PROSPECTUS
2,400,000 SHARES
ROYCE MICRO-CAP TRUST, INC.
6.00% CUMULATIVE PREFERRED STOCK
LIQUIDATION PREFERENCE $25.00 PER SHARE
-----------------
The 6.00% Cumulative Preferred Stock, initial liquidation preference
$25.00 per share (the "Cumulative Preferred Stock") is being offered by Royce
Micro-Cap 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 80% of its assets in the equity
securities of micro-cap companies. 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 6.00% 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.
-----------------
Per Share Total
--------- -----
Public Offering Price (1) $ 25.00 $60,000,000
Underwriting Discount (2) $ .7875 $ 1,890,000
Proceeds to the Fund (before expenses) (3) $24.2125 $58,110,000
-------------------
(1) Plus accumulated dividends, if any, from October 16, 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 $207,350.
-----------------
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 16, 2003, which is
the fifth business day following the date of this Prospectus, against payment
therefore in immediately available funds.
-----------------
Joint Book-Running Managers
CITIGROUP UBS INVESTMENT BANK
-----------------
MERRILL LYNCH & CO. WACHOVIA SECURITIES
-----------------
LEGG MASON WOOD WALKER
Incorporated
October 9, 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 100%, 83% and 84% 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 16, 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 16,
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 9, 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
----
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....................................................28
INVESTMENT ADVISORY AND OTHER SERVICES.......................................29
DESCRIPTION OF CUMULATIVE PREFERRED STOCK....................................33
DESCRIPTION OF CAPITAL STOCK.................................................41
TAXATION.....................................................................42
CUSTODIAN, DIVIDEND-PAYING AGENT, TRANSFER AGENT AND REGISTRAR...............44
UNDERWRITING.................................................................44
LEGAL MATTERS................................................................46
EXPERTS......................................................................47
ADDITIONAL INFORMATION.......................................................47
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS............................47
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION.....................48
GLOSSARY.....................................................................49
3
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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 Micro-Cap Trust, Inc. (the "Fund") has been
engaged in business as a closed-end diversified
management investment company since its initial
offering in December 1993. The Fund's investment goal
is long-term capital growth. Royce & Associates, LLC
("Royce"), the Fund's investment adviser, normally
invests at least 80% of the Fund's assets in the equity
securities of companies that, at time of investment,
have stock market capitalizations of $400 million or
less ("micro-cap companies"). Up to 20% of the Fund's
assets may be invested in non-micro-cap company equity
securities and/or non-convertible debt securities. See
"Investment Goal, Policies and Risks".
THE OFFERING............ The Fund is offering 2,400,000 shares of 6.00%
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
7.75% Cumulative Preferred Stock, par value $.001 per
share, of the Fund (the "7.75% Preferred"). In order
for the Fund to redeem the 7.75% Preferred, the Fund
must pay the 7.75% Preferred's aggregate initial
liquidation preference of $40,000,000, plus an amount
equal to accumulated and unpaid dividends (whether or
not earned or declared) on the 7.75% Preferred through
the redemption date. Royce expects to use any proceeds
remaining after the redemption of the 7.75% Preferred
to purchase additional portfolio securities in
accordance with the Fund's investment goal and
policies. See "Use of Proceeds".
DIVIDENDS............... Dividends on the Cumulative Preferred Stock, at the
annual rate of 6.00% of the initial liquidation
preferenceof $25.00 per share, are cumulative from the
Date of
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4
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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 Prospectus as "Other Ordinary Income". The
Fund is required to allocate long-term capital gains,
qualified dividend income and/or Other Ordinary Income
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5
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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 100%,
83% and 84% long-term capital gains and qualified
dividend income and approximately 0%, 17% and 16% 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 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
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6
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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 7.75% Preferred as of June 30, 2003, the
Asset Coverage would have been 424%. 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 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
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7
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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".
OPTIONAL REDEMPTION..... Commencing October 16, 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
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8
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Redemption Price. Prior to October 16, 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
illiquid during such period. No assurance can be
provided that listing on any securities exchange or
market
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9
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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 micro-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 Micro-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 Preferred Stock is subject to redemption
under specified circumstances. To the extent that the
Fund experiences a
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10
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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.
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 7.75% 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
"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
addition, borrowed funds are subject to interest costs
that may 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
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11
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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.
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
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12
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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 its inception. 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, Royce's President and Chief
Investment Officer, is primarily responsible for
managing the Fund's portfolio. He is assisted by
Royce's investment staff, including W. Whitney George,
Senior Portfolio Manager, Managing Director and Vice
President, Boniface A. Zaino, Senior Portfolio Manager
and Managing Director, and Charles R. Dreifus, Senior
Portfolio Manager and Principal, and 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.
As compensation for its services under the Investment
Advisory Agreement, Royce receives a fee at a rate
ranging from .5% up to 1.5% per annum of the Fund's
average net assets (including assets obtained from the
sale of Preferred Stock) for the applicable performance
period, depending upon the investment performance of
the Fund relative to the investment record of the
Russell 2000 Index (the "Russell 2000"), over rolling
periods of 36 months. For a more detailed description
of the method by which the advisory fee is determined,
see "Investment Advisory and Other Services -- Advisory
Fee".
Royce has volunteered to waive the portion of its
investment advisory fee attributable to the liquidation
preference of the 7.75% Preferred and the Cumulative
Preferred Stock (net of the liquidation preference of
the 7.75% Preferred) for any month when the Fund's net
asset value average annual total return since the
initial issuance of the 7.75% Preferred or the
Cumulative
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13
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Preferred Stock fails to exceed the blended dividend
rate on those assets.
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
June 30, Years ended December 31,
2003 -----------------------------------------------------------------------------------
(unaudited) 2002 2001 2000 1999 1998 1997 1996 1995
----------- ------- ------- ------- ------- ------- ------- ------- -------
NET ASSET VALUE, BEGINNING
OF PERIOD.................. $9.39 $11.83 $10.14 $11.00 $10.06 $10.84 $9.38 $8.89 $7.58
INVESTMENT OPERATIONS:
Net investment income
(loss).................. (0.06) (0.13) (0.05) 0.09 0.12 0.13 0.17 0.09 0.02
Net realized and
unrealized gain (loss)
on investments.......... 1.87 (1.29) 2.57 1.23 1.35 (0.36) 2.61 1.32 1.69
----------------------------------------------------------------------------------------------
Total investment
operations.............. 1.81 (1.42) 2.52 1.32 1.47 (0.23) 2.78 1.41 1.71
----------------------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED
STOCKHOLDERS:
Net investment income... - - - (0.01) (0.05) (0.06) (0.02) - -
Net realized gain on
investments............. - (0.18) (0.19) (0.22) (0.18) (0.18) (0.12) - -
Quarterly distributions** (0.09) - - - - - - - -
----------------------------------------------------------------------------------------------
Total distributions to
Preferred
Stockholders........... (0.09) (0.18) (0.19) (0.23) (0.23) (0.24) (0.14) - -
----------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN
NET ASSETS APPLICABLE TO
COMMON STOCKHOLDERS
RESULTING FROM INVESTMENT
OPERATIONS 1.72 (1.60) 2.33 1.09 1.24 (0.47) 2.64 1.41 1.71
----------------------------------------------------------------------------------------------
DISTRIBUTIONS TO COMMON
STOCKHOLDERS:
Net investment income... - - - (0.09) (0.06) (0.07) (0.16) (0.10) (0.02)
Net realized gain on
investments............. - (0.80) (0.57) (1.63) (0.21) (0.22) (0.84) (0.70) (0.34)
Quarterly distributions** (0.47) - - - - - - - -
----------------------------------------------------------------------------------------------
Total distributions to
Common
Stockholders........... (0.47) (0.80) (0.57) (1.72) (0.27) (0.29) (1.00) (0.80) (0.36)
----------------------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Effect of reinvestment
of distributions
by Common Stockholders.. (0.03) (0.04) (0.07) (0.23) (0.03) (0.02) (0.06) (0.12) (0.04)
Effect of Common Stock
Rights Offering or
Preferred Stock Offering - - - - - - (0.12) - -
----------------------------------------------------------------------------------------------
Total capital stock
transactions........... (0.03) (0.04) (0.07) (0.23) (0.03) (0.02) (0.18) (0.12) (0.04)
==============================================================================================
NET ASSET VALUE, END OF PERIOD $10.61 $9.39 $11.83 $10.14 $11.00 $10.06 $10.84 $9.38 $8.89
==============================================================================================
MARKET VALUE, END OF PERIOD $9.77 $8.44 $10.50 $8.625 $ 9.00 $8.875 $10.125 $8.25 $8.00
==============================================================================================
TOTAL RETURN(a):
Market Value............... 22.2%**** (12.7)% 28.8% 15.3% 4.5% (9.4)% 35.0% 13.9% 19.8%
Net Asset Value............ 19.3%**** (13.8)% 23.4% 10.9% 12.7% (4.1)% 27.1% 16.6% 22.9%
RATIOS BASED ON AVERAGE
NET ASSETS APPLICABLE TO
COMMON STOCKHOLDERS:
Total expenses (b, c)...... 1.98%*** 1.96% 1.78% 1.32% 1.27% 1.18% 0.83% 0.85% 1.36%
Management fee expense.. 1.72%*** 1.59% 1.57% 1.08% 0.91% 0.80% 0.40% 0.47% 0.77%
Other operating expenses 0.26%*** 0.37% 0.21% 0.24% 0.36% 0.38% 0.43% 0.38% 0.59%
Net investment income (loss) (1.42)%*** (1.23)% (0.43)% 0.74% 1.20% 1.21% 1.77% 0.88% 0.26%
SUPPLEMENTAL DATA:
Net Assets Applicable to
Common Stockholders; End of
Period (in thousands).... $196,724 $167,571 $200,443 $163,820 $151,269 $135,495 $142,362 $113,952 $100,065
Liquidation Value of
Preferred Stock; End of
Period (in thousands)...... $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 - -
Portfolio Turnover Rate.... 11% 39% 27% 49% 49% 44% 34% 51% 51%
Average Commission Rate
Paid (d)................... $0.0415 $0.0418 $0.0451 $0.0503 $0.0547 $0.0554 $0.0549 $0.0485
PREFERRED STOCK:
Total shares outstanding... 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 - -
Asset coverage per share... $147.95 $129.73 $150.28 $127.39 $119.54 $109.68 $113.98 - -
Liquidation preference per
share...................... $25.00 $25.00 $25.00 $25.00 $25.00 $25.00 $25.00 - -
Average market value per
share (e):................. $25.90 $25.91 $25.30 $23.08 $24.67 $25.40 $25.56 - -
Year Ended Period from
December 31, Dec. 14, 1993*
----------- to Dec. 31,
1994 1993
----------- --------------
NET ASSET VALUE, BEGINNING
OF PERIOD.................. $7.27 $7.25
INVESTMENT OPERATIONS:
Net investment income
(loss).................. 0.01 -
Net realized and
unrealized gain (loss)
on investments.......... 0.41 0.02
---------------------------
Total investment
operations.............. 0.42 0.02
---------------------------
DISTRIBUTIONS TO PREFERRED
STOCKHOLDERS:
Net investment income... - -
Net realized gain on
investments............. - -
Quarterly distributions** - -
---------------------------
Total distributions to
Preferred
Stockholders........... - -
---------------------------
NET INCREASE (DECREASE) IN
NET ASSETS APPLICABLE TO
COMMON STOCKHOLDERS
RESULTING FROM INVESTMENT
OPERATIONS 0.42 0.02
---------------------------
DISTRIBUTIONS TO COMMON
STOCKHOLDERS:
Net investment income... (0.02) -
Net realized gain on
investments............. (0.03) -
Quarterly distributions** - -
---------------------------
Total distributions to
Common
Stockholders........... (0.05) -
---------------------------
CAPITAL STOCK TRANSACTIONS:
Effect of reinvestment
of distributions
by Common Stockholders.. - -
Effect of Common Stock
Rights Offering or
Preferred Stock Offering (0.06) -
---------------------------
Total capital stock
transactions........... (0.06) -
===========================
NET ASSET VALUE, END OF PERIOD $7.58 $7.27
===========================
MARKET VALUE, END OF PERIOD $7.00 $7.50
===========================
TOTAL RETURN(a):
Market Value............... (5.1)% 0.0%
Net Asset Value............ 6.0% 0.3%
RATIOS BASED ON AVERAGE
NET ASSETS APPLICABLE TO
COMMON STOCKHOLDERS:
Total expenses (b, c)...... 1.88% 1.92%***
Management fee expense.. 1.20% 0.00%
Other operating expenses 0.68% 1.92%***
Net investment income (loss) 0.21% (0.06)%***
SUPPLEMENTAL DATA:
Net Assets Applicable to
Common Stockholders; End of
Period (in thousands).... $82,534 $71,126
Liquidation Value of
Preferred Stock; End of
Period (in thousands)...... - -
Portfolio Turnover Rate.... 23% 0%
Average Commission Rate
Paid (d)...................
PREFERRED STOCK:
Total shares outstanding... - -
Asset coverage per share... - -
Liquidation preference per
share...................... - -
Average market value per
share (e):................. - -
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. Net Asset Value and Market Value Total
Return, assuming a continuous stockholder who fully participated in the
1994 Common Stock Rights offering, was 6.1% and (5.5)% for the year ended
December 31, 1994. This return includes the positive impact to a
stockholder from participation in the primary subscription of this rights
offering resulting from the purchase of shares in such offering at a
discount to the market price and net asset value of the Fund.
(b) Expense ratios based on total average net assets including liquidation
value of Preferred Stock were 1.60%, 1.62%, 1.46%, 1.06%, 0.98%, 0.92%,
0.72%, 0.85%, 1.36%, 1.88%, and 1.92%*** for the six months ended June 30,
2003 and the periods 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 Royce would have been 2.21%, 2.04%,
1.81%, 1.44%, 1.24% and 2.12% for the six months ended June 30, 2003 and
the periods ended December 31, 2002, 2001, 1999, 1998 and 1993,
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.
* Commencement of operations.
** 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 100%, 83% and 84% long-term capital gains and qualified dividend
income and approximately 0%, 17% and 16% 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 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 ANNUAL A CUMULATIVE PREFERRED STOCK
DIVIDEND COMPOSED OF ANNUAL DIVIDEND RATE OF
------------------------------------------------------ ------------------------------------------------------
6.00%
LONG-TERM CAPITAL GAINS AND OTHER ORDINARY
QUALIFIED DIVIDEND INCOME** INCOME IS EQUIVALENT TO AN OTHER ORDINARY INCOME YIELD OF
---------------------------- ------------------------- ------------------------------------------------------
90% 10% 7.66%
75% 25% 7.38%
50% 50% 6.92%
Assuming that long-term capital gains and qualified dividend income
comprise 90% of the 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 dividend rate for taxpayers in the indicated tax
brackets.
A CUMULATIVE PREFERRED STOCK
ANNUAL DIVIDEND RATE OF
--------------------------------------------------------
6.00%
2003 FEDERAL MARGINAL INCOME TAX BRACKET* IS EQUIVALENT TO AN OTHER ORDINARY INCOME YIELD OF
----------------------------------------------------------- --------------------------------------------------------
35.0%................................................... 7.66%
33.0%................................................... 7.45%
28.0%................................................... 6.98%
25.0%**................................................. 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 "Royce OTC Micro-Cap Fund, Inc." under the laws
of the State of Maryland on September 9, 1993 and is registered under the 1940
Act. The Fund commenced operations on December 14, 1993. Assuming the Fund had
issued and sold the Cumulative Preferred Stock and redeemed the 7.75% Preferred
as of June 30, 2003, the Fund would have had 18,540,334 shares of Common Stock
issued and outstanding, with an aggregate net asset value of $194,626,668, and
2,400,000 shares of Cumulative Preferred Stock issued and outstanding, with an
aggregate initial liquidation preference of $60,000,000. 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.
The Fund's investment goal is long-term capital growth. Royce normally
invests at least 80% of the Fund's assets in the equity securities of micro-cap
companies. Up to 20% of the Fund's assets may be invested in non-micro-cap
company equity securities and/or non-convertible debt 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 $57,902,650, 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 7.75% Preferred. In order for the Fund to redeem the 7.75%
Preferred, the Fund must pay the 7.75% Preferred's aggregate initial liquidation
preference of $40,000,000, plus an amount equal to accumulated and unpaid
dividends (whether or not earned or declared) on the 7.75% Preferred through the
redemption date. Royce expects to invest any proceeds remaining after the
redemption of the 7.75% 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 7.75% Preferred.
OUTSTANDING AS ADJUSTED
---------------- ----------------
Preferred stock, $.001 par value per share:
7.75% Cumulative Preferred Stock, authorized 5,000,000 shares,
issued and outstanding 1,600,000 shares.................... $ 40,000,000 $ -
6.00% Cumulative Preferred Stock, as adjusted, authorized
2,400,000 shares, issued and outstanding 2,400,000 shares.. - 60,000,000
--------------- ---------------
$ 40,000,000 $ 60,000,000
============== ===============
Common stock, $.001 par value per share:
Initially authorized 150,000,000 shares, issued $ $
and outstanding 18,540,334 shares.......................... 18,540 18,540
Additional paid-in capital...................................... 142,059,397 139,962,047(1)
Accumulated net investment loss................................. (1,199,081) (1,199,081)
Accumulated net realized gain on investments.................... 16,392,806 16,392,806
Net unrealized appreciation on investments...................... 49,544,805 49,544,805
Quarterly and accrued distributions............................. (10,092,449) (10,092,449)
--------------- ---------------
Net assets applicable to outstanding common stock............... $ 196,724,018 $ 194,626,668
============== ===============
-------------
(1) After deducting underwriting discounts and estimated costs of this
offering of $2,097,350.
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................................................................... $ 220,210,760 92.8%
Preferred stocks................................................................ 1,041,641 0.5%
U.S. Treasury obligations....................................................... 5,049,220 2.1%
Repurchase agreement............................................................ 10,850,000 4.6%
-------------- --------------
Total investments........................................................ $ 237,151,621 100.0%
============== ==============
SECTOR WEIGHTINGS IN COMMON STOCK PORTFOLIO
Technology...................................................................... $ 56,906,196 24.0%
Industrial Products............................................................. 32,402,329 13.7%
Industrial Services............................................................. 28,830,143 12.2%
Health.......................................................................... 26,422,351 11.1%
Consumer Products............................................................... 21,335,171 9.0%
Natural Resources............................................................... 20,364,698 8.6%
Financial Intermediaries........................................................ 11,980,689 5.0%
Consumer Services............................................................... 10,571,896 4.5%
Miscellaneous................................................................... 6,896,550 2.9%
Financial Services.............................................................. 3,900,137 1.6%
Diversified Investment Companies................................................ 600,600 0.2%
-------------- --------------
Total common stocks...................................................... $220,210,760 92.8%
============== ==============
OTHER INFORMATION REGARDING COMMON STOCK INVESTMENTS
Number of issuers............................................................... 383
Median market capitalization.................................................... $230 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 80% of the Fund's
assets in the equity securities of companies with stock market capitalizations
of $400 million or less. For purposes of calculating this 80% minimum,
securities purchased before a company's market capitalization increases to above
$400 million will continue to be classified as securities of a micro-cap
company. Up to 20% of the Fund's assets may be invested in non-micro-cap company
equity securities and/or non-convertible debt securities. 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. See
"--Changes in Investment Goal and Policies" below. 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 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 micro-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 micro-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 micro-cap market declines, it may also potentially have the effect of
limiting gains in strong micro-cap up markets.
The Fund invests primarily in securities of micro-cap companies based
on Royce's belief that, because the securities of such companies may have fewer
market makers, wider spreads between their quoted bid and asked prices and lower
trading volumes, resulting in comparatively greater price volatility and less
liquidity, and may not be followed by many securities analysts or be well-known
to the investing public, they may also be available for purchase at substantial
discounts from Royce's estimate of such companies' current worth. Royce attempts
to identify and to have the Fund invest in such securities, with the expectation
that such value "discounts" will narrow over time and thus provide capital
appreciation for the Fund's portfolio.
Under normal market conditions, at least 80% of the Fund's net assets
(including assets acquired from the sale of Preferred Stock), plus the amount of
any borrowings for investment purposes, will be invested in the common stock,
convertible securities and warrants of micro-cap companies. This is a
non-fundamental policy and may be changed by the Board of Directors of the Fund
provided that stockholders are provided with at least 60 days' prior notice of
any change as required by the rules under the 1940 Act.
Foreign Investments. The Fund may invest up to 10% 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, the possibility of imposition of exchange controls,
nationalization or expropriation of assets, and more difficulty obtaining
information on the foreign companies. These securities may also be subject to
greater fluctuations in price than the securities of U.S. corporations.
23
Fixed Income Securities. Up to 20% of the Fund's assets may be invested
in non-convertible debt securities of various domestic 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 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.
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 and
high-quality commercial paper, 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.
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.
24
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.
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, except with respect
to the investment of 80% of its net assets in micro-cap companies, 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 MICRO-CAP COMPANIES
Royce defines micro-cap as those companies with market capitalizations
of $400 million or less.
The securities of micro-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
micro-cap security may affect its market price. Royce may need a considerable
amount of time to purchase or sell its positions
25
in these securities, particularly when other accounts managed by Royce or other
investors are also seeking to purchase or sell them. Accordingly, Royce's
investment focus on micro-cap companies generally requires it to have a
long-term (at least three years) investment outlook for a portfolio security.
There are more than 5,900 micro-cap companies. These companies are
followed by relatively few, if any, securities analysts, and there tends to be
less publicly available information about them. Their securities generally have
even more limited trading volumes and are subject to more abrupt or erratic
market price movements than are the securities of larger-cap companies, and
Royce may be able to deal with only a few market-makers when purchasing and
selling these securities. Such companies may also have limited markets,
financial resources or product lines, may lack management depth and may be more
vulnerable to adverse business or market developments. These conditions, which
create greater opportunities to find securities trading well below Royce's
estimate of the company's current worth, also involve increased risk. This leads
Royce to broadly diversify the Fund's assets invested in micro-cap stocks.
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 - 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
26
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.
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.
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
27
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 7.75% Preferred as of June 30, 2003, the Fund would have had
18,540,334 shares of Common Stock issued and outstanding, with an aggregate net
asset value of $194,626,668, and 2,400,000 shares of Cumulative Preferred Stock,
par value $.001 per share, with an aggregate initial liquidation preference of
$60,000,000, issued and outstanding, and no outstanding indebtedness.
Accordingly, assuming the Fund had issued and sold the Cumulative Preferred
Stock and redeemed the 7.75% 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 $127 million or
additional shares of Preferred Stock having an aggregate involuntary liquidation
preference of up to approximately $135 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
28
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 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 December
1993, when the Fund commenced operations. 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.
29
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.
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 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. He is also the primary portfolio manager of the Fund.
Royce's investment staff also includes three other Senior Portfolio
Managers: W. Whitney George, Managing Director and Vice President; 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,
30
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 receives a fee comprised of a Basic Fee ("Basic Fee") and an
adjustment to the Basic Fee based on the investment performance of the Fund in
relation to the investment record of the Russell 2000.
The Basic Fee is a monthly fee equal to 1/12 of 1% (1% on an annualized
basis) of the average of the month-end net assets of the Fund (including assets
obtained from the sale of Preferred Stock) for the rolling 36-month period
ending with such month. The Basic Fee for each month is increased or decreased
at the rate of 1/12 of .05% for each percentage point that the investment
performance of the Fund exceeds, or is exceeded by, the percentage change in the
investment record of the Russell 2000 for the performance period by more than
two percentage points. The performance period for each such month is a rolling
36-month period ending with such month. The maximum increase or decrease in the
Basic Fee for any month may not exceed 1/12 of .5%. Accordingly, for each month,
the maximum monthly fee rate as adjusted for performance is 1/12 of 1.5% and is
payable if the investment performance of the Fund exceeds the percentage change
in the investment record of the Russell 2000 by 12 or more percentage points for
the performance period, and the minimum monthly fee rate as adjusted for
performance is 1/12 of .5% and is payable if the percentage change in the
investment record of the Russell 2000 exceeds the investment performance of the
Fund by 12 or more percentage points for the performance period. As a result,
the actual investment advisory fee rate may at times be greater than the rate
paid by many other funds.
Because the Basic Fee is computed based on the Fund's net assets and
not of 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. See "Investment Advisory and Other Services" in the
Statement of Additional Information.
31
The following table illustrates, on an annualized basis, the full range
of permitted increases or decreases to the Basic Fee.
DIFFERENCE BETWEEN PERFORMANCE
OF FUND AND % CHANGE IN ADJUSTMENT TO 1%
RUSSELL 2000 BASIC FEE FEES AS ADJUSTED
------------------------------ ------------------------- -----------------------
+12 or more +0.50% 1.50%
+11 +0.45% 1.45%
+10 +0.40% 1.40%
+9 +0.35% 1.35%
+8 +0.30% 1.30%
+7 +0.25% 1.25%
+6 +0.20% 1.20%
+5 +0.15% 1.15%
+4 +0.10% 1.10%
+3 +0.05% 1.05%
+/-2 0.00% 1.00%
-3 -0.05% 0.95%
-4 -0.10% 0.90%
-5 -0.15% 0.85%
-6 -0.20% 0.80%
-7 -0.25% 0.75%
-8 -0.30% 0.70%
-9 -0.35% 0.65%
-10 -0.40% 0.60%
-11 -0.45% 0.55%
-12 or less -0.50% 0.50%
Royce has volunteered to waive the portion of its investment advisory
fee attributable to the liquidation preference of the 7.75% Preferred and the
Cumulative Preferred Stock (net of the liquidation preference of the 7.75%
Preferred) for any month when the Fund's net asset value average annual total
return since the initial issuance of the 7.75% 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.
32
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 2,400,000 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 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 6.00% 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,
33
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 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 7.75% 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 7.75% Preferred (after giving effect to the deduction
of the underwriting discounts and estimated offering expenses for such shares),
would have been computed as follows:
34
Value of Fund assets less
liabilities not constituting senior securities $254,626,668
------------------------------------------------------------------------ = ---------------- = 424%
Senior securities representing indebtedness plus $ 60,000,000
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.
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 last 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
35
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
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
36
deposited with the Paying Agent, no redemptions of Cumulative Preferred Stock or
any other Preferred Stock may be made.
Optional Redemption. Prior to October 16, 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 16, 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 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.
37
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 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
38
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
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
39
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 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
40
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 150,000,000 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, 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 2,400,000 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 7.75% Preferred, 1,600,000 of which are issued and
outstanding. The Fund will use a substantial portion of the net proceeds from
the issuance and sale of the Cumulative Preferred Stock to redeem the 7.75%
Preferred. The terms of the 7.75% Preferred are substantially similar to the
terms of the Cumulative Preferred Stock.
------------------------
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.
41
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..................................... 145,000,000 0 18,540,334
7.75% Preferred.................................. 5,000,000 0 1,600,000
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 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
42
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 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
43
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 generally will not be entitled to claim a credit or
deduction with respect to such taxes paid by the Fund.
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
9, 2003 (the "Underwriting Agreement"), each Underwriter named below has
severally agreed to purchase, and the Fund has agreed to sell to
44
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................... 600,000
UBS Securities LLC............................. 600,000
Merrill Lynch, Pierce, Fenner & Smith
Incorporated....................... 575,000
Wachovia Capital Markets, LLC.................. 575,000
Legg Mason Wood Walker, Incorporated........... 50,000
===========
Total 2,400,000
===========
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.
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 $.50 per share of
Cumulative Preferred Stock. The sales load or underwriting discount the Fund
will pay of $.7875 per share of Cumulative Preferred Stock is equal to 3.15% of
the initial offering price. The Underwriters may allow, and such dealers may
reallow, a concession not to exceed $.45 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 16, 2003.
It is expected that delivery of the Cumulative Preferred Stock will be
made against payment therefore on or about October 16, 2003, which is the fifth
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 day 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
45
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 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.
46
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. 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
47
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.
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
A Statement of Additional Information dated October 9, 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...................................................................... 7
Principal Stockholders........................................................13
Directors and Officers........................................................14
Code of Ethics and Related Matters............................................20
Investment Advisory and Other Services........................................21
Brokerage Allocation and Other Practices......................................22
Proxy Voting Policies and Procedures..........................................23
Net Asset Value...............................................................24
Book-Entry System.............................................................25
Financial Statements..........................................................25
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 6.00% 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 Micro-Cap 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.
Terms To Maturity of Rating Category Below B
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.
51
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 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
53
Fund has received prior written authorization from Moody's
or (B)(1) with 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.
56
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 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
57
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
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
58
Machinery (Non-Agriculture, Non-Construction, Non-Electronic):
Industrial, Machine Tools, Steam Generators
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.
59
"Paying Agent" means Equiserve Trust Company, N.A. and its successors
or any other paying agent appointed by the Fund.
"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.
"7.75% Preferred" means, so long as any shares of such series are
issued and outstanding, the 7.75% 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
60
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 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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================================================================================
$60,000,000
ROYCE MICRO-CAP TRUST, INC.
2,400,000 SHARES
6.00% CUMULATIVE PREFERRED STOCK
-------------------
PROSPECTUS
OCTOBER 9, 2003
-------------------
CITIGROUP
UBS INVESTMENT BANK
MERRILL LYNCH & CO.
WACHOVIA SECURITIES
LEGG MASON WOOD WALKER
Incorporated
-------------------
================================================================================
STATEMENT OF ADDITIONAL INFORMATION
2,400,000 SHARES
ROYCE MICRO-CAP TRUST, INC.
6.00% CUMULATIVE PREFERRED STOCK
LIQUIDATION PREFERENCE $25.00 PER SHARE
The 6.00% Cumulative Preferred Stock, initial liquidation preference
$25.00 per share (the "Cumulative Preferred Stock"), to be issued by Royce
Micro-Cap 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 7.75%
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 7.75% 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 investment goal is long-term capital growth, which it seeks by normally
investing at least 80% of its assets in the equity securities of micro-cap
companies. 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 9,
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..................................................................... 7
Principal Stockholders...................................................... 13
Directors and Officers...................................................... 14
Code of Ethics and Related Matters.......................................... 20
Investment Advisory and Other Services...................................... 21
Brokerage Allocation and Other Practices.................................... 22
Proxy Voting Policies and Procedures........................................ 23
Net Asset Value............................................................. 24
Book-Entry System........................................................... 25
Financial Statements........................................................ 25
Date: October 9, 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 20% 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 may invest up to 10% of its assets in the securities of
foreign issuers. (For purposes of this restriction, securities issued by a
foreign domiciled company that are registered with the Commission under Section
12(b) or (g) of the Securities Exchange Act are not treated as securities of
foreign issuers.) Foreign investments involve certain risks which typically are
not present in securities of domestic issuers. There may be less information
publicly 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. Markets for foreign securities may
be less liquid and may be subject to greater price volatility than those for
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 may also be subject to local economic
and political risks, political, economic and social instability, military action
or unrest or adverse diplomatic developments, and possible nationalization of
issuers or expropriation of their assets, which might adversely affect the
Fund's ability to realize on its investment in such securities. Royce may not be
able to anticipate
3
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. Foreign markets may also give less protection to investors such as the
Fund.
Although changes in foreign currency rates may adversely affect the
Fund's foreign investments, Royce does not expect to purchase or sell foreign
currencies for the Fund to hedge against declines in the U.S. dollar or to lock
in the value of any foreign securities it purchases for the Fund. Consequently,
the risks associated with such investments may be greater than if the Fund were
to engage in foreign currency transactions for hedging purposes.
Exchange control regulations in such foreign markets may also adversely
affect the Fund's foreign investments, and the Fund's ability to make certain
distributions necessary to maintain its eligibility as a regulated investment
company and avoid the imposition of income and excise taxes may, to that extent,
be limited.
The considerations noted above are generally intensified for
investments in developing countries. Developing countries may have relatively
unstable governments, economies based on only a few industries and securities
markets that trade a small number of securities.
The Fund may purchase the securities of foreign companies in the form
of American Depositary Receipts ("ADRs"). ADRs are certificates held in trust by
a bank or similar financial institution evidencing ownership of securities of a
foreign-based issuer. Designed for use in U.S. securities markets, ADRs are
alternatives to the purchase of the underlying foreign securities in their
national markets and currencies.
Depositories may establish either unsponsored or sponsored ADR
facilities. While ADRs issued under these two types of facilities are in some
respects similar, there are distinctions between them relating to the rights and
obligations of ADR holders and the practices of market participants. A
depository may establish an unsponsored facility without participation by (or
even necessarily the acquiescence of) the issuer of the deposited securities,
although typically the depository requests a letter of non-objection from such
issuer prior to the establishment of the facility. Holders of unsponsored ADRs
generally bear all the costs of such facilities. The depository usually charges
fees upon the deposit and withdrawal of the deposited securities, the conversion
of dividends into U.S. dollars, the disposition of non-cash distributions and
the performance of other services. The depository of an unsponsored facility
frequently is under no obligation to distribute stockholder communications
received from the issuer of the deposited securities or to pass through voting
rights to ADR holders in respect of the deposited securities. Depositories
create sponsored ADR facilities in generally the same manner as unsponsored
facilities, except that the issuer of the deposited securities enters into a
deposit agreement with the depository. The deposit agreement sets out the rights
and responsibilities of the issuer, the depository and the ADR holders. With
sponsored facilities, the issuer of the deposited securities generally will bear
some of the costs relating to the facility (such as deposit and withdrawal
fees). Under the terms of most sponsored arrangements, depositories agree to
distribute notices of stockholder meetings and voting instructions and to
provide stockholder communications and other information to the ADR holders at
the request of the issuer of the deposited securities.
4
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 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 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,
5
investing in warrants, rights and options permits the Fund to incur additional
risk and/or to hedge against risk.
INVESTMENT IN OTHER INVESTMENT COMPANIES
The Fund may invest in other investment companies whose investment
goals and policies are consistent with those of the Fund. 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. If the Fund acquires shares in
investment companies, stockholders would bear both their proportionate share of
expenses in the Fund (including advisory fees) and, indirectly, the expenses of
such investment companies (including management and advisory fees).
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. Purchase securities on margin or write call options on its portfolio
securities.
2. Sell securities short.
3. Borrow money or issue any senior securities, except for (i)
borrowings and/or senior securities representing indebtedness having an
asset coverage of at least 300% immediately after such borrowing and/or
issuance and (ii) preferred stock having an asset coverage of at least
200% immediately after such issuance.
4. Underwrite the securities of other issuers.
5. Invest in restricted securities unless such securities are
redeemable shares issued by money market funds registered under the
1940 Act.
6. Engage in repurchase agreement ("repo") transactions, except for
repo transactions with any bank that is the custodian of the Fund's
assets covering U.S. Treasury and agency obligations and having a term
of not more than one week.
7. Invest in the securities of any one issuer (other than the United
States or an agency or instrumentality of the United States) if, at the
time of acquisition, the Fund would own more than 10% of the voting
securities of such issuer or, as to 75% of the Fund's total assets,
more than 5% of the Fund's assets would be invested in the securities
of such issuer.
8. Invest more than 25% of its total assets in any one industry.
6
9. Purchase or sell real estate or real estate mortgage loans, or
invest in the securities of real estate companies unless such
securities are publicly traded.
10. Purchase or sell commodities or commodity contracts.
11. Make loans, except for purchases of portions of issues of publicly
distributed bonds, debentures and other securities, whether or not such
purchases are made upon the original issuance of such securities, and
except that the Fund may loan up to 25% of its assets to qualified
brokers, dealers or institutions for their use relating to short sales
or other security transactions (provided that such loans are secured by
collateral equal at all times to at least 100% of the value of the
securities loaned).
12. Invest in companies for the purpose of exercising control of
management.
13. Purchase portfolio securities from or sell such securities directly
to any of its officers, directors, employees or investment adviser, as
principal for their own accounts.
14. Invest more than 5% of its total assets in warrants, rights or
options.
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 will not be considered a
violation of the above restrictions.
In addition to issuing and selling senior securities as set forth in
No. 3 above, the Fund may obtain (i) temporary bank borrowings (not in excess of
5% of the value of its total assets) for emergency or extraordinary purposes and
(ii) such short-term credits (not in excess of 5% of the value of its total
assets) as are necessary for the clearance of securities transactions. Under the
terms of the Cumulative Preferred Stock and the 1940 Act, such temporary bank
borrowings would be treated as indebtedness in determining whether or not asset
coverage was at least 300% for senior securities of the Fund representing
indebtedness.
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 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
7
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
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
8
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.
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
9
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 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
10
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.
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
11
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 generally will not be entitled to claim a credit or
deduction with respect to such taxes paid by the Fund.
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.
12
PRINCIPAL STOCKHOLDERS
As of September 22, 2003, there were 18,540,334 shares of Common Stock
and 1,600,000 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:
NAME AND ADDRESS AMOUNT AND NATURE PERCENT OF
OF OWNER CLASS/SERIES OF STOCK OF OWNERSHIP CLASS/SERIES
--------------------------------- ------------------------------ ----------------------------------- --------------
Charles M. Royce Common Stock 1,195,032 shares--
1414 Avenue of the Americas Beneficial (sole voting 6.45%
New York, NY 10019 and investment power)
Cede & Co.* Common Stock 17,978,984 shares--Record* 96.97%
Depository Trust Company
P.O. Box #20
Bowling Green Station
New York, NY 10028 7.75% Cumulative Preferred 1,593,491 shares--Record* 99.59%
Stock
-----------------
* Shares held by brokerage firms, banks and other financial intermediaries
on behalf of beneficial owners are registered in the name of Cede & Co.
13
DIRECTORS AND OFFICERS
The Board of Directors of the Fund is comprised of the eight
individuals named below. Two of the Directors, William L. Koke 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 Stephen L. Isaacs, 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 DURING PORTFOLIOS DIRECTORSHIPS
ADDRESS* WITH THE FUND TIME SERVED PAST FIVE YEARS OVERSEEN HELD BY DIRECTOR
--------------------- ------------------ ------------------ ------------------------------- ---------------- ----------------------
Charles M. Royce** Class I Director Term as Director President, Chief Investment 18 None
(63) and President expires 2006; Officer and Member of Board of
Director and Managers of Royce; and
Officer since President of The Royce Funds.
1986
Mark R. Fetting** Class II Director Term as Director Executive Vice President of 18 Director/Trustee
(48) expires 2004; Legg Mason; Member of Board of of registered
Director since Managers of Royce; and Division investment
2001 President and Senior Officer of companies
Prudential Financial Group, constituting the
Inc. and related companies, 22 Legg Mason
including Fund Boards and Funds
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.
14
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 DURING PORTFOLIOS DIRECTORSHIPS
ADDRESS* WITH THE FUND TIME SERVED 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 Class III Term as President of The Center 18 None
(63) Director Director for Health and Social
expires 2005; Policy (since September
Director since 1996); Attorney and
1986 President of Health
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 Director elected Term as Financial planner with 18 None
(68) by Preferred Director Shoreline Financial
Stockholders expires Consultants. Mr. Koke's
annually; prior business experience
Director since includes having served as
2001 Director of Financial
Relations of SONAT, Inc.,
Treasurer of Ward Foods,
Inc. and President of
CFC, Inc.
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
15
TERM OF NUMBER OF OTHER PUBLIC
OFFICE AND ROYCE FUNDS' COMPANY
NAME, AGE AND POSITION(S) LENGTH OF PRINCIPAL OCCUPATIONS DURING PORTFOLIOS DIRECTORSHIPS
ADDRESS* WITH THE FUND TIME SERVED PAST FIVE YEARS OVERSEEN HELD BY DIRECTOR
--------------------- ------------------ ---------------- ---------------------------------- ---------------- ----------------------
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
(57) Director Director University, President of the registered
expires 2006; Hill House, Inc. and investment companies
Director since Managing Director/Equity constituting the 22
2001 Capital Markets Group of Legg Mason Funds;
Merrill Lynch & Co. (from Director of
1971 to 1999). Renaissance Capital
Greenwich Fund.
-----------
* 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.
** Solely as a result of his ownership of securities of one of the
Underwriters, Mr. O'Brien is technically an "interested person," as
defined in the 1940 Act, of the Fund until the completion of the
offering of the Cumulative Preferred Stock. After the completion of
the offering of the Cumulative Preferred Stock, Mr. O'Brien will be
a non-interested Director.
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.
16
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...................... $10,001-$50,000 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...................... None Over $100,000
David L. Meister..................... None Over $100,000
G. Peter O'Brien..................... $10,001-$50,000 Over $100,000
-------------------------
* 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 1,207,455 shares
of the Fund's Common Stock, constituting 6.51% of the outstanding shares, and
600 shares of its Preferred Stock, constituting less than .1% 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.
17
The Audit Committee is responsible for, among other things, the appointment,
compensation, 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, $8,500 None None $65,250
Director(1)
Richard M. Galkin, $8,500 None None $65,250
Director(2)
Stephen L. Isaacs, $8,500 None None $65,250
Director
William L. Koke, $8,500 None None $65,250
Director
David L. Meister, $8,500 None None $65,250
Director
G. Peter O'Brien, $8,500 None None $65,250
Director
-------------
(1) Includes $1,275 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 $8,500 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
18
effect from year to year. In its consideration of the current Investment
Advisory Agreement, the 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 14 other funds with substantially similar investment objectives and policies
plus funds in Morningstar's micro-cap value category. As set forth in the
Prospectus under the heading "Investment Advisory and Other Services - Advisory
Fee," Royce is entitled to receive the monthly Basic Fee of 1/12 of 1% (1% on an
annualized basis) of the Fund's average month-end net assets (including assets
obtained from the sale of Preferred Stock) during a rolling 36-month period and
an adjustment to the Basic Fee based on the investment performance of the Fund
in relation to the investment record of the Russell 2000 during such rolling
36-month period. The Basic Fee for each month is increased or decreased at the
rate of 1/12 of .05% for each percentage point that the investment performance
of the Fund exceeds, or is exceeded by, the percentage change in the investment
record of the Russell 2000 for the performance period by more than two
percentage points.
With respect to investment advisory fee rates, the Board of Directors
noted that the Basic Fee was equal to the peer group average. Although the Fund
paid a higher investment advisory fee rate than any other fund in the peer
group, the Board of Directors noted that the amounts paid in excess of the peer
group average were due to the Fund's outperformance of the Russell 2000. The
Board of Directors believes that the performance adjustment feature serves as an
appropriate incentive for Royce to manage the Fund's portfolio to the best of
its abilities for the benefit of the Fund's stockholders. 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 7.75%
Preferred for any month when the Fund's net asset value average annual total
return since the initial issuance of the 7.75% Preferred failed to exceed the
blended dividend rate on those assets to be a positive factor. With respect to
annual net expense ratios, even with the performance adjustment feature
described above and 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 7.75% Preferred) placed the Fund in the third quartile for
funds in Morningstar's micro-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
19
investment performance. On this basis, the Fund placed at or near the median for
the peer group and for Morningstar's micro-cap value category for the most
recent one-year period. For the most recent three and five-year periods, the
Fund's risk-adjusted investment performance placed it in the second quartile and
first quartile, respectively, for funds in the peer group.
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.
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
20
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.
INVESTMENT ADVISORY AND OTHER SERVICES
ADVISORY FEE
For the years ended December 31, 2002 and 2001, Royce received
investment advisory fees from the Fund of $3,062,647 and $2,844,285 (net of
$150,000 and $50,000 voluntarily waived by Royce), respectively. For the year
ended December 31, 2000, Royce received investment advisory fees from the Fund
of $1,776,697.
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.
21
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 $123,117,
$109,774 and $114,928 in fees to the Fund's custodian and transfer agent.
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
22
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.
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 $551,362, $206,574 and
$308,586, 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.
23
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 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 39%, 27% and 49%, respectively.
24
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.
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 statements for the six months ended June 30, 2003, are
included below in this Statement of Additional Information.
25
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS DECEMBER 31, 2002
--------------------------------------------------------------------------------
COMMON STOCKS - 94.5%
SHARES VALUE
------ -----
CONSUMER PRODUCTS - 9.6%
Apparel and Shoes - 3.5%
Ashworth (a) 65,000 $ 416,000
DELTA APPAREL 176,800 2,722,720
Kleinert's (a,e) 14,200 113,600
Nautica Enterprises (a) 107,600 1,195,436
Oshkosh B'Gosh Cl. A 37,000 1,037,850
WEYCO GROUP 48,400 1,661,088
-----------
7,146,694
-----------
Collectibles - 1.3%
The Boyds Collection (a,d) 226,800 1,508,220
Enesco Group (a) 52,400 370,992
Topps Company (The) (a,d) 101,000 878,700
-----------
2,757,912
-----------
Food/Beverage/Tobacco - 1.2%
800 JR CIGAR (a,e) 193,000 2,509,000
-----------
Home Furnishing/Appliances - 0.4%
Bassett Furniture Industries 26,300 376,616
Lifetime Hoan 109,854 524,004
-----------
900,620
-----------
Publishing - 0.5%
Information Holdings (a) 35,000 543,200
Marvel Enterprises (a) 42,700 383,446
-----------
926,646
-----------
Sports and Recreation - 0.8%
Lund International Holdings (a) 362,950 471,835
Monaco Coach (a) 65,900 1,090,645
+National R.V. Holdings (a,d) 31,800 190,164
-----------
1,752,644
-----------
Other Consumer Products - 1.9%
Cross (A.T.) & Company Cl. A (a) 100,000 535,000
+JAKKS Pacific (a) 35,000 471,450
Lazare Kaplan International (a) 151,700 825,248
MATTHEWS INTERNATIONAL CL. A 96,000 2,143,776
-----------
3,975,474
-----------
TOTAL (Cost $13,428,343) 19,968,990
===========
CONSUMER SERVICES - 4.0%
Direct Marketing - 0.2%
+Blair 15,000 349,800
ValueVision Media Cl. A (a) 5,000 74,900
-----------
424,700
-----------
Leisure/Entertainment - 0.2%
ACTV (a) 55,000 38,500
+Acres Gaming (a) 66,000 349,140
TiVo (a,d) 20,000 104,600
-----------
492,240
-----------
Restaurants/Lodgings - 0.2%
Angelo and Maxie's (a) 3,333 11,499
Benihana Cl. A (a) 21,470 289,845
Diedrich Coffee (a) 32,350 112,254
-----------
413,598
-----------
Retail Stores - 2.9%
Brookstone (a) 23,000 332,580
Buckle (The) (a) 36,500 657,000
Cato Cl. A 58,000 1,252,220
Dress Barn (The) (a) 53,660 713,678
La Senza Corporation 99,900 632,399
STEIN MART (a) 285,200 1,739,720
Wet Seal (The) Cl. A (a) 73,000 785,553
-----------
6,113,150
-----------
Other Consumer Services - 0.5%
Ambassadors International (a) 6,100 54,839
E-LOAN (a) 505,500 934,670
-----------
989,509
-----------
TOTAL (Cost $7,048,154) 8,433,197
===========
DIVERSIFIED INVESTMENT COMPANIES - 0.3%
Closed-End Mutual Funds - 0.3%
Central Fund of Canada Cl. A (d) 140,000 667,800
-----------
TOTAL (Cost $554,082) 667,800
-----------
FINANCIAL INTERMEDIARIES - 6.4%
Banking - 0.4%
First Midwest Financial 1,000 15,900
Queen City Investments 948 437,976
Sterling Bancorp 14,520 382,166
-----------
836,042
-----------
Insurance - 6.0%
Arch Capital Group (a) 25,700 801,069
Argonaut Group 30,900 455,775
Independence Holding 36,630 786,446
NYMAGIC (a) 107,100 2,083,095
Navigators Group (a) 47,200 1,083,240
PICO Holdings (a) 82,200 1,103,946
PXRE GROUP 73,164 1,792,518
Philadelphia Consolidated Holding (a) 35,000 1,239,000
PROASSURANCE (a) 99,900 2,097,900
Wellington Underwriting (a) 444,712 572,611
Zenith National Insurance 19,100 449,232
-----------
12,464,832
-----------
TOTAL (Cost $8,411,826) 13,300,874
===========
FINANCIAL SERVICES - 2.6%
Information and Processing - 0.7%
+Fidelity National Information Solutions (a) 65,668 1,132,773
+InterCept (a,d) 15,000 253,965
Multex.com (a) 15,000 63,000
-----------
1,449,738
-----------
Insurance Brokers - 0.6%
Clark/Bardes (a) 20,900 402,325
CorVel (a) 18,750 670,313
Hilb, Rogal & Hamiln 5,200 212,680
-----------
1,285,318
-----------
Investment Management - 0.2%
BKF Capital Group (a) 27,700 488,905
-----------
26
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS DECEMBER 31, 2002
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
FINANCIAL SERVICES (CONTINUED)
Other Financial Services - 1.1%
+LendingTree (a,d) 55,000 $ 708,400
New Century Financial (d) 5,000 126,950
PRG-Schultz International (a) 165,000 1,468,500
-----------
2,303,850
-----------
TOTAL (Cost $3,493,521) 5,527,811
===========
HEALTH - 10.2%
Commercial Services - 2.2%
ICON ADR a,b 800 21,528
PAREXEL International (a) 134,400 1,477,056
The TriZetto Group (a) 149,000 914,860
YOUNG INNOVATIONS (a) 93,850 2,183,889
-----------
4,597,333
-----------
Drugs and Biotech - 3.7%
Antigenics (a,d) 60,800 622,592
Arena Pharmaceuticals (a) 14,000 91,140
BioReliance (a) 20,300 470,351
BioSource International (a) 163,600 979,800
+Bruker Daltonics (a,d) 200,300 973,458
Emisphere Technologies (a) 362,900 1,262,892
+Gene Logic (a) 110,000 691,900
Geron (a,d) 6,000 21,600
Lexicon Genetics (a) 192,100 908,633
Martek Biosciences (a,d) 33,800 850,408
Myriad Genetics (a,d) 5,000 73,000
Sangamo BioSciences (a) 10,000 30,100
3-Dimensional Pharmaceuticals (a) 10,000 31,900
ViroPharma (a,d) 18,800 27,448
VIVUS (a,d) 167,200 623,656
-----------
7,658,878
-----------
Health Services - 1.1%
aaiPharma (a,d) 47,000 658,940
Covalent Group (a) 25,000 74,000
MedCath Corporation (a,d) 18,000 180,000
RehabCare Group (a) 25,000 477,000
+SFBC International (a) 30,000 389,400
Sierra Health Services (a) 40,000 480,400
-----------
2,259,740
-----------
Personal Care - 1.1%
+Inter Parfums 46,200 357,588
OCULAR SCIENCES (a) 130,700 2,028,464
-----------
2,386,052
-----------
Surgical Products and Devices - 2.1%
Aksys (a,d) 85,000 450,500
Allied Healthcare Products (a) 258,400 710,600
+Cantel Medical (a,d) 20,000 253,200
Cohesion Technologies (a) 5,000 19,150
CONMED (a) 3,900 76,401
Cyberonics (a,d) 5,000 92,000
Exactech (a) 25,000 486,000
Interpore International (a) 17,600 112,640
NMT Medical (a,d) 44,000 133,320
Orthofix International (a) 29,500 827,475
Osteotech (a) 62,100 399,924
PLC Systems (a) 105,200 61,016
+Utah Medical Products (a) 42,300 807,930
-----------
4,430,156
-----------
TOTAL (Cost $19,455,444) 21,332,159
===========
INDUSTRIAL PRODUCTS - 13.4%
Building Systems and Components - 2.1%
Juno Lighting (a) 108,600 1,050,162
LSI Industries 43,850 607,322
SIMPSON MANUFACTURING (a) 55,200 1,816,080
Skyline (d) 32,100 946,950
-----------
4,420,514
-----------
Construction Materials - 2.0%
Ash Grove Cement Company 8,000 1,010,000
Encore Wire (a,d) 10,000 90,500
Florida Rock Industries 35,000 1,331,750
Monarch Cement 50,410 887,216
Synalloy Corporation (a) 221,000 928,200
-----------
4,247,666
-----------
Industrial Components - 2.0%
+Aaon (a) 37,500 691,125
Bel Fuse Cl. A (a,d) 52,600 952,060
Penn Engineering & Manufacturing 56,600 602,790
Penn Engineering & Manufacturing Cl. A 30,800 344,960
+Powell Industries (a) 85,800 1,465,378
Scientific Technologies (a) 10,700 53,489
Woodhead Industries 10,000 113,000
-----------
4,222,802
-----------
Machinery - 1.3%
Astec Industries (a) 31,700 314,781
+LeCroy Corporation (a) 31,500 349,650
Lindsay Manufacturing 10,000 214,000
Mueller (Paul) 16,650 505,328
+T-3 Energy Services (a) 104,310 678,015
Woodward Governor 15,300 665,550
-----------
2,727,324
-----------
Pumps, Valves and Bearings - 1.9%
DENISON INTERNATIONAL ADR (a,b) 113,500 1,816,000
NN 80,500 804,195
Sun Hydraulics 152,550 1,220,400
-----------
3,840,595
-----------
Specialty Chemicals and Materials - 1.5%
Aceto 58,421 932,983
Balchem 10,000 243,000
CFC International (a) 144,700 643,915
Hawkins 122,667 1,102,776
+NuCo2 (a,d) 20,000 161,000
-----------
3,083,674
-----------
27
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS DECEMBER 31, 2002
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
INDUSTRIAL PRODUCTS (CONTINUED)
Textiles - 0.3%
Fab Industries (a) 76,400 $ 622,660
-----------
Other Industrial Products - 2.3%
+Astronics (a) 61,400 423,660
BHA GROUP HOLDINGS (a) 96,915 1,662,092
Maxwell Technologies (a) 15,300 92,565
Myers Industries 29,342 313,959
Peerless Mfg. (a) 43,200 358,560
Quixote 12,500 225,750
Velcro Industries 81,500 745,725
Wescast Industries Cl. A 37,900 943,710
-----------
4,766,021
-----------
TOTAL (Cost $21,286,619) 27,931,256
===========
INDUSTRIAL SERVICES - 12.7%
Advertising/Publishing - 0.3%
+Digital Generation Systems (a) 320,900 343,363
+Modem Media Cl. A (a) 141,200 367,120
-----------
710,483
-----------
Commercial Services - 6.3%
American Bank Note Holographics (a) 257,200 180,040
Butler International (a) 38,500 17,710
Carlisle Holdings (a) 400,000 1,100,000
Edgewater Technology (a) 18,339 86,560
Exponent (a) 63,200 928,345
iGATE Corporation (a) 274,700 719,714
Kforce (a) 55,000 232,100
Manufacturers Services (a) 100,000 554,000
NCO Group (a) 20,000 319,000
NIC (a) 26,800 38,592
National Service Industries 92,800 666,304
New Horizons Worldwide (a) 282,000 1,113,900
On Assignment (a) 132,000 1,124,640
Pegasystems (a) 65,000 332,150
+PLATO Learning (a) 70,000 415,800
ProBusiness Services (a) 10,000 100,000
RemedyTemp Cl. A (a) 71,700 1,003,800
+TRC Companies (a,d) 24,000 315,120
Tyler Technologies (a) 50,000 208,500
Volt Information Sciences (a) 36,600 625,860
WACKENHUT CORRECTIONS (a) 164,800 1,830,928
+Watson Wyatt & Company Holdings Cl. A (a) 15,000 326,250
Westaff (a) 362,500 906,250
-----------
13,145,563
-----------
Food/Tobacco Processors - 1.1%
MGP Ingredients 96,122 749,752
Seneca Foods Cl. A (a) 58,500 863,753
Seneca Foods Cl. B (a) 47,200 767,236
-----------
2,380,741
-----------
Industrial Distribution - 1.3%
+Central Steel & Wire 1,200 572,400
Elamex (a) 70,200 315,900
Lawson Products 12,200 377,956
Strategic Distribution (a) 104,690 1,329,563
-----------
2,595,819
-----------
Printing - 1.6%
Bowne & Co. 110,000 1,314,500
Ennis Business Forms 11,200 130,144
Moore Corporation (a) 39,600 360,360
New England Business Service 52,900 1,290,760
Schawk Cl. A 21,300 211,083
-----------
3,306,847
-----------
Transportation and Logistics - 2.1%
AirNet Systems (a) 119,700 588,924
EGL (a) 42,100 599,925
Forward Air (a) 36,800 714,288
Frozen Food Express Industries (a) 227,500 590,818
Hawaiian Holdings (a) 86,000 175,440
Hub Group Cl. A (a) 6,500 31,200
Knight Transportation (a) 38,925 817,425
Patriot Transportation Holding (a) 27,700 767,290
-----------
4,285,310
-----------
TOTAL (Cost $24,678,088) 26,424,763
===========
NATURAL RESOURCES - 8.2%
Energy Services - 2.6%
Carbo Ceramics 33,600 1,132,320
Dril-Quip (a) 42,700 721,630
GulfMark Offshore (a) 69,200 1,020,700
Input/Output (a) 193,500 822,375
Lufkin Industries 25,000 586,250
MarkWest Hydrocarbon (a) 15,200 86,640
NATCO Group Cl. A (a) 100,400 630,512
Valley National Gases (a) 30,100 171,570
Willbros Group (a) 30,900 253,998
-----------
5,425,995
-----------
Oil and Gas - 3.5%
BONAVISTA PETROLEUM (a) 81,000 1,745,420
Denbury Resources (a) 112,000 1,265,600
Evergreen Resources (a,d) 20,000 897,000
PETROCORP (a) 171,200 1,754,800
+Prima Energy (a) 21,000 469,560
3TEC Energy (a,d) 51,075 724,754
+Veritas DGC (a) 51,300 405,270
-----------
7,262,404
-----------
Precious Metals and Mining - 0.7%
Apex Silver Mines (a) 79,600 1,178,080
Brush Engineered Materials (a) 15,500 85,250
MK Gold (a) 603,700 256,573
-----------
1,519,903
-----------
Real Estate - 1.4%
HomeFed (a) 998,521 1,447,855
Liberte Investors 346,800 1,494,708
-----------
2,942,563
-----------
TOTAL (Cost $10,833,191) 17,150,865
===========
28
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS DECEMBER 31, 2002
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
TECHNOLOGY - 22.2%
Aerospace/Defense - 2.4%
Ducommun (a) 99,500 $ 1,577,075
HEICO 55,000 583,550
Herley Industries (a) 77,000 1,340,416
Integral Systems (a) 58,300 1,168,915
Mesaba Holdings (a) 51,600 315,792
-----------
4,985,748
-----------
Components and Systems - 4.0%
CSP (a) 117,581 303,477
Com21 (a) 17,500 3,850
+Del Global Technologies (a) 468,279 1,123,870
EXCEL TECHNOLOGY (a) 97,900 1,751,431
Kronos (a) 20,750 767,543
MOCON 22,600 160,211
Newport (a) 45,000 565,200
+OSI Systems (a) 20,000 339,600
PC-Tel (a) 61,100 414,258
Performance Technologies (a) 24,750 80,685
Rainbow Technologies (a) 206,500 1,480,605
Read-Rite (a) 5,000 1,750
REMEC (a) 246,500 956,420
Spectrum Control (a) 17,500 91,875
TransAct Technologies (a) 68,200 323,268
-----------
8,364,043
-----------
Distribution - 2.2%
Bell Industries (a) 85,700 137,120
Daisytek International (a) 53,300 422,669
Jaco Electronics (a) 38,000 104,500
Nu Horizons Electronics (a) 40,000 231,200
PC Connection (a) 5,000 25,350
Pioneer-Standard Electronics (d) 120,000 1,101,600
+Plexus (a) 80,000 702,400
RICHARDSON ELECTRONICS 206,600 1,789,156
-----------
4,513,995
-----------
Internet Software and Services - 1.3%
Lionbridge Technologies (a) 37,500 73,163
+Overstock.com (a,d) 30,000 390,000
RealNetworks (a) 65,700 250,317
Register.com (a) 179,000 805,500
Stamps.com (a) 185,000 863,950
+United Online (a,d) 15,000 239,115
-----------
2,622,045
-----------
IT Services - 4.9%
CACI International Cl. A (a) 10,000 356,400
CIBER (a) 225,000 1,158,750
Computer Task Group (a) 221,100 771,639
Covansys Corporation (a) 242,500 911,315
DiamondCluster International Cl. A (a) 255,000 800,700
Forrester Research (a) 105,500 1,642,635
+SAPIENT CORPORATION (a) 1,155,000 2,367,750
SYNTEL (a) 87,700 1,842,577
Technology Solutions (a) 50,000 54,500
Tier Technologies Cl. B (a) 24,500 392,000
-----------
10,298,266
-----------
Semiconductors and Equipment - 1.6%
August Technology (a) 60,000 303,600
California Micro Devices (a) 25,000 113,750
Exar (a) 48,500 601,400
FSI International (a) 34,500 155,250
GlobespanVirata (a) 40,000 176,400
Helix Technology 9,500 106,400
Intevac (a) 111,450 444,685
Oak Technology (a) 135,000 357,750
Photronics (a) 29,750 407,575
Semitool (a) 50,500 313,605
Teradyne (a) 13,604 176,988
Xicor (a) 35,000 130,550
-----------
3,287,953
-----------
Software - 3.2%
ANSYS (a) 15,400 311,080
Aladdin Knowledge Systems (a) 27,300 70,680
Applix (a) 20,000 21,600
Aspen Technology (a) 65,000 183,950
+Chordiant Software (a,d) 130,000 187,200
JDA Software Group (a) 110,500 1,067,430
Lightspan (a) 480,000 504,480
MSC.Software (a) 42,700 329,644
SCB Computer Technology (a) 50,000 37,000
SPSS (a) 91,900 1,285,681
Transaction Systems Architects Cl. A (a) 155,100 1,008,150
+Verity (a) 120,000 1,606,920
-----------
6,613,815
-----------
Telecommunication - 2.6%
+Allegiance Telecom (a) 840,000 562,800
+Anaren (a,d) 109,000 959,200
Brooktrout (a) 28,400 150,520
C-COR.net (a,d) 5,000 16,600
Captaris (a) 30,000 72,000
Computer Access Technology (a) 48,000 119,520
+Finisar Corporation (a,d) 30,000 28,500
Giga-tronics (a) 3,200 4,480
+Interland (a,d) 25,000 32,500
+Level 3 Communications (a,d) 84,300 413,070
Liberty Satellite & Technology Cl. A (a) 68,200 180,730
MetaSolv (a) 26,100 35,757
Somera Communications (a,d) 132,900 358,830
+SpectraLink Corporation (a) 132,000 947,760
+Stratos Lightwave (a,d) 5,760 25,338
Technical Communications (a,c) 96,700 34,812
+Tollgrade Communications (a,d) 36,500 428,145
+ViaSat (a,d) 98,200 1,133,228
-----------
5,503,790
-----------
TOTAL (Cost $47,001,974) 46,189,655
===========
MISCELLANEOUS - 4.9%
TOTAL (Cost $13,116,225) 10,238,165
===========
29
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS DECEMBER 31, 2002
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
TOTAL COMMON STOCKS
(Cost $169,307,467) $197,165,535
=============
PREFERRED STOCKS - 0.5%
Angelo and Maxie's 10.00% Conv. 6,991 14,681
SENECA FOODS CONV. (a) 75,409 919,990
-------------
TOTAL PREFERRED STOCKS
(Cost $957,998) 934,671
=============
PRINCIPAL
AMOUNT
---------
U.S. TREASURY OBLIGATIONS - 2.4%
U.S Treasury Notes
+1.875%, due 9/30/04 $5,000,000 5,034,960
-------------
TOTAL U.S. TREASURY OBLIGATIONS
(Cost $5,015,040) 5,034,960
=============
REPURCHASE AGREEMENT - 2.6%
State Street Bank & Trust Company,
0.50% dated 12/31/02, due 1/2/03,
maturity value $5,429,151 (collateralized
by U.S. Treasury Notes, 5.00% due 8/15/11,
valued at $5,539,531) (Cost $5,429,000) 5,429,000
=============
TOTAL INVESTMENTS - 100.0%
(Cost $180,709,505) 208,564,166
-------------
LIABILITIES LESS CASH
AND OTHER ASSETS (992,987)
PREFERRED STOCK (40,000,000)
-------------
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS $167,571,179
=============
--------------------------------------------------------------------------------
(a) Non-income producing.
(b) American Depository Receipt.
(c) At December 31, 2002, the Fund owned 5% or more of the Company's outstanding
voting securities thereby making the Company an Affiliated Company as that
term is defined in the Investment Company Act of 1940.
(d) A portion of these securities were on loan at December 31, 2002. Total
market value of loaned securities at December 31, 2002 was $4,495,930.
(e) Securities for which market quotations are no longer readily available
represent 1.26% of net assets. These securities have been valued at their
fair value under procedures established by the Fund's Board of Directors.
+ 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 $181,855,758. At December 31, 2002, net unrealized appreciation for
all securities was $26,708,408, consisting of aggregate gross unrealized
appreciation of $49,389,750 and aggregate gross unrealized depreciation of
$22,681,342. 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.
30
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES DECEMBER 31, 2002
--------------------------------------------------------------------------------
ASSETS:
Investments at value (identified cost $175,280,505) $203,135,166
Repurchase agreement (at cost and value) 5,429,000
Cash 765
Collateral from brokers on securities loaned 4,883,393
Receivable for investments sold 73,603
Receivable for dividends and interest 113,596
Prepaid expenses 6,875
--------------------------------------------------------------------------------
Total Assets 213,642,398
--------------------------------------------------------------------------------
LIABILITIES:
Payable for collateral on securities loaned 4,883,393
Payable for investments purchased 812,735
Payable for investment advisory fee 225,816
Preferred dividends accrued but not yet declared 68,887
Accrued expenses 80,388
--------------------------------------------------------------------------------
Total Liabilities 6,071,219
--------------------------------------------------------------------------------
PREFERRED STOCK:
7.75% Cumulative Preferred Stock - $0.001 par value,
$25 liquidation value per share; 1,600,000
shares outstanding 40,000,000
--------------------------------------------------------------------------------
Total Preferred Stock 40,000,000
--------------------------------------------------------------------------------
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS $167,571,179
================================================================================
ANALYSIS OF NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS:
Par value of Common Stock - $0.001 per share; 17,842,058 shares
outstanding (150,000,000 shares authorized) $ 17,842
Additional paid-in capital 136,080,965
Accumulated net realized gain on investments 3,686,600
Net unrealized appreciation on investments 27,854,661
Preferred dividends accrued but not yet declared (68,889)
--------------------------------------------------------------------------------
Net Assets applicable to Common Stockholders (net asset value
per share - $9.39) $167,571,179
================================================================================
STATEMENTS OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
Year ended Year ended
December 31, December 31,
2002 2001
------------ ------------
INVESTMENT OPERATIONS:
Net investment income (loss) $ (2,363,582) $ (775,205)
Net realized gain on investments 16,747,557 12,077,022
Net change in unrealized appreciation on
investments (38,936,315) 29,883,551
--------------------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from investment operations (24,552,340) 41,185,368
--------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS:
Net investment income - -
Net realized gain on investments (3,100,000) (3,100,000)
--------------------------------------------------------------------------------
Total distributions to Preferred
Stockholders (3,100,000) (3,100,000)
--------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS APPLICABLE
TO COMMON STOCKHOLDERS RESULTING FROM
INVESTMENT OPERATIONS (27,652,340) 38,085,368
================================================================================
DISTRIBUTIONS TO COMMON STOCKHOLDERS:
Net investment income - -
Net realized gain on investments (13,769,198) (9,211,976)
--------------------------------------------------------------------------------
Total distributions to Common
Stockholders (13,769,198) (9,211,976)
--------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Reinvestment of distributions to Common
Stockholders 8,549,592 7,749,904
--------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS APPLICABLE
TO COMMON STOCKHOLDERS (32,871,946) 36,623,296
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS:
Beginning of year 200,443,125 163,819,829
--------------------------------------------------------------------------------
End of year $ 167,571,179 $200,443,125
================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
31
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 2002
--------------------------------------------------------------------------------
INVESTMENT INCOME:
Income:
Dividends $ 1,031,310
Interest 383,031
--------------------------------------------------------------------------------
Total income 1,414,341
--------------------------------------------------------------------------------
Expenses:
Investment advisory fees 3,212,647
Stockholder meeting costs 305,681
Custody and transfer agent fees 123,117
Directors' fees 60,581
Administrative and office facilities expenses 60,521
Stockholder reports 55,912
Professional fees 43,964
Other expenses 65,500
--------------------------------------------------------------------------------
Total expenses 3,927,923
Fees waived by investment advisor (150,000)
--------------------------------------------------------------------------------
Net expenses 3,777,923
--------------------------------------------------------------------------------
Net investment income (loss) (2,363,582)
--------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments 16,747,557
Net change in unrealized appreciation on investments (38,936,315)
--------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments (22,188,758)
--------------------------------------------------------------------------------
NET DECREASE IN NET ASSETS RESULTING FROM INVESTMENT OPERATIONS (24,552,340)
================================================================================
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS (3,100,000)
================================================================================
NET DECREASE IN NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS
RESULTING FROM INVESTMENT OPERATIONS $(27,652,340)
================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
32
ROYCE MICRO-CAP 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 $11.83 $10.14 $11.00 $10.06 $10.84
----------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS:
Net investment income (loss) (0.13) (0.05) 0.09 0.12 0.13
Net realized and unrealized gain (loss) on investments (1.29) 2.57 1.23 1.35 (0.36)
----------------------------------------------------------------------------------------------------------------------------------
Total investment operations (1.42) 2.52 1.32 1.47 (0.23)
----------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS:
Net investment income - - (0.01) (0.05) (0.06)
Net realized gain on investments (0.18) (0.19) (0.22) (0.18) (0.18)
----------------------------------------------------------------------------------------------------------------------------------
Total distributions to Preferred Stockholders (0.18) (0.19) (0.23) (0.23) (0.24)
----------------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS APPLICABLE TO COMMON
STOCKHOLDERS RESULTING FROM INVESTMENT OPERATIONS (1.60) 2.33 1.09 1.24 (0.47)
----------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO COMMON STOCKHOLDERS:
Net investment income - - (0.09) (0.06) (0.07)
Net realized gain on investments (0.80) (0.57) (1.63) (0.21) (0.22)
----------------------------------------------------------------------------------------------------------------------------------
Total distributions to Common Stockholders (0.80) (0.57) (1.72) (0.27) (0.29)
----------------------------------------------------------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Effect of reinvestment of distributions by Common Stockholders (0.04) (0.07) (0.23) (0.03) (0.02)
----------------------------------------------------------------------------------------------------------------------------------
Total capital stock transactions (0.04) (0.07) (0.23) (0.03) (0.02)
----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.39 $11.83 $10.14 $11.00 $10.06
==================================================================================================================================
MARKET VALUE, END OF PERIOD $8.44 $10.50 $8.625 $9.00 $8.875
==================================================================================================================================
TOTAL RETURN(a):
Market Value (12.7)% 28.8% 15.3% 4.5% (9.4)%
Net Asset Value (13.8)% 23.4% 10.9% 12.7% (4.1)%
RATIOS BASED ON AVERAGE NET ASSETS APPLICABLE TO
COMMON STOCKHOLDERS:
Total expenses (b,c) 1.96% 1.78% 1.32% 1.27% 1.18%
Management fee expense 1.59% 1.57% 1.08% 0.91% 0.80%
Other operating expenses 0.37% 0.21% 0.24% 0.36% 0.38%
Net investment income (loss) (1.23)% (0.43)% 0.74% 1.20% 1.21%
SUPPLEMENTAL DATA:
Net Assets Applicable to Common Stockholders,
End of Period (in thousands) $167,571 $200,443 $163,820 $151,269 $135,495
Liquidation Value of Preferred Stock,
End of Period (in thousands) $40,000 $40,000 $40,000 $40,000 $40,000
Portfolio Turnover Rate 39% 27% 49% 49% 44%
PREFERRED STOCK:
Total shares outstanding 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000
Asset coverage per share $129.73 $150.28 $127.39 $119.54 $109.68
Liquidation preference per share $25.00 $25.00 $25.00 $25.00 $25.00
Average market value per share (d) $25.91 $25.30 $23.08 $24.67 $25.40
==================================================================================================================================
(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 1.62%, 1.46%, 1.06%, 0.98% and 0.92% 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 2.04%,
1.81%, 1.44% and 1.24% for the periods ended December 31, 2002, 2001, 1999
and 1998, respectively.
(d) The average of month-end market values during the period.
33
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Royce Micro-Cap Trust, Inc. (the "Fund") was incorporated under the
laws of the State of Maryland on September 9, 1993 as a diversified closed-
end investment company. The Fund commenced operations on December 14, 1993.
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:
Effective April 25, 2002, the Fund adopted a policy of paying quarterly
distributions on the Fund's Common Stock. Distributions are currently being
made at the annual rate of 9% of the rolling average of the prior four
calendar quarter-end NAVs of the Fund's Common Stock, with the fourth quarter
distribution being the greater of 2.25% of the rolling average or the
distribution required by IRS regulations. 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.
34
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
3. CAPITAL STOCK:
The Fund currently has 1,600,000 shares of 7.75% 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 896,290 and 784,403 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:
As compensation for its services under the Investment Advisory Agreement,
Royce & Associates, LLC ("Royce") receives a fee comprised of a Basic Fee
("Basic Fee") and an adjustment to the Basic Fee based on the investment
performance of the Fund in relation to the investment record of the Russell
2000.
The Basic Fee is a monthly fee equal to 1/12 of 1% (1% on an annualized
basis) of the average of the Fund's month-end net assets applicable to Common
Stockholders plus liquidation value of Preferred Stock for the rolling
36-month period ending with such month. The Basic Fee for each month is
increased or decreased at the rate of 1/12 of .05% for each percentage point
that the investment performance of the Fund exceeds, or is exceeded by, the
percentage change in the investment record of the Russell 2000 for the
performance period by more than two percentage points. The performance period
for each such month is a rolling 36-month period ending with such month. The
maximum increase or decrease in the Basic Fee for any month may not exceed
1/12 of .5%. Accordingly, for each month, the maximum monthly fee rate as
adjusted for performance is 1/12 of 1.5% and is payable if the investment
performance of the Fund exceeds the percentage change in the investment
record of the Russell 2000 by 12 or more percentage points for the
performance period, and the minimum monthly fee rate as adjusted for
performance is 1/12 of .5% and is payable if the percentage change in the
investment record of the Russell 2000 exceeds the investment performance of
the Fund by 12 or more percentage points for the performance period.
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 $3,062,647, which is net of $150,000 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 $ -- $ 3,817,946
Long-term capital gain 16,869,198 8,494,030
---------- ---------
$16,869,198 $12,311,976
=========== ===========
--------------------------------------------------------------------------------
As of December 31, 2002, the tax basis components of distributable earnings
included in stockholders' equity were as follows:
--------------------------------------------------------------------------------
Undistributed long-term gain $ 4,832,853
Unrealized appreciation 26,708,408
Accrued preferred distributions (68,889)
-------
$31,472,372
===========
--------------------------------------------------------------------------------
35
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
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 $89,735,728 and $101,913,519, respectively.
7. TRANSACTIONS IN SHARES OF AFFILIATED COMPANIES:
An "Affiliated Company", as defined in the Investment Company Act of 1940,
is a company in which a Fund owns 5% or more of the company's outstanding
voting securities. The Fund effected the following transactions in shares of
such companies during the year ended December 31, 2002:
--------------------------------------------------------------------------------
Purchases Sales
------------------- ------------------
Affiliated Company Shares Cost Shares Cost Realized Gain (Loss) Dividend Income
------------------ ------ ---- ------ ---- -------------------- ---------------
Strategic Distribution 18,000 $109,695 122,000 $971,224 $674,038 --
Technical Communications -- -- -- -- -- --
----------------------------------------------------------------------------------------------------------------------------------
8. 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.
REPORT OF INDEPENDENT AUDITORS
--------------------------------------------------------------------------------
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF ROYCE MICRO-CAP TRUST, INC.
We have audited the accompanying statement of assets and liabilities of Royce
Micro-Cap 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 Micro-Cap 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 8, as to which the date is September 12, 2003
36
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
COMMON STOCKS - 92.8%
SHARES VALUE
------ -----
CONSUMER PRODUCTS - 9.0%
Apparel and Shoes - 3.0%
Ashworth (a) 43,000 $ 304,870
DELTA APPAREL 146,500 2,380,625
Kleinert's (a,d) 14,200 0
Marisa Christina (a) 51,600 73,788
Nautica Enterprises (a) 107,600 1,380,508
Oshkosh B'Gosh Cl. A 37,000 999,000
WEYCO GROUP 40,000 1,840,400
---------------
6,979,191
---------------
Collectibles - 1.0%
The Boyds Collection (a,c) 227,700 1,072,467
Enesco Group (a) 52,400 387,760
Topps Company (The) (a) 101,000 867,590
---------------
2,327,817
---------------
Food/Beverage/Tobacco - 1.3%
800 JR CIGAR (a,d) 193,000 2,509,000
+Green Mountain Coffee Roasters (a,c) 15,000 285,000
Monterey Pasta Company (a,c) 69,000 341,550
---------------
3,135,550
---------------
Home Furnishing/Appliances - 0.8%
Bassett Furniture Industries 26,300 349,264
Falcon Products (a) 150,000 634,500
Lifetime Hoan (c) 109,854 837,088
Stanley Furniture Company 2,500 68,525
---------------
1,889,377
---------------
Publishing - 0.3%
Information Holdings (a) 40,000 730,000
Sports and Recreation - 0.8%
Johnson Outdoors Cl. A (a) 31,600 431,340
Monaco Coach (a,c) 85,900 1,316,847
National R.V. Holdings (a) 31,800 164,724
---------------
1,912,911
---------------
Other Consumer Products - 1.8%
Concord Camera (a) 30,000 212,700
Cross (A. T.) & Company Cl. A (a) 100,000 594,000
JAKKS Pacific (a) 35,000 465,150
Lazare Kaplan International (a) 151,700 879,860
Matthews International Cl. A 76,000 1,881,760
Pillowtex Corporation (a) 20,000 4,400
Water Pik Technologies (a,c) 41,500 322,455
---------------
4,360,325
---------------
TOTAL (Cost $15,141,248) 21,335,171
===============
Consumer Services - 4.5%
Direct Marketing - 0.1%
ValueVision Media Cl. A (a) 5,000 68,150
---------------
Leisure/Entertainment - 0.2%
ACTV (a) 55,000 53,900
IMAX Corporation (a,c) 25,000 225,000
TiVo (a,c) 20,000 247,000
---------------
525,900
---------------
Restaurants/Lodgings - 0.2%
Angelo and Maxie's (a) 3,333 9,832
Benihana Cl. A (a) 29,770 392,964
IHOP Corporation (c) 3,900 123,123
---------------
525,919
---------------
Retail Stores - 3.6%
Brookstone (a) 23,000 465,750
Buckle (The) (a) 36,500 701,895
Cato Cl. A 58,000 1,222,640
+Charming Shoppes (a,c) 50,000 248,500
Dress Barn (The) (a) 53,660 679,872
+FTD Cl. A (a,c) 10,000 201,800
Gadzooks (a,c) 63,000 357,840
InterTAN (a) 49,800 408,360
La Senza Corporation 99,900 722,124
STEIN MART (a) 285,200 1,708,348
United Retail Group (a) 60,600 119,382
WET SEAL (THE) CL. A (a) 157,000 1,676,760
---------------
8,513,271
---------------
Other Consumer Services - 0.4%
Ambassadors Group (a) 7,500 104,775
Ambassadors International (a) 6,100 73,261
E-LOAN (a,c) 80,500 469,315
First Cash Financial Services (a) 20,500 291,305
---------------
938,656
---------------
TOTAL (Cost $7,950,925) 10,571,896
===============
DIVERSIFIED INVESTMENT COMPANIES - 0.2%
Closed-End Mutual Funds - 0.2%
Central Fund of Canada Cl. A (c) 140,000 600,600
---------------
TOTAL (Cost $554,082) 600,600
===============
FINANCIAL INTERMEDIARIES - 5.0%
Banking - 0.4%
First Midwest Financial 1,000 18,585
Queen City Investments (a) 948 466,416
Sterling Bancorp 14,520 404,963
---------------
889,964
===============
Insurance - 4.6%
Arch Capital Group (a) 25,700 892,561
Argonaut Group (a) 30,900 380,997
Ceres Group (a) 50,300 144,864
Independence Holding 18,630 393,279
NYMAGIC 67,900 1,375,654
Navigators Group (a) 47,200 1,407,504
PICO Holdings (a) 91,600 1,190,800
PMA Capital Cl. A 80,000 1,005,600
PXRE Group 73,164 1,448,647
ProAssurance Corporation (a) 57,500 1,551,925
Wellington Underwriting (a) 444,712 754,544
Zenith National Insurance (c) 19,100 544,350
---------------
11,090,725
---------------
TOTAL (Cost $7,574,357) 11,980,689
===============
FINANCIAL SERVICES - 1.6%
Information and Processing - 0.3%
Fidelity National Information Solutions (a) 20,668 539,021
InterCept (a) 32,000 267,520
---------------
806,541
---------------
Insurance Brokers - 0.4%
Clark (a) 20,900 249,755
CorVel (a) 18,750 675,000
---------------
924,755
---------------
37
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
FINANCIAL SERVICES (CONTINUED)
Investment Management - 0.2%
BKF Capital Group (a) 27,700 $ 604,691
Other Financial Services - 0.7%
MicroFinancial (a) 10,000 18,400
New Century Financial 5,000 218,250
PRG-Schultz International (a,c) 225,000 1,327,500
---------------
1,564,150
---------------
TOTAL (Cost $2,775,622) 3,900,137
===============
HEALTH - 11.1%
Commercial Services - 3.1%
BioReliance Corporation (a) 58,300 1,235,960
Bruker Daltonics (a,c) 200,300 1,067,599
ICON ADR (a,b) 800 25,456
PAREXEL International (a) 134,400 1,874,880
The TriZetto Group (a) 181,500 1,096,260
Young Innovations (a) 73,850 2,104,725
---------------
7,404,880
---------------
Drugs and Biotech - 2.5%
Antigenics (a,c) 60,800 700,416
Arena Pharmaceuticals (a) 14,000 92,960
BioSource International (a) 177,900 1,227,510
Emisphere Technologies (a) 187,200 673,920
Geron Corporation (a,c) 6,000 44,160
Lexicon Genetics (a) 192,100 1,288,991
Martek Biosciences (a) 12,800 549,632
Myriad Genetics (a) 5,000 68,050
Nabi Biopharmaceuticals (a) 40,000 274,400
Sangamo BioSciences (a) 10,000 28,500
ViroPharma (a,c) 18,800 48,880
VIVUS (a,c) 167,200 859,408
---------------
5,856,827
---------------
Health Services - 2.2%
ATC Healthcare Cl. A (a) 35,000 22,050
aaiPharma (a,c) 31,600 628,208
Covalent Group (a) 25,000 56,250
First Consulting Group (a) 146,700 685,089
Gene Logic (a) 210,000 1,253,700
MIM Corporation (a,c) 38,100 248,793
MedCath Corporation (a,c) 18,000 105,300
On Assignment (a,c) 132,000 528,000
Quovadx (a) 45,000 134,550
RehabCare Group (a) 25,000 366,250
SFBC International (a,c) 23,000 416,300
Sierra Health Services (a,c) 40,000 800,000
Superior Consultant Holdings (a) 10,000 30,000
---------------
5,274,490
---------------
Personal Care - 0.8%
Helen of Troy (a) 20,000 303,200
Inter Parfums 46,200 341,880
Ocular Sciences (a,c) 60,800 1,206,880
---------------
1,851,960
---------------
Surgical Products and Devices - 2.5%
Aksys (a,c) 85,000 1,100,750
Allied Healthcare Products (a) 258,400 922,488
Cantel Medical (a) 21,000 281,820
Colorado MEDtech (a) 5,400 25,380
CONMED Corporation (a,c) 3,900 71,214
Cyberonics (a,c) 5,000 107,550
Exactech (a) 50,000 720,000
Interpore International (a) 17,600 224,048
Molecular Devices (a) 10,000 159,100
NMT Medical (a) 44,000 174,680
Orthofix International (a) 29,500 965,830
Osteotech (a) 22,100 300,339
PLC Systems (a) 105,200 68,380
Theragenics Corporation (a) 15,000 64,500
Utah Medical Products (a) 42,300 848,115
---------------
6,034,194
---------------
TOTAL (Cost $21,482,648) 26,422,351
===============
INDUSTRIAL PRODUCTS - 13.7%
Building Systems and Components - 2.0%
Drew Industries (a) 15,000 273,000
Juno Lighting (a) 108,600 1,453,068
LSI Industries 43,850 486,735
SIMPSON MANUFACTURING (a) 44,200 1,617,720
Skyline Corporation 32,100 963,000
---------------
4,793,523
---------------
Construction Materials - 1.8%
Ash Grove Cement Company 8,000 944,000
Eagle Building Technologies (a,c) 15,000 21,000
Encore Wire (a) 10,000 95,000
Florida Rock Industries 35,000 1,444,800
Monarch Cement 50,410 879,655
Synalloy Corporation (a) 171,000 928,530
Universal Stainless & Alloy Products (a) 7,700 50,589
---------------
4,363,574
---------------
Industrial Components - 2.2%
Aaon (a) 37,500 694,500
Bel Fuse Cl. A 52,600 1,078,300
Cable Design Technologies (a) 30,000 214,500
Penn Engineering & Manufacturing 56,600 772,590
Penn Engineering & Manufacturing Cl. A 30,800 373,912
Powell Industries (a) 85,800 1,256,112
Scientific Technologies (a) 10,700 51,895
Tech/Ops Sevcon 76,200 400,050
II-VI (a) 10,000 230,800
Woodhead Industries 10,000 125,200
---------------
5,197,859
---------------
Machinery - 1.6%
Astec Industries (a) 40,200 350,544
Hurco Companies (a) 16,100 37,835
LeCroy Corporation (a) 34,000 328,440
Lindsay Manufacturing 10,000 232,200
MTS Systems 10,000 147,400
Mueller (Paul) 16,650 674,325
T-3 Energy Services (a) 198,610 1,306,854
Woodward Governor 15,300 657,900
---------------
3,735,498
---------------
Pumps, Valves and Bearings - 2.0%
DENISON INTERNATIONAL ADR (a,b) 123,500 2,377,375
NN 80,500 1,019,130
Sun Hydraulics 152,550 1,229,553
---------------
4,626,058
---------------
38
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
INDUSTRIAL PRODUCTS (CONTINUED)
Specialty Chemicals and Materials - 2.0%
Aceto 87,631 $ 1,616,792
American Pacific (a) 15,000 112,200
Balchem Corporation 10,000 235,200
CFC International (a) 144,700 781,380
Eastern Company (The) 20,000 292,000
Hawkins 122,667 1,229,123
NuCo2 (a,c) 20,000 188,200
Park Electrochemical 10,000 199,500
---------------
4,654,395
---------------
Textiles - 0.3%
Fab Industries (a) 76,400 702,880
Other Industrial Products - 1.8%
Astronics Corporation (a) 26,400 85,668
BHA GROUP HOLDINGS 96,915 1,919,886
Maxwell Technologies (a) 15,300 88,128
Myers Industries 29,342 278,749
Peerless Mfg. (a) 43,200 477,360
Quixote Corporation 12,500 319,125
Spartan Motors (c) 26,200 216,674
Wescast Industries Cl. A 37,900 942,952
---------------
4,328,542
---------------
TOTAL (Cost $23,162,094) 32,402,329
===============
INDUSTRIAL SERVICES - 12.2%
Advertising/Publishing - 0.3%
Digital Generation Systems (a) 6,700 12,864
+FindWhat.com (a,c) 10,000 188,100
Modem Media Cl. A (a) 141,200 561,976
---------------
762,940
---------------
Commercial Services - 5.0%
American Bank Note Holographics (a) 267,200 325,984
Butler International (a) 38,500 30,800
Carlisle Holdings (a) 400,000 1,320,000
Core Laboratories (a) 24,000 259,200
Edgewater Technology (a) 18,339 88,027
Exponent (a) 63,200 979,600
+Heidrick & Struggles International (a,c) 10,000 126,200
iGATE Corporation (a) 324,700 1,126,709
Innodata Corporation (a) 245,100 330,885
Kforce (a) 55,000 265,650
Manufacturers Services (a) 95,000 460,750
NCO Group (a) 20,000 358,200
NIC (a) 26,800 78,256
New Horizons Worldwide (a,c) 282,000 1,206,960
Pegasystems (a) 75,000 552,750
RemedyTemp Cl. A (a) 71,700 661,791
TRC Companies (a,c) 25,000 369,000
Tyler Technologies (a) 65,000 276,250
Volt Information Sciences (a) 36,600 499,590
Wackenhut Corrections (a) 94,800 1,299,708
Watson Wyatt & Company Holdings Cl. A (a) 15,000 347,700
Westaff (a) 362,500 808,375
---------------
11,772,385
---------------
Engineering and Construction - 0.6%
Insituform Technologies Cl. A (a) 70,000 1,237,600
Keith Companies (a) 10,000 99,900
---------------
1,337,500
---------------
Food/Tobacco Processors - 1.5%
Galaxy Nutritional Foods (a) 113,500 $ 320,070
MGP Ingredients 96,122 839,626
ML Macadamia Orchards LP Cl. A 120,200 420,700
SENECA FOODS CL. A (a) 58,500 1,024,920
SENECA FOODS CL. B (a) 47,200 854,792
---------------
3,460,108
---------------
Industrial Distribution - 0.9%
Central Steel & Wire 1,200 450,000
Elamex (a) 70,200 239,031
Lawson Products 12,200 335,976
Strategic Distribution (a) 68,490 1,113,716
---------------
2,138,723
---------------
Printing - 1.6%
Bowne & Co. 90,000 1,172,700
Ennis Business Forms 11,200 162,960
Moore Wallace (a) 39,600 581,328
New England Business Service 52,900 1,587,000
Schawk Cl. A 16,300 170,824
---------------
3,674,812
---------------
Transportation and Logistics - 2.2%
AirNet Systems (a) 196,000 793,800
Atlas Air Worldwide Holdings (a,c) 120,000 176,400
EGL (a) 42,100 639,920
Forward Air (a) 43,800 1,111,206
Frozen Food Express Industries (a) 227,500 718,900
Hawaiian Holdings (a) 75,000 63,750
Hub Group Cl. A (a) 6,500 57,070
Knight Transportation (a) 38,925 969,233
Patriot Transportation Holding (a) 28,400 800,596
---------------
5,330,875
---------------
Other Industrial Services - 0.1%
Team (a) 44,100 352,800
---------------
TOTAL (Cost $24,350,375) 28,830,143
===============
NATURAL RESOURCES - 8.6%
Energy Services - 2.7%
Carbo Ceramics 33,600 1,251,600
Dril-Quip (a) 42,700 777,140
GulfMark Offshore (a) 69,200 1,168,096
Input/Output (a) 193,500 1,041,030
Lufkin Industries 25,000 608,750
MarkWest Hydrocarbon (a) 15,200 115,672
NATCO Group Cl. A (a) 100,400 685,732
Valley National Gases (a) 30,100 179,095
Willbros Group (a) 55,900 580,801
---------------
6,407,916
---------------
Oil and Gas - 3.3%
BONAVISTA PETROLEUM (a) 71,000 2,010,990
Contango Oil & Gas Company (a) 50,000 204,500
Denbury Resources (a) 87,000 1,168,410
Evergreen Resources (a,c) 20,000 1,086,200
PETROCORP (a) 171,200 1,908,880
Prima Energy (a) 21,000 438,480
Toreador Resources (a) 2,300 6,923
Veritas DGC (a,c) 79,400 913,100
---------------
7,737,483
---------------
39
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
NATURAL RESOURCES (CONTINUED)
Precious Metals and Mining - 0.7%
Apex Silver Mines (a) 79,600 $ 1,174,100
Brush Engineered Materials (a) 15,500 129,425
MK Gold (a) 603,700 458,812
---------------
1,762,337
---------------
Real Estate - 1.9%
HOMEFED CORPORATION (a) 898,521 2,470,933
LIBERTE INVESTORS (a) 346,800 1,883,124
Stratus Properties (a) 11,000 102,905
---------------
4,456,962
---------------
TOTAL (Cost $10,827,234) 20,364,698
===============
TECHNOLOGY - 24.0%
Aerospace/Defense - 2.1%
Ducommun (a) 99,500 1,402,950
HEICO Corporation (c) 66,600 812,520
Herley Industries (a) 76,000 1,290,480
Integral Systems (a) 58,300 1,159,004
Mesaba Holdings (a) 51,600 318,372
SIFCO Industries (a) 45,800 92,058
---------------
5,075,384
---------------
Components and Systems - 5.0%
Advanced Photonix Cl. A (a) 455,200 409,680
CSP (a) 117,581 378,611
Concurrent Computer (a) 102,500 299,300
Del Global Technologies (a) 468,279 1,077,042
EXCEL TECHNOLOGY (a,c) 97,900 2,235,057
Intrusion (a) 75,000 56,250
Kronos (a) 20,750 1,054,308
Lantronix (a) 224,500 166,130
+Mobility Electronics (a,c) 90,000 364,500
MOCON 22,600 163,850
Newport Corporation (a) 45,000 666,000
OSI Systems (a) 20,000 321,200
Pemstar (a,c) 71,500 299,585
Performance Technologies (a) 24,750 180,675
Printronix (a) 45,300 507,360
Rainbow Technologies (a) 181,500 1,526,415
Read-Rite (a) 1,000 65
REMEC (a,c) 182,500 1,270,200
Spectrum Control (a) 12,500 70,250
TransAct Technologies (a) 68,200 827,266
---------------
11,873,744
---------------
Distribution - 1.8%
Bell Industries (a) 85,700 185,969
Daisytek International (a) 40,300 2,821
Jaco Electronics (a) 38,000 183,882
Nu Horizons Electronics (a) 40,000 240,000
PC Connection (a) 5,000 34,000
Pioneer-Standard Electronics 90,000 763,200
Plexus Corporation (a) 83,000 956,990
Pomeroy IT Solutions (a) 31,100 343,966
RICHARDSON ELECTRONICS 206,600 1,673,460
---------------
4,384,288
---------------
Internet Software and Services - 1.5%
Convera Corporation (a,c) 33,200 132,136
CyberSource Corporation (a) 86,000 235,640
Digitas (a) 50,500 250,480
Lionbridge Technologies (a,c) 37,500 190,875
Overstock.com (a,c) 37,000 536,870
RealNetworks (a,c) 65,700 445,446
Register.com (a) 84,000 492,240
Stamps.com (a) 170,000 816,000
United Online (a,c) 15,000 380,100
---------------
3,479,787
---------------
IT Services - 4.6%
CACI International Cl. A (a) 10,000 343,000
CIBER (a) 220,000 1,544,400
Computer Task Group (a) 341,100 968,724
Covansys Corporation (a) 242,500 744,475
DiamondCluster International Cl. A (a) 280,000 1,038,800
DynTek Cl. A (a) 224,000 179,200
FORRESTER RESEARCH (a) 105,500 1,725,980
SAPIENT CORPORATION (a) 995,000 2,756,150
Syntel (a) 81,000 1,274,130
Technology Solutions (a) 50,000 50,000
Tier Technologies Cl. B (a) 40,500 313,875
---------------
10,938,734
---------------
Semiconductors and Equipment - 2.0%
August Technology (a) 72,000 457,200
California Micro Devices (a) 25,000 53,750
Exar Corporation (a,c) 68,500 1,084,355
FSI International (a) 34,500 134,550
GlobespanVirata (a) 14,000 115,500
Helix Technology 9,500 125,685
Inficon Holding ADR (a,b) 10,000 64,500
Intevac (a) 114,050 766,416
Oak Technology (a,c) 20,000 124,200
PDF Solutions (a) 25,000 288,750
Photronics (a) 29,750 519,138
+Pixelworks (a,c) 36,000 213,840
Semitool (a) 50,500 248,965
Teradyne (a) 13,604 235,485
Xicor (a) 35,000 219,450
---------------
4,651,784
---------------
Software - 3.8%
ANSYS (a) 15,400 478,940
Aladdin Knowledge Systems (a) 27,300 103,494
Applix (a,c) 20,000 32,000
+AsiaInfo Holdings (a,c) 67,000 549,400
Aspen Technology (a,c) 22,000 105,600
Chordiant Software (a) 160,000 297,600
ILOG ADR (a,b,c) 35,000 292,950
Indus International (a) 144,800 290,903
JDA Software Group (a) 110,500 1,236,495
Lightspan (a) 480,000 325,440
MSC.Software (a,c) 63,700 429,338
PLATO Learning (a) 70,000 402,500
Retek (a) 25,000 160,000
SCB Computer Technology (a) 50,000 80,000
SPSS (a) 91,900 1,538,406
Transaction Systems Architects Cl. A (a) 155,100 1,389,696
Verity (a) 95,000 1,202,700
---------------
8,915,462
---------------
40
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
SHARES VALUE
------ -----
TECHNOLOGY (CONTINUED)
Telecommunication - 3.2%
ADC Telecommunications (a,c) 100,000 $ 232,800
Allegiance Telecom (a,c) 790,000 43,450
Anaren (a,c) 123,000 1,152,510
Brooktrout (a) 28,400 220,441
C-COR.net (a,c) 5,000 24,500
Captaris (a) 30,000 102,600
Centillium Communications (a) 24,000 237,840
Computer Access Technology (a) 48,000 156,000
Computer Network Technology (a,c) 20,000 162,000
Giga-tronics (a) 3,200 5,536
ITXC Corporation (a) 36,000 93,960
Interland (a) 25,000 24,500
Level 3 Communications (a,c) 84,300 559,752
Liberty Satellite & Technology Cl. A (a) 118,200 307,320
MetaSolv (a,c) 44,100 86,436
Optical Communication Products Cl. A (a) 220,300 396,540
PC-Tel (a) 31,100 368,846
Radyne ComStream (a) 65,000 132,600
Somera Communications (a,c) 132,900 194,034
SpectraLink Corporation (a) 132,000 1,304,160
Tollgrade Communications (a,c) 20,000 373,000
ViaSat (a) 98,200 1,408,188
--------------
7,587,013
--------------
TOTAL (Cost $51,202,632) 56,906,196
==============
MISCELLANEOUS - 2.9%
TOTAL (Cost $5,766,793) 6,896,550
==============
TOTAL COMMON STOCKS
(Cost $170,788,010) 220,210,760
==============
PREFERRED STOCKS - 0.5%
Angelo and Maxie's 10.00% Conv. 6,991 $ 16,079
SENECA FOODS CONV. (a) 75,409 1,025,562
--------------
TOTAL PREFERRED STOCKS
(Cost $957,998) 1,041,641
==============
PRINCIPAL
AMOUNT
---------
U.S. TREASURY OBLIGATIONS - 2.1%
U.S Treasury Notes
+1.875%, due 9/30/04 $5,000,000 5,049,220
--------------
TOTAL U.S. TREASURY OBLIGATIONS
(Cost $5,010,808) 5,049,220
==============
REPURCHASE AGREEMENT - 4.6%
State Street Bank & Trust Company,
0.30% dated 6/30/03, due 7/1/03,
maturity value $10,850,090
(collateralized by U.S. Treasury Bonds,
8.50% due 2/15/20, valued at
$11,063,754)
(Cost $10,850,000) 10,850,000
==============
TOTAL INVESTMENTS - 100.0%
(Cost $187,606,816) 237,151,621
LIABILITIES LESS CASH
AND OTHER ASSETS (427,603)
PREFERRED STOCK (40,000,000)
---------------
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS $196,724,018
==============
--------------------------------------------------------------------------------
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 $7,992,197.
d Securities for which market quotations are no longer readily available
represent 1.06% of net assets. These securities have been valued at
their fair value under procedures established by the Fund's Board of
Directors.
+ 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 $188,619,900. At June 30, 2003, net unrealized appreciation for all
securities was $48,531,721, consisting of aggregate gross unrealized
appreciation of $65,691,964 and aggregate gross unrealized depreciation of
$17,160,243. 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.
41
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
ASSETS:
Investments at value (identified cost $176,756,816) $226,301,621
Repurchase agreement (at cost and value) 10,850,000
Cash 624
Collateral from brokers on securities loaned 8,369,427
Receivable for investments sold 126,725
Receivable for dividends and interest 70,652
Prepaid expenses 9,686
--------------------------------------------------------------------------------
Total Assets 245,728,735
--------------------------------------------------------------------------------
LIABILITIES:
Payable for collateral on securities loaned 8,369,427
Payable for investments purchased 194,112
Payable for investment advisory fee 278,115
Preferred dividends accrued but not yet declared 68,887
Accrued expenses 94,176
--------------------------------------------------------------------------------
Total Liabilities 9,004,717
--------------------------------------------------------------------------------
PREFERRED STOCK:
7.75% Cumulative Preferred Stock -- $0.001 par value,
$25 liquidation value per share; 1,600,000 shares outstanding 40,000,000
--------------------------------------------------------------------------------
Total Preferred Stock 40,000,000
================================================================================
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS $196,724,018
================================================================================
ANALYSIS OF NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS:
Par value of Common Stock -- $0.001 per share; 18,540,334
shares outstanding (150,000,000 shares authorized) $ 18,540
Additional paid-in capital 142,059,397
Accumulated net investment loss (1,199,081)
Accumulated net realized gain on investments 16,392,806
Net unrealized appreciation on investments 49,544,805
Quarterly and accrued distributions (10,092,449)
--------------------------------------------------------------------------------
Net Assets applicable to Common Stockholders
(net asset value per share -- $10.61) $196,724,018
================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
42
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
STATEMENT OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2003 (UNAUDITED)
--------------------------------------------------------------------------------
INVESTMENT INCOME:
Income:
Dividends $ 402,854
Interest 72,794
--------------------------------------------------------------------------------
Total income 475,648
--------------------------------------------------------------------------------
Expenses:
Investment advisory fees 1,658,923
Custody and transfer agent fees 61,256
Stockholder reports 48,061
Professional fees 30,077
Directors' fees 26,132
Administrative and office facilities expenses 16,672
Other expenses 33,608
--------------------------------------------------------------------------------
Total expenses 1,874,729
Fees waived by investment advisor (200,000)
--------------------------------------------------------------------------------
Net expenses 1,674,729
--------------------------------------------------------------------------------
Net investment loss (1,199,081)
--------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments 12,706,206
Net change in unrealized appreciation on investments 21,690,144
--------------------------------------------------------------------------------
Net realized and unrealized gain on investments 34,396,350
--------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM INVESTMENT OPERATIONS 33,197,269
================================================================================
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS (1,550,000)
================================================================================
NET INCREASE IN NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS
RESULTING FROM INVESTMENT OPERATIONS $ 31,647,269
================================================================================
STATEMENTS OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
Six months ended Year ended
June 30, 2003 December 31,
(unaudited) 2002
---------------- -------------
INVESTMENT OPERATIONS:
Net investment loss $ (1,199,081) $ (2,363,582)
Net realized gain on investments 12,706,206 16,747,557
Net change in unrealized appreciation
on investments 21,690,144 (38,936,315)
--------------------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from investment operations 33,197,269 (24,552,340)
--------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS:
Net investment income - -
Net realized gain on investments - (3,100,000)
Quarterly distributions* (1,550,000) -
--------------------------------------------------------------------------------
Total distributions to Preferred
Stockholders (1,550,000) (3,100,000)
--------------------------------------------------------------------------------
NET INCREASE (DECREASED) IN NET ASSETS
APPLICABLE TO COMMON STOCKHOLDERS
RESULTING FROM INVESTMENT OPERATIONS 31,647,269 (27,652,340)
================================================================================
DISTRIBUTIONS TO COMMON STOCKHOLDERS:
Net investment income - -
Net realized gain on investments - (13,769,198)
Quarterly distributions* (8,473,560) -
--------------------------------------------------------------------------------
Total distributions to Common
Stockholders (8,473,560) (13,769,198)
--------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Reinvestment of distributions to Common
Stockholders 5,979,130 8,549,592
--------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
APPLICABLE TO COMMON STOCKHOLDERS: 29,152,839 (32,871,946)
NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS:
Beginning of period 167,571,179 200,443,125
--------------------------------------------------------------------------------
End of period (including accumulated net
investment loss of $1,199,081 in 2003) $196,724,018 $167,571,179
================================================================================
*To be allocated to net investment income and capital gains at year-end.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
43
ROYCE MICRO-CAP 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,
Six months ended --------------------------------------------------------
June 30, 2003
(unaudited) 2002 2001 2000 1999 1998
-------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF
PERIOD $9.39 $11.83 $10.14 $11.00 $10.06 $10.84
-------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS:
Net investment income (loss) (0.06) (0.13) (0.05) 0.09 0.12 0.13
Net realized and unrealized
gain (loss) on investments 1.87 (1.29) 2.57 1.23 1.35 (0.36)
-------------------------------------------------------------------------------------------------------------
Total investment operations 1.81 (1.42) 2.52 1.32 1.47 (0.23)
-------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO PREFERRED
STOCKHOLDERS:
Net investment income - - - (0.01) (0.05) (0.06)
Net realized gain on investments - (0.18) (0.19) (0.22) (0.18) (0.18)
Quarterly distributions* (0.09) - - - - -
-------------------------------------------------------------------------------------------------------------
Total distributions to
Preferred Stockholders (0.09) (0.18) (0.19) (0.23) (0.23) (0.24)
-------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN
NET ASSETS APPLICABLE TO
COMMON STOCKHOLDERS RESULTING
FROM INVESTMENT OPERATIONS 1.72 (1.60) 2.33 1.09 1.24 (0.47)
-------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS TO COMMON
STOCKHOLDERS:
Net investment income - - - (0.09) (0.06) (0.07)
Net realized gain on investments - (0.80) (0.57) (1.63) (0.21) (0.22)
Quarterly distributions* (0.47) - - -- - - -
-------------------------------------------------------------------------------------------------------------
Total distributions to Common
Stockholders (0.47) (0.80) (0.57) (1.72) (0.27) (0.29)
-------------------------------------------------------------------------------------------------------------
CAPITAL STOCK TRANSACTIONS:
Effect of reinvestment of
distributions by Common
Stockholders (0.03) (0.04) (0.07) (0.23) (0.03) (0.02)
-------------------------------------------------------------------------------------------------------------
Total capital stock
transactions (0.03) (0.04) (0.07) (0.23) (0.03) (0.02)
-------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $10.61 $9.39 $11.83 $10.14 $11.00 $10.06
=============================================================================================================
MARKET VALUE, END OF PERIOD $9.77 $8.44 $10.50 $8.625 $9.00 $8.875
=============================================================================================================
TOTAL RETURN (a):
Market Value 22.2%*** (12.7)% 28.8% 15.3% 4.5% (9.4)%
Net Asset Value 19.3%*** (13.8)% 23.4% 10.9% 12.7% (4.1)%
RATIOS BASED ON AVERAGE NET ASSETS
APPLICABLE TO COMMON STOCKHOLDERS:
Total expenses (b,c) 1.98%** 1.96% 1.78% 1.32% 1.27% 1.18%
Management fee expense 1.72%** 1.59% 1.57% 1.08% 0.91% 0.80%
Other operating expenses 0.26%** 0.37% 0.21% 0.24% 0.36% 0.38%
Net investment income (loss) (1.42)%** (1.23)% (0.43)% 0.74% 1.20% 1.21%
SUPPLEMENTAL DATA:
Net Assets Applicable to
Common Stockholders,
End of Period (in thousands) $196,724 $167,571 $200,443 $163,820 $151,269 $135,495
Liquidation Value
of Preferred Stock,
End of Period (in thousands) $40,000 $40,000 $40,000 $40,000 $40,000 $40,000
Portfolio Turnover Rate 11% 39% 27% 49% 49% 44%
PREFERRED STOCK:
Total shares outstanding 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000
Asset coverage per share $147.95 $129.73 $150.28 $127.39 $119.54 $109.68
Liquidation preference per share $25.00 $25.00 $25.00 $25.00 $25.00 $25.00
Average market value per share (d) $25.90 $25.91 $25.30 $23.08 $24.67 $25.40
=============================================================================================================
(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
1.60%, 1.62%, 1.46%, 1.06%, 0.98% and 0.92% 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 2.21%, 2.04%, 1.81%, 1.44% and 1.24% for the periods ended June 30,
2003 and December 31, 2002, 2001, 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.
44
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Royce Micro-Cap Trust, Inc. (the "Fund") was incorporated under the laws of
the State of Maryland on September 9, 1993 as a diversified closed-end
investment company. The Fund commenced operations on December 14, 1993.
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:
The Fund currently has a policy of paying quarterly distributions on the
Fund's Common Stock. Distributions are currently being made at the annual rate
of 9% of the rolling average of the prior four calendar quarter-end NAVs of
the Fund's Common Stock, with the fourth quarter distribution being the
greater of 2.25% of the rolling average or the distribution required by IRS
regulations. 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.
45
ROYCE MICRO-CAP TRUST, INC.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
CAPITAL STOCK:
The Fund currently has 1,600,000 shares of 7.75% 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 698,276 and 896,290 shares of Common Stock as reinvestment
of distributions by Common Stockholders for the periods ended June 30, 2003
and December 31, 2002, respectively.
INVESTMENT ADVISORY AGREEMENT:
As compensation for its services under the Investment Advisory Agreement,
Royce & Associates, LLC ("Royce") receives a fee comprised of a Basic Fee
("Basic Fee") and an adjustment to the Basic Fee based on the investment
performance of the Fund in relation to the investment record of the Russell
2000.
The Basic Fee is a monthly fee equal to 1/12 of 1% (1% on an annualized
basis) of the average of the Fund's month-end net assets applicable to Common
Stockholders plus the liquidation value of Preferred Stock for the rolling
36-month period ending with such month. The Basic Fee for each month is
increased or decreased at the rate of 1/12 of .05% for each percentage point
that the investment performance of the Fund exceeds, or is exceeded by, the
percentage change in the investment record of the Russell 2000 for the
performance period by more than two percentage points. The performance period
for each such month is a rolling 36-month period ending with such month. The
maximum increase or decrease in the Basic Fee for any month may not exceed
1/12 of .5%. Accordingly, for each month, the maximum monthly fee rate as
adjusted for performance is 1/12 of 1.5% and is payable if the investment
performance of the Fund exceeds the percentage change in the investment record
of the Russell 2000 by 12 or more percentage points for the performance
period, and the minimum monthly fee rate as adjusted for performance is 1/12
of .5% and is payable if the percentage change in the investment record of the
Russell 2000 exceeds the investment performance of the Fund by 12 or more
percentage points for the performance period.
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 $1,458,923, which is net of $200,000 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 $22,799,895 and $34,025,558, respectively.
TRANSACTIONS IN SHARES OF AFFILIATED COMPANIES:
An "Affiliated Company", as defined in the Investment Company Act of 1940,
is a company in which a Fund owns 5% or more of the company's outstanding
voting securities. The Fund effected the following transactions in shares of
such companies during the six months ended June 30, 2003:
==================================================================================================================
Purchases Sales
------------- ---------------
Affiliated Company Shares Cost Shares Cost Realized Gain (Loss) Dividend Income
------------------ ------ ---- ------ ---- -------------------- ---------------
Technical Communications -- -- 96,700 $108,304 $(61,331) --
==================================================================================================================
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.
46