<PAGE> 1
======================================LOGO=====================================
LONGLEAF PARTNERS FUNDS
ANNUAL REPORT
at December 31, 1997
PARTNERS FUND
REALTY FUND
SMALL-CAP FUND
================================================================================
MANAGED BY:
SOUTHEASTERN ASSET MANAGEMENT, INC.
Memphis, TN
<PAGE> 2
CONTENTS
<TABLE>
<S> <C>
Letter to Shareholders..................................... 2
Longleaf Partners Fund (Partners Fund)
Performance History...................................... 6
Portfolio Summary........................................ 7
Portfolio Investments.................................... 8
Management Discussion and Analysis....................... 10
Performance Contributions................................ 13
Financial Reports and Footnotes.......................... 30
Financial Highlights..................................... 42
Longleaf Partners Realty Fund (Realty Fund)
Performance History...................................... 14
Portfolio Summary........................................ 15
Portfolio Investments.................................... 16
Management Discussion and Analysis....................... 18
Performance Contributions................................ 21
Financial Reports and Footnotes.......................... 30
Financial Highlights..................................... 42
Longleaf Partners Small-Cap Fund (Small-Cap Fund)
Performance History...................................... 22
Portfolio Summary........................................ 23
Portfolio Investments.................................... 24
Management Discussion and Analysis....................... 26
Performance Contributions................................ 28
Financial Reports and Footnotes.......................... 30
Financial Highlights..................................... 42
Report of Independent Accountants.......................... 29
Service Directory.......................................... 44
Trustees and Officers...................................... 45
</TABLE>
<PAGE> 3
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
LETTER TO SHAREHOLDERS
TO OUR SHAREHOLDERS:
Report Card for 1997
We are pleased to report that 1997 marked another auspicious year of compounding
capital for the Longleaf Partners family of mutual funds. The increases in the
three Funds' net asset values were: Partners Fund up 28.3%; Realty Fund up
29.7%; and, Small-Cap Fund up 29.0%. Each Fund's return significantly exceeded
Southeastern Asset Management's long-term record and, with the exception of the
Partners Fund, outperformed its benchmark index. Furthermore, with inflation
quiescent, our investing partners saw their portfolios make material progress on
a real basis. The Partners and Small-Cap Funds continue to receive Morningstar's
highest "*****" rating while the Realty Fund, too young to be rated, remains one
of the top real estate funds since its inception.
Your Funds continue to operate more efficiently. The overall expense ratios
declined from: .95% to .94% in the Partners Fund, 1.50% to 1.20% in the Realty
Fund, and 1.23% to 1.09% in the Small-Cap Fund.
Pricing vs. Timing
Over the past few years many of you have asked why we have held cash reserves
and why cash levels have varied so markedly among the three Longleaf Funds.
These inquiries have the benefit of hindsight and imply that owning treasury
bills is foolish when it is "obvious the market will rise." We have never
intentionally raised cash. Cash levels are the residual of our attempt to own
competitively entrenched businesses, managed by competent individuals when their
shares are available at significantly discounted prices. When we cannot find
those opportunities, cash levels increase. To commit your assets and ours to
equities, we require a substantial margin of safety between appraised corporate
value and price. This conservative and disciplined approach has served us well
for 26 years. We are extremely confident it will in the future.
In 1949, Benjamin Graham, in his seminal work The Intelligent Investor, gave the
following sage advice regarding the investment of one's liquidity.
Since common stocks, even of investment grade, are subject to
recurrent and wide fluctuations in their prices, the intelligent
investor should be interested in the possibilities of profiting from
these pendulum swings. There are two possible ways by which he
2
<PAGE> 4
may try to do this: the way of timing and the way of pricing. By timing we
mean the endeavor to anticipate the action of the stock market -- to buy or
hold when the future course is deemed to be upward, to sell or refrain from
buying when the course is downward. By pricing we mean the endeavor to buy
stocks when they are quoted below their fair value and to sell them when
they rise above such value. We are convinced that the intelligent investor
can derive satisfactory results from pricing . . . We are equally sure that
if he places his emphasis on timing, in the sense of forecasting, he will
end up as a speculator and with a speculator's financial results.
The "Boffo" 1990's
The United States equity markets, in closing out 1997, have just completed the
longest uninterrupted period of compounding in the twentieth century. The S&P
500 has recorded seven consecutive up years, a run unmatched since the index was
compiled.
The magnitude of the returns for the past three years is even more amazing. The
average annual return of the S&P 500 over that time was 31.2%, the highest ever
for three straight years. Only two previous such spans exceeded the 30% annual
return barrier: the last three years of the 1920's bull market - 1926, 1927,
1928 - posted a 30.1% per annum profit; and, in the recovery years after the
worst bear market in our history - 1933, 1934, 1935 - the S&P 500 grew annually
at 30.9%. You should clearly remember our recent 1990's experience. We firmly
believe it is unlikely to be repeated soon, if ever again in our lifetimes.
Our mission is to grow capital at the highest possible rate commensurate with
the fewest risks. Our goal has never been to beat an index but, rather, to
select one qualifying investment at a time with the requisite undervaluation we
demand. As a by-product of this approach we have done well in absolute terms.
Our firm has outperformed the market most years, and our long-term returns have
significantly exceeded the indices. Currently we are delivering historically
high absolute numbers with below-average risk. The most likely future scenario
is that today's good absolute results will be tough to match. Ironically, those
who care more about relative performance will probably be happier than they are
now, even though we are likely to see a lower rate of return.
Businesses, People, Price vs. Asset Allocation
Roger Lowenstein's "Intrinsic Value" column in The Wall Street Journal is one of
the most on-the-money reads we know. We encourage you not to miss his weekly
contribution to sensible investing. Late last year he penned a wonderful piece
on the current folly many pursue in mindlessly investing
3
<PAGE> 5
their assets in the international arena for the sake of asset allocation. We
include various excerpts for your edification.
What faddish bit of investing "wisdom" was exposed as nonwisdom in
1997? Easy. For years, financial planners have been saying that it is
indispensable for ordinary Americans to invest all over the planet.
They dressed up the argument with attractive pie charts - so slick you
almost forgot they were talking about putting your money in markets
you know nothing about . . . Thus, the "sound" investor is defined as
one who has moved a goodly chunk of his money out of the society he
knows to countries with which he is unfamiliar, each according to
their market weights. Indeed, not to put assets in such terra
incognita is deemed to be "unsound" . . .
None of these experts has a bulb so dim that cannot recite that as
Asia's collapse was unexpected so may be the next region's boom. This
is like saying that because you never know which lottery ticket will
hit, you should buy them all. To be sure, gambling on every country is
wiser than gambling on one. But not gambling at all is wiser still.
Meaning that investing in selected securities that meet a price and
value test is to my mind safer than treating your portfolio like a
food fair.
It is of course, possible to intelligently invest overseas . . . And
the burden of proof should be higher away from home . . . The
difference between finding an undervalued societe (company) in France
and deciding in advance to allocate cash to the Paris Bourse is night
and day. And the latter is what planners are pushing.
Alas, profits don't accrue to categories; they are earned, singly, by
companies.
There are a number of individual offshore companies whose economics have appeal
and whose shares are extremely undervalued. As a result, Southeastern Asset
Management is aggressively pursuing the introduction of Longleaf Partners
International Fund. We will inform you when it is available for investment. We
will commit a significant amount of our own capital for opportunistic reasons,
not because we think we should have foreign exposure. If the business, the
people and the price aren't right, Longleaf will not participate.
Investment Opportunity in Asia
As you will see when reviewing the Partners and Small-Cap Funds' holdings, we
have quite successfully established positions in several extremely over-
capitalized and very undervalued Japanese property and casualty insurance
companies. These shares were available at prices reminiscent of those in the
1974 U.S. market. We paid nothing for the underwriting businesses and
4
<PAGE> 6
received the excess cash and depressed security portfolios for approximately 50%
of their marked to market values. While the shares have appreciated handsomely
above our cost since the end of the year, they remain dramatically discounted
from our appraisals. We have more than adequately hedged the yen exposure
associated with our Japanese insurers, thanks to the expanded investment powers
that shareholders overwhelmingly granted in our 1997 proxy. We are continuing to
search for opportunities that the Asian turmoil may present for all three Funds.
However, as said above, the burden of proof is much higher.
Annual Meeting
Our Annual Meeting is scheduled for Wednesday, May 13, at 5:30 p.m. at the
Memphis Botanic Garden. We hope to see many of you there. We wish you a very
happy New Year and trust each of you will have a healthy and prosperous 1998. As
always, we are very appreciative of your long-term support.
Sincerely,
/s/ /s/ /s/
O. Mason Hawkins, CFA G. Staley Cates, CFA C.T. Fitzpatrick, CFA
Co-Portfolio Manager Co-Portfolio Manager Co-Portfolio Manager
- --------------------------------------------------------------------------------
Morningstar ratings, updated monthly, reflect historical risk-adjusted
performance at 12/31/97, and are calculated from a fund's 3, 5 & 10 year average
annual returns in excess of 90-day T-Bill returns with appropriate fee
adjustments and a risk factor reflecting performance below 90-day T-Bills. The
Partners Fund and Small-Cap Fund each received 5 stars overall and for five
years. Partners Fund received 5 stars for ten years and 4 stars for three years.
Small-Cap Fund received 5 stars for three years. 676, 1292 and 2332 equity funds
were rated for ten, five & three years, respectively. The top 10% of funds in a
category receive 5 stars.
For complete performance information, see the "Performance Summary" page for
each Fund.
5
<PAGE> 7
- --------------------------------------------------------------------------------
PARTNERS FUND - PERFORMANCE HISTORY
LONGLEAF PARTNERS FUND
GRAPH
Comparison of Change in Value of $10,000 Investment
The line graph required by Item 5A(b) of Form N-1A, entitled "Comparison of
Change in Value of a $10,000 Investment" appears in this location. The line
graph covers the period from inception of Longleaf Partners Fund on 4/8/87 to
12/31/97, the close of the latest fiscal year. The change in value for the Fund
is compared with the S&P 500 Stock Index, the Fund's primary broad-based
securities index, and with the Value-Line Index, a secondary securities index.
As shown on the graph, the ending results of the changes in value for the Fund,
the S&P 500 Stock Index, and the Value-Line Index are, respectively, $53,603,
$44,622, and $16,757. The changes in value for the Fund and the S&P 500 Stock
Index are shown with all distributions and dividends reinvested. The Value-Line
Index is not available with reinvested dividends.
AVERAGE ANNUAL RETURNS*
FOR THE PERIODS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Partners S&P 500 Value-Line
Fund Index Index
-------- ------- ----------
<S> <C> <C> <C>
Most Recent Quarter (2.64)% 2.88% (2.77)%
One Year 28.25 33.36 21.06
Three Years 25.55 31.15 17.86
Five Years 21.38 20.25 11.24
Ten Years 19.94 18.03 8.46
</TABLE>
* The average annual returns for the Longleaf Partners Fund and the S&P 500 are
shown with all dividends and distributions reinvested; the Value-Line Index is
not available with reinvested dividends. The indices shown are unmanaged. Past
performance is no guarantee of future performance, and the value of an
investment when redeemed may be more or less than the purchase price.
6
<PAGE> 8
- --------------------------------------------------------------------------------
PARTNERS FUND - PORTFOLIO SUMMARY
FIVE LARGEST HOLDINGS
(REPRESENTS 46.9% OF NET ASSETS)
KNIGHT-RIDDER, INC. (KRI) 13.0%
One of the largest newspaper publishers in the U.S. and a worldwide provider of
electronic information services.
U S WEST MEDIA GROUP (UMG) 13.0%
Cable and communications company whose focus is providing a single line to the
home for multiple services including voice, video and Internet access.
FEDERAL EXPRESS CORPORATION (FDX) 7.6%
Integrated air-ground transportation company providing overnight and second-day
delivery of packages and documents worldwide.
PHILIPS ELECTRONICS N.V. (PHG) 6.7%
Owner of 75% of recording company Polygram. Also a leading manufacturer of
lighting systems, electronics products including television and stereo
equipment, appliances and semiconductors.
WASTE MANAGEMENT, INC. (WMX) 6.6%
The world's largest solid waste collection and disposal company with
residential, commercial and industrial customers throughout North America.
PORTFOLIO CHANGES
JANUARY 1, 1997 THROUGH DECEMBER 31, 1997
<TABLE>
<CAPTION>
NEW HOLDINGS ELIMINATIONS
------------ ------------
<S> <C>
Host Marriott Corporation Alexander & Alexander Services Inc.
ITT Corporation American Stores Company
Mallinckrodt Inc. Chris-Craft Industries, Inc.
Marriott International, Inc. Cousins Properties Incorporated
Mitsui Marine and Fire Ecolab, Inc.
Insurance Company, Ltd. ITT Corporation
The News Corporation Limited Louisiana-Pacific Corporation
The Nippon Fire & Marine Nabisco Holdings Corp.
Insurance Company, Ltd. PaineWebber Group Inc.
U S West Media Group Safety-Kleen Corp.
The Yasuda Fire and Marine United HealthCare Corporation
Insurance Company, Ltd. USG Corporation
Whitman Corporation
The Washington Post Company -Class
B
</TABLE>
7
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PARTNERS FUND - PORTFOLIO INVESTMENTS
AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- ------------
<S> <C> <C> <C> <C> <C>
Common Stock 109.8%
Beverages 5.7%
4,604,800 The Seagram Company Ltd. ............... $148,792,600
Broadcasting 6.2%
7,284,362 The News Corporation Limited............ 162,532,327
Business Services 0.3%
279,200 * The Union Corporation................... 8,777,350
Cable 12.9%
11,686,100 * U S West Media Group.................... 337,436,138
Environmental Services 6.6%
6,236,400 Waste Management, Inc................... 171,501,000
Food 9.1%
3,000,000 The Quaker Oats Company................. 158,250,000
846,500 Ralston Purina Company.................. 78,671,594
------------
236,921,594
------------
Lodging 8.9%
7,552,000 * Host Marriott Corporation............... 148,208,000
1,203,800 Marriott International, Inc............. 83,363,150
------------
231,571,150
------------
Multi-Industry 8.4%
1,565,000 Alexander & Baldwin, Inc................ 42,744,062
2,903,800 Philips Electronics N.V................. 175,679,900
------------
218,423,962
------------
Natural Resources 6.1%
1,237,700 The Pioneer Group, Inc.................. 34,810,312
2,900,000 Rayonier Inc.(b)........................ 123,431,250
------------
158,241,562
------------
Property & Casualty Insurance 7.7%
112,828 * Alleghany Corp.......................... 32,127,773
25,046,000 Mitsui Marine and Fire Insurance
Company, Ltd.......................... 128,291,762
6,603,000 The Nippon Fire & Marine Insurance
Company, Ltd.......................... 24,833,408
3,373,000 The Yasuda Fire and Marine Insurance
Company, Ltd.......................... 14,475,604
------------
199,728,547
------------
</TABLE>
See Notes to Financial Statements.
8
<PAGE> 10
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PARTNERS FUND - PORTFOLIO INVESTMENTS
AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- --------------
<S> <C> <C> <C> <C> <C>
Pharmaceuticals 2.6%
1,770,350 Mallinckrodt Inc. ...................... $ 67,273,300
Publishing 13.0%
6,500,000 Knight-Ridder, Inc.(b).................. 338,000,000
Real Estate 5.5%
6,224,291 TrizecHahn Corporation.................. 144,325,748
Telecommunications 4.8%
6,143,637 * 360 degrees Communications Company(b)... 124,024,672
Transportation 12.0%
3,234,800 * Federal Express Corporation............. 197,524,975
3,617,600 Kansas City Southern Industries, Inc.... 114,858,800
--------------
312,383,775
--------------
TOTAL COMMON STOCKS (COST
$2,090,857,614)....................... 2,859,933,725
--------------
Short-Term Obligations 2.8%
Repurchase Agreement with State Street Bank,
5.0% due 1-2-98............................................ 72,999,000
--------------
TOTAL INVESTMENTS (COST $2,163,856,614)(A)............ 112.6% 2,932,932,725
SHAREHOLDER DISTRIBUTION PAYABLE...................... (12.8) (333,437,885)
OTHER ASSETS AND LIABILITIES, NET..................... 0.2 5,575,335
----- --------------
NET ASSETS............................................ 100.0% $2,605,070,175
===== ==============
NET ASSET VALUE PER SHARE.................................... $25.98
==============
</TABLE>
* Non-income producing security
(a) Also represents aggregate cost for Federal income tax purposes. Aggregate
unrealized appreciation and depreciation are $801,685,719 and ($32,609,608),
respectively.
(b) Affiliated company. See Note 7.
Open Forward Currency Contracts -- See Note 2
<TABLE>
<CAPTION>
CURRENCY CURRENCY SOLD AND CURRENCY UNREALIZED
UNITS SOLD SETTLEMENT DATE MARKET VALUE GAIN
- -------------- -------------------------- ------------ ----------
<C> <S> <C> <C>
2,864,692,545 Japanese Yen 1/6/98....... $22,053,168 $1,861,799
1,239,727,950 Japanese Yen 1/28/98...... 9,576,520 948,380
11,847,114,197 Japanese Yen 2/10/98...... 91,695,521 2,259,405
3,939,690,935 Japanese Yen 2/27/98...... 30,570,799 575,181
------------ ----------
Total Forward Contracts... $153,896,008 $5,644,765
============ ==========
</TABLE>
See Notes to Financial Statements.
9
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- --------------------------------------------------------------------------------
PARTNERS FUND - MANAGEMENT DISCUSSION AND ANALYSIS
BY MASON HAWKINS AND STALEY CATES
1997 was a productive year for Longleaf Partners Fund. In addition to returning
28.3%, we found qualifying investments for much of the Fund's liquidity. While
volatility from the turmoil in Asia hindered our returns in the fourth quarter,
it should be positive for the long-term owners of the Partners Fund because we
gained opportunities to own businesses at very attractive prices.
The Fund's 1997 performance benefitted substantially from our concentrated
approach. Four of our five largest holdings at the outset of 1997 provided $265
million or over 40% of the Fund's total $651 million gain. Knight Ridder had a
very good advertising year and successfully integrated its papers acquired from
Disney. The reforms instituted by Cor Boonstra at Philips continued to improve
free cash flow and earnings. Before the market's pullback in October we had
begun to reduce our stake in Philips, following our discipline of selling
companies as they approach full value. Subsequently, the Asian crisis created
fears about the future of some of Philips' segments, and its price declined. The
potential problems from Asia have been over-discounted, and we are excited to
retain our Philips position at the current price. Federal Express also lost
ground with the recent Asian turmoil. Longer term, however, the Far East offers
great growth potential for FedEx. Both the residual business FedEx maintained
after the UPS strike and the acquisition of Caliber (which competes head-on with
UPS' core business), add significantly to intrinsic value. Finally, Wall Street
rewarded Quaker Oats for its sale of Snapple and the announced search for a new
CEO. Throughout the Snapple debacle, the value of Gatorade and Quaker's food
brands continued to grow strongly.
Kansas City Southern also made a significant impact on performance adding a
combined $101 million in realized and unrealized gains. The company benefitted
from both the expansion of its railroad business as well as growth at its mutual
fund companies. The price rose dramatically when KSU decided to split those two
businesses into separate companies. During the year we sold part of our
holdings, maintaining a core position in the portfolio. We also sold a number of
smaller holdings as their prices approached fair value. The combined
contribution to 1997 performance from those divested companies was $97 million.
Two of our long-term holdings hindered the Fund's return by a combined $31
million. 360 degrees Communications had a year that disappointed Wall Street.
Although cash flow grew nicely throughout the year, 360 degrees remained very
undervalued. Seagram lost ground in the fourth quarter as sales in Asia were
threatened. Longer term, Asia is much more an opportunity than a negative to the
company. Seagram also made a sagacious deal to combine its television production
business with Barry Diller's HSN.
10
<PAGE> 12
The last three years have presented a challenging environment for finding 60c
dollars. However, we do not spend our time worrying about or predicting market
levels. We look for individual businesses that meet our criteria. When we find
one, we buy it. In 1997 we added nine new names to the Fund, and those
investments have already benefitted shareholders. The combined contribution to
performance from new holdings in 1997 was $130 million or 20% of the total
gains. US West Media Group had the most significant impact. We purchased a
double position (10% of assets) during the third quarter when the company became
mispriced. The cable industry fell out of favor in general, and Wall Street
particularly disliked this target stock which is controlled by a regional phone
company. US West's announcement that it would spin out the cable company,
combined with strong operating results, enabled US West Media Group to provide
over $79 million to the Fund's gain. News Corp. is another exciting new
opportunity. Rupert Murdoch has delivered incredible returns to his long-term
shareholders. The stock became undervalued on fears that Murdoch was overpaying
for acquisitions and he received negative press for his U.S. satellite efforts.
News Corp.'s assets in broadcasting, certain newspapers and foreign satellite
companies are unique and very valuable. Finally, we bought Host Marriott in the
fourth quarter. The company owns high-end resort and urban hotels under the
Marriott and Ritz-Carlton brand names. It reduced the gains of the Fund by $22
million as hotel and paired-share REITs stole the limelight and their C-Corp.
peers were ignored. Host Marriott is a great example of what we look for - a
wonderful business with competitive advantages and strong brand names, run by
capable owner-operator partners, that is temporarily mispriced for irrational
reasons.
The table on the following page provides a more detailed accounting of
contributions to performance in 1997.
11
<PAGE> 13
LOGO
[Intentionally Left Blank]
12
<PAGE> 14
- --------------------------------------------------------------------------------
PARTNERS FUND - PERFORMANCE CONTRIBUTIONS
The following table delineates the specific dollar contributions of each
individual holding to the 28.3% total return for 1997.
<TABLE>
<CAPTION>
PERCENTAGE
CONTRIBUTION OF TOTAL
IN 1997 CONTRIBUTION
------------ ------------
<S> <C> <C>
REALIZED GAINS:
Kansas City Southern Industries, Inc...... $ 40,169,830 6.2%
Philips Electronics N.V................... 21,767,588 3.3
PaineWebber Group Inc..................... 20,732,039 3.2
Nabisco Holdings Corp..................... 18,560,933 2.9
The Washington Post Company - Class B..... 15,325,054 2.4
All others, net........................... 42,036,124 6.4
------------ -----
158,591,568 24.4
------------ -----
INCREASE (DECREASE) IN UNREALIZED
APPRECIATION:
FROM SECURITIES HELD AT DECEMBER 31, 1996:
Knight-Ridder, Inc........................ 89,660,401 13.8
Kansas City Southern Industries, Inc...... 60,990,459 9.4
Philips Electronics N.V................... 55,326,756 8.5
Federal Express Corporation............... 53,576,375 8.2
The Quaker Oats Company................... 44,538,056 6.8
Ralston Purina Company.................... 16,559,656 2.5
360 DEGREES Communications Company........ (13,535,685) (2.1)
The Seagram Company Ltd................... (17,426,120) (2.7)
All others, net........................... 51,155,028 7.9
------------ -----
340,844,926 52.3
------------ -----
FROM NEW HOLDINGS IN 1997:
U S West Media Group...................... 79,435,881 12.2
The News Corporation Limited.............. 32,589,935 5.0
Marriott International, Inc............... 22,229,256 3.4
Host Marriott Corporation................. (21,963,298) (3.4)
All others, net........................... 17,706,133 2.8
------------ -----
129,997,907 20.0
------------ -----
Net realized and unrealized gain on
investments............................... 629,434,401 96.7
Net investment income....................... 21,420,547 3.3
------------ -----
NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS............................. $650,854,948 100.0%
============ =====
</TABLE>
13
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- --------------------------------------------------------------------------------
REALTY FUND - PERFORMANCE HISTORY
LONGLEAF PARTNERS REALTY FUND
GRAPH
Comparison of Change in Value of $10,000 Investment
The line graph required by Item 5A(b) of Form N-1A, entitled "Comparison of
Change in Value of a $10,000 Investment" appears in this location. The line
graph covers the period from inception of Longleaf Partners Realty Fund on
1/2/96 to 12/31/97, the close of the latest fiscal year. The change in value for
the Fund is compared with the Wilshire Real Estate Securities Index and the
NAREIT Equity Index. As shown on the graph, the ending results of the changes in
value for the Fund, the Wilshire Real Estate Securities Index, and the NAREIT
Index are, respectively, $18,251, $16,267, and $16,422. The changes in value for
the Fund and these indices are shown with all distributions and dividends
reinvested.
AVERAGE ANNUAL RETURNS*
FOR THE PERIODS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Wilshire
Real Estate NAREIT
Realty Securities Equity
Fund Index Index
------ ----------- ------
<S> <C> <C> <C>
Most Recent Quarter (3.09)% (0.09)% 1.75%
One Year 29.73 19.85 20.26
Since inception 1/2/96 35.15 28.19 27.58
</TABLE>
* The average annual returns shown are calculated with dividend and
distributions reinvested. The indices shown are unmanaged. Past performance is
no guarantee of future performance, and the value of an investment when
redeemed may be more or less than the purchase price.
14
<PAGE> 16
- --------------------------------------------------------------------------------
REALTY FUND - PORTFOLIO SUMMARY
FIVE LARGEST HOLDINGS
(REPRESENTS 36.0% OF NET ASSETS)
HOST MARRIOTT CORPORATION (HMT) 10.0%
Owner of over 80 full service Marriott and Ritz Carlton hotels and 30 assisted
living centers, most of which are operated by Marriott International.
WELLSFORD REAL PROPERTIES, INC. (WRP) 7.2%
A manager, owner and developer whose properties, which are primarily in New
Jersey, were spun out from Wellsford Residential Properties, an apartment REIT.
CATELLUS DEVELOPMENT CORPORATION (CDX) 6.9%
A diversified real estate company that owns, manages and develops industrial
warehouses, offices, apartments and residential communities. CDX has substantial
land holdings throughout the U.S.
ARDEN REALTY, INC. (ARI) 6.3%
An office REIT with over 10 million square feet of class A space in southern
California.
TIMBERWEST TIMBER TRUST (TBW) 5.6%
The largest private timberland owner in Western Canada with over 800,000 acres
in British Columbia.
PORTFOLIO CHANGES
JANUARY 1, 1997 THROUGH DECEMBER 31, 1997
<TABLE>
<CAPTION>
NEW HOLDINGS ELIMINATIONS
------------ ------------
<S> <C>
Alexandria Real Estate Equities, Inc. Alexander & Alexander Services Inc.
Boston Properties Inc. Alexander & Baldwin, Inc.
CB Commercial Real Estate Bradley Real Estate, Inc.
Services Group, Inc. Burnham Pacific Properties
Deltic Timber Corporation CB Commercial Real Estate
Getty Petroleum Marketing Inc. Services Group
Getty Realty Corp. Essex Property Trust
Host Marriott Corporation First Fed Financial Corp.
Imperial Credit Commercial Getty Petroleum Marketing Inc.
Mortgage Investment Heilig Meyers Company
Company (formerly Rhodes, Inc.)
ITT Corporation Hilb, Rogal and Hamilton Company
Marriott International, Inc. Imperial Credit Commercial
Marriott LYONs Mortgage Investment Company
Newhall net options ITT Corporation
Pacific Forest Products Limited Knight-Ridder, Inc.
Prime Group Realty Trust Louisiana-Pacific Corporation
Prime Retail, Inc. Pacific Forest Products Limited
Sunburst Hospitality Corporation Quaker City Bancorp, Inc.
TimberWest Timber Trust Reckson Associates Realty Corp.
Trizec Warrants Trizec Warrants
Wellsford Real Properties, Inc. USG Corporation
Wolohan Lumber Co.
Zurn Industries, Inc.
</TABLE>
15
<PAGE> 17
- --------------------------------------------------------------------------------
REALTY FUND - PORTFOLIO INVESTMENTS
AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- ------------
<S> <C> <C> <C> <C> <C>
Common Stock 93.2%
Real Estate Industry 93.0%
Diversified Realty 16.6%
2,558,700 * Catellus Development Corporation........ $ 51,174,000
619,100 Forest City Enterprises, Inc. - Class
A....................................... 35,985,188
61,200 Forest City Enterprises, Inc. - Class
B....................................... 3,530,475
783,000 Sizeler Property Investors, Inc.
(REIT)(b)............................... 8,221,500
1,012,300 TrizecHahn Corporation.................. 23,472,706
------------
122,383,869
------------
Lodging 16.0%
3,770,100 * Host Marriott Corporation............... 73,988,212
102,300 Marriott International, Inc............. 7,084,275
1,999,600 * Red Roof Inns, Inc.(b).................. 30,618,875
41,600 * Sunburst Hospitality Corporation........ 410,800
558,346 * Supertel Hospitality, Inc.(b)........... 5,583,460
------------
117,685,622
------------
Mortgage Financing 3.3%
674,500 Bay View Capital Corp.(b)............... 24,450,625
Natural Resources/Land 15.3%
1,427,600 * Castle & Cooke, Inc.(b)................. 24,090,750
650,000 Deltic Timber Corporation(b)............ 17,793,750
650,000 The Pioneer Group, Inc.................. 18,281,250
261,000 Rayonier Inc............................ 11,108,812
5,701,900 TimberWest Timber Trust(b).............. 41,240,157
------------
112,514,719
------------
Office 29.1%
892,400 Alexandria Real Estate Equities, Inc.
(REIT)(b)............................... 28,166,375
1,507,000 Arden Realty, Inc. (REIT)............... 46,340,250
1,047,900 Boston Properties Inc. (REIT)........... 34,646,194
504,900 Cousins Properties Incorporated
(REIT).................................. 14,799,881
1,850,000 Prime Group Realty Trust (REIT)(b)...... 37,462,500
3,398,000 * Wellsford Real Properties, Inc.(b)(c)... 53,093,750
------------
214,508,950
------------
Retail 12.7%
1,223,800 Getty Realty Corp.(b)................... 27,076,575
993,800 * IHOP Corp.(b)........................... 32,298,500
2,442,100 Prime Retail, Inc. (REIT)(b)............ 34,647,294
------------
94,022,369
------------
</TABLE>
See Notes to Financial Statements.
16
<PAGE> 18
- --------------------------------------------------------------------------------
REALTY FUND - PORTFOLIO INVESTMENTS
AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- ------------
<S> <C> <C> <C> <C> <C>
Non-Realty 0.2%
14,500 * White River Corporation................. $ 1,152,750
------------
TOTAL COMMON STOCKS (COST
$598,970,233)........................... 686,718,904
------------
CONTRACTS Options 1.2%
----------
Put Options Written
5,494 Newhall Land and Farming Company,
expiring
April '99 @ $20 (Premiums received
$1,076,268)............................. (60,434)
2,967 Newhall Land and Farming Company,
expiring October '99 @ $25 (Premiums
received $709,919)...................... (272,964)
Call Options Purchased
5,494 Newhall Land and Farming Company,
expiring
April '99 @ $20 (Cost $1,761,493)....... 6,499,402
2,967 Newhall Land and Farming Company,
expiring October '99 @ $25 (Cost
$1,225,243)............................. 2,533,818
------------
8,699,822
------------
PRINCIPAL Corporate Bonds 3.0%
AMOUNT
----------
34,000,000 Marriott International, Inc. Liquid
Yield
Option Notes (LYONs), zero coupon conv.
sub. notes due 2011 (Cost
$19,410,087)............................ 22,142,500
------------
Short-Term Obligations 6.9%
U.S. Treasury Bill, 5.03% due 1-2-98..................... 34,995,188
Repurchase Agreement with State Street Bank, 5.00% due
1-2-98................................................... 16,179,000
------------
51,174,188
------------
TOTAL INVESTMENTS (COST $670,755,057)(A).............. 104.3% 768,735,414
SHAREHOLDER DISTRIBUTION PAYABLE...................... (4.5) (32,851,014)
OTHER ASSETS AND LIABILITIES, NET..................... 0.2 1,417,804
----- ------------
NET ASSETS............................................ 100.0% $737,302,204
===== ============
NET ASSET VALUE PER SHARE.................................... $17.35
</TABLE>
* Non-income producing security
(a) Also represents aggregate cost for Federal income tax purposes. Aggregate
unrealized appreciation and depreciation are $122,830,438 and ($24,850,081),
respectively.
(b) Affiliated company. See Note 7.
(c) Illiquid security. See Note 8.
See Notes to Financial Statements.
17
<PAGE> 19
- --------------------------------------------------------------------------------
REALTY FUND - MANAGEMENT DISCUSSION AND ANALYSIS
BY C.T. FITZPATRICK, MASON HAWKINS AND STALEY CATES
Longleaf Partners Realty Fund returned 29.7% in 1997, significantly
outperforming the Wilshire Real Estate Securities Index's 19.9%. This
performance included a fourth quarter decline of 3.1% which was primarily the
result of two new investments discussed below.
The real estate industry has undergone several years of unprecedented change.
Properties are transitioning from private to public ownership more rapidly than
we had anticipated. This enormous flow of capital has created mispricing
opportunities because the public capital markets are relatively unsophisticated
in evaluating real estate assets. Most properties are treated as commodities
which they are not.
Furthermore, those companies creating the most long-term value for shareholders,
at the expense of short-term earnings, are being penalized by Wall Street. This
dichotomy has allowed us to purchase those companies compounding value more
rapidly at discounts. We have been fortunate to acquire sizeable positions in
many of these businesses and have concentrated the Fund in our best ideas.
Real estate fundamentals in most geographic areas and property types are well
into recovery and many are approaching equilibrium between supply and demand. We
are currently finding better opportunities in development versus acquisition
biased companies. Most REITs continue to be less attractive than C-Corps.
because C-Corps. have much greater flexibility to pursue the value added
projects that the majority of REITs avoid. Catellus, our largest single
contributor to 1997's return is illustrative. The company is a C-Corp. and
receives little coverage from the investment community. Catellus is primarily a
development company with significant raw land assets. It was our largest
position during much of 1997. The company has benefitted from the rapid recovery
in California's real estate market and management's focus on accelerating the
development process. As a result, Catellus added over $18 million to the Fund's
total $113 million gain in 1997.
Our second largest contributor to 1997 results, Wellsford Real Properties, is
also a C-Corp. Wellsford was spun out of a REIT to take advantage of
opportunities that REITs are unable or unwilling to pursue. No brokerage firm
covers the company. It was a 10% position in the Fund when we purchased it in
the second quarter. Wellsford added $18 million to our gain as the company moved
forward on numerous redevelopment projects. In addition, late in the year,
Wellsford announced a promising joint venture with the Whitehall Street Real
Estate Fund.
Forest City Enterprises, also a development company and C-Corp. was the third
largest contributor to 1997 performance accounting for over $10 million of the
Fund's appreciation. The company benefitted from an anticipated increase in
18
<PAGE> 20
earnings due to completion of projects during the year. Forest City also broke
ground on several new, large-scale properties.
A few other concentrated positions positively impacted the Fund's results. IHOP,
which was the Realty Fund's largest holding at the outset of 1997, added almost
$8.5 million as its emphasis on site locations paid off. Arden was the Fund's
fourth largest holding at both the beginning and end of the year. The California
real estate recovery and Arden's low cost basis in suburban LA office space
helped the company contribute $6.8 million to the portfolio. Bay View, a
California savings and loan, steadily built value throughout the year and
provided over $8 million to the Fund's gain.
During 1997 we had an unusually large number of sales. The 28.7% turnover rate
is higher than we would generally anticipate. We were confronted with an excess
of qualifying investments and limited cash resources during the spring and late
fall. Consequently, we made the difficult decision to sell companies whose
prices more fully reflected fair value to fund the purchase of more deeply
discounted new investments. These sales provided over $18 million to the Fund's
return.
Proceeds from the companies we sold combined with $500 million of cash inflows
enabled us to buy a number of businesses which have already contributed
substantially to our results. In addition to Wellsford, these new holdings added
over $35 million to the portfolio. As mentioned above, two of our new positions
diminished the portfolio's return by $24 million. TimberWest's price declined
with the fall of the Asian markets. Lower Japanese demand will cause a decline
in short-term revenues. However, its timber acreage will continue to grow
(literally) in value. Host Marriott owns superior resort and urban hotels under
the Marriott and Ritz-Carlton names and has ample opportunity to grow value
through Marriott branded acquisitions and development. Its properties are much
more insulated from new supply than other hotel companies that we have
evaluated. The company remained undervalued as hotel and paired-share REITs
stole the limelight and their C-Corp. peers were ignored. We are confident that
both Host Marriott and TimberWest will provide excellent returns over our five
year time horizon.
We can continue to compound capital at superior rates of return over the long-
term by focusing on individual businesses and maintaining our value discipline.
We will make money throughout all phases of the real estate cycle if we purchase
good companies, managed by good people at significant discounts to their values.
Inevitably, real estate fundamentals will deteriorate in a number of sectors,
but a general downturn appears several years away. We would welcome poor
property level fundamentals if they caused the market to over-discount
companies' inherent values. Currently, the Realty Fund is fully invested and we
are finding more real estate companies that meet our criteria than we have cash
to buy them.
The table on the following page provides a more detailed accounting of
contributions to performance in 1997.
19
<PAGE> 21
LOGO
[Intentionally Left Blank]
20
<PAGE> 22
- --------------------------------------------------------------------------------
REALTY FUND - PERFORMANCE CONTRIBUTIONS
The following table delineates the specific dollar contributions of each
individual holding to the 29.7% total return for 1997.
<TABLE>
<CAPTION>
PERCENTAGE
CONTRIBUTION OF TOTAL
IN 1997 CONTRIBUTION
------------ ------------
<S> <C> <C>
REALIZED GAINS:
Knight-Ridder, Inc....................... $ 7,731,568 6.9%
CB Commercial Real Estate Services
Group................................. 2,857,205 2.5
All others, net.......................... 7,923,136 7.0
------------ -----
18,511,909 16.4
------------ -----
INCREASE (DECREASE) IN UNREALIZED
APPRECIATION:
FROM SECURITIES HELD AT DECEMBER 31,
1997:
Catellus Development Corporation......... 18,690,727 16.6
Forest City Enterprises, Inc............. 10,251,840 9.1
IHOP Corp................................ 8,458,725 7.5
Bay View Capital Corp.................... 8,122,136 7.2
Arden Realty, Inc........................ 6,836,496 6.1
The Pioneer Group, Inc................... 2,571,208 2.3
All others, net.......................... 4,965,240 4.3
------------ -----
59,896,372 53.1
------------ -----
FROM NEW HOLDINGS IN 1997:
Wellsford Real Properties, Inc........... 18,094,350 16.0
Boston Properties Inc.................... 7,778,265 6.9
Getty Realty Corp........................ 7,716,446 6.8
Newhall net options...................... 7,499,273 6.6
Alexandria Real Estate Equities, Inc..... 5,074,472 4.5
Marriott LYONs........................... 2,732,413 2.4
Deltic Timber Corporation................ 2,701,003 2.4
Host Marriott Corporation................ (8,361,484) (7.4)
TimberWest Timber Trust.................. (15,782,664) (14.0)
All others, net.......................... 3,167,359 3.0
------------ -----
30,619,433 27.2
------------ -----
Net realized and unrealized gain on
investments.............................. 109,027,714 96.7
Net investment income...................... 3,776,009 3.3
------------ -----
NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS............................ $112,803,723 100.0%
============ =====
</TABLE>
21
<PAGE> 23
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PERFORMANCE HISTORY
LONGLEAF PARTNERS SMALL-CAP FUND
GRAPH
Comparison of Change in Value of $10,000 Investment
The line graph required by Item 5A(b) of Form N-1A, entitled "Comparison of
Change in Value of a $10,000 Investment" appears in this location. The line
graph covers the period from inception of Longleaf Partners Small-Cap Fund on
2/21/89 to 12/31/97, the close of the latest fiscal year. The change in value
for the Fund is compared with the Wilshire 5000 Stock Index, the Fund's former
primary broad-based securities index, the Russell 2000 Stock Index, the Fund's
new primary broad-based securities index, and with the Value-Line Index, a
secondary securities index. As shown on the graph, the ending results of the
changes in value for the Wilshire 5000, the Russell 2000, the Fund, and the
Value-Line Index are, respectively, $40,194, $32,454, $28,492, and $18,417. The
changes in value for the Fund, the Wilshire 5000 and the Russell 2000 are shown
with all distributions and dividends reinvested. The Value-Line Index is not
available with reinvested dividends.
AVERAGE ANNUAL RETURNS*
FOR THE PERIODS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Small-Cap Russell 2000 Value-Line Wilshire 5000
Fund Index Index Index
--------- ------------ ---------- -------------
<S> <C> <C> <C> <C>
Most Recent Quarter 2.02% (3.35)% (2.77)% 2.00%
One Year 29.04 22.36 21.06 31.71
Three Years 25.98 22.34 17.86 29.63
Five Years 19.95 16.40 11.24 19.36
</TABLE>
* The average annual returns for the Longleaf Partners Small-Cap Fund and its
benchmark, the Russell 2000 Index, from its initial public offering on
2/21/89 through 12/31/97 were 12.54% and 14.21%, respectively. From inception
through 3/31/91, the Fund was managed by a different portfolio manager.
The Small-Cap Fund has changed its benchmark index from the Wilshire 5000 to
the Russell 2000 to more closely reflect the portfolio's universe. The
average annual returns for the Fund, the Russell 2000 and the Wilshire 5000
are shown with all dividends and distributions reinvested; the Value-Line
Index is not available with reinvested dividends. The indices shown are
unmanaged. Past performance is no guarantee of future performance, and the
value of an investment when redeemed may be more or less than the purchase
price.
22
<PAGE> 24
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PORTFOLIO SUMMARY
FIVE LARGEST HOLDINGS
(REPRESENTS 26.9% OF NET ASSETS)
U S WEST MEDIA GROUP (UMG) 6.2%
Cable and communications company whose focus is providing a single line to the
home for multiple services including voice, video and Internet access.
SHAW COMMUNICATIONS INC. (SCL) 6.0%
A Canadian cable television company which also provides high-speed Internet
access and digital audio services.
SHOWBOAT, INC. (SBO) 5.1%
An owner and operator of gaming properties in Atlantic City, Las Vegas and
Sydney, Australia.
TIMBERWEST TIMBER TRUST (TBW) 4.8%
The largest private timberland owner in Western Canada with over 800,000 acres
in British Columbia.
FEDERAL EXPRESS CORPORATION (FDX) 4.8%
Integrated air-ground transportation company providing overnight and second-day
delivery of packages and documents worldwide.
PORTFOLIO CHANGES
JANUARY 1, 1997 THROUGH DECEMBER 31, 1997
<TABLE>
<CAPTION>
NEW HOLDINGS ELIMINATIONS
------------ ------------
<S> <C>
Baker, Fentress & Company Baldwin Technology Company, Inc.
The Chiyoda Fire and Marine -- Class A
Insurance Company, Ltd. Culligan Water Technologies, Inc.
Corecomm, Inc. Delchamps, Inc.
Culligan Water Technologies, Franklin Electric Co., Inc.
Inc. GoodMark Foods, Inc.
The Dai-Tokyo Fire and Marine Healthsource, Inc.
Insurance Company, Ltd. Heilig Meyers Company
Dart Group Corporation -- Class (formerly Rhodes, Inc.)
A Kaydon Corp.
Deltic Timber Corporation Lexington Global Asset Managers, Inc.
Federal Express Corporation Markel Corporation
Gendis, Inc. -- Class A Plenum Publishing Corporation
Kaydon Corp. Ralcorp Holdings
The Koa Fire and Marine Seafield Capital Corporation
Insurance Company, Ltd. SLH Corporation
The Nissan Fire & Marine
Insurance Company, Ltd.
Ralcorp Holdings
Shaw Communications Inc.
-- Class B
Showboat, Inc.
SLH Corporation
TimberWest Timber Trust
U S West Media Group
</TABLE>
23
<PAGE> 25
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PORTFOLIO INVESTMENTS
AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- ------------
<S> <C> <C> <C> <C> <C>
Common Stock 93.3%
Advertising 0.5%
15,100 Grey Advertising Inc. - Class A......... $ 4,952,800
Beverages 0.7%
215,000 * Celestial Seasonings, Inc.(b)........... 6,772,500
Building Materials 1.7%
506,400 Zurn Industries, Inc.................... 15,919,950
Business Services 2.5%
587,000 * Pinkerton's, Inc........................ 13,794,500
300,000 * The Union Corporation(b)................ 9,431,250
------------
23,225,750
------------
Cable 12.2%
5,184,800 * Shaw Communications Inc. -- Class
B(b).................................. 55,072,648
1,980,000 * U S West Media Group.................... 57,172,500
------------
112,245,148
------------
Commercial Lighting 0.5%
223,350 Thomas Industries, Inc.................. 4,411,162
Financial Services 4.0%
209,700 Duff & Phelps Credit Rating Co.......... 8,519,063
351,200 * White River Corporation(b).............. 27,920,400
------------
36,439,463
------------
Gaming 5.1%
1,600,000 Showboat, Inc. (b)...................... 47,000,000
Investment Management Companies 2.4%
87,600 Baker, Fentress & Company............... 1,598,700
836,000 United Asset Management Corporation..... 20,429,750
------------
22,028,450
------------
Manufacturing 3.1%
850,000 * American Safety Razor Company(b)........ 17,000,000
407,500 AMETEK, Inc............................. 11,002,500
------------
28,002,500
------------
Mortgage Financing 3.7%
930,000 Bay View Capital Corp.(b)............... 33,712,500
Natural Resources 14.5%
845,000 Deltic Timber Corporation(b)............ 23,131,875
2,748,496 Gendis Inc. -- Class A(b)............... 40,814,493
865,000 The Pioneer Group, Inc.................. 24,328,125
6,100,000 TimberWest Timber Trust(b).............. 44,119,497
------------
132,393,990
------------
Property & Casualty Insurance
15.1%
126,273 * Alleghany Corporation................... 35,956,237
1,019,000 The Chiyoda Fire and Marine Insurance
Company, Ltd.......................... 3,056,504
</TABLE>
See Notes to Financial Statements.
24
<PAGE> 26
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PORTFOLIO INVESTMENTS
AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- ------------
<S> <C> <C> <C> <C> <C>
Property & Casualty Insurance 15.1%
(Continued)
2,584,000 The Dai-Tokyo Fire and Marine Insurance
Company, Ltd.......................... $ 8,903,416
1,777,400 Hilb, Rogal and Hamilton Company(b)..... 34,326,038
1,702,000 The Koa Fire and Marine Insurance
Company, Ltd.......................... 6,414,190
6,155,000 The Nissan Fire & Marine Insurance
Company, Ltd.......................... 18,793,373
660,800 Orion Capital Corporation............... 30,685,900
------------
138,135,658
------------
Real Estate 12.7%
1,500,700 * Catellus Development Corporation........ 30,014,000
1,135,400 Cousins Properties Incorporated......... 33,281,412
552,900 * IHOP Corp.(b)........................... 17,969,250
1,520,000 TrizecHahn Corporation.................. 35,245,000
------------
116,509,662
------------
Restaurants 1.9%
982,400 * VICORP Restaurants, Inc.(b)............. 17,192,000
Retail 4.1%
325,730 Dart Group Corporation -- Class A....... 37,784,680
Telecommunications 3.8%
1,703,000 * Corecomm, Inc.(b)....................... 17,242,875
1,349,109 * Vanguard Cellular Systems, Inc. -- Class
A..................................... 17,201,140
------------
34,444,015
------------
Transportation 4.8%
712,400 * Federal Express Corporation............. 43,500,925
------------
TOTAL COMMON STOCKS (COST $691,357,333)............. 854,671,153
------------
Short-Term Obligations 11.1%
Federal Home Loan Mortgage Corporation, 5.7% due 1-9-98...... 79,901,156
Repurchase Agreement with State Street Bank, 5.0%, due
1-2-98..................................................... 21,391,000
------------
101,292,156
------------
TOTAL INVESTMENTS (COST $792,649,489)(A).............. 104.4% 955,963,309
SHAREHOLDER DISTRIBUTION PAYABLE...................... (3.9) (35,733,571)
OTHER ASSETS AND LIABILITIES, NET..................... (0.5) (4,970,603)
----- ------------
NET ASSETS............................................ 100.0% $915,259,135
===== ============
NET ASSET VALUE PER SHARE.................................... $22.18
============
</TABLE>
* Non-income producing security
(a) Also represents aggregate cost for Federal income tax purposes. Aggregate
unrealized appreciation and depreciation are $195,668,020 and ($32,354,200),
respectively.
(b) Affiliated company. See Note 7.
Open Forward Currency Contracts -- See Note 2
<TABLE>
<CAPTION>
CURRENCY CURRENCY SOLD AND CURRENCY UNREALIZED
UNITS SOLD SETTLEMENT DATE MARKET VALUE GAIN
- ------------- ---------------------------------- ------------ ----------
<C> <S> <C> <C>
1,535,436,260 Japanese Yen 2/27/98.............. $11,914,517 $ 66,948
3,737,523,927 Japanese Yen 5/13/98.............. 29,331,234 574,595
71,992,494 Canadian Dollars 10/28/98......... 50,495,725 1,451,494
------------ ----------
Total Forward Contracts........... $91,741,476 $2,093,037
============ ==========
</TABLE>
See Notes to Financial Statements.
25
<PAGE> 27
- --------------------------------------------------------------------------------
SMALL-CAP FUND -MANAGEMENT DISCUSSION AND ANALYSIS
BY MASON HAWKINS AND STALEY CATES
1997 was a banner year for Longleaf Partners Small-Cap Fund. The 1996 Annual
Report stated that we "have had little difficulty finding qualifying investments
for the Small-Cap Fund. As a result, the Fund remains fully invested . . ." We
asked shareholders and prospective shareholders to send money to enable us to
take advantage of the numerous opportunities to own high quality small cap
companies run by wonderful managements and selling at significant discounts.
We greatly appreciate the many of you who responded to our request. The cash
in-flows received during the first half of 1997 helped us purchase a number of
fantastic new businesses for the portfolio including the current seven largest
holdings.
Unfortunately, the market's pricing inefficiency was short-lived. By summer we
were struggling to find new investment ideas and our cash levels were rising. In
addition, we sold several companies which reached their full value. To avoid
diluting the investments of existing shareholders, we closed Small-Cap to new
investors on August 1. The Fund's liquidity during the second half and its
dramatic increase in size did not compromise performance. Small-Cap produced a
29.0% return in 1997, significantly outperforming the Russell 2000's 22.4% gain.
Of the fourteen companies sold during the year, Healthsource was the most
significant. It contributed $7.8 million of the Fund's total $148 million gain
during the year when CIGNA agreed to purchase the business in January. The
thirteen other companies sold were relatively small positions in the portfolio
either because they were spin-offs from other holdings or their prices rose
before we could buy a meaningful stake. Their combined sales added $13 million
to the Fund.
Our long-time holdings compounded nicely, contributing $99 million to 1997
performance. Catellus and Bay View both benefitted from the rapid economic
recovery in California's real estate market. Combined, they provided almost $23
million to the Fund's return. Our corporate partners at the Fund's three
insurance related holdings each continued to make wise capital allocation and
operating decisions which benefitted shareholders. Hilb, Rogal and Hamilton,
Orion Capital, and Alleghany together contributed over $30 million to
performance. White River provided almost $9 million to the portfolio, and
Harvard Management announced its plan to buy the company in December.
Several of the businesses we bought during 1997 have already contributed
substantially to our results. In aggregate, these new businesses added over $20
million to the portfolio. Most notably, Showboat added over $15 million to 1997
performance. The stock rose when Harrah's announced its acquisition of
26
<PAGE> 28
the company. US West Media Group became mispriced during the third quarter as
cable companies fell out of favor in general, and Wall Street particularly
disliked this target stock which is controlled by a regional phone company. US
West's announcement that it would spin out the cable company combined with the
industry's regained stature enabled US West Media Group to provide over $14
million to the Fund's gain. TimberWest diminished the portfolio's return by $16
million as its price declined with the fall of the Asian markets. Lower Japanese
demand will cause a decline in short-term revenues. However, the timber will
continue to grow (literally) in value.
It is worth noting that since year end several holdings have been liquidated or
soon will be. Showboat, Union Corp. and White River are each being acquired.
These sales have returned the cash level in the Fund to approximately 21%. We
will continue to look for qualifying businesses to own but will not compromise
our criteria.
The table on the following page provides a more detailed accounting of
contributions to performance in 1997.
27
<PAGE> 29
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PERFORMANCE CONTRIBUTIONS
The following table delineates the specific dollar contributions of each
individual holding to the 29.0% total return for 1997.
<TABLE>
<CAPTION>
PERCENTAGE
CONTRIBUTION OF TOTAL
IN 1997 CONTRIBUTION
------------ ------------
<S> <C> <C>
REALIZED GAINS:
Healthsource, Inc.............................. $ 7,793,319 5.3%
All others, net................................ 13,107,089 8.8
------------ -----
20,900,408 14.1
------------ -----
INCREASE (DECREASE) IN UNREALIZED APPRECIATION:
FROM SECURITIES HELD AT DECEMBER 31, 1996:
Catellus Development Corporation............... 11,490,702 7.8
Bay View Capital Corp.......................... 11,445,739 7.7
Hilb, Rogal and Hamilton Company............... 10,361,424 7.0
Orion Capital Corporation...................... 10,330,216 7.0
Alleghany Corporation.......................... 9,689,728 6.5
White River Corporation........................ 8,780,000 5.9
American Safety Razor Company.................. 5,100,000 3.4
VICORP Restaurants, Inc........................ 4,865,960 3.3
IHOP Corp...................................... 4,861,100 3.3
Pinkerton's, Inc............................... 3,784,426 2.6
AMETEK, Inc.................................... 3,472,959 2.3
Duff & Phelps Credit Rating Co................. 3,434,894 2.3
Vanguard Cellular Systems, Inc. -- Class A..... (3,177,191) (2.2)
All others, net................................ 14,616,456 9.9
------------ -----
99,056,413 66.8
------------ -----
FROM NEW HOLDINGS IN 1997:
Showboat, Inc.................................. 15,164,157 10.3
U S West Media Group........................... 14,134,717 9.5
Gendis, Inc. -- Class A........................ 4,792,703 3.2
Dart Group Corporation -- Class A.............. 3,583,505 2.4
Shaw Communications Inc. -- Class B............ 3,125,429 2.1
Deltic Timber Corporation...................... 3,104,808 2.1
The Nissan Fire & Marine Insurance Company,
Ltd.......................................... (3,803,721) (2.6)
Corecomm, Inc.................................. (7,541,481) (5.1)
TimberWest Timber Trust........................ (15,948,246) (10.8)
All others, net................................ 4,093,832 3.0
------------ -----
20,705,703 14.1
------------ -----
Net realized and unrealized gain on
investments.................................... 140,662,524 95.0
Net investment income............................ 7,445,302 5.0
------------ -----
NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS................................... $148,107,826 100.0%
============ =====
</TABLE>
28
<PAGE> 30
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders of
Longleaf Partners Funds
We have audited the accompanying statements of assets and liabilities of
Longleaf Partners Fund, Longleaf Partners Small-Cap Fund, and Longleaf Partners
Realty Fund (the three Funds comprising Longleaf Partners Funds Trust),
including the schedules of portfolio investments, as of December 31, 1997, and
the related statements of operations for the year then ended, the statements of
changes in net assets for each of the two years in the period then ended, and
the related financial highlights for each of the periods indicated. These
financial statements and financial highlights are the responsibility of the
Funds' management. Our responsibility is to express an opinion of these
financial statements and financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures include confirmation of securities owned as of
December 31, 1997 by correspondence with 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 present fairly, in all material respects, the financial positions of
Longleaf Partners Fund, Longleaf Partners Small-Cap Fund, and Longleaf Partners
Realty Fund (the three Funds comprising Longleaf Partners Funds Trust) as of
December 31, 1997 and the results of each of their operations for the year then
ended, changes in each of their net assets for each of the two years in the
period then ended, and the financial highlights for each of the periods
indicated in conformity with generally accepted accounting principles.
/s/
COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
January 30, 1998
29
<PAGE> 31
- -------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
STATEMENTS OF ASSETS AND LIABILITIES
AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
PARTNERS FUND
<S> <C>
ASSETS:
Investments:
Securities, at market value (cost $2,090,857,614,
$601,956,969, and $691,357,333, respectively) (Note
2)......................................................
Short-term cash equivalents...............................
Repurchase agreement (Note 2).............................
Corporate bonds (cost $19,410,087)........................
TOTAL INVESTMENTS
Cash........................................................
Receivable for:
Forward currency contracts (Note 2).......................
Dividends and interest....................................
Prepaid assets..............................................
Insurance reserve premium...................................
TOTAL ASSETS
LIABILITIES:
Payable for:
Shareholder Distribution..................................
Investment Counsel fee (Note 3)...........................
Administration fee (Note 4)...............................
Securities purchased......................................
Fund shares sold..........................................
Options written, at market value (premiums received
$1,786,187)...............................................
Other accrued expenses......................................
TOTAL LIABILITIES
NET ASSETS:
Net assets consist of:
Paid-in capital...........................................
Undistributed net investment income.......................
Accumulated net realized gain(loss).......................
Unrealized appreciation of investments....................
Unrealized foreign exchange gain..........................
Net Assets
NET ASSET VALUE PER SHARE...................................
FUND SHARES ISSUED AND OUTSTANDING..........................
</TABLE>
See Notes to Financial Statements.
30
<PAGE> 32
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
STATEMENTS OF ASSETS AND LIABILITIES
AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
PARTNERS FUND REALTY FUND SMALL-CAP FUND
- -------------- ------------ --------------
<S> <C> <C>
$2,859,933,725 $695,752,124 $854,671,153
- 34,995,188 79,901,156
72,999,000 16,179,000 21,391,000
- 22,142,500 -
- -------------- ------------ ------------
2,932,932,725 769,068,812 955,963,309
798 894 968
5,644,765 - 2,093,037
2,168,234 2,295,203 1,623,480
108,948 37,528 39,430
52,272 - 7,274
- -------------- ------------ ------------
2,940,907,742 771,402,437 959,727,498
- -------------- ------------ ------------
333,437,885 32,851,014 35,733,571
1,938,916 646,434 688,193
247,198 64,643 80,435
- - 7,742,011
56,000 - -
- 333,398 -
157,568 204,744 224,153
- -------------- ------------ ------------
335,837,567 34,100,233 44,468,363
- -------------- ------------ ------------
$2,605,070,175 $737,302,204 $915,259,135
============== ============ ============
1,835,103,781 639,246,346 751,847,302
89,373 24,232 22,599
(4,843,855) 46,795 (2,022,091)
774,720,876 97,980,357 165,406,857
- 4,474 4,468
- -------------- ------------ ------------
$2,605,070,175 $737,302,204 $915,259,135
============== ============ ============
$25.98 $17.35 $22.18
============== ============ ============
100,282,071 42,498,080 41,262,786
</TABLE>
See Notes to Financial Statements.
31
<PAGE> 33
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
INVESTMENT INCOME:
INCOME:
Dividends (net of foreign tax withheld of $565,817,
$182,876, and $210,058, respectively) (Note 7).........
Interest..................................................
Total income......................................
EXPENSES:
Investment Counsel fee (Note 3)...........................
Administration fee (Note 4)...............................
Transfer Agent fee........................................
Registration and filing fees..............................
Supplies and postage......................................
Reimbursable administration expenses (Note 4).............
Printing..................................................
Annual meeting expenses...................................
Trustees' fees............................................
Custodian fee.............................................
Insurance expense.........................................
Professional fees.........................................
Miscellaneous.............................................
Total expenses....................................
Net investment income.............................
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on securities...........................
Net unrealized appreciation on securities.................
Net unrealized appreciation on options....................
Net unrealized foreign exchange gain......................
Net realized and unrealized gain on investments...
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........
</TABLE>
See Notes to Financial Statements.
32
<PAGE> 34
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
PARTNERS SMALL-CAP
FUND REALTY FUND FUND
- ------------- ------------ --------------
<S> <C> <C>
$ 28,815,668 $ 6,154,534 $ 5,512,300
17,581,204 3,716,063 8,851,576
- ------------ ------------ ------------
46,396,872 9,870,597 14,363,876
- ------------ ------------ ------------
20,885,285 5,064,551 5,697,623
2,651,375 506,455 632,636
451,053 85,587 106,930
58,614 189,211 209,864
167,354 52,666 62,391
192,492 19,076 26,959
135,801 40,089 41,414
122,670 38,535 29,478
60,000 27,500 30,000
35,309 25,171 23,385
47,458 8,244 10,099
21,915 15,556 19,803
146,999 21,947 27,992
- ------------ ------------ ------------
24,976,325 6,094,588 6,918,574
- ------------ ------------ ------------
21,420,547 3,776,009 7,445,302
- ------------ ------------ ------------
306,865,056 27,323,623 26,187,400
322,569,345 74,200,344 114,470,656
- 7,499,273 -
- 4,474 4,468
- ------------ ------------ ------------
629,434,401 109,027,714 140,662,524
- ------------ ------------ ------------
$650,854,948 $112,803,723 $148,107,826
============ ============ ============
</TABLE>
See Notes to Financial Statements.
33
<PAGE> 35
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
PARTNERS FUND
---------------------------------
YEAR ENDED DECEMBER 31,
1997 1996
---------------- --------------
<S> <C> <C>
OPERATIONS:
Net investment income................ $ 21,420,547 $ 34,373,697
Net realized gain on securities...... 306,865,056 213,673,408
Net unrealized appreciation on
securities........................ 322,569,345 158,628,871
Net unrealized appreciation on
options........................... - -
Net unrealized foreign exchange
gain.............................. - -
-------------- --------------
Net increase in net assets
resulting from operations....... 650,854,948 406,675,976
-------------- --------------
DISTRIBUTIONS TO SHAREHOLDERS:
From net investment income........... (21,460,363) (34,349,264)
From net realized gain on
investments....................... (311,977,522) (213,539,413)
From return of capital............... - -
-------------- --------------
Net decrease in net assets
resulting from distributions.... (333,437,885) (247,888,677)
-------------- --------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from sale of shares..... 477,572,262 415,870,054
Net asset value of shares issued to
shareholders for reinvestment of
shareholder distributions......... - 234,252,018
Cost of shares redeemed.............. (489,998,326) (385,297,441)
-------------- --------------
Net increase(decrease) in net
assets from fund share
transactions.................... (12,426,064) 264,824,631
-------------- --------------
Total increase in net assets...... 304,990,999 423,611,930
NET ASSETS:
Beginning of year.................... 2,300,079,176 1,876,467,246
-------------- --------------
End of year.......................... $2,605,070,175 $2,300,079,176
============== ==============
Undistributed net investment income
included in net assets at end of
year.............................. $ 89,373 $ 129,189
============== =========
</TABLE>
See Notes to Financial Statements.
34
<PAGE> 36
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
REALTY FUND SMALL-CAP FUND
---------------------------------- ----------------------------------
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
1997 1996 1997 1996
---------------- -------------- ---------------- --------------
<S> <C> <C> <C>
$ 3,776,009 $ 405,735 $ 7,445,302 $ 305,763
27,323,623 490,532 26,187,400 13,416,172
74,200,344 16,280,740 114,470,656 33,330,915
7,499,273 - - -
4,474 - 4,468 -
-------------- -------------- -------------- --------------
112,803,723 17,177,007 148,107,826 47,052,850
-------------- -------------- -------------- --------------
(3,757,696) (399,816) (7,427,301) (313,153)
(27,280,191) (487,169) (28,306,270) (13,335,532)
(1,813,127) (159,496) - -
-------------- -------------- -------------- --------------
(32,851,014) (1,046,481) (35,733,571) (13,648,685)
-------------- -------------- -------------- --------------
685,515,315 150,091,326 770,142,361 108,358,068
- 999,870 - 12,582,527
(184,175,044) (11,212,498) (219,414,438) (38,164,599)
-------------- -------------- -------------- --------------
501,340,271 139,878,698 550,727,923 82,775,996
-------------- -------------- -------------- --------------
581,292,980 156,009,224 663,102,178 116,180,161
156,009,224 0 252,156,957 135,976,796
-------------- -------------- -------------- --------------
$ 737,302,204 $ 156,009,224 $ 915,259,135 $ 252,156,957
============== ============== ============== ==============
$24,233 $5,919 $22,599 $4,598
========= ======= ========= =======
</TABLE>
See Notes to Financial Statements.
35
<PAGE> 37
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
NOTES TO FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION
The Funds are each a series of Longleaf Partners Funds Trust, a Massachusetts
business trust which is registered under the Investment Company Act of 1940, as
amended, as an open-end management investment company. Capitalization for each
fund was provided by principals of Southeastern Asset Management, Inc., the
Investment Counsel, as follows:
<TABLE>
<CAPTION>
PARTNERS FUND REALTY FUND SMALL-CAP FUND
----------------- ------------------ -----------------
<S> <C> <C> <C>
Organization date.... November 26, 1986 September 12, 1995 December 21, 1988
Initial
capitalization
date............... March 24, 1987 January 2, 1996 December 28, 1988
Amount of initial
capitalization..... $100,000 $100,000 $1,500,000
Shares issued at
capitalization..... 10,000 10,000 150,000
Shares authorized.... Unlimited Unlimited Unlimited
Public offering
date............... April 8, 1987 January 2, 1996 February 21, 1989
</TABLE>
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
Security Valuation
(1) Portfolio securities listed or traded on a securities exchange and
over-the-counter securities traded on the NASDAQ national market are
valued at the last sales price. If there are no transactions in the
security that day, securities are valued at the midpoint between the
closing bid and ask prices.
(2) All other portfolio securities for which over-the-counter market
quotations are readily available are valued at the midpoint between the
closing bid and ask prices. Repurchase agreements are valued at cost
which, combined with accrued interest, approximates market. Short-term
U.S. Government obligations are valued at amortized cost which
approximates current market value.
(3) Option contracts are marked-to-market daily. Listed options are valued at
the latest closing price. If there are no transactions that day, the
options are valued at the midpoint between the closing bid and ask prices.
Over-the-counter options are valued as determined in good faith under
procedures established by the Funds' trustees.
(4) When market quotations are not readily available, portfolio securities are
valued at their fair value as determined in good faith under procedures
36
<PAGE> 38
established by and under the general supervision of the Funds' Trustees.
In determining fair value, the Board considers all relevant qualitative
and quantitative information available. These factors are subject to
change over time and are reviewed periodically. Estimated values may
differ from the values that would have been used had a ready market of the
investment existed.
Accounting for Investments
The Funds follow industry practice and record security transactions on trade
date plus one. Realized gains and losses on security transactions are determined
using the specific identification method. Dividend income is recognized on the
ex-dividend date and interest income is recognized on an accrual basis.
Distributions to Shareholders
Dividends and distributions to shareholders are recorded on the ex-dividend
date.
Federal Income Taxes
The Funds' policy is to comply with the requirements of the Internal Revenue
Code that are applicable to regulated investment companies and to distribute all
taxable income to shareholders. Accordingly, no federal income tax provision is
required. In addition, the Funds intend to make any required distributions to
avoid the application of a 4% nondeductible excise tax.
Foreign Currency Translations
The books and records of the Funds are maintained in U.S. dollars. Securities
denominated in currencies other than U.S. dollars are subject to changes in
value due to fluctuations in exchange rates. Purchases and sales of securities
and income and expenses are translated into U.S. dollars at the prevailing
exchange rate on the respective date of each transaction. The market value of
investment securities, assets and liabilities are translated into U.S. dollars
daily.
The Funds do not isolate the portion of net realized and unrealized gains or
losses in equity security investments which is attributable to changes in
foreign exchange rates. Accordingly, the impact of foreign currency conversions
is included in the realized and unrealized gains or losses on the underlying
equity securities.
Forward Currency Contracts
The Funds may execute forward currency contracts to reduce their exposure to
currency risk on portfolio investments denominated in foreign currency. Forward
currency contracts are commitments to purchase or sell a foreign currency at a
future maturity date. The resulting obligation is marked-to-market daily using
foreign currency exchange rates supplied by an independent pricing service. An
unrealized gain or loss is recorded for the difference between the contract
opening value and its current value. When a contract is closed or delivery is
taken, this gain or loss is realized. For federal tax purposes, open forward
contracts are treated as realized and subject to distribution at our excise tax
year-end date.
37
<PAGE> 39
Options
Upon the purchase of a put or call option, the premium paid is recorded as an
investment. When the Funds write a put or a call option, the premium received by
the Funds is recorded as a liability. When a purchased option expires, a loss is
recognized for the cost of the option. When a written option expires, a gain is
realized for the premium received. When the Funds enter into a closing sale
transaction, a gain or loss is recognized based on the difference between the
proceeds of the closing transaction and the cost of the option.
Risk of Foreign Currency Contracts and Options
Using puts and calls in conjunction with each other for hedging purposes can
reduce market risks. However, when used separately, options and forwards have
risks. For example, the price movements of the securities underlying the options
and forwards may not follow the price movements of the portfolio securities
subject to the hedge. Gains on investments in options and forwards depend on the
ability to predict correctly the direction of stock prices, interest rates, and
other economic factors. Where a liquid secondary market for options or forwards
does not exist, the Funds may not be able to close their positions and in such
an event, the loss is theoretically unlimited.
Repurchase Agreements
The Funds may engage in repurchase agreement transactions. The Funds' custodian
bank sells U.S. government securities to each Fund under agreements to
repurchase these securities from each Fund at a stated repurchase price
including interest for the term of the agreement, which is usually overnight or
over a weekend. Each Fund, through its custodian, receives delivery of the
underlying U.S. government securities as collateral, whose market value is
required to be at least equal to the repurchase price. If the custodian becomes
bankrupt, the Fund might be delayed, or may incur costs or possible losses of
principal and income, in selling the collateral.
NOTE 3. INVESTMENT COUNSEL AGREEMENT
Southeastern Asset Management, Inc. ("Southeastern") serves as Investment
Counsel to the Funds and receives annual compensation, computed daily and paid
monthly, in accordance with the following schedule for the Partners Fund and
Small-Cap Fund:
<TABLE>
<S> <C>
First $400 million of average daily net
assets.................................... 1.00%
In excess of $400 million................... .75%
</TABLE>
The Realty Fund fee is calculated on the same basis at 1.00% per annum on all
asset levels.
Southeastern has agreed to reduce its fees on a pro rata basis to the extent
that the Funds' normal annual operating expenses (excluding taxes, interest,
brokerage fees, and extraordinary expenses) exceed 1.5% of average annual net
assets. No such reductions were necessary for the current year.
38
<PAGE> 40
NOTE 4. FUND ADMINISTRATOR
Southeastern also serves as the Fund Administrator and in this capacity is
responsible for managing, performing or supervising the administrative and
business operations of the Funds. Functions include the preparation of all
registration statements, prospectuses, tax returns and proxy statements, daily
valuation of the portfolios and calculation of daily net asset values per share.
The Funds pay a fee as compensation for these services, accrued daily and paid
monthly, of 0.10% per annum of average daily net assets.
Reimbursable administration expenses paid by the Funds to Southeastern consist
of the cost of computer software dedicated to valuation calculations and a
portion of the Funds' Treasurer's salary allocated in accordance with Trustee
review and approval.
NOTE 5. SHARES OF BENEFICIAL INTEREST
Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
--------------------------------------------
PARTNERS FUND REALTY FUND SMALL-CAP FUND
------------- ----------- --------------
<S> <C> <C> <C>
Shares sold.................. 18,272,322 42,365,845 37,816,017
Shares redeemed.............. (18,643,094) (11,033,373) (10,675,148)
----------- ----------- -----------
(370,772) 31,332,472 27,140,869
=========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
--------------------------------------------
PARTNERS FUND REALTY FUND SMALL-CAP FUND
------------- ----------- --------------
<S> <C> <C> <C>
Shares sold.................. 18,238,896 11,949,427 6,357,663
Reinvestment of shareholder
distribution............... 10,180,444 71,778 706,090
Shares redeemed.............. (16,493,540) (855,598) (2,348,601)
----------- ----------- -----------
11,925,800 11,165,607 4,715,152
=========== =========== ===========
</TABLE>
NOTE 6. INVESTMENT TRANSACTIONS
Purchases and sales of equity securities and related brokerage commissions for
the period (excluding short-term obligations) are summarized below:
<TABLE>
<CAPTION>
PARTNERS FUND REALTY FUND SMALL-CAP FUND
-------------- ------------ --------------
<S> <C> <C> <C>
Purchases................ $1,179,765,879 $604,005,753 $552,436,450
Sales.................... 874,988,296 127,844,694 79,801,615
Brokerage commissions.... 4,707,780 1,791,258 1,632,755
</TABLE>
NOTE 7. AFFILIATED COMPANIES
Under Section 2(a)(3) of the Investment Company Act of 1940, a portfolio company
is defined as "affiliated" if a Fund owns five percent or more of its voting
39
<PAGE> 41
stock. At December 31, 1997, each Fund held at least five percent of the
outstanding voting stock of the following companies:
<TABLE>
<CAPTION>
DIVIDEND
% INCOME
OUTSTANDING MARKET IN THE
SHARES OF VALUE AT YEAR ENDED
THE DECEMBER 31, DECEMBER 31,
COMPANY 1997 1997
----------- ------------ ------------
<S> <C> <C> <C>
PARTNERS FUND
Knight-Ridder, Inc. 7.7 $338,000,000 $5,187,920
Rayonier Inc. 9.9 123,431,250 3,480,000
360 DEGREES Communications Company 5.0 124,024,672 -
------------ ----------
$585,455,922 $8,667,920
============ ==========
REALTY FUND
Alexandria Real Estate Equities,
Inc. 7.8% $28,166,375 $ 189,628
Bay View Capital Corp. 5.4 24,450,625 238,722
Castle & Cooke, Inc. 7.1 24,090,750 -
Deltic Timber Corporation 5.1 17,793,750 153,169
Getty Realty Corp. 9.1 27,076,575 125,622
IHOP Corp. 10.3 32,298,500 -
Prime Group Realty Trust 14.9 37,462,500 229,400
Prime Retail, Inc. 9.0 34,647,294 -
Red Roof Inns, Inc. 7.1 30,618,875 -
Sizeler Property Investors, Inc. 9.3 8,221,500 355,077
Supertel Hospitality, Inc. 11.5 5,583,460 -
TimberWest Timber Trust 8.2 41,240,157 539,037
Wellsford Real Properties, Inc.
(See Note 8) 20.5 53,093,750 -
------------ ----------
$364,744,111 $1,830,655
============ ==========
SMALL-CAP FUND
American Safety Razor Company 7.0% $17,000,000 $ -
Bay View Capital Corp. 7.5 33,712,500 282,376
Celestial Seasonings, Inc. 5.3 6,772,500 -
Corecomm, Inc. 13.0 17,242,875 -
Deltic Timber Corporation 6.6 23,131,875 194,125
Gendis, Inc. - Class A 16.4 40,814,493 54,976
Hilb, Rogal and Hamilton Company 13.9 34,326,038 1,012,491
IHOP Corp. 5.7 17,969,250 -
Shaw Communications Inc. -- Class B 7.4 55,072,648 -
Showboat, Inc. 9.9 47,000,000 50,463
TimberWest Timber Trust 8.8 44,119,497 901,050
The Union Corporation 5.2 9,431,250 -
VICORP Restaurants, Inc. 10.8 17,192,000 -
White River Corporation 7.2 27,920,400 -
------------ ----------
$391,705,326 $2,495,481
============ ==========
</TABLE>
40
<PAGE> 42
Realized net gains on the sales of affiliated companies were:
<TABLE>
<CAPTION>
Gain
----------
<S> <C> <C>
Partners Fund............... Knight-Ridder, Inc. $1,352,592
Realty Fund................. None --
Small-Cap Fund.............. Celestial Seasonings, Inc. 307,411
Corecomm, Inc. 163,996
</TABLE>
NOTE 8. ILLIQUID SECURITIES
The Realty Fund holds 3,398,000 shares of Wellsford Real Properties, Inc.
carried at its current market value of $53,093,750 or $15.625 per share. These
shares were acquired in a private placement which closed June 2, 1997. The
securities are valued in good faith under guidelines established by the Fund
Trustees. This investment represents 7.2% of the Realty Fund at December 31,
1997.
NOTE 9. COLLATERAL
Securities with the following aggregate market value were segregated to
collateralize portfolio obligations at December 31, 1997:
<TABLE>
<CAPTION>
Market
Value of
Segregated
Obligation Assets
--------------------------- ------------
<S> <C> <C>
Partners Fund.............. Forward Currency Contracts $337,436,138
Realty Fund................ Newhall-Land and Farming
Company Put Options
Written 35,325,000
Small-Cap Fund............. Forward Currency Contracts 109,507,663
</TABLE>
41
<PAGE> 43
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
FINANCIAL HIGHLIGHTS
The following condensed financial information, including total returns, has been
financial statements appears in this report and should be read in
is for a share outstanding throughout each period.
<TABLE>
<CAPTION>
NET
GAINS
NET ON DISTRI-
ASSET SECURITIES TOTAL DIVIDENDS BUTIONS
VALUE NET REALIZED FROM FROM NET FROM RETURN
BEGINNING INVESTMENT AND INVESTMENT INVESTMENT CAPITAL OF
OF PERIOD INCOME(E) UNREALIZED OPERATIONS INCOME GAINS CAPITAL
--------- ---------- ---------- ---------- ---------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
PARTNERS FUND
Year ended December 31,
1997.................... $22.85 $.21 $ 6.24 $ 6.45 $ (.21) $(3.11) $ -
1996.................... 21.15 .37 4.09 4.46 (.38) (2.38) -
1995.................... 17.13 .30 4.40 4.70 (.24) (.44) -
1994.................... 16.92 .21 1.30 1.51 (.16) (1.14) -
1993.................... 14.70 .10 3.16 3.26 (.09) (.95) -
1992.................... 13.34 .07 2.65 2.72 (.07) (1.29) -
REALTY FUND
Year ended December 31,
1997...................... 13.97 .19 3.96 4.15 (0.09) (0.64) (0.04)
January 2, 1996 (Initial
Capitalization) through
December 31, 1996....... 10.00 .16 3.91 4.07 (.04) (.05) (.01)
SMALL-CAP FUND
Year ended December 31,
1997.................... 17.86 .25 4.94 5.19 (.18) (.69) -
1996.................... 14.46 .03 4.40 4.43 (.02) (1.01) -
1995.................... 13.28 .12 2.35 2.47 (.12) (1.17) -
1994.................... 13.49 (.03) .52 .49 - (.70) -
1993.................... 11.40 (.06) 2.32 2.26 - (.17) -
1992.................... 10.67 (.01) .74 .73 - - -
</TABLE>
* Annualized
(a) Aggregate, not annualized.
(b) Not applicable for prior periods prior to 1996.
(c) Before expense limitation fee waiver, this ratio was 1.60%.
(d) Before expense limitation fee waiver, this ratio was .82%.
(e) Calculated based on weighted average shares outstanding for the period.
42
<PAGE> 44
- --------------------------------------------------------------------------------
LONGLEAF PARTNERS FUNDS
FINANCIAL HIGHLIGHTS
audited by Coopers & Lybrand L.L.P. The audit report on the 1997
conjunction with this condensed financial information. The presentation
<TABLE>
<CAPTION>
RATIO OF
NET EXPENSES RATIO OF
ASSET NET ASSETS TO NET
TOTAL VALUE END OF AVERAGE INCOME TO PORTFOLIO AVERAGE
DISTRI- END OF TOTAL PERIOD NET AVERAGE TURNOVER COMMISSION
BUTIONS PERIOD RETURN (THOUSANDS) ASSETS NET ASSETS RATE RATE PAID(B)
------- ------ ------ ----------- -------- ----------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$(3.32) $25.98 28.25%(a) $2,605,070 .94% 0.81% 38.07% $0.0514
(2.76) 22.85 21.02 2,300,079 .95 1.61 33.18 0.0750
(.68) 21.15 27.50 1,876,467 1.01 1.45 12.60
(1.30) 17.13 8.96 753,527 1.17 1.18 27.39
(1.04) 16.92 22.20 397,282 1.26 .63 19.12
(1.36) 14.70 20.47 243,678 1.29 .50 29.12
(0.77) 17.35 29.73 737,302 1.20 0.75 28.66 0.0739
(.10) 13.97 40.69 156,009 1.50(c) .92(d) 4.28 0.0613
(.87) 22.18 29.04 915,259 1.09 1.18 16.95 0.0514
(1.03) 17.86 30.64 252,157 1.23 .18 27.97 0.0605
(1.29) 14.46 18.61 135,977 1.30 .84 32.95
(.70) 13.28 3.64 99,609 1.38 (.22) 19.79
(.17) 13.49 19.83 85,087 1.45 (.45) 14.37
- 11.40 6.87 62,181 1.45 (.03) 25.80
</TABLE>
43
<PAGE> 45
- --------------------------------------------------------------------------------
SERVICE DIRECTORY
FUND INFORMATION (800) 445-9469
To request a prospectus, financial report, application or other Fund information
call (800) 445-9469 from 8:00 a.m. to 8:00 p.m. Eastern time, seven days a week.
EXISTING SHAREHOLDER INQUIRIES (800) 488-4191
To request action on your existing account contact the transfer agent, NFDS, at
(800) 488-4191 from 9:00 a.m. to 6:00 p.m. Eastern time, Monday through Friday.
<TABLE>
<CAPTION>
<S> <C>
Mail correspondence to: Overnight address:
Longleaf Partners Funds Longleaf Partners Funds
c/o NFDS c/o NFDS
P.O. Box 419929 1004 Baltimore, 5th Floor
Kansas City, MO 64141-6929 Kansas City, MO 64105
(816) 435-5241
</TABLE>
24-HOUR AUTOMATED INFORMATION (800) 378-3788
For automated reporting of daily prices, account balances and transaction
activity call (800) 378-3788, 24-hours a day, seven days a week. Please have
your Fund number (see below) and account number ready to access your investment
information.
SERVICES FOR FINANCIAL ADVISORS (800) 761-2509
Please contact Lee Harper or Mary Williamson for additional information.
PUBLISHED DAILY PRICE QUOTATIONS
Daily net asset values per share of each Fund are reported in mutual fund
quotations tables of major newspapers in alphabetical order under the bold
heading LONGLEAF PARTNERS as follows:
<TABLE>
<CAPTION>
TRANSFER AGENT
ABBREVIATION SYMBOL CUSIP FUND NUMBER
- ------------ ------ --------- --------------
<C> <S> <C> <C>
Partners LLPFX 543069108 133
Realty LLREX 543069306 135
Sm-Cap LLSCX 543069207 134
</TABLE>
44
<PAGE> 46
- --------------------------------------------------------------------------------
TRUSTEES AND OFFICERS
Trustees
O. Mason Hawkins, Chairman
Chadwick H. Carpenter, Jr.
Daniel W. Connell, Jr.
Steven N. Melnyk
C. Barham Ray
W. Reid Sanders
Officers
O. Mason Hawkins, Co-Portfolio Manager and Chief Executive Officer
W. Reid Sanders, President
G. Staley Cates, Co-Portfolio Manager and Vice President - Investments
C. T. Fitzpatrick, Co-Portfolio Manager of the Realty Fund
and Vice-President - Investments
Charles D. Reaves, Executive Vice President and General Counsel
Julie M. Douglas, Executive Vice President - Operations and Treasurer
Lee B. Harper, Executive Vice President - Marketing
Frank N. Stanley III, Vice President - Investments
John B. Buford, Vice President - Investments
Randy D. Holt, Vice President and Secretary
Transfer Agent
National Financial Data Services
Kansas City, Missouri
Custodian
State Street Bank & Trust Company
Boston, Massachusetts
Special Legal Counsel
Dechert Price & Rhodes
Washington D.C.
Independent Public Accountants
Coopers & Lybrand L.L.P.
Boston, Massachusetts
45
<PAGE> 47
Longleaf Partners Funds
c/o NFDS
P.O. Box 419929
Kansas City, MO 64141-6929
Fund Information Requests
(800) 445-9469
Shareholder Account Inquiries
(800) 488-4191
