reference to the remaining term to maturity of such
asset, in accordance with the table set forth below.
Rating Category Below B
Terms To Maturity of --------------------------------------------------
Corporate Debt Security and
-----------------------
Aaa Aa A Baa Ba B Unrated(1)
--- -- - --- -- - ----------
1 year or less................................. 109% 112% 115% 118% 137% 150% 250%
2 years or less (but longer than 1 year)....... 115 118 122 125 146 160 250
3 years or less (but longer than 2 years)...... 120 123 127 131 153 168 250
4 years or less (but longer than 3 years)...... 126 129 133 138 161 176 250
5 years or less (but longer than 4 years)...... 132 135 139 144 168 185 250
7 years or less (but longer than 5 years)...... 139 143 147 152 179 197 250
10 years or less (but longer than 7 years)..... 145 150 155 160 189 208 250
15 years or less (but longer than 10 years).... 150 155 160 165 196 216 250
20 years or less (but longer than 15 years).... 150 155 160 165 196 228 250
30 years or less (but longer than 20 years).... 150 155 160 165 196 229 250
Greater than 30 years.......................... 165 173 181 189 205 240 250
--------------------------
(1) Unless conclusions regarding liquidity risk as well as estimates of both the
probability and severity of default for the Fund's assets can be derived from
other sources as well as combined with a number of sources as presented by the
Fund to Moody's, securities rated below B3 by Moody's and unrated securities,
which are securities rated by neither Moody's, S&P nor Fitch, are limited to 10%
of Moody's Eligible Assets. If a corporate debt security is unrated by Moody's,
S&P or Fitch, the Fund will use the percentage set forth under "Below B and
Unrated" in this table. Ratings assigned by S&P or Fitch are generally accepted
by Moody's at face value. However, adjustments to face value may be made by
Moody's to particular categories of credits for which the S&P and/or Fitch
rating does not seem to approximate a Moody's rating equivalent. Split rated
securities assigned by S&P and Fitch will be accepted by Moody's at the lower of
the two ratings.
The Moody's Discount Factors presented in the immediately preceding table will
also apply to corporate debt securities that do not pay interest in U.S. dollars
or euros, provided that the
51
Moody's Discount Factor determined from the table shall be multiplied by a
factor of 120% for purposes of calculating the Discounted Value of such
securities.
(iii) U.S. Government Obligations and U.S. Treasury Strips:
U.S. Government Obligations U.S. Treasury Strips
Remaining Term To Maturity Discount Factor Discount Factor
-------------------------------------------------------- --------------------------------- ------------------------
1 year or less........................................ 107% 107%
2 years or less (but longer than 1 year).............. 113 115
3 years or less (but longer than 2 years)............. 118 121
4 years or less (but longer than 3 years)............. 123 128
5 years or less (but longer than 4 years)............. 128 135
7 years or less (but longer than 5 years)............. 135 147
10 years or less (but longer than 7 years)............ 141 163
15 years or less (but longer than 10 years)........... 146 191
20 years or less (but longer than 15 years)........... 154 218
30 years or less (but longer than 20 years)........... 154 244
(iv) Short term instruments and cash: The Moody's Discount
Factor applied to short term portfolio securities, including
without limitation short term corporate debt securities, Short
Term Money Market Instruments and short term municipal debt
obligations, will be (A) 100%, so long as such portfolio
securities mature or have a demand feature at par exercisable
within the Moody's Exposure Period; (B) 115%, so long as such
portfolio securities mature or have a demand feature at par not
exercisable within the Moody's Exposure Period; (C) 125%, if
such securities are not rated by Moody's, so long as such
portfolio securities are rated at least A-1+/AA or SP-1+/AA by
S&P and mature or have a demand feature at par exercisable
within the Moody's Exposure Period; and (D) 148%, if such
securities are not rated by Moody's, so long as such portfolio
securities are rated at least A-1+/AA or SP-1+/AA by S&P and
mature or have a demand feature at par exercisable greater than
the Moody's Exposure Period. A Moody's Discount Factor of 100%
will be applied to cash. A Moody's Discount Factor of 100% will
also apply to money market funds rated by a NRSRO that comply
with Rule 2a-7 under the 1940 Act.
(v) Rule 144A Securities: Except as set forth in clause (i)
above with respect to non-convertible preferred securities, the
Moody's Discount Factor applied to Rule 144A Securities will be
130% of the Moody's Discount Factor which would apply if the
securities were registered under the Securities Act.
(vi) Convertible securities (including convertible preferred
securities):
52
Rating Category
----------------------------------------------------------------------------------
Below B and
Industry Category Aaa Aa A Baa Ba B Unrated(1)
-------------------------------- --- -- - --- -- - ----------
Utility 162% 167% 172% 188% 195% 199% 300%
Industrial 256 261 266 282 290 293 300
Financial 233 238 243 259 265 270 300
Transportation 250 265 275 285 290 295 300
(1) Unless conclusions regarding liquidity risk as well as estimates of both the
probability and severity of default for the Fund's assets can be derived from
other sources as well as combined with a number of sources as presented by the
Fund to Moody's, securities rated below B3 by Moody's and unrated securities,
which are securities rated by neither Moody's, S&P nor Fitch, are limited to 10%
of Moody's Eligible Assets. If a convertible security is unrated by Moody's, S&P
or Fitch, the Fund will use the percentage set forth under "Below B and Unrated"
in this table. Ratings assigned by S&P or Fitch are generally accepted by
Moody's at face value. However, adjustments to face value may be made by Moody's
to particular categories of credits for which the S&P and/or Fitch rating does
not seem to approximate a Moody's rating equivalent. Split rated securities
assigned by S&P and Fitch will be accepted by Moody's at the lower of the two
ratings.
(vii) U.S. Common Stock and Common Stock of foreign issuers
for which ADRs are traded.
Utility.................................................................... 170%
Industrial................................................................. 264
Financial.................................................................. 241
Other...................................................................... 300
(viii) The Moody's Discount Factor applied to Common Stock of
foreign issuers (in existence for at least five years) for
which no ADRs are traded will be 400%.
The Moody's Discount Factor for any Moody's Eligible Asset other than the
securities set forth above will be the percentage provided in writing by
Moody's.
For purposes of this definition, ratings assigned by S&P or Fitch are generally
accepted by Moody's at face value. However, adjustments to face value may be
made by Moody's to particular categories of credits for which the S&P and/or
Fitch rating does not seem to approximate a Moody's rating equivalent. Split
rated securities assigned by S&P and Fitch will be accepted by Moody's at the
lower of the two ratings.
"Moody's Eligible Assets" means:
(i) Cash (including interest and dividends due on assets rated
(A) Baa3 or higher by Moody's if the payment date is within
five Business Days of the Valuation Date, (B) A2 or higher if
the payment date is within thirty days of the Valuation Date,
and (C) A1 or higher if the payment date is within the Moody's
Exposure Period) and receivables for assets sold if the
receivable is due within five Business Days of the Valuation
Date, and if the trades which generated such receivables are
(A) settled through clearing house firms with respect to which
the Fund has received prior written authorization from Moody's
or (B)(1) with
53
counterparties having a Moody's long term debt rating of at
least Baa3 or the equivalent from S&P or Fitch or (2) with
counterparties having a Moody's Short Term Money Market
Instrument rating of at least P-1 or the equivalent from S&P or
Fitch.
(ii) Short Term Money Market Instruments, so long as (A) such
securities are rated at least P-1 or if not rated by Moody's,
rated at least A-1+/AA or SP-1+/AA by S&P or the equivalent by
Fitch, (B) in the case of demand deposits, time deposits and
overnight funds, the supporting entity is rated at least A2 by
Moody's or the equivalent by S&P or Fitch, or (C) in all other
cases, the supporting entity (1) is rated A2 by Moody's or the
equivalent by S&P or Fitch and the security matures within one
month, (2) is rated A1 by Moody's or the equivalent by S&P or
Fitch and the security matures within three months or (3) is
rated at least Aa3 by Moody's or the equivalent by S&P or Fitch
and the security matures within six months. In addition, money
market funds that comply with Rule 2a-7 under the 1940 Act are
Moody's Eligible Assets;
(iii) U.S. Government Obligations and U.S. Treasury Strips;
(iv) Rule 144A Securities;
(v) Corporate debt securities, except as noted below, if
(A)(1) such securities are rated B3 or higher by Moody's or the
equivalent by S&P or Fitch; (2) for securities, which provide
for conversion or exchange at the option of the issuer into
equity capital at some time over their lives, the issuer must
be rated at least B3 by Moody's or the equivalent by S&P or
Fitch; or (3) for debt securities rated Ba1 and below by
Moody's or the equivalent by S&P or Fitch, no more than 10% of
the original amount of such issue may constitute Moody's
Eligible Assets; (B) such securities provide for the periodic
payment of interest in cash in U.S. dollars or euros, except
that such securities that do not pay interest in U.S. dollars
or euros shall be considered Moody's Eligible Assets if they
are rated by Moody's, S&P or Fitch; and (C) such securities
have been registered under the Securities Act or are restricted
as to resale under Federal securities laws but are eligible for
resale pursuant to Rule 144A under the Securities Act, except
that such securities that are not subject to U.S. Federal
securities laws shall be considered Moody's Eligible Assets if
they are publicly traded.
In order to merit consideration as Moody's Eligible Asset, debt
securities are issued by entities which have not filed for
bankruptcy within the past three years, are current on all
principal and interest in their fixed income obligations, are
current on all preferred security dividends and possess a
current, unqualified auditor's report without qualified,
explanatory language.
Corporate debt securities not rated at least B3 by Moody's or
the equivalent by S&P or Fitch or not rated by Moody's, S&P or
Fitch shall be considered to be Moody's Eligible Assets only to
the extent the market value of such corporate
54
debt securities does not exceed 10% of the aggregate market
value of all Moody's Eligible Assets.
(vi) Preferred securities if (A) such preferred securities
pay cumulative or non-cumulative dividends, (B) such securities
provide for the periodic payment of dividends thereon in cash
in U.S. dollars or euros, (C) the issuer or the parent company
of the issuer of such a preferred security has common stock
listed on either the New York Stock Exchange, the American
Stock Exchange or Nasdaq or is a U.S. Government Agency, (D)
the issuer or the parent company of the issuer of such a
preferred security has a senior debt rating or a preferred
security rating from Moody's of Baa3 or higher or the
equivalent from S&P or Fitch and (E) such preferred security
has paid consistent cash dividends in U.S. dollars or euros
over the last three years or has a minimum rating of A1 from
Moody's or the equivalent from S&P or Fitch (if the issuer of
such preferred security or the parent company of the issuer has
other preferred issues outstanding that have been paying
dividends consistently for the last three years, then a
preferred security without such a dividend history would also
be eligible). In addition, the preferred securities must have
the diversification requirements set forth in the table below
and the preferred securities issue must be greater than $50
million.
Diversification Table:
---------------------
The table below establishes maximum limits for inclusion as Moody's Eligible
Assets (other than common stock as set forth below) prior to applying Moody's
Discount Factors to Moody's Eligible Assets.
Minimum Maximum Maximum Maximum Single
Issue Size Single Single Industry Industry
Ratings(1) ($ in Million)(2) Issuer (3)(4) Non-Utility (4)(5) Utility(4)(5)
---------- ----------------- ------------- ------------------ -------------
Aaa.................. $100 100% 100% 100%
Aa................... 100 20 60 30
A.................... 100 10 40 25
Baa.................. 100 6 20 20
Ba................... 50(6) 4 12 12
B1-B2................ 50(6) 3 8 8
B3 or below.......... 50(6) 2 5 5
----------
(1) Refers to the preferred security and senior debt rating of the portfolio
holding.
(2) Except for preferred security, which has a minimum issue size of $50
million.
(3) Companies subject to common ownership of 25% or more are
considered as one issuer.
(4) Percentages represent a portion of the aggregate market value of the Fund's
total assets.
(5) Industries are determined according to Moody's Industry Classifications, as
defined herein.
(6) Portfolio holdings from issues ranging from $50 million to $100 million are
limited to 20% of the Fund's total assets.
(vii) Common stocks (A) (i) which are traded in the United
States on a national securities exchange or in the
over-the-counter market, (ii) which, if cash dividend paying,
pay cash dividends in U.S. dollars, and (iii) which may be sold
without restriction by the Fund; provided, however, that common
stock which, while a Moody's Eligible Asset owned by the Fund,
ceases paying any regular cash dividend will no longer be
considered a Moody's Eligible Asset until 71 days after the
date of the announcement of such cessation, unless the issuer
of the
55
common stock has senior debt securities rated at least A3 by
Moody's or the equivalent by S&P or Fitch, (B) which are
securities denominated in any currency other than the U.S.
dollar or securities of issuers formed under the laws of
jurisdictions other than the United States, its states,
commonwealths, territories and possessions, including the
District of Columbia, for which there are (i) sponsored ADR
programs or (ii) Level II or Level III ADRs, and (C) which are
securities of issuers formed under the laws of jurisdictions
other than the United States, its states, commonwealths,
territories and possessions, including the District of Columbia
(and in existence for at least five years), for which no ADRs
are traded.
Common Stock Diversification Table:
----------------------------------
Maximum Single Maximum Single Maximum Single
Industry Category Issuer (%)(1) Industry (%)(1) State (%)(1)
----------------- ------------- --------------- ------------
Utility 4 50 7(2)
Industrial 4 45 7
Financial 5 40 6
Other 6 20 N/A
-----------------------
(1) Percentages represent both a portion of the aggregate
market value and the number of outstanding shares of the
common stock portfolio.
(2) Utility companies operating in more than one state should
be diversified according to the state of incorporation.
(viii) Financial contracts, as such term is defined in Section
3(c)(2)(B)(ii) of the 1940 Act, not otherwise provided for in
this definition but only upon receipt by the Fund of a letter
from Moody's specifying any conditions on including such
financial contract in Moody's Eligible Assets and assuring the
Fund that including such financial contract in the manner so
specified would not affect the credit rating assigned by
Moody's to the AMPS.
When the Fund sells a portfolio security and agrees to
repurchase it at a future date, the Discounted Value of such
security will constitute a Moody's Eligible Asset and the
amount the Fund is required to pay upon repurchase of such
security will count as a liability for purposes of calculating
the Basic Maintenance Amount. When the Fund purchases a
security and agrees to sell it at a future date to another
party, cash receivable by the Fund thereby will constitute a
Moody's Eligible Asset if the long term debt of such other
party is rated at least A2 by Moody's or the equivalent by S&P
or Fitch and such agreement has a term of 30 days or less;
otherwise the Discounted Value of such security will constitute
a Moody's Eligible Asset. For the purpose of calculation of
Moody's Eligible Assets, portfolio securities which have been
called for redemption by the issuer thereof shall be valued at
the lower of market value or the call price of such portfolio
securities.
Notwithstanding the foregoing, an asset will not be considered
a Moody's Eligible Asset to the extent that it has been
irrevocably deposited for the payment of (i)(A) through (i)(D)
under the definition of Basic Maintenance Amount or to the
extent
56
it is subject to any Liens, including assets segregated under
margin account requirements in connection with the engagement
in hedging transactions, except for (A) Liens which are being
contested in good faith by appropriate proceedings and which
Moody's has indicated to the Fund will not affect the status of
such assets as a Moody's Eligible Asset, (B) Liens for taxes
that are not then due and payable or that can be paid
thereafter without penalty, (C) Liens to secure payment for
services rendered or cash advanced to the Fund by Royce, the
Fund's custodian, transfer agent or registrar or the Auction
Agent and (D) Liens arising by virtue of any repurchase
agreement.
For purposes of this definition, ratings assigned by S&P or Fitch are generally
accepted by Moody's at face value. However, adjustments to face value may be
made by Moody's to particular categories of credits for which the S&P and/or
Fitch rating does not seem to approximate a Moody's rating equivalent. Split
rated securities assigned by S&P and Fitch will be accepted by Moody's at the
lower of the two ratings.
"Moody's Exposure Period" means the sum of (i) that number of calendar
days from the last Valuation Date on which the Portfolio Calculation was at
least equal to the Basic Maintenance Amount to the Valuation Date on which the
Portfolio Calculation was not at least equal to the Basic Maintenance Amount,
(ii) that number of calendar days following a Valuation Date that the Fund has
under the terms of the Cumulative Preferred Stock to cure any failure to
maintain a Portfolio Calculation at least equal to the Basic Maintenance Amount,
and (iii) the maximum number of calendar days the Fund has to effect a
redemption under the terms of the Cumulative Preferred Stock.
"Moody's Industry Classifications" means, for the purposes of
determining Moody's Eligible Assets, each of the following industry
classifications (or such other classifications as Moody's may from time to time
approve for application to the Cumulative Preferred Stock):
Aerospace and Defense: Major Contractor, Subsystems, Research, Aircraft
Manufacturing, Arms, Ammunition
Automobile: Automotive Equipment, Auto-Manufacturing, Auto Parts
Manufacturing, Personal Use Trailers, Motor Homes, Dealers
Banking: Bank Holding, Savings and Loans, Consumer Credit, Small Loan,
Agency, Factoring, Receivables
Beverage, Food and Tobacco: Beer and Ale, Distillers, Wines and
Liquors, Distributors, Soft Drink Syrup, Bottlers, Bakery, Mill Sugar,
Canned Foods, Corn Refiners, Dairy Products, Meat Products, Poultry
Products, Snacks, Packaged Foods, Distributors, Candy, Gum, Seafood,
Frozen Food, Cigarettes, Cigars, Leaf/Snuff, Vegetable Oil
Buildings and Real Estate: Brick, Cement, Climate Controls,
Contracting, Engineering, Construction, Hardware, Forest Products
(building-related only), Plumbing, Roofing, Wallboard, Real Estate,
Real Estate Development, REITs, Land Development
57
Chemicals, Plastics and Rubber: Chemicals (non-agriculture), Industrial
Gases, Sulfur, Plastics, Plastic Products, Abrasives, Coatings, Paints,
Varnish, Fabricating
Containers, Packaging and Glass: Glass, Fiberglass, Containers made of:
Glass, Metal, Paper, Plastic, Wood, or Fiberglass
Personal and Non Durable Consumer Products (Manufacturing Only): Soaps,
Perfumes, Cosmetics, Toiletries, Cleaning Supplies, School Supplies
Diversified/Conglomerate Manufacturing
Diversified/Conglomerate Service
Diversified Natural Resources, Precious Metals and Minerals:
Fabricating, Distribution
Ecological: Pollution Control, Waste Removal, Waste Treatment, Waste
Disposal
Electronics: Computer Hardware, Electric Equipment, Components,
Controllers, Motors, Household Appliances, Information Service
Communication Systems, Radios, Televisions, Tape Machines, Speakers,
Printers, Drivers, Technology
Finance: Investment Brokerage, Leasing, Syndication, Securities
Farming and Agriculture: Livestock, Grains, Produce; Agricultural
Chemicals, Agricultural Equipment, Fertilizers
Grocery: Grocery Stores, Convenience Food Stores
Healthcare, Education and Childcare: Ethical Drugs, Proprietary Drugs,
Research, Health Care Centers, Nursing Homes, HMOs, Hospitals, Hospital
Supplies, Medical Equipment
Home and Office Furnishings, Housewares, and Durable Consumer Products:
Carpets, Floor Coverings, Furniture, Cooking, Ranges
Hotels, Motels, Inns and Gaming
Insurance: Life, Property and Casualty, Broker, Agent, Surety
Leisure, Amusement, Motion Pictures, Entertainment: Boating, Bowling,
Billiards, Musical Instruments, Fishing, Photo Equipment, Records,
Tapes, Sports, Outdoor Equipment (Camping), Tourism, Resorts, Games,
Toy Manufacturing, Motion Picture Production Theaters, Motion Picture
Distribution
Machinery (Non-Agriculture, Non-Construction, Non-Electronic):
Industrial, Machine Tools, Steam Generators
58
Mining, Steel, Iron and Non Precious Metals: Coal, Copper, Lead,
Uranium, Zinc, Aluminum, Stainless Steel, Integrated Steel, Ore
Production, Refractories, Steel Mill Machinery, Mini-Mills,
Fabricating, Distribution and Sales of the foregoing
Oil and Gas: Crude Producer, Retailer, Well Supply, Service and
Drilling
Printing, Publishing and Broadcasting: Graphic Arts, Paper, Paper
Products, Business Forms, Magazines, Books, Periodicals, Newspapers,
Textbooks, Radio, Television, Cable Broadcasting Equipment
Cargo Transport: Rail, Shipping, Railroads, Rail-Car Builders, Ship
Builders, Containers, Container Builders, Parts, Overnight Mail,
Trucking, Truck Manufacturing, Trailer Manufacturing, Air Cargo,
Transport
Retail Stores: Apparel, Toy, Variety, Drugs, Department, Mail Order
Catalog, Showroom
Telecommunications: Local, Long Distance, Independent, Telephone,
Telegraph, Satellite, Equipment, Research, Cellular
Textiles and Leather: Producer, Synthetic Fiber, Apparel Manufacturer,
Leather Shoes
Personal Transportation: Air, Bus, Rail, Car Rental
Utilities: Electric, Water, Hydro Power, Gas
Diversified Sovereigns: Semi-sovereigns, Canadian Provinces,
Supra-national agencies
The Fund will use its discretion in determining which industry classification is
applicable to a particular investment in consultation with the Fund's
independent accountants and Moody's, to the extent the Fund considers necessary.
"Nasdaq" means the Nasdaq Stock Market, Inc.
"1940 Act" means the Investment Company Act of 1940, as amended.
"Notice of Redemption" means written notice by the Fund to holders of
Cumulative Preferred Stock in compliance with the provisions of the Articles
Supplementary of the Fund's intention to redeem shares of Cumulative Preferred
Stock.
"NRSRO" means any nationally recognized statistical rating
organization, as that term is used in Rule 15a3-1 under the Securities Exchange
Act or any successor provisions.
"Other Ordinary Income" means ordinary income other than qualified
dividend income but including short-term capital gains, interest income and
non-qualified dividend income.
"Paying Agent" means Equiserve Trust Company, N.A. and its successors
or any other paying agent appointed by the Fund.
59
"Portfolio Calculation" means the aggregate Discounted Value of all
Moody's Eligible Assets.
"Preferred Stock" means the issued and outstanding shares of preferred
stock, par value $.001 per share, of the Fund, and includes the Cumulative
Preferred Stock.
"Quarterly Valuation Date" means the last Valuation Date of March,
June, September and December, commencing December 26, 2003.
"Redemption Price" means $25.00 per share plus accumulated and unpaid
dividends through the date of redemption (whether or not earned or declared).
"Rule 144A Securities" means securities that are restricted as to
resale under U.S. Federal securities laws but are eligible for resale pursuant
to Rule 144A under the Securities Act or successor provisions.
"7.45% Preferred" means, so long as any shares of such series are
issued and outstanding, the 7.45% Cumulative Preferred Stock, par value $.001
per share, of the Fund.
"Short-Term Money Market Instruments" means the following types of
instruments if, on the date of purchase or other acquisition thereof by the
Fund, the remaining term to maturity thereof is not in excess of 180 days:
(i) Commercial paper rated P-1 by Moody's, F1 by Fitch or A-1
by S&P if such commercial paper matures in 30 days or less, or P-1 by
Moody's and either F1 by Fitch or A-1+ by S&P if such commercial paper
matures in over 30 days;
(ii) Demand or time deposits in, and banker's acceptances and
certificates of deposit of (A) a depository institution or trust
company incorporated under the laws of the United States of America or
any state thereof or the District of Columbia or (B) a United States
branch office or agency of a foreign depository institution (provided
that such branch office or agency is subject to banking regulation
under the laws of the United States, any state thereof or the District
of Columbia);
(iii) Overnight funds;
(iv) U.S. Government Obligations; and
(v) Eurodollar demand or time deposits in, or certificates of
deposit of, the head office or the London branch office of a depository
institution or trust company if the certificates of deposit, if any,
and the long-term unsecured debt obligations (other than such
obligations the ratings of which are based on the credit of a person or
entity other than such depository institution or trust company) of such
depository institution or trust company that have (1) credit ratings on
such Valuation Date of at least P-1 from Moody's and either F1+ from
Fitch or A-1+ from S&P, in the case of commercial paper or certificates
of deposit, and (2) credit ratings on each Valuation Date of at least
Aa3 from Moody's and either AA- from Fitch or AA- from S&P, in the case
of long-term unsecured debt obligations; provided, however, that in the
case of any such investment
60
that matures in no more than one Business Day from the date of purchase
or other acquisition by the Fund, all of the foregoing requirements
shall be applicable except that the required long-term unsecured debt
credit rating of such depository institution or trust company from
Moody's, Fitch and S&P shall be at least A2, A and A, respectively; and
provided further, however, that the foregoing credit rating
requirements shall be deemed to be met with respect to a depository
institution or trust company if (1) such depository institution or
trust company is the principal depository institution in a holding
company system, (2) the certificates of deposit, if any, of such
depository institution or trust company are not rated on any Valuation
Date below P-1 by Moody's, F1+ by Fitch or A-1+ by S&P and there is no
long-term rating, and (3) the holding company shall meet all of the
foregoing credit rating requirements (including the preceding proviso
in the case of investments that mature in no more than one Business Day
from the date of purchase or other acquisition by the Fund); and
provided further, that the interest receivable by the Fund shall not be
subject to any withholding or similar taxes.
"S&P" means Standard & Poor's or its successor.
"2003 Tax Act" means the Jobs and Growth Tax Relief Reconciliation Act
of 2003, Public Law 108-27.
"U.S. Government Agency" means any agency, sponsored enterprise or
instrumentality of the United States of America.
"U.S. Government Obligations" means direct obligations of the United
States or U.S. Government Agencies that are entitled to the full faith and
credit of the United States and that, other than United States Treasury Bills
and U.S. Treasury Strips, provide for the periodic payment of interest and the
full payment of principal at maturity.
"U.S. Treasury Strips" means securities based on direct obligations of
the United States Treasury created through the Separate Trading of Registered
Interest and Principal of Securities program.
"Valuation Date" means every Friday or, if such day is not a Business
Day, the immediately preceding Business Day.
61
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================================================================================
$25,000,000
ROYCE FOCUS TRUST, INC.
1,000,000 SHARES
% CUMULATIVE PREFERRED STOCK
-------------------
PROSPECTUS
OCTOBER , 2003
-------------------
CITIGROUP
UBS INVESTMENT BANK
LEGG MASON WOOD WALKER
Incorporated
-------------------
================================================================================
The information in this Statement of Additional Information is not complete and
may be changed. These securities may not be sold until the registration
statement filed with the Securities and Exchange Commission is effective. This
Statement of Additional Information is not an offer to sell these securities and
it is not soliciting an offer to buy these securities in any state where the
offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED OCTOBER 9, 2003
STATEMENT OF ADDITIONAL INFORMATION
1,000,000 SHARES
ROYCE FOCUS TRUST, INC.
% CUMULATIVE PREFERRED STOCK
LIQUIDATION PREFERENCE $25.00 PER SHARE
The % Cumulative Preferred Stock, initial liquidation preference $25.00
per share (the "Cumulative Preferred Stock"), to be issued by Royce Focus Trust,
Inc. (the "Fund") will be senior securities of the Fund. The Fund will use a
substantial portion of the net proceeds from the offering of the Cumulative
Preferred Stock to redeem the issued and outstanding shares of 7.45% Cumulative
Preferred Stock, par value $.001 per share, of the Fund. Royce & Associates, LLC
("Royce"), the Fund's investment adviser, expects to use any proceeds remaining
after the redemption of the 7.45% Preferred to purchase additional portfolio
securities in accordance with the Fund's investment goal and policies.
The Fund is a closed-end diversified management investment company. The
Fund's primary investment goal is long-term capital growth, which it seeks by
normally investing at least 75% of its assets in equity securities. The Fund's
address is 1414 Avenue of the Americas, New York, New York 10019, and its
telephone number is (212) 355-7311.
This Statement of Additional Information is not a prospectus, but
should be read in conjunction with the Fund's Prospectus (dated October , 2003).
Please retain this document for future reference. To obtain an additional copy
of the Prospectus, please call Investor Information at 1-800-221-4268. Defined
terms used in this Statement of Additional Information have the meanings given
to them in the Prospectus.
TABLE OF CONTENTS
PAGE
----
Risk Factors and Special Considerations..................................... 2
Investment Restrictions..................................................... 6
Taxation.................................................................... 8
Principal Stockholders...................................................... 15
Directors and Officers...................................................... 16
Code of Ethics and Related Matters.......................................... 22
Investment Advisory and Other Services...................................... 23
Brokerage Allocation and Other Practices.................................... 24
Proxy Voting Policies and Procedures........................................ 25
Net Asset Value............................................................. 26
Book-Entry System........................................................... 26
Financial Statements........................................................ 27
Date: October , 2003
RISK FACTORS AND SPECIAL CONSIDERATIONS
FUND'S RIGHTS AS STOCKHOLDER
The Fund may not invest in a company for the purpose of exercising
control of management. However, the Fund may exercise its rights as a
stockholder and communicate its views on important matters of policy to
management, the board of directors and/or stockholders if Royce or the Board of
Directors determines that such matters could have a significant effect on the
value of the Fund's investment in the company. The activities that the Fund may
engage in, either individually or in conjunction with others, may include, among
others, supporting or opposing proposed changes in a company's corporate
structure or business activities; seeking changes in a company's board of
directors or management; seeking changes in a company's direction or policies;
seeking the sale or reorganization of a company or a portion of its assets; or
supporting or opposing third party takeover attempts. This area of corporate
activity is increasingly prone to litigation, and it is possible that the Fund
could be involved in lawsuits related to such activities. Royce will monitor
such activities with a view to mitigating, to the extent possible, the risk of
litigation against the Fund and the risk of actual liability if the Fund is
involved in litigation. However, no assurance can be given that litigation
against the Fund will not be undertaken or liabilities incurred.
The Fund may, at its expense or in conjunction with others, pursue
litigation or otherwise exercise its rights as a security holder to seek to
protect the interests of security holders if Royce and the Board of Directors
determine this to be in the best interests of the Fund's stockholders.
HIGH-YIELD/HIGH-RISK AND INVESTMENT GRADE DEBT SECURITIES
Up to 25% of the Fund's assets may be invested in non-convertible debt
securities of various domestic issuers. Within this category, up to 5% of the
Fund's assets may be invested in below investment-grade debt securities, also
known as high-yield/high-risk securities. These securities have poor protection
with respect to the payment of interest and repayment of principal and may be in
default as to the payment of principal or interest. These securities are often
speculative and involve greater risk of loss or price changes due to changes in
the issuer's capacity to pay. The market prices of high-yield debt securities
may fluctuate more than those of higher-rated debt securities and may decline
significantly in periods of general economic difficulty, which may follow
periods of rising interest rates.
The market for high-yield debt securities may be thinner and less
active than that for higher-rated debt securities, which can adversely affect
the prices at which the former are sold. If market quotations cease to be
readily available for a high-yield debt security in which the Fund has invested,
the security will then be valued in accordance with procedures established by
the Board of Directors. Judgment may play a greater role in valuing high-yield
debt securities than is the case for securities for which more external sources
for quotations and last sale information are available. Adverse publicity and
changing investor perceptions may affect the Fund's ability to dispose of
high-yield debt securities.
2
Since the risk of default is higher for high-yield debt securities,
Royce's research and credit analysis may play an important part in managing
securities of this type for the Fund. In considering such investments for the
Fund, Royce will attempt to identify those issuers of high-yield debt securities
whose financial condition is adequate to meet future obligations, has improved
or is expected to improve in the future. Royce's analysis may focus on relative
values based on such factors as interest or dividend coverage, asset coverage,
earnings prospects and the experience and managerial strength of the issuer.
The Fund may also invest in non-convertible debt securities in the
lowest rated category of investment grade debt. Such securities may have
speculative characteristics, and adverse changes in economic conditions or other
circumstances are more likely to lead to a weakened capacity to make principal
and interest payments than is the case with higher grade securities.
The Fund may also invest in higher rated investment grade
non-convertible debt securities. Such securities include those rated Aaa by
Moody's or AAA by S&P (which are considered to be of the highest credit quality
and where the capacity to pay interest and repay principal is extremely strong),
those rated Aa by Moody's or AA by S&P (where the capacity to repay principal is
considered very strong, although elements may exist that make risks appear
somewhat larger than expected with securities rated Aaa or AAA), securities
rated A by Moody's or A by S&P (which are considered to possess adequate factors
giving security to principal and interest) and securities rated Baa by Moody's
or BBB by S&P (which are considered to have an adequate capacity to pay interest
and repay principal, but may have some speculative characteristics).
FOREIGN INVESTMENTS
The Fund invests a portion of its assets in securities of foreign
issuers. Foreign investments involve certain risks which typically are not
present in securities of domestic issuers. There may be less information
available about a foreign company than a domestic company; foreign companies may
not be subject to accounting, auditing and reporting standards and requirements
comparable to those applicable to domestic companies; and foreign markets,
brokers and issuers are generally subject to less extensive government
regulation than their domestic counterparts. Foreign securities may be less
liquid and may be subject to greater price volatility than domestic securities.
Foreign brokerage commissions and custodial fees are generally higher than those
in the United States. Foreign markets also have different clearance and
settlement procedures, and in certain markets there have been times when
settlements have been unable to keep pace with the volume of securities
transactions, thereby making it difficult to conduct such transactions. Delays
or problems with settlements might affect the liquidity of the Fund's portfolio.
Foreign investments also may be subject to local economic and political risks,
political, economic and social instability, military action, social or political
unrest, adverse diplomatic developments, or possible nationalization of issuers
or expropriation of their assets, any of which might adversely affect the Fund's
ability to realize on its investment in such securities. No assurance can be
given that Royce will be able to anticipate these potential events or counter
their effects. Furthermore, some foreign securities are subject to brokerage
taxes levied by foreign governments, which have the effect of increasing the
cost of such investment and reducing the realized gain or increasing the
realized loss on such securities at the time of sale.
3
The Fund does not expect to purchase or sell foreign currencies to
hedge against declines in the U.S. dollar or to lock in the value of the foreign
securities it purchases, and its foreign investments may be adversely affected
by changes in foreign currency rates. Consequently, the risks associated with
such investments may be greater than if the Fund did engage in foreign currency
transactions for hedging purposes. Foreign investments may also be adversely
affected by exchange control regulations, if any, in such foreign markets, and
the Fund's ability to make certain distributions necessary to maintain
eligibility as a regulated investment company and avoid the imposition of income
and excise taxes may to that extent be limited.
Income earned or received by the Fund from sources within foreign
countries may be subject to withholding and other taxes imposed by such
countries. Any such taxes paid by the Fund will reduce its cash available for
distribution to stockholders. The Fund is required to calculate its
distributable income and capital gains for U.S. Federal income tax purposes by
reference to the U.S. dollar. Fluctuations in applicable foreign currency
exchange rates may cause the Fund's distributable income and capital gains for
U.S. Federal income tax purposes to differ from the value of its investments
calculated by reference to foreign currencies. If the Fund invests in stock of a
passive foreign investment company, the Fund may make certain elections that
will affect the calculation of its net investment income and capital gains. See
"Taxation" below and in the Prospectus.
DEPOSITARY RECEIPTS
The Fund may invest in the securities of foreign issuers in the form of
sponsored or unsponsored ADRs, European Depositary Receipts ("EDRs") and Global
Depositary Receipts ("GDRs") (collectively, "Depositary Receipts") or other
securities convertible into securities of foreign issuers. Depositary Receipts
may not necessarily be denominated in the same currency as the underlying
securities into which they may be converted. ADRs are receipts typically issued
by an American bank or trust company that evidence ownership of underlying
securities issued by a foreign corporation. EDRs are receipts issued in Europe
that evidence a similar ownership arrangement. GDRs are receipts issued
throughout the world that evidence a similar arrangement. Generally, ADRs, in
registered form, are designed for use in the U.S. securities markets, and EDRs,
in bearer form, are designed for use in European securities markets. GDRs are
tradeable both in the U.S. and in Europe and are designed for use throughout the
world. Depositary Receipts are alternatives to the purchase of the underlying
foreign securities in their national markets and currencies. The Fund may invest
in unsponsored Depositary Receipts. The issuers of unsponsored Depositary
Receipts are not obligated to disclose material information in the United States
and, therefore, there may be less information available regarding such issuers
and there may not be a correlation between such information and the market value
of the Depositary Receipts. Depositary Receipts also involve the risks
associated with other investments in foreign securities, as discussed above.
REPURCHASE AGREEMENTS
In a repurchase agreement, the Fund in effect makes a loan by
purchasing a security and simultaneously committing to resell that security to
the seller at an agreed upon price on an agreed upon date within a number of
days (usually not more than seven) from the date of purchase. The resale price
reflects the purchase price plus an agreed upon incremental amount
4
which is unrelated to the coupon rate or maturity of the purchased security. A
repurchase agreement requires or obligates the seller to pay the agreed upon
price, which obligation is in effect secured by the value (at least equal to the
amount of the agreed upon resale price and marked to market daily) of the
underlying security.
The Fund may engage in repurchase agreements, provided that such
agreements are collateralized by cash or securities issued by the U.S.
Government or its agencies having a value at least equal to the amount loaned.
Repurchase agreements could involve certain risks if the custodian defaults or
becomes insolvent, including possible delays or restrictions upon the Fund's
ability to dispose of collateral. While it does not presently appear possible to
eliminate all risks from these transactions (particularly the possibility of a
decline in the market value of the underlying securities, as well as delays and
costs to the Fund in connection with bankruptcy proceedings), it is the policy
of the Fund to enter into repurchase agreements only with its custodian, State
Street Bank and Trust Company, and having a term of seven days or less.
WARRANTS, RIGHTS AND OPTIONS
The Fund may invest up to 5% of its total assets in warrants, rights
and options. A warrant, right or call option entitles the holder to purchase a
given security within a specified period for a specified price and does not
represent an ownership interest. A put option gives the holder the right to sell
a particular security at a specified price during the term of the option. These
securities have no voting rights, pay no dividends and have no liquidation
rights. In addition, their market prices do not necessarily move parallel to the
market prices of the underlying securities.
The sale of warrants, rights or options held for more than one year
generally results in a long-term capital gain or loss to the Fund, and the sale
of warrants, rights or options held for one year or less generally results in a
short term capital gain or loss to the Fund. The holding period for securities
acquired upon exercise of a warrant, right or call option, however, generally
begins on the day after the date of exercise, regardless of how long the
warrant, right or option was held. The securities underlying warrants, rights
and options could include shares of common stock of a single company or
securities market indices representing shares of the common stocks of a group of
companies, such as the Russell 2000.
Investing in warrants, rights and call options on a given security
allows the Fund to hold an interest in that security without having to commit
assets equal to the market price of the underlying security and, in the case of
securities market indices, to participate in a market without having to purchase
all of the securities comprising the index. Put options, whether on shares of
common stock of a single company or on a securities market index, would permit
the Fund to protect the value of a portfolio security against a decline in its
market price and/or to benefit from an anticipated decline in the market price
of a given security or of a market. Thus, investing in warrants, rights and
options permits the Fund to incur additional risk and/or to hedge against risk.
5
INVESTMENT IN OTHER INVESTMENT COMPANIES
The Fund also may indirectly invest in the securities of domestic and
foreign companies by investing in the securities of other investment companies
that invest primarily in such companies. The other investment companies in which
the Fund may invest may be domestic companies registered under the 1940 Act or
foreign companies that are not so registered or otherwise regulated. Such
investment companies usually have their own management fees and expenses, and
Royce will also earn its own fee on Fund assets invested in such other
companies, which would result in a duplication of fees to the extent of any such
investment. However, Royce will waive its management fee on any Fund assets
invested in open-end investment companies (other than exchange-traded funds),
and no sales charge will be incurred on such an investment. See "Investment
Advisory and Other Services -- Advisory Fee" in the Prospectus.
In accordance with the 1940 Act, the Fund may invest up to 10% of its
total assets in securities of other investment companies. In addition, under the
1940 Act the Fund may not own more than 3% of the total outstanding voting stock
of any investment company and not more than 5% of the value of the Fund's total
assets may be invested in securities of any one investment company.
INVESTMENT RESTRICTIONS
The policies set forth below are fundamental policies of the Fund and
may not be changed without the affirmative vote of the holders of a majority of
the Fund's outstanding voting securities, as indicated in the Prospectus under
"Investment Goal, Policies and Risks -- Changes in Investment Goal and
Policies". The Fund may not:
1. As to 75% of the Fund's total assets, invest more than 5% of its total
assets in the securities of any one issuer. (This limitation does not apply
to cash and cash items or to obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.)
2. Invest in any investment company if a purchase of its shares would result
in the Fund and its affiliates owning more than 3% of the total outstanding
stock of such company.
3. Purchase more than 10% of the voting securities or more than 10% of any
class of securities of any issuer. For purposes of this restriction, all
outstanding fixed income securities of an issuer are considered as one
class.
4. Purchase or sell commodities or commodity future contracts. (This
restriction does not limit the Fund's use of financial futures and options
thereon, or the investment of not more than 25% of the Fund's assets in
gold and silver bullion or certificates for such precious metals. Illiquid
investments in either gold, silver or certificates for gold or silver are
limited to 10% of the Fund's assets.)
5. Make loans of money or securities, except (i) by the purchase of fixed
income obligations in which the Fund may invest consistent with its
investment objective and policies; (ii) by entering into securities lending
transactions described in "Investment Goal, Policies and Risks" in the
Prospectus; and (iii) by entering into reverse repurchase agreements (but
may
6
not do so under the Rating Agency Guidelines), as described in "Investment
Goal, Policies and Risks" in the Prospectus.
6. Invest in the securities of any company if, to the knowledge of the Fund,
any officer or director of the Fund or the investment adviser owns more
than .5% of the outstanding securities of such company and such officers
and directors (who own more than .5%) in the aggregate own more than 5% of
the outstanding securities of such company.
7. Borrow money, except to the extent that it may (i) borrow from banks for
temporary or emergency purposes in an amount not exceeding 5% of the Fund's
assets or (ii) borrow in an amount up to 33 1/3% of the value of the Fund's
total assets (including the amount borrowed) valued at market less
liabilities (not including the amount borrowed) at the time the borrowing
was made; provided that the Fund is authorized to enter into reverse
repurchase agreements (but may not do so under the Rating Agency
Guidelines), as set forth in "Investment Goal, Policies and Risks" in the
Prospectus.
8. Pledge, hypothecate, mortgage or otherwise encumber its assets, except in
an amount up to 33 1/3% of the value of its net assets, but only to secure
borrowings authorized by Restriction 7 above.
9. Engage in the underwriting of securities, except insofar as the Fund may be
deemed an underwriter under the Securities Act of 1933 in disposing of a
portfolio security.
10. Purchase or sell real estate or interests therein, although it may purchase
securities of issuers which engage in real estate operations and securities
which are secured by real estate or interests therein.
11. Invest for the purpose of exercising control or management of another
company.
12. Purchase oil, gas or other mineral leases, rights or royalty contracts or
exploration or development programs, except that the Fund may invest in the
securities of companies which invest in or sponsor such programs.
13. Concentrate its investments in any industry.
14. Make purchases of securities on "margin" from an affiliated person,
provided that the Fund may engage in short sales and may satisfy margin
requirements with respect to futures transactions.
15. Issue any class of senior security, or sell any such security of which it
is the Issuer, except as permitted by the 1940 Act.
Notwithstanding Restriction 4 above, the Fund has no current intention
of investing in financial futures and options thereon, gold and silver bullion
or certificates for such precious metals.
7
The policies set forth below are operating policies of the Fund and may
be changed by the Board of Directors without stockholder approval or prior
notice to stockholders. The Fund may not:
a. Make investments which would cause more than 50% of the Fund's
assets to be invested in equity securities traded exclusively in
markets outside the United States.
b. Invest in emerging market countries.
Limitations a. and b. above do not prevent the Fund from
purchasing sponsored or unsponsored depository receipts trading within
the U.S. and/or developed markets in Europe which represent an interest
in foreign equity securities trading in other markets, including
securities of issuers located or trading in emerging market countries.
c. Make investments which would cause more that 25% of the Fund's
assets to be invested in non-equity securities traded exclusively in
markets outside the U.S.
d. Make investments which would cause more than 5% of the Fund's assets
to be invested in below investment grade non-convertible debt
securities.
e. Deal in foreign currency futures, either for speculative or hedging
purposes.
f. Engage in "swaps" , or invest more than 10% of its assets in
illiquid securities.
g. Make short sales of securities, other than short sales
against-the-box in which, at the time of the short sale, the Fund holds
or has an unrestricted right to receive the security to be sold short.
h. Invest in derivative securities of a speculative nature. (This
limitation is not intended to prevent the Fund from using investments
in repurchase agreements, reverse repurchase agreements, warrants,
rights, options and convertible securities.)
i. Borrow from banks for leveraging purposes. (The Fund may, however,
issue other senior securities under Section 18 of the 1940 Act.)
If a percentage restriction is met at the time of investment, a later
increase or decrease in percentage resulting from a change in values of
portfolio securities or amount of total assets is not considered a violation of
any of the above restrictions.
TAXATION
The Fund has elected to be treated as a RIC, and has qualified and
intends to continue to qualify for the special tax treatment afforded RICs under
the Code. As long as it so qualifies, in any taxable year in which it
distributes at least 90% of its investment company taxable income ("ICTI") (as
that term is defined in the Code without regard to the deduction for dividends
paid) for such taxable year, the Fund will not be subject to Federal income tax
on the part of its ICTI and net capital gains (i.e., the excess of the Fund's
net realized long-term capital gains over its
8
net realized short-term capital losses), if any, that it distributes to its
stockholders in each taxable year. The Fund intends to distribute substantially
all of such income.
The Code requires RIC to pay a non-deductible 4% excise tax to the
extent the RIC does not distribute, during each calendar year, 98% of its
ordinary income, determined on a calendar year basis, and 98% of its capital
gains, determined, in general, on an October 31 year end, plus 100% of
undistributed amounts from previous years. For these purposes, the Fund will be
deemed to have distributed any income or gains on which it paid corporate income
tax. While the Fund intends to distribute its ordinary income and capital gains
in the manner necessary to minimize imposition of the 4% excise tax, there can
be no assurance that sufficient amounts of the Fund's ordinary income and
capital gains will be distributed to avoid entirely the imposition of the tax.
In such event, the Fund will be liable for the tax only on the amount by which
it does not meet the foregoing distribution requirements.
In the opinion of Sidley Austin Brown & Wood LLP, the shares of
Cumulative Preferred Stock will be treated as stock of the Fund for Federal
income tax purposes and distributions with respect to such shares (other than
distributions in redemption of the Cumulative Preferred Stock under section
302(b) of the Code) will constitute dividends to the extent of the Fund's
current and accumulated earnings and profits, as calculated for Federal income
tax purposes. Nevertheless, the IRS might take a contrary position, asserting,
for example, that the shares of Cumulative Preferred Stock constitute debt of
the Fund. The Fund believes this position, if asserted, would be unlikely to
prevail. If this position were upheld, however, the discussion of the treatment
of distributions below would not apply. Instead, distributions by the Fund to
holders of shares of Cumulative Preferred Stock would constitute taxable
interest income, whether or not they exceeded the earnings and profits of the
Fund. In such event, the designations of particular types of income, such as
capital gains and qualified dividend income, as discussed below, would not be
effective.
Dividends paid by the Fund from its ICTI (such dividends are referred
to in this section as "ordinary income dividends") are taxable to stockholders
as ordinary income (some of which may represent qualified dividend income,
taxable at a reduced rate, as discussed below) to the extent of the Fund's
earnings and profits. Earnings and profits are treated as first being used to
pay distributions on the Cumulative Preferred Stock and any other Preferred
Stock, and only the earnings and profits remaining after the distribution
preference of the Fund's Preferred Stock has been satisfied are treated as being
used to pay distributions on the Fund's Common Stock. Distributions made from
net capital gains (including gains or losses from certain transactions in
warrants, rights and options) and properly designated by the Fund (such
distributions are referred to in this section as "capital gain dividends") are
taxable to stockholders as long-term capital gains, regardless of the length of
time the stockholder has owned Fund shares. Distributions in excess of the
Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset).
The Fund may elect to retain its net capital gains or a portion thereof
for investment and be taxed at corporate rates on the amount retained. In such
case, it may designate the retained amount as undistributed capital gains in a
notice to its stockholders, who will be treated as if each received a
distribution of his pro rata share of such gains, with the result that each
9
stockholder will (i) be required to report his pro rata share of such gains on
his tax return as long-term capital gain, (ii) receive a refundable tax credit
for his pro rata share of tax paid by the Fund on the gains and (iii) increase
the tax basis for his shares by an amount equal to the deemed distributions less
the tax credit.
Gain or loss, if any, recognized on the sale or other disposition of
shares of the Fund will be taxed as a capital gain or loss if the shares are
capital assets in the stockholder's hands. Such gain or loss will be long-term
or short-term, depending upon the stockholder's holding period for the shares.
Generally, a stockholder's gain or loss will be a long-term gain or loss if the
shares have been held for more than one year. Any loss realized upon the sale or
exchange of Fund shares will be disallowed to the extent the shares disposed of
are replaced within a period of 61 days beginning 30 days before and ending 30
days after disposition of the original shares. In such case, the basis of the
shares acquired will be adjusted to reflect the disallowed loss. Any loss
realized upon the sale or exchange of Fund shares held for six months or less
will be treated as long-term capital loss to the extent of any capital gain
dividends received by the stockholder (or amounts credited to the stockholder as
undistributed capital gains) with respect to such shares.
Under the 2003 Tax Act, Fund distributions comprised of dividends from
domestic corporations and certain foreign corporations (generally, corporations
incorporated in a possession of the United States, some corporations eligible
for treaty benefits under a treaty with the United States and corporations whose
stock is readily tradable on an established securities market in the United
States) are eligible for taxation at a maximum tax rate of 15% also applicable
to capital gains in the hands of individual stockholders, provided holding
period and other requirements are satisfied. Capital gain dividends likewise,
are taxed at the reduced maximum rate of 15% for non-corporate taxpayers. The
15% income tax rate applicable to capital gains and qualified dividend income is
scheduled to expire after December 31, 2008. After this date, absent extension
or modification of the relevant legislative provisions, long-term capital gain
dividends paid by the Fund generally will be taxable at the previously
applicable maximum 20% rate and distributions attributable to qualified dividend
income will be taxed to the stockholder at his or her marginal Federal income
tax rate (which generally will be higher than 15%).
A portion of the Fund's ordinary income dividends may be eligible for
the dividends received deduction ("DRD") allowed to corporations under the Code,
if certain requirements are met. For these purposes, the Fund will allocate any
dividends eligible and any other Preferred Stock for the DRD between the holders
of Common Stock, Cumulative Preferred Stock and any other Preferred Stock in
proportion to the total dividends paid to each class during the taxable year, or
otherwise as required by applicable law. A holder of shares of Cumulative
Preferred stock (a) that is taxed as a corporation for Federal income tax
purposes, (b) meets applicable holding period and taxable income requirements of
section 246 of the Code, (c) is not subject to the "debt-financed portfolio
stock" rules of section 246A of the Code with respect to an investment in the
Fund and (d) is otherwise entitled to the DRD can claim a deduction equal to 70%
of the dividends received on the Cumulative Preferred Stock which are designated
by the Fund as qualifying for the DRD.
10
The IRS has taken the position in Revenue Ruling 89-81 that if a RIC
has more than one class of shares, it may designate distributions made to each
class in any year as consisting of no more than such class's proportionate share
of particular types of income, such as long-term capital gains and qualified
dividend income. A class's proportionate share of a particular type of income is
determined according to the percentage of total dividends paid by the RIC during
such year that was paid to such class. Consequently, the Fund will designate
distributions made to the Common Stock and Cumulative Preferred Stock and any
other Preferred Stock as consisting of particular types of income in accordance
with the classes' proportionate shares of such income. The amount of long-term
capital gains, qualified dividend income, and Other Ordinary Income allocable
among the Cumulative Preferred Stock, other Preferred Stock, and the Common
Stock will depend upon the amount of such long-term capital gains, qualified
dividend income, and Other Ordinary Income realized by the Fund and the total
dividends paid by the Fund on shares of Common Stock, Cumulative Preferred Stock
and other Preferred Stock during a taxable year.
In the opinion of Sidley Austin Brown & Wood LLP, under current law,
the manner in which the Fund intends to allocate long-term capital gains,
qualified dividend income and Other Ordinary Income among shares of Common
Stock, Cumulative Preferred Stock and other Preferred Stock will be respected
for Federal income tax purposes. However, there is currently no direct guidance
from the IRS or other sources specifically addressing whether the Fund's method
of allocation will be respected for Federal income tax purposes, and it is
possible that the IRS could disagree with counsel's opinion and attempt to
reallocate the Fund's long-term capital gains, qualified dividend income or
Other Ordinary Income. Sidley Austin Brown & Wood LLP has advised the Fund that,
in its opinion, if the IRS were to challenge in court the Fund's allocations,
the IRS would be unlikely to prevail. The opinion of Sidley Austin Brown & Wood
LLP, however, represents only its best legal judgment and is not binding on the
IRS or courts.
If the Fund does not meet the asset coverage requirements of the 1940
Act or the Articles Supplementary, the Fund will be required to suspend
distributions to the holders of the Common Stock until the asset coverage is
restored. See "Description of Cumulative Preferred Stock -- Dividends" in the
Prospectus. Such a suspension of distributions might prevent the Fund from
distributing 90% of its ICTI, as is required in order to avoid Fund-level
taxation of such income, or might prevent it from distributing enough ordinary
income and capital gains to avoid completely imposition of the excise tax. Upon
any failure to meet the asset coverage requirements of the 1940 Act or the
Articles Supplementary, the Fund may, and in certain circumstances will be
required to, partially redeem the shares of Cumulative Preferred Stock in order
to maintain or restore the requisite asset coverage and avoid the adverse
consequences to the Fund and its stockholders of failing to qualify as a RIC. If
asset coverage were restored, the Fund would again be able to pay dividends and
might be able to avoid Fund-level taxation of its income.
Qualification as a RIC requires, among other things, that at least 90%
of the Fund's gross income in each taxable year consist of certain types of
income, including dividends, interest, gains from the disposition of stocks and
securities and other investment-type income. In addition, the Fund's investments
must meet certain diversification standards. If the Fund were unable to satisfy
the 90% distribution requirement or otherwise were to fail to qualify to be
taxed as a RIC in any year, it would be subject to tax in such year on all of
its taxable income, whether or not the Fund made any distributions. To qualify
again to be taxed as a RIC in a subsequent
11
year, the Fund would be required to distribute to Cumulative Preferred
Stockholders and Common Stockholders as an ordinary income dividend, its
earnings and profits attributable to non-RIC years reduced by an interest charge
on 50% of such earnings and profits payable by the Fund to the IRS. In addition,
if the Fund failed to qualify as a RIC for a period greater than one taxable
year, the Fund would be required to recognize and pay tax on any net built-in
gains (the excess of aggregate gains, including items of income, over aggregate
losses that would have been realized if the Fund had been liquidated) or,
alternatively, to elect to be subject to taxation on such built-in-gains
recognized for a period of 10 years, in order to qualify as a RIC in a
subsequent year.
The Fund may invest in debt obligations purchased at a discount with
the result that the Fund may be required to accrue income (and to distribute
such income in accordance with the distribution requirements of the Code) for
Federal income tax purposes before amounts due under the obligations are paid.
The Fund may also invest in securities rated in the medium to lower rating
categories of nationally recognized rating organizations, and in unrated
securities ("high yield securities"). A portion of the interest payments on such
high yield securities may be treated as dividends for Federal income tax
purposes.
Certain transactions of the Fund are subject to complex federal income
tax provisions that may, among other things, a) affect the character of gains
and losses realized, b) disallow, suspend or otherwise limit the allowance of
certain losses or deductions, and c) accelerate the recognition of income.
Operation of these rules could, therefore, affect the character, amount and
timing of distributions to stockholders. The Fund will monitor its transactions
and may make certain tax elections in order to mitigate the effect of these
provisions.
Foreign currency gains or losses from certain debt instruments or
arising from delays between accrual and receipt of investment income will
generally be treated as ordinary income or loss, and will therefore generally
increase or decrease the amount of the Fund's net investment income available
for distribution as ordinary income dividends. If substantial in relation to net
investment income, such foreign currency losses could affect the ability of the
Fund to distribute ordinary income dividends in a taxable year, and could
require all or a portion of distributions made before the losses were realized,
but in the same taxable year, to be recharacterized as a return of capital.
If the Fund invests in stock of a passive foreign investment company
("PFIC"), it may be subject to Federal income tax at ordinary rates and an
additional charge in the nature of interest, on a portion of its distributions
from the PFIC and on gain from the disposition of the shares of the PFIC, even
if such distributions and gain are paid by the Fund as a dividend to its
stockholders. In some cases, the Fund may be able to elect to include annually
in income its pro rata share of the ordinary earnings and capital gains (whether
or not distributed) of the PFIC. Alternatively, the Fund could elect to mark to
market at the end of each taxable year its shares in PFICs; in this case, the
Fund would recognize as ordinary income any increase in the value of such
shares, and as ordinary loss any decrease in such value to the extent it did not
exceed prior increases included in income. Under either election, the Fund might
be required to recognize in a year income in excess of its distributions from
PFICs and its proceeds from dispositions of PFIC stock during that year.
Dividends paid by PFICs will not qualify as qualified dividend income eligible
for taxation at reduced rates under the 2003 Tax Act.
12
Under certain provisions of the Code, some stockholders may be subject
to a withholding tax (28% for 2003) on ordinary income dividends, capital gain
dividends and redemption payments ("backup withholding"). A stockholder,
however, may generally avoid becoming subject to this requirement by filing an
appropriate form with the payor (i.e., the financial institution or brokerage
firm where the stockholder maintains his or her account), certifying under
penalties of perjury that such stockholder's taxpayer identification number is
correct and that such stockholder (i) has never been notified by the IRS that he
or she is subject to backup withholding, (ii) has been notified by the IRS that
he or she is no longer subject to backup withholding, or (iii) is exempt from
backup withholding. Corporate stockholders and certain other stockholders are
exempt from backup withholding. Backup withholding is not an additional tax. Any
amounts withheld under the backup withholding rules from payments made to a
stockholder may be refunded or credited against such stockholder's Federal
income tax liability, provided the required information is furnished to the IRS.
Ordinary income dividends (but not capital gain dividends) paid to
stockholders who are non-resident aliens or foreign entities generally will be
subject to a 30% United States withholding tax under existing provisions of the
Code applicable to foreign individuals and entities unless a reduced rate of
withholding or a withholding exemption is provided under applicable treaty law.
However, if ordinary income dividends or capital gain dividends received by a
non-resident stockholder are effectively connected with the conduct by such
stockholder of a trade or business in the United States, the dividends will be
subject to United States federal income tax at regular income tax rates.
Non-resident stockholders are urged to consult their own tax advisers concerning
the applicability of the United States withholding and income taxes.
Dividends and interest received by the Fund may give rise to
withholding and other taxes imposed by foreign countries. Tax conventions
between certain countries and the United States may reduce or eliminate such
taxes. Stockholders may be able to claim a deduction or United States foreign
tax credit with respect to such taxes, subject to certain conditions and
limitations contained in the Code. For example, certain retirement accounts
cannot claim foreign tax credits on investments in foreign securities held in
the Fund. In addition, a foreign tax credit may be claimed with respect to
withholding tax on a dividend paid by the Fund only if the stockholder meets
certain holding period requirements with respect to its Fund stock. The Fund
also must meet these holding period requirements with respect to its foreign
securities in order to be able to "pass through" to stockholders the ability to
claim a credit or a deduction for the related foreign taxes paid by the Fund. If
the Fund satisfies the holding period requirements, qualifies for the special
treatment afforded RICs under the Code and more than 50% in value of its total
assets at the close of its taxable year consists of securities of foreign
corporations, the Fund will be eligible, and intends, to file an election with
the IRS pursuant to which stockholders of the Fund (i) will be required to
include their proportionate shares of such foreign taxes in their United States
income tax returns as gross income, (ii) will treat such proportionate shares as
taxes paid by them, and (iii) will deduct such proportionate shares in computing
their taxable incomes or, alternatively, use them as foreign tax credits against
their United States income taxes. No deductions for foreign taxes, however, may
be claimed by noncorporate stockholders who do not itemize deductions. A
stockholder that is a nonresident alien individual or a foreign corporation may
be subject to United States withholding tax on the income resulting from the
Fund's election described in this paragraph but may not be able to claim a
credit or deduction against such United States tax for the foreign taxes treated
as having been paid by such stockholder. The
13
Fund will report annually to its stockholders the amount per share of such
foreign taxes and other information needed to claim the deduction or foreign tax
credit.
Under recently promulgated Treasury regulations, if a stockholder
recognizes a loss on the disposition of shares of Cumulative Preferred Stock of
$2 million or more for an individual stockholder or $10 million or more for a
corporate stockholder in any single taxable year (or a greater loss over a
combination of years), the stockholder must file with the IRS a disclosure
statement on Form 8886. The fact that a loss is reportable under these
regulations does not affect the legal determination of whether the taxpayer's
treatment of the loss is proper. Stockholders should consult their tax advisers
to determine the applicability of these regulations in light of their individual
circumstances.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect and
discusses some of the consequences under Federal tax law of an investment in
Cumulative Preferred Stock of the Fund. For the complete provisions, reference
should be made to the pertinent Code sections and the Treasury regulations
promulgated thereunder. The Code and the Treasury regulations are subject to
change by legislative, judicial or administrative action, either prospectively
or retroactively. The discussion above is not a substitute for personal tax
advice. Distributions may also be subject to additional state, local and foreign
taxes, depending on each stockholder's particular situation. Stockholders are
advised to consult their own tax advisers with respect to the particular tax
consequences to them of an investment in the Cumulative Preferred Stock.
14
PRINCIPAL STOCKHOLDERS
As of September 22, 2003, there were 9,241,025 shares of Common Stock
and 800,000 shares of Preferred Stock of the Fund outstanding. The following
persons were known to the Fund to be beneficial owners or owners of record of 5%
or more of its outstanding shares of Common Stock or Preferred Stock as of the
date above:
AMOUNT AND NATURE PERCENT OF
NAME AND ADDRESS OF OWNER CLASS/SERIES OF STOCK OF OWNERSHIP CLASS/SERIES
-------------------------------------- ---------------------------- ----------------------------- ----------------
Chilton Investment Company Common Stock 916,608 shares--Beneficial 9.92%
1266 East Main Street (sole voting and investment
7th Floor power)
Stamford, CT 06902
Richard J. Shaker Common Stock 904,669 shares--Beneficial 9.79%
1094 Magothy Circle (sole voting and investment
Annapolis, MD 21401 power)
Charles M. Royce Common Stock 775,116 shares--Beneficial
1414 Avenue of the Americas (sole voting and investment
New York, NY 10019 power) 8.38%
W. Whitney George Common Stock 567,812 shares--Beneficial
1414 Avenue of the Americas (sole voting and investment
New York, NY 10019 power) 6.14%
Arthur D. Lipton Common Stock 503,676 shares--Beneficial 5.45%
c/o Western Investment LLC (sole voting and investment
2954 East Bengal Boulevard power)
Salt Lake City, UT 84121
Cede & Co.* Common Stock 8,601,230 shares--Record* 93.07%
Depository Trust Company
P.O. Box #20
Bowling Green Station
New York, NY 10028 7.45% Cumulative 788,899 shares--Record* 98.61%
Preferred Stock
-----------------
* Shares held by brokerage firms, banks and other financial
intermediaries on behalf of beneficial owners are registered in the
name of Cede & Co.
15
DIRECTORS AND OFFICERS
The Board of Directors of the Fund is comprised of the eight
individuals named below. Two of the Directors, Stephen L. Isaacs and David L.
Meister, are elected annually by the holders of Preferred Stock, voting as a
separate class. The remaining six Directors are divided into three classes and
are elected by the holders of Common Stock and Preferred Stock, voting together
as a single class. The Class I Directors, Charles M. Royce and G. Peter O'Brien,
have terms that expire in 2006; the Class II Directors, Mark R. Fetting and
Richard M. Galkin, have terms that expire in 2004; and the Class III Directors,
Donald R. Dwight and William L. Koke, have terms that expire in 2005. To the
extent permitted by the 1940 Act and Maryland law, vacancies on the Board can be
filled by the remaining Directors for the remainder of the term of the
respective Board position.
There are no family relationships between any of the Fund's Directors
and officers. Each Director will hold office until his term expires and his
successor has been duly elected and qualifies or until his earlier resignation
or removal. Each of the Fund's Directors is also a director/trustee of the other
management investment companies comprising "The Royce Funds", which have
seventeen portfolios.
DIRECTORS
Interested Directors. Certain biographical and other information
concerning the Directors who are "interested persons" as defined in the 1940
Act, of the Fund, including their designated classes, is set forth below.
Officers are elected by and serve at the pleasure of the Board of Directors.
Each officer will hold office for the year ending December 31, 2003, and
thereafter until his respective successor is duly elected and qualifies.
TERM OF NUMBER OF OTHER PUBLIC
OFFICE AND ROYCE FUNDS' COMPANY
NAME, AGE AND POSITION(S) LENGTH OF PRINCIPAL OCCUPATIONS PORTFOLIOS DIRECTORSHIPS
ADDRESS* WITH THE FUND TIME SERVED DURING PAST FIVE YEARS OVERSEEN HELD BY DIRECTOR
--------------------- ---------------- ---------------- ----------------------------- ---------------- -----------------------------
Charles M. Royce** Class I Term as President, Chief 18 None
(63) Director and Director Investment Officer and
President expires 2006; Member of Board of
Director and Managers of Royce; and
Officer since President of The Royce
1986 Funds.
Mark R. Fetting** Class II Director Term as Executive Vice President 18 Director/Trustee of
(48) Director of Legg Mason; Member of registered investment
expires 2004; Board of Managers of companies constituting the
Director Royce; and Division 22 Legg Mason Funds
since 2001 President and Senior
Officer of Prudential
Financial Group, Inc. and
related companies,
including Fund Boards and
consulting services to
subsidiary companies
(from 1991 to 2000). Mr.
Fetting's prior business
experience also includes
having served as Partner,
Greenwich Associates, and
Vice President, T. Rowe
Price Group, Inc.
----------------------
* Mr. Royce's address is c/o Royce, 1414 Avenue of the Americas, New York,
New York 10019. Mr. Fetting's address is c/o Legg Mason, 100 Light
Street, Baltimore, Maryland 21202.
** Messrs. Royce and Fetting are "interested persons" of the Fund within the
meaning of Section 2(a)(19) of the 1940 Act due to the positions they
hold with Royce and for Mr. Fetting, Legg Mason, and their ownership in
Legg Mason.
16
Non-Interested Directors. Certain biographical and other information
concerning the Fund Directors who are not "interested persons," as defined in
the 1940 Act, of the Fund, including their designated classes, is set forth
below. Each non-interested Director is also a member of the Fund's audit
committee.
TERM OF NUMBER OF OTHER PUBLIC
OFFICE AND ROYCE FUNDS' COMPANY
NAME, AGE AND POSITION(S) LENGTH OF PRINCIPAL OCCUPATIONS PORTFOLIOS DIRECTORSHIPS
ADDRESS* WITH THE FUND TIME SERVED DURING PAST FIVE YEARS OVERSEEN HELD BY DIRECTOR
--------------------- ---------------- ---------------- ----------------------------- ---------------- -----------------------------
Donald R. Dwight Class III Term as President of Dwight 18 None
(72) Director Director Partners, Inc., corporate
expires 2005; communications
Director since consultants; and Chairman
1998 (from 1982 until March
1998) of Newspapers
New England, Inc. Mr.
Dwight's prior
experience includes
having served as
Lieutenant Governor of
the Commonwealth of
Massachusetts,
President and
Publisher of
Minneapolis Star and
Tribune Company and as
Trustee of the
registered investment
companies constituting
the 94 Eaton Vance
Funds.
Richard M. Galkin Class II Term as Private investor. Mr. 18 None
(65) Director Director Galkin's prior business
expires 2004; of Richard M. Galkin
Director Associates, Inc.,
since 1986 telecommunications
consultants, President of
Manhattan Cable
Television (a subsidiary
of Time Inc.), President
of Haverhills Inc.
(another Time Inc.
subsidiary), President of
Rhode Island Cable
Television and Senior
Vice President of
Satellite Television
Corp. (a subsidiary of
Comsat).
Stephen L. Isaacs Director Term as President of The Center 18 None
(63) elected by Director for Health and Social
Preferred expires Policy (since September
Stockholders annually; 1996); Attorney and
Director since President of Health
1986 Policy Associates, Inc.,
consultants. Mr.
Isaacs' prior
experience includes
having served as
Director of Columbia
University Development
Law and Policy Program
and Professor at
Columbia University.
William L. Koke Class III Term as Financial planner with 18 None
(68) Director Director Shoreline Financial
expires 2005; Consultants. Mr. Koke's
Director since prior business experience
2001 includes having served as
Director of Financial
Relations of SONAT, Inc.,
Treasurer of Ward Foods,
Inc. and President of
CFC, Inc.
17
TERM OF NUMBER OF OTHER PUBLIC
OFFICE AND ROYCE FUNDS' COMPANY
NAME, AGE AND POSITION(S) LENGTH OF PRINCIPAL OCCUPATIONS PORTFOLIOS DIRECTORSHIPS
ADDRESS* WITH THE FUND TIME SERVED DURING PAST FIVE YEARS OVERSEEN HELD BY DIRECTOR
--------------------- ---------------- ---------------- ----------------------------- ---------------- -----------------------------
David L. Meister Director elected Term as Chairman and Chief 18 None
(63) by Preferred Director Executive Officer of The
Stockholders expires Tennis Channel (since
annually; June 2000); and Chief
Director since Executive Officer of
1986 Seniorlife.com (from
December 1999 to May
2000). Mr. Meister's
prior business
experience includes
having served as a
consultant to the
communications
industry, President of
Financial News
Network, Senior Vice
President of HBO,
President of Time-Life
Films and Head of
Broadcasting for Major
League Baseball.
G. Peter O'Brien Class I Term as Trustee of Colgate 18 Director/Trustee of the
(57) Director Director University, President of registered investment
expires 2006; Hill House, Inc. and companies constituting the
Director since Managing Director/Equity 22 Legg Mason Funds;
2001 Capital Markets Group of Director of Renaissance
Merrill Lynch & Co. (from Capital Greenwich Fund.
1971 to 1999).
---------
* Messrs. Dwight, Galkin, Isaacs, Koke, Meister and O'Brien's address is
c/o Royce, 1414 Avenue of the Americas, New York, New York 10019
OFFICERS
Certain biographical and other information concerning the other
officers of the Fund is set forth below. Officers are elected by and
serve at the pleasure of the Board of Directors. Each officer will hold
office for the year ending December 31, 2003, and thereafter until his
respective successor is duly elected and qualified.
TERM OF OFFICE
POSITION(S) AND LENGTH OF PRINCIPAL OCCUPATIONS DURING
NAME, AGE AND ADDRESS* WITH THE FUND TIME SERVED PAST FIVE YEARS
----------------------------- ----------------------- ---------------------- ---------------------------------------
John D. Diederich (52) Vice President, Officer since 2001 Member of Board of Managers, Chief
Director of Operating Officer (since October
Administration and 2001), Chief Financial Officer (since
Treasurer March 2002) and Managing Director of
Royce; Vice President, Treasurer and
Director of Administration of the
other Royce Funds; and President of
Royce Fund Services, Inc.
Jack E. Fockler, Jr. (44) Vice President Officer since 1995 Managing Director and Vice President
of Royce; Vice President of The Royce
Funds.
W. Whitney George (45) Vice President Officer since 1995 Managing Director and Vice President
of Royce; and Vice President of The
Royce Funds.
Daniel A. O'Byrne (41) Vice President and Officer since 1994 Principal and Vice President of Royce;
Assistant Secretary and Vice President of The Royce Funds.
18
TERM OF OFFICE
POSITION(S) AND LENGTH OF PRINCIPAL OCCUPATIONS DURING
NAME, AGE AND ADDRESS* WITH THE FUND TIME SERVED PAST FIVE YEARS
----------------------------- ----------------------- ---------------------- ---------------------------------------
John E. Denneen (36) Secretary and Officer from 1996 to General Counsel of Royce (Deputy
General Counsel 2001 and since April General Counsel prior to 2003);
2002 Principal, Chief Legal and Compliance
Officer and Secretary of Royce (since
March 2002); Secretary of The Royce
Funds (1996-2001 and since April 2002);
Associate General Counsel, Principal
and Chief Compliance Officer of Royce
(1996-2001); and Principal of Credit
Suisse First Boston Private Equity
(2001-2002).
-------------------
* The address of each officer is c/o Royce, 1414 Avenue of the Americas,
New York, New York 10019.
OWNERSHIP OF SECURITIES
Information relating to each Director's share ownership in the Fund and
in The Royce Funds as of December 31, 2002 is set forth in the tables below.
Aggregate Dollar Range of Aggregate Dollar Range of Equity
Name Equity Securities in the Fund Securities in The Royce Funds
------------------------------------ -------------------------------- -----------------------------------
Interested Directors
Charles M. Royce..................... Over $100,000 Over $100,000
Mark R. Fetting...................... None* Over $100,000
Non-Interested Directors
Donald R. Dwight..................... $1-$10,000 Over $100,000
Richard M. Galkin.................... $1-$10,000 Over $100,000
Stephen L. Isaacs.................... $1-$10,000 $10,001-$50,000**
William L. Koke...................... $1-$10,000 Over $100,000
David L. Meister..................... None Over $100,000
G. Peter O'Brien..................... $1-$10,000 Over $100,000
---------------
* As of the date of this Statement of Additional Information, the aggregate
dollar range equity securities in the Fund held by Mr. Fetting
was $10,001-$50,000.
** As of the date of this Statement of Additional Information, the aggregate
dollar amount of equity securities in The Royce Funds held by Mr. Isaacs
was over $100,000.
Mr. Royce has sole voting power and sole investment power as to the
shares beneficially owned by him. As of September 22, 2003, all Directors and
officers of the Fund as a group (13 persons) beneficially owned 1,370,344 shares
of the Fund's Common Stock, constituting 14.83% of the outstanding shares, and
2,000 shares of its Preferred Stock, constituting less than .3% of the
outstanding shares. As of the date of this Statement of Additional Information,
none of the non-interested Directors of the Fund nor any of their immediate
family members owned beneficially or of record any securities issued by Legg
Mason or any of its affiliates (other than registered investment companies).
BOARD COMMITTEES AND MEETINGS
The Board of Directors has an Audit Committee, comprised of Donald R.
Dwight, Richard M. Galkin, Stephen L. Isaacs, William L. Koke, David L. Meister
and G. Peter O'Brien. The Audit Committee is responsible for, among other
things, the appointment, compensation,
19
and oversight of the work of the Fund's independent accountants including the
resolution of disagreements regarding financial reporting between Fund
management and such independent accountants. The Fund has adopted an Audit
Committee charter. Mr. Galkin serves as Chairman of the Audit Committee. The
members of the Audit Committee are "independent" within the meaning of the 1940
Act and the New York Stock Exchange corporate governance standards for audit
committees. The Fund's Audit Committee held three meetings during the year ended
December 31, 2002. Although the Board of Directors does not have a standing
compensation committee or a nominating committee, the non-interested Directors
review and nominate candidates to serve as non-interested Directors. The
non-interested Directors generally will not consider nominees recommended by
stockholders of the Fund.
COMPENSATION OF DIRECTORS AND CERTAIN OFFICERS
For the year ended December 31, 2002, the following Directors of the
Fund received compensation from the Fund and The Royce Funds, as follows:
Aggregate Pension or Retirement Estimated Total Compensation
Compensation Benefits Accrued as Annual Benefits from The Royce Funds
Name from Fund Part of Fund Expenses upon Retirement paid to Directors
--------------------------- ------------------ ------------------------- ------------------- -------------------------
Donald R. Dwight, $5,250 None None $65,250
Director(1)
Richard M. Galkin, $5,250 None None $65,250
Director(2)
Stephen L. Isaacs, $5,250 None None $65,250
Director
William L. Koke, $5,250 None None $65,250
Director
David L. Meister, $5,250 None None $65,250
Director
G. Peter O'Brien, $5,250 None None $65,250
Director
-------------
(1) Includes $787.50 from the Fund ($9,563 from the Fund and other Royce
Funds) deferred during 2002 at the election of Mr. Dwight under The Royce
Funds' Deferred Compensation Plan for Trustees/Directors.
(2) Includes $5,250 from the Fund ($63,750 from the Fund and other Royce
Funds) deferred during 2002 at the election of Mr. Galkin under The Royce
Funds' Deferred Compensation Plan for Trustees/Directors.
DIRECTORS' CONSIDERATION OF INVESTMENT ADVISORY AGREEMENT
The Board of Directors determined at meetings held on June 4 and 5,
2003, to approve the continuance of the current Investment Advisory Agreement
relating to the Fund. In making their determination, the Directors considered a
wide range of information of the type they regularly consider when determining
whether to continue a fund's advisory arrangements as in effect from year to
year. In its consideration of the current Investment Advisory Agreement, the
20
Board of Directors focused on information it had received relating to, among
other things: (a) the nature, quality and extent of the advisory and other
services to be provided to the Fund by Royce, (b) comparative data with respect
to advisory fees paid by other funds with similar investment objectives, (c) the
operating expenses and expense ratio of the Fund compared to funds with similar
investment objectives, (d) the performance of the Fund as compared to such
comparable funds, including risk-adjusted performance information prepared by
Morningstar Inc., (e) the relative profitability of the arrangements to Royce,
(f) information about the services to be performed and the personnel performing
such services under the current Investment Advisory Agreement, (g) the general
reputation and financial resources of Royce and Legg Mason, (h) compensation
payable by the Fund to affiliates of Royce for other services and (i) Royce's
practices regarding the selection and compensation of brokers that execute
portfolio transactions for the Fund and the brokers' provision of brokerage and
research services to Royce.
In particular, the Board of Directors compared the investment advisory
fee rate, the annual net expense ratio, and the risk-adjusted investment
performance of the Fund to a peer group selected by Morningstar that consisted
of 11 other funds with substantially similar investment objectives and policies
plus funds in Morningstar's small-cap value category. As set forth in the
Prospectus under the heading "Investment Advisory and Other Services - Advisory
Fee," Royce is entitled to receive a monthly fee equal to 1/12 of 1% (1% on an
annualized basis) of the Fund's average net assets (including assets obtained
from the sale of Preferred Stock) for each month during the term of the
agreement.
With respect to investment advisory fee rates, the Board of Directors
noted that the Fund's fee was lower than the peer group average and less than
seven other funds in the peer group. The Board of Directors also considered the
fact that Royce volunteered to waive the portion of its investment advisory fee
attributable to the liquidation preference of the 7.45% Preferred for any month
when the Fund's net asset value average annual total return since the initial
issuance of the 7.45% Preferred failed to exceed the dividend rate on those
assets to be a positive factor. With respect to annual net expense ratios, even
with increased stockholder meeting costs arising from a proxy contest, the Board
of Directors observed that the Fund's annual net expense ratio on total net
assets (which includes assets attributable to the liquidation preference of the
7.45% Preferred) placed the Fund within the third quartile for funds in the peer
group and in the second quartile for funds in Morningstar's small-cap value
category. Adjusting for the increased stockholder meeting costs described above,
the Fund would have placed in the first quartile for funds in Morningstar's
small-cap value category.
Because the Fund uses a risk-averse approach to investing, the Board of
Directors believed that risk-adjusted performance continued to be an appropriate
measure of the Fund's investment performance. For the most recent five-year
period, the Fund's risk-adjusted investment performance exceeded the averages
for the peer group and Morningstar's small-cap value category, placing the Fund
within the second quartile for funds in the peer group and Morningstar's
small-cap value category.
After its review of the above-described matters, the Board of Directors
approved the continuation of the Investment Advisory Agreement between the Fund
and Royce. The Board of Directors was advised by separate legal counsel in
connection with its review of the investment advisory arrangements of the Fund.
21
INFORMATION CONCERNING ROYCE
On October 1, 2001, Royce became an indirect wholly-owned subsidiary of
Legg Mason. On March 31, 2002, Royce's corporate predecessor was merged into
Royce Holdings, LLC (a wholly-owned subsidiary of Legg Mason), which then
changed its name to Royce & Associates, LLC. As a result of this merger, Royce &
Associates, LLC became the Fund's investment adviser and a direct wholly-owned
subsidiary of Legg Mason.
CODE OF ETHICS AND RELATED MATTERS
Royce and the Fund have adopted a Code of Ethics under which directors
(other than non-management directors), officers and employees of Royce
("Royce-related persons") and interested trustees/directors, officers and
employees of the Fund are generally prohibited from personal trading in any
security which is then being purchased or sold or considered for purchase or
sale by the Fund or any other Royce account. The Code of Ethics permits such
persons to engage in other personal securities transactions if (i) the
securities involved are certain debt securities, money market instruments,
shares of registered open-end investment companies or shares acquired from an
issuer in a rights offering or under an automatic dividend reinvestment or
employer-sponsored automatic payroll deduction cash purchase plan, (ii) the
transactions are either non-volitional or are effected in an account over which
such person has no direct or indirect influence or control or (iii) they first
obtain permission to trade from Royce's Compliance Officer and either an
executive officer or Senior Portfolio Manager of Royce. The Code contains
standards for the granting of such permission, and permission to trade will
usually be granted only in accordance with such standards.
Royce's clients include several private investment companies in which
Royce, Royce-related persons and/or other Legg Mason affiliates have (and,
therefore, may be deemed to beneficially own) a share of up to 15% of the
company's realized and unrealized net capital gains from securities
transactions, but less than 25% of the company's equity interests. The Code of
Ethics does not restrict transactions effected by Royce for such private
investment company accounts, and transactions for such accounts are subject to
Royce's allocation policies and procedures. See "Brokerage Allocation and Other
Practices".
The Code of Ethics can be reviewed and copied at the Commission's
Public Reference Room in Washington, D.C. Information on the operation of the
Public Reference Room may be obtained by calling the Commission at
1-202-942-8090. The Code of Ethics is available on the EDGAR Database on the
Commission's Internet site at http://www.sec.gov. Copies of the Code of Ethics
may be obtained, after paying a duplicating fee, by electronic request at the
following E-mail address: publicinfo@sec.gov, or by writing the Commission's
Public Reference Section, Washington, D.C. 20549-0102.
As of June 30, 2003, Royce-related persons, interested trustees/
directors, officers and employees of The Royce Funds and members of their
immediate families beneficially owned shares of The Royce Funds having a total
value of over $48.2 million, and such persons beneficially owned equity
interests in Royce-related private investment companies totaling approximately
$9.9 million.
22
INVESTMENT ADVISORY AND OTHER SERVICES
ADVISORY FEE
For the years ended December 31, 2002, 2001 and 2000, Royce received
investment advisory fees from the Fund of $715,813, $681,153 and $542,043 (net
of $117,259, $132.604 and $200,001 voluntarily waived by Royce), respectively.
OTHER
The Investment Advisory Agreement provides that the Fund may use
"Royce" as part of its name only for as long as the Investment Advisory
Agreement remains in effect. The name "Royce" is a property right of Royce, and
it may at any time permit others, including other investment entities, to use
such name.
The Investment Advisory Agreement protects and indemnifies Royce
against liability to the Fund, its stockholders or others for any action taken
or omitted to be taken by Royce in connection with the performance of any of its
duties or obligations under Investment Advisory Agreement or otherwise as an
investment adviser to the Fund. However, Royce is not protected or indemnified
against liabilities to which it would otherwise be subject by reason of willful
malfeasance, bad faith or gross negligence in the performance of its duties or
by reason of its reckless disregard of its duties and obligations under the
Investment Advisory Agreement.
Royce's services to the Fund are not deemed to be exclusive, and Royce
or any of its affiliates may provide similar services to other investment
companies and other clients or engage in other activities.
The Investment Advisory Agreement will remain in effect until June 30,
2004 and may be continued in effect from year to year thereafter if such
continuance is specifically approved at least annually by the Board of Directors
or by the vote of a majority of the Fund's outstanding voting securities and, in
either case, by a majority of the directors who are not parties to the Agreement
or interested persons of any such party. The Investment Advisory Agreement will
automatically terminate if it is assigned (as defined by the 1940 Act and the
rules thereunder) and may be terminated without penalty by vote of a majority of
the Fund's outstanding voting securities or by either party thereto on not less
than 60 days' written notice.
SERVICE CONTRACT WITH STATE STREET
State Street Bank and Trust Company ("State Street"), the custodian of
the Fund's assets, provides certain management-related services to the Fund.
Such services include keeping books of accounts and rendering such financial and
other statements as may be requested by the Fund from time to time generally
assisting in the preparation of reports to the Fund's stockholders, to the
Commission and others and in the auditing of accounts and in other ministerial
matters of like nature, as agreed to between the Fund and State Street. For the
fiscal years ended December 31, 2002, 2001 and 2000, the Fund paid $73,880,
$73,253 and $75,123 in fees to the Fund's custodian and transfer agent.
23
BROKERAGE ALLOCATION AND OTHER PRACTICES
Royce is responsible for selecting the brokers who effect the purchases
and sales of the Fund's portfolio securities. No broker is selected to effect a
securities transaction for the Fund unless such broker is believed by Royce to
be capable of obtaining the best price for the security involved in the
transaction. Best price and execution is comprised of several factors, including
the liquidity of the security, the commission charged, the promptness and
reliability of execution, priority accorded the order and other factors
affecting the overall benefit obtained. In addition to considering a broker's
execution capability, Royce generally considers the brokerage and research
services which the broker has provided to it, including any research relating to
the security involved in the transaction and/or to other securities. Such
services may include general economic research, market and statistical
information, industry and technical research, strategy and company research and
performance measurement, and may be written or oral. Brokers that provide both
research and execution services are generally paid higher commissions than those
paid to brokers who do not provide such research and execution services. Royce
determines the overall reasonableness of brokerage commissions paid, after
considering the amount another broker might have charged for effecting the
transaction and the value placed by Royce upon the brokerage and/or research
services provided by such broker, viewed in terms of either that particular
transaction or Royce's overall responsibilities with respect to its accounts.
Royce is authorized, under Section 28(e) of the Securities Exchange Act
and under its Investment Advisory Agreement with the Fund, to pay a broker a
commission in excess of that which another broker might have charged for
effecting the same transaction, in recognition of the value of brokerage and
research services provided by the broker.
Brokerage and research services furnished by brokers through whom the
Fund effects securities transactions may be used by Royce in servicing all of
its accounts, and not all of such services may be used by Royce in connection
with the Fund.
Even though investment decisions for the Fund are made independently
from those for the other accounts managed by Royce, securities of the same
issuer are frequently purchased, held or sold by more than one Royce account
because the same security may be suitable for all of them. When the same
security is being purchased or sold for more than one Royce account on the same
trading day, Royce may seek to average the transactions as to price and allocate
them as to amount in a manner believed to be equitable to each. Such purchases
and sales of the same security are generally effected pursuant to Royce's Trade
Allocation Guidelines and Procedures. Under such Guidelines and Procedures,
unallocated orders are placed with and executed by broker-dealers during the
trading day. The securities purchased or sold in such transactions are then
allocated to one or more of Royce's accounts at or shortly following the close
of trading, using the average net price obtained. Such allocations are done
based on a number of judgmental factors that Royce believes should result in
fair and equitable treatment to those of its accounts for which the securities
may be deemed suitable. In some cases, this procedure may adversely affect the
price paid or received by the Fund or the size of the position obtained for the
Fund. In addition, from time to time, certain other Royce accounts managed by
Royce portfolio managers other than Charles M. Royce, may establish short
positions in securities in which the Fund has a long position.
24
The Fund may effect brokerage transactions on a securities exchange
with Legg Mason Wood Walker, Incorporated ("Legg Mason Wood Walker") and any
other affiliated broker-dealers in accordance with the procedures and
requirements set forth in Rule 17e-1 under the 1940 Act. Any such transactions
would involve the use of the affiliated broker-dealer for execution purposes
only and/or for locating the purchasers or sellers involved in the transaction.
The affiliated broker-dealer would not be compensated because of any other
research-related service or product provided or to be provided by it and may not
be used to effect brokerage transactions in Nasdaq or other over-the-counter
securities. Although the Fund will not effect any principal transactions with
any affiliated broker-dealers, they may purchase securities that are offered in
certain underwritings in which an affiliated broker-dealer is a participant in
accordance with the procedures and requirements set forth in Rule 10f-3 under
the 1940 Act. Charles M. Royce and/or trusts primarily for the benefit of
members of his family may own or acquire substantial amounts of Legg Mason
common stock.
During the year ended December 31, 2002, the Fund did not acquire any
securities of any of its regular brokers (as defined in Rule 10b-1 under the
1940 Act) or of any of their parents.
During each of the three years ended December 31, 2002, 2001 and 2000,
the Fund paid brokerage commissions of approximately $263,061, $135,156 and
$167,182, respectively. Since October 1, 2001, when Royce became an indirect
wholly-owned subsidiary of Legg Mason, the Fund paid no brokerage commissions to
Legg Mason Wood Walker or to any other affiliates of Legg Mason.
PROXY VOTING POLICIES AND PROCEDURES
In June 2003, in response to rules adopted by the Commission, Royce
adopted written proxy voting policies and procedures (the "Proxy Voting
Procedures") for itself, the Fund, and all The Royce Funds and clients accounts
for which Royce is responsible for voting proxies. The Board of Directors of the
Fund has delegated all proxy voting decisions to Royce. In voting proxies, Royce
is guided by general fiduciary principles. Royce's goal is to act prudently,
solely in the best interest of the beneficial owners of the accounts it manages.
Royce attempts to consider all factors of its vote that could affect the value
of the investment and will vote proxies in the manner it believes will be
consistent with efforts to enhance and/or protect stockholder value.
Royce personnel are responsible for monitoring receipt of all proxies
and ensuring that proxies are received for all securities for which Royce has
proxy voting responsibility. Royce divides proxies into "regularly recurring"
and "non-regularly recurring" matters. Examples of regularly recurring matters
include non-contested elections of directors and non-contested approvals of
independent auditors. Regularly recurring matters are usually voted as
recommended by the issuer's board of directors or management. Non-regularly
recurring matters are brought to the attention of portfolio manager(s) for the
applicable account(s) and, after giving consideration to advisories provided by
an independent third party research firm, the portfolio manager(s) directs that
such matters be voted in a way that he believes should better protect or enhance
the value of the investment. If the portfolio manager determines that
information relating to a proxy requires additional analysis, is missing, or is
incomplete, the
25
portfolio manager will give the proxy to an analyst or another portfolio manager
for review and analysis. Under certain circumstances, Royce may vote against a
proposal from the issuer's board of directors or management. Royce's portfolio
managers decide these issues on a case-by-case-basis. A Royce portfolio manager
may, on occasion, decide to abstain from voting a proxy or a specific proxy item
when such person concludes that the potential benefit of voting is outweighed by
the cost or when it is not in the client's best interest to vote.
In furtherance of Royce's goal to vote proxies in the best interests of
its clients, Royce follows specific procedures outlined in the Proxy Voting
Procedures to identify, assess and address material conflicts that may arise
between Royce's interests and those of its clients before voting proxies on
behalf of such clients. In the event such a material conflict of interest is
identified, the proxy will be voted by Royce in accordance with the
recommendation given by an independent third party research firm.
NET ASSET VALUE
The net asset value ("NAV") of the Fund's shares of Common Stock is
calculated as of the close of regular trading on the NYSE (generally 4:00 p.m.
Eastern time) every day that the NYSE is open. The Fund makes this information
available daily by telephone (800-221-4268) and via its web site
(www.roycefunds.com) and through electronic distribution for media publication,
including major internet-based financial services web sites and portals
(bloomberg.com, yahoo.com, cbsmarketwatch.com, etc.). Currently, The Wall Street
Journal, The New York Times and Barron's publish NAVs for closed-end investment
companies weekly.
The NAV per share of the Fund's Common Stock is calculated by dividing
the current value of the Fund's total assets less the sum of all of its
liabilities and the aggregate liquidation preferences of its outstanding shares
of Preferred Stock, by the total number of outstanding shares of Common Stock.
The Fund's investments are valued based on market value or, if market quotations
are not readily available, at their fair value as determined in good faith under
procedures established by the Fund's Board of Directors.
For the years ended December 31, 2002, 2001 and 2000, the Fund's
portfolio turnover rates were 61%, 54% and 69%, respectively.
BOOK-ENTRY SYSTEM
Shares of Cumulative Preferred Stock will initially be held in the name
of Cede & Co. ("Cede"), as nominee for The Depository Trust Company ("DTC"). The
Fund will treat Cede as the holder of record of the Cumulative Preferred Stock
for all purposes. In accordance with the procedures of DTC, however, purchasers
of Cumulative Preferred Stock will be deemed the beneficial owners of shares
purchased for purposes of dividends, voting and liquidation rights. The
Cumulative Preferred Stock will be held in book-entry only form. Shares of
Cumulative Preferred Stock will not be delivered in certificated form to
individual purchasers thereof. The laws of some jurisdictions require that
certain purchasers of Cumulative Preferred Stock take physical delivery of such
securities in certificated form. Such limits and laws may impair the ability to
transfer beneficial interests in shares of Cumulative Preferred Stock.
26
DTC has provided us with the following information: DTC is a
limited-purpose trust company organized under the New York Banking Law, a
"banking organization" within the meaning of the New York Banking Law, a member
of the United States Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code and a "clearing corporation"
registered under Section 17A of the Securities Exchange Act of 1934, as amended.
DTC holds securities that its participants ("Direct Participants") deposit with
DTC. DTC also facilitates the settlement among Direct Participants of securities
transactions, such as transfers and pledges, in deposited securities through
computerized records for Direct Participants' accounts. This eliminates the need
to exchange certificates. Direct Participants include securities brokers and
dealers, banks, trust companies, clearing corporations and certain other
organizations.
Other organizations, such as securities brokers and dealers, banks and
trust companies that work through a Direct Participant, also use DTC's
book-entry system. The rules that apply to DTC and its participants are on file
with the Securities and Exchange Commission.
A number of Direct Participants, together with the New York Stock
Exchange, Inc., The American Stock Exchange LLC and the National Association of
Securities Dealers, Inc., own DTC.
DTC's ability to perform properly its services is also dependent upon
other parties, including, but not limited to, issuers and their agents, as well
as DTC's participants, third party vendors from whom DTC licenses software and
hardware, and third party vendors on whom DTC relies for information or the
provision of services, including telecommunication and electrical utility
service providers, among others.
The information in this section concerning DTC and DTC's system has
been obtained from sources that we believe to be reliable, but we take no
responsibility for the accuracy thereof.
FINANCIAL STATEMENTS
The audited financial statements for the fiscal year ended December 31,
2002, together with the report of Tait, Weller & Baker thereon, and the
unaudited financial for the six months ended June 30, 2003, are included below
in this Statement of Additional Information.
27
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS DECEMBER 31, 2002
--------------------------------------------------------------------------------
COMMON STOCKS - 77.3%
SHARES VALUE
------ -----
CONSUMER PRODUCTS - 6.5%
Apparel and Shoes - 1.5%
Nautica Enterprises (a) 104,000 $ 1,155,440
--------------
Home Furnishing/Appliances - 1.1%
Natuzzi ADR (b) 83,800 851,408
--------------
Sports and Recreation - 3.0%
+CALLAWAY GOLF (c) 100,000 1,325,000
Monaco Coach (a) 61,350 1,015,342
--------------
2,340,342
--------------
Other Consumer Products - 0.9%
Oakley (a) 69,100 709,657
--------------
TOTAL (Cost $4,838,569) 5,056,847
==============
CONSUMER SERVICES - 4.6%
Direct Marketing - 1.9%
+NU SKIN ENTERPRISES CL. A 127,000 1,520,190
--------------
Retail Stores - 2.7%
Big Lots (a) 89,400 1,182,762
Charming Shoppes (a) 216,000 902,880
--------------
2,085,642
--------------
TOTAL (Cost $2,918,318) 3,605,832
==============
FINANCIAL INTERMEDIARIES - 6.8%
Insurance - 6.2%
PROASSURANCE (a) 124,255 2,609,355
WHITE MOUNTAINS INSURANCE GROUP (c) 4,000 1,292,000
Zenith National Insurance 39,800 936,096
--------------
4,837,451
--------------
Securities Brokers - 0.6%
E*TRADE Group (a,c) 100,000 486,000
--------------
TOTAL (Cost $3,274,573) 5,323,451
==============
FINANCIAL SERVICES - 2.3%
Insurance Brokers - 1.4%
Gallagher (Arthur J.) & Company 36,000 1,057,680
--------------
Investment Management - 0.9%
+U.S. Global Investors Cl. A (a) 295,605 723,937
--------------
TOTAL (Cost $913,723) 1,781,617
==============
HEALTH - 13.2%
Drugs and Biotech - 8.2%
+Antigenics (a,c) 90,000 921,600
+Emisphere Technologies (a) 200,000 696,000
+ENDO PHARMACEUTICALS HOLDINGS (a) 200,000 1,539,800
+Gene Logic (a) 89,000 559,810
Lexicon Genetics (a) 150,000 709,500
+Perrigo (a) 87,300 1,060,695
+VIVUS (a,c) 250,000 932,500
--------------
6,419,905
--------------
Health Services - 0.8%
Covance (a,c) 25,000 614,750
--------------
Personal Care - 2.0%
OCULAR SCIENCES (a) 100,000 1,552,000
--------------
Surgical Products and Devices - 2.2%
Arrow International 30,200 1,228,234
+VISX (a) 50,000 479,000
--------------
1,707,234
--------------
TOTAL (Cost $10,273,863) 10,293,889
==============
INDUSTRIAL PRODUCTS - 12.5%
Building Systems and Components - 3.0%
SIMPSON MANUFACTURING (a) 70,000 2,303,000
--------------
Construction Materials - 3.1%
FLORIDA ROCK INDUSTRIES 63,350 2,410,467
--------------
Machinery - 5.2%
LINCOLN ELECTRIC HOLDINGS 101,600 2,352,040
WOODWARD GOVERNOR 40,000 1,740,000
--------------
4,092,040
--------------
Other Industrial Products - 1.2%
Wescast Industries Cl. A 37,700 938,730
--------------
TOTAL (Cost $6,861,083) 9,744,237
==============
INDUSTRIAL SERVICES - 5.9%
Commercial Services - 3.7%
Carlisle Holdings (a) 400,000 1,100,000
CORNELL COMPANIES (a) 150,000 1,350,000
On Assignment (a) 50,000 426,000
--------------
2,876,000
--------------
Engineering and Construction - 2.2%
+DYCOM INDUSTRIES (a) 132,500 1,755,625
--------------
TOTAL (Cost $3,810,026) 4,631,625
==============
NATURAL RESOURCES - 13.1%
Energy Services - 1.7%
INPUT/OUTPUT (a) 300,000 1,275,000
--------------
Oil and Gas - 4.4%
TOM BROWN (a) 68,800 1,726,880
3TEC ENERGY (a) 120,000 1,702,800
--------------
3,429,680
--------------
Precious Metals and Mining - 7.0%
ANGLOGOLD ADR (b) 54,600 1,870,596
+GLAMIS GOLD (a,c) 150,000 1,701,000
+GOLDCORP 150,000 1,908,000
--------------
5,479,596
--------------
TOTAL (Cost $7,540,265) 10,184,276
==============
TECHNOLOGY - 12.4%
Aerospace/Defense - 0.4%
Curtiss-Wright 4,800 306,336
--------------
Components and Systems - 2.4%
Dionex (a) 20,000 594,200
Kronos (a) 12,750 471,623
+REMEC (a) 200,000 776,000
--------------
1,841,823
--------------
Distribution - 1.4%
Richardson Electronics (c) 129,000 1,117,140
--------------
28
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS DECEMBER 31, 2002
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
TECHNOLOGY (CONTINUED)
IT Services - 2.7%
PEROT SYSTEMS CL. A (a) 133,600 $ 1,432,192
Syntel (a) 30,200 634,502
--------------
2,066,694
--------------
Semiconductors and Equipment - 0.8%
Exar (a) 50,000 620,000
--------------
Software - 2.6%
JDA Software Group (a,c) 70,000 676,200
+Lightspan (a) 669,500 703,644
+Transaction Systems Architects Cl. A (a) 100,000 650,000
--------------
2,029,844
--------------
Telecommunication - 2.0%
+ANAREN (a,c) 140,000 1,232,000
+Somera Communications (a,c) 130,000 351,000
--------------
1,583,000
--------------
TOTAL (Cost $9,079,144) 9,564,837
==============
TOTAL COMMON STOCKS
(Cost $49,509,564) 60,186,611
--------------
PRINCIPAL
AMOUNT
---------
CORPORATE BONDS - 2.9%
+E*TRADE Group 6.00%
Conv. Sub. Note due 2/1/07 $3,000,000 $ 2,250,000
--------------
TOTAL CORPORATE BONDS
(Cost $2,147,894) 2,250,000
==============
U.S. TREASURY OBLIGATIONS - 7.0%
U.S. Treasury Notes
7.25%, due 8/15/04 5,000,000 5,469,335
--------------
TOTAL U.S. TREASURY OBLIGATIONS
(Cost $5,047,341) 5,469,335
==============
REPURCHASE AGREEMENT - 12.8%
State Street Bank & Trust Company,
0.50% dated 12/31/02, due 1/2/03,
maturity value $9,943,276
(collateralized by U.S. Treasury Notes,
5.00% due 8/15/11, valued at $10,145,560)
(Cost $9,943,000) 9,943,000
==============
TOTAL INVESTMENTS - 100.0%
(Cost $66,647,799) 77,848,946
CASH AND OTHER ASSETS
LESS LIABILITIES 107,020
PREFERRED STOCK (20,000,000)
--------------
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS $ 57,955,966
==============
--------------------------------------------------------------------------------
(a) Non-income producing.
(b) American Depository Receipt.
(c) A portion of these securities were on loan at December 31, 2002. Total
market value of loaned securities at December 31, 2002 was $1,242,139.
(+) New additions in 2002.
BOLD INDICATES THE FUND'S LARGEST 20 EQUITY HOLDINGS IN TERMS OF
DECEMBER 31, 2002 MARKET VALUE.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $66,972,929. At December 31, 2002, net unrealized appreciation for
all securities was $10,876,017, consisting of aggregate gross unrealized
appreciation of $14,442,522 and aggregate gross unrealized depreciation of
$3,566,505. The primary differences in book and tax basis cost is the timing of
the recognition of losses on securities sold and amortization of discount for
book and tax purposes.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
29
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES DECEMBER 31, 2002
--------------------------------------------------------------------------------
ASSETS:
Investments at value (identified cost $56,704,799) $67,905,946
Repurchase agreement (at cost and value) 9,943,000
Cash 333
Collateral from brokers on securities loaned 1,295,145
Receivable for dividends and interest 240,052
Prepaid expenses 2,423
--------------------------------------------------------------------------------
Total Assets 79,386,899
--------------------------------------------------------------------------------
LIABILITIES:
Payable for collateral on securities loaned 1,295,145
Payable for investment advisory fee 49,620
Preferred dividends accrued but not yet declared 33,112
Accrued expenses 53,056
--------------------------------------------------------------------------------
Total Liabilities 1,430,933
--------------------------------------------------------------------------------
PREFERRED STOCK:
7.45% Cumulative Preferred Stock - $0.001 par value,
$25 liquidation value per share; 800,000 shares outstanding 20,000,000
--------------------------------------------------------------------------------
Total Preferred Stock 20,000,000
--------------------------------------------------------------------------------
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS $57,955,966
================================================================================
ANALYSIS OF NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS:
Par value of Common Stock - $0.001 per share;
9,241,025 shares outstanding (100,000,000 shares authorized) $ 9,241
Additional paid-in capital 45,713,027
Accumulated net realized gain on investments 1,065,663
Net unrealized appreciation on investments 11,201,147
Preferred dividends accrued but not yet declared (33,112)
--------------------------------------------------------------------------------
Net Assets applicable to Common Stockholders
(net asset value per share - $6.27) $57,955,966
================================================================================
STATEMENTS OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
Year ended Year ended
December 31, December 31,
2002 2001
------------ ------------
INVESTMENT OPERATIONS:
Net investment income (loss) $ (103,396) $ 431,263
Net realized gain on investments 1,317,847 2,603,772
Net change in unrealized appreciation
on investments (8,047,125) 4,458,997
--------------------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from investment operations (6,832,674) 7,494,032
--------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS:
Net investment income (272,620) (321,840)
Net realized gain on investments (1,217,380) (1,168,160)
--------------------------------------------------------------------------------
Total distributions to Preferred Stockholders (1,490,000) (1,490,000)
--------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS APPLICABLE TO
COMMON STOCKHOLDERS RESULTING FROM INVESTMENT
OPERATIONS (8,322,674) 6,004,032
================================================================================
DISTRIBUTIONS TO COMMON STOCKHOLDERS:
Net investment income (150,865) (272,127)
Net realized gain on investments (673,654) (987,720)
--------------------------------------------------------------------------------
Total distributions to Common Stockholders (824,519) (1,259,847)
--------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Reinvestment of distributions to Common
Stockholders 449,516 976,135
--------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS APPLICABLE
TO COMMON STOCKHOLDERS (8,697,677) 5,720,320
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS:
Beginning of year 66,653,643 60,933,323
--------------------------------------------------------------------------------
End of year (including undistributed net
investment income of $423,485 in 2001) $57,955,966 $66,653,643
================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
30
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 2002
--------------------------------------------------------------------------------
INVESTMENT INCOME:
Income:
Interest $ 684,730
Dividends 400,374
--------------------------------------------------------------------------------
Total income 1,085,104
--------------------------------------------------------------------------------
Expenses:
Investment advisory fees 833,072
Stockholder meeting costs 212,505
Custody and transfer agent fees 73,880
Professional fees 34,460
Stockholder reports 37,213
Directors' fees 34,053
Administrative and office facilities expenses 21,538
Other expenses 59,038
--------------------------------------------------------------------------------
Total expenses 1,305,759
Fees waived by investment adviser (117,259)
--------------------------------------------------------------------------------
Net expenses 1,188,500
--------------------------------------------------------------------------------
Net investment income (loss) (103,396)
--------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments 1,317,847
Net change in unrealized appreciation on investments (8,047,125)
--------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments (6,729,278)
--------------------------------------------------------------------------------
NET DECREASE IN NET ASSETS RESULTING FROM INVESTMENT OPERATIONS (6,832,674)
================================================================================
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS (1,490,000)
================================================================================
NET DECREASE IN NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS
RESULTING FROM INVESTMENT OPERATIONS $(8,322,674)
================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
31
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
This table is presented to show selected data for a share of Common Stock
outstanding throughout each period, and to assist stockholders in evaluating the
Fund's performance for the periods presented.
Years ended December 31,
------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $7.28 $6.77 $5.94 $5.63 $6.04
----------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS:
Net investment income (loss) (0.01) 0.05 0.12 0.08 0.12
Net realized and unrealized gain (loss) on investments (0.74) 0.79 1.26 0.58 (0.35)
----------------------------------------------------------------------------------------------------------------------------------
Total investment operations (0.75) 0.84 1.38 0.66 (0.23)
----------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS:
Net investment income (0.03) (0.04) (0.03) (0.01) (0.16)
Net realized gain on investments (0.13) (0.13) (0.14) (0.17) (0.02)
----------------------------------------------------------------------------------------------------------------------------------
Total distributions to Preferred Stockholders (0.16) (0.17) (0.17) (0.18) (0.18)
----------------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS APPLICABLE TO COMMON
STOCKHOLDERS RESULTING FROM INVESTMENT OPERATIONS (0.91) 0.67 1.21 0.48 (0.41)
----------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO COMMON STOCKHOLDERS:
Net investment income (0.02) (0.03) (0.06) (0.01) -
Net realized gain on investments (0.07) (0.11) (0.28) (0.14) -
----------------------------------------------------------------------------------------------------------------------------------
Total distributions to Common Stockholders (0.09) (0.14) (0.34) (0.15) -
----------------------------------------------------------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Effect of reinvestment of distributions by Common Stockholders (0.01) (0.02) (0.04) (0.02) -
----------------------------------------------------------------------------------------------------------------------------------
Total capital stock transactions (0.01) (0.02) (0.04) (0.02) -
----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $6.27 $7.28 $6.77 $5.94 $5.63
==================================================================================================================================
MARKET VALUE, END OF PERIOD $5.56 $6.65 $5.69 $4.72 $4.88
==================================================================================================================================
TOTAL RETURN (a):
Market Value (15.1)% 19.7% 27.9% (0.3)% (3.7)%
Net Asset Value (12.5)% 10.0% 20.9% 8.7% (6.8)%
RATIOS BASED ON AVERAGE NET ASSETS APPLICABLE TO
COMMON STOCKHOLDERS:
Total expenses (b,c) 1.88% 1.47% 1.44% 1.51% 1.62%
Management fee expense 1.13% 1.11% 1.00% 1.00% 1.14%
Other operating expenses 0.75% 0.36% 0.44% 0.51% 0.48%
Net investment income (loss) (0.16)% 0.70% 1.93% 1.47% 1.95%
SUPPLEMENTAL DATA:
Net Assets Applicable to Common Stockholders, End of Period
(in thousands) $57,956 $66,654 $60,933 $51,003 $47,457
Liquidation Value of Preferred Stock, End of Period
(in thousands) $20,000 $20,000 $20,000 $20,000 $20,000
Portfolio Turnover Rate 61% 54% 69% 60% 90%
PREFERRED STOCK:
Total shares outstanding 800,000 800,000 800,000 800,000 800,000
Asset coverage per share $97.44 $108.32 $101.17 $88.75 $84.32
Liquidation preference per share $25.00 $25.00 $25.00 $25.00 $25.00
Average market value per share (d) $25.64 $25.09 $22.23 $24.00 $25.16
==================================================================================================================================
(a) The Market Value Total Return is calculated assuming a purchase of Common
Stock on the opening of the first business day and a sale on the closing of
the last business day of each period reported. Dividends and distributions,
if any, are assumed for the purposes of this calculation, to be reinvested
at prices obtained under the Fund's Distribution Reinvestment and Cash
Purchase Plan. Net Asset Value Total Return is calculated on the same basis,
except that the Fund's net asset value is used on the purchase and sale
dates instead of market value.
(b) Expense ratios based on total average net assets including liquidation value
of Preferred Stock were 1.43%, 1.11%, 1.05%, 1.06% and 1.16% for the periods
ended December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
(c) Expense ratios based on average net assets applicable to Common Stockholders
before waiver of fees by the investment adviser would have been 2.06%,
1.69%, 1.81%, 1.93% and 1.88% for the periods ended December 31, 2002, 2001,
2000, 1999 and 1998, respectively.
(d) The average of month-end market values during the period.
32
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Royce Focus Trust, Inc. (the "Fund") is a diversified closed-end
investment company. The Fund commenced operations on March 2, 1988 and Royce
& Associates,LLC ("Royce") assumed investment management responsibility for
the Fund on November 1, 1996.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts
of income and expenses during the reporting period. Actual results could
differ from those estimates.
VALUATION OF INVESTMENTS:
Securities listed on an exchange or on the Nasdaq National Market
System (NMS) are valued on the basis of the last reported sale prior to
the time the valuation is made or, if no sale is reported for such day,
at their bid price for exchange-listed securities and at the average of
their bid and asked prices for Nasdaq NMS securities. Quotations are
taken from the market where the security is primarily traded. Other
over-the-counter securities for which market quotations are readily
available are valued at their bid price. Securities for which market
quotations are not readily available are valued at their fair value under
procedures established by the Fund's Board of Directors. Bonds and other
fixed income securities may be valued by reference to other securities
with comparable ratings, interest rates and maturities, using established
independent pricing services.
INVESTMENT TRANSACTIONS AND RELATED INVESTMENT INCOME:
Investment transactions are accounted for on the trade date. Dividend
income is recorded on the ex-dividend date and any non-cash dividend income
is recorded at the fair market value of the securities received. Interest
income is recorded on the accrual basis. Realized gains and losses from
investment transactions are determined on the basis of identified cost for
book and tax purposes.
EXPENSES:
The Fund incurs direct and indirect expenses. Expenses directly
attributable to the Fund are charged to the Fund's operations, while expenses
applicable to more than one of the Royce Funds are allocated in an equitable
manner. Allocated personnel and occupancy costs related to The Royce Funds
are included in administrative and office facilities expenses. The Fund has
adopted a deferred fee agreement that allows the Fund's Directors to defer
the receipt of all or a portion of Directors' Fees otherwise payable. The
deferred fees remain invested in certain Royce Funds until distributed in
accordance with the agreement.
TAXES:
As a qualified regulated investment company under Subchapter M of the
Internal Revenue Code, the Fund is not subject to income taxes to the extent
that it distributes substantially all of its taxable income for its fiscal
year. The Schedule of Investments includes information regarding income taxes
under the caption "Income Tax Information".
DISTRIBUTIONS:
Distributions to Common Stockholders are recorded on the ex-dividend date
and paid annually in December. Distributions to Preferred Stockholders are
recorded on an accrual basis and paid quarterly. Distributions are determined
in accordance with income tax regulations that may differ from accounting
principles generally accepted in the United States of America. Permanent book
and tax basis differences relating to stockholder distributions will result
in reclassifications within the capital accounts. Undistributed net
investment income may include temporary book and tax basis differences, which
will reverse in a subsequent period. Any taxable income or gain remaining
undistributed at fiscal year end is distributed in the following year.
REPURCHASE AGREEMENTS:
The Fund enters into repurchase agreements with respect to its portfolio
securities solely with State Street Bank and Trust Company ("SSB&T"), the
custodian of its assets. The Fund restricts repurchase agreements to
maturities of no more than seven days. Securities pledged as collateral for
repurchase agreements, which are held by SSB&T until maturity of the
repurchase agreements, are marked-to-market daily and maintained at a value
at least equal to the principal amount of the repurchase agreement (including
accrued interest). Repurchase agreements could involve certain risks in the
event of default or insolvency of SSB&T, including possible delays or
restrictions upon the ability of the Fund to dispose of the underlying
securities.
2. SECURITIES LENDING:
The Fund loans securities to qualified institutional investors for
the purpose of realizing additional income. This income is included in
interest income. Collateral on all securities loaned for the Fund is accepted
in cash and is invested temporarily, typically, and specifically at December
31, 2002, in a registered money market fund, by the custodian. The collateral
is equal to at least 100% of the current market value of the loaned
securities.
33
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
3. CAPITAL STOCK:
The Fund currently has 800,000 shares of 7.45% Cumulative Preferred Stock
outstanding. The stock has a liquidation preference of $25.00 per share.
Under the Investment Company Act of 1940, the Fund is required to
maintain an asset coverage of at least 200% for the Preferred Stock. In
addition, pursuant to the Rating Agency Guidelines established by Moody's,
the Fund is required to maintain a certain discounted asset coverage. The
Fund has met these requirements since issuing the Preferred Stock.
The Fund is required to allocate long-term capital gain distributions
and other types of income proportionately to distributions made to holders of
shares of Common Stock and Preferred Stock. To the extent that distributions
on the shares of Preferred Stock are not paid from long-term capital gains,
net investment income or net short-term capital gains, they will represent a
return of capital.
The Fund issued 79,701 and 162,419 shares of Common Stock as reinvestment
of distributions by Common Stockholders for the years ended December 31, 2002
and 2001, respectively.
4. INVESTMENT ADVISORY AGREEMENT:
The Investment Advisory Agreement between Royce and the Fund provides for
fees to be paid at an annual rate of 1.0% of the Fund's average daily net
assets applicable to Common Stockholders plus liquidation value of Preferred
Stock. Royce has voluntarily committed to waive the portion of its investment
advisory fee attributable to the Fund's Preferred Stock for any month in
which the Fund's average annual NAV total return since issuance of the
Preferred Stock fails to exceed the Preferred Stock's dividend rate.
For the year ended December 31, 2002, the Fund accrued and paid Royce
advisory fees totaling $715,813, which is net of $117,259 voluntarily waived
by Royce.
5. DISTRIBUTIONS TO STOCKHOLDERS:
The tax character of distributions paid to stockholders during 2002
and 2001 was as follows:
---------------------------------------------------------------------
Distributions paid from: 2002 2001
---- ----
Ordinary income $ 423,485 $ 593,967
Long-term capital gain 1,891,034 2,155,880
---------- ----------
$2,314,519 $2,749,847
========== ==========
---------------------------------------------------------------------
As of December 31, 2002, the tax basis components of distributable
earnings included in stockholders' equity were as follows:
----------------------------------------------
Undistributed long-term gain $ 1,390,793
Unrealized appreciation 10,876,017
Accrued preferred distributions (33,112)
-----------
$12,233,698
===========
----------------------------------------------
6. PURCHASES AND SALES OF INVESTMENT SECURITIES:
For the year ended December 31, 2002, the cost of purchases and proceeds
from sales of investment securities, other than short-term securities,
amounted to $43,961,561 and $47,800,885, respectively.
7. PREFERRED STOCK PRESENTATION
To reflect recent accounting guidance from the Securities and Exchange
Commission, the Statement of Assets and Liabilities has been modified to
present the liquidation value of Preferred Stock below Liabilities and above
Net Assets Applicable to Common Stockholders. As revised, Preferred Stock is
no longer included as a component of net assets of the Fund. Likewise, the
Statement of Operations, the Statement of Changes in Net Assets, and the
Financial Highlights have been revised to show distributions to Preferred
Stockholders as a component of the net decrease in net assets applicable to
Common Stockholders resulting from investment operations. These
modifications do not change the amount of net assets applicable to Common
Stockholders, the net asset value per share of Common Stock, or the total
return per share of Common Stock.
34
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT AUDITORS
--------------------------------------------------------------------------------
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF ROYCE FOCUS TRUST, INC.
We have audited the accompanying statement of assets and liabilities of
Royce Focus Trust, Inc., including the schedule of investments, as of December
31, 2002, and the related statement of operations for the year ended, and the
statement of changes in net assets for the two years in the period then ended
and the financial highlights for each of the five years in the period then
ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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 and financial highlights. Our procedures
included confirmation of securities owned as of December 31, 2002, by
correspondence with the custodian and brokers. 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 and audited by us present fairly, in all material respects, the
financial position of Royce Focus Trust, Inc. at December 31, 2002, the results
of its operations for the year then ended, the changes in its net assets for
each of the two years in the period then ended and the financial highlights for
each of the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America.
TAIT, WELLER & BAKER
Philadelphia, PA
January 15, 2003, except for Note 7, as to which the date is September 12, 2003
35
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
COMMON STOCKS - 75.3%
SHARES VALUE
------ -----
CONSUMER PRODUCTS - 6.2%
Sports and Recreation - 3.6%
Callaway Golf 100,000 $ 1,322,000
+WINNEBAGO INDUSTRIES (c) 50,000 1,895,000
---------------
3,217,000
---------------
Other Consumer Products - 2.6%
Oakley (a) 75,000 882,750
+YANKEE CANDLE COMPANY (a) 60,000 1,393,200
---------------
2,275,950
---------------
TOTAL (Cost $4,305,372) 5,492,950
===============
CONSUMER SERVICES - 5.2%
Direct Marketing - 2.4%
NU SKIN ENTERPRISES CL. A 200,000 2,090,000
---------------
Retail Stores - 2.8%
Big Lots (a) 89,400 1,344,576
Charming Shoppes (a,c) 230,000 1,143,100
---------------
2,487,676
---------------
TOTAL (Cost $3,614,159) 4,577,676
===============
FINANCIAL INTERMEDIARIES - 9.4%
Insurance - 5.1%
ProAssurance Corporation (a) 47,155 1,272,713
WHITE MOUNTAINS INSURANCE GROUP (c) 4,000 1,580,000
ZENITH NATIONAL INSURANCE 59,000 1,681,500
---------------
4,534,213
---------------
Securities Brokers - 1.5%
E*TRADE GROUP (a) 150,000 1,275,000
---------------
Other Financial Intermediaries - 2.8%
+TSX GROUP 120,000 2,434,077
---------------
TOTAL (Cost $4,622,704) 8,243,290
===============
FINANCIAL SERVICES - 1.7%
Information and Processing - 1.1%
+eFunds Corporation (a) 85,000 980,050
---------------
Investment Management - 0.6%
U.S. Global Investors Cl. A (a,c) 295,605 546,869
---------------
TOTAL (Cost $1,566,006) 1,526,919
===============
HEALTH - 10.5%
Drugs and Biotech - 8.9%
Antigenics (a,c) 80,000 921,600
+Durect Corporation (a,c) 220,000 530,200
Emisphere Technologies (a) 200,000 720,000
ENDO PHARMACEUTICALS HOLDINGS (a) 100,000 1,692,000
Lexicon Genetics (a) 200,000 1,342,000
Perrigo Company 87,300 1,365,372
VIVUS (a,c) 250,000 1,285,000
---------------
7,856,172
---------------
Personal Care - 1.6%
OCULAR SCIENCES (a) 70,000 1,389,500
---------------
TOTAL (Cost $7,522,624) 9,245,672
===============
INDUSTRIAL PRODUCTS - 9.1%
Building Systems and Components - 2.9%
SIMPSON MANUFACTURING (a) 70,000 2,562,000
---------------
Construction Materials - 2.7%
FLORIDA ROCK INDUSTRIES 58,350 2,408,688
---------------
Machinery - 3.5%
LINCOLN ELECTRIC HOLDINGS 99,800 2,036,918
Woodward Governor 24,400 1,049,200
---------------
3,086,118
---------------
TOTAL (Cost $4,617,941) 8,056,806
===============
INDUSTRIAL SERVICES - 7.2%
Commercial Services - 5.3%
Carlisle Holdings (a) 400,000 1,320,000
Cornell Companies (a) 75,000 1,135,500
Covance (a) 50,000 905,000
+West Corporation (a) 50,000 1,332,500
---------------
4,693,000
---------------
Engineering and Construction - 1.9%
DYCOM INDUSTRIES (a) 100,000 1,630,000
---------------
TOTAL (Cost $3,871,542) 6,323,000
===============
NATURAL RESOURCES - 12.2%
Energy Services - 2.7%
+Ensign Resource Service Group 53,000 789,674
INPUT/OUTPUT (a) 300,000 1,614,000
---------------
2,403,674
---------------
Oil and Gas - 1.6%
TOM BROWN (a) 50,000 1,389,500
---------------
Precious Metals and Mining - 7.9%
AngloGold ADR b 25,000 797,500
+APEX SILVER MINES (a) 100,000 1,475,000
Glamis Gold (a) 125,000 1,433,750
GOLDCORP 180,000 2,160,000
+Meridian Gold (a) 99,800 1,146,702
---------------
7,012,952
---------------
TOTAL (Cost $8,749,421) 10,806,126
===============
TECHNOLOGY - 13.8%
Components and Systems - 1.6%
REMEC (a) 200,000 1,392,000
---------------
Distribution - 1.2%
Richardson Electronics 129,000 1,044,900
---------------
Internet Software and Services - 1.6%
+Overstock.com (a,c) 100,000 1,451,000
---------------
IT Services - 3.1%
PEROT SYSTEMS CL. A (a) 140,500 1,596,080
Syntel (a) 70,000 1,101,100
---------------
2,697,180
---------------
Semiconductors and Equipment - 1.9%
Exar Corporation (a) 50,000 791,500
+ParthusCeva (a,c) 109,600 893,240
---------------
1,684,740
---------------
Software - 1.6%
Lightspan (a) 750,000 508,500
Transaction Systems Architects Cl. A (a) 100,000 896,000
---------------
1,404,500
---------------
36
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
TECHNOLOGY (CONTINUED)
Telecommunication - 2.8%
Anaren (a,c) 140,000 $ 1,311,800
+ViaSat (a,c) 83,700 1,200,258
---------------
2,512,058
---------------
TOTAL (Cost $10,466,402) 12,186,378
===============
TOTAL COMMON STOCKS
(Cost $49,336,171) 66,458,817
===============
PRINCIPAL
AMOUNT
------
CORPORATE BONDS - 3.3%
E*TRADE GROUP 6.00%
Conv. Sub. Note due 2/1/07 $3,000,000 2,940,000
---------------
TOTAL CORPORATE BONDS
(Cost $2,226,761) 2,940,000
GOVERNMENT BONDS - 5.7%
NEW ZEALAND 6.50%, DUE 2/15/06 8,250,000 5,025,385
---------------
TOTAL GOVERNMENT BONDS
(Cost $4,910,697) 5,025,385
===============
PRINCIPAL
AMOUNT
------
U.S. TREASURY OBLIGATIONS - 6.1%
U.S. Treasury Notes
7.25%, due 8/15/04 5,000,000 $5,344,725
---------------
TOTAL U.S. TREASURY OBLIGATIONS
(Cost $5,033,324) 5,344,725
===============
REPURCHASE AGREEMENT - 9.6%
State Street Bank & Trust Company,
0.30% dated 6/30/03, due 7/1/03,
maturity value $8,442,070
(collateralized by U.S. Treasury Bonds,
6.375% due 8/15/27, valued at $8,613,909)
(Cost $8,442,000) 8,442,000
===============
TOTAL INVESTMENTS - 100.0%
(Cost $69,948,953) 88,210,927
CASH AND OTHER ASSETS
LESS LIABILITIES 519,568
PREFERRED STOCK (20,000,000)
---------------
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS $ 68,730,495
===============
--------------------------------------------------------------------------------
(a) Non-income producing.
(b) American Depository Receipt.
(c) A portion of these securities were on loan at June 30, 2003. Total market
value of loaned securities at June 30, 2003 was $3,305,289.
+ New additions in 2003.
BOLD INDICATES THE FUND'S LARGEST 20 EQUITY HOLDINGS IN TERMS OF JUNE 30,
2003 MARKET VALUE.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $70,316,034. At June 30, 2003, net unrealized appreciation for all
securities was $17,894,893, consisting of aggregate gross unrealized
appreciation of $19,366,001 and aggregate gross unrealized depreciation of
$1,471,108. The primary differences in book and tax basis cost is the timing of
the recognition of losses on securities sold and amortization of discount for
book and tax purposes.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
37
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
ASSETS:
Investments at value (identified cost $61,506,953) $79,768,927
Repurchase agreement (at cost and value) 8,442,000
Cash 517
Collateral from brokers on securities loaned 3,403,611
Receivable for investments sold 284,594
Receivable for dividends and interest 370,313
Prepaid expenses 11,545
--------------------------------------------------------------------------------
Total Assets 92,281,507
--------------------------------------------------------------------------------
LIABILITIES:
Payable for collateral on securities loaned 3,403,611
Payable for investment advisory fee 56,720
Preferred dividends accrued but not yet declared 33,112
Accrued expenses 57,569
--------------------------------------------------------------------------------
Total Liabilities 3,551,012
--------------------------------------------------------------------------------
PREFERRED STOCK:
7.45% Cumulative Preferred Stock - $0.001 par value,
$25 liquidation value per share; 800,000 shares outstanding 20,000,000
--------------------------------------------------------------------------------
Total Preferred Stock 20,000,000
--------------------------------------------------------------------------------
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS $68,730,495
--------------------------------------------------------------------------------
ANALYSIS OF NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS:
Par value of Common Stock - $0.001 per share; 9,241,025
shares outstanding (100,000,000 shares authorized) $ 9,241
Additional paid-in capital 45,713,027
Undistributed net investment income 165,852
Accumulated net realized gain on investments 5,356,492
Net unrealized appreciation on investments 18,263,995
Quarterly and accrued distributions (778,112)
--------------------------------------------------------------------------------
Net Assets applicable to Common Stockholders
(net asset value per share - $7.44) $68,730,495
================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
38
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
STATEMENT OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
INVESTMENT INCOME:
Income:
Interest $ 401,058
Dividends 197,770
--------------------------------------------------------------------------------
Total income 598,828
--------------------------------------------------------------------------------
Expenses:
Investment advisory fees 392,077
Custody and transfer agent fees 38,899
Stockholder reports 26,154
Professional fees 25,830
Directors' fees 15,771
Administrative and office facilities expenses 6,178
Other expenses 27,244
--------------------------------------------------------------------------------
Total expenses 532,153
Fees waived by investment adviser (99,177)
--------------------------------------------------------------------------------
Net expenses 432,976
--------------------------------------------------------------------------------
Net investment income 165,852
--------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments 4,290,829
Net change in unrealized appreciation on investments 7,062,848
--------------------------------------------------------------------------------
Net realized and unrealized gain on investments 11,353,677
--------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM INVESTMENT OPERATIONS 11,519,529
--------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS (745,000)
--------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS
RESULTING FROM INVESTMENT OPERATIONS $10,774,529
================================================================================
STATEMENTS OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
Six months ended Year ended
June 30, 2003 December 31,
(unaudited) 2002
---------------- -----------
INVESTMENT OPERATIONS:
Net investment income (loss) $ 165,852 $ (103,396)
Net realized gain on investments 4,290,829 1,317,847
Net change in unrealized appreciation
on investments 7,062,848 (8,047,125)
--------------------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from investment operations 11,519,529 (6,832,674)
--------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS:
Net investment income - (272,620)
Net realized gain on investments - (1,217,380)
Quarterly distributions* (745,000) -
--------------------------------------------------------------------------------
Total distributions to
Preferred Stockholders (745,000) (1,490,000)
--------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
APPLICABLE TO COMMON STOCKHOLDERS RESULTING
FROM INVESTMENT OPERATIONS 10,774,529 (8,322,674)
--------------------------------------------------------------------------------
DISTRIBUTIONS TO COMMON STOCKHOLDERS:
Net investment income - (150,865)
Net realized gain on investments - (673,654)
--------------------------------------------------------------------------------
Total distributions to Common
Stockholders - (824,519)
--------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Reinvestment of distributions to
Common Stockholders - 449,516
--------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
APPLICABLE TO COMMON STOCKHOLDERS 10,774,529 (8,697,677)
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS:
Beginning of period 57,955,966 66,653,643
--------------------------------------------------------------------------------
End of period (including undistributed
net investment income of $165,852
in 2003) $68,730,495 $57,955,966
================================================================================
*To be allocated to net investment income and capital gains at year-end.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
39
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
This table is presented to show selected data for a share of Common Stock
outstanding throughout each period, and to assist stockholders in evaluating the
Fund's performance for the periods presented.
Six months ended Years ended December 31,
June 30, 2003 --------------------------------------------
(unaudited) 2002 2001 2000 1999 1998
----------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $6.27 $7.28 $6.77 $5.94 $5.63 $6.04
----------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS:
Net investment income (loss) 0.02 (0.01) 0.05 0.12 0.08 0.12
Net realized and unrealized
gain (loss) on investments 1.23 (0.74) 0.79 1.26 0.58 (0.35)
----------------------------------------------------------------------------------------------------
Total investment operations 1.25 (0.75) 0.84 1.38 0.66 (0.23)
----------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS:
Net investment income - (0.03) (0.04) (0.03) (0.01) (0.16)
Net realized gain on investments - (0.13) (0.13) (0.14) (0.17) (0.02)
Quarterly distributions* (0.08) - - - - -
----------------------------------------------------------------------------------------------------
Total distributions to
Preferred Stockholders (0.08) (0.16) (0.17) (0.17) (0.18) (0.18)
----------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
APPLICABLE TO COMMON STOCKHOLDERS
RESULTING FROM INVESTMENT OPERATIONS 1.17 (0.91) 0.67 1.21 0.48 (0.41)
----------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO COMMON STOCKHOLDERS:
Net investment income - (0.02) (0.03) (0.06) (0.01) -
Net realized gain on investments - (0.07) (0.11) (0.28) (0.14) -
----------------------------------------------------------------------------------------------------
Total distributions to
Common Stockholders - (0.09) (0.14) (0.34) (0.15) -
----------------------------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Effect of reinvestment of
distributions by
Common Stockholders - (0.01) (0.02) (0.04) (0.02) -
----------------------------------------------------------------------------------------------------
Total capital stock transactions - (0.01) (0.02) (0.04) (0.02) -
----------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $7.44 $6.27 $7.28 $6.77 $5.94 $5.63
----------------------------------------------------------------------------------------------------
MARKET VALUE, END OF PERIOD $6.77 $5.56 $6.65 $5.69 $4.72 $4.88
----------------------------------------------------------------------------------------------------
TOTAL RETURN (a):
Market Value 21.8%*** (15.1)% 19.7% 27.9% (0.3)% (3.7)%
Net Asset Value 18.7%*** (12.5)% 10.0% 20.9% 8.7% (6.8)%
RATIOS BASED ON AVERAGE NET ASSETS
APPLICABLE TO COMMON STOCKHOLDERS:
Total expenses (b,c) 1.48%** 1.88% 1.47% 1.44% 1.51% 1.62%
Management fee expense 1.00%** 1.13% 1.11% 1.00% 1.00% 1.14%
Other operating expenses 0.48%** 0.75% 0.36% 0.44% 0.51% 0.48%
Net investment income (loss) 0.57%** (0.16)% 0.70% 1.93% 1.47% 1.95%
SUPPLEMENTAL DATA:
Net Assets Applicable to Common
Stockholders, End of Period
(in thousands) $68,730 $57,956 $66,654 $60,933 $51,003 $47,457
Liquidation Value of Preferred Stock,
End of Period (in thousands) $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
Portfolio Turnover Rate 34% 61% 54% 69% 60% 90%
PREFERRED STOCK:
Total shares outstanding 800,000 800,000 800,000 800,000 800,000 800,000
Asset coverage per share $110.91 $97.44 $108.32 $101.17 $88.75 $84.32
Liquidation preference per share $25.00 $25.00 $25.00 $25.00 $25.00 $25.00
Average market value per share (d) $25.62 $25.64 $25.09 $22.23 $24.00 $25.16
----------------------------------------------------------------------------------------------------
(a) The Market Value Total Return is calculated assuming a purchase of Common
Stock on the opening of the first business day and a sale on the closing of
the last business day of each period reported. Dividends and distributions,
if any, are assumed for the purposes of this calculation to be reinvested at
prices obtained under the Fund's Distribution Reinvestment and Cash Purchase
Plan. Net Asset Value Total Return is calculated on the same basis, except
that the Fund's net asset value is used on the purchase and sale dates
instead of market value.
(b) Expense ratios based on total average net assets including liquidation
value of Preferred Stock were 1.10%, 1.43%, 1.11%, 1.05%, 1.06% and 1.16%
for the periods ended June 30, 2003 and December 31, 2002, 2001, 2000, 1999
and 1998, respectively.
(c) Expense ratios based on average net assets applicable to Common Stockholders
before waiver of fees by the investment adviser would have been 1.82%,
2.06%, 1.69%, 1.81%, 1.93% and 1.88% for the periods ended June 30, 2003 and
December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
(d) The average of month-end market values during the period.
* To be allocated to net investment income and capital gains at year-end.
** Annualized.
*** Not annualized.
40
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Royce Focus Trust, Inc. (the "Fund") is a diversified closed-end
investment company. The Fund commenced operations on March 2, 1988 and Royce
& Associates, LLC ("Royce") assumed investment management responsibility for
the Fund on November 1, 1996. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements,
and the reported amounts of income and expenses during the reporting period.
Actual results could differ from those estimates.
VALUATION OF INVESTMENTS:
Securities are valued as of the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern Time) on the valuation date. Securities
listed on an exchange or the Nasdaq National Market System (NMS) are valued
at their last reported sales price or official closing price taken from the
primary market in which each security trades or, if no sale is reported for
such day, at their bid price for exchange-listed securities and at the
average of their bid and asked prices for Nasdaq NMS securities. Other
over-the-counter securities for which market quotations are readily available
are valued at their bid price. Securities for which market quotations are not
readily available are valued at their fair value under procedures established
by the Fund's Board of Directors. Bonds and other fixed income securities may
be valued by reference to other securities with comparable ratings, interest
rates and maturities, using established independent pricing services.
INVESTMENT TRANSACTIONS AND RELATED INVESTMENT INCOME:
Investment transactions are accounted for on the trade date. Dividend
income is recorded on the ex-dividend date and any non-cash dividend income
is recorded at the fair market value of the securities received. Interest
income is recorded on the accrual basis. Realized gains and losses from
investment transactions are determined on the basis of identified cost for
book and tax purposes.
EXPENSES:
The Fund incurs direct and indirect expenses. Expenses directly
attributable to the Fund are charged to the Fund's operations, while expenses
applicable to more than one of the Royce Funds are allocated in an equitable
manner. Allocated personnel and occupancy costs related to The Royce Funds
are included in administrative and office facilities expenses. The Fund has
adopted a deferred fee agreement that allows the Fund's Directors to defer
the receipt of all or a portion of Directors' Fees otherwise payable. The
deferred fees are invested in certain Royce Funds until distributed in
accordance with the agreement.
TAXES:
As a qualified regulated investment company under Subchapter M of the
Internal Revenue Code, the Fund is not subject to income taxes to the extent
that it distributes substantially all of its taxable income for its fiscal
year. The Schedule of Investments includes information regarding income taxes
under the caption "Income Tax Information".
DISTRIBUTIONS:
Distributions to Common Stockholders are recorded on the ex-dividend date
and paid annually in December. Distributions to Preferred Stockholders are
recorded on an accrual basis and paid quarterly. Distributions are determined
in accordance with income tax regulations that may differ from accounting
principles generally accepted in the United States of America. Permanent book
and tax basis differences relating to stockholder distributions will result
in reclassifications within the capital accounts. Undistributed net
investment income may include temporary book and tax basis differences, which
will reverse in a subsequent period. Any taxable income or gain remaining
undistributed at fiscal year end is distributed in the following year.
REPURCHASE AGREEMENTS:
The Fund enters into repurchase agreements with respect to its portfolio
securities solely with State Street Bank and Trust Company ("SSB&T"), the
custodian of its assets. The Fund restricts repurchase agreements to
maturities of no more than seven days. Securities pledged as collateral for
repurchase agreements, which are held by SSB&T until maturity of the
repurchase agreements, are marked-to-market daily and maintained at a value
at least equal to the principal amount of the repurchase agreement (including
accrued interest). Repurchase agreements could involve certain risks in the
event of default or insolvency of SSB&T, including possible delays or
restrictions upon the ability of the Fund to dispose of the underlying
securities.
SECURITIES LENDING:
The Fund loans securities to qualified institutional investors for the
purpose of realizing additional income. This income is included in interest
income. Collateral on all securities loaned for the Fund is accepted in cash
and is invested temporarily, typically, and specifically at June 30, 2003, in
a registered money market fund, by the custodian. The collateral is equal to
at least 100% of the current market value of the loaned securities.
41
ROYCE FOCUS TRUST, INC.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
CAPITAL STOCK:
The Fund currently has 800,000 shares of 7.45% Cumulative Preferred Stock
outstanding. The stock has a liquidation preference of $25.00 per share.
Under the Investment Company Act of 1940, the Fund is required to
maintain an asset coverage of at least 200% for the Preferred Stock. In
addition, pursuant to the Rating Agency Guidelines established by Moody's,
the Fund is required to maintain a certain discounted asset coverage. The
Fund has met these requirements since issuing the Preferred Stock.
The Fund is required to allocate long-term capital gain distributions and
other types of income proportionately to distributions made to holders of
shares of Common Stock and Preferred Stock. To the extent that distributions
are not paid from long-term capital gains, net investment income or net
short-term capital gains, they will represent a return of capital.
The Fund issued 79,701 shares of Common Stock as reinvestment of
distributions by Common Stockholders for the year ended December 31, 2002.
INVESTMENT ADVISORY AGREEMENT:
The Investment Advisory Agreement between Royce and the Fund provides for
fees to be paid at an annual rate of 1.0% of the Fund's average daily net
assets applicable to Common Stockholders plus the liquidation value of
Preferred Stock. Royce has voluntarily committed to waive the portion of its
investment advisory fee attributable to the Fund's Preferred Stock for any
month in which the Fund's average annual NAV total return since issuance of
the Preferred Stock fails to exceed the Preferred Stock's dividend rate. For
the six months ended June 30, 2003, the Fund accrued and paid Royce advisory
fees totaling $292,900, which is net of $99,177 voluntarily waived by Royce.
PURCHASES AND SALES OF INVESTMENT SECURITIES:
For the six months ended June 30, 2003, the cost of purchases and
proceeds from sales of investment securities, other than short-term
securities, amounted to $23,629,502 and $23,175,577, respectively.
PREFERRED STOCK PRESENTATION:
To reflect recent accounting guidance from the Securities and Exchange
Commission, the Statement of Assets and Liabilities has been modified to
present the liquidation value of Preferred Stock below Liabilities and above
Net Assets Applicable to Common Stockholders. As revised, Preferred Stock is
no longer included as a component of net assets of the Fund. Likewise, the
Statement of Operations, the Statement of Changes in Net Assets, and the
Financial Highlights have been revised to show distributions to Preferred
Stockholders as a component of the net increase/decrease in net assets
applicable to Common Stockholders resulting from investment operations. These
modifications do not change the amount of net assets applicable to Common
Stockholders, the net asset value per share of Common Stock, or the total
return per share of Common Stock.
42
PART C
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
1. a. The following audited financial statements of Royce Focus
Trust, Inc. (the "Fund") are included in Part B hereof:
Schedule of Investments, December 31, 2002; Statement of
Assets and Liabilities, December 31, 2002; Statement of
Operations for the fiscal year ended December 31, 2002;
Statement of Changes in Net Assets for the years ended
December 31, 2002 and 2001; Notes to Financial Statements at
December 31, 2002; Financial Highlights for the five fiscal
years ended December 31, 2002; and Report of Independent
Accountants.
b. The following unaudited financial statements of the Fund are
included in Part B hereof:
Schedule of Investments, June 30, 2003; Statement of Assets
and Liabilities, June 30, 2003; Statement of Operations for
the six months ended June 30, 2003; Statement of Changes in
Net Assets for the six months ended June 30, 2003 and for
the year ended December 31, 2002; Notes to Financial
Statements at June 30, 2003; Financial Highlights for the
six months ended June 30, 2003 and for the five fiscal years
ended December 31, 2002.
2. Exhibits
(a)(1) Articles of Amendment and Restatement to the Articles of
Incorporation dated October 30, 1996. (1)
(2) Articles of Correction dated November 5, 1996. (1)
(3) Articles of Amendment dated April 28, 1999.*
(4) Form of Articles Supplementary creating the 7.45% Cumulative
Preferred Stock ("7.45% Preferred"). (2)
(5) Form of Articles Supplementary dated January 31, 2003. (3)
(6) Form of Articles Supplementary creating the ___% Cumulative
Preferred Stock (the "Cumulative Preferred Stock").*
(b) Amended and Restated By-laws. (3)
(c) Not applicable.
(d)(1) Form of share certificate for Common Stock. (1)
(2) Form of share certificate for 7.45% Preferred. (4)
(3) Not applicable.
(e) Amended and Restated Distribution Reinvestment and Cash
Purchase Plan. (4)
(f) Not applicable.
(g) Investment Advisory Agreement dated October 1, 2001 between
the Fund and Royce & Associates ("R & A"). (5)
(h) Form of Underwriting Agreement.*
(i) Not applicable.
(j)(1) Custodian Contract with State Street Bank and Trust Company
("State Street"). (4)
(2) Amendment to Custodian Contract dated September 14, 2000.*
(3) Amendment to Custodian Contract dated April 16, 2003.*
(k)(1) Registrar, Transfer Agency and Service Agreement with State
Street (Common Stock).(4)
(2) Registrar, Transfer Agency and Paying Agreement with State
Street (7.45% Preferred). (2)
(3) Form of Amendment to Registrar, Transfer Agency and Paying
Agency Agreement (Cumulative Preferred Stock)*
(l) Opinion and Consent of Venable LLP.*
(m) Not applicable.
(n) Consent of Tait, Weller & Baker, independent auditors for the
Fund.*
(o) Not applicable.
(p) Not applicable.
(q) Not applicable.
(r) Code of Ethics.*
-------
(1) Incorporated by reference to Amendment No. 8 to the Fund's Registration
Statement on Form N-2, filed with the SEC on November 21, 1996 (File No.
811-5397).
(2) Incorporated by reference to Pre-Effective Amendment No. 1 to the Fund's
Registration Statement on Form N-2, filed with the SEC on November 14,
1997 (File No. 333-34325).
(3) Incorporated by reference to the Fund's Report on Form NSAR-B, filed with
the SEC on February 27, 2003.
(4) Incorporated by reference to the Fund's Registration Statement on
Form N-2, filed with the SEC on August 25, 1997 (File No. 333-34325).
(5) Incorporated by reference to the Fund's Report on Form NSAR-B, filed with
the SEC on February 28, 2002.
* Filed herewith.
ITEM 25. MARKETING ARRANGEMENTS
Please see Exhibit (h) to this Registration Statement.
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the estimated expenses to be incurred in
connection with the offering described in this Registration Statement:
Estimated
Category Expenses
--------------------------------------------------------- ------------------
Registration fees..................................... $ 2,023
New York Stock Exchange listing fees.................. 20,000
Printing expenses .................................... 13,800
Rating agency fees.................................... 10,000
Accounting fees and expenses.......................... 7,500
Legal fees and expenses............................... 140,000
Miscellaneous......................................... 3,202
------------------
Total................................................. $196,525
==================
ITEM 27. PERSON CONTROLLED BY OR UNDER COMMON CONTROL WITH FUND
None.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES
The following information is given as of September 22, 2003:
Title of Class Number of Record Holders
--------------------------------------------------------------------------------------------------
Common Stock, $.001 par value............................................... 1072
7.45% Cumulative Preferred Stock, $.001 par value........................... 12
ITEM 29. INDEMNIFICATION
Reference is made to Section 2-418 of the Maryland General Corporation
Law, Article VI and VII of the Fund's Articles of Incorporation, as amended,
Article V of the Fund's Amended and Restated By-laws, and the Investment
Advisory Agreement, each of which provide for indemnification.
The Investment Advisory Agreement between the Fund and R & A obligates
the Fund to indemnify R & A and hold it harmless from and against all damages,
liabilities, costs and expenses (including reasonable attorneys' fees) incurred
by R & A in or by reason of any action, suit, investigation or other proceeding
arising out of or otherwise based upon any action actually or allegedly taken or
omitted to be taken by R & A in connection with the performance of any of its
duties or obligations under the Agreement or otherwise as an investment adviser
of the Fund. R & A is not entitled to indemnification in respect of any
liability to the Fund or its security holders to which it would otherwise be
subject by reason of its willful misfeasance, bad faith or gross negligence.
Under the Underwriting Agreement relating to the Cumulative Preferred
Stock offered hereby, the Registrant agrees to indemnify the Underwriters and
each person, if any, who controls the Underwriters within the meaning of the
Securities Act of 1933, as amended (the "1933 Act"), against certain types of
civil liabilities arising in connection the Registration Statement or Prospectus
and Statement of Additional Information.
Insofar as indemnification for liability arising under the 1933 Act,
may be permitted to directors, officers and controlling persons of the Fund
pursuant to the foregoing provisions or otherwise, the Fund has been advised
that, in the opinion of the SEC, such indemnification is against public policy
as expressed in the 1933 Act and is, therefore, unenforceable. In the event that
a claim for indemnification against such liabilities (other than the payment by
the Fund of expenses incurred or paid by a director, officer or controlling
person of the Fund in the successful defense of any action, suit or proceeding)
is asserted by such director, officer or controlling person in connection with
the securities being registered, the Fund will, unless in the opinion of its
counsel the matter has been settled by controlling precedent or such claim is to
be paid under insurance policies, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
The Fund, its officers and directors, R & A and certain others are
presently insured under a Directors and Officers/Errors and Omissions Liability
Insurance Policy issued by ICI Mutual Insurance Company, which generally covers
claims by the Fund's stockholders and third persons based on or alleging
negligent acts, misstatements or omissions by the insureds and the costs and
expenses of defending those claims, up to a limit of $15,000,000, with a
deductible amount of $250,000.
ITEM 30. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Reference is made to Schedules D and F to Royce's amended Form ADV
(File No. 801-8268), which are incorporated herein by reference.
ITEM 31. LOCATION OF ACCOUNTS AND RECORDS
Records are located at:
1. Royce Focus Trust, Inc.
10th Floor
1414 Avenue of the Americas
New York, New York 10019
(Corporate records and records relating to the function of Royce as investment
adviser)
2. State Street Bank and Trust Company Two Heritage Drive North
Quincy, Massachusetts 02171 Attention: Royce Focus Trust, Inc.
(Records relating to its functions as Custodian for the Fund)
3. Equiserve Trust Company, N.A. PO Box 43011 Providence, RI
02940-3011 Attention: Royce Focus Trust, Inc.
(Records relating to its functions as Registrar and Transfer Agent and Dividend
Paying Agent for the Fund)
ITEM 32. MANAGEMENT SERVICES
Not applicable.
ITEM 33. UNDERTAKINGS
(1) Not applicable.
(2) Not applicable.
(3) Not applicable.
(4) Not applicable.
(5) The Fund undertakes that, for the purpose of determining any liability under
the Securities Act, the information omitted from the form of prospectus filed as
part of the Registration Statement in reliance upon Rule 430A and contained in
the form of prospectus filed by the Fund pursuant to Rule 497(h) will be deemed
to be a part of the Registration Statement as of the time it was declared
effective. The Fund undertakes that, for the purpose of determining any
liability under the Securities Act, each post-effective amendment that contains
a form of prospectus will be deemed to be a new Registration Statement relating
to the securities offered therein, and the offering of such securities at that
time will be deemed to be the initial bona fide offering thereof.
(6) The Fund undertakes to send by first class mail or other means designed to
ensure equally prompt delivery, within two business days of receipt of a written
or oral request, any Statement of Additional Information.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of New York, and State of New York, on the 9th day of
October, 2003.
ROYCE FOCUS TRUST, INC.
(Registrant)
By: /s/ Charles M. Royce
--------------------
Charles M. Royce, President
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
/s/ Charles M. Royce* President (Principal Executive Officer)
----------------------------------------- and Director
Charles M. Royce
/s/ John D. Diederich* Vice President and Treasurer (Principal
----------------------------------------- Financial and Accounting Officer)
John D. Diederich
Donald R. Dwight* Director
-----------------------------------------
Donald R. Dwight
Mark R. Fetting* Director
-----------------------------------------
Mark R. Fetting
Richard M. Galkin* Director
-----------------------------------------
Richard M. Galkin
Stephen L. Isaacs* Director
-----------------------------------------
Stephen L. Isaacs
William L. Koke* Director
-----------------------------------------
William L. Koke
David L. Meister* Director
-----------------------------------------
David L. Meister
G. Peter O'Brien* Director
-----------------------------------------
G. Peter O'Brien
*By: /s/ Charles M. Royce October 9, 2003
-----------------------------------------
Charles M. Royce
Attorney-in-Fact
EXHIBIT INDEX
Exhibit Number Document
-------------- --------
(a)(3) Articles of Amendment dated April 28, 1999.
Form of Articles Supplementary creating the ___%
Cumulative Preferred Stock (the "Cumulative
(a)(6) Preferred Stock").
(h) Form of Underwriting Agreement.
(j)(2) Amendment to Custodian Contract dated September 14, 2000.
(j)(3) Amendment to Custodian Contract dated April 16, 2003.
Form of Amendment to Registrar, Transfer Agency and Paying
Agency Agreement
(k)(3) (Cumulative Preferred Stock)
(l) Opinion and Consent of Venable LLP.
(n) Consent of Tait, Weller & Baker, independent auditors
for the Fund.
(r) Code of Ethics.