<PAGE>
Baker, Fentress & Company
[ARTWORK APPEARS HERE]
1998 MIDYEAR REPORT
<PAGE>
DIRECTORS AND OFFICERS
BOARD OF DIRECTORS
Frederick S. Addy
Bob D. Allen
Jessica M. Bibliowicz
Eugene V. Fife
J. Barton Goodwin
James P. Gorter
David D. Grumhaus
Jeffrey A. Kigner
John A. Levin
Burton G. Malkiel
David D. Peterson
William H. Springer
Dean J. Takahashi
OFFICERS
James P. Gorter Chairman of the Board
John A. Levin President and Chief Executive Officer
James P. Koeneman Executive Vice President and Secretary
Scott E. Smith Executive Vice President
Julie A. Heironimus Treasurer and Assistant Secretary
CORPORATE DATA
Transfer and Dividend Disbursing Agent
Harris Trust and Savings Bank
1-800-394-5187 or 312-360-5198
Custodian
UMB Bank, N.A.
Legal Counsel
Bell, Boyd & Lloyd
Address of Company
200 West Madison Street
Suite 3510
Chicago, Illinois 60606
312-236-9190 or 1-800-BKF-1891
[RECYCLED LOGO APPEARS HERE]
The Company's Midyear Report is printed on recycled paper. We encourage
recycling and use of recycled products.
<PAGE>
TO OUR SHAREHOLDERS
In the second quarter, the market, as measured by the S&P 500 Index,
fluctuated within a relatively narrow range, ending the quarter with an increase
of 3.3%. This rise was well below the market's 14.0% gain in the first quarter.
For the six months ended June 30, 1998, the market was up 17.7%.
As has been the case for some time, the market's performance has been
extremely tiered. In the second quarter, the increase in the market
capitalization of a group of only 14 stocks was equal to the increase in the
market capitalization of the entire S&P 500 Index. In other words, there was no
net increase in the market capitalization of the other 486 stocks comprising the
index. Furthermore, the unweighted average return of these 14 stocks for the
second quarter was 20.7%, while the unweighted average return on the remainder
of the stocks in the index was a negative 2.0% (a). The gains achieved by these
market leaders were reflected in the increases in their multiples, as the
price/earnings ratio of these 14 stocks was 42.2x (b) based on the trailing four
quarters, which is very high relative to historic valuations.
The second quarter dramatically illustrated how the returns of a
capitalization-weighted index such as the S&P 500 can be strongly impacted by
the performance of a few stocks, masking the price action of the vast majority
of other stocks in the Index. While a benchmark is an important way of measuring
performance, an attempt to match a benchmark should not divert an investment
manager from following its basic investment philosophy. We, and the investment
management team at John A. Levin & Co., Inc. (Levco), believe that a market
based on such narrow leadership contains significant risks and that the
structuring of a diversified portfolio is especially important in such an
environment, even at the cost of lagging the S&P 500 in the short term.
MIDYEAR RESULTS
Baker, Fentress & Company (BKF) total net assets at June 30, 1998 were $811.7
million, or $21.67 per share, compared with $783.7 million, or $21.78 per share,
at December 31, 1997. Our net asset value total return was 9.8% for the six
months ended June 30, 1998, and shareholder total return, which is based on
market value, was 11.0%. This reflects a decrease in our discount from 16.2% at
December 31, 1997 to 15.5% at June 30, 1998. The accompanying chart shows our
Company-wide total return and the returns of our portfolio sectors for this six-
month period.
TOTAL RETURNS
For Six Months Ended June 30,1998
[GRAPH APPEARS HERE]
BKF NAV 9.8%
BKF MARKET 11.0%
PUBLIC 10.1%
LEVCO 7.6%
PRIVATE 35.4%
CTO -2.2%
As previously announced, on May 5, 1998, midyear distributions totaling
$2.00 per share ($1.75 in capital gain and $0.25 in ordinary income) were paid
to shareholders of record as of March 27, 1998. As a result, the cash position
in our public portfolio as of June 30, 1998 has been significantly reduced.
Since we expect to make another capital gain distribution
(a) Birinyi Associates
(b) Baseline
Baker, Fentress & Company | Midyear Report 1998 1
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<PAGE>
TO OUR SHAREHOLDERS (continued)
and pay another ordinary income dividend in December, we anticipate that 1998
calendar year distributions will exceed 12% of average net assets for the 12
months ending October 31, 1998. Beginning in 1999, however, we intend to return
to our minimum targeted payout of 8%.
Although we have always accurately reported net asset value total return and
shareholder total return for Baker Fentress, we recently discovered the total
return for the public portion of our portfolio has been inaccurately reported in
quarterly and annual shareholder reports since the acquisition of Levco at the
end of June 1996. This was due to an incorrect internal calculation involving
some dividend and interest income within the public portfolio by Baker Fentress.
For example, total return for the public portfolio for 1997 was reported last
year as 19.8%, whereas the correct number was 17.5%. The error in reporting
public portfolio performance has been corrected in this report.
PUBLIC PORTFOLIO
As Levco implements its investment program, it seeks to construct a diversified
portfolio with companies that possess one, or ideally several, of the following
characteristics:
1) proprietary products or services;
2) an inexpensive valuation relative to asset value or cash flow;
3) new products or developments; or
4) securities with an attractive yield component.
This value-oriented approach seeks to produce positive relative performance
during down or flat markets and provide superior returns over an entire market
cycle. In this market environment, Levco is seeking to construct a portfolio
containing stocks with strong relative values, some others with absolute value,
and securities that can provide a significant degree of downside protection. The
performance differential with respect to the S&P 500 is in large part
attributable to the significant differences between the diversified structure of
our value-oriented portfolio and the tiered nature of the current market.
LEVCO
In June, Levco announced the hiring of James H. Kelly, 46, as Director of
Institutional Marketing and Client Services. Mr. Kelly has over 13 years
experience in the investment management industry. Most recently, Mr. Kelly was
for six years a managing director and a director of marketing at Harbor Capital
Management Co. in Boston, where he was responsible for overseeing business
development and client service.
Complementing Levco's efforts in the retail area, Mr. Kelly will be launching
a major effort in the institutional market. Seeking to take advantage of Levco's
reputation, Mr. Kelly will be implementing a coordinated client service and
marketing campaign directed at consultants, pension plans and other
institutional clients.
Levco's total assets under management as of June 30, 1998 were $8.2 billion,
compared to $7.4 billion at the end of 1997. Unaudited revenues for the six
months ended June 30, 1998 were $18.7 million, compared to $17.7 million for the
same six month period in 1997.
We continue to believe that Levco's 1998 earnings will be below those reported
in 1997, primarily because of their continuing investments in people and
infrastructure. Nevertheless, in June, Baker Fentress raised the value of our
Levco investment by $6.6 million to reflect a number of factors, including our
2 Baker, Fentress & Company Midyear Report 1998
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<PAGE>
continuing confidence in Levco's long-term prospects and current market
valuations of investment management companies.
CONSOLIDATED-TOMOKA
LAND CO. (CTO)
CTO's real estate operations are heavily influenced by the Florida economy,
which remains strong. The company continues to add to its sales contract
backlog, thereby improving prospects for real estate earnings. CTO's citrus
production for the 1997-98 crop year was 1,255,508 boxes, a 20% increase over
the prior year. Looking forward to the 1998-99 crop year, we note that Brazil,
the world's leading citrus producer, is forecasting a large decrease in
production. This decrease should support higher citrus prices and boost CTO's
citrus earnings in the 1998-99 crop year.
The recent fires in the Daytona Beach area caused only minimal economic
losses to CTO's operations. While fires engulfed more than eight thousand acres
of company land, they did not damage any structures or golf course property.
Aggressive harvesting of fire damaged pine trees will largely eliminate any
losses in timber value. Based on a preliminary assessment of the effect the
fires will have on the local economy, no loss of future land sales is expected
due to the fires.
PRIVATE PLACEMENTS
On June 30, 1998, Citadel Communications completed an initial public offering of
6.88 million common shares at a price of $16 (NASDAQ ticker symbol: CITC). We
converted our CITC preferred shares into 2,239,236 common shares, which are
valued at a 10% liquidity discount to their market price because they are
subject to trading restrictions for 180 days following the initial public
offering.
Prior to the public offering, BKF's investment in Citadel was carried at $22.4
million. On July 15, CITC shares closed at $20 3/8, resulting in a value of
$41.1 million for our position.
The improved liquidity provided by the CITC public offering reflects
continued progress in our efforts to unwind the private placement portfolio. We
remain confident this process can be largely completed over the next 12-18
months.
CLOSING COMMENTS
The quality of the Levco personnel and the growth of Levco's marketing, client
servicing, and operations infrastructure give us optimism as we move into what
we believe will be a challenging and exciting market environment. We are focused
on planning and preparing for long-term success. As always, please feel free to
contact us at (800) BKF-1891 with any questions or comments you may have.
Respectfully yours,
/s/ James P. Gorter
James P. Gorter
Chairman of the Board
/s/ John A. Levin
John A. Levin
President and
Chief Executive Officer
Baker, Fentress & Company Midyear Report 1998 3
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<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
June 30, 1998
(Unaudited)
-------------
Assets
Investments, at Value:
<S> <C>
Portfolio securities:
Unaffiliated issuers (cost $406,179,734).................. $508,286,153
Non-controlled affiliates (cost $13,110,996).............. 32,744,984
Controlled affiliates (cost $136,676,517)................. 235,645,905
------------
Total Investments (cost $555,967,247)................. 776,677,042
Cash and Cash Equivalents..................................... 40,407,153
Receivable for Securities Sold................................ 1,644,774
Dividends and Interest Receivable............................. 2,634,060
Other Assets.................................................. 662,755
------------
Total Assets.......................................... 822,025,784
------------
Liabilities
Bank Borrowing................................................ 5,000,000
Payable for Securities Purchased.............................. 4,492,871
Payable to Affiliate for Investment Management Fee............ 135,000
Accounts Payable and Accrued Liabilities...................... 678,423
------------
Total Liabilities..................................... 10,306,294
------------
Net Assets.............................................................. $811,719,490
============
Analysis of Net Assets
Common Stock, $1 par value, authorized 60,000,000 shares;
issued and outstanding 37,450,610 shares................. $ 37,450,610
Capital Surplus............................................... 440,734,434
Undistributed Net Realized Gain from Investment Transactions.. 61,183,725
Other Retained Earnings (a)................................... 51,640,925
Unrealized Appreciation of Investments........................ 220,709,796
------------
Net Assets.............................................................. $ 811,719,490
=============
Net Asset Value Per Share............................................... $ 21.67
=============
</TABLE>
---------------
(a) Prior to January 1, 1970, operating and other non-portfolio
activities were included in other retained earnings.
See accompanying Notes to Financial Statements
4 Baker, Fentress & Company Midyear Report 1998
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<PAGE>
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Six Months Ended
June 30, 1998 Year Ended
(Unaudited) December 31, 1997
Investment Income: ---------------- -----------------
<S> <C> <C>
Dividends from:
Unaffiliated issuers.......................................... $ 4,469,229 $ 7,089,124
Controlled affiliate.......................................... 1,750,000 3,250,000
------------ ------------
6,219,229 10,339,124
------------ ------------
Interest from:
Unaffiliated issuers.......................................... 1,615,118 4,151,774
Non-controlled affiliates..................................... -- 960,000
Controlled affiliates......................................... 3,648,750 7,442,931
------------ ------------
5,263,868 12,554,705
------------ ------------
Total Income.............................................. 11,483,097 22,893,829
------------ ------------
Expenses:
Investment management fee......................................... 769,231 1,536,578
Administration and operations..................................... 786,817 1,319,697
Interest on bank borrowing........................................ 170,988 1,012,447
Investment research............................................... 360,594 929,882
Professional fees................................................. 171,608 370,476
Directors' fees and expenses...................................... 220,818 368,907
Rent.............................................................. 172,701 309,983
Reports to shareholders........................................... 148,285 179,631
Custodian and transfer agent fees................................. 70,277 117,854
Taxes other than income........................................... 35,421 91,079
Other............................................................. 139,849 520,757
------------ ------------
Total Expenses............................................... 3,046,589 6,757,291
------------ ------------
Net Investment Income...................................... 8,436,508 16,136,538
------------ ------------
Net Realized and Unrealized Gain:
Net realized gain on sales of investments in unaffiliated issuers,
including options purchased and closed short positions........... 74,960,570 100,020,610
Net realized gain on covered call options written................. -- 103,416
------------ ------------
Net realized gain.............................................. 74,960,570 100,124,026
Net change in unrealized appreciation............................. (11,219,979) (13,722,353)
------------ ------------
Net Realized and Unrealized Gain............................. 63,740,591 86,401,673
------------ ------------
Net Increase in Net Assets Resulting from Operations........................ $ 72,177,099 $102,538,211
============= ============
</TABLE>
See accompanying Notes to Financial Statements
Baker, Fentress & Company | Midyear Report 1998 5
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<PAGE>
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
June 30, 1998 Year Ended
(Unaudited) December 31, 1997
---------------- -----------------
Cash Flows from Operating Activities:
<S> <C> <C>
Net increase in net assets resulting from operations.............. $ 72,177,099 $ 102,538,211
Adjustments to reconcile increase in
net assets resulting from operations to net cash
provided by (used in) operating activities:
Net realized and unrealized (gain) on investments................ (63,740,591) (86,401,673)
(Increase) decrease in receivable for securities sold............ 366,948 (1,614,159)
Decrease in deposits for securities sold short................... -- 13,697,890
(Increase) decrease in dividends and interest receivable......... 560,318 (1,344,935)
(Increase) decrease in other assets.............................. (52,695) 31,154
Increase (decrease) in accounts payable and accrued liabilities.. (1,377,197) 1,456,807
Increase in payable for investment management fee................ -- 15,000
Increase (decrease) in payable for securities purchased.......... (2,009,308) 6,502,179
Net amortization of (discounts).................................. (223,261) (216,111)
------------- -------------
Net cash provided by operating activities..................... 5,701,313 34,664,363
------------- -------------
Cash Flows from Investing Activities:
Purchases of portfolio securities and closing
of short positions................................................. (200,532,613) (268,551,573)
Proceeds from sales of portfolio securities
and securities sold short.......................................... 216,036,663 331,001,639
Proceeds from options written........................................ -- 366,138
Cost of options repurchased.......................................... -- (262,721)
(Purchases) and sales/maturities of money
market securities, net............................................. 29,753,562 (9,801,287)
------------- -------------
Net cash provided by investing activities...................... 45,257,612 52,752,196
------------- -------------
Cash Flows from Financing Activities:
Repayment of bank borrowing.......................................... -- (13,000,000)
Dividends and capital gain distributions............................. (44,174,832) (59,967,171)
------------- -------------
Net cash (used in) financing activities.......................... (44,174,832) (72,967,171)
------------- -------------
Net Increase in Cash and Cash Equivalents...................................... 6,784,093 14,449,388
Cash and Cash Equivalents at the
Beginning of the Period........................................................ 33,623,060 19,173,672
------------- -------------
Cash and Cash Equivalents at the
End of the Period.............................................................. $ 40,407,153 $ 33,623,060
============= =============
Supplemental Disclosure of Noncash Financing Activities:
Capital gain distribution reinvestments.............................. $ 27,791,330 $ 34,329,668
============= =============
</TABLE>
See accompanying Notes to Financial Statements
6 Baker, Fentress & Company | Midyear Report 1998
- --------------------------------------------------
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Six Months Ended
June 30, 1998 Year Ended
(Unaudited) December 31, 1997
<S> <C> <C>
Operations:
Net investment income.................................................... $ 8,436,508 $ 16,136,538
Net realized gain........................................................ 74,960,570 100,124,026
Net change in unrealized appreciation.................................... (11,219,979) (13,722,353)
------------ ------------
Net increase in net assets resulting from operations................. 72,177,099 102,538,211
------------ ------------
Distributions to Shareholders from:
Net investment income.................................................... (4,610,788) (15,795,572)
Net realized gain........................................................ (67,355,374) (78,501,267)
------------ ------------
Total distributions to shareholders.................................. (71,966,162) (94,296,839)
------------ ------------
Net increase in net assets from operations after distributions.. 210,937 8,241,372
Capital Share Transactions-Net Increase............................................ 27,791,330 34,329,668
------------ ------------
Total Increase in Net Assets....................................................... 28,002,267 42,571,040
Net Assets at the Beginning of the Period.......................................... 783,717,223 741,146,183
------------ ------------
Net Assets at the End of the Period................................................ $811,719,490 $783,717,223
============ ============
</TABLE>
See accompanying Notes to Financial Statements
Baker, Fentress & Company Midyear Report 1998 7
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<PAGE>
STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
June 30, 1998 - Unaudited Shares Value
------- -----------
INVESTMENTS IN UNAFFILIATED ISSUERS-62.62%
Public -- 60.63%
Common Stock -- 57.92%
Basic Materials -- 5.06%
<S> <C> <C>
Air Products & Chemicals, Inc................ 115,800 $ 4,632,000
Allegheny Teledyne Incorporated.............. 230,200 5,265,825
E.I. du Pont de Nemours and Company.......... 100,000 7,468,750
Getchell Gold Corporation (b)................ 240,500 3,697,688
Inland Steel Industries, Inc................. 260,400 7,340,155
Monsanto Company............................. 122,200 6,827,925
Sealed Air Corporation (b)................... 158,240 5,815,320
-----------
41,047,663
-----------
Capital Goods -- 10.41%
The Boeing Company........................... 96,436 4,297,477
FMC Corporation (b).......................... 17,200 1,172,833
General Electric Company..................... 86,000 7,815,250
Harnischfeger Industries, Inc................ 218,920 6,198,282
Lockheed Martin Corporation.................. 73,400 7,771,225
Minnesota Mining and Manufacturing Company... 145,600 11,966,573
Northrop Grumman Corporation................. 103,700 10,694,063
Owens-Illinois, Inc. (b)..................... 226,500 10,135,875
Republic Services, Inc. (b).................. 123,300 3,144,150
Rockwell International Corporation........... 51,300 2,462,400
Sunstrand Corporation........................ 30,600 1,751,850
United Technologies Corporation.............. 117,300 10,850,250
York International Corporation............... 145,000 6,316,635
-----------
84,576,863
-----------
Communication Services -- 2.44%
Bell Atlantic Corporation.................... 191,000 8,714,375
MediaOne Group Inc. (b)...................... 245,000 10,764,810
US West, Inc................................. 6,691 313,220
-----------
19,792,405
-----------
Consumer Cyclical -- 4.65%
The Black & Decker Corporation............... 182,200 11,114,200
J.C. Penney Company, Inc..................... 35,000 2,530,955
TRW Inc...................................... 151,500 8,275,687
Tribune Company.............................. 230,000 15,826,990
-----------
37,747,832
-----------
Consumer Staples -- 2.92%
Fortune Brands, Inc.......................... 147,300 5,661,917
General Mills, Inc........................... 110,900 7,568,925
Philip Morris Companies Inc.................. 157,200 6,189,750
Ralston Purina Company....................... 36,800 4,298,719
-----------
23,719,311
-----------
Energy -- 3.79%
Amerada Hess Corporation..................... 77,400 4,203,826
Sempra Energy (b)............................ 542,844 15,097,847
Unocal Corporation........................... 320,300 11,450,725
-----------
30,752,398
-----------
</TABLE>
See accompanying Notes to Statement of Investments
8 Baker, Fentress & Company Midyear Report 1998
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<PAGE>
STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
June 30, 1998 - Unaudited Shares Value
------- ------------
<S> <C> <C>
INVESTMENTS IN UNAFFILIATED ISSUERS (continued)
Financials -- 13.42%
Ace Ltd.................................................. 161,500 $ 6,298,500
Aetna Inc................................................ 216,500 16,481,063
American General Corporation............................. 7,500 533,910
Aon Corporation.......................................... 175,000 12,293,750
The Bank of New York Company............................. 100,800 6,136,200
BankBoston Corporation................................... 9,600 534,000
The CIT Group, Class A................................... 35,000 1,312,500
Citicorp................................................. 42,500 6,343,125
CRIIMI MAE Inc........................................... 90,000 1,248,750
EXEL Limited............................................. 126,600 9,843,150
Fairfax Financial Holdings Ltd. (Stock Purchase Rights).. 78,000 34,125
Financial Security Assurance Holdings Ltd................ 6,200 364,250
First Chicago NBD Corporation............................ 6,000 531,750
First Investors Financial Services Group, Inc. (b)....... 177,300 1,130,288
First Sierra Financial, Inc. (b)......................... 15,000 457,500
First Union Corporation.................................. 138,750 8,082,188
Fleet Financial Group, Inc............................... 4,500 375,750
Heller Financial Inc. (b)................................ 39,000 1,170,000
KeyCorp.................................................. 9,000 320,625
Mid Ocean Limited (ORD).................................. 14,700 1,153,950
Mutual Risk Management Ltd............................... 14,000 507,500
NAC Re Corp.............................................. 19,000 1,014,125
NationsBank Corporation.................................. 78,187 5,995,966
Partner Re Ltd........................................... 79,000 4,029,000
Risk Capital Holdings Inc. (b)........................... 6,200 154,616
SLM Holding Corporation Inc.............................. 24,100 1,180,900
TIG Holdings, Inc........................................ 310,000 7,130,000
Terra Nova Holdings Ltd., Class A........................ 32,800 1,029,100
Tokio Marine and Fire Insurance Company (ADR)............ 125,000 6,359,375
Travelers Group Inc...................................... 14,450 876,031
UICI (b)................................................. 49,000 1,335,250
Unitrin, Inc............................................. 52,000 3,614,000
Willis Corroon Group (ADR)............................... 82,000 1,030,164
------------
108,901,401
------------
</TABLE>
See accompanying Notes to Statement of Investments
Baker, Fentress & Company Midyear Report 1998 9
<PAGE>
STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
June 30, 1998 - Unaudited Shares or
Principal
Amount Value
--------- ------------
<S> <C> <C>
INVESTMENTS IN UNAFFILIATED ISSUERS (continued)
Health Care -- 3.39%
Eli Lilly and Company........................... 159,700 $ 10,580,125
Genentech, Inc. (b)............................. 139,400 9,461,775
Pfizer Inc...................................... 69,000 7,499,472
------------
27,541,372
------------
Technology -- 4.83%
First Data Corporation.......................... 423,700 14,114,718
Hewlett-Packard Company......................... 78,400 4,694,200
International Business Machines Corporation..... 86,900 9,977,250
Philips Electronics N.V......................... 53,300 4,523,837
Texas Instruments Incorporated.................. 100,700 5,872,119
------------
39,182,124
------------
Utilities -- 7.01%
Consolidated Edison of New York, Inc............ 65,700 3,026,339
Duke Energy Corporation......................... 365,540 21,658,245
Marketspan Corporation.......................... 498,520 14,924,692
Potomac Electric Power Company.................. 455,100 11,406,171
Texas Utilities Company......................... 141,100 5,873,288
------------
56,888,735
------------
Total common stock (Cost $369,830,589)... 470,150,104
------------
Preferred Stock -- 1.22%
Aetna Inc., 6.25% Class C....................... 25,000 1,878,125
Owens-Illinois Inc., 4.75%...................... 37,600 1,959,900
Sealed Air Corporation, $2.00 Series A.......... 42,750 1,795,500
Union Pacific Capital Trust, 6.25% (h).......... 93,100 4,270,962
------------
Total preferred stock (Cost $9,672,195).. 9,904,487
------------
Convertible Bonds -- 1.49%
Hewlett-Packard Company, Zero Coupon Bond
due 10/14/2017 (h)............................. $22,785,000 12,076,050
------------
Total convertible bonds (Cost $12,336,338)... 12,076,050
------------
Total public portfolio (Cost $391,839,122)... 492,130,641
------------
</TABLE>
See accompanying Notes to Statement of Investments
10 Baker, Fentress & Company Midyear Report 1998
<PAGE>
STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
June 30, 1998 - Unaudited Shares or
Principal
Amount Value
----------- ------------
<S> <C> <C>
INVESTMENTS IN UNAFFILIATED ISSUERS (continued)
Private Placement -- 1.99%
Paracelsus Healthcare Corporation - hospital management company
Common Stock (b)(c)(e).................................................... 535,443 $ 1,338,608
Security Capital U.S. Realty - real estate investment trust
Common Stock (b).......................................................... 983,528 13,080,917
Golder, Thoma, Cressey Fund II Limited Partnership (c)(d)................... $ 210,453 1,708,441
Phillips-Smith Specialty Retail Group Limited Partnership (c)(d)............ $ 61,175 27,546
------------
Total private placement portfolio (Cost $14,340,612)................ 16,155,512
------------
Total investments in unaffiliated issuers (Cost $406,179,734)............... 508,286,153
------------
INVESTMENTS IN NON-CONTROLLED AFFILIATES -- 4.03%
Private Placement -- 4.03%
Citadel Communications Corporation - radio broadcasting
Common Stock (b)(c)(f).................................................... 2,239,236 32,244,984
TBN Holdings Inc. - hazardous waste recycler
12% Subordinated Note Due 12/31/2002 (b)(c)(d)(g)........................ $8,000,000 500,000
Series C-3 Convertible Preferred Stock (b)(c)(d)......................... 1,511,628 --
Stock Purchase Warrants Expiring 12/31/2002 (b)(c)(d).................... 1,100,000 --
------------
Total investments in non-controlled affiliates (Cost $13,110,996)........... 32,744,984
------------
INVESTMENTS IN CONTROLLED AFFILIATES -- 29.03%
Publicly-Traded -- 10.70%
Consolidated-Tomoka Land Co., Common Stock
(majority-owned) - development of Florida real estate;
production and sale of citrus fruit (Cost $5,030,627)...................... 5,000,000 86,875,000
------------
Private Placement -- 1.36%
DuroLite International, Inc. - manufacturer and distributor of specialized
lighting products
Convertible Preferred Stock (b)(c)(d)..................................... 2,500 2,627,250
12% Subordinated Note due 11/03/2004 (c)(d)............................... $ 8,000,000 7,872,750
E-Sales, Inc. - diversified environmental services marketing organization
Convertible Preferred Stock (b)(c)(d)..................................... 500,000 500,000
------------
Total private placement portfolio (Cost $11,000,000).................... 11,000,000
------------
Wholly-Owned Subsidiary -- 16.97%
Levin Management Co., Inc - investment management
Common Stock (b)(c)(d).................................................... 1,000 72,770,905
9.75% Notes due 06/28/1999 (c)(d)......................................... $65,000,000 65,000,000
------------
Total wholly-owned subsidiary (Cost $120,645,890)....................... 137,770,905
------------
Total investments in controlled affiliates (Cost $136,676,517).............. 235,645,905
------------
TOTAL INVESTMENTS -- 95.68% (Cost $555,967,247)..................................... 776,677,042
------------
Cash and Other Assets, Less Liabilities -- 4.32%.................................... 35,042,448
------------
NET ASSETS -- 100.00%............................................................... $811,719,490
============
</TABLE>
See accompanying Notes to Statement of Investments
Baker, Fentress & Company Midyear Report 1998 11
<PAGE>
NOTES TO STATEMENT OF INVESTMENTS (Unaudited)
---------------
(a) Based on the cost of investments of $505,062,564, for federal income
tax purposes at June 30, 1998, net unrealized appreciation was
$271,614,478, which consisted of gross unrealized appreciation of
$296,924,830 and gross unrealized depreciation of $25,310,352.
(b) Non-income producing security.
(c) Securities subject to legal or contractual restrictions on sale.
Valued at cost on the dates of acquisition and at a fair value as
determined in good faith by the board of directors of the Company as
of June 30, 1998, based upon all factors deemed relevant by the board.
The quantitative and qualitative factors considered by the board of
directors may include, but are not limited to, type of securities,
nature of business, marketability, restrictions on disposition, market
price of unrestricted securities of the same issue (if any),
comparative valuation of securities of publicly-traded companies in
the same or similar industries, valuation of recent mergers and
acquisitions of similar companies, current financial condition and
operating results, sales and earnings growth, operating revenues,
competitive conditions, and current and prospective conditions in the
overall stock market.
The values determined by the board of directors may not reflect
amounts that could be realized upon immediate sale, nor amounts that
ultimately may be realized. Accordingly, the fair values included in
the statement of investments may differ from the values that would
have been used had a ready market existed for these securities, and
such differences could be significant. The aggregate value of
restricted securities was $184,590,484 or 22.7% of net assets, at June
30, 1998.
(d) There were no unrestricted securities of the same issue outstanding on
June 30, 1998 or the dates of acquisition.
(e) Represents 80% of the current market price of unrestricted common
stock of Paracelsus Healthcare Corporation.
(f) Represents 90% of the current market price of unrestricted common
stock of Citadel Communications Corporation.
(g) Security not current as to payment of interest.
(h) Security exempt from registration requirements under Rule 144A of the
Securities Act of 1933 which permits resales of eligible securities
issued in private placements and other transactions to "Qualified
Institutional Investors."
12 Baker, Fentress & Company | Midyear Report 1998
- ---------------------------------------------------
<PAGE>
NOTES TO FINANCIAL STATEMENTS--(Unaudited)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
The Company is registered under the Investment Company Act of 1940 as a non-
diversified closed-end management investment company. The Company invests for
total return with an emphasis on capital appreciation.
Investment valuation
Investments are stated at "value." Securities traded on securities exchanges or
on the Nasdaq National Market are valued at the last reported sales prices on
the day of valuation; listed and Nasdaq securities for which no sales were
reported on that day and other securities traded in the over-the-counter market
are valued at the mean of closing bid and asked prices on that day. Money market
securities are valued at amortized cost, which approximates market value.
Restricted securities and other securities for which prices are not readily
available, or for which market quotations are considered not to reflect fair
value, are valued at a fair value as determined by the board of directors as
explained in Note (C) in the Notes to Statement of Investments. The values
determined by the board of directors, including the values of the Company's
investments in Consolidated-Tomoka Land Co. (CTO) and Levin Management Co., Inc.
(Levco), discussed below, may not reflect amounts that could be realized upon
immediate sale, nor amounts that ultimately may be realized. Accordingly, the
fair values included in the Company's financial statements may differ from the
values that would have been used had a ready market existed for these
securities, and such differences could be significant.
The Company may be considered to be a "controlling person" of CTO and Levco
within the meaning of the Securities Act of 1933. A public distribution of
shares of these companies would require registration under the Securities Act.
The shares of CTO are valued by the board of directors at the closing price as
reported by the American Stock Exchange on the day of valuation. The shares of
Levco are not publicly-traded and are valued at a fair value as determined by
the board of directors.
Investment transactions
Investment transactions are accounted for on the trade date. Realized gains and
losses on investment transactions are determined on an identified cost basis.
Investment income
The Company records dividends on the ex-dividend date. Interest income is
recorded on an accrual basis and includes amortization of premium and discount.
Such income is classified based on the affiliation status of the issuer as of
the date of the financial statements.
Cash equivalents
The Company maintains cash balances at its custodian bank in an interest-bearing
demand deposit account.
Federal income taxes, dividends, and distributions to shareholders
In order to qualify as a regulated investment company and avoid being subject to
federal income or excise taxes, the Company intends to distribute substantially
all of its taxable net investment income (including net realized short-term
capital gain, if any) within the time limits prescribed by the Internal Revenue
Code. Accordingly, no provision has been made for federal income or excise tax
on such income.
Dividends and distributions payable to shareholders are recorded by the
Company on the ex-dividend date.
Baker, Fentress & Company | Midyear Report 1998 13
---------------------------------------------------
<PAGE>
NOTES TO FINANCIAL STATEMENTS--(Unaudited) (continued)
NOTE 2. CAPITAL STOCK
Transactions in capital stock for the first six months of 1998 and for the year
ended December 31, 1997 were as follows:
<TABLE>
<CAPTION>
Shares Amount
----------------------- ------------------------
1998 1997 1998 1997
---------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Reinvestment of
capital gain
distributions.... 1,467,529 1,940,900 $ 1,467,529 $ 1,940,900
Increase in
capital surplus.. 26,323,801 32,388,768
----------- -----------
Net increase..... $27,791,330 $34,329,668
----------- -----------
</TABLE>
The Company may purchase shares of its own stock in open market or private
transactions from time to time and at such prices and amounts as management may
deem advisable. Since such purchases are made at prices below net asset value,
they increase the net asset value per share of the remaining shares outstanding.
The Company made no such purchases for the first six months of 1998 and for the
year ended December 31, 1997.
NOTE 3. EXPENSES
Aggregate compensation paid or accrued during the first six months of 1998 and
for the year ended December 31, 1997 to officers of the Company amounted to
$400,037 and $930,000, respectively. Fees, excluding expenses, of $183,500 and
$303,400 were incurred during the first six months of 1998 and for the year
ended December 31, 1997, respectively, for directors who were not officers of
the Company.
NOTE 4. FEDERAL INCOME TAX STATUS OF DISTRIBUTIONS
In December of each year, the Company distributes to its shareholders all or a
portion of its net long-term capital gain realized during the year. The capital
gain distribution is paid in additional shares of the Company's stock, or in
cash if so elected by individual shareholders.
In 1997, the Company made a long-term capital gain distribution of $2.23
per share, of which 54.7% is subject to a 20% capital gain tax rate, and 45.3%
is subject to a 28% capital gain tax rate. Approximately 44.1% of the $0.54 per
share of ordinary income dividends paid during 1997 qualified for the corporate
dividends received deduction, and 4.6% represented income earned on U.S.
government obligations. In the first six months of 1998, the Company made a
long-term capital gain distribution of $1.75 per share. An additional long-term
capital gain distribution will be paid in December 1998.
NOTE 5. INVESTMENT TRANSACTIONS
The cost of securities purchased and proceeds from securities sold during the
first six months of 1998, excluding money market investments, aggregated
$200,532,613 and $216,036,663, respectively.
NOTE 6. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company may sell securities short or enter into option transactions. Even
though the Company engaged in this activity in 1997, there were no such
transactions for the months ended June 30, 1998.
NOTE 7. RETIREMENT PLANS AND POST-RETIREMENT HEALTH CARE BENEFITS
The Company maintains a non-contributory money purchase pension plan covering
all employees. Company contributions are based on compensation. Total plan
contributions for 1997 were $180,870.
The Company also provides certain health care benefits for retired
employees. All of the Company's employees become eligible for these benefits
upon retirement and the coverage is provided on a contributory basis. These
benefits are subject to deductible and co-payment provisions, medicare
supplements and other limitations. The net expense for post-retirement health
care benefits for 1997 was $75,270.
14 Baker, Fentress & Company | Midyear Report 1998
- ---------------------------------------------------
<PAGE>
NOTE 8. BANK BORROWING AND LINE OF CREDIT
On June 24, 1996, the Company entered into a $40 million revolving credit
agreement with The Northern Trust Company. The facility expires on June 24,
1999. Borrowings outstanding are at the London Interbank Offered Rate (LIBOR)
plus 0.35%. The commitment fee associated with the unused portion of the
revolving credit agreement is 0.08% per annum.
The amount outstanding at June 30, 1998 was $5.0 million. The interest rate is
reset periodically under the revolving credit facility and the fair value of the
debt at June 30, 1998 approximates its carrying value. The maximum borrowing and
the average daily borrowing balances during the period for which borrowings were
outstanding were $5.0 million and $5.0 million, respectively. The interest rate
at June 30, 1998 and the weighted average interest rate during the first six
months of 1998 were 6.1% and 6.2%, respectively.
NOTE 9. AGREEMENTS AND TRANSACTIONS WITH AFFILIATES
Agreements:
The Company has an investment advisory contract with John A. Levin & Co., Inc.,
a wholly-owned subsidiary of Levin Management Co., Inc., and an indirect wholly-
owned subsidiary of the Company, which provides for payment of a fee at an
annual rate of 0.30%, based on the value of the assets of the public portfolio
of the Company. For the six months ended June 30, 1998, the Company incurred
management fees of $769,231. The Company's investments, other than the public
portfolio, are managed by the Company's officers under the supervision of its
board of directors.
A summary of transactions with affiliated companies during the six months ended
June 30, 1998 follows:
<TABLE>
<CAPTION>
Purchases Realized
(Sales) Gain (Loss) Income
--------- ----------- ----------
<S> <C> <C> <C>
Consolidated-Tomoka
Land Co................ $ -- $ -- $1,750,000
DuroLite International
Note................... -- -- 480,000
Levin Management Co., Inc.
Common stock........... -- -- --
Notes due 6/30/1997
and 6/28/1999........ -- -- 3,168,750
TBN Holdings
Note................... -- --
E-Sales Inc.
Convertible
Preferred.............. 500,000 $ --
-------- ----------- ----------
$500,000 $ -- $5,938,750
-------- ----------- ----------
</TABLE>
NOTE 10. YEAR 2000
The Company could be adversely affected if the computer systems used by the
Company and its service providers, including John A. Levin & Co., Inc., do not
properly process and calculate date-related information relating to the Year
2000. The Company is taking steps that it believes are reasonably designed to
address the Year 2000 problem with respect to the computer systems it uses and
to obtain satisfactory assurances that comparable steps are being taken by each
of the Company's other major service providers. The Company does not expect to
incur any significant costs in order to address the Year 2000 problem. However,
at this time, there can be no assurance that these steps will be sufficient to
avoid any adverse impact on the Company.
Baker, Fentress & Company Midyear Report 1998 15
--------------------------------------------------
<PAGE>
ANNUAL MEETING OF STOCKHOLDERS
The Annual Meeting of Shareholders was held on June 11, 1998. The results of all
matters voted on by shareholders were as follows:
A proposal to approve and ratify the selection of Ernst & Young LLP as the
Company's independent auditors for 1998 was approved with 31,018,070 votes for,
83,921 votes against and 190,638 votes abstaining.
In addition, shareholders elected five directors, as follows:
<TABLE>
<CAPTION>
Nominee For Withheld
------- ---------- --------
<S> <C> <C>
Bob D. Allen 31,145,569 147,061
Jessica M. Bibliowicz 30,936,469 356,135
David D. Peterson 31,118,076 174,554
William H. Springer 31,133,853 158,777
Dean J. Takahashi 31,056,957 235,674
</TABLE>
The term of office of the following directors continued after the meeting:
Frederick S. Addy, Eugene V. Fife, J. Barton Goodwin, James P. Gorter, Dave D.
Grumhaus, Jeffrey A. Kinger, John A. Levin and Burton G. Malkiel.
PORTFOLIO CHANGES EXCEEDING $2.5 MILLION
Quarter Ended June 30, 1998 - Unaudited
<TABLE>
<CAPTION>
Purchases Cost Sales Proceeds
- --------- ----------- ----- -----------
<S> <C> <C> <C>
Eli Lilly and Company.................... $12,547,657 Union Texas Petroleum Holdings, Inc. .. $ 7,823,314
Northrop Grumman Corporation............. 11,055,987 Union Pacific Corporation.............. 4,406,284
TRW Inc.................................. 8,276,413 Pfizer Inc............................. 4,265,061
The Bank of New York Company............. 5,065,040 Electronic Data Systems Corporation.... 4,178,761
Philips Electronics N.V.................. 4,879,870 Xerox 0.57% Conv. Bond due 4/21/98..... 3,545,800
Sealed Air Corporation................... 4,644,457 E.I. du Pont de Nemours
Xerox 0.57% Conv. Bond due 4/21/98....... 3,539,076 and Company........................... 2,974,374
Long Island Lighting Company............. 3,213,554 Rhone-Poulenc S.A. (ADR)............... 2,860,183
Texas Instruments Incorporated........... 3,067,511 Warner-Lambert Company................. 2,804,984
Republic Services, Inc................... 2,959,200 -----------
Hewlett-Packard Company.................. 2,753,624 $32,858,761
Inland Steel Industries, Inc............. 2,726,261 ===========
-----------
$64,728,650
===========
</TABLE>
16 Baker, Fentress & Company | Midyear Report 1998
- ---------------------------------------------------
<PAGE>
FINANCIAL HIGHLIGHTS
The following table shows per share operating performance data, total investment
return, ratios and supplemental data for the six months ended June 30, 1998 and
the year ended December 31, 1997.
<TABLE>
<CAPTION>
Six Months Ended Year Ended
June 30, 1998 December 31,
(Unaudited) 1997
---------------- ------------
<S> <C> <C>
Per Share Operating Performance
Net asset value, beginning of year.................................. $ 21.78 $ 21.77
-------- --------
Net investment income.......................................... .35 0.72
Net realized gain (loss) and net change in unrealized
appreciation and other changes............................. 1.65 2.26
-------- --------
Total investment operations......................................... 2.00 2.98
Less distributions:
Dividends from net investment income........................... (0.25) (0.54)
Distribution from net realized gain............................ (1.75) (2.23)
-------- --------
Total distributions................................................. (2.00) (2.27)
-------- --------
Dilution (a) resulting from:
Reinvestment of capital gain distribution...................... (0.11) (0.20)
-------- --------
Total dilution...................................................... (0.11) (0.20)
-------- --------
Net asset value, end of period...................................... $ 21.67 $ 21.78
======== ========
Per share market price, end of period............................... $18.3125 $ 18.25
Total Investment Return-Shareholder Return.................................... 10.95% 25.17%
Ratios to Average Net Assets
Expenses............................................................ .77% .87%
Expenses before interest on bank borrowing.......................... .73% .74%
Net investment income............................................... 2.13% 2.07%
Supplemental Data
Net assets, end of period (000's omitted)........................... 811,719 783,717
Portfolio turnover.................................................. 53.23% 33.72%
Shares outstanding, end of period (000's omitted)................... 37,451 35,983
Average commission rate paid per share.............................. $ .0591 $ .0582
</TABLE>
---------------
(a) Effect of the Company's issuance of shares at a price below net asset
value.
Baker, Fentress & Company | Midyear Report 1998 17
---------------------------------------------------
<PAGE>
[BAKER, FENTRESS & COMPANY LOGO APPEARS HERE]
Baker, Fentress & Company
Established 1891
SUITE 3510, 200 WEST MADISON STREET
CHICAGO, ILLINOIS 60606
