-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PhG53SsgGwmQti5c9ikcQ/b4vdBFDk5D8+lMTCjI0yUrx74JLw2S/WW7L6zItE7N Jt9ciOx7S+IT4/aKjHNz/w== 0000893220-97-001964.txt : 19971223 0000893220-97-001964.hdr.sgml : 19971223 ACCESSION NUMBER: 0000893220-97-001964 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19971031 FILED AS OF DATE: 19971222 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD EXPLORER FUND INC CENTRAL INDEX KEY: 0000034066 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] IRS NUMBER: 510106626 STATE OF INCORPORATION: PA FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: N-30D SEC ACT: SEC FILE NUMBER: 811-01530 FILM NUMBER: 97742246 BUSINESS ADDRESS: STREET 1: PO BOX 2600 STREET 2: VM #V34 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 6106696289 FORMER COMPANY: FORMER CONFORMED NAME: EXPLORER FUND INC DATE OF NAME CHANGE: 19900305 N-30D 1 VANGUARD EXPLORER FUND ANNUAL REPORT 1 VANGUARD EXPLORER FUND Annual Report October 31, 1997 [PHOTO] [THE VANGUARD GROUP LOGO] 2 [PHOTO] OUR CREW MAKES THE DIFFERENCE Throughout our history, The Vanguard Group has received considerable attention as the low-cost provider of mutual funds. While such accolades are gratifying, we are most proud, not of our low operating expenses or the billions of dollars we manage, but of our sterling reputation created by the Vanguard crew. We recognize that it is our crew members--some 6,000 highly motivated men and women--who form the cornerstone of our operations. As with any cornerstone, we could not survive long--let alone prosper--without it. That's why we chose this fiscal year's annual report to celebrate the spirit, enthusiasm, and achievements of our crew. (We call those who work at Vanguard crew members, not employees, because they operate as a team to accomplish our mission of serving you, our clients.) But while we prize the collective contributions of our crew, we also take time to recognize the importance of the individual. Each calendar quarter, we present our Award For Excellence to a handful of crew members who have demonstrated particular excellence in the performance of their jobs and who embody "The Vanguard Spirit." Our report cover shows only a few of the more than 300 crew members who have received this distinction since 1984. They, along with the rest of our valiant crew, look forward to serving you in the years ahead. [PHOTO] John J. Brennan President John C. Bogle Chairman CONTENTS A MESSAGE TO OUR SHAREHOLDERS................... 1 THE MARKETS IN PERSPECTIVE...................... 4 REPORT FROM THE ADVISERS........................ 6 PORTFOLIO PROFILE............................... 8 PERFORMANCE SUMMARY............................. 10 FINANCIAL STATEMENTS............................ 11 REPORT OF INDEPENDENT ACCOUNTANTS............... 22 All comparative mutual fund data are from Lipper Analytical Services, Inc., or Morningstar unless otherwise noted. 3 [PHOTO] FELLOW SHAREHOLDER, The astounding bull market for stocks continued during the twelve months ended October 31, 1997, and Vanguard Explorer Fund rallied to earn a total return of +18.9% for the fiscal year. Our performance represented a big rebound from our loss of -6.0% during the first half of the year and was quite good on an absolute basis, but it was disappointing on a relative basis because it fell well short of the returns of our primary comparative benchmarks. The table at right compares Explorer Fund's total return (capital change plus reinvested dividends) for the twelve months with those of the Small Company Growth Fund Stock Index (based on the stock held by the nation's largest small-capitalization mutual funds) and the average small-cap growth mutual fund. The Fund's return is based on an increase in net asset value from $55.44 per share on October 31, 1996, to $62.31 per share on October 31, 1997, with the latter figure adjusted for our annual dividend of $0.27 per share from net investment income and distributions totaling $2.83 per share paid from net realized capital gains, both paid in December 1996. (We expect to make a distribution of about $5.88 per share from net realized capital gains to shareholders of record on December 18, 1997, with the distribution payable on December 24.)
- --------------------------------------------------------- TOTAL RETURNS FISCAL YEAR ENDED OCTOBER 31, 1997 - --------------------------------------------------------- Vanguard Explorer Fund +18.9% - --------------------------------------------------------- Average Small-Cap Stock Fund +27.1% - --------------------------------------------------------- Small Company Growth Fund Stock Index* +31.0% - ---------------------------------------------------------
*Russell 2000 Index through May 1997; Small Company Growth Fund Stock Index thereafter. FISCAL 1997 PERFORMANCE OVERVIEW Despite taking a tumble in late October, the U.S. stock market posted banner gains for a third consecutive twelve-month period. Economic conditions during the fiscal year were almost picture-perfect for equity investors. Business activity and corporate profits continued to increase apace, yet inflation decelerated and long-term interest rates declined. On balance during the year, the yield on the benchmark 30-year U.S. Treasury bond declined 0.49 percentage point to 6.15%; short-term interest rates edged up just a bit. This positive interest-rate environment, along with the splendid economic fundamentals, elevated the already-high spirits of investors. But after reaching an all-time high in early October, the stock market retreated late in the month, most notably with a -7% plunge on Monday, October 27. The market rallied strongly the next day, steadied through the rest of the week, and finished the fiscal year with gains of roughly 30%, as reflected in broad market averages. Despite the late-October downturn (of almost 11% from high to low), market indexes at fiscal year-end were near historical highs in relation to such fundamentals as dividends, earnings, and book values. A notable shift occurred during the year in the relative performance of large- and small-capitalization stocks. Large-cap stocks had left small-caps in the dust during the first half of the fiscal year, with the large-cap-dominated Standard & Poor's 500 Composite Stock Price Index rising +14.7%, while the Russell 2000 Index of small-cap stocks was up a mere +1.6%. We noted in our midyear report to shareholders that the valuations of small-cap stocks relative to large-cap stocks were at their lowest levels in 15 years, and we surmised that "the worst damage may have been done" to small-cap stocks. Events in 1 4 the second half of the year justified our optimism: In a reversal of fortunes, the Russell 2000 Index returned +27.3% in the six months ended October 31, 1997, versus +15.2% for the S&P 500 Index. For the full year, the +29.3% return of the Russell 2000 was only modestly short of the +32.1% earned on the S&P 500. Although we claim no particular prescience on the subject, we note that it is not unusual for returns on the two groups of stocks to diverge and that, in the past at least, their long-term returns have tended to be similar. The second-half rally among small-cap stocks seemed to stem from two main beliefs: first, that these stocks offered good value relative to large ones and, second, that turmoil in foreign economies and currencies, especially in Asia, was less likely to affect earnings of small companies than those of large multinational enterprises. Vanguard Explorer Fund's performance was subpar--we trailed the average small-cap fund and the Small Company Growth Fund Stock Index by 8.2 and 12.1 percentage points, respectively. Our shortfall versus the Index and other small-cap funds was partly the result of poor stock selection, particularly among technology issues, by our advisers. We also lagged in financial-services stocks. In this top-performing sector, the return of our selections trailed the Index's return by 6 percentage points. As we told you in our report six months ago, we added two investment advisers to our multiadviser format, effective August 1, in order to maintain Explorer Fund's character as a small-cap growth portfolio as the Fund grows. The transfer of some of the Fund's assets to the new advisers--Chartwell Investment Partners and Vanguard Core Management Group--went smoothly. The table at left shows the distribution of Explorer's assets as of October 31.
- ----------------------------------------------------------------- TOTAL ASSETS MANAGED ------------------------ $ MILLION PERCENT - ----------------------------------------------------------------- Granahan Investment Management, Inc. $1,214 47% Wellington Management Company, LLP 758 30 Chartwell Investment Partners 224 9 Vanguard Core Management Group 223 9 Cash Reserve* 131 5 - ----------------------------------------------------------------- Total $2,550 100% - -----------------------------------------------------------------
*Each adviser also may maintain a modest cash reserve. We believe that the additions to our lineup of advisers give us the opportunity to improve our long-term performance relative to our comparative benchmarks. LONG-TERM PERFORMANCE OVERVIEW Vanguard Explorer Fund's record for the past decade, while solid on an absolute basis, trailed the returns of our comparative benchmarks, as the table below shows. Our average annual return was a bit behind that of our unmanaged Index benchmark, but a full 2 percentage points behind the return of the average small-cap growth fund.
- --------------------------------------------------------------- TOTAL RETURNS 10 YEARS ENDED OCTOBER 31, 1997 ------------------------------- AVERAGE FINAL VALUE OF ANNUAL A $10,000 RATE INITIAL INVESTMENT - --------------------------------------------------------------- Vanguard Explorer Fund +15.7% $43,110 - --------------------------------------------------------------- Average Small-Cap Growth Fund +17.7% $51,090 - --------------------------------------------------------------- Small Company Growth Fund Stock Index* +16.0% $44,264 - ---------------------------------------------------------------
*Russell 2000 Index through May 1997; Small Company Growth Fund Stock Index thereafter. As we have said in past reports, we believe that a more relevant comparison is our record since adopting a multimanager strategy on February 28, 1990. From that date through October 31, 1997, our annual 2 5 return of +16.8% was a bit superior to the return of +16.2% on the benchmark Index but still slightly behind the +18.0% earned by the average small-cap growth fund. We caution that the past performance of Explorer Fund and its comparative benchmarks is no indication of future returns. The returns on U.S. stocks over the past decade--indeed, the past 15 years--have been extraordinarily high. The absolute returns earned in coming years will almost certainly be less generous than those from the recent past. That said, however, we are confident that Explorer Fund can substantially improve its performance relative to its peers and its benchmark index. IN SUMMARY After a year in which the stock market provided a return equivalent to almost three years' worth of those produced at its long-term average of nearly 11% annually, investors have every reason to be thankful for the market's bounty. But the recent market volatility--punctuated by October's sudden slide--should make investors mindful of the risks of investing in stocks. The danger of the breathtaking bull market in U.S. stocks, now in its 16th year, is that it may have dulled investors' awareness of the fact that sudden and sharp declines in prices are a permanent, if unpredictable, feature of the market. Nevertheless, the greatest investment risk is not investing in the first place. We believe that a sound method for dealing with risk is to construct a balanced portfolio of stocks, bonds, and reserves appropriate to your objectives, time horizon, and financial situation. With such a program in place, you should be prepared to "stay the course" toward your investment goals. /s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN John C. Bogle John J. Brennan Chairman of the Board President November 18, 1997 3 6 [PHOTO] THE MARKETS IN PERSPECTIVE YEAR ENDED OCTOBER 31, 1997 U.S. EQUITY MARKETS The 12-month period ended October 31, 1997, was exceptionally strong for stock investors, although it wound up on a rather unpleasant note. Over the period, large-capitalization stocks continued their advance, propelling the S&P 500 Index to a 32.1% gain. Small-cap stocks also fared well, as illustrated by the 29.3% increase of the Russell 2000 Index. These gains stood despite October's volatile final week, when sharp declines in Asian stock markets led many investors to question their expectations regarding the U.S. market. While the domestic market dropped substantially--the Dow Jones Industrial Average fell 554 points, or 7.2%, on October 27--it then rebounded smartly over the next few days. This quick recovery probably can be attributed to investors' recognition that three major factors underlying the bull market of recent years were unaffected by the turmoil in Asia. These factors are solid economic growth; restrained inflation, at levels not experienced since the 1960s; and impressive growth in corporate profits. Among large-cap stocks, the best-performing sectors in fiscal 1997 were technology and financial services, with increases of 51.1% and 41.4%, respectively. The surge in technology reflects robust corporate spending on this industry's products, particularly desktop computers, networking equipment, and software. Consumer discretionary and cyclical stocks could be considered laggards by contrast, despite their respective gains of 20.4% and 14.5%. (Clearly the market has shown amazing growth when a 15%-20% advance over a one-year period can be viewed as inadequate.)
- ------------------------------------------------------------------------------------ AVERAGE ANNUALIZED RETURNS PERIODS ENDED OCTOBER 31, 1997 ------------------------------------ 1 YEAR 3 YEARS 5 YEARS - ------------------------------------------------------------------------------------ EQUITY S&P 500 Index 32.1% 27.5% 19.9% Russell 2000 Index 29.3 21.3 18.7 MSCI EAFE Index 4.9 5.1 12.1 - ------------------------------------------------------------------------------------ FIXED INCOME Lehman Aggregate Bond Index 8.9% 10.1% 7.5% Lehman 10-Year Municipal Bond Index 8.7 9.4 7.8 Salomon Brothers Three-Month U.S. Treasury Bill Index 5.2 5.4 4.6 - ------------------------------------------------------------------------------------ OTHER Consumer Price Index 2.1% 2.6% 2.6% - ------------------------------------------------------------------------------------
While small-company stocks failed to match the outsized advance of the S&P 500 Index, their performance grew notably stronger in the second half of the fiscal year. This was evident in both absolute and relative terms: During the past six months, the Russell 2000 Index rose 27.3%, compared to 15.2% for the S&P 500. The improved performance of smaller companies cannot be attributed to any single factor, but is, rather, due to a combination of attractive valuations and good earnings. U.S. FIXED-INCOME MARKETS Interest rates fell across the yield curve, rewarding fixed-income investors with higher total returns. For example, the rates on 1-, 5-, 10-, and 30-year Treasury issues decreased 0.06%, 0.35%, 0.51%, and 0.49%, respectively, during the fiscal year. These declines reflected the continuing good news regarding inflation and the relative dormancy of 4 7 the Federal Reserve. The benefit to investors was illustrated by the 8.9% return of the Lehman Brothers Aggregate Bond Index, the broadest measure of investment-grade issues. Investors in lower-quality securities fared even better, as shown by the 13.7% gain of the Lehman High Yield Bond Index. The strength of the economy combined with the lack of inflationary pressure produced an ideal environment for junk bonds. INTERNATIONAL EQUITY MARKETS The last quarter of the fiscal year proved to be horrible for investments in Pacific markets, with declines both widespread and pronounced. The Morgan Stanley Capital International (MSCI) Pacific Index declined by 21.4% in U.S. dollar terms during the three months and was down 19.7% for the full fiscal year. Among individual markets (also in U.S. dollar terms), Japan fell 18.4% for the quarter and 18.1% for the 12 months, while the declines over the same periods reached 34.3% and 17.5% in Hong Kong and 49.0% and 57.2% in Malaysia. These markets suffered for a variety of reasons, but concern about future economic growth was particularly significant. By contrast, the European markets continued to provide U.S. investors with solid returns, although they, too, stumbled in late October. The MSCI Europe Index posted a gain of 26.0% for the 12 months despite a 4.9% decline in October. The robust character of the European markets reflects strong earnings and optimism that the growth will remain solid. 5 8 [PHOTO] REPORT FROM THE ADVISERS Small-capitalization stocks returned to favor in the second half of Vanguard Explorer Fund's fiscal year ended October 31, 1997. As a result, the Fund provided a 26.5% second-half return and a total return of 18.9% for the full 12-month period. Among the Fund's strongest performers during the fiscal year were energy-related stocks, which provided a 65% return; financial-services stocks, which returned 35% as a group; and health-care stocks, which earned about 30% for the Fund. The worst-performing sector among our major concentrations was technology, where our holdings broke even for the year. Further details on the performance of Explorer Fund are provided in the Message To Shareholders, beginning on page 1. THE ENVIRONMENT FOR SMALL-CAP STOCKS The economic and market conditions for small-cap stocks continue to be, in a word, superb. The combination of solid economic growth, low interest rates, and low inflation is an ideal backdrop for our companies. Most earnings surprises among the companies owned by the Fund have been on the upside. What's more, we continue to find stocks that are attractively priced and that are good candidates for the Fund. The international economic and currency turmoil that has been especially severe in Southeast Asia has indirectly benefited small-cap stocks versus their large-cap cousins. This is because of a classic distinction between small- and large-cap stocks: Large-cap companies, many of which garner a significant portion of their revenue and profits from overseas operations, are much more sensitive than small-caps to changes in the value of the U.S. dollar versus other currencies. Big companies benefited more than small companies in recent years from a generally weak U.S. dollar, which makes U.S.-made products cheaper abroad and raises the cost of foreign-made products that compete with U.S. companies at home. Now that several Asian currencies (notably the Thai baht, the Malaysian ringgit, the Indonesian rupiah, and the Korean won) have fallen sharply in value against the U.S. dollar, large companies are expected to be hit harder by sales slumps abroad and by increased competition from lower-cost imports to the United States. CHANGES IN THE FUND'S HOLDINGS Additions to the Fund during the past year included: several regional brokerage firms, such as McDonald & Co. Investments, Piper Jaffray, and Raymond James Financial, which have sound franchises and were added at attractive price/earnings ratios; energy service and transportation companies, such as Hvide Marine, Halter Marine, and SEACOR, which are benefiting from increased drilling activity, especially in the Gulf of Mexico; industry consolidators, such as Service Experts, that are combining operations in fragmented businesses; and telecommunications service providers, such as McLeodUSA, NTL, and EchoStar Communications, that are benefiting from the deregulation of the telephone business. We slightly reduced the proportion of health-care stocks in the Fund during the year, partly because some of our holdings were acquired by other companies. However, among the stocks new to the Fund's top 6 9 ten holdings since last year are three health-care firms: Sofamor Danek, which makes devices for treating spinal ailments and injuries; Sybron International, which makes laboratory and dental products; and MedPartners, the largest physician practice management company, which is being acquired by a competitor, PhyCor (also among our holdings). Also new to our "top ten" are Investment Technology Group, which provides computerized trading and research services to brokers and investors; Noble Drilling, which does contract petroleum drilling; and two computer software companies, Structural Dynamics Research and Boole & Babbage. OUR NEW ADVISERS As announced six months ago in the report to shareholders, Chartwell Investment Partners and Vanguard Core Management Group have now joined Wellington Management Company and Granahan Investment Management to help manage Explorer Fund's assets. Although all four advisers share the same objective of long-term capital appreciation through investments in small-capitalization growth stocks, each oversees its portion of the Fund's assets independently. Brief descriptions of the investment strategies employed by our two new advisers follow. Vanguard Core Management Group uses its computer programs to select a sampling of stocks that, as a group, are expected to have returns and investment characteristics similar to those of the nation's largest small-cap mutual funds. Chartwell Investment Partners uses in-depth, company-by-company research to select stocks of small companies that demonstrate not only strong growth in earnings but the ability to continually improve their capabilities, competitive positions, products and services, and customer bases. Chartwell's portion of the Fund currently reflects several investment themes, including: - - The outsourcing trend among businesses, which creates opportunities for temporary-service, data processing, and equipment rental companies. - - Increasing traffic for airlines, which is a boon to aircraft maintenance firms and parts suppliers. - - Cost-cutting pressure in the health-care arena, which benefits companies that can help reduce costs of providing care. - - Technology companies that are somewhat insulated from cyclical forces, such as those involved in speech recognition, high-frequency semiconductors, and increasing telecommunications bandwidth. LOOKING AHEAD We believe that small-capitalization stocks remain undervalued in relation to large-cap stocks. Further, we believe that your Fund is well-positioned to take advantage of the values to be found among small-cap stocks. The portfolio, which comprises investments in more than 500 companies, is widely diversified and well-balanced. We look forward to reporting to you six months from now on the results from the first half of fiscal 1998. Granahan Investment Management, Inc. Wellington Management Company, LLP Chartwell Investment Partners Vanguard Core Management Group November 19, 1997 INVESTMENT PHILOSOPHY The Fund reflects a belief that superior long-term investment results can be achieved by selecting a diversified group of small-company stocks with prospects for above-average growth. 7 10 [PHOTO] PORTFOLIO PROFILE EXPLORER FUND This Profile provides a snapshot of the Fund's characteristics as of October 31, 1997, compared where appropriate to an unmanaged index. Key elements of this Profile are defined on page 9.
PORTFOLIO CHARACTERISTICS - ------------------------------------------------------- EXPLORER RUSSELL 2000 - ------------------------------------------------------- Number of Stocks 541 1,933 Median Market Cap $0.7B $0.7B Price/Earnings Ratio 22.7x 20.7x Price/Book Ratio 3.63x 2.8x Yield 0.4% 1.3% Return on Equity 17.4% 13.1% Earnings Growth Rate 15.4% 14.7% Foreign Holdings 2.3% 0% Turnover Rate 84% -- Expense Ratio 0.62% -- Cash Reserves 10.3% --
VOLATILITY MEASURES - ------------------------------------------------------- EQUITY INCOME S&P 500 - ------------------------------------------------------- R-Squared 0.37 1.00 Beta 0.72 1.00
INVESTMENT FOCUS - ------------------------------------------------------- [GRAPHIC]
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) - ----------------------------------------------- Sofamor Danek Group, Inc. 1.0% Air Express International Corp. 1.0 Interra Financial, Inc. 0.9 Valmont Industries, Inc. 0.9 Investment Technology Group, Inc. 0.9 Sybron International Corp. 0.9 Structural Dynamics Research Corp. 0.8 Noble Drilling Corp. 0.8 MedPartners, Inc. 0.8 Boole & Babbage Inc. 0.8 - ----------------------------------------------- Top Ten 8.8%
SECTOR DIVERSIFICATION (% OF COMMON STOCK) - ------------------------------------------------------------------------------- OCTOBER 31, 1996 OCTOBER 31, 1997 ------------------------------------------- EXPLORER EXPLORER RUSSELL 2000 ------------------------------------------- Auto & Transportation............ 7.0% 7.4% 4.2% Consumer Discretionary........... 18.6 17.9 16.3 Consumer Staples................. 2.1 1.6 2.8 Financial Services............... 14.3 14.9 23.9 Health Care...................... 19.7 17.6 10.1 Integrated Oils.................. 0.0 0.0 0.5 Other Energy..................... 4.4 4.9 4.3 Materials & Processing........... 3.3 4.5 9.6 Producer Durables................ 9.3 7.4 8.0 Technology....................... 17.8 19.8 12.3 Utilities........................ 3.0 2.8 6.8 Other............................ 0.5 1.2 1.2 - -------------------------------------------------------------------------------
8 11 BETA. A measure of the magnitude of a portfolio's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a portfolio with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. CASH RESERVES. The percentage of a portfolio's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing investments--after adjusting for cash held as collateral for futures contracts. EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a portfolio. EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. FOREIGN HOLDINGS. The percentage of a portfolio's net assets represented by stocks or American Depository Receipts of companies based outside the United States. INVESTMENT FOCUS. This grid indicates the focus of a portfolio in terms of two attributes: market capitalization (large, medium, or small) and relative valuation (growth, value, or a blend). MEDIAN MARKET CAP. The midpoint of market capitalization (market price x shares outstanding) of the stocks in a portfolio. Half the stocks in the portfolio have higher market capitalizations and half lower. NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio holds, the more diversified it is and the more likely to perform in line with the overall stock market. PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a portfolio, the weighted average price/book ratio of the stocks it holds. PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a portfolio, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. R-SQUARED. A measure of how much of a portfolio's past returns can be explained by the returns from the overall market (or its benchmark index). If a portfolio's total return were precisely synchronized with the overall market's return, its R-squared would be 1.00. If a portfolio's returns bore no relationship to the market's returns, its R-squared would be 0. RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a portfolio, the weighted average return on equity for the companies whose stocks it holds. SECTOR DIVERSIFICATION. The percentages of a portfolio's common stocks that come from each of the major industry groups that compose the stock market. TEN LARGEST HOLDINGS. The percentage of net assets that a portfolio has invested in its ten largest holdings. (The average for stock mutual funds is about 30%). As this percentage rises, a portfolio's returns are likely to be more volatile, because they are more dependent on the fortunes of a few companies. TURNOVER RATE. An indication of trading activity during the past year. Portfolios with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). YIELD. A snapshot of a portfolio's income from interest and dividends. The yield, expressed as a percentage of the portfolio's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. 9 12 [PHOTO] PERFORMANCE SUMMARY EXPLORER FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the Fund. Note, too, that both share price and return can fluctuate widely so that an investment in the Fund could lose money.
TOTAL INVESTMENT RETURNS: OCTOBER 31, 1977-OCTOBER 31, 1997 - --------------------------------------------------------- EXPLORER FUND SMALL COMPANY INDEX* FISCAL CAPITAL INCOME TOTAL TOTAL YEAR RETURN RETURN RETURN RETURN - --------------------------------------------------------- 1978 26.0% 0.1% 26.1% 6.3% 1979 30.6 1.9 32.5 15.3 1980 60.7 2.3 63.0 55.3 1981 8.5 1.1 9.6 4.1 1982 20.5 2.2 22.7 14.8 1983 35.2 1.0 36.2 38.3 1984 -15.3 1.4 -13.9 -3.2 1985 5.4 1.4 6.8 15.8 1986 1.0 1.0 2.0 22.2 1987 -11.5 0.1 -11.4 -13.6 1988 28.2 0.5 28.7 27.1 1989 9.8 1.2 11.0 15.6 1990 -23.9 1.0 -22.9 -27.3 1991 62.5 2.1 64.6 58.6 1992 12.2 0.8 13.0 9.5 1993 21.9 0.4 22.3 32.4 1994 4.2 0.3 4.5 -0.3 1995 17.0 0.5 17.5 18.3 1996 17.4 0.6 18.0 16.6 1997 18.4 0.5 18.9 31.0 - ---------------------------------------------------------
*S&P 500 Index through 1979; Russell 2000 Index from 1980 through May 1997; Small Company Growth Fund Stock Index thereafter. See Financial Highlights table on page 19 for dividend and capital gains information for the past five years.
CUMULATIVE PERFORMANCE: OCTOBER 31, 1987-OCTOBER 31, 1997 - ------------------------------------------------------------------ SMALL AVERAGE COMPANY SMALL-COMPANY GROWTH FUND EXPLORER FUND GROWTH STOCK FUND STOCK INDEX* 1987 10 10000 10000 10000 1988 01 10701 10596 10668 1988 04 12525 12035 12450 1988 07 12938 12404 12852 1988 10 12873 12237 12711 1989 01 13321 13101 13339 1989 04 14055 14150 14353 1989 07 14580 15135 15198 1989 10 14282 15088 14691 MULTI-MANAGER 1990 01 13063 14017 13547 APPROACH ADOPTED 1990 04 13564 14771 14041 1990 07 14640 15688 14414 1990 10 11009 12118 10681 1991 01 13815 14988 13024 1991 04 16183 17216 15461 1991 07 16819 18026 15794 1991 10 18126 19472 16941 1992 01 20960 21768 18865 1992 04 19188 20384 18100 1992 07 19029 20172 18087 1992 10 20474 20916 18547 1993 01 22591 23798 21362 1993 04 21348 22968 20954 1993 07 22687 24502 22320 1993 10 25035 26827 24558 1994 01 26266 27830 25339 1994 04 25032 26314 24059 1994 07 24099 25214 23364 1994 10 26158 27296 24482 1995 01 25712 26535 23817 1995 04 27427 28726 25795 1995 07 30479 33245 29189 1995 10 30726 33438 28969 1996 01 32442 35000 30949 1996 04 36907 40270 34304 1996 07 33710 36896 31206 1996 10 36247 40305 33779 1997 01 37637 43175 36814 1997 04 34074 38944 34321 1997 07 41332 48948 42185 1997 10 43110 51090 44264
AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED OCTOBER 31, 1997 ---------------------------------- FINAL VALUE OF A 1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT - ------------------------------------------------------------------------------------------------------- Explorer Fund 18.93% 16.06% 15.73% $43,110 Average Small-Company Growth Stock Fund 27.05 19.69 17.72 51,090 Small Company Growth Fund Stock Index* 31.04 19.00 16.04 44,264
* Russell 2000 Index through May 1997; Small Company Growth Fund Index thereafter.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1997* - ------------------------------------------------------------------------------------------------- 10 YEARS INCEPTION -------------------------------- DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL - ------------------------------------------------------------------------------------------------- Explorer Fund 12/11/1967 22.01% 18.61% 11.76% 0.75% 12.51%
*SEC rules require that we provide this average annual total return information through the latest calendar quarter. 10 13 [PHOTO] FINANCIAL STATEMENTS OCTOBER 31, 1997 STATEMENT OF NET ASSETS This Statement provides a detailed list of the Fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, preferred stocks, bonds, etc.) and by industry sector. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the Fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the Fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the Fund's net assets on both a dollar and per-share basis. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the Fund had available to distribute to shareholders as income dividends or capital gains as of the statement date. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the Fund's investments and their cost, and reflects the gains (losses) that would be realized if the Fund were to sell all of its investments at their statement-date values.
- --------------------------------------------------------------------------------- MARKET VALUE* EXPLORER FUND SHARES (000) - --------------------------------------------------------------------------------- COMMON STOCKS (89.1%) - --------------------------------------------------------------------------------- AUTO & TRANSPORTATION (6.6%) AAR Corp. 140,900 $ 5,046 Air Express International Corp. 830,275 24,908 Airborne Freight Corp. 17,600 1,115 - - Atlas Air, Inc. 13,200 365 Borg-Warner Automotive, Inc. 12,000 654 - - C.H. Robinson Worldwide, Inc. 181,000 3,982 - - Coach USA, Inc. 23,200 690 Coachmen Industries, Inc. 436,000 8,665 ComAir Holdings, Inc. 10,600 390 Expeditors International of Washington, Inc. 214,200 7,738 - - Halter Marine Group, Inc. 202,000 10,567 - - Heartland Express, Inc. 669,233 17,735 - - Hvide Marine, Inc. Class A 403,900 13,278 - - Kirby Corp. 633,800 12,518 - - Landstar System 25,900 647 - - M.S. Carriers Inc. 355,000 8,875 - - Mark VII, Inc. 75,800 2,321 - -(1) Midwest Express Holdings, Inc. 486,000 15,613 - - Miller Industries, Inc. 46,800 474 - - Monaco Coach Corp. 3,200 75 - - National R. V. Holdings, Inc. 21,300 498 - - Old Dominion Freight Line, Inc. 8,600 126 - - O'Reilly Automotive, Inc. 23,100 560 Petroleum Helicopters, Inc. 25,800 593 Pittston Burlington Group 31,200 848 - - RailTex, Inc. 400,000 6,400 - - Simon Transportation Services, Inc. 216,500 4,817 - - Swift Transportation Co., Inc. 309,800 9,836 Werner Enterprises, Inc. 300,000 7,200 - - Wisconsin Central Transportation Corp. 32,900 1,012 Wynn's International, Inc. 6,800 231 ---------- 167,777 ---------- CONSUMER DISCRETIONARY (16.0%) - - ACNielson Corp. 32,100 734 - - ADVO, Inc. 11,400 256 - - APAC Teleservices, Inc. 28,300 386 - - Alternative Resources Corp. 188,800 4,531 - - AnnTaylor Stores Corp. 66,000 945 - - BT Office Products International, Inc. 82,500 897 BeautiControl Cosmetics 58,800 481 Blair Corp. 21,800 392 - - Boise Cascade Office Products Corp. 37,100 705 - - Borg-Warner Security Corp. 167,400 2,835 - - Boston Chicken, Inc. 54,000 483 - - Brinker International, Inc. 46,900 657 - - Budget Group, Inc. 28,800 1,008 CKE Restaurants Inc. 29,500 1,178 Callaway Golf Co. 305,000 9,836 - - CapStar Hotel Co. 110,000 3,898 - - Caribiner International, Inc. 20,900 937 - - Carmike Cinemas, Inc. Class A 300,000 9,750 - - Catalina Marketing Corp. 6,000 274 Cato Corp. Class A 42,900 367 - - Central Garden and Pet Co. 179,100 4,612 - - The Cheesecake Factory 7,300 227 - - Circuit City Stores, Inc.- CarMax Group 46,600 647 - - Circus Circus Enterprises Inc. 40,800 908 Claire's Stores, Inc. 630,000 13,939
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- --------------------------------------------------------------------------------- MARKET VALUE* EXPLORER FUND SHARES (000) - --------------------------------------------------------------------------------- - - Claremont Technology Group, Inc. 45,300 $ 985 - - Cole National Corp. Class A 8,000 339 - - Kenneth Cole Productions, Inc. 62,400 858 - - Computer Learning Centers, Inc. 9,660 437 Computer Task Group, Inc. 11,400 322 - - Consolidated Graphics, Inc. 25,500 1,323 - - Copart, Inc. 11,200 193 Crown Crafts, Inc. 54,500 814 - - Daisytek International Corp. 13,800 526 - - Dave & Busters 84,300 2,213 - - dELiA*s Inc. 191,800 3,836 - - Discount Auto Parts Inc. 23,600 494 - - The Dress Barn, Inc. 628,600 15,636 - - Eastern Environmental Services, Inc. 117,900 2,947 - - Education Management Corp. 29,500 752 - - Electronic Arts Inc. 250,000 8,437 Ethan Allen Interiors, Inc. 18,300 649 - - Extended Stay America, Inc. 432,400 5,675 - - Family Golf Centers, Inc. 100,000 2,662 Food Lion Inc. Class A 85,800 665 - - Footstar Inc. 32,100 873 Fred's, Inc. 29,300 641 - - GT Interactive Software Corp. 1,207,800 11,776 - - Gaylord Entertainment Co. Class A 11,266 325 - - General Nutrition Cos., Inc. 240,100 7,503 Gray Communications Systems, Inc. Class B 1,000 25 - - Gymboree Corp. 37,900 914 - - HSN, Inc. 169,900 6,796 Hancock Fabrics, Inc. 2,000 27 Harte-Hanks Communications Co. 29,700 1,032 - - Hearst-Argyle Television, Inc. 2,804 79 Hertz Corp. Class A 22,600 781 - - Tommy Hilfiger Corp. 26,600 1,052 - - ITI Technologies, Inc. 344,000 8,729 - - Interim Services, Inc. 26,000 681 International Speedway Corp. 24,400 512 King World Productions, Inc. 65,100 3,076 - - Landry's Seafood Restaurants, Inc. 31,000 852 - - Learning Tree International, Inc. 8,600 298 - - Linens 'n Things, Inc. 190,300 6,839 - - LodgeNet Entertainment Corp. 390,000 5,167 - - Mail-Well, Inc. 22,300 772 (1) Marcus Corp. 646,200 18,094 The McGraw-Hill Cos., Inc. 4,000 262 - - Metro One Telecommunications, Inc. 54,700 499 - - Metro Networks, Inc. 32,900 1,012 - - Metzler Group, Inc. 100,000 3,850 - - Fred Meyer, Inc. 30,800 880 - - Mortons Restaurant Group 97,200 2,102 - - NCO Group, Inc. 11,900 425 - - Nautica Enterprises Inc. 585,000 15,539 Norrell Corp. 27,600 804 - - The North Face, Inc. 300,000 7,050 - - Nu Skin Asia Pacific Inc. 15,500 293 - - Object Design, Inc. 595,000 6,396 Oneida Ltd. 116,500 3,976 - - O'Sullivan Industries Holdings, Inc. 50,000 694 - - PalEx, Inc. 19,000 252 - - Penske Motorsports, Inc. 15,900 469 - - Personnel Group of America, Inc. 139,000 4,822 Pier 1 Imports Inc. 41,300 754 - - Piercing Pagoda, Inc. 6,800 170 Pittston Brink's Group 26,400 954 - - Plantronics, Inc. 136,600 5,037 - - Playboy Enterprises Inc. Class B 677,800 9,362 - - Play-By-Play Toys & Novelties, Inc. 174,700 3,625 - - Premier Parks Inc. 70,300 2,777 - - Primadonna Resorts, Inc. 373,000 6,527 - - Prime Hospitality Corp. 595,000 12,123 - - QuickResponse Services, Inc. 271,600 8,759 - - Rainforest Cafe, Inc. 15,200 517 - - Rent-Way, Inc. 205,800 3,730 - - Rental Service Corp. 101,800 2,723 - - Renters Choice, Inc. 749,300 16,391 - -(1) Rex Stores Corp. 464,000 5,365 The Rival Co. 13,000 197 - - Rockshox, Inc. 385,000 3,465 - - Romac International, Inc. 56,000 1,120 Ross Stores, Inc. 28,500 1,065 St. John Knits, Inc. 202,200 8,126 - - Samsonite Corp. 23,600 1,086 Sbarro, Inc. 13,100 346 - - Scholastic Corp. 149,900 5,921 - - Sonic Corp. 498,500 12,836 - - Stage Stores, Inc. 9,700 349 Sturm, Ruger & Co., Inc. 246,000 4,628 - - Sun International Hotels Ltd. 109,300 3,935 - - Sunglass Hut International, Inc. 9,700 76 TJX Cos., Inc. 5,900 175 - - Tefron Ltd. 238,500 4,576 - - TETRA Technologies, Inc. 300,000 6,919 - - ThermoLase Corp. 42,700 665 Tiffany & Co. 24,600 972 - - U.S. Rentals, Inc. 50,000 1,219 - - Universal Outdoor Holdings, Inc. 32,000 1,344 - - Urban Outfitters, Inc. 706,500 11,746 - - Vail Resorts Inc. 49,800 1,385 - - Vistana, Inc. 408,000 9,180 - - WMS Industries, Inc. 101,300 2,463 - - Wackenhut Corrections Corp. 20,000 575 The Warnaco Group, Inc. Class A 250,000 7,062 - - Waste Industries, Inc. 13,500 283 ---------- 407,343 ---------- CONSUMER STAPLES (1.5%) Casey's General Stores 5,000 119 - - Consolidated Cigar Holdings Inc. Class A 170,500 6,692 McCormick & Co., Inc. 112,300 2,807 - - Robert Mondavi Corp. Class A 250,000 12,687 - - Quality Food Centers Inc. 21,000 1,000 - - Ralcorp Holdings, Inc. 53,600 995 - - Suiza Foods Corp. 24,300 1,224 - - Whole Foods Market, Inc. 300,000 11,625 ---------- 37,149 ---------- FINANCIAL SERVICES (13.3%) Advest Group, Inc. 28,100 643 - - Advent Software, Inc. 337,500 8,374 - - Affiliated Computer Services, Inc. Class A 248,900 6,254
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- ---------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - ---------------------------------------------------------------------------------- AmerUs Life Holdings, Inc. 6,100 $ 186 AmVestors Financial Corp. 35,100 706 - - BISYS Group, Inc. 463,300 14,362 Banco Latinoamericano de Exportaciones, SA 5,000 199 - - Banctec, Inc. 33,100 757 - - Billing Information Concepts 23,300 897 Charter One Financial 12,495 725 City National Corp. 30,900 929 - - Cityscape Financial Corp. 23,100 33 - - Columbia Banking System, Inc. 18,300 467 Comdisco, Inc. 460,000 14,519 - - Concord EFS, Inc. 418,000 12,383 - - Credit Acceptance Corp. 7,800 43 - - DST Systems, Inc. 280,000 9,887 - - Data Transmission Network Corp. 9,600 259 - - E*TRADE Group, Inc. 206,300 6,344 - - Envoy Corp. 10,300 286 Equity Inns, Inc. REIT 55,600 876 - - Farm Family Holdings, Inc. 14,800 459 Felcor Suite Hotels, Inc. REIT 7,900 289 Fidelity National Financial, Inc. 350,000 7,613 FINOVA Group, Inc. 26,000 1,142 - - First Alliance Corp. 71,700 2,348 - - First Federal Financial Corp. 395,000 13,825 First Mutual Bancorp, Inc. 46,400 858 - - FIRSTPLUS Financial Group, Inc. 28,700 1,575 Franklin Bank N.A. 16,400 254 Frontier Insurance Group, Inc. 163,400 5,505 HUBCO, Inc. 22,000 765 Hartford Life, Inc. 82,300 3,040 Jack Henry & Associates 27,800 709 Household International, Inc. 755 86 ING Groep NV ADR 3,768 157 - - ITLA Capital Corp. 41,400 828 Interpool, Inc. 8,500 136 Interra Financial, Inc. 420,800 23,197 - - Investment Technology Group, Inc. 786,000 22,204 Investors Financial Services Corp. Class A 12,700 533 Jefferies Group, Inc. 75,100 4,975 John Alden Financial Corp. 33,100 908 Lawyers Title Insurance Corp. 26,500 841 Legg Mason Inc. 273,733 13,430 Long Island Bancorp, Inc. 167,900 7,472 MMI Cos., Inc. 13,600 339 Magna Group 21,700 857 Manufactured Home Communities, Inc. REIT 599,250 14,981 McDonald & Co. Investments 260,000 6,354 (1) McGrath RentCorp 785,000 18,742 The Money Store 150,400 4,268 NAC Re Corp. 273,800 12,184 - - National Western Life Insurance Co. Class A 2,800 277 Omega Healthcare Investors, Inc. REIT 24,900 896 Patriot American Hospitality, Inc. REIT 149,700 4,940 Peoples Bank of Bridgeport 375,000 12,281 Peoples Heritage Financial Group Inc. 200,000 7,800 - - Philadelphia Consolidated Holding Corp. 5,200 191 Phoenix Duff & Phelps Corp. 121,700 860 Piper Jaffray Cos., Inc. 208,900 5,236 - - Policy Management Systems Corp. 200,000 12,250 Raymond James Financial, Inc. 295,500 8,865 Reinsurance Group of America, Inc. 112,500 4,409 Resource Bancshares Mortgage Group, Inc. 410,000 5,330 - - SPS Transaction Services 25,100 532 - - Silicon Valley Bancshares 4,100 221 - - Southwest Bancorporation of Texas, Inc. 23,300 687 Stifel Financial Corp. 64,200 863 Student Loan Corp. 18,300 900 Sun Communities, Inc. REIT 495,000 17,263 - - UICI 44,600 1,477 WestAmerica Bancorporation 2,500 218 Westcorp, Inc. 154,300 2,864 ----------- 338,363 ----------- HEALTH CARE (15.7%) - - Advanced Magnetics, Inc. 191,800 1,774 - - Agouron Pharmaceuticals, Inc. 34,000 1,547 - - Alliance Pharmaceutical Corp. 600,000 5,925 - - American HomePatient, Inc. 44,300 1,130 - - American Retirement Corp. 215,300 4,185 - - Amylin Pharmaceuticals, Inc. 700,000 5,863 - - Angeion Corp. 250,000 969 - - Apria Healthcare 29,300 445 Arrow International, Inc. 384,500 13,457 - - Atria Communities, Inc. 462,800 7,521 Ballard Medical Products 866,100 19,541 - - Bio-Rad Laboratories, Inc. Class A 352,250 8,718 - - Calypte Biomedical Corp. 43,300 217 - - Capstone Pharmacy Services, Inc. 492,700 5,235 - - Cell Genesys, Inc. 700,000 6,781 - - Cohr, Inc. 258,000 2,677 - - Concentra Managed Care, Inc. 22,200 721 - - Coventry Corp. 48,000 669 - - Creative Biomolecules, Inc. 833,000 7,497 - - Cytotherapeutics, Inc. 343,000 1,801 - - Cytyc Corp. 110,200 2,590 DENTSPLY International Inc. 512,500 14,542 - - FPA Medical Management, Inc. 268,200 6,470 - - Genesis Health Ventures Inc. 336,600 8,247 - - Genome Therapeutics Corp. 600,600 5,030 - - Genzyme Corp. 368,800 10,050 - - Gilead Sciences, Inc. 23,800 806 - - GranCare Inc. 56,500 636 - - Guilford Pharmaceuticals, Inc. 33,300 799 - - HCIA, Inc. 155,800 1,928 - - Haemonetics Corp. 479,400 7,251 - - Harborside Healthcare Corp. 274,000 5,000 - - HEALTHSOUTH Corp. 121,400 3,103 - - Health Management Associates Class A 182,800 4,456
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- ---------------------------------------------------------------------------------- MARKET VALUE* EXPLORER FUND SHARES (000) - ---------------------------------------------------------------------------------- - - Healthdyne Technologies, Inc. 250,000 $ 4,938 - - Hologic, Inc. 33,800 849 ICN Pharmaceuticals, Inc. 30,400 1,463 - - IDX Systems Corp. 250,000 8,437 - - Inhale Therapeutic Systems 22,400 610 Integrated Health Services, Inc. 19,100 606 Jones Medical Industries, Inc. 36,100 1,078 Kinetic Concepts, Inc. 385,300 7,273 - - Ligand Pharmaceuticals Class B 350,000 5,119 - - MIM Corp. 65,800 362 - - Magainin Pharmaceuticals, Inc. 559,630 4,687 - - Magellan Health Services, Inc. 600,400 17,299 - - Marquette Medical Systems Inc. 28,300 722 - - Matria Healthcare, Inc. 1,100,000 6,738 McKesson Corp. 160,000 17,170 - - Medicis Pharmaceutical Corp. 29,600 1,406 - - MedPartners, Inc. 837,300 21,299 - - Mid Atlantic Medical Services, Inc. 60,000 874 Minntech Corp. 73,400 817 - - NABI 551,225 2,549 - - NaPro BioTherapeutics, Inc. 18,200 132 Olsten Corp. 37,800 576 - - PathoGenesis Corp. 368,000 13,018 - - Patterson Dental Co. 414,250 16,570 - - Pediatrix Medical Group, Inc. 25,800 1,090 - - PhyCor, Inc. 166,000 3,808 - - Renal Care Group, Inc. 35,400 1,168 - - Res-Care, Inc. 10,400 250 - - Safeskin Corp. 14,800 668 - - Sangstat Medical Corp. 36,900 1,125 - - Henry Schein, Inc. 38,200 1,237 - - R. P. Scherer Corp. 15,300 901 - - Schick Technologies, Inc. 117,500 2,526 - - Sierra Health Services 19,800 731 - - Sofamor Danek Group, Inc. 371,300 25,573 - - Spine-Tech, Inc. 20,100 623 - - STERIS Corp. 27,200 1,071 - - Suburban Ostomy Supply Co., Inc. 49,600 533 - - Sunrise Assisted Living, Inc. 136,100 4,985 - - Sybron International Corp. 550,000 22,069 - - TheraTech, Inc. 554,000 5,679 - - United Payors & United Providers, Inc. 300,000 5,400 - - Universal Health Services Class B 33,400 1,472 - - Vencor, Inc. 411,400 11,108 - - Vista Medical Technologies, Inc. 202,700 2,534 - - Wellpoint Health Networks Inc. Class A 80,000 3,660 ----------- 400,384 ----------- INTEGRATED OILS Giant Industries, Inc. 11,000 197 - - Seagull Energy Corp. 38,000 929 ----------- 1,126 ----------- OTHER ENERGY (4.4%) - - American Oilfield Divers, Inc. 245,000 4,042 - - Barrett Resources Corp. 4,600 162 - - Benton Oil & Gas Co. 21,100 425 - - Chieftain International, Inc. 217,000 5,317 Devon Energy Corp. 27,300 1,222 - - EVI Inc. 105,800 6,791 - - Enserch Exploration, Inc. 90,020 810 - - Evergreen Resources, Inc. 33,900 593 - - Falcon Drilling Co., Inc. 357,700 13,011 - - Global Industries Ltd. 95,000 1,900 ICO, Inc. 82,400 597 - - Input/Output, Inc. 300,000 8,044 - - Marine Drilling Co., Inc. 47,000 1,389 - - Noble Drilling Corp. 600,000 21,337 - - Patterson Energy, Inc. 12,900 719 - - Precision Drilling Corp. 221,500 6,811 - - Pride International Inc. 22,900 756 - - SEACOR SMIT Inc. 200,000 13,025 - - Smith International, Inc. 117,100 8,929 - - Stolt Comex Seaway SA 6,800 406 - - Trico Marine Services, Inc. 384,900 14,145 - - Varco International, Inc. 23,900 1,456 ----------- 111,887 ----------- MATERIALS & PROCESSING (4.0%) - - ABT Building Products Corp. 40,500 719 - - Airgas, Inc. 51,700 805 - - ArQule, Inc. 37,900 805 - - Avatar Holding, Inc. 10,500 320 BMC Industries, Inc. 292,500 9,415 - - The Carbide/Graphite Group, Inc. 31,000 1,100 Culp, Inc. 26,000 494 Elcor Corp. 186,000 6,801 - - Fairfield Communities, Inc. 195,000 8,568 - - Kaynar Technologies Inc. 136,100 3,947 Lindberg Corp. 32,200 459 - - Lydall, Inc. 479,800 9,836 Minerals Technologies, Inc. 10,800 447 - - Mohawk Industries, Inc. 23,000 701 Mosinee Paper Corp. 28,100 780 Northland Cranberries, Inc. 35,900 547 OM Group, Inc. 47,400 1,789 - - Service Experts Inc. 707,800 17,695 - - Shaw Group, Inc. 501,200 10,463 Spartech Corp. 10,000 159 - - Steel Dynamics, Inc. 36,100 754 - - Triangle Pacific Corp. 24,200 783 UNR Industries, Inc. 584,500 2,922 - - United States Can Co. 29,300 472 Valmont Industries, Inc. 979,000 22,272 ----------- 103,053 ----------- PRODUCER DURABLES (6.6%) - - Allied Waste Industries, Inc. 373,200 7,557 - - Alpine Group, Inc. 55,600 817 - - American Homestar Corp. 313,100 7,045 - - American Power Conversion Corp. 667,700 17,944 - - Antec Corp. 10,400 164 Applied Power, Inc. 293,600 18,166 - - Brooks Automation, Inc. 23,900 529 - - The Cherry Corp. Class A 454,500 7,016 - - Continental Circuits Corp. 14,300 247 - - Culligan Water Technologies 24,900 1,061 - - Cuno Inc. 390,800 6,644 - - Cymer, Inc. 48,300 1,105 - - Dionex Corp. 250,000 12,187 Donaldson Co., Inc. 270,000 13,669
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- ---------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - ---------------------------------------------------------------------------------- - - Dynatech Corp. 22,000 $ 751 EG&G, Inc. 34,000 703 - - Electro Scientific Industries, Inc. 9,800 470 - - GTS Duratek, Inc. 16,000 212 - - Gulfstream Aerospace Corp. 300,000 8,700 - - Interdigital Communications Corp. 128,400 642 - - Kellstrom Industries, Inc. 265,400 5,573 - - Knoll, Inc. 33,300 924 - - Kulicke & Soffa Industries, Inc. 14,700 375 Lindsay Manufacturing Co. 149,000 6,463 Herman Miller, Inc. 10,000 489 - - Oak Industries, Inc. 250,000 7,172 Oakwood Homes Corp. 34,000 895 - - Orbital Sciences Corp. 36,100 866 - - Osmonics, Inc. 30,700 485 - - PRI Automation, Inc. 68,100 2,588 - - Palm Harbor Homes, Inc. 535,187 13,982 Pittway Corp. Class A 11,200 698 Pulte Corp. 22,300 833 - - Republic Industries, Inc. 166,100 4,900 - - Rohr, Inc. 30,600 928 Scotsman Industries, Inc. 34,100 902 - - Southern Energy Homes, Inc. 692,750 6,235 - - Transcrypt International, Inc. 204,300 4,367 - - Trident International, Inc. 296,500 4,373 ----------- 168,677 ----------- TECHNOLOGY (17.7%) - - ACE*COMM Corp. 230,000 4,054 - - Acxiom Corp. 22,540 366 Adobe Systems, Inc. 59,200 2,819 - - Adtran, Inc. 21,400 760 - - Advanced Fibre Communications 26,600 771 - - Alliant Techsystems, Inc. 12,700 756 American Precision Industries Inc. 32,800 775 - - ANADIGICS, Inc. 147,200 5,428 - - Anixter International Inc. 54,400 1,027 - - Arbor Software Corp. 400,500 14,568 - - Aspect Development, Inc. 17,300 800 - - Aspen Technologies, Inc. 33,500 1,248 - - Avid Technology, Inc. 275,000 7,838 - - Black Box Corp. 26,500 1,073 - - Boole & Babbage Inc. 729,150 20,963 - - Burr-Brown Corp. 12,800 382 - - CDW Computer Centers, Inc. 11,700 720 - - CSG Systems International, Inc. 11,600 454 - - Cadence Design Systems, Inc. 82,600 4,398 - -(1) Cayenne Software Inc. 1,510,000 4,530 - - Cerprobe Corp. 180,000 3,150 - - Ciber, Inc. 29,100 1,288 - - Cirrus Logic 33,000 497 - - Citrix Systems, Inc. 19,800 1,453 - - Cognos Inc. 249,600 5,647 - - Coherent Communications Systems Corp. 34,400 1,023 - - CompUSA, Inc. 277,600 9,091 - - Comverse Technology, Inc. 26,200 1,074 - - Cyberoptics Corp. 28,900 780 - - Cypress Semiconductor Corp. 178,000 2,003 - - DII Group, Inc. 29,500 719 - - DataWorks Corp. 24,700 489 - - Davox Corp. 412,800 14,654 - - Discreet Logic, Inc. 239,700 4,674 - - Documentum, Inc. 274,500 8,166 - - ESS Technology, Inc. 51,260 622 - - ENCAD, Inc. 34,200 1,103 - - Esterline Technologies Corp. 16,900 615 - - Glenayre Technologies, Inc. 40,000 515 - - Hadco Corp. 17,500 962 - - Harbinger Corp. 34,900 1,016 - - Harmonic Lightwaves, Inc. 228,000 2,821 - - Hutchinson Technology, Inc. 130,100 3,415 - - Hyperion Software Corp. 14,400 545 - -(1) IKOS Systems, Inc. 509,000 4,517 - - Ingram Micro, Inc. Class A 400,000 11,925 - - JDA Software Group, Inc. 6,700 209 - - Kronos, Inc. 186,500 5,269 - - Learning Co., Inc. 267,600 5,051 - - Legato Systems, Inc. 11,400 485 - - Lernout & Hauspie Speech Products NV 93,000 4,511 - - Lightbridge, Inc. 338,500 4,866 - - Mechanical Dynamics, Inc. 261,500 2,190 - - Melita International Corp. 487,700 5,121 - - Mercury Interactive Corp. 350,000 7,875 - - MetaCreations Corp. 30,900 448 - - Metro Information Services, Inc. 30,500 755 - - Micrel, Inc. 22,000 787 - - National Instruments Corp. 24,900 1,108 - - Natural Microsystems Corp. 433,300 20,690 - - Netscape Communications Corp. 625,000 20,508 - - Network Equipment Technologies, Inc. 52,100 886 Newport News Shipbuilding Inc. 6,700 144 - - OAO Technology Rights Exp. 11/25/97 2,920 12 - - Oak Technology, Inc. 942,000 9,067 - - P-Com, Inc. 305,400 6,070 - - PMC Sierra Inc. 185,900 4,880 - - Pairgain Technologies, Inc. 202,800 5,704 - - Peerless Systems Corp. 99,800 1,285 - - Pinnacle Systems, Inc. 305,500 7,943 - - Planar Systems, Inc. 32,100 357 - - RadiSys Corp. 21,200 986 - - Rational Software Corp. 739,300 6,700 - - Read Rite Corp. 42,600 847 - - Remedy Corp. 238,000 11,008 - - SEEC, Inc. 13,000 299 - - SPSS, Inc. 4,200 96 - - STB Systems, Inc. 220,750 6,457 - - S3, Inc. 451,100 3,975 - - Safeguard Scientifics, Inc. 14,600 453 - - Sanmina Corp. 12,800 950 - - Sapient Corp. 10,500 546 - - Scopus Technology, Inc. 25,200 370 - - Security Dynamics Technologies, Inc. 249,000 8,357 - - Siebel Systems, Inc. 188 8 - - SMART Modular Technologies, Inc. 13,500 670 - - Speedfam International, Inc. 15,000 555 - - Splash Technology Holdings, Inc. 170,000 7,013 - - Sterling Software, Inc. 409,200 13,964
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- ---------------------------------------------------------------------------------- MARKET VALUE* EXPLORER FUND SHARES (000) - ---------------------------------------------------------------------------------- - - Stratus Computer, Inc. 20,000 $ 708 - - Structural Dynamics Research Corp. 1,140,000 21,660 - - Sykes Enterprises, Inc. 24,600 603 - - Symantec Corp. 19,300 420 Symbol Technologies, Inc. 20,100 799 - - Synopsys, Inc. 529,800 20,530 - - Tech-Sym Corp. 19,900 632 - - Technology Solutions Co. 11,500 359 - - Total Control Products, Inc. 185,000 2,336 - - Tracor, Inc. 17,300 456 - - Transaction Systems Architects, Inc. 10,000 388 - - TranSwitch Corp. 2,700 30 - - TriQuint Semiconductor, Inc. 171,600 4,204 - - VLSI Technology, Inc. 284,600 8,431 - - VWR Scientific Products Corp. 351,900 7,742 - - Veritas Software Corp. 23,850 990 - - Viewlogic Systems, Inc. 524,000 12,707 - - VideoServer, Inc. 677,500 8,511 - - Visio Corp. 403,000 14,810 - - Xionics Document Technologies, Inc. 526,000 8,022 ----------- 450,307 ----------- UTILITIES (2.5%) - - ACC Corp. 26,346 1,044 - - Davel Communications Group, Inc. 3,700 93 - - EchoStar Communications Corp. Class A 350,000 6,650 - - Gilat Satellite Networks Ltd. 331,400 10,646 - - IXC Communications, Inc. 16,800 542 KN Energy, Inc. 4,100 178 - - McLeodUSA, Inc. Class A 220,300 8,151 - - NTL Inc. 248,500 6,523 Northeast Utilities 28,800 331 - -(1) Peoples Telephone Co., Inc. 1,540,300 5,584 - - Tucson Electric Power Co. 952,200 15,771 - - USLD Communications Corp. 42,700 843 - - Western Wireless Corp. Class A 438,400 7,782 ----------- 64,138 ----------- OTHER (0.6%) - - Coltec Inc. 13,300 266 - - PEC Israel Economic Corp. 43,800 876 Teleflex Inc. 402,000 14,974 Westinghouse Electric Corp. 20,482 542 ----------- 16,658 ----------- FOREIGN (0.2%) - - Peak International Ltd. 210,900 4,745 - - Teledata Communications Ltd. 7,100 218 ----------- 4,963 ----------- - ---------------------------------------------------------------------------------- TOTAL COMMON STOCKS (COST $1,758,173) 2,271,825 - ---------------------------------------------------------------------------------- CONVERTIBLE PREFERRED STOCKS (0.6%) - ---------------------------------------------------------------------------------- AMC Entertainment $1.75 Cvt. Pfd. 300,000 10,350 - -(3) SGW Holding Corp. 0.00% Cvt. Pfd. 483,840 5,000 - ---------------------------------------------------------------------------------- TOTAL CONVERTIBLE PREFERRED STOCKS (COST $14,438) 15,350 - ----------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------- FACE MARKET AMOUNT VALUE* (000) (000) - ---------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (12.5%) - ---------------------------------------------------------------------------------- U.S. TREASURY BILLS (2) 4.90%, 1/8/98 $ 3,500 $ 3,467 (2) 5.02%, 1/22/98 700 692 REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 5.66%, 11/3/97 283,996 283,996 5.67%, 11/3/97--Note F 31,531 31,531 - ---------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (COST $319,687) 319,686 - ---------------------------------------------------------------------------------- TOTAL INVESTMENTS (102.2%) (COST $2,092,298) 2,606,861 - ---------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-2.2%) - ---------------------------------------------------------------------------------- Other Assets--Note C 51,111 Liabilities--Note F (108,072) ----------- (56,961) - ---------------------------------------------------------------------------------- NET ASSETS (100%) - ---------------------------------------------------------------------------------- Applicable to 40,922,561 outstanding $.001 par value shares (authorized 100,000,000 shares) $2,549,900 ================================================================================== NET ASSET VALUE PER SHARE $62.31 ==================================================================================
* See Note A in Notes to Financial Statements. - - Non-Income-Producing Security. (1) Considered an affiliated company as the Fund owns more than 5% of the outstanding voting securities of such company. The total market value of investments in affiliated companies was $72,445,000. (2) Securities with an aggregate value of $4,159,000 have been segregated as initial margin for open futures contracts. (3) Restricted security represents 0.2% of net assets. ADR--American Depository Receipt. REIT--Real Estate Investment Trust.
- ---------------------------------------------------------------------------------- AT OCTOBER 31, 1997, NET ASSETS CONSISTED OF: - ---------------------------------------------------------------------------------- AMOUNT PER (000) SHARE - ---------------------------------------------------------------------------------- Paid in Capital $1,787,999 $43.69 Undistributed Net Investment Income 7,648 .19 Accumulated Net Realized Gains 243,183 5.94 Unrealized Appreciation (Depreciation)--Note E Investment Securities 514,563 12.58 Futures Contracts (3,493) (.09) - ---------------------------------------------------------------------------------- NET ASSETS $2,549,900 $62.31 ==================================================================================
16 19 STATEMENT OF OPERATIONS This Statement shows dividend and interest income earned by the Fund during the reporting period, and details the operating expenses charged to the Fund. These expenses directly reduce the amount of investment income available to pay to shareholders as dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) on investments during the period.
- ----------------------------------------------------------------------------- EXPLORER FUND YEAR ENDED OCTOBER 31, 1997 (000) - ----------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 8,374 Interest 15,984 ---------- Total Income 24,358 ---------- EXPENSES Investment Advisory Fees--Note B Basic Fee 4,687 Performance Adjustment (332) The Vanguard Group--Note C Management and Administrative 8,743 Marketing and Distribution 520 Taxes (other than income taxes) 169 Custodian Fees 30 Auditing Fees 10 Shareholders' Reports 207 Annual Meeting and Proxy Costs 16 Directors' Fees and Expenses 7 ---------- Total Expenses 14,057 - ----------------------------------------------------------------------------- NET INVESTMENT INCOME 10,301 - ----------------------------------------------------------------------------- REALIZED NET GAIN Investment Securities Sold* 228,431 Futures Contracts 15,630 - ----------------------------------------------------------------------------- REALIZED NET GAIN 244,061 - ----------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities 147,040 Futures Contracts (3,493) - ----------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 143,547 - ----------------------------------------------------------------------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 397,909 =============================================================================
*Dividend income and realized net gain from affiliated companies were $435,000 and $7,135,000, respectively. 17 20 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the Fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information that is detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the Fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the amount shareholders invested in the Fund, either by purchasing shares or by reinvesting distributions, as well as the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed are shown at the end of the Statement.
- ------------------------------------------------------------------------------------------------------------------ EXPLORER FUND YEAR ENDED OCTOBER 31, ---------------------------------- 1997 1996 (000) (000) - ------------------------------------------------------------------------------------------------------------------ INCREASE IN NET ASSETS OPERATIONS Net Investment Income $ 10,301 $ 9,837 Realized Net Gain 244,061 111,853 Change in Unrealized Appreciation (Depreciation) 143,547 157,545 ---------------------------------- Net Increase in Net Assets Resulting from Operations 397,909 279,235 ---------------------------------- DISTRIBUTIONS Net Investment Income (10,671) (7,088) Realized Capital Gain (111,842) (118,130) ---------------------------------- Total Distributions (122,513) (125,218) ---------------------------------- CAPITAL SHARE TRANSACTIONS(1) Issued 746,689 916,013 Issued in Lieu of Cash Distributions 120,564 122,486 Redeemed (778,827) (482,398) ---------------------------------- Net Increase from Capital Share Transactions 88,426 556,101 - ------------------------------------------------------------------------------------------------------------------ Total Increase 363,822 710,118 - ------------------------------------------------------------------------------------------------------------------ NET ASSETS Beginning of Year 2,186,078 1,475,960 ---------------------------------- End of Year $ 2,549,900 $ 2,186,078 ================================================================================================================== (1)Shares Issued (Redeemed) Issued 13,183 17,091 Issued in Lieu of Cash Distributions 2,263 2,493 Redeemed (13,954) (9,063) ---------------------------------- Net Increase in Shares Outstanding 1,492 10,521 ==================================================================================================================
18 21 FINANCIAL HIGHLIGHTS This table summarizes the Fund's investment results and distributions to shareholders on a per-share basis. It also presents the Fund's Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the Fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the Fund's total return; how much it costs to operate the Fund; and the extent to which the Fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the Fund for one year. Finally, the table lists the Fund's Average Commission Rate Paid, a disclosure required by the SEC beginning in 1996. This rate is calculated by dividing total commissions paid on portfolio securities by the total number of shares purchased and sold on which commissions were charged.
- ------------------------------------------------------------------------------------------------------------------------------ EXPLORER FUND YEAR ENDED OCTOBER 31, ------------------------------------------------------------- FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF YEAR $55.44 $51.05 $45.99 $49.37 $41.23 - ------------------------------------------------------------------------------------------------------------------------------ INVESTMENT OPERATIONS Net Investment Income .26 .26 .24 .16 .14 Net Realized and Unrealized Gain (Loss) on Investments 9.71 8.37 7.25 1.77 8.91 ------------------------------------------------------------- Total from Investment Operations 9.97 8.63 7.49 1.93 9.05 ------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.27) (.24) (.17) (.14) (.13) Distributions from Realized Capital Gains (2.83) (4.00) (2.26) (5.17) (.78) ------------------------------------------------------------- Total Distributions (3.10) (4.24) (2.43) (5.31) (.91) - ------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF YEAR $62.31 $55.44 $51.05 $45.99 $49.37 ============================================================================================================================== TOTAL RETURN 18.93% 17.97% 17.46% 4.49% 22.28% ============================================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Year (Millions) $2,550 $2,186 $1,476 $1,112 $802 Ratio of Total Expenses to Average Net Assets 0.62% 0.63% 0.68% 0.70% 0.73% Ratio of Net Investment Income to Average Net Assets 0.45% 0.51% 0.52% 0.39% 0.32% Portfolio Turnover Rate 84% 51% 66% 82% 51% Average Commission Rate Paid $.0434 $.0424 N/A N/A N/A - ------------------------------------------------------------------------------------------------------------------------------
19 22 NOTES TO FINANCIAL STATEMENTS Vanguard Explorer Fund is registered under the Investment Company Act of 1940 as a diversified open-end investment company, or mutual fund. A. The following significant accounting policies conform to generally accepted accounting principles for mutual funds. The Fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Securities listed on an exchange are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Securities not listed on an exchange are valued at the latest quoted bid prices. Temporary cash investments are valued at cost, which approximates market value. 2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for federal income taxes is required in the financial statements. 3. REPURCHASE AGREEMENTS: The Fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account, which is invested in repurchase agreements secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 4. FUTURES: The Fund uses S&P Midcap 400 and Russell 2000 Index futures contracts to a limited extent, with the objectives of maintaining full exposure to the stock market while maintaining liquidity. The Fund may purchase or sell futures contracts to achieve a desired level of investment, whether to accommodate portfolio turnover or cash flows from capital shares transactions. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of stocks held by the Fund and the prices of futures contracts, and the possibility of an illiquid market. Futures contracts are valued at their quoted daily settlement prices. The aggregate principal amounts of the contracts are not recorded in the financial statements. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized futures gains (losses). 5. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. 6. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. B. Granahan Investment Management, Inc., Wellington Management Company, LLP, and effective August 1, 1997, Chartwell Investment Partners provide investment advisory services to the Fund for fees calculated at an annual percentage rate of average net assets. The basic fees of Granahan and Wellington, for the period ended July 31, 1997, were subject to quarterly adjustments based on performance relative to the Russell 2000 Index and, beginning August 1, 1997, an index of the stocks held by the largest small-capitalization stock mutual funds. For the year ended October 31, 1997, the aggregate investment advisory fee represented an effective annual basic rate of 0.21% of average net assets before a decrease of $332,000 (0.01%) based on performance. Effective August 1, 1997, the Vanguard Group provides investment advisory services to a portion of the funds on an at-cost basis. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the Fund under methods approved 20 23 by the board of directors. At October 31, 1997, the Fund had contributed capital of $179,000 to Vanguard (included in Other Assets), representing 0.9% of Vanguard's capitalization. The Fund's directors and officers are also directors and officers of Vanguard. D. During the year ended October 31, 1997, the Fund purchased $1,675,752,000 of investment securities and sold $1,710,739,000 of investment securities, other than temporary cash investments. E. At October 31, 1997, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $514,563,000, consisting of unrealized gains of $598,060,000 on securities that had risen in value since their purchase and $83,497,000 in unrealized losses on securities that had fallen in value since their purchase. At October 31, 1997, the aggregate settlement value of open futures contracts expiring in December 1997, and the related unrealized depreciation were:
- ---------------------------------------------------------------------------- (000) --------------------------------------------------- AGGREGATE NUMBER OF SETTLEMENT UNREALIZED FUTURES CONTRACTS LONG CONTRACTS VALUE DEPRECIATION - ---------------------------------------------------------------------------- S&P Midcap 400 Index 231 $37,000 $(1,225) Russell 2000 Index 442 96,411 (2,268) - ----------------------------------------------------------------------------
F. The market value of securities on loan to broker/dealers at October 31, 1997, was $30,180,000, for which the Fund held cash collateral of $31,531,000. Cash collateral received is invested in repurchase agreements. 21 24 [PHOTO] REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Board of Directors of Vanguard Explorer Fund In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard Explorer Fund (the "Fund") at October 31, 1997, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at October 31, 1997 by correspondence with the custodian and the application of alternative auditing procedures where securities purchased had not been settled, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Thirty South Seventeenth Street Philadelphia, Pennsylvania 19103 December 3, 1997 22 25 [PHOTO] SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR EXPLORER FUND This information for the fiscal year ended October 31, 1997, is included pursuant to provisions of the Internal Revenue Code. The Fund designates $235,206,000 as capital gains dividends (from net long-term capital gains), which will be distributed in December 1997. Of the $235,206,000 capital gains dividends, the Fund designates $179,282,000 as a 20% rate gain distribution. For corporate shareholders, 51.8% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction. 23 26 DIRECTORS AND OFFICERS JOHN C. BOGLE Chairman of the Board and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. JOHN J. BRENNAN President, Chief Executive Officer, and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. ROBERT E. CAWTHORN Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Managing Director of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun Company, Inc., and Westinghouse Electric Corp. BARBARA BARNES HAUPTFUHRER Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions, Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley College. BRUCE K. MACLAURY President Emeritus of The Brookings Institution; Director of American Express Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Prudential Insurance Co. of America, Amdahl Corp., Baker Fentress & Co., The Jeffrey Co., and Southern New England Telecommunications Co. ALFRED M. RANKIN, JR. Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co. JOHN C. SAWHILL President and Chief Executive Officer of The Nature Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and President of New York University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., and NACCO Industries. JAMES O. WELCH, JR. Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp. J. LAWRENCE WILSON Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins Engine Co., and The Mead Corp.; Trustee of Vanderbilt University. OTHER FUND OFFICERS RAYMOND J. KLAPINSKY Secretary; Managing Director and Secretary of The Vanguard Group, Inc.; Secretary of each of the investment companies in The Vanguard Group. RICHARD F. HYLAND Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies in The Vanguard Group. KAREN E. WEST Controller; Principal of The Vanguard Group, Inc.; Controller of each of the investment companies in The Vanguard Group. OTHER VANGUARD OFFICERS R. GREGORY BARTON Managing Director, Legal Department. ROBERT A. DISTEFANO Managing Director, Information Technology. JAMES H. GATELY Managing Director, Individual Investor Group. KATHLEEN C. GUBANICH Managing Director, Human Resources. IAN A. MACKINNON Managing Director, Fixed Income Group. F. WILLIAM MCNABB, III Managing Director, Institutional Investor Group. MICHAEL S. MILLER Managing Director, Planning and Development. RALPH K. PACKARD Managing Director and Chief Financial Officer. GEORGE U. SAUTER Managing Director, Core Management Group. "Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and "500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell Company is the owner of trademarks and copyrights relating to the Russell Indexes. "Wilshire 4500" and "Wilshire 5000" are trademarks of Wilshire Associates. 27 THE VANGUARD FAMILY OF FUNDS EQUITY AND BALANCED FUNDS GROWTH AND INCOME FUNDS Vanguard/Windsor Fund Vanguard/Windsor II Vanguard Equity Income Fund Vanguard Growth and Income Portfolio Vanguard Selected Value Portfolio Vanguard/Trustees' Equity-U.S. Portfolio Vanguard Convertible Securities Fund BALANCED FUNDS Vanguard/Wellington Fund Vanguard/Wellesley Income Fund Vanguard STAR Portfolio Vanguard Asset Allocation Fund Vanguard LifeStrategy Portfolios GROWTH FUNDS Vanguard/Morgan Growth Fund Vanguard/PRIMECAP Fund Vanguard U.S. Growth Portfolio AGGRESSIVE GROWTH FUNDS Vanguard Explorer Fund Vanguard Specialized Portfolios Vanguard Horizon Fund INTERNATIONAL FUNDS Vanguard International Growth Portfolio Vanguard International Value Portfolio INDEX FUNDS Vanguard Index Trust Vanguard Tax-Managed Fund Vanguard Balanced Index Fund Vanguard Bond Index Fund Vanguard International Equity Index Fund Vanguard Total International Portfolio FIXED-INCOME FUNDS MONEY MARKET FUNDS Vanguard Money Market Reserves Vanguard Treasury Money Market Portfolio Vanguard Admiral Funds INCOME FUNDS Vanguard Fixed Income Securities Fund Vanguard Admiral Funds Vanguard Preferred Stock Fund TAX-EXEMPT MONEY MARKET FUNDS Vanguard Municipal Bond Fund Vanguard State Tax-Free Funds (CA, NJ, NY, OH, PA) TAX-EXEMPT INCOME FUNDS Vanguard Municipal Bond Fund Vanguard State Tax-Free Funds (CA, FL, NJ, NY, OH, PA) Q240-10/97 - (C) 1997 Vanguard Marketing Corporation, Distributor>> FUND INFORMATION 1-800-662-7447 INDIVIDUAL ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 http://www.vanguard.com online@vanguard.com All Vanguard funds are offered by prospectus only. Prospectuses contain more complete information on advisory fees, distribution charges, and other expenses and should be read carefully before you invest or send money. Prospectuses can be obtained directly from The Vanguard Group. [THE VANGUARD GROUP LOGO] Post Office Box 2600 Valley Forge, Pennsylvania 19482 -----END PRIVACY-ENHANCED MESSAGE-----