<PAGE>
THE
ROYCE
FUNDS
Value Investing In Small Companies For 25 Years
ROYCE
SPECIAL
EQUITY
FUND
1998 Semi-Annual Report
<PAGE>
SEMI-ANNUAL REPORT REFERENCE GUIDE
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LETTER TO SHAREHOLDERS 2-3
An Introduction to Royce Special Equity Fund
PORTFOLIO DIAGNOSTICS 4
An X-Ray of the Portfolio
SCHEDULES OF INVESTMENTS AND OTHER FINANCIAL STATEMENTS 5-9
[PULL QUOTE]
For over 25 years, our value approach has focused on evaluating a company's
"private worth" - what we believe an enterprise would sell for in a private
transaction between rational and well-informed parties. This requires a
thorough analysis of the financial and operating dynamics of a business, as
though we were purchasing the entire company. The price we will pay for a
security must be significantly lower than our appraisal of its private worth.
[END PULL QUOTE]
<PAGE>
LETTER TO SHAREHOLDERS
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Dear Fellow Shareholders:
It gives me great pleasure to write this inaugural report for Royce
Special Equity Fund (RSE). In an interesting coincidence, RSE shares its
inception date of May 1st with the first mutual fund that I managed - Quest
for Value Fund - which was launched in 1980.
RSE uses an intensely disciplined value approach to invest in small and
micro-cap companies. The approach traces its roots to the teachings of the
late Benjamin Graham and Abraham Briloff and combines classic value analysis
with accounting cynicism. The objective is to invest in companies whose
profile among investors is low. We believe that this helps to ensure that a
company's price will be significantly lower than our assessment of its
economic value at the time of purchase. We want to buy $100 bills selling at
substantial discounts. The goal is to find good businesses selling at low
prices.
Our process, which has evolved over the years, involves carefully
screening databases for signs of pricing inefficiencies through the use of
various financial ratios. Candidates selected from these screens are further
analyzed, through the careful scrutiny of the companies' SEC filings, to gain
insight into management and to provide an overall comfort level with the
business. Companies that pass the first two levels of examination then go
through traditional security analysis. The critical steps, however, lie in
the screening process and in the painstaking review of the SEC filings. This
is where I believe we distinguish ourselves.
I have been using this disciplined method for over 20 years. In fact, it
was in the '70s, during my early "quest" for attractive businesses with high
returns on assets at inexpensive prices, that I first met Chuck Royce. We
soon discovered that we shared common investment principles. My true
appreciation for his investment passion, however, manifested itself in 1987 on
a trip to Australia and New Zealand. Chuck and I had each been chosen to be
managers for a fund of funds for Australian and New Zealand investors. I was
managing portfolios at Lazard Freres Asset Management at the time. For two
weeks we traveled together, including a fair amount of "R&R." Though our
entourage was fairly large, Chuck and I always seemed to be bumping into each
other. We would meet not on the golf course or the tennis courts, but at the
newsstand searching for a newspaper covering U.S. financial news, or at the
front desk faxing buy and sell instructions to our respective offices.
Chuck's intense dedication to the business convinced me that we were quite
similar. Therefore, it came as little surprise that when I decided to make my
second career change in 30 years, it would be to join Chuck at Royce &
Associates. I am delighted to have become a member of the Royce team.
Although the period covered in this report is brief - May 1 through June
30, 1998 - it has been consistent with my past experiences. We cannot
guarantee future results, although you should know what to expect from us.
While we invest in small-cap and micro-cap companies, an area that is
generally riskier than investing in larger-cap companies, our investment
approach is designed to result in a more conservative risk profile because we
focus on companies for whom expectations, and therefore valuations, are low.
To para-
<PAGE>
phrase Will Rogers, while we are mindful of the return we earn on your money,
we know that you are mindful of the return of your money.
Of possible significance, particularly to new RSE shareholders, are the
portfolio's diagnostics. While a list of the companies can be found in the
Schedule of Investments, more insight may be gained from an overview of the
portfolio's characteristics and a comparison to the small-cap oriented Russell
2000 - what we call the portfolio "x-ray." Not only is the portfolio
inexpensively priced in our opinion, but it also possesses very attractive
financial attributes, such as low leverage and high return on assets.
In the future, we will elaborate on some of the x-ray's attributes. The
first one we will focus on is "Current Assets Less All Liabilities as % of
Market Price." This refers to net-net working capital per share. A weighted
average calculation of 34.2% for the portfolio means that this percentage of
the companies' weighted average share prices are represented by cash plus
inventories and receivables less all liabilities. This is a measure advocated
by Ben Graham, one of the ratios he used in determining "a margin of safety"
for the companies in which he invested. One way of viewing this statistic -
if you bought a company at its market price, how much would be available to
the buyer, from current assets, after paying all obligations? Some believe,
ourselves included, that a high net-net ratio may provide a financial anchor
during market turbulence.
I am very enthusiastic about the portfolio, as well as the introduction
of this new Royce offering. I appreciate your confidence and look forward to
our continuing dialogue.
Sincerely,
/s/ Charlie
Charlie Dreifus
Senior Portfolio Manager
July 20, 1998
NOTES TO PERFORMANCE AND RISK INFORMATION
All performance information is presented on a total return basis. Past
performance is no guarantee of future results. Investment return and
principal value will fluctuate so that shares may be worth more or less than
their original cost when redeemed. Royce Special Equity Fund invests in small
and micro-cap companies that may involve considerably more risk than
investments in securities of larger-cap companies (see "Investment Risks" in
the prospectus). This report is not authorized for distribution unless
preceded or accompanied by a current prospectus. Please read the prospectus
carefully before sending money.
The Russell 2000 is an unmanaged index of small-cap domestic common stocks.
<PAGE>
PORTFOLIO DIAGNOSTICS
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ROYCE SPECIAL EQUITY FUND "X-RAY"
As of June 30, 1998
<TABLE>
<CAPTION>
Royce Special Russell
Equity Fund* 2000**
- --------------------------------------------------------------------------------------
<S> <C> <C>
Performance From Inception Date of 5/1/98 (not annualized)+ -1.0% -5.6%
Net Assets+ $2.4 million NA
Trailing 12 Months Price/Earnings 13.5x 23.9x
Enterprise Value/Earnings Before Interest and Taxes 7.9x 15.7x
Enterprise Value/Earnings Before Interest, Taxes,
Depreciation and Amortization 6.4x 11.3x
Price/Book 1.9x 3.2x
Yield 1.9% 1.4%
Return on Equity 14.1% 11.2%
Return on Assets 10.2% 5.1%
Total Assets Financed by Other Than Equity 27.0% 57.4%
Current Assets Less All Liabilities as % of Market Price 34.2% -16.6%
Cash as % of Market Price 19.1% 11.4%
Average Market Capitalization $201 million $956 million
</TABLE>
Source: Prudential Securities Inc. - Small-Cap Quantitative Research (except
where noted)
* Portfolio Weighted
** Market Capitalization Weighted
+ Source: Royce & Associates
Top 10 Positions % of Net Assets
- -------------------------------------------
Liqui-Box Corporation 4.7%
The L.S. Starrett Company Cl. A 4.5
National Presto Industries 4.5
Garan Incorporated 4.3
Superior Uniform Group 4.3
Ampco-Pittsburgh Corporation 4.1
Lawson Products 4.0
TSI Incorporated 4.0
Value Line 3.9
Lifetime Hoan Corporation 3.9
Top Portfolio Industries % of Net Assets
- ---------------------------------------------
Apparel and Shoes 13.3%
Home Furnishings/Appliances 10.9
Building Systems and Components 8.8
Industrial Distribution 7.6
Other Industrial Products 7.3
Commercial Services 5.0
Construction Materials 4.7
Paper and Packaging 4.7
See the Schedule of Investments for a complete list of portfolio holdings.
<PAGE>
SCHEDULE OF INVESTMENTS June 30, 1998 (unaudited)
- -----------------------------------------------------------------------------
COMMON STOCKS - 90.6%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products - 32.5%
Apparel and Shoes - 13.3%
R. G. Barry Corporation* 5,500 $ 90,750
Garan Incorporated 3,900 105,788
Superior Uniform Group 6,500 105,625
Weyco Group 900 23,512
-----------
325,675
-----------
Home Furnishings/Appliances - 10.9%
Chromcraft Revington* 3,500 63,438
Lifetime Hoan Corporation 9,500 95,000
National Presto Industries 2,800 109,025
-----------
267,463
-----------
Sports and Recreation - 3.8%
Allen Organ Company Cl. B 2,300 92,575
-----------
Other Consumer Products - 4.5%
The L. S. Starrett Company Cl. A 2,800 110,600
-----------
796,313
-----------
Consumer Services - 1.4%
Retail - 1.4%
Deb Shops 4,000 34,500
-----------
Financial Services - 3.9%
Information and Processing - 3.9%
Value Line 2,500 95,625
-----------
Health - 2.5%
Personal Care - 2.5%
Jean-Philippe Fragrances* 7,500 60,469
-----------
Industrial Products - 34.8%
Building Systems and Components - 8.8%
Ampco-Pittsburgh Corporation 6,500 99,937
Thor Industries 2,500 69,219
Twin Disc, Incorporated 1,500 45,375
-----------
214,531
-----------
Construction Materials - 4.7%
Florida Rock Industries 1,100 32,106
Republic Group 4,000 84,000
-----------
116,106
-----------
Industrial Components - 1.2%
Standex International Corporation 1,000 29,625
-----------
Paper and Packaging - 4.7%
Liqui-Box Corporation 2,400 113,700
-----------
Pumps, Valves and Bearings - 3.7%
Gorman-Rupp Company 2,500 45,313
Met-Pro Corporation 3,000 44,812
-----------
90,125
-----------
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Specialty Chemicals and Materials - 3.3%
Aceto Corporation 5,000 $ 81,250
-----------
Textiles - 1.1%
Fab Industries 1,000 27,875
-----------
Other Industrial Products - 7.3%
Farr Company* 3,000 36,938
O'Sullivan Corporation 4,500 43,875
TSI Incorporated 12,000 97,500
-----------
178,313
-----------
851,525
-----------
Industrial Services - 15.5%
Commercial Services - 5.0%
Harding Lawson Associates Group* 5,500 49,844
LCS Industries 5,000 73,125
-----------
122,969
-----------
Food/Tobacco Processors - 2.9%
Farmer Bros. 300 71,700
-----------
Industrial Distribution - 7.6%
Lawson Products 3,800 97,850
Mine Safety Appliances Company 300 22,500
NCH Corporation 1,000 64,062
-----------
184,412
-----------
379,081
-----------
TOTAL COMMON STOCKS
(Cost $2,222,513) 2,217,513
-----------
REPURCHASE AGREEMENT - 8.2%
State Street Bank and Trust Company,
5.15% dated 6/30/98, due 7/01/98,
maturity value $200,029 (collateralized
by U.S. Treasury Notes, 5.875% due
2/15/00, valued at $205,257)
(Cost $200,000) 200,000
-----------
TOTAL INVESTMENTS - 98.8%
(Cost $2,422,513) 2,417,513
CASH AND OTHER ASSETS
LESS LIABILITIES - 1.2% 28,327
-----------
NET ASSETS - 100.0% $ 2,445,840
-----------
</TABLE>
* Non-income producing.
Income Tax Information - The cost of total investments for federal income
tax purposes was $2,422,513. At June 30, 1998, net unrealized depreciation
for all securities was $5,000, consisting of aggregate gross unrealized
appreciation of $57,932 and aggregate gross unrealized depreciation of
$62,932.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES AT JUNE 30, 1998 (unaudited)
- ------------------------------------------------------------------------------
ASSETS:
Investments at value (identified cost $2,222,513) $ 2,217,513
Repurchase agreement (at cost and value) 200,000
Cash 96,394
Receivable for capital shares sold 9,316
Receivable for dividends and interest 973
Prepaid expenses and other assets 4,021
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Total Assets 2,528,217
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LIABILITIES:
Payable for investments purchased 77,697
Accrued expenses 4,680
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Total Liabilities 82,377
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Net Assets $ 2,445,840
==============================================================================
ANALYSIS OF NET ASSETS:
Net investment loss $ (476)
Net unrealized depreciation on investments (5,000)
Capital shares 247
Additional paid-in capital 2,451,069
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Net Assets $ 2,445,840
==============================================================================
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized) 247,096
==============================================================================
NET ASSET VALUE (Net Assets / Shares Outstanding):
(offering and redemption price* per share) $9.90
==============================================================================
* Shares redeemed within one year of purchase are subject to a 1% redemption
fee, payable to the Fund.
- ------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
- ------------------------------------------------------------------------------
Period ended
June 30, 1998 (a)
INVESTMENT OPERATIONS: (unaudited)
-----------
Net investment loss $ (476)
Net change in unrealized depreciation on investments (5,000)
- ------------------------------------------------------------------------------
Net decrease in net assets from investment operations (5,476)
- ------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income --
Net realized gain on investments --
- ------------------------------------------------------------------------------
Total dividends and distributions --
- ------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold 2,451,316
Distributions reinvested --
Cost of shares redeemed --
- ------------------------------------------------------------------------------
Net increase in net assets from capital share transactions 2,451,316
- ------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS 2,445,840
NET ASSETS:
Beginning of period --
- ------------------------------------------------------------------------------
End of period (including net investment loss of $476) $ 2,445,840
==============================================================================
CAPITAL SHARE TRANSACTIONS:
Shares sold 247,096
Shares issued for reinvestment of distributions --
Shares redeemed --
- ------------------------------------------------------------------------------
Net increase in shares outstanding 247,096
- ------------------------------------------------------------------------------
(a) The Fund commenced operations on May 1, 1998.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
<PAGE>
STATEMENT OF OPERATIONS FOR THE PERIOD ENDED JUNE 30, 1998 (unaudited)
- ------------------------------------------------------------------------------
INVESTMENT INCOME:
Income:
Dividends $4,341
Interest 29
- ------------------------------------------------------------------------------
Total Income 4,370
- ------------------------------------------------------------------------------
Expenses:
Investment advisory fees 3,252
Custodian fees 2,112
Shareholder servicing fees 1,311
Audit fees 1,250
Trustees' fees 85
Administrative and office facilities expenses 56
Legal fees 6
Other expenses 160
- ------------------------------------------------------------------------------
Total Expenses 8,232
Fees Waived by Investment Adviser (3,252)
Expenses Reimbursed by Investment Adviser (134)
- ------------------------------------------------------------------------------
Net Expenses 4,846
- ------------------------------------------------------------------------------
Net Investment Loss (476)
- ------------------------------------------------------------------------------
REALIZED AND UNREALIZED LOSS ON INVESTMENTS:
Net change in unrealized depreciation on investments (5,000)
- ------------------------------------------------------------------------------
Net realized and unrealized loss on investments (5,000)
- ------------------------------------------------------------------------------
NET DECREASE IN NET ASSETS FROM INVESTMENT OPERATIONS ($5,476)
==============================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
- ------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- ------------------------------------------------------------------------------
This table is presented to show selected data for a share outstanding
throughout the period, and to assist shareholders in evaluating the Fund's
performance for the period presented.
==============================================================================
Period ended
June 30, 1998
(Unaudited)
-----------
Net Asset Value, Beginning of Period $10.00
Investment Operations:
Net investment loss --
Net realized and unrealized loss on investments (0.10)
- ------------------------------------------------------------------------------
Total from investment operations (0.10)
- ------------------------------------------------------------------------------
Dividends and Distributions:
Net investment income --
Net realized gain on investments --
- ------------------------------------------------------------------------------
Total dividends and distributions --
- ------------------------------------------------------------------------------
Net Asset Value, End of Period $9.90
==============================================================================
Total Return: -1.0%
==============================================================================
Ratios Based on Average Net Assets:
Total expenses (a) 1.49% *
Net investment loss -0.15% *
Supplemental Data:
Net Assets, End of Period (in thousands) $2,446
Portfolio Turnover Rate 0%
Average Commission Rate Paid $0.0631
(a) Expense ratios are shown after fee waivers and expense
reimbursements by the investment adviser. For the period
ended June 30, 1998, the expense ratio before the waivers
and reimbursements would have been 2.53%. The Fund commenced
operations on May 1, 1998.
* Annualized.
<PAGE>
Notes to Financial Statements (unaudited)
- ------------------------------------------------------------------------------
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Royce Special Equity Fund (the "Fund") is a series of The Royce Fund
(the "Trust"), a diversified open-end management investment company organized
as a Delaware business trust. The Fund commenced operations on May 1, 1998.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of 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
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 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 and supervised by the Board
of Trustees. 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 and unrealized appreciation and depreciation 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 one or more Royce Funds are allocated in an equitable manner.
Allocated personnel costs of employees of The Royce Funds are included in
administrative and office facilities expenses.
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".
<PAGE>
Notes to Financial Statements (unaudited) (continued)
- ------------------------------------------------------------------------------
Distributions:
Any dividend and capital gain distributions are recorded on the ex-
dividend date and paid annually in December. These distributions are
determined in accordance with income tax regulations which may differ from
generally accepted accounting principles. Permanent book and tax basis
differences relating to shareholder 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 at
fiscal year end is distributable in the following year.
Repurchase agreements:
The Fund enters into repurchase agreements with respect to portfolio
securities solely with State Street Bank and Trust Company ("SSB&T"), the
custodian of the Fund's 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 its underlying
securities.
Organizational expenses:
Costs incurred by the Fund in connection with its organization and
initial registration of shares of $4,160 have been deferred and are being
amortized on a straight-line basis over a five-year period from the date of
commencement of operations.
INVESTMENT ADVISER:
Under the Trust's investment advisory agreements with Royce &
Associates, Inc., ("Royce"), Royce is entitled to receive a monthly fee at an
annual rate of 1.0% of the average net assets of Royce Special Equity Fund.
For the period ended June 30, 1998, Royce voluntarily waived advisory fees of
$3,252.
PURCHASES AND SALES OF INVESTMENT SECURITIES:
For the period ended June 30, 1998, the cost of purchases and the
proceeds from sales of investment securities, other than short-term
securities, were as follows:
Royce Special Equity Fund
-------------------------
Purchases $2,222,513
Sales $ 0
