N-CSR 1 incncsr.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number: 811-5029 Name of Fund: Legg Mason Income Trust, Inc. Fund Address: 100 Light Street Baltimore, MD 21202 Name and address of agent for service: Mark R. Fetting, President, Legg Mason Income Trust, Inc. 100 Light Street Baltimore, MD 21202 Registrant's telephone number, including area code: (410) 539-0000 Date of fiscal year end: December 31, 2003 Date of reporting period: December 31, 2003 Item 1 - Report to Shareholders Annual Report to Shareholders December 31, 2003 Legg Mason Income Trust, Inc. High Yield Investment Grade U.S. Government Intermediate U.S. Government Money Market (THIS PAGE INTENTIONALLY LEFT BLANK) Annual Report to Shareholders 1 To Our Shareholders, We are pleased to provide you with Legg Mason Income Trust's annual report, combining reports for the Legg Mason High Yield Portfolio, Investment Grade Income Portfolio, U.S. Government Intermediate-Term Portfolio and the U.S. Government Money Market Portfolio. The following table summarizes key statistics for the Primary Class of each portfolio, as of December 31, 2003:
Net Asset Value SEC Yield(A) Average Life Per Share ----------------------------------------------------------------------------- High Yield 5.76% 5.59 years $ 9.10 Investment Grade 3.87% 10.41 years $10.88 U.S. Government Intermediate 2.93% 4.26 years $10.54 U.S. Government Money Market(B) 0.39% 68 days $ 1.00
In calendar 2003, total returns for the Primary Class of shares of the High Yield, Investment Grade and Government Intermediate Portfolios were +23.03%, +10.16%, and +1.11%, respectively. Total returns for the Institutional Class of shares were +23.54%, +10.71%, and +1.71%, respectively. (Total return measures investment performance in terms of appreciation or depreciation in a portfolio's net asset value per share, plus dividends and any capital gain distributions.) PricewaterhouseCoopers LLP, Income Trust's independent accountants, has completed its annual examination, and audited financial statements for the fiscal year ended December 31, 2003, are included in this report. For each of our Funds, historical performance is not indicative of future results, and the principal value of the High Yield, Investment Grade and Government Intermediate Portfolios will continue to fluctuate so that shares, when redeemed, may be worth more or less than their original cost. The U.S. Government Money Market Portfolio seeks to preserve the value of your investment at $1.00 per share; however, it is possible to lose money by investing in the Fund. --------------- (A) SEC yields reported for the High Yield, Investment Grade and U.S. Government Intermediate Portfolios are for the 30 days ended December 31, 2003. For the U.S. Government Money Market Portfolio, the SEC yield is for the 7 days ended December 31, 2003. (B) An investment in the U.S. Government Money Market Portfolio is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Annual Report to Shareholders 2 Many of our shareholders regularly add to their Primary Class Fund holdings by authorizing automatic, monthly transfers from their bank checking or Legg Mason accounts. Your Legg Mason Financial Advisor will be happy to help you make these arrangements if you would like to purchase additional shares in this convenient way. Sincerely, /s/ JOHN F. CURLEY, JR. /s/ MARK R. FETTING John F. Curley, Jr. Mark R. Fetting Chairman President January 30, 2004 Annual Report to Shareholders 3 Management's Discussion of Fund Performance High Yield Portfolio Average annual total returns for the High Yield Portfolio and its benchmark for various periods ended December 31, 2003, are presented below:
Since Five Three One Inception(A) Years Years Year -------------------------------------------------------------------------- High Yield(B) Primary Class +4.76% +1.14% +5.19% +23.03% Institutional Class 0.00% +1.44% +5.46% +23.54% Lehman High Yield Index(C) +6.72% +5.23% +10.21% +28.97%
For the year ended December 31, 2003, the Primary Class of the Fund returned 23.03% versus 28.97% for the Fund's benchmark, the Lehman High Yield Index. The option-adjusted-spread of the Index narrowed 437 basis points(D) (bps) on the year from +851 bps on December 31, 2002, to +394 bps on December 31, 2003. The portfolio's underperformance is attributable to the manager's focus on companies in the high yield arena that have a below-market probability of default due to the companies' quantifiable asset base and sufficient free cash flow. The manager's investment style is based on the view that, over the long term, returns in the high yield sector are more a function of income (coupon) than price appreciation. This bias for higher quality high yield hurt relative performance, as the distressed and lower quality sectors of the market contributed a disproportionate share to the asset class's total return. CCC rated and below issues in the Index returned more than 60% for the period, versus 20% for BB rated issues and 26.50% for B rated issues. The average price of the CCC rated portion of the Index, which on December 31, 2002, was approximately $64 (a bond priced below $65 is often referred to as distressed) had risen to $94 by December 31, 2003. --------------- (A) The inception date of the Primary Class is August 7, 1987. The inception date of the Institutional Class is May 5, 1998. Index returns are for periods beginning July 31, 1987. (B) Past performance does not guarantee future results. The investment return and principal value of the Fund will fluctuate so that an investor's shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Returns do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. (C) A market value-weighted index that tracks the daily price-only, coupon, and total return performance of non- investment grade, fixed rate, publicly placed, dollar-denominated, and non-convertible debt registered with the U.S. Securities and Exchange Commission. (D) 100 basis points = 1%. Management's Discussion of Fund Performance -- Continued Annual Report to Shareholders 4 Investment Grade Income Portfolio Average annual total returns for the Investment Grade Income Portfolio and its benchmark for various periods ended December 31, 2003, are presented below:
Since Ten Five One Inception(E) Years Years Year -------------------------------------------------------------------------- Investment Grade(F) Primary Class +8.07% +6.98% +6.87% +10.16% Institutional Class +7.59% N/A +7.43% +10.71% Lehman Credit Bond Index(G) +8.45% +7.19% +7.22% +6.91%
For the year ended December 31, 2003, the Primary Class of the Fund returned 10.16% versus 6.91% for the Fund's benchmark, the Lehman Credit Bond Index. The option-adjusted-spread of the Index narrowed from +169 bps to similar duration treasuries on December 31, 2002, to +89 bps on December 31, 2003. The portfolio's outperformance is attributable to the manager's decision to overweight BBB rated issues, which returned 11.81% for the year, as well as overweight and underweight subsector and issue selection decisions. Overweights to industrials, particularly in the auto space, which returned 12.74% for the period, helped relative performance. An underweight in the portfolio to sovereigns and Yankees, which returned 4.78% in 2003, also helped relative performance. The portfolio's term structure hurt relative performance as the fund was positioned throughout the year for a flatter yield curve. --------------- (E) The inception date of the Primary Class is August 7, 1987. The inception date of the Institutional Class is December 1, 1995. Index returns are for periods beginning July 31, 1987. (F) Past performance does not guarantee future results. The investment return and principal value of the Fund will fluctuate so that an investor's shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Returns do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. (G) This index includes all publicly issued, fixed rate, non-convertible, investment grade, domestic corporate debt. It also includes Yankee bonds, which are dollar-denominated, SEC-registered public, non-convertible debt issued or guaranteed by foreign sovereign governments, municipalities, governmental agencies, and international agencies. Annual Report to Shareholders 5 U.S. Government Intermediate-Term Portfolio Average annual total returns for the U.S. Government Intermediate-Term Portfolio and its benchmark for various periods ended December 31, 2003, are presented below:
Since Ten Five One Inception(H) Years Years Year -------------------------------------------------------------------------- U.S. Government Intermediate(I) Primary Class +6.73% +5.32% +4.76% +1.11% Institutional Class +6.72% N/A +5.33% +1.71% Lehman Intermediate Government Bond Index(J) +7.53% +6.32% +6.18% +2.29%
The Fund was challenged by this environment, lagging the performance of its benchmark, the Lehman Intermediate Government Bond Index, with a Primary Class total return of 1.11% versus 2.29% for the year ended December 31, 2003. The Fund's duration posture had little impact on returns, but a steeper curve worked against the portfolio's barbelled exposure to maturities, which was structured to benefit from a flatter yield curve. Overweight exposure to mortgage-backed securities was also a drag on performance, since their higher yield was not sufficient to compensate for unprecedented prepayment speeds as interest rates fell. --------------- (H) The inception date of the Primary Class is August 7, 1987. The inception date of the Institutional Class is December 1, 1994. Index returns are for periods beginning July 31, 1987. (I) Past performance does not guarantee future results. The investment return and principal value of the Fund will fluctuate so that an investor's shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Returns do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. (J) A total return index consisting of investment grade corporate debt issues as well as U.S. government securities. The debt issues all maintain maturities within a range of 1 to 10 years. Annual Report to Shareholders 6 Performance Information High Yield Portfolio The following graphs compare the Fund's total returns against that of a closely matched broad-based securities market index. The graphs illustrate the cumulative total return of an initial $10,000 investment in the Primary Class and a $1,000,000 investment in the Institutional Class of the Fund, for the periods indicated. The line for the Fund represents the total return after deducting all Fund investment management and other administrative expenses and the transaction costs of buying and selling securities. The line representing the securities market index does not include any transaction costs associated with buying and selling securities in the index or other administrative expenses. Both the Fund's results and the index's results assume reinvestment of all dividends and distributions. Total return measures investment performance in terms of appreciation or depreciation in a fund's net asset value per share, plus dividends and any capital gain distributions. It assumes that dividends and distributions were reinvested at the time they were paid. The investment return and principal value of an investment in the Fund will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Average annual returns tend to smooth out variations in a fund's return, so that they differ from actual year-to-year results. Performance would have been lower if fees had not been waived in various periods. Annual Report to Shareholders 7 Growth of a $10,000 Investment -- Primary Class [VALUE TRUST GRAPH]
High Yield Portfolio - Primary Class Lehman High Yield Index ------------------------------------ ----------------------- 2/1/1994 10000.00 10000.00 3/31/1994 9863.00 9597.00 6/30/1994 9740.00 9566.00 9/30/1994 9779.00 9716.00 12/31/1994 9711.00 9687.00 3/31/1995 10060.00 10264.00 6/30/1995 10612.00 10889.00 9/30/1995 11102.00 11197.00 12/31/1995 11461.00 11544.00 3/31/1996 11917.00 11749.00 6/30/1996 12241.00 11943.00 9/30/1996 12705.00 12421.00 12/31/1996 13170.00 12855.00 3/31/1997 13451.00 12998.00 6/30/1997 14086.00 13602.00 9/30/1997 14780.00 14221.00 12/31/1997 15258.00 14495.00 3/31/1998 15993.00 14982.00 6/30/1998 16582.00 15148.00 9/30/1998 15003.00 14458.00 12/31/1998 14985.00 14766.00 3/31/1999 16684.00 15039.00 6/30/1999 16279.00 15091.00 9/30/1999 15143.00 14876.00 12/31/1999 16307.00 15119.00 3/31/2000 15966.00 14766.00 6/30/2000 15778.00 14936.00 9/30/2000 15210.00 15020.00 12/31/2000 13628.00 14233.00 3/31/2001 14053.00 15138.00 6/30/2001 13688.00 14792.00 9/30/2001 12976.00 14166.00 12/31/2001 13610.00 14985.00 3/31/2002 13682.00 15326.00 6/30/2002 12530.00 14259.00 9/30/2002 12076.00 13841.00 12/31/2002 12891.00 14774.00 3/31/2003 13724.00 15898.00 6/30/2003 14781.00 17505.00 9/30/2003 15052.00 17990.00 12/31/2003 15860.00 19054.00
Cumulative Average Annual Total Return Total Return One Year +23.03% +23.03% Five Years +5.84% +1.14% Life of Class* +58.60% +4.76% *Inception date: February 1, 1994
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Past performance does not predict future performance. --------------- (A) A market value-weighted index that tracks the daily price-only, coupon, and total return performance of non-investment grade, fixed rate, publicly placed, dollar-denominated, and non-convertible debt registered with the U.S. Securities and Exchange Commission. Index returns are for periods beginning January 31, 1994. Performance Information -- Continued Annual Report to Shareholders 8 Growth of a $1,000,000 Investment -- Institutional Class [VALUE TRUST GRAPH]
High Yield Portfolio - Institutional Class Lehman High Yield Index (B) ------------------------------------ --------------------------- 5/5/1998 1000000.00 1000000.00 6/30/1998 1026430.00 1007100.00 9/30/1998 930176.00 961300.00 12/31/1998 930903.00 981700.00 3/31/1999 1035270.00 999900.00 6/30/1999 1010780.00 1003300.00 9/30/1999 941175.00 989000.00 12/31/1999 1014850.00 1005200.00 3/31/2000 994652.00 981700.00 6/30/2000 984731.00 993000.00 9/30/2000 949633.00 998600.00 12/31/2000 852607.00 946300.00 3/31/2001 877924.00 1006500.00 6/30/2001 855416.00 983400.00 9/30/2001 813346.00 941800.00 12/31/2001 852086.00 996200.00 3/31/2002 857298.00 1013000.00 6/30/2002 785425.00 948000.00 9/30/2002 757698.00 920200.00 12/31/2002 809466.00 982200.00 3/31/2003 860873.00 1057000.00 6/30/2003 929595.00 1163800.00 9/30/2003 948262.00 1196100.00 12/31/2003 1000100.00 1266800.00
Cumulative Average Annual Total Return Total Return One Year +23.54% +23.54% Five Years +7.42% +1.44% Life of Class* +0.01% +0.00% *Inception date: May 5, 1998
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Past performance does not predict future performance. --------------- (B) Index returns are for periods beginning April 30, 1998. Annual Report to Shareholders 9 Statement of Net Assets High Yield Portfolio December 31, 2003 (Amounts in Thousands)
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Long-Term Securities -- 94.2% Corporate Bonds and Notes -- 85.3% Advertising -- 0.8% Vertis Inc. 9.750% 4/1/09 $ 490 $ 532 Vertis Inc. 10.875% 6/15/09 1,220 1,296 -------- 1,828 -------- Aerospace/Defense -- 1.6% Armor Holdings Incorporated 8.250% 8/15/13 950 1,016(A) Esterline Technologies Corporation 7.750% 6/15/13 1,063 1,143(A) Hexcel Corporation 9.875% 10/1/08 1,146 1,292 Hexcel Corporation 9.750% 1/15/09 350 367 -------- 3,818 -------- Animal Hospitals -- 0.4% Vicar Operating, Inc. 9.875% 12/1/09 915 1,016 -------- Apparel -- 1.5% Oxford Industries, Inc. 8.875% 6/1/11 1,181 1,292(A) Russell Corporation 9.250% 5/1/10 1,038 1,076 The William Carter Company 10.875% 8/15/11 887 1,024 -------- 3,392 -------- Auto and Automotive Parts -- 1.6% Cummins Inc. 9.500% 12/1/10 992 1,141(A) Keystone Automotive Operations Inc. 9.750% 11/1/13 1,030 1,107(A) TRW Automotive 9.375% 2/15/13 425 486 TRW Automotive 11.000% 2/15/13 904 1,064 -------- 3,798 -------- Building Materials -- 3.8% Atrium Companies, Inc. 10.500% 5/1/09 1,460 1,562 Atrium Companies, Inc. 10.500% 5/1/09 520 556(A) Collins & Aikman Floor Cover 9.750% 2/15/10 825 883 Interface, Inc. 7.300% 4/1/08 553 528
Statement of Net Assets -- Continued High Yield Portfolio -- Continued Annual Report to Shareholders 10
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Building Materials -- Continued Interface, Inc. 10.375% 2/1/10 $ 1,263 $ 1,336 Koppers Inc. 9.875% 10/15/13 1,490 1,643(A) Nortek Holdings, Inc. 9.125% 9/1/07 700 723 Nortek Holdings, Inc. 0.000% 5/15/11 1,910 1,380(A,B) Nortek Holdings, Inc. 9.875% 6/15/11 251 277 -------- 8,888 -------- Cable -- 2.5% Charter Communications Holdings, LLC 9.625% 11/15/09 1,890 1,663 Charter Communications, Inc. 10.250% 9/15/10 1,200 1,260(A) CSC Holdings Inc. 7.875% 12/15/07 299 315 Insight Communications Company, Inc. 0.000% 2/15/11 1,581 1,352(B) LodgeNet Entertainment Corporation 9.500% 6/15/13 1,022 1,119 -------- 5,709 -------- Casino Resorts -- 2.3% Harrah's Operating Company, Inc. 7.875% 12/15/05 1,121 1,219 Inn of the Mountain Gods 12.000% 11/15/10 220 234(A) Mandalay Resort Group 9.500% 8/1/08 332 388 MGM MIRAGE 9.750% 6/1/07 274 312 Mirage Resorts, Incorporated 7.250% 10/15/06 355 383 Park Place Entertainment Corporation 7.875% 12/15/05 959 1,027 Station Casinos, Inc. 9.875% 7/1/10 846 931 Wynn Las Vegas LLC 12.000% 11/1/10 729 858 -------- 5,352 -------- Chemicals -- 6.1% Equistar Chemicals LP 10.625% 5/1/11 566 625 Equistar Chemicals LP 10.625% 5/1/11 490 542(A) FMC Corporation 10.250% 11/1/09 524 613
Annual Report to Shareholders 11
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Chemicals -- Continued Georgia Gulf Corporation 7.125% 12/15/13 $ 490 $ 510(A) Hercules Incorporated 11.125% 11/15/07 510 611 Huntsman International Holdings LLC 0.000% 12/31/09 1,826 881(C) Huntsman International LLC 9.875% 3/1/09 732 801 Huntsman International LLC 10.125% 7/1/09 1,067 1,099 IMC Global Inc. 10.875% 6/1/08 596 656 IMC Global Inc. 11.250% 6/1/11 281 309 IMC Global Inc. 10.875% 8/1/13 210 230(A) Lyondell Chemical Company 9.625% 5/1/07 453 480 MacDermid, Incorporated 9.125% 7/15/11 1,597 1,789 Millennium America Inc. 7.000% 11/15/06 96 98 Millennium America Inc. 9.250% 6/15/08 1,262 1,376 Nalco Company 7.750% 11/15/11 450 482(A) Nalco Company 8.875% 11/15/13 640 678(A) Rockwood Specialties, Inc. 10.625% 5/15/11 840 936(A) Westlake Chemical Corporation 8.750% 7/15/11 1,230 1,347(A) -------- 14,063 -------- Commercial/Industrial Services -- 0.4% NationsRent, Inc. 9.500% 10/15/10 870 935(A) -------- Containers and Packaging -- 0.7% Ball Corporation 7.750% 8/1/06 250 269 Graphic Packaging International Corp. 9.500% 8/15/13 1,160 1,282(A) -------- 1,551 -------- Diversified Services -- 0.2% SPX Corporation 7.500% 1/1/13 432 470 --------
Statement of Net Assets -- Continued High Yield Portfolio -- Continued Annual Report to Shareholders 12
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Electric -- 3.7% Orion Power Holdings, Inc. 12.000% 5/1/10 $ 2,488 $ 3,023 The AES Corporation 10.000% 7/15/05 361 367(A) The AES Corporation 8.375% 8/15/07 360 364 The AES Corporation 8.500% 11/1/07 513 521 The AES Corporation 8.750% 6/15/08 619 664 The AES Corporation 9.500% 6/1/09 929 1,030 The AES Corporation 8.875% 2/15/11 14 15 The AES Corporation 9.000% 5/15/15 2,143 2,422(A) -------- 8,406 -------- Electronics -- 2.0% Amkor Technology, Inc. 9.250% 2/15/08 900 1,021 BRL Universal Equipment 2001 A., L.P. 8.875% 2/15/08 300 322 Fairchild Semiconductor International, Inc. 10.500% 2/1/09 1,090 1,215 Rayovac Corporation 8.500% 10/1/13 860 912 Viasystems Inc. 10.500% 1/15/11 1,030 1,100(A) -------- 4,570 -------- Energy -- 3.0% Calpine Corporation 7.625% 4/15/06 880 779 Calpine Corporation 7.750% 4/15/09 27 21 Calpine Corporation 8.625% 8/15/10 2,725 2,126 Calpine Corporation 8.500% 2/15/11 544 430 Calpine Corporation 8.750% 7/15/13 1,550 1,511(A) PG&E Corporation 6.875% 7/15/08 1,850 2,002(A) -------- 6,869 -------- Environmental Services -- 1.1% Allied Waste North America Incorporated 7.625% 1/1/06 69 73
Annual Report to Shareholders 13
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Environmental Services -- Continued Allied Waste North America Incorporated 8.500% 12/1/08 $ 1,984 $ 2,207 Safety-Kleen Corp. 9.250% 5/15/09 3,894 195(D) -------- 2,475 -------- Food, Beverage and Tobacco -- 1.5% Cott Beverages Incorporated 8.000% 12/15/11 1,090 1,177 DIMON Incorporated 9.625% 10/15/11 1,171 1,306 Smithfield Foods, Inc. 8.000% 10/15/09 250 264 Smithfield Foods, Inc. 7.750% 5/15/13 759 789 -------- 3,536 -------- Gaming -- 2.2% Argosy Gaming Company 9.000% 9/1/11 1,082 1,198 Horseshoe Gaming Holding Corp. 8.625% 5/15/09 1,636 1,728 Mohegan Tribal Gaming Authority 6.375% 7/15/09 1,110 1,146 Pinnacle Entertainment, Inc. 9.250% 2/15/07 1,010 1,046 -------- 5,118 -------- Gas and Pipeline Utilities -- 7.5% ANR Pipeline, Inc. 8.875% 3/15/10 362 407 ANR Pipeline, Inc. 9.625% 11/1/21 1,007 1,197 Colorado Interstate Gas Company 10.000% 6/15/05 1,090 1,158 Dynegy Holdings Inc. 8.750% 2/15/12 673 679 Dynegy Holdings Inc. 10.125% 7/15/13 980 1,127(A) GulfTerra Energy Partners, L.P. 10.625% 12/1/12 406 503 Northwest Pipelines Corporation 8.125% 3/1/10 254 282 Pride International, Inc. 9.375% 5/1/07 555 572 Sonat Inc. 6.875% 6/1/05 990 975 Southern Natural Gas Company 8.875% 3/15/10 768 864 Southern Natural Gas Company 8.000% 3/1/32 1,480 1,528 The Williams Companies, Inc. 9.250% 3/15/04 1,154 1,169
Statement of Net Assets -- Continued High Yield Portfolio -- Continued Annual Report to Shareholders 14
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Gas and Pipeline Utilities -- Continued The Williams Companies, Inc. 6.750% 1/15/06 $ 1,520 $ 1,573 The Williams Companies, Inc. 8.625% 6/1/10 762 855 The Williams Companies, Inc. 8.125% 3/15/12 540 599 The Williams Companies, Inc. 7.500% 1/15/31 334 338 The Williams Companies, Inc. 8.750% 3/15/32 852 963 Transcontinental Gas Pipeline Corporation 7.000% 8/15/11 352 375 Transcontinental Gas Pipeline Corporation 8.875% 7/15/12 729 862 Western Gas Resources, Inc. 10.000% 6/15/09 1,060 1,140 -------- 17,166 -------- Health Care -- 1.5% Equinox Holdings Inc. 9.000% 12/15/09 710 733(A) Genesis HealthCare Corporation 8.000% 10/15/13 520 542(A) Tenet Healthcare Corporation 5.375% 11/15/06 102 100 Tenet Healthcare Corporation 5.000% 7/1/07 555 537 Tenet Healthcare Corporation 6.375% 12/1/11 181 174 Tenet Healthcare Corporation 7.375% 2/1/13 1,422 1,429 -------- 3,515 -------- Homebuilding -- 0.5% Schuler Homes, Inc. 9.375% 7/15/09 265 298 Schuler Homes, Inc. 10.500% 7/15/11 640 743 -------- 1,041 -------- Insurance -- 0.5% Willis Corroon Corporation 9.000% 2/1/09 1,000 1,050 --------
Annual Report to Shareholders 15
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Lodging/Hotels -- 2.9% Extended Stay America, Inc. 9.150% 3/15/08 $ 629 $ 655 Extended Stay America, Inc. 9.875% 6/15/11 800 896 Felcor Lodging LP 10.000% 9/15/08 1,058 1,143 Hilton Hotels Corporation 7.950% 4/15/07 133 147 Host Marriott Corporation 7.875% 8/1/08 1,440 1,498 Host Marriott Corporation 8.450% 12/1/08 52 54 ITT Corporation 6.750% 11/15/05 280 294 La Quinta Inns, Inc. 7.400% 9/15/05 610 636 Meristar Hospitality Operating Partnership, L.P. 10.500% 6/15/09 510 553 Starwood Hotels & Resorts Worldwide, Inc. 7.375% 5/1/07 720 778 Starwood Hotels & Resorts Worldwide, Inc. 7.875% 5/1/12 100 112 -------- 6,766 -------- Machinery -- 4.1% AGCO Corporation 9.500% 5/1/08 1,503 1,646 Case New Holland Incorporated 9.250% 8/1/11 1,520 1,702(A) Case New Holland Incorporated 9.250% 8/1/11 540 605(A) Grant Prideco, Inc. 9.000% 12/15/09 697 768 Hanover Compressor Company 8.625% 12/15/10 680 707 Joy Global Inc. 8.750% 3/15/12 1,005 1,121 NMHG Holdings Co. 10.000% 5/15/09 1,141 1,261 Terex Corporation 10.375% 4/1/11 935 1,047 Terex Corporation 9.250% 7/15/11 440 484 -------- 9,341 --------
Statement of Net Assets -- Continued High Yield Portfolio -- Continued Annual Report to Shareholders 16
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Manufacturing (Diversified) -- 1.4% Jacuzzi Brands Incorporated 9.625% 7/1/10 $ 1,714 $ 1,885(A) Transdigm Funding Corp. 8.375% 7/15/11 990 1,053 -------- 2,938 -------- Media -- 1.9% Brill Media Company, LLC 12.000% 12/15/07 3,000 1,500(D) Emmis Communications Corporation 8.125% 3/15/09 907 951 Paxson Communications Corporation 10.750% 7/15/08 645 704 Paxson Communications Corporation 0.000% 1/15/09 25 22(B) Sinclair Broadcast Group, Inc. 8.750% 12/15/11 990 1,099 -------- 4,276 -------- Medical Care Facilities -- 2.4% Ardent Health Services Incorporated 10.000% 8/15/13 1,120 1,221(A) Extendicare Health Services, Inc. 9.350% 12/15/07 673 693 Extendicare Health Services, Inc. 9.500% 7/1/10 260 288 HCA Inc. 6.910% 6/15/05 49 52 HCA Inc. 8.750% 9/1/10 136 162 HCA Inc. 7.875% 2/1/11 510 582 HCA Inc. 6.300% 10/1/12 324 334 HCA Inc. 9.000% 12/15/14 550 665 Triad Hospitals, Inc. 8.750% 5/1/09 1,385 1,501 -------- 5,498 -------- Medical Products -- 0.4% Fresenius Medical Care Capital Trust II 7.875% 2/1/08 950 1,016(E) -------- Medical Supplies and Services -- 0.4% AmeriPath Inc. 10.500% 4/1/13 913 972 --------
Annual Report to Shareholders 17
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Metals -- 0.8% IMCO Recycling Inc. 10.375% 10/15/10 $ 1,250 $ 1,284(A) Kaiser Aluminum & Chemical 12.750% 2/1/49 2,500 550(D) -------- 1,834 -------- Oil and Gas -- 3.9% Amerigas Partners LP 8.875% 5/20/11 696 766 Chesapeake Energy Corporation 8.375% 11/1/08 140 154 Chesapeake Energy Corporation 9.000% 8/15/12 683 785 El Paso CGP Co. 7.750% 6/15/10 1,090 1,029 El Paso Corporation 6.950% 12/15/07 1,088 1,046 El Paso Corporation 7.750% 1/15/32 250 213 El Paso Energy Partners 8.500% 6/1/11 173 195 Nuevo Energy Company 9.375% 10/1/10 320 351 Parker Drilling Company 10.125% 11/15/09 1,030 1,092 Pride International, Inc. 10.000% 6/1/09 1,065 1,142 Suburban Propane Partners LP 6.875% 12/15/13 710 717(A) Vintage Petroleum, Inc. 7.875% 5/15/11 592 624 Vintage Petroleum, Inc. 8.250% 5/1/12 250 272 Westport Resources Corporation 8.250% 11/1/11 174 191 Westport Resources Corporation 8.250% 11/1/11 324 357(A) -------- 8,934 -------- Paper and Forest Products -- 1.6% Georgia-Pacific Corp. 7.500% 5/15/06 170 180 Georgia-Pacific Corp. 8.875% 2/1/10 13 15 Georgia-Pacific Corp. 8.125% 5/15/11 1,214 1,335 Georgia-Pacific Corp. 9.500% 12/1/11 912 1,058 Georgia-Pacific Corp. 7.700% 6/15/15 9 9 Georgia-Pacific Corp. 8.250% 3/1/23 201 204
Statement of Net Assets -- Continued High Yield Portfolio -- Continued Annual Report to Shareholders 18
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Paper and Forest Products -- Continued Georgia-Pacific Corp. 7.750% 11/15/29 $ 6 $ 6 Georgia-Pacific Corp. 8.875% 5/15/31 749 824 -------- 3,631 -------- Publishing -- 1.2% Dex Media East LLC 9.875% 11/15/09 706 808 Dex Media East LLC 12.125% 11/15/12 986 1,213 Hollinger International Publishing 9.000% 12/15/10 760 808 -------- 2,829 -------- Real Estate -- 0.5% Ventas Realty, Limited Partnership 8.750% 5/1/09 695 763 Ventas Realty, Limited Partnership 9.000% 5/1/12 408 453 -------- 1,216 -------- Restaurants -- 0.7% Domino's Inc. 8.250% 7/1/11 1,566 1,678(A) -------- Retail -- 1.6% Backsaver Acquisition Corp. 9.250% 5/31/08 1,196 260(F,G) Hollywood Entertainment Corporation 9.625% 3/15/11 411 442 J.C. Penney Company, Inc. 7.400% 4/1/37 1,407 1,528 Norcraft Companies 9.000% 11/1/11 1,330 1,436(A) Relax The Back Acquisition Corp. 9.250% 5/31/08 513 112(F,G) -------- 3,778 -------- Special Purpose -- 7.0% ACC Escrow Corporation 10.000% 8/1/11 1,210 1,349(A) Asbury Automotive Group Inc. 9.000% 6/15/12 1,576 1,667 Asbury Automotive Group Inc. 8.000% 3/15/14 30 30(A) Couche Tard United States L.P. 7.500% 12/15/13 820 859(A)
Annual Report to Shareholders 19
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Special Purpose -- Continued H & E Equipment Services LLC 11.125% 6/15/12 $ 1,454 $ 1,461 Kraton Polymers LLC 8.125% 1/15/14 600 624(A) Midland Funding II 11.750% 7/23/05 1,368 1,478 Qwest Capital Funding, Inc. 5.875% 8/3/04 1,030 1,033 Qwest Capital Funding, Inc. 7.000% 8/3/09 1,411 1,400 Qwest Capital Funding, Inc. 7.250% 2/15/11 815 803 Qwest Capital Funding, Inc. 6.875% 7/15/28 1,423 1,238 River Rock Entertainment 9.750% 11/1/11 900 968(A) Sensus Metering Systems Incorporated 8.625% 12/15/13 970 995(A) Toll Corp. 8.000% 5/1/09 479 502 UCAR Finance Inc. 10.250% 2/15/12 1,435 1,650 -------- 16,057 -------- Storage Facilities -- 0.5% Mobile Mini, Inc. 9.500% 7/1/13 1,020 1,122 -------- Telecommunications -- 4.6% Cincinnati Bell Inc. 7.250% 7/15/13 1,170 1,228(A) Cincinnati Bell Inc. 8.375% 1/15/14 570 613(A) Crown Castle International Corp. 10.750% 8/1/11 510 574 EchoStar DBS Corporation 4.410% 10/1/08 1,090 1,135(A,H) EchoStar DBS Corporation 9.125% 1/15/09 142 159 MCI Communications Corporation 6.500% 4/15/10 1,360 1,095(D) PanAmSat Corporation 6.375% 1/15/08 651 676 PanAmSat Corporation 8.500% 2/1/12 147 163 Qwest Corporation 6.875% 9/15/33 2,310 2,194 Qwest Services Corporation 13.500% 12/15/10 2,339 2,842(A) -------- 10,679 --------
Statement of Net Assets -- Continued High Yield Portfolio -- Continued Annual Report to Shareholders 20
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Corporate Bonds and Notes -- Continued Telecommunications (Cellular/Wireless) -- 2.0% Nextel Communications, Inc. 9.375% 11/15/09 $ 1,287 $ 1,403 Nextel Communications, Inc. 5.250% 1/15/10 1,139 1,156(I) Nextel Communications, Inc. 7.375% 8/1/15 840 903 SBA Communications Corporation 0.000% 12/15/11 1,665 1,174(A,B) -------- 4,636 -------- Transportation -- 1.7% Continental Airlines, Inc. 7.373% 12/15/15 482 418 Delta Air Lines, Inc. 7.900% 12/15/09 690 558 Kansas City Southern Railway 9.500% 10/1/08 1,834 2,036 OMI Corporation 7.625% 12/1/13 430 434(A) Quality Distribution LLC 9.000% 11/15/10 440 460(A) -------- 3,906 -------- Water Utilities -- 0.3% National Waterworks, Inc. 10.500% 12/1/12 667 745 -------- Total Corporate Bonds and Notes (Identified Cost -- $189,564) 196,418 ------------------------------------------------------------------------------ Yankee Bonds(J) -- 7.1% Building Materials -- 0.5% North American Energy Partners 8.750% 12/1/11 1,070 1,124(A) -------- Chemicals -- 0.9% Rhodia S.A. 7.625% 6/1/10 540 518(A) Rhodia S.A. 8.875% 6/1/11 1,750 1,610(A) -------- 2,128 --------
Annual Report to Shareholders 21
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Yankee Bonds -- Continued Manufacturing (Diversified) -- 1.0% Tyco International Group S.A. 6.375% 10/15/11 $ 1,653 $ 1,767 Tyco International Group S.A. 6.875% 1/15/29 503 515 -------- 2,282 -------- Media -- 0.8% Alliance Atlantis Communications Inc. 13.000% 12/15/09 338 385 Vivendi Universal S.A. 9.250% 4/15/10 1,156 1,370(A) -------- 1,755 -------- Paper and Forest Products -- 0.5% Abitibi-Consolidated Inc. 8.500% 8/1/29 783 816 Abitibi-Consolidated Inc. 8.850% 8/1/30 203 220 -------- 1,036 -------- Publishing -- 0.2% Sun Media Corporation 7.625% 2/15/13 501 536 -------- Services -- 0.4% Compagnie Generale de Geophysique S.A. 10.625% 11/15/07 828 878 -------- Special Purpose -- 1.8% Calpine Canada Energy Finance 8.500% 5/1/08 1,443 1,151 Eircom Funding 8.250% 8/15/13 1,030 1,141 MDP Acquisitions plc 9.625% 10/1/12 1,189 1,331 Yell Finance B.V. 10.750% 8/1/11 510 597 -------- 4,220 --------
Statement of Net Assets -- Continued High Yield Portfolio -- Continued Annual Report to Shareholders 22
Maturity Rate Date Par Value ------------------------------------------------------------------------------ Yankee Bonds -- Continued Telecommunications (Cellular/Wireless) -- 0.3% Rogers Wireless Communications Inc. 9.625% 5/1/11 $ 628 $ 751 -------- Transportation -- 0.7% Teekay Shipping Corporation 8.875% 7/15/11 1,455 1,651 -------- Total Yankee Bonds (Identified Cost -- $15,311) 16,361 ------------------------------------------------------------------------------ Common Stocks -- 0.1% Diversified Telecommunication Services -- N.M. Cincinnati Bell Inc. 0.1shs 1(K) -------- Engineering and Construction -- 0.1% Washington Group International, Inc. 5 166(K) -------- Food -- N.M. International Fast Food Corporation 40 0.005(K) -------- Total Common Stocks (Identified Cost -- $2,847) 167 ------------------------------------------------------------------------------ Preferred Stocks -- 1.6% Cablevision Systems New York Group 11.125% 19 1,978 Cablevision Systems New York Group 11.750% 5 537 High Voltage Engineering Corporation 12.500% 0.5 5(L) Paxson Communications Corporation 14.250% 0.1 1,273(F,L) -------- Total Preferred Stocks (Identified Cost -- $3,992) 3,793 ------------------------------------------------------------------------------ Warrants -- 0.1% American Tower Corporation 1wts 104(A,L) Horizon PCS, Inc. 2 0.02(A,L) Next Generation Network, Inc. 16 0.2(L) Washington Group International, Series A 3 27(L) Washington Group International, Series B 3 26(L) Washington Group International, Series C 2 13(L) -------- Total Warrants (Identified Cost -- $310) 170 Total Long-Term Securities (Identified Cost -- $211,024) 216,909 ------------------------------------------------------------------------------
Annual Report to Shareholders 23
Par Value ------------------------------------------------------------------------------ Short-Term Securities -- 4.4% Repurchase Agreements -- 4.4% Credit Suisse First Boston USA 0.97%, dated 12/31/03, to be repurchased at $4,140 on 1/2/04 (Collateral: $4,195 Federal Home Loan Bank bonds, 2.25%, due 12/15/05, value $4,227) $ 4,140 $ 4,140 Goldman, Sachs & Company 0.97%, dated 12/31/03, to be repurchased at $6,000 on 1/2/04 (Collateral: $5,880 Freddie Mac notes, 3.875%, due 2/15/05, value $6,209) 6,000 6,000 -------- Total Short-Term Securities (Identified Cost -- $10,140) 10,140 ------------------------------------------------------------------------------ Total Investments -- 98.6% (Identified Cost -- $222,164) 227,049 Other Assets Less Liabilities -- 1.4% 3,158 -------- Net assets consist of: Accumulated paid-in capital applicable to: 24,584 Primary Class shares outstanding $ 376,878 706 Institutional Class shares outstanding 6,497 Under/(over) distributed net investment income (88) Accumulated net realized gain/(loss) on investments (157,965) Unrealized appreciation/(depreciation) of investments 4,885 --------- Net assets -- 100.0% $230,207 ======== Net asset value per share: Primary Class $9.10 ======== Institutional Class $9.11 ======== ------------------------------------------------------------------------------
Statement of Net Assets -- Continued High Yield Portfolio -- Continued Annual Report to Shareholders 24 ------------------------------------------------------------------------------ (A) Rule 144a Security -- A security purchased pursuant to Rule 144a under the Securities Act of 1933 which may not be resold subject to that rule except to qualified institutional buyers. These securities represent 24.3% of net assets. (B) Stepped coupon security -- A security with a predetermined schedule of interest or dividend rate changes, at which time it begins to accrue interest or pay dividends. (C) Zero coupon bond -- A bond with no periodic interest payments which is sold at such a discount as to produce a current yield to maturity. (D) Bond is in default at December 31, 2003. (E) Unit -- A security which consists of a bond and warrants to purchase the common stock of the issuer. (F) Private placement. (G) Illiquid security valued at fair value under procedures adopted by the Board of Directors. (H) Indexed security -- The rates of interest earned on these securities are tied to the London Interbank Offered Rate ("LIBOR"). The coupon rates are the rates as of December 31, 2003. (I) Convertible security -- Security may be converted into the issuer's common stock. (J) Yankee Bond -- A dollar-denominated bond issued in the U.S. by foreign entities. (K) Non-income producing. (L) Pay-in-Kind ("PIK") security -- A security in which interest or dividends during the initial few years is paid in additional PIK securities rather than in cash. See notes to financial statements. Annual Report to Shareholders 25 Statement of Operations High Yield Portfolio For the Year Ended December 31, 2003 (Amounts in Thousands) -------------------------------------------------------------------------- Investment Income: Dividends $ 336 Interest 17,596 ------- Total income $17,932 Expenses: Management fee 1,344 Distribution and service fees 1,008 Audit and legal fees 58 Custodian fee 175 Directors' fees and expenses 17 Registration fees 31 Reports to shareholders 43 Transfer agent and shareholder servicing expense: Primary Class 205 Institutional Class 2 Other expenses 10 ------- Total expenses 2,893 ------- Net Investment Income 15,039 Net Realized and Unrealized Gain/(Loss) on Investments: Net realized gain/(loss) on investments 2,379 Change in unrealized appreciation/(depreciation) of investments 24,619 ------- Net Realized and Unrealized Gain/(Loss) on Investments 26,998 -------------------------------------------------------------------------- Change in Net Assets Resulting From Operations $42,037 --------------------------------------------------------------------------
See notes to financial statements. Annual Report to Shareholders 26 Statement of Changes in Net Assets High Yield Portfolio (Amounts in Thousands)
For the Years Ended --------------------------------- 12/31/03 12/31/02 ---------------------------------------------------------------------------- Change in Net Assets: Net investment income $ 15,039 $ 16,637 Net realized gain/(loss) on investments 2,379 (35,418) Change in unrealized appreciation/ (depreciation) of investments 24,619 8,382 ---------------------------------------------------------------------------- Change in net assets resulting from operations 42,037 (10,399) Distributions to shareholders from net investment income: Primary Class (14,885) (16,509) Institutional Class (389) (204) Change in net assets from Fund share transactions: Primary Class 35,499 (10,226) Institutional Class 3,066 1,672 ---------------------------------------------------------------------------- Change in net assets 65,328 (35,666) Net Assets: Beginning of year 164,879 200,545 ---------------------------------------------------------------------------- End of year $230,207 $164,879 ---------------------------------------------------------------------------- Under/(over) distributed net investment income $ (88) $ 135 ----------------------------------------------------------------------------
See notes to financial statements. Annual Report to Shareholders 27 Financial Highlights High Yield Portfolio Contained below is per share operating performance data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements. Primary Class:
Years Ended December 31, ---------------------------------------------------- 2003 2002 2001 2000 1999 ------------------------------------------------------------------------------ Net asset value, beginning of year $7.96 $9.22 $10.18 $14.97 $14.72 ---------------------------------------------------- Investment operations: Net investment income .63 .77 .94 1.32 1.01 Net realized and unrealized gain/(loss) on investments 1.15 (1.26) (.94) (3.45) .29 ---------------------------------------------------- Total from investment operations 1.78 (.49) -- (2.13) 1.30 ---------------------------------------------------- Distributions: From net investment income (.64) (.77) (.96) (1.27) (1.05) From net realized gain on investments -- -- -- (1.39) -- ---------------------------------------------------- Total distributions (.64) (.77) (.96) (2.66) (1.05) ---------------------------------------------------- Net asset value, end of year $9.10 $7.96 $9.22 $10.18 $14.97 ---------------------------------------------------- Ratios/supplemental data: Total return 23.03% (5.28)% (.13)% (16.43)% 8.82% Expenses to average net assets 1.41% 1.36% 1.51% 1.51% 1.31% Net investment income to average net assets 7.26% 9.06% 9.59% 9.98% 6.51% Portfolio turnover rate 122% 97% 130% 45% 83% Net assets, end of year (in thousands) $223,773 $162,175 $199,214 $217,769 $375,099 ------------------------------------------------------------------------------
See notes to financial statements. Annual Report to Shareholders 28 Financial Highlights -- Continued Institutional Class:
Period From Period Years Ended December 31, March 8 to Ended --------------------------------- December 31, January 28, 2003 2002 2001 2000 1999 1999 ------------------------------------------------------------------------------------------- Net asset value, beginning of year $7.96 $9.20 $10.18 $14.97 $15.98 $14.67 ------------------------------------------------------------------- Investment operations: Net investment income .66 .78 1.01 1.41 .89 .08 Net realized and unrealized gain/(loss) on investments 1.15 (1.24) (1.00) (3.47) (.92) .72 ------------------------------------------------------------------- Total from investment operations 1.81 (.46) .01 (2.06) (.03) .80 ------------------------------------------------------------------- Distributions: From net investment income (.66) (.78) (.99) (1.34) (.98) (.04) From net realized gain on investments -- -- -- (1.39) -- -- ------------------------------------------------------------------- Total distributions (.66) (.78) (.99) (2.73) (.98) (.04) ------------------------------------------------------------------- Net asset value, end of year $9.11 $7.96 $9.20 $10.18 $14.97 $15.43 ------------------------------------------------------------------- Ratios/supplemental data: Total return 23.54% (5.00)% (.06)% (15.99)% (.20)%(A) 5.47%(A) Expenses to average net assets .85% .82% .97% 1.03% .82%(B) .81%(B) Net investment income to average net assets 7.78% 9.63% 10.20% 10.98% 7.19%(B) 7.17%(B) Portfolio turnover rate 122% 97% 130% 45% 78%(B) 116%(B) Net assets, end of year (in thousands) $6,434 $2,704 $1,331 $ 673 $ 673 $ -- -------------------------------------------------------------------------------------------
(A) Not annualized. (B) Annualized. See notes to financial statements. Annual Report to Shareholders 29 Performance Information Investment Grade Income Portfolio The following graphs compare the Fund's total returns against those of a closely matched broad-based securities market index. The lines illustrate the cumulative total return of an initial $10,000 investment in Primary Class shares and an initial $1,000,000 investment in Institutional Class shares of the Fund, for the periods indicated. The lines for the Fund represent the total return after deducting all Fund investment management and other administrative expenses and the transaction costs of buying and selling securities. The lines representing the securities market index do not include any transaction costs associated with buying and selling securities in the index or other administrative expenses. Total return measures investment performance in terms of appreciation or depreciation in a fund's net asset value per share, plus dividends and any capital gain distributions. It assumes that dividends and distributions were reinvested at the time they were paid. The investment return and principal value of an investment in the Fund will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Average annual returns tend to smooth out variations in a fund's return, so that they differ from actual year-to-year results. Performance would have been lower if fees had not been waived in various periods. Effective September 30, 2002, Investment Grade changed its comparative index from the Lehman Aggregate Bond Index to the Lehman Credit Bond Index, because the new index is more representative of the types of securities in which the Fund invests. Performance Information -- Continued Annual Report to Shareholders 30 Growth of a $10,000 Investment -- Primary Class [VALUE TRUST GRAPH]
Investment Grade Income Lehman Aggregate Bond Lehman Credit Bond Portfolio - Primary Class Index(A) Index(B) ------------------------- --------------------- ------------------ 12/31/1993 10000.00 10000.00 10000.00 3/31/1994 9709.00 9713.00 9727.00 6/30/1994 9503.00 9613.00 9652.00 9/30/1994 9539.00 9672.00 9751.00 12/31/1994 9518.00 9708.00 9734.00 3/31/1995 10098.00 10198.00 10253.00 6/30/1995 10729.00 10819.00 10896.00 9/30/1995 10957.00 11032.00 11120.00 12/31/1995 11435.00 11502.00 11583.00 3/31/1996 11260.00 11298.00 11422.00 6/30/1996 11294.00 11362.00 11477.00 9/30/1996 11536.00 11572.00 11701.00 12/31/1996 11928.00 11919.00 12043.00 3/31/1997 11882.00 11853.00 11993.00 6/30/1997 12348.00 12288.00 12410.00 9/30/1997 12802.00 12696.00 12803.00 12/31/1997 13158.00 13070.00 13049.00 3/31/1998 13355.00 13274.00 13269.00 6/30/1998 13588.00 13584.00 13533.00 9/30/1998 13899.00 14158.00 14074.00 12/31/1998 14077.00 14206.00 14131.00 3/31/1999 13883.00 14135.00 14133.00 6/30/1999 13752.00 14011.00 14018.00 9/30/1999 13844.00 14106.00 14116.00 12/31/1999 13949.00 14089.00 14154.00 3/31/2000 14253.00 14400.00 14329.00 6/30/2000 14318.00 14651.00 14537.00 9/30/2000 14729.00 15092.00 15003.00 12/31/2000 15226.00 15727.00 15494.00 3/31/2001 15704.00 16204.00 16109.00 6/30/2001 15918.00 16296.00 16272.00 9/30/2001 16404.00 17047.00 16948.00 12/31/2001 16371.00 17055.00 17007.00 3/31/2002 16362.00 17071.00 16978.00 6/30/2002 16575.00 17701.00 17517.00 9/30/2002 17176.00 18512.00 18251.00 12/31/2002 17815.00 18804.00 18731.00 3/31/2003 18340.00 19066.00 19154.00 6/30/2003 19462.00 19542.00 19923.00 9/30/2003 19387.00 19514.00 19948.00 12/31/2003 19626.00 19576.00 20026.00
Cumulative Average Annual Total Return Total Return One Year +10.16% +10.16% Five Years +39.42% +6.87% Ten Years +96.26% +6.98%
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Past performance does not predict future performance. --------------- (A) A market value-weighted index that tracks the daily price, coupon, pay-downs, and total return performance of fixed rate, publicly placed, dollar-denominated, and nonconvertible investment grade debt issues with at least $100 million par amount outstanding and with at least one year to final maturity. (B) This index includes all publicly issued, fixed rate, non-convertible, investment grade, domestic corporate debt. It also includes Yankee bonds, which are dollar-denominated, SEC-registered public, non-convertible debt issued or guaranteed by foreign sovereign governments, municipalities, governmental agencies, and international agencies. Annual Report to Shareholders 31 Growth of a $1,000,000 Investment -- Institutional Class [VALUE TRUST GRAPH]
Investment Grade Income Lehman Aggregate Bond Lehman Credit Bond Portfolio - Institutional Class Index(C) Index(C) ------------------------------- --------------------- ------------------ 12/1/1995 1000000.00 1000000.00 1000000.00 12/31/1995 1014220.00 1014000.00 1012700.00 3/31/1996 999934.00 996100.00 998500.00 6/30/1996 1004200.00 1001700.00 1003400.00 9/30/1996 1026950.00 1020200.00 1022900.00 12/31/1996 1063760.00 1050800.00 1052800.00 3/31/1997 1060180.00 1045000.00 1048500.00 6/30/1997 1104520.00 1083400.00 1084900.00 9/30/1997 1146710.00 1119300.00 1119300.00 12/31/1997 1180240.00 1152300.00 1140800.00 3/31/1998 1199600.00 1170200.00 1160000.00 6/30/1998 1222200.00 1197600.00 1183100.00 9/30/1998 1251810.00 1248200.00 1230400.00 12/31/1998 1269590.00 1252400.00 1235400.00 3/31/1999 1253790.00 1246200.00 1235500.00 6/30/1999 1243630.00 1235200.00 1225500.00 9/30/1999 1254520.00 1243600.00 1234100.00 12/31/1999 1265380.00 1242100.00 1237400.00 3/31/2000 1294720.00 1269500.00 1252700.00 6/30/2000 1300890.00 1291600.00 1270900.00 9/30/2000 1341390.00 1330600.00 1311700.00 12/31/2000 1387190.00 1386500.00 1354500.00 3/31/2001 1432610.00 1428600.00 1408300.00 6/30/2001 1453760.00 1436700.00 1422600.00 9/30/2001 1501340.00 1502900.00 1481700.00 12/31/2001 1500330.00 1503600.00 1486800.00 3/31/2002 1501550.00 1505000.00 1484300.00 6/30/2002 1522920.00 1560600.00 1531400.00 9/30/2002 1580220.00 1632100.00 1595600.00 12/31/2002 1641110.00 1657800.00 1637500.00 3/31/2003 1691570.00 1680900.00 1674500.00 6/30/2003 1797170.00 1722900.00 1741800.00 9/30/2003 1792460.00 1720400.00 1743900.00 12/31/2003 1806400.00 1725800.00 1750700.00
Cumulative Average Annual Total Return Total Return One Year +10.71% +10.71% Five Years +43.11% +7.43% Life of Class* +80.64% +7.59% *Inception date: December 1, 1995
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Past performance does not predict future performance. --------------- (C) Index returns are for periods beginning November 30, 1995. Annual Report to Shareholders 32 Statement of Net Assets Investment Grade Income Portfolio December 31, 2003 (Amounts in Thousands)
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Long-Term Securities -- 97.7% Corporate Bonds and Notes -- 69.9% Aerospace/Defense -- 1.2% General Dynamics Corporation 3.000% 5/15/08 $ 525 $ 513 Lockheed Martin Corporation 8.500% 12/1/29 1,200 1,572 Raytheon Company 6.150% 11/1/08 600 653 Raytheon Company 5.375% 4/1/13 500 501 Raytheon Company 6.400% 12/15/18 840 882 United Technologies Corporation 7.500% 9/15/29 550 673 -------- 4,794 -------- Auto Parts and Equipment -- 0.1% American Axle & Manufacturing Inc. 9.750% 3/1/09 50 53 Lear Corporation 7.960% 5/15/05 231 247 -------- 300 -------- Automotive -- 1.8% Ford Motor Company 7.450% 7/16/31 2,000 2,021 Ford Motor Company 8.900% 1/15/32 370 414 Ford Motor Company 7.700% 5/15/97 630 605 General Motors Corporation 7.125% 7/15/13 370 406 General Motors Corporation 8.250% 7/15/23 650 738 General Motors Corporation 8.375% 7/15/33 2,960 3,436 -------- 7,620 -------- Banking and Finance -- 6.9% Boeing Capital Corporation 6.500% 2/15/12 1,000 1,093 Boeing Capital Corporation 5.800% 1/15/13 1,500 1,573 Capital One Bank 6.875% 2/1/06 150 162 Countrywide Home Loans, Inc. 3.250% 5/21/08 1,200 1,180 Ford Motor Credit Company 6.875% 2/1/06 250 267 Ford Motor Credit Company 6.500% 1/25/07 4,800 5,113 Ford Motor Credit Company 5.800% 1/12/09 2,500 2,575 Ford Motor Credit Company 7.250% 10/25/11 1,600 1,735 General Motors Acceptance Corporation 6.125% 2/1/07 910 979
Annual Report to Shareholders 33
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Banking and Finance -- Continued General Motors Acceptance Corporation 6.150% 4/5/07 $ 1,090 $ 1,168 General Motors Acceptance Corporation 6.125% 8/28/07 1,000 1,074 General Motors Acceptance Corporation 7.250% 3/2/11 160 176 General Motors Acceptance Corporation 7.000% 2/1/12 1,250 1,344 General Motors Acceptance Corporation 0.000% 6/15/15 2,700 1,285(A) Household Finance Corporation 7.000% 5/15/12 2,727 3,110 John Deere Capital Corporation 4.500% 8/22/07 495 518 MBNA America Bank 7.750% 9/15/05 1,200 1,309(B) National Rural Utilities Cooperative Finance Corporation 7.250% 3/1/12 1,700 1,981 SB Treasury Company LLC 9.400% 12/29/49 840 965(B) Toyota Motor Credit Corporation 2.800% 1/18/06 1,000 1,018 -------- 28,625 -------- Banks -- 5.8% Bank of America Corporation 3.875% 1/15/08 1,500 1,529 Bank of America Corporation 7.400% 1/15/11 2,000 2,346 Bank of America Corporation 6.250% 4/15/12 1,720 1,896 Bank of America Corporation 4.750% 8/15/13 470 462 Bank One Corporation 4.125% 9/1/07 1,000 1,033 Bank One Corporation 5.250% 1/30/13 3,300 3,385 CBA Capital Trust I 5.805% 12/31/49 3,510 3,618(B) FleetBoston Financial Corporation 7.250% 9/15/05 1,600 1,740 UnionBanCal Corporation 5.250% 12/16/13 785 793 US Bank N.A. 6.375% 8/1/11 1,000 1,115
Statement of Net Assets -- Continued Investment Grade Income Portfolio -- Continued Annual Report to Shareholders 34
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Banks -- Continued Wachovia Bank N.A. 7.800% 8/18/10 $ 800 $ 965 Wachovia Corporation 3.500% 8/15/08 2,400 2,390 Washington Mutual Bank 5.500% 1/15/13 1,000 1,031 Washington Mutual, Inc. 5.625% 1/15/07 1,600 1,724 -------- 24,027 -------- Building Materials -- N.M. American Standard, Inc. 8.250% 6/1/09 37 43 American Standard, Inc. 7.625% 2/15/10 5 5 Nortek Holdings, Inc. 8.875% 8/1/08 100 105 -------- 153 -------- Cable -- 1.4% Comcast Cable Communications, Inc. 6.750% 1/30/11 1,250 1,391 Comcast Corporation 5.850% 1/15/10 800 854 Comcast Corporation 7.050% 3/15/33 1,800 1,958 Cox Communications, Inc. 7.125% 10/1/12 1,250 1,442 Tele-Communications, Inc. 7.125% 2/15/28 180 195 -------- 5,840 -------- Casino Resorts -- 0.2% Harrah's Operating Company, Inc. 7.875% 12/15/05 500 544 Harrah's Operating Company, Inc. 7.500% 1/15/09 405 461 -------- 1,005 -------- Chemicals -- 0.7% Rohm and Haas Company 7.400% 7/15/09 1,000 1,172 The Dow Chemical Company 6.000% 10/1/12 750 789 The Dow Chemical Company 7.375% 11/1/29 800 895 -------- 2,856 --------
Annual Report to Shareholders 35 Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Computer Services and Systems -- 1.0% Compaq Computer Corporation 7.650% 8/1/05 $ 1,500 $ 1,620 Hewlett-Packard Company 6.500% 7/1/12 700 777 International Business Machines Corporation 4.750% 11/29/12 1,750 1,754 -------- 4,151 -------- Consumer Products -- 0.4% Kimberly-Clark Corporation 4.500% 7/30/05 500 520(B) The Procter & Gamble Company 4.300% 8/15/08 1,000 1,037 -------- 1,557 -------- Diversified Financial Services -- 8.4% Associates Corporation of North America 8.150% 8/1/09 775 933 Capital One Financial Corporation 8.750% 2/1/07 400 451 Capital One Financial Corporation 7.125% 8/1/08 340 367 CIT Group Inc. 4.000% 5/8/08 1,000 1,011 CIT Group Inc. 3.875% 11/3/08 1,350 1,346 Citigroup Inc. 5.800% 3/15/04 1,000 1,009 Citigroup Inc. 5.000% 3/6/07 4,800 5,096 Citigroup Inc. 5.625% 8/27/12 1,600 1,689 Citigroup Inc. 5.875% 2/22/33 1,200 1,179 FDA Queens LP 6.990% 6/15/17 1,687 1,874 General Electric Capital Corporation 6.800% 11/1/05 1,970 2,139 General Electric Capital Corporation 5.000% 6/15/07 3,000 3,195 General Electric Capital Corporation 3.500% 5/1/08 2,640 2,643 General Electric Capital Corporation 5.875% 2/15/12 1,600 1,720 General Electric Capital Corporation 6.750% 3/15/32 980 1,085 IBJ Preferred Capital Corp. LLC 8.790% 12/29/49 1,520 1,657(B) Transamerica Finance Corporation 5.750% 1/28/04 2,000 2,005
Statement of Net Assets -- Continued Investment Grade Income Portfolio -- Continued Annual Report to Shareholders 36
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Diversified Financial Services -- Continued U.S. Bancorp 3.125% 3/15/08 $ 1,650 $ 1,627 Wells Fargo & Company 5.125% 2/15/07 2,600 2,774 Wells Fargo & Company 6.375% 8/1/11 800 892 -------- 34,692 -------- Drug and Grocery Store Chains -- 0.7% Fred Meyer, Inc. 7.375% 3/1/05 1,000 1,059 Kroger Company 8.000% 9/15/29 1,000 1,200 Safeway Inc. 5.800% 8/15/12 750 776 -------- 3,035 -------- Electric -- 4.0% AEP Texas Central Company 5.500% 2/15/13 1,060 1,086 American Electric Power Company, Inc. 6.125% 5/15/06 965 1,040 American Electric Power Company, Inc. 5.250% 6/1/15 350 344 Commonwealth Edison Company 6.150% 3/15/12 560 611 Dominion Resources, Inc. 5.125% 12/15/09 490 512 Dominion Resources, Inc. 5.700% 9/17/12 2,280 2,402 FirstEnergy Corp. 5.500% 11/15/06 2,120 2,196 FirstEnergy Corp. 6.450% 11/15/11 305 316 FirstEnergy Corp. 7.375% 11/15/31 1,075 1,100 Niagara Mohawk Power Corporation 7.750% 10/1/08 1,010 1,172 Oncor Electric Delivery Company 7.000% 9/1/22 500 551 Southern California Edison Company 8.000% 2/15/07 950 1,086 System Energy Resources, Inc. 7.430% 1/15/11 490 505 Tampa Electric Company 6.375% 8/15/12 380 408 The Cleveland Electric Illuminating Company 5.650% 12/15/13 800 787(B)
Annual Report to Shareholders 37
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Electric -- Continued The Cleveland Electric Illuminating Company 7.880% 11/1/17 $ 850 $ 994 The Detroit Edison Company 5.200% 10/15/12 1,260 1,294 -------- 16,404 -------- Electrical Equipment -- 0.2% Emerson Electric Co. 6.000% 8/15/32 900 917 -------- Energy -- 2.4% Alabama Power Company 3.125% 5/1/08 920 905 Calpine Corporation 7.750% 4/15/09 49 38 Calpine Corporation 8.500% 2/15/11 620 490 DTE Energy Company 6.375% 4/15/33 350 343 Duke Energy Corporation 1.630% 12/8/05 1,020 1,019(C) Duke Energy Corporation 5.625% 11/30/12 270 281 Entergy Gulf States, Inc. 8.250% 4/1/04 1,800 1,828 Exelon Corporation 6.750% 5/1/11 2,000 2,234 MidAmerican Energy Holdings Company 5.875% 10/1/12 750 786 TXU Corp. 6.375% 6/15/06 100 106 TXU Energy Co. 7.000% 3/15/13 930 1,029 Xcel Energy, Inc. 7.000% 12/1/10 900 1,021 -------- 10,080 -------- Entertainment -- 0.3% The Walt Disney Company 6.375% 3/1/12 1,250 1,375 -------- Environmental Services -- 1.0% Republic Services, Inc. 6.750% 8/15/11 2,340 2,616 Safety-Kleen Corp. 9.250% 5/15/09 119 6(D)
Statement of Net Assets -- Continued Investment Grade Income Portfolio -- Continued Annual Report to Shareholders 38
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Environmental Services -- Continued Waste Management, Inc. 6.375% 11/15/12 $ 230 $ 249 Waste Management, Inc. 7.375% 5/15/29 700 788 Waste Management, Inc. 7.750% 5/15/32 420 495 -------- 4,154 -------- Food, Beverage and Tobacco -- 4.6% Altria Group, Inc. 6.375% 2/1/06 490 520 Altria Group, Inc. 7.000% 11/4/13 1,550 1,654 Altria Group, Inc. 7.750% 1/15/27 665 717 Anheuser-Busch Companies, Inc. 4.375% 1/15/13 800 778 Anheuser-Busch Companies, Inc. 6.500% 2/1/43 600 652 Archer-Daniels-Midland Company 7.000% 2/1/31 1,000 1,149 Campbell Soup Company 5.000% 12/3/12 800 817 Coca-Cola Enterprises Inc. 5.250% 5/15/07 980 1,051 Kellogg Company 6.000% 4/1/06 1,000 1,071 Kellogg Company 6.600% 4/1/11 800 897 Kellogg Company 7.450% 4/1/31 650 768 Kraft Foods Inc. 5.250% 6/1/07 750 798 Kraft Foods Inc. 6.250% 6/1/12 210 229 Kraft Foods Inc. 6.500% 11/1/31 1,250 1,306 Nabisco Incorporated 7.050% 7/15/07 3,100 3,487 R.J. Reynolds Tobacco Holdings, Inc. 7.750% 5/15/06 1,280 1,344 R.J. Reynolds Tobacco Holdings, Inc. 7.875% 5/15/09 860 897 The Pepsi Bottling Group, Inc. 7.000% 3/1/29 900 1,031 -------- 19,166 -------- Gaming -- N.M. Horseshoe Gaming Holding Corp. 8.625% 5/15/09 69 73 -------- Gas and Pipeline Utilities -- 1.7% CenterPoint Energy Resources Corp. 7.875% 4/1/13 1,010 1,143(B) Dynegy Holdings Inc. 8.750% 2/15/12 1,690 1,705
Annual Report to Shareholders 39
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Gas and Pipeline Utilities -- Continued Panhandle Eastern Pipeline Company 4.800% 8/15/08 $ 1,170 $ 1,206(B) Tennessee Gas Pipeline Company 8.375% 6/15/32 1,000 1,061 The Williams Companies, Inc. 7.625% 7/15/19 2,000 2,092 -------- 7,207 -------- Health Care -- 0.6% Tenet Healthcare Corporation 7.375% 2/1/13 2,310 2,322 -------- Homebuilding -- 0.2% Centex Corporation 5.125% 10/1/13 420 414 Pulte Homes, Inc. 6.250% 2/15/13 385 409 -------- 823 -------- Insurance -- 0.6% Ace Capital Trust II 9.700% 4/1/30 50 65 Loews Corporation 7.625% 6/1/23 1,000 1,028 Loews Corporation 7.000% 10/15/23 1,000 994 Provident Companies, Inc. 7.000% 7/15/18 590 593 -------- 2,680 -------- Investment Banking/Brokerage -- 5.2% Credit Suisse First Boston USA, Inc. 3.875% 1/15/09 1,500 1,498 J.P. Morgan Chase & Co. 5.350% 3/1/07 1,400 1,498 J.P. Morgan Chase & Co. 6.625% 3/15/12 2,750 3,072 J.P. Morgan Chase & Co. 5.750% 1/2/13 1,100 1,160 Lehman Brothers Holdings Inc. 6.250% 5/15/06 2,000 2,173 Lehman Brothers Holdings Inc. 6.625% 1/18/12 800 903 Merrill Lynch & Co., Inc. 3.375% 9/14/07 1,345 1,362 Merrill Lynch & Co., Inc. 6.000% 2/17/09 800 880 Morgan Stanley 5.800% 4/1/07 2,600 2,826 Morgan Stanley 7.250% 4/1/32 1,200 1,407 The Bear Stearns Companies Inc. 4.000% 1/31/08 1,600 1,630
Statement of Net Assets -- Continued Investment Grade Income Portfolio -- Continued Annual Report to Shareholders 40
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Investment Banking/Brokerage -- Continued The Goldman Sachs Group, Inc. 6.600% 1/15/12 $ 1,550 $ 1,732 The Goldman Sachs Group, Inc. 6.125% 2/15/33 1,300 1,309 -------- 21,450 -------- Machinery -- 0.3% Caterpillar Inc. 6.550% 5/1/11 1,070 1,215 -------- Manufacturing (Diversified) -- 0.1% The Gillette Company 2.875% 3/15/08 410 401 -------- Media -- 3.9% AOL Time Warner Inc. 6.150% 5/1/07 1,600 1,741 AOL Time Warner Inc. 6.875% 5/1/12 2,050 2,307 AOL Time Warner Inc. 7.700% 5/1/32 2,020 2,357 Clear Channel Communications, Inc. 4.400% 5/15/11 1,210 1,182 Liberty Media Corporation 2.670% 9/17/06 2,335 2,360(C) Liberty Media Corporation 8.500% 7/15/29 840 1,017 Liberty Media Corporation 8.250% 2/1/30 420 503 News America Holdings 8.875% 4/26/23 500 641 News America Holdings 7.750% 2/1/24 80 94 News America Holdings 8.250% 10/17/96 200 236 News America Incorporated 7.625% 11/30/28 1,410 1,634 News America Incorporated 6.550% 3/15/33 110 114 Time Warner Entertainment Company, L.P. 8.375% 7/15/33 460 584 Viacom Inc. 5.625% 8/15/12 1,250 1,330 -------- 16,100 -------- Medical Care Facilities -- 0.4% HCA Inc. 6.300% 10/1/12 1,790 1,846 --------
Annual Report to Shareholders 41
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Metals and Mining -- 0.5% Alcoa Inc. 5.375% 1/15/13 $ 1,800 $ 1,880 -------- Oil and Gas -- 2.1% Apache Corporation 6.250% 4/15/12 1,010 1,123 ConocoPhillips 4.750% 10/15/12 2,170 2,179 Devon Energy Corporation 7.950% 4/15/32 1,080 1,302 El Paso Corporation 7.800% 8/1/31 1,660 1,413 El Paso Corporation 7.750% 1/15/32 340 290 Ocean Energy Inc. 4.375% 10/1/07 965 997 XTO Energy, Inc. 6.250% 4/15/13 1,250 1,316 -------- 8,620 -------- Paper and Forest Products -- 1.0% MeadWestvaco Corporation 6.850% 4/1/12 1,130 1,243 Weyerhaeuser Company 6.125% 3/15/07 750 813 Weyerhaeuser Company 6.750% 3/15/12 1,070 1,167 Weyerhaeuser Company 7.375% 3/15/32 720 783 -------- 4,006 -------- Pharmaceuticals -- 0.4% Bristol-Myers Squibb Company 4.750% 10/1/06 300 317 Bristol-Myers Squibb Company 5.750% 10/1/11 1,160 1,254 -------- 1,571 -------- Photo Equipment and Supplies -- 0.4% Eastman Kodak Company 3.625% 5/15/08 975 926 Eastman Kodak Company 7.250% 11/15/13 500 525 -------- 1,451 -------- Real Estate -- 0.4% EOP Operating Limited Partnership 6.750% 2/15/12 1,500 1,657 --------
Statement of Net Assets -- Continued Investment Grade Income Portfolio -- Continued Annual Report to Shareholders 42
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Retail -- 0.4% Target Corporation 5.875% 3/1/12 $ 1,240 $ 1,346 Wal-Mart Stores, Inc. 7.550% 2/15/30 200 246 -------- 1,592 -------- Special Purpose -- 6.4% American Honda Finance Corporation 3.850% 11/6/08 960 967(B) BAE Systems Holdings Inc. 6.400% 12/15/11 1,250 1,344(B) DaimlerChrysler NA Holding Corp. 6.400% 5/15/06 800 857 DaimlerChrysler NA Holding Corp. 4.050% 6/4/08 730 725 DaimlerChrysler NA Holding Corp. 7.300% 1/15/12 735 818 DaimlerChrysler NA Holding Corp. 6.500% 11/15/13 290 306 DaimlerChrysler NA Holding Corp. 8.500% 1/18/31 1,800 2,151 Devon Financing Corporation ULC 6.875% 9/30/11 140 159 Duke Capital Corporation 6.250% 2/15/13 340 359 Gemstone Investors Limited 7.710% 10/31/04 440 444(B) H.J. Heinz Finance Company 6.750% 3/15/32 800 893 NiSource Finance Corp. 3.200% 11/1/06 985 993 Sprint Capital Corporation 6.000% 1/15/07 700 748 Sprint Capital Corporation 8.375% 3/15/12 2,750 3,211 Sprint Capital Corporation 6.900% 5/1/19 720 735 Sprint Capital Corporation 8.750% 3/15/32 700 827 TCI Communications Financing III 9.650% 3/31/27 3,350 4,037 Unilever Capital Corporation 7.125% 11/1/10 480 558 Verizon Global Funding Corp. 6.125% 6/15/07 2,600 2,845 Verizon Global Funding Corp. 6.875% 6/15/12 1,000 1,122 Verizon Global Funding Corp. 7.375% 9/1/12 1,300 1,506 Verizon Wireless Capital LLC 5.375% 12/15/06 800 854 -------- 26,459 --------
Annual Report to Shareholders 43
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Corporate Bonds and Notes -- Continued Telecommunications -- 1.9% AT&T Corp. 8.050% 11/15/11 $ 800 $ 921 AT&T Corp. 8.750% 11/15/31 640 748 Citizens Communications Company 8.500% 5/15/06 1,000 1,092 EchoStar DBS Corporation 4.410% 10/1/08 500 520(B,C) GTE Corporation 6.940% 4/15/28 1,700 1,784 Qwest Corporation 5.625% 11/15/08 550 544 SBC Communications Inc. 5.875% 8/15/12 2,020 2,145 -------- 7,754 -------- Telecommunications (Cellular/Wireless) -- 0.8% AT&T Wireless Services Inc. 7.500% 5/1/07 1,500 1,682 Cingular Wireless LLC 5.625% 12/15/06 800 858 Motorola, Inc. 7.625% 11/15/10 850 977 -------- 3,517 -------- Transportation -- 1.5% Burlington Northern Railroad Company 6.960% 3/22/09 275 297 Burlington Northern Railroad Company 7.330% 6/23/10 201 225 Consolidated Rail Corporation 7.875% 5/15/43 600 723 Continental Airlines, Inc. 7.256% 3/15/20 610 620 Delta Air Lines, Inc. 7.111% 9/18/11 230 232 Delta Air Lines, Inc. 7.570% 5/18/12 400 414 Delta Air Lines, Inc. 6.718% 7/2/24 792 848 Norfolk Southern Railway Company 7.000% 6/15/05 475 510 Northwest Airlines Corporation 7.575% 3/1/19 203 209 Union Pacific Corporation 6.500% 4/15/12 1,750 1,944 United Airlines, Inc. 7.783% 1/1/14 245 204 -------- 6,226 -------- Total Corporate Bonds and Notes (Identified Cost -- $275,340) 289,601 -----------------------------------------------------------------------------
Statement of Net Assets -- Continued Investment Grade Income Portfolio -- Continued Annual Report to Shareholders 44
Maturity Rate Date Par Value ----------------------------------------------------------------------------- U.S. Government and Agency Obligations -- 5.6% Fixed Rate Securities -- 5.6% Fannie Mae 2.250% 5/15/06 $ 17,620 $ 17,620 Federal Home Loan Bank 3.625% 11/14/08 3,030 3,047 Tennessee Valley Authority 5.375% 11/13/08 150 162 United States Treasury Notes 3.375% 11/15/08 1,245 1,255 United States Treasury Bonds 5.375% 2/15/31 970 1,011 -------- Total U.S. Government and Agency Obligations (Identified Cost -- $23,061) 23,095 ----------------------------------------------------------------------------- U.S. Government Agency Mortgage-Backed Securities -- N.M. Fixed Rate Securities -- N.M. Fannie Mae 8.000% 4/25/06 46 48 -------- Indexed Securities(C) -- N.M. Freddie Mac 3.423% 9/1/24 146 151 -------- Total U.S. Government Agency Mortgage-Backed Securities (Identified Cost -- $193) 199 ----------------------------------------------------------------------------- Yankee Bonds(F) -- 22.2% Banks -- 1.7% ABN Amro Bank NV 4.650% 6/4/18 1,530 1,408(B) HBOS Treasury Services plc 3.750% 9/30/08 985 986(B) ING Bank N.V. 5.125% 5/1/15 500 498(B) Inter-American Development Bank 4.000% 1/18/05 2,450 2,517 Royal Bank of Scotland Group plc 8.817% 3/31/49 1,500 1,624 -------- 7,033 -------- Cable -- 0.2% British Sky Broadcasting Group plc 6.875% 2/23/09 870 977 -------- Electric -- 0.7% Empresa Nacional de Electricidad S.A. 8.500% 4/1/09 905 1,020 Hydro-Quebec 7.500% 4/1/16 1,625 2,003 -------- 3,023 --------
Annual Report to Shareholders 45
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Yankee Bonds -- Continued Foreign Governments -- 7.3% Federative Republic of Brazil 2.063% 4/15/09 $ 162 $ 153(C) Federative Republic of Brazil 14.500% 10/15/09 280 366 Federative Republic of Brazil 12.000% 4/15/10 580 696 Federative Republic of Brazil 2.063% 4/15/12 430 386(C) Federative Republic of Brazil 2.063% 4/15/12 660 592(C) Federative Republic of Brazil 8.000% 4/15/14 1,589 1,557 Federative Republic of Brazil 11.000% 8/17/40 410 451 Italian Republic 3.625% 9/14/07 1,700 1,735 Province of Nova Scotia 5.750% 2/27/12 1,500 1,611 Province of Ontario 3.500% 9/17/07 1,000 1,016 Province of Ontario 5.125% 7/17/12 900 942 Quebec Province 7.500% 9/15/29 1,440 1,794 Republic of Colombia 10.500% 7/9/10 360 404 Republic of Colombia 11.750% 2/25/20 510 614 Republic of Panama 9.625% 2/8/11 120 138 Republic of Panama 9.375% 7/23/12 470 536 Republic of Panama 10.750% 5/15/20 240 288 Republic of Peru 9.125% 2/21/12 50 56 Republic of Peru 9.875% 2/6/15 70 81 Republic of Peru 4.500% 3/7/17 50 45(B,E) Republic of Peru 5.000% 3/7/17 884 817(E) Republic of Peru 8.750% 3/7/17 235 217(B,E) Republic of Peru 8.750% 11/21/33 150 150 Republic of South Africa 7.375% 4/25/12 650 730 Republic of the Philippines 9.875% 1/15/19 400 423 Republic of the Philippines 10.625% 3/16/25 50 56 Russian Federation 8.250% 3/31/10 80 89 Russian Federation 5.000% 3/31/30 1,190 1,141(E) United Mexican States 8.375% 1/14/11 6,475 7,689 United Mexican States 11.500% 5/15/26 3,705 5,363 -------- 30,136 --------
Statement of Net Assets -- Continued Investment Grade Income Portfolio -- Continued Annual Report to Shareholders 46
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Yankee Bonds -- Continued Insurance -- 0.9% Axa 8.600% 12/15/30 $ 1,630 $ 2,055 Oil Insurance Ltd. 5.150% 8/15/33 585 589(B) XL Capital plc 6.500% 1/15/12 700 766 -------- 3,410 -------- Manufacturing (Diversified) -- 1.7% Tyco International Group S.A. 6.375% 6/15/05 1,000 1,053 Tyco International Group S.A. 6.375% 2/15/06 900 959 Tyco International Group S.A. 6.375% 10/15/11 250 267 Tyco International Group S.A. 7.000% 6/15/28 554 575 Tyco International Group S.A. 6.875% 1/15/29 3,976 4,075 -------- 6,929 -------- Oil and Gas -- 1.4% Anderson Exploration Ltd. 6.750% 3/15/11 450 499 Petrobras International Finance Company (PIFCO) 9.750% 7/6/11 905 1,054 Petroliam Nasional Berhad 7.625% 10/15/26 610 704(B) YPF Sociedad Anonima 10.000% 11/2/28 3,500 3,745 -------- 6,002 -------- Special Purpose -- 5.4% Anadarko Finance Company 6.750% 5/1/11 970 1,099 Anadarko Finance Company 7.500% 5/1/31 710 832 ChevronTexaco Capital Company 3.500% 9/17/07 1,000 1,018 Conoco Funding Company 5.450% 10/15/06 1,250 1,341 Conoco Funding Company 6.350% 10/15/11 640 718 Conoco Funding Company 7.250% 10/15/31 1,500 1,770 Deutsche Telekom International Finance BV 8.750% 6/15/30 1,400 1,789 Deutsche Telekom International Finance BV 9.250% 6/1/32 670 919 Diageo Capital plc 3.500% 11/19/07 630 636 Diageo Capital plc 3.375% 3/20/08 120 119
Annual Report to Shareholders 47
Maturity Rate Date Par Value ----------------------------------------------------------------------------- Yankee Bonds -- Continued Special Purpose -- Continued General Motors Nova Scotia Finance Company 6.850% 10/15/08 $ 1,160 $ 1,241 HSBC Capital Funding LP 4.610% 12/13/49 760 716(E) HSBC Holdings plc 5.250% 12/12/12 1,700 1,741 INTELSAT 6.500% 11/1/13 400 417(B) PDVSA Finance Ltd. 1999 - I 9.750% 2/15/10 2,840 2,996 Petronas Capital Ltd. 7.875% 5/22/22 770 912(B) Redwood Capital II Ltd. 4.160% 1/1/04 200 200(B,C) Telefonica Europe BV 8.250% 9/15/30 800 1,010 UFJ Finance Aruba A E C 6.750% 7/15/13 2,835 3,023 -------- 22,497 -------- Telecommunications -- 2.6% British Telecommunications plc 8.375% 12/15/10 900 1,095 British Telecommunications plc 8.875% 12/15/30 420 550 France Telecom S.A. 9.000% 3/1/11 3,000 3,603 France Telecom S.A. 9.750% 3/1/31 340 452 Koninklijke KPN NV 8.000% 10/1/10 990 1,184 Tele Norte Leste Participacoes S.A. 8.000% 12/18/13 1,080 1,061(B) Telecom Italia S.p.A. 5.250% 11/15/13 1,065 1,067(B) Telecom Italia S.p.A. 6.375% 11/15/33 880 885(B) Vodafone Group plc 7.625% 2/15/05 1,000 1,066 -------- 10,963 -------- Transportation -- 0.3% C P Railway Limited 7.125% 10/15/31 1,000 1,154 -------- Total Yankee Bonds (Identified Cost -- $86,669) 92,124 -------- Total Long-Term Securities (Identified Cost -- $385,263) 405,019 ----------------------------------------------------------------------------- Short-Term Securities -- 0.9% Repurchase Agreements -- 0.9% Credit Suisse First Boston 0.97%, dated 12/31/03, to be repurchased at $1,653 on 1/2/04 (Collateral: $1,675 Federal Home Loan Bank bonds, 2.25%, due 12/15/05, value $1,688) 1,653 1,653
Statement of Net Assets -- Continued Investment Grade Income Portfolio -- Continued Annual Report to Shareholders 48
Par Value ----------------------------------------------------------------------------- Repurchase Agreements -- Continued Goldman, Sachs & Company 0.97%, dated 12/31/03, to be repurchased at $2,000 on 1/2/04 (Collateral: $1,740 Freddie Mac bonds, 6.75%, due 3/15/31, value $2,075) $ 2,000 $ 2,000 -------- Total Short-Term Securities (Identified Cost -- $3,653) 3,653 ----------------------------------------------------------------------------- Total Investments -- 98.6% (Identified Cost -- $388,916) 408,672 Other Assets Less Liabilities -- 1.4% 5,908 -------- Net assets consist of: Accumulated paid-in capital applicable to: 37,571 Primary Class shares outstanding $388,722 542 Institutional Class shares outstanding 5,641 Under/(over) distributed net investment income (116) Accumulated net realized gain/(loss) on investments, options and futures 577 Unrealized appreciation/(depreciation) of investments, options and futures 19,756 -------- Net assets -- 100.0% $414,580 ======== Net asset value per share: Primary Class $10.88 ======== Institutional Class $10.89 ======== -----------------------------------------------------------------------------
(A) Zero coupon bond -- A bond with no periodic interest payments which is sold at such a discount as to produce a current yield to maturity. (B) Rule 144a Security -- A security purchased pursuant to Rule 144a under the Securities Act of 1933 which may not be resold subject to that rule except to qualified institutional buyers. These securities represent 5.7% of net assets. (C) Indexed security -- The rates of interest earned on these securities are tied to the London Interbank Offered Rate ("LIBOR") or the one-year Treasury Bill rate. The coupon rates are the rates as of December 31, 2003. (D) Bond is in default at December 31, 2003. (E) Stepped coupon security -- A security with a predetermined schedule of interest or dividend rate changes, at which time it begins to accrue interest or pay dividends. (F) Yankee Bond -- A dollar-denominated bond issued in the U.S. by foreign entities. See notes to financial statements. Annual Report to Shareholders 49 Statement of Operations Investment Grade Income Portfolio For the Year Ended December 31, 2003 (Amounts in Thousands) -------------------------------------------------------------------------- Investment Income: Interest $21,952 Expenses: Management fee $ 2,342 Distribution and service fees 1,932 Audit and legal fees 63 Custodian fee 231 Directors' fees and expenses 27 Registration fees 43 Reports to shareholders 41 Transfer agent and shareholder servicing expense: Primary Class 283 Institutional Class 4 Other expenses 20 ------- 4,986 Less fees waived (1,103) ------- Total expenses, net of waivers 3,883 ------- Net Investment Income 18,069 ------- Net Realized and Unrealized Gain/(Loss) on Investments: Net realized gain/(loss) on investments, options and futures Investments 5,559 Options 0.4 Futures 1,148 ------- 6,707 Change in unrealized appreciation/(depreciation) of investments, options and futures 11,745 ------- Net Realized and Unrealized Gain/(Loss) on Investments 18,452 -------------------------------------------------------------------------- Change in Net Assets Resulting From Operations $36,521 --------------------------------------------------------------------------
See notes to financial statements. Annual Report to Shareholders 50 Statement of Changes in Net Assets Investment Grade Income Portfolio (Amounts in Thousands)
For the Years Ended --------------------------------- 12/31/03 12/31/02 ---------------------------------------------------------------------------- Change in Net Assets: Net investment income $ 18,069 $ 15,507 Net realized gain/(loss) on investments, options and futures 6,707 4,513 Change in unrealized appreciation/ (depreciation) of investments, options and futures 11,745 6,234 ---------------------------------------------------------------------------- Change in net assets resulting from operations 36,521 26,254 Distributions to shareholders: From net investment income: Primary Class (18,075) (15,366) Institutional Class (209) (142) From net realized gain on investments: Primary Class (2,770) -- Institutional Class (36) -- Change in net assets from Fund share transactions: Primary Class 58,641 68,814 Institutional Class 2,909 1,317 ---------------------------------------------------------------------------- Change in net assets 76,981 80,877 Net Assets: Beginning of year 337,599 256,722 ---------------------------------------------------------------------------- End of year $414,580 $337,599 ---------------------------------------------------------------------------- Under/(over) distributed net investment income $ (116) $ 99 ----------------------------------------------------------------------------
See notes to financial statements. Annual Report to Shareholders 51 Financial Highlights Investment Grade Income Portfolio Contained below is per share operating performance data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements. Primary Class:
Years Ended December 31, ------------------------------------------------ 2003 2002 2001 2000 1999 --------------------------------------------------------------------------------- Net asset value, beginning of year $10.42 $10.10 $9.97 $9.78 $10.52 ------------------------------------------------ Investment operations: Net investment income .50(A) .54(A) .60(A) .67(A) .61(A) Net realized and unrealized gain/(loss) on investments, options and futures .53 .32 .14 .19 (.71) ------------------------------------------------ Total from investment operations 1.03 .86 .74 .86 (.10) ------------------------------------------------ Distributions: From net investment income (.50) (.54) (.61) (.67) (.61) From net realized gain on investments (.07) -- -- -- (.03) ------------------------------------------------ Total distributions (.57) (.54) (.61) (.67) (.64) ------------------------------------------------ Net asset value, end of year $10.88 $10.42 $10.10 $9.97 $9.78 ------------------------------------------------ Ratios/supplemental data: Total return 10.16% 8.82% 7.52% 9.16% (.91)% Expenses to average net assets 1.00%(A) 1.00%(A) 1.00%(A) 1.00%(A) 1.00%(A) Net investment income to average net assets 4.62%(A) 5.32%(A) 5.90%(A) 6.82%(A) 6.08%(A) Portfolio turnover rate 78% 131% 131% 94% 145% Net assets, end of year (in thousands) $408,685 $334,763 $255,298 $194,987 $183,615 ---------------------------------------------------------------------------------
(A) Net of fees waived by LMFA for expenses in excess of a voluntary expense limitation of 1.00% until April 30, 2004. If no fees had been waived by LMFA, the annualized ratio of expenses to average daily net assets would have been as follows: for the years ended December 31, 2003, 1.28%; 2002, 1.30%; 2001, 1.27%; 2000, 1.31%; and 1999, 1.31%. See notes to financial statements. Annual Report to Shareholders 52 Financial Highlights -- Continued Institutional Class:
Years Ended December 31, -------------------------------------------------- 2003 2002 2001 2000 1999 ---------------------------------------------------------------------------- Net asset value, beginning of year $10.43 $10.11 $9.97 $9.79 $10.52 -------------------------------------------------- Investment operations: Net investment income .55(B) .59(B) .66(B) .71(B) .66(B) Net realized and unrealized gain/(loss) on investments, options and futures .53 .31 .14 .19 (.70) -------------------------------------------------- Total from investment operations 1.08 .90 .80 .90 (.04) -------------------------------------------------- Distributions: From net investment income (.55) (.58) (.66) (.72) (.66) From net realized gain on investments (.07) -- -- -- (.03) -------------------------------------------------- Total distributions (.62) (.58) (.66) (.72) (.69) -------------------------------------------------- Net asset value, end of year $10.89 $10.43 $10.11 $9.97 $ 9.79 -------------------------------------------------- Ratios/supplemental data: Total return 10.71% 9.38% 8.16% 9.63% (.33)% Expenses to average net assets .50%(B) .48%(B) .47%(B) .48%(B) .46%(B) Net investment income to average net assets 5.13%(B) 5.85%(B) 6.50%(B) 7.32%(B) 6.59%(B) Portfolio turnover rate 78% 131% 131% 94% 145% Net assets, end of year (in thousands) $5,895 $2,836 $1,424 $ 839 $ 238 ----------------------------------------------------------------------------
(B) Net of fees waived by LMFA for expenses in excess of a voluntary expense limitation of 0.50% until April 30, 2004. If no fees had been waived by LMFA, the annualized ratio of expenses to average daily net assets would have been as follows: for the years ended December 31, 2003, 0.78%; 2002, 0.78%; 2001, 0.74%; 2000, 0.79%; and 1999, 0.77%. See notes to financial statements. Annual Report to Shareholders 53 Performance Information U.S. Government Intermediate-Term Portfolio The following graphs compare the Fund's total returns against those of a closely matched broad-based securities market index. The lines illustrate the cumulative total return of an initial $10,000 investment in Primary Class shares and an initial $1,000,000 investment in Institutional Class shares of the Fund, for the periods indicated. The lines for the Fund represent the total return after deducting all Fund investment management and other administrative expenses and the transaction costs of buying and selling securities. The lines representing the securities market index do not include any transaction costs associated with buying and selling securities in the index or other administrative expenses. Total return measures investment performance in terms of appreciation or depreciation in a fund's net asset value per share, plus dividends and any capital gain distributions. It assumes that dividends and distributions were reinvested at the time they were paid. The investment return and principal value of an investment in the Fund will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Average annual returns tend to smooth out variations in a fund's return, so that they differ from actual year-to-year results. Performance would have been lower if fees had not been waived in various periods. Effective September 30, 2002, Government Intermediate changed its comparative index from the Lehman Intermediate Government/Credit Bond Index to the Lehman Intermediate Government Bond Index, because the new index is more representative of the types of securities in which the Fund invests. Performance Information -- Continued Annual Report to Shareholders 54 Growth of a $10,000 Investment -- Primary Class [VALUE TRUST GRAPH]
U.S. Government Lehman Intermediate Intermediate Term Portfolio - Government/Credit Bond Lehman Intermediate Primary Class Index Government Bond Index ----------------------------- ---------------------- --------------------- 12/31/1993 10000.00 10000.00 10000.00 3/31/1994 9855.00 9687.00 9815.00 6/30/1994 9789.00 9566.00 9760.00 9/30/1994 9793.00 9614.00 9835.00 12/31/1994 9807.00 9649.00 9825.00 3/31/1995 10188.00 10130.00 10234.00 6/30/1995 10672.00 10787.00 10712.00 9/30/1995 10845.00 10994.00 10878.00 12/31/1995 11168.00 11506.00 11241.00 3/31/1996 11092.00 11237.00 11165.00 6/30/1996 11167.00 11290.00 11240.00 9/30/1996 11337.00 11489.00 11434.00 12/31/1996 11668.00 11840.00 11698.00 3/31/1997 11635.00 11738.00 11695.00 6/30/1997 11954.00 12165.00 12021.00 9/30/1997 12232.00 12591.00 12329.00 2/31/1997 12481.00 12995.00 12601.00 3/31/1998 12634.00 13192.00 12792.00 6/30/1998 12871.00 13537.00 13028.00 9/30/1998 13295.00 14208.00 13637.00 12/31/1998 13300.00 14226.00 13671.00 3/31/1999 13246.00 14056.00 13633.00 6/30/1999 13096.00 13902.00 13606.00 9/30/1999 13218.00 13977.00 13744.00 12/31/1999 13236.00 13921.00 13737.00 3/31/2000 13547.00 14295.00 13962.00 6/30/2000 13743.00 14502.00 14216.00 9/30/2000 14095.00 14919.00 14597.00 12/31/2000 14553.00 15570.00 15176.00 3/31/2001 14876.00 16068.00 15632.00 6/30/2001 14920.00 16117.00 15697.00 9/30/2001 15535.00 16884.00 16476.00 12/31/2001 15400.00 16894.00 16453.00 3/31/2002 15418.00 16815.00 16410.00 6/30/2002 15943.00 17446.00 17044.00 9/30/2002 16453.00 18440.00 17865.00 12/31/2002 16600.00 18759.00 18039.00 3/31/2003 16744.00 19067.00 18206.00 6/30/2003 16961.00 19740.00 18514.00 9/30/2003 16808.00 19640.00 18489.00 12/31/2003 16785.00 19634.00 18452.00
Cumulative Average Annual Total Return Total Return One Year +1.11% +1.11% Five Years +26.20% +4.76% Ten Years +67.85% +5.32%
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Past performance does not predict future performance. --------------- (A) An index based on all publicly issued intermediate government and corporate debt securities with an average maturity of 4 to 5 years. (B) A total return index consisting of investment grade corporate debt issues as well as U.S. government securities. The debt issues all maintain maturities within a range of 1 to 10 years. Annual Report to Shareholders 55 Growth of a $1,000,000 Investment -- Institutional Class [VALUE TRUST GRAPH]
U.S. Government Lehman Intermediate Intermediate Term Portfolio - Government/Credit Bond Lehman Intermediate Institutional Class Index (C) Government Bond Index (C) ----------------------------- ---------------------- ------------------------- 12/1/1994 1000000.00 1000000.00 1000000.00 12/31/1994 1005190.00 1006600.00 1003300.00 3/31/1995 1045430.00 1056700.00 1045000.00 6/30/1995 1096620.00 1125300.00 1093800.00 9/30/1995 1115960.00 1146900.00 1110800.00 12/31/1995 1150230.00 1200300.00 1147800.00 3/31/1996 1143110.00 1172200.00 1140100.00 6/30/1996 1152660.00 1177700.00 1147700.00 9/30/1996 1172050.00 1198500.00 1167500.00 12/31/1996 1208790.00 1235100.00 1194500.00 3/31/1997 1207800.00 1224500.00 1194200.00 6/30/1997 1240830.00 1269000.00 1227500.00 9/30/1997 1271410.00 1313500.00 1258800.00 12/31/1997 1299050.00 1355600.00 1286700.00 3/31/1998 1317990.00 1376200.00 1306200.00 6/30/1998 1344490.00 1412200.00 1330300.00 9/30/1998 1389370.00 1482100.00 1392500.00 12/31/1998 1391780.00 1484100.00 1395900.00 3/31/1999 1387890.00 1466300.00 1392100.00 6/30/1999 1373940.00 1450300.00 1389300.00 9/30/1999 1388530.00 1458100.00 1403400.00 12/31/1999 1392310.00 1452200.00 1402700.00 3/31/2000 1426830.00 1491200.00 1425600.00 6/30/2000 1450840.00 1512900.00 1451600.00 9/30/2000 1490000.00 1556300.00 1490500.00 12/31/2000 1540490.00 1624300.00 1549600.00 3/31/2001 1575330.00 1676200.00 1596100.00 6/30/2001 1582190.00 1681300.00 1602800.00 9/30/2001 1649570.00 1761400.00 1682300.00 12/31/2001 1637480.00 1762400.00 1680000.00 3/31/2002 1641550.00 1754100.00 1675600.00 6/30/2002 1699550.00 1819900.00 1740300.00 9/30/2002 1757830.00 1923600.00 1824200.00 12/31/2002 1774240.00 1956900.00 1842000.00 3/31/2003 1791920.00 1989100.00 1859000.00 6/30/2003 1819200.00 2059200.00 1890400.00 9/30/2003 1802870.00 2048800.00 1887900.00 12/31/2003 1804600.00 1943900.00 1884100.00
Cumulative Average Annual Total Return Total Return One Year +1.71% +1.71% Five Years +29.66% +5.33% Life of Class* +80.46% +6.72% *Inception date: December 1, 1994
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Past performance does not predict future performance. --------------- (C) Index returns are for periods beginning November 30, 1994. Annual Report to Shareholders 56 Statement of Net Assets U.S. Government Intermediate-Term Portfolio December 31, 2003 (Amounts in Thousands)
Maturity Rate Date Par Value --------------------------------------------------------------------------------- Long-Term Securities -- 76.8% U.S. Government and Agency Obligations -- 34.3% Fixed Rate Securities -- 34.3% Fannie Mae 4.375% 7/17/13 $ 7,000 $ 6,701 Freddie Mac 4.500% 1/15/13 33,000 32,833 United States Treasury Notes 3.000% 11/15/07 9,310 9,390 United States Treasury Notes 2.625% 5/15/08 950 936 United States Treasury Notes 5.000% 8/15/11 1,880 2,012 United States Treasury Notes 4.250% 8/15/13 37,000 37,046 United States Treasury Bonds 5.750% 8/15/10 3,490 3,913 United States Treasury Bonds 8.000% 11/15/21 7,670 10,359 United States Treasury Bonds 5.250% 11/15/28 11,560 11,644 -------- Total U.S. Government and Agency Obligations (Identified Cost -- $116,502) 114,834 --------------------------------------------------------------------------------- U.S. Government Agency Mortgage-Backed Securities -- 36.8% Fixed Rate Securities -- 36.5% Fannie Mae 8.500% 6/1/10 to 8/1/11 147 151 Fannie Mae 6.500% 11/1/10 to 10/1/32 13,400 14,049 Fannie Mae 7.000% 1/1/13 to 1/1/33 15,522 16,439 Fannie Mae 9.500% 7/1/14 173 192 Fannie Mae 11.000% 12/1/15 123 138 Fannie Mae 5.500% 9/1/17 4,927 5,110 Fannie Mae 12.500% 1/1/18 to 4/1/18 145 169 Fannie Mae 5.000% 6/1/18 39,532 40,371 Fannie Mae 9.000% 11/1/21 291 324 Fannie Mae 6.000% 11/1/27 to 9/1/32 2,242 2,319 Freddie Mac 8.250% 2/1/08 41 42 Freddie Mac 8.500% 12/1/08 to 6/1/21 234 248 Freddie Mac 9.750% 11/1/09 to 11/1/14 78 84 Freddie Mac 9.000% 1/1/17 to 1/1/21 400 438 Freddie Mac 5.500% 3/1/17 to 8/1/17 5,364 5,563 Freddie Mac 7.000% 1/25/21 to 4/1/32 7,253 7,669 Freddie Mac 8.000% 2/1/31 846 912 Freddie Mac 5.000% 8/1/33 23,723 23,429
Annual Report to Shareholders 57
Maturity Rate Date Par Value --------------------------------------------------------------------------------- U.S. Government Agency Mortgage-Backed Securities -- Continued Fixed Rate Securities -- Continued Government National Mortgage Association 9.000% 7/15/04 to 9/15/22 $ 721 $ 772 Government National Mortgage Association 6.000% 5/15/14 to 11/15/32 2,202 2,295 Government National Mortgage Association 6.500% 10/15/31 to 6/15/32 1,308 1,379 -------- 122,093 -------- Indexed Securities(A) -- 0.3% Government National Mortgage Association 7.313% 6/16/26 4,616 519(B1) Government National Mortgage Association 7.363% 8/16/26 3,813 482(B1) -------- 1,001 -------- Total U.S. Government Agency Mortgage-Backed Securities (Identified Cost -- $123,499) 123,094 --------------------------------------------------------------------------------- Corporate Bonds and Notes -- 0.3% Banking and Finance -- 0.3% Household Finance Corporation 8.000% 7/15/10 690 826 -------- Total Corporate Bonds and Notes (Identified Cost -- $730) 826 ---------------------------------------------------------------------------------
Statement of Net Assets -- Continued U.S. Government Intermediate-Term Portfolio -- Continued Annual Report to Shareholders 58
Maturity Rate Date Par Value --------------------------------------------------------------------------------- Mortgage-Backed Securities -- 5.1% Fixed Rate Securities -- 5.1% Blackrock Capital Finance L.P. 1997-R3 7.220% 11/25/28 $ 960 $ 980(C) Residential Asset Securitization Trust 2003-A14 4.750% 2/25/19 16,100 16,216 -------- Total Mortgage-Backed Securities (Identified Cost -- $17,129) 17,196 --------------------------------------------------------------------------------- Preferred Stocks -- 0.3% Home Ownership Funding Corporation 13.331% 5shs 251(C,D) Home Ownership Funding Corporation II 13.338% 14 704(C,D) -------- Total Preferred Stocks (Identified Cost -- $1,537) 955 -------- Total Long-Term Securities (Identified Cost -- $259,397) 256,905 --------------------------------------------------------------------------------- Short-Term Securities -- 22.8% U.S. Governmental Agency Obligations -- 0.3% Fannie Mae 0.000% 3/24/04 $ 850 848(E,F) Fannie Mae 0.000% 3/24/04 50 50(E,F) -------- 898 --------
Annual Report to Shareholders 59
Par Value --------------------------------------------------------------------------------- Short-Term Securities -- Continued Repurchase Agreements -- 22.5% Credit Suisse First Boston 0.97%, dated 12/31/03, to be repurchased for $31,436 on 1/2/04 (Collateral: $31,685 Federal Home Loan Bank bonds, 2.25%, due 12/15/05, value $32,110) $ 31,436 $ 31,436 Goldman, Sachs & Company 0.97%, dated 12/31/03, to be repurchased at $44,000 on 1/2/04 (Collateral: $42,795 Fannie Mae notes, 5.25%, due 8/1/12, value $45,817) 44,000 44,000 -------- 75,436 -------- Total Short-Term Securities (Identified Cost -- $76,334) 76,334 --------------------------------------------------------------------------------- Total Investments -- 99.6% (Identified Cost -- $335,731) 333,239 Other Assets Less Liabilities -- 0.4% 1,345 --------
Net assets consist of: Accumulated paid-in capital applicable to: 31,012 Primary Class shares outstanding $332,095 734 Institutional Class shares outstanding 7,551 Under/(over) distributed net investment income 1,269 Accumulated net realized gain/(loss) on investments, options and futures (3,277) Unrealized appreciation/(depreciation) of investments, options and futures (3,054) -------- Net assets -- 100.0% $334,584 ======== Net asset value per share: Primary Class $10.54 ======== Institutional Class $10.55 ========
Statement of Net Assets -- Continued U.S. Government Intermediate-Term Portfolio -- Continued Annual Report to Shareholders 60
Expiration Actual Appreciation/ Date Contracts (Depreciation) ---------------------------------------------------------------------- Futures Contracts Purchased(G) Eurodollar Futures September 2004 39 $ 35 Eurodollar Futures December 2004 100 141 ----- $ 176 ----- Futures Contracts Written(G) U.S. Treasury Note Futures March 2004 234 $(415) U.S. Treasury Bond Futures March 2004 148 (323) ----- $(738) ----- ----------------------------------------------------------------------
(A) Indexed security -- The rates of interest earned on these securities are tied to the London Interbank Offered Rate ("LIBOR"). The coupon rates are the rates as of December 31, 2003. (B) Stripped security -- Security with interest-only or principal-only payment streams, denoted by a 1 or 2, respectively. For interest-only securities, the amount shown as principal is the notional balance used to calculate the amount of interest due. (C) Rule 144a Security -- A security purchased pursuant to Rule 144a under the Securities Act of 1933 which may not be resold subject to that rule except to qualified institutional buyers. These securities represent 0.6% of net assets. (D) Stepped coupon security -- A security with a predetermined schedule of interest or dividend rate changes. (E) Zero coupon bond -- A bond with no periodic interest payments which is sold at such a discount as to produce a current yield to maturity. (F) Collateral to cover futures contracts. (G) Futures are described in more detail in the notes to financial statements. See notes to financial statements. Annual Report to Shareholders 61 Statement of Operations U.S. Government Intermediate-Term Portfolio
For the Year Ended December 31, 2003 (Amounts in Thousands) -------------------------------------------------------------------------- Investment Income: Dividends $ 310 Interest 12,576 ------- Total income $ 12,886 Expenses: Management fee 2,052 Distribution and service fees 1,821 Audit and legal fees 62 Custodian fee 200 Directors' fees and expenses 22 Registration fees 33 Reports to shareholders 32 Transfer agent and shareholder servicing expense: Primary Class 237 Institutional Class 3 Other expenses 21 ------- 4,483 Less fees waived (800) ------- Total expenses, net of waivers 3,683 -------- Net Investment Income 9,203 -------- Net Realized and Unrealized Gain/(Loss) on Investments: Net realized gain/(loss) on: Investments 11,399 Options 18 Futures (3,365) ------- 8,052 Change in unrealized appreciation/(depreciation) of investments, options and futures (13,276) -------- Net Realized and Unrealized Gain/(Loss) on Investments (5,224) -------------------------------------------------------------------------- Change in Net Assets Resulting From Operations $ 3,979 --------------------------------------------------------------------------
See notes to financial statements. Annual Report to Shareholders 62 Statement of Changes in Net Assets U.S. Government Intermediate-Term Portfolio (Amounts in Thousands)
For the Years Ended ----------------------- 12/31/03 12/31/02 -------------------------------------------------------------------------- Change in Net Assets: Net investment income $ 9,203 $ 13,614 Net realized gain/(loss) on investments, options and futures 8,052 4,950 Change in unrealized appreciation/(depreciation) of investments, options and futures (13,276) 7,494 -------------------------------------------------------------------------- Change in net assets resulting from operations 3,979 26,058 Distributions to shareholders from net investment income: Primary Class (9,512) (13,280) Institutional Class (279) (374) Change in net assets from Fund share transactions: Primary Class (47,284) 67,093 Institutional Class (1,598) 1,963 -------------------------------------------------------------------------- Change in net assets (54,694) 81,460 Net Assets: Beginning of year 389,278 307,818 -------------------------------------------------------------------------- End of year $334,584 $389,278 -------------------------------------------------------------------------- Under/(over) distributed net investment income $ 1,269 $ 138 --------------------------------------------------------------------------
See notes to financial statements. Annual Report to Shareholders 63 Financial Highlights U.S. Government Intermediate-Term Portfolio Contained below is per share operating performance data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements. Primary Class:
Years Ended December 31, -------------------------------------------------------- 2003 2002 2001 2000 1999 ---------------------------------------------------------------------------------- Net asset value, beginning of year $10.70 $10.32 $10.26 $9.92 $10.51 -------------------------------------------------------- Investment operations: Net investment income .26(A) .41(A) .53(A) .62(A) .54(A) Net realized and unrealized gain/(loss) on investments, options and futures (.14) .38 .06 .33 (.59) -------------------------------------------------------- Total from investment operations .12 .79 .59 .95 (.05) -------------------------------------------------------- Distributions: From net investment income (.28) (.41) (.53) (.61) (.54) -------------------------------------------------------- Total distributions (.28) (.41) (.53) (.61) (.54) -------------------------------------------------------- Net asset value, end of year $10.54 $10.70 $10.32 $10.26 $9.92 -------------------------------------------------------- Ratios/supplemental data: Total return 1.11% 7.79% 5.83% 9.95% (.48)% Expenses to average net assets 1.00%(A) 1.00%(A) 1.00%(A) 1.00%(A) 1.00%(A) Net investment income to average net assets 2.48%(A) 3.85%(A) 5.08%(A) 6.14%(A) 5.28%(A) Portfolio turnover rate 487% 204% 535% 248% 979% Net assets, end of year (in thousands) $326,844 $379,793 $300,597 $272,668 $298,207 ----------------------------------------------------------------------------------
(A) Net of fees waived by LMFA for expenses in excess of a voluntary expense limitation of 1.00% until April 30, 2004. If no fees had been waived by LMFA, the annualized ratio of expenses to average daily net assets would have been as follows: for the years ended December 31, 2003, 1.21%; 2002, 1.19%; 2001, 1.17%; 2000, 1.19%; and 1999, 1.19%. See notes to financial statements. Annual Report to Shareholders 64 Financial Highlights -- Continued Institutional Class:
Years Ended December 31, -------------------------------------------------- 2003 2002 2001 2000 1999 ---------------------------------------------------------------------------- Net asset value, beginning of year $10.70 $10.32 $10.27 $9.92 $10.51 -------------------------------------------------- Investment operations: Net investment income .32(B) .46(B) .58(B) .67(B) .59(B) Net realized and unrealized gain/(loss) on investments, options and futures (.14) .38 .05 .35 (.59) -------------------------------------------------- Total from investment operations .18 .84 .63 1.02 -- -------------------------------------------------- Distributions: From net investment income (.33) (.46) (.58) (.67) (.59) -------------------------------------------------- Total distributions (.33) (.46) (.58) (.67) (.59) -------------------------------------------------- Net asset value, end of year $10.55 $10.70 $10.32 $10.27 $9.92 -------------------------------------------------- Ratios/supplemental data: Total return 1.71% 8.35% 6.30% 10.64% .04% Expenses to average net assets 0.46%(B) .47%(B) .46%(B) .46%(B) .47%(B) Net investment income to average net assets 3.03%(B) 4.38%(B) 5.63%(B) 6.66%(B) 5.84%(B) Portfolio turnover rate 487% 204% 535% 248% 979% Net assets, end of year (in thousands) $7,740 $9,485 $7,221 $6,723 $9,076 ----------------------------------------------------------------------------
(B) Net of fees waived by LMFA for expenses in excess of a voluntary expense limitation of 0.50% until April 30, 2004. If no fees had been waived by LMFA, the annualized ratio of expenses to average daily net assets would have been as follows: for the years ended December 31, 2003, 0.68%; 2002, 0.66%; 2001, 0.63%; 2000, 0.65%; and 1999, 0.66%. See notes to financial statements. Annual Report to Shareholders 65 Statement of Net Assets U.S. Government Money Market Portfolio December 31, 2003 (Amounts in Thousands)
Maturity Rate Date Par Value ----------------------------------------------------------------------------- U.S. Government and Agency Obligations -- 81.8% Fannie Mae 0.82% to 5.125% 1/2/04 to 182,060 182,139 1/19/05 $ $ Federal Farm Credit Bank 1.08% 5/17/04 7,000 6,971 Federal Home Loan Bank 1.00% to 3.375% 1/14/04 to 1/18/05 23,500 23,564 Freddie Mac 0.80% to 5.25% 1/5/04 to 11/16/04 134,644 134,767 Sallie Mae 1.00% 1/26/04 7,900 7,895 Sallie Mae 0.961% 3/18/04 3,250 3,250(A) Sallie Mae 0.944% 4/15/04 2,000 2,000(A) Sallie Mae 0.951% 5/20/04 2,500 2,500(A) -------- Total U.S. Government and Agency Obligations (Identified Cost -- $363,086) 363,086 ----------------------------------------------------------------------------- Repurchase Agreements -- 18.6% Goldman Sachs & Company 0.97%, dated 12/31/03, to be repurchased at $40,000 on 1/2/04 (Collateral: $33,105 Fannie Mae notes, 7.125%, due 1/15/30, value $41,890) 40,000 40,000 Lehman Brothers, Inc. 0.95%, dated 12/31/03, to be repurchased at $42,373 on 1/2/04 (Collateral: $102,925 Resolution Funding Corp. principal-only securities, due 10/15/19, value $43,220) 42,373 42,373 -------- Total Repurchase Agreements (Identified Cost --$82,373) 82,373 ----------------------------------------------------------------------------- Total Investments, at Amortized Cost and Value --100.4% 445,459(B) Other Assets Less Liabilities -- (0.4)% (1,578) -------- Net assets applicable to 443,881 shares outstanding -- 100.0% $443,881 ======== Net asset value per share $1.00 ======== -----------------------------------------------------------------------------
(A) Rates of interest earned on these securities are tied to the quarterly Treasury rate. The coupon rates are the rates as of December 31, 2003. (B) Also represents cost for federal income tax purposes. See notes to financial statements. Annual Report to Shareholders 66 Statement of Operations U.S. Government Money Market Portfolio For the Year Ended December 31, 2003 (Amounts in Thousands) ----------------------------------------------------------------------------
Investment Income: Interest $6,118 Expenses: Management fee $2,550 Distribution and service fees 1,021 Audit and legal fees 40 Custodian fee 149 Directors' fees and expenses 25 Registration fees 50 Reports to shareholders 23 Transfer agent and shareholder servicing expense 276 Other expenses 17 ------ 4,151 Less fees waived (510) ------ Total expenses, net of waivers 3,641 ------ Net Investment Income 2,477 ---------------------------------------------------------------------------- Change in Net Assets Resulting From Operations $2,477 ----------------------------------------------------------------------------
See notes to financial statements. Annual Report to Shareholders 67 Statement of Changes in Net Assets U.S. Government Money Market Portfolio (Amounts in Thousands)
For the Years Ended ----------------------- 12/31/03 12/31/02 -------------------------------------------------------------------------- Change in Net Assets: Net investment income $ 2,477 $ 5,624 -------------------------------------------------------------------------- Change in net assets resulting from operations 2,477 5,624 Distributions to shareholders from net investment income (2,633) (5,624) Change in net assets from Fund share transactions (97,836) 40,803 -------------------------------------------------------------------------- Change in net assets (97,992) 40,803 Net Assets: Beginning of year 541,873 501,070 -------------------------------------------------------------------------- End of year $443,881 $541,873 --------------------------------------------------------------------------
See notes to financial statements. Annual Report to Shareholders 68 Financial Highlights U.S. Government Money Market Portfolio Contained below is per share operating performance data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements.
Years Ended December 31, -------------------------------------------------------------------- 2003 2002 2001 2000 1999 ------------------------------------------------------------------------------------------------- Net asset value, beginning of year $1.00 $1.00 $1.00 $1.00 $1.00 -------------------------------------------------------------------- Investment operations: Net investment income .0049(A) .01(A) .04(A) .06(A) .04(A) -------------------------------------------------------------------- Total from investment operations .0049 .01 .04 .06 .04 -------------------------------------------------------------------- Distributions: From net investment income (.0049) (.01) (.04) (.06) (.04) -------------------------------------------------------------------- Total distributions (.0049) (.01) (.04) (.06) (.04) -------------------------------------------------------------------- Net asset value, end of year $1.00 $1.00 $1.00 $1.00 $1.00 -------------------------------------------------------------------- Ratios/supplemental data: Total return .51% 1.13% 3.57% 5.66% 4.44% Expenses to average net assets .71%(A) .72%(A) .71%(A) .73%(A) .73%(A) Net investment income to average net assets .49%(A) 1.11%(A) 3.46%(A) 5.53%(A) 4.34%(A) Net assets, end of year (in thousands) $443,881 $541,873 $501,070 $426,988 $379,994 -------------------------------------------------------------------------------------------------
(A) Net of 12b-1 service fees waived by Legg Mason Wood Walker, Inc. of 0.10% of average daily net assets. If no fees had been waived by Legg Mason, the annualized ratio of expenses to average daily net assets would have been as follows for the years ended December 31, 2003: 0.81%; 2002: 0.82%; 2001: 0.81%; 2000: 0.83%; 1999: 0.83%. See notes to financial statements. Annual Report to Shareholders 69 Notes to Financial Statements Legg Mason Income Trust, Inc. (Amounts in Thousands) 1. Significant Accounting Policies: The Legg Mason Income Trust, Inc. ("Corporation"), consisting of the High Yield Portfolio ("High Yield"), the Investment Grade Income Portfolio ("Investment Grade"), the U.S. Government Intermediate-Term Portfolio ("Government Intermediate"), and the U.S. Government Money Market Portfolio ("Government Money Market") (each a "Fund"), is registered under the Investment Company Act of 1940 ("1940 Act"), as amended, as an open-end, diversified investment company. The High Yield, Investment Grade and Government Intermediate Portfolios consist of two classes of shares: Primary Class and Institutional Class. The income and expenses of each of these Funds are allocated proportionately to the two classes of shares based on daily net assets, except for Rule 12b-1 distribution fees, which are charged only on Primary Class shares, and transfer agent and shareholder servicing expenses, which are determined separately for each class. Preparation of the financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from those estimates. The following is a summary of significant accounting policies followed by the Funds in the preparation of their financial statements: Security Valuation Securities owned by High Yield, Investment Grade and Government Intermediate for which market quotations are readily available are valued at current market value. Securities for which market quotations are not readily available are fair valued by the Board of Directors and management. In determining fair value, the Board of Directors and management consider all relevant qualitative and quantitative information available. These factors are subject to change over time and are reviewed periodically. The values assigned to fair value investments are based on available information and do not necessarily represent amounts that might ultimately be realized, since such amounts depend on future developments inherent in long-term investments. Further, because of the inherent uncertainty of valuation, those estimated values may differ significantly from the values that would have been used had a ready market of the investments existed, and the differences could be material. At December 31, 2003, $372, or 0.16%, of the High Yield Portfolio's net assets were fair valued in accordance with the procedures adopted by the Board of Directors. With respect to High Yield, where a security is traded on more than one market, which may include foreign markets, the securities are generally valued on the market considered by the Fund's adviser to be the primary market. The Fund will value its foreign securities in U.S. dollars on the basis of the then-prevailing exchange rates. In accordance with Rule 2a-7, the investments of Government Money Market are valued on the basis of amortized cost, so long as the Fund's Board of Directors determines that this Notes to Financial Statements -- Continued Legg Mason Income Trust, Inc. -- Continued Annual Report to Shareholders 70 method constitutes fair value. Under this method, securities are valued at cost when purchased and, thereafter, a constant proportionate accretion or amortization of any discount or premium is recorded until maturity of the security. Security Transactions Security transactions are recorded on the trade date. Realized gains and losses from security transactions are reported on an identified cost basis for both financial reporting and federal income tax purposes. At December 31, 2003, $27 was receivable for securities sold in Investment Grade; High Yield, Government Intermediate and Government Money Market had no receivables for securities sold. There were no payables for securities purchased for any of the Funds. For the year ended December 31, 2003, investment transactions (excluding short-term investments) were as follows:
Purchases Proceeds From Sales ---------------------- ---------------------- U.S. Gov't. U.S. Gov't. Securities Other Securities Other ---------------------------------------------------------------------------- High Yield $ 1,705 $274,684 $ 1,711 $240,514 Investment Grade 177,267 219,752 161,211 130,990 Government Intermediate 1,621,878 16,216 1,629,577 16,936
Repurchase Agreements The Funds may engage in repurchase agreement transactions. Under the terms of a typical repurchase agreement, a fund takes possession of an underlying debt obligation subject to an obligation of the seller to repurchase, and a fund to resell, the obligation at an agreed-upon price and time, thereby determining the yield during a fund's holding period. This arrangement results in a fixed rate of return that is not subject to market fluctuations during the fund's holding period. The value of the collateral is at all times at least equal to the total amount of the repurchase obligation, including interest. In the event of counterparty default, a fund has the right to use the collateral to satisfy the terms of the repurchase agreement. However, there could be potential loss to the fund in the event the fund is delayed or prevented from exercising its right to dispose of the collateral securities, including the risk of a possible decline in the value of the collateral securities during the period in which the fund seeks to assert its rights. The Funds' investment adviser reviews the value of the collateral and the creditworthiness of those banks and dealers with which the Funds enter into repurchase agreements to evaluate potential risks. Annual Report to Shareholders 71 Investment Income and Distributions to Shareholders Dividend income and distributions to shareholders are allocated at the class level and are recorded on the ex-dividend date. Dividends from net investment income are declared daily and paid monthly for each Fund except High Yield, which declares and pays dividends monthly. Net capital gain distributions, which are calculated at the fund level, are declared and paid after the end of the tax year in which the gain is realized. Distributions are determined in accordance with federal income tax regulations, which may differ from those determined in accordance with accounting principles generally accepted in the United States of America; accordingly, periodic reclassifications are made within the Funds' capital accounts to reflect income and gains available for distribution under federal income tax regulations. At December 31, 2003, accrued dividends payable were as follows: High Yield, $150; Investment Grade, $114; Government Intermediate, $72; and Government Money Market, $1. There were no capital gain distributions payable at December 31, 2003. 2. Federal Income Taxes: No provision for federal income or excise taxes is required since each Fund intends to continue to qualify as a regulated investment company and distribute substantially all of its taxable income and capital gain to its shareholders. Because federal income tax regulations differ from accounting principles generally accepted in the United States of America, income and capital gain distributions determined in accordance with tax regulations may differ from net investment income and realized gains recognized for financial reporting purposes. Accordingly, the character of distributions and composition of net assets for tax purposes differ from those reflected in the accompanying financial statements. Distributions during the years ended December 31, 2003 and 2002, were characterized as follows for tax purposes:
Investment High Yield Grade ----------------- ----------------- 2003 2002 2003 2002 ------------------------------------------------------------------------- Ordinary income $15,274 $16,713 $18,284 $15,508 Long-term capital gains -- -- 2,806 -- ------- ------- ------- ------- Total distributions $15,274 $16,713 $21,090 $15,508 ======= ======= ======= =======
Government Government Intermediate Money Market ----------------- ----------------- 2003 2002 2003 2002 ------------------------------------------------------------------------- Ordinary income $ 9,791 $13,654 $ 2,633 $ 5,624 ------- ------- ------- ------- Total distributions $ 9,791 $13,654 $ 2,633 $ 5,624 ======= ======= ======= =======
Notes to Financial Statements -- Continued Legg Mason Income Trust, Inc. -- Continued Annual Report to Shareholders 72 Pursuant to federal income tax regulations applicable to investment companies, the Funds have elected to treat net capital losses realized between November 1 and December 31 of each year ("post-October loss") as occurring on the first day of the following tax year. For the year ended December 31, 2003, realized capital losses reflected in the accompanying financial statements, as shown in the table below, will not be recognized for federal income tax purposes until 2004. The tax basis components of net assets at December 31, 2003, were as follows:
Investment Government Government High Yield Grade Intermediate Money Market ---------------------------------------------------------------------------------- Unrealized appreciation $ 16,363 $ 21,385 $ 1,963 $ -- Unrealized depreciation (11,202) (1,879) (4,499) -- --------- -------- -------- -------- Net unrealized appreciation/ (depreciation) 5,161 19,506 (2,536) -- Undistributed ordinary income -- 124 1,380 79 Undistributed long-term capital gains -- 701 -- -- Capital loss carryforwards (158,017) -- (3,834) -- Post-October loss push and other loss deferrals (171) -- -- -- Paid-in capital 383,234 394,249 339,574 443,802 --------- -------- -------- -------- Net assets $ 230,207 $414,580 $334,584 $443,881 ========= ======== ======== ========
The Funds intend to retain realized capital gains that may be offset against available capital loss carryforwards for federal income tax purposes. Investment Grade and Government Money Market have no capital loss carryforwards. Unused capital loss carryforwards for federal income tax purposes for Government Intermediate, and High Yield at December 31, 2003, are as follows:
Government Expiration Date High Yield Intermediate ------------------------------------------------------ 2008 $ (38,887) $ (3,834) 2009 (83,723) -- 2010 (32,610) -- 2011 (2,797) --
For financial reporting purposes, capital accounts and distributions to shareholders are adjusted to reflect the tax character of permanent book/tax differences. For the year ended December 31, 2003, the Funds recorded the following permanent reclassifications, which Annual Report to Shareholders 73 relate primarily to reclassifications of gains/losses on paydown securities. Results of operations and net assets were not affected by these reclassifications.
High Investment Government Government Yield Grade Intermediate Money Market ---------------------------------------------------------------------------------- Undistributed net investment income $ 12 $ -- $ 1,719 $ -- Accumulated realized gain/(loss) -- (1) (1,707) -- Paid-in capital (12) 1 (12) --
At December 31, 2003, the cost of investments for federal income tax purposes was $221,570 for High Yield, $389,166 for Investment Grade, $335,213 for Government Intermediate, and $445,459 for Government Money Market. 3. Financial Instruments: Options and Futures As part of their investment programs, High Yield, Investment Grade and Government Intermediate may utilize options and futures. Options may be written (sold) or purchased by these Funds. When a Fund purchases a put or call option, the premium paid is recorded as an investment and its value is marked-to-market daily. When a Fund writes a put or call option, an amount equal to the premium received by the Fund is recorded as a liability and its value is marked-to-market daily. When options, whether written or purchased, expire, are exercised or are closed (by entering into a closing purchase or sale transaction), the Fund realizes a gain or loss as described in the chart below:
Purchased option: Impact on the Fund: ------------------------------------------------------------------------ The option expires Realize a loss in the amount of the cost of the option. ------------------------------------------------------------------------ The option is closed Realize a gain or loss depending on whether through a closing sale the proceeds from the closing sale transaction transaction are greater or less than the cost of the option. ------------------------------------------------------------------------ The Fund exercises a The cost of the security purchased through the call option exercise of the option will be increased by the premium originally paid to purchase the option. ------------------------------------------------------------------------ The Fund exercises a put Realize a gain or loss from the sale of the option underlying security. The proceeds of that sale will be reduced by the premium originally paid to purchase the put option. ------------------------------------------------------------------------
Notes to Financial Statements -- Continued Legg Mason Income Trust, Inc. -- Continued Annual Report to Shareholders 74
Written option: Impact on the Fund: ------------------------------------------------------------------------ The option expires Realize a gain equal to the amount of the premium received. ------------------------------------------------------------------------ The option is closed Realize a gain or loss without regard to any through a closing unrealized gain or loss on the underlying purchase transaction security and eliminate the option liability. The Fund will realize a loss in this transaction if the cost of the closing purchase exceeds the premium received when the option was written. ------------------------------------------------------------------------ A written call option is Realize a gain or loss from the sale of the exercised by the option underlying security. The proceeds of that sale purchaser will be increased by the premium originally received when the option was written. ------------------------------------------------------------------------ A written put option is The amount of the premium originally received exercised by the option will reduce the cost of the security that the purchaser Fund purchased when the option was exercised. ------------------------------------------------------------------------
The risk associated with purchasing options is limited to the premium originally paid. Options written by a Fund involve, to varying degrees, risk of loss in excess of the option value reflected in the statement of net assets. The risk in writing a covered call option is that a Fund may forgo the opportunity of profit if the market price of the underlying security increases and the option is exercised. The risk in writing a put option is that a Fund may incur a loss if the market price of the underlying security decreases and the option is exercised. In addition, there is the risk a Fund may not be able to enter into a closing transaction because of an illiquid secondary market or, for over-the-counter options, because of the counterparty's inability to perform. Activity in written call and put options during the year ended December 31, 2003, was as follows:
Calls Puts -------------------- -------------------- Actual Actual Investment Grade Contracts Premiums Contracts Premiums ------------------------------------------------------------------------------- Options outstanding, December 31, 2002 -- $ -- -- $ -- Options written 17,480 107 -- -- Options closed -- -- -- -- Options expired (17,480) (107) -- -- Options exercised -- -- -- -- ------- ----- ---- ----- Options outstanding, December 31, 2003 -- $ -- -- $ -- ======= ===== ==== =====
Annual Report to Shareholders 75
Calls Puts -------------------- -------------------- Actual Actual Government Intermediate Contracts Premiums Contracts Premiums ------------------------------------------------------------------------------- Options outstanding, December 31, 2002 50 $ 48 50 $ 40 Options written -- -- 200 39 Options closed -- -- (150) (27) Options expired (50) (48) (100) (52) Options exercised -- -- -- -- ------- ----- ---- ----- Options outstanding, December 31, 2003 -- $ -- -- $ -- ======= ===== ==== =====
Upon entering into a futures contract, the Fund is required to deposit with the broker cash or cash equivalents in an amount equal to a certain percentage of the contract amount. This is known as the "initial margin." Subsequent payments ("variation margin") are made or received by the Fund each day, depending on the daily fluctuation in the value of the contract. The daily changes in contract value are recorded as unrealized gains or losses and the Fund recognizes a realized gain or loss when the contract is closed. Futures contracts are valued daily at the settlement price established by the board of trade or exchange on which they are traded. The Funds enter into futures contracts as a hedge against anticipated changes in interest rates. There are several risks in connection with the use of futures contracts as a hedging device. Futures contracts involve, to varying degrees, risk of loss in excess of the amounts reflected in the financial statements. The change in the value of futures contracts primarily corresponds with the value of their underlying instruments, which may not correlate with the change in the value of the hedged instruments. In addition, there is the risk that a Fund may not be able to enter into a closing transaction because of an illiquid secondary market. The open futures positions and related appreciation or depreciation at December 31, 2003 for Government Intermediate are listed at the end of its statement of net assets. Forward Currency Exchange Contracts As part of its investment program, High Yield may utilize forward currency exchange contracts. The nature and risks of these financial instruments and the reasons for using them are set forth more fully in the Corporation's prospectus and statement of additional information. Forward foreign currency contracts are marked-to-market daily using forward foreign currency exchange rates supplied by an independent pricing service. The change in a contract's market value is recorded by High Yield as an unrealized gain or loss. When the contract is closed or delivery is taken, the Fund records a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. Notes to Financial Statements -- Continued Legg Mason Income Trust, Inc. -- Continued Annual Report to Shareholders 76 The use of forward foreign currency contracts does not eliminate fluctuations in the underlying prices of the Fund's securities, but it does establish a rate of exchange that can be achieved in the future. These forward foreign currency contracts involve market risk in excess of amounts reflected in the financial statements. Although forward foreign currency contracts used for hedging purposes limit the risk of loss due to a decline in the value of the hedged currency, they also limit any potential gain that might result should the value of the currency increase. In addition, the Fund could be exposed to risks if the counterparties to the contracts are unable to meet the terms of their contracts. The Fund's adviser will enter into forward foreign currency contracts only with parties approved by the Board of Directors because there is a risk of loss to the Fund if the counterparties do not complete the transaction. At December 31, 2003, High Yield had no open forward currency exchange contracts. 4. Transactions With Affiliates: Each Fund has a management agreement with Legg Mason Fund Adviser, Inc. ("LMFA"). Pursuant to their respective agreements, LMFA provides the Funds with management and administrative services for which each Fund pays a fee, computed daily and payable monthly, at annual rates of each Fund's average daily net assets. LMFA has voluntarily agreed to waive its fees to the extent each Fund's expenses (exclusive of taxes, interest, brokerage and extraordinary expenses) exceed during any month certain annual rates. These voluntary expense limitations for Investment Grade and Government Intermediate are due to expire on April 30, 2004, or when net assets reach $500 million. High Yield and Government Money Market have no expense limitations. The following chart shows Annual Report to Shareholders 77 annual rates of management fees, expense limits, management fees waived, and management fees payable for each Fund:
Year Ended At December 31, December 31, 2003 2003 ------------ ------------ Management Expense Management Management Fund Fee Limitation Fees Waived Fees Payable ----------------------------------------------------------------------------------------------------- High Yield -- Primary Class 0.65% None $ -- $123 -- Institutional Class 0.65% None -- 3 Investment Grade -- Primary Class 0.60% 1.00% 1,092 115 -- Institutional Class 0.60% 0.50% 11 2 Government Intermediate -- Primary Class 0.55% 1.00% 781 89 -- Institutional Class 0.55% 0.50% 19 2 Government Money Market 0.50% - 0.40%(A) None -- 200
Western Asset Management Company ("Adviser") serves as investment adviser to the Funds. The Adviser is responsible for the actual investment activity of each Fund. LMFA pays the Adviser a fee, computed daily and payable monthly, at an annual rate of: 77% of the management fee received by LMFA for High Yield; 40% for Investment Grade; and 30% for Government Money Market. For Government Intermediate, LMFA pays the Adviser a fee, computed daily and payable monthly, of 0.20% of its average daily net assets, not to exceed the fee received by LMFA. --------------- (A) Government Money Market's management fee varies with the level of the Fund's average daily net assets. The management fee is calculated as follows:
Average Net Assets Advisory Fee Rate -------------------------------------------- $0 - $500 million 0.50% next $500 million 0.475% next $500 million 0.45% next $500 million 0.425% thereafter 0.40%
Notes to Financial Statements -- Continued Legg Mason Income Trust, Inc. -- Continued Annual Report to Shareholders 78 Legg Mason Wood Walker, Incorporated ("Legg Mason"), a member of the New York Stock Exchange, serves as distributor of the Funds. Legg Mason receives an annual distribution fee and an annual service fee based on each Fund's Primary Class's average daily net assets, computed daily and payable monthly as follows:
At December 31, 2003 ------------------------ Distribution Service Distribution and Service Fee Fee Fees Payable ----------------------------------------------------------------------------------- High Yield 0.25% 0.25% $ 94 Investment Grade 0.25% 0.25% 172 Government Intermediate 0.25% 0.25% 140 Government Money Market -- 0.10% 40
Legg Mason has agreed that it will not request payment of more than 0.10% annually from Government Money Market indefinitely. If this voluntary limit is terminated, the Fund may pay Legg Mason a Rule 12b-1 service fee in an amount not to exceed an annual rate of 0.20% of its average daily net assets. LM Fund Services, Inc. ("LMFS"), a registered transfer agent, has an agreement with the Funds' transfer agent to assist it with some of its duties. For this assistance, the transfer agent paid LMFS the following amounts for the year ended December 31, 2003: High Yield, $62; Investment Grade, $78; Government Intermediate, $66; and Government Money Market, $101. LMFA, the Adviser, Legg Mason and LMFS are corporate affiliates and wholly owned subsidiaries of Legg Mason, Inc. 5. Line of Credit: The Funds, except for Government Money Market, but including certain other Legg Mason Funds, participate in a $300 million line of credit ("Credit Agreement") to be used for temporary or emergency purposes. Pursuant to the Credit Agreement, each participating Fund is liable only for principal and interest payments related to borrowings made by that Fund. Borrowings under the Credit Agreement bear interest at a rate equal to the federal funds rate plus the federal funds rate margin. For the year ended December 31, 2003, the Funds had no borrowings under the Credit Agreement. Annual Report to Shareholders 79 6. Fund Share Transactions: At December 31, 2003, there were 1,750,000 shares authorized at $.001 par value for all classes of each portfolio of the Corporation. Share transactions were as follows:
High Yield ------------------------------------------- Primary Class Institutional Class --------------------- ------------------- Year Ended Year Ended 12/31/03 12/31/02 12/31/03 12/31/02 --------------------------------------------------------------------------- Shares: Sold 11,415 7,016 978 539 Reinvested 1,342 1,548 44 24 Repurchased (8,542) (9,809) (656) (368) --------- --------- ------- ------- Net Change 4,215 (1,245) 366 195 ========= ========= ======= ======= Amount: Sold $ 97,837 $ 59,520 $ 8,358 $ 4,580 Reinvested 11,598 12,937 385 199 Repurchased (73,936) (82,683) (5,677) (3,107) --------- --------- ------- ------- Net Change $ 35,499 $ (10,226) $ 3,066 $ 1,672 ========= ========= ======= =======
Investment Grade ------------------------------------------- Primary Class Institutional Class --------------------- ------------------- Year Ended Year Ended 12/31/03 12/31/02 12/31/03 12/31/02 --------------------------------------------------------------------------- Shares: Sold 14,879 13,866 412 248 Reinvested 1,713 1,351 23 14 Repurchased (11,141) (8,370) (165) (131) --------- --------- ------- ------- Net Change 5,451 6,847 270 131 ========= ========= ======= ======= Amount: Sold $ 159,989 $ 139,370 $ 4,456 $ 2,494 Reinvested 18,456 13,611 244 142 Repurchased (119,804) (84,167) (1,791) (1,319) --------- --------- ------- ------- Net Change $ 58,641 $ 68,814 $ 2,909 $ 1,317 ========= ========= ======= =======
Notes to Financial Statements -- Continued Legg Mason Income Trust, Inc. -- Continued Annual Report to Shareholders 80
U.S. Government Intermediate ------------------------------------------- Primary Class Institutional Class --------------------- ------------------- Year Ended Year Ended 12/31/03 12/31/02 12/31/03 12/31/02 --------------------------------------------------------------------------- Shares: Sold 10,382 19,141 417 525 Reinvested 785 1,104 26 35 Repurchased (15,656) (13,879) (595) (374) --------- --------- ------- ------- Net Change (4,489) 6,366 (152) 186 ========= ========= ======= ======= Amount: Sold $ 110,857 $ 200,888 $ 4,469 $ 5,520 Reinvested 8,339 11,577 272 365 Repurchased (166,480) (145,372) (6,339) (3,922) --------- --------- ------- ------- Net Change $ (47,284) $ 67,093 $(1,598) $ 1,963 ========= ========= ======= =======
U.S. Government Money Market ------------------------- Year Ended 12/31/03 12/31/02 -------------------------------------------------------------------------- Shares: Sold 1,306,465 1,465,517 Reinvested 2,476 5,423 Repurchased (1,406,777) (1,430,137) ----------- ----------- Net Change (97,836) 40,803 =========== =========== Amount: Sold $ 1,306,465 $ 1,465,517 Reinvested 2,476 5,423 Repurchased (1,406,777) (1,430,137) ----------- ----------- Net Change $ (97,836) $ 40,803 =========== ===========
Annual Report to Shareholders 81 Report of Independent Auditors To the Shareholders of High Yield Portfolio, Investment Grade Income Portfolio, U.S. Government Intermediate-Term Portfolio, and U.S. Government Money Market Portfolio and to the Directors of Legg Mason Income Trust, Inc.: In our opinion, the accompanying statements 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 High Yield Portfolio, Investment Grade Income Portfolio, U.S. Government Intermediate-Term Portfolio, and U.S. Government Money Market Portfolio (comprising the Legg Mason Income Trust, Inc., hereafter referred to as the "Funds") at December 31, 2003, and the results of their operations, the changes in their net assets and the financial highlights for each of the fiscal periods presented, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Funds' 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 auditing standards generally accepted in the United States of America, 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 December 31, 2003, by correspondence with the custodian and brokers, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Baltimore, Maryland January 30, 2004 Annual Report to Shareholders 82 Directors and Officers The table below provides information about each of the Corporation's directors and officers, including biographical information about their business experience and information about their relationships with Legg Mason, Inc. and its affiliates. The mailing address of each director and officer is 100 Light Street, c/o Legal and Compliance Department, 23rd Floor, Baltimore, Maryland 21202.
---------------------------------------------------------------------------------------------------------- Term of Office and Position(s) Length Number of Other Held With of Time Legg Mason Directorships Principal Occupation(s) Name and Age Fund Served(A) Funds Overseen Held During the Past Five Years ---------------------------------------------------------------------------------------------------------- INDEPENDENT DIRECTORS: ---------------------------------------------------------------------------------------------------------- Lehman, Arnold Director Since Director/Trustee None Director of The Brooklyn L.(B) 1987 of all Legg Mason Museum of Art since 1997; Age 59 funds (consisting Trustee of American of 22 Federation of Arts since portfolios). 1998. Formerly: Director of The Baltimore Museum of Art (1979-1997). ---------------------------------------------------------------------------------------------------------- Masters, Robin Director Since Director/Trustee None Retired. Director of J.W.(B) 2002 of all Legg Mason Bermuda SMARTRISK Age 48 funds (consisting (non-profit) since 2001. of 22 Formerly: Chief Investment portfolios). Officer of ACE Limited (insurance) (1995-2000). ---------------------------------------------------------------------------------------------------------- McGovern, Jill Director Since Director/Trustee None Chief Executive Officer of E.(B) 1989 of all Legg Mason The Marrow Foundation Age 59 funds (consisting since 1993. Formerly: of 22 Executive Director of the portfolios). Baltimore International Festival (1991-1993); Senior Assistant to the President of The Johns Hopkins University (1985-1990). ---------------------------------------------------------------------------------------------------------- Mehlman, Arthur Director Since Director/Trustee None Retired. Director of The S.(B) 2002 of all Legg Mason League for People with Age 61 funds (consisting Disabilities, Inc.; of 22 Director of University of portfolios). Maryland Foundation and University of Maryland College Park Foundation (non-profits). Formerly: Partner, KPMG LLP (international accounting firm) (1972-2002). ----------------------------------------------------------------------------------------------------------
Annual Report to Shareholders 83
---------------------------------------------------------------------------------------------------------- Term of Office and Position(s) Length Number of Other Held With of Time Legg Mason Directorships Principal Occupation(s) Name and Age Fund Served(A) Funds Overseen Held During the Past Five Years ---------------------------------------------------------------------------------------------------------- O'Brien, G. Director Since Director/Trustee Director of the Trustee of Colgate Peter(B) 2002 of all Legg Mason Royce Family of University; President of Age 58 funds (consisting Funds Hill House, Inc. of 22 (consisting of (residential home care). portfolios). 19 portfolios); Formerly: Managing Director of Director, Equity Capital Renaissance Markets Group of Merrill Capital Lynch & Co. (1971- 1999). Greenwich Funds; Director of Technology Investment Capital Corp. ---------------------------------------------------------------------------------------------------------- Rowan, S. Director Since Director/Trustee None Consultant, Rowan & Ford(B) 2002 of all Legg Mason Blewitt Inc. (management Age 60 funds (consisting consulting); Visiting of 22 Associate Professor, portfolios). George Washington University since 2002; Director of Santa Fe Institute (scientific research institute) since 1999; Director of Annapolis Center for Science-Based Public Policy since 1995. ---------------------------------------------------------------------------------------------------------- INTERESTED DIRECTORS: ---------------------------------------------------------------------------------------------------------- Curley, John Chairman Since Chairman and None Director and/or officer of F., Jr.(C) and 1987 Director/Trustee various Legg Mason Age 64 Director of all Legg Mason affiliates. Formerly: Vice funds (consisting Chairman and Director of of 22 Legg Mason, Inc. and Legg portfolios). Mason Wood Walker, Incorporated; Director of Legg Mason Fund Adviser, Inc. and Western Asset Management Company (each a registered investment adviser). ---------------------------------------------------------------------------------------------------------- Fetting, Mark President President President and Director of the Executive Vice President R.(C) and since Director/Trustee Royce Family of of Legg Mason, Inc.; Age 49 Director 2001; of all Legg Mason Funds Director and/or officer of Director funds (consisting (consisting of various Legg Mason since of 22 19 portfolios). affiliates since 2000. 2002 portfolios). Formerly: Division President and Senior Officer of Prudential Financial Group, Inc. and related companies, including fund boards and consulting services to subsidiary companies (1991-2000); Partner, Greenwich Associates; Vice President, T. Rowe Price Group, Inc. ----------------------------------------------------------------------------------------------------------
Directors and Officers -- Continued Annual Report to Shareholders 84
---------------------------------------------------------------------------------------------------------- Term of Office and Position(s) Length Number of Other Held With of Time Legg Mason Directorships Principal Occupation(s) Name and Age Fund Served(A) Funds Overseen Held During the Past Five Years ---------------------------------------------------------------------------------------------------------- EXECUTIVE OFFICERS: ---------------------------------------------------------------------------------------------------------- Karpinski, Vice Since Vice President None Vice President and Marie K.(D) President 1987 and Treasurer of Treasurer of Legg Mason Age 54 and all Legg Mason Fund Adviser, Inc. and Treasurer funds (consisting Western Asset Funds, Inc.; of 22 Treasurer and Principal portfolios). Financial and Accounting Officer of Pacific American Income Shares, Inc., Western Asset Premier Bond Fund and Western Asset/ Claymore U.S. Treasury Inflation Protected Securities Fund, and Western Asset/ Claymore U.S. Treasury Inflation Protected Securities Fund 2. ---------------------------------------------------------------------------------------------------------- Merz, Gretory Vice Since Vice President, None Vice President and Deputy T.(D) President, 2003 Secretary and General Counsel of Legg Age 45 Secretary Chief Legal Mason, Inc. since 2003. and Chief Officer of all Formerly: Associate Legal Legg Mason funds General Counsel, Fidelity Officer (consisting of 22 Investments (1993-2002); portfolios) Associate, Debevoise & Plimpton (1985-1993). ----------------------------------------------------------------------------------------------------------
ADDITIONAL INFORMATION ABOUT THE CORPORATION'S DIRECTORS AND OFFICERS IS CONTAINED IN THE STATEMENT OF ADDITIONAL INFORMATION, AVAILABLE WITHOUT CHARGE UPON REQUEST BY CALLING 1-800-822-5544. --------------- (A) Directors of the Corporation serve a term of indefinite length until their resignation or removal and stand for re-election by shareholders only as and when required by the 1940 Act. Officers of the Corporation serve one-year terms, subject to annual reappointment by the Board of Directors. (B) Each of the Independent Directors serves on the standing committees of the Board of Directors, which include the Audit Committee (chair: Arthur Mehlman), the Nominating Committee (co-chairs: Peter O'Brien and Jill McGovern), and the Independent Directors Committee (chair: Arnold Lehman). (C) Mr. Curley and Mr. Fetting are considered to be interested persons (as defined in the 1940 Act) of the Corporation by virtue of being employees of Legg Mason Wood Walker, Incorporated, the principal underwriter of the Corporation. (D) Officers of the Corporation are interested persons (as defined in the 1940 Act). Notes Notes Investment Manager Legg Mason Fund Adviser, Inc. Baltimore, MD Investment Adviser Western Asset Management Company Pasadena, CA Board of Directors John F. Curley, Jr., Chairman Mark R. Fetting, President Arnold L. Lehman Robin J.W. Masters Dr. Jill E. McGovern Arthur S. Mehlman G. Peter O'Brien S. Ford Rowan Officers Marie K. Karpinski, Vice President and Treasurer Gregory T. Merz, Vice President, Secretary and Chief Legal Officer Erin K. Morris, Assistant Treasurer Transfer and Shareholder Servicing Agent Boston Financial Data Services Braintree, MA Custodian State Street Bank & Trust Company Boston, MA Counsel Kirkpatrick & Lockhart LLP Washington, DC Independent Auditors PricewaterhouseCoopers LLP Baltimore, MD About the Legg Mason Funds Legg Mason, Inc., based in Baltimore, Maryland, has built its reputation, at least in part, on the success of the Legg Mason Funds, introduced in 1979. The primary purpose of our funds is to enable investors to diversify their portfolios across various asset classes and, consequently, enjoy the stability and growth prospects generally associated with diversification. The success of our funds is contingent on the experience, discipline, and acumen of our fund managers. We believe the quality of our managers is crucial to investment success. Unlike many firms, which focus on a particular asset class or the fluctuations of the market, at Legg Mason we focus on providing a collection of top-notch managers in all the major asset classes. This report is not to be distributed unless preceded or accompanied by a prospectus. Legg Mason Funds Legg Mason Institutional Funds For Primary Class Shareholders For FI and I Class 800-822-5544 Shareholders www.leggmasonfunds.com 888-425-6432 www.lminstitutionalfunds.com Legg Mason Wood Walker, Incorporated P.O. Box 1476, Baltimore, MD 21203-1476 410-539-0000 LMF-056 [LEGG MASON FUNDS LOGO] Item 2 - Code of Ethics Did the registrant adopt a code of ethics, as of the end of the period covered by this report, which applies to the registrant's principal executive officer, principal financial officer, principle accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party? If not, why not? Briefly describe any amendments or waivers that occurred during the period. State if the code of ethics, including amendments and waivers are on a website and provide the website address. State if the registrant will send a copy of the code of ethics to shareholders at no charge upon request. THE REGISTRANT, LEGG MASON INCOME TRUST, INC. ON AUGUST 6, 2003, ADOPTED A CODE OF ETHICS THAT APPLIES TO THE FUND PRESIDENT AND TREASURER, A COPY OF WHICH IS ATTACHED AS AN EXHIBIT TO THIS FORM N-CSR. Item 3 - Audit Committee Financial Expert Did the registrant's board of directors determine that the registrant either: (a) has at least one audit committee financial expert serving on its audit committee; or (b) does not have an audit committee financial expert serving on its audit committee? If yes, disclose the name of the financial expert and whether he/she is "independent." If no, explain why not. THE DIRECTORS OF LEGG MASON INCOME TRUST, INC. DETERMINED THAT THE FUND HAS AT LEAST ONE AUDIT COMMITTEE FINANCIAL EXPERT SERVING ON ITS AUDIT COMMITTEE. MR. ARTHUR S. MEHLMAN IS THE AUDIT COMMITTEE FINANCIAL EXPERT. HE IS "INDEPENDENT." Item 4 - Principal Accounting Fees and Services (a) Audit Fees - Disclose the aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant's annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years. FY 02 - $127,000 FY 03 - $139,220 (b) Audit-Related Fees - Disclose the aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant's financial statements and are not reported under paragraph (a) of this Item. Describe the nature of the services comprising the fees disclosed under this category. THERE WERE NO ADDITIONAL FEES DURING EACH OF THE LAST TWO FISCAL YEARS THAT WERE NOT DISCLOSED IN ITEM (a) ABOVE. (c) Tax Fees - Disclose the aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning. Describe the nature of the services comprising the fees disclosed under this category. FY 02 - $3,200 FY 03 - $3,480 SERVICES INCLUDE PREPARATION OF FEDERAL AND STATE INCOME TAX RETURNS, REVIEW OF EXCISE TAX DISTRIBUTION REQUIREMENTS AND PREPARATION OF EXCISE TAX RETURNS. (d) All Other Fees - Disclose the aggregate fees billed in each of the last two fiscal years for products or services provided by the principal accountant, other than the services reporting in paragraphs (a) through (c) of this Item. Describe the nature of the services comprising the fees disclosed under this category. THERE WERE NO ADDITIONAL FEES DURING EACH OF THE LAST TWO FISCAL YEARS THAT WERE NOT DISCLOSED IN ITEMS (a) OR (c) ABOVE. (e) (1) Disclose the audit committee's pre-approval policies and procedures described in paragraph (c)(7) of Rule 2-01 of Regulation S-X. THE AUDIT COMMITTEE'S ONLY POLICY IS DELEGATION TO ITS CHAIRPERSON OF THE AUTHORITY TO PRE-APPROVE ITEMS THAT REQUIRE A DECISION PRIOR TO THE NEXT MEETING OF THE COMMITTEE. (2) Disclose the percentage of services described in each of paragraphs (a) through (d) of this Item that were approved by the audit committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X. NONE. (f) If greater than 50%, disclose the percentage of hours expended on the principal accountant's engagement to audit the registrant's financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountant's full-time, permanent employees. NOT APPLICABLE. (g) Disclose the aggregate non-audit fees billed by the registrant's accountant for services rendered, and rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the adviser that provides ongoing services to the registrant for each of the last two fiscal years of the registrant. FY 02 - $542,653 FY 03 - $883,350 (h) Disclose whether the registrant's audit committee of the board of directors has considered whether the provision of non-audit services that were rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the adviser that provides ongoing services to the registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible with maintaining the principal accountant's independence. THE MEMBERS OF THE AUDIT COMMITTEE OF LEGG MASON INCOME TRUST, INC. HAVE CONSIDERED WHETHER THE NON-AUDIT SERVICES THAT WERE RENDERED BY THE FUND'S PRINCIPAL ACCOUNTANT TO THE ENTITIES SPECIFIED IN THIS ITEM AND THAT WERE NOT PRE- APPROVED BY THE AUDIT COMMITTEE ARE COMPATIBLE WITH MAINTAINING THE PRINCIPAL ACCOUNTANT'S INDEPENDENCE. Item 5 - Reserved Item 6 - Reserved Item 7 - Disclosure of Proxy Voting Policies and Procedures For closed-end management investment companies, describe the policies and procedures that it uses to determine how to vote proxies relating to portfolio securities, including the procedures that the company uses when a vote presents a conflict between the interests of its shareholders, and those of the company's investment adviser; principal underwriter; or any affiliated person of the company, its investment adviser, or its principal underwriter. (NOT APPLICABLE) Item 8 - Reserved Item 9 - Controls and Procedures (a) Disclose the conclusions of the registrant's principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, regarding the effectiveness of the registrant's disclosure controls and procedures (as defined in Rule 30a-3(c) under the Act (17 CFR 270.30a-3(c))) as of a date within 90 days of the filing date of the report that includes the disclosure required by this paragraph, based on the evaluation of these controls and procedures required by Rule 30a-3(b) under the Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Exchange Act (17 CFR 240-13a-15(b) or 240.15d-15(b)). WITHIN 90 DAYS OF THE FILING DATE OF THIS FORM N-CSR, THE REGISTRANT'S PRESIDENT AND TREASURER REVIEWED THE REGISTRANT'S DISCLOSURE CONTROLS AND PROCEDURES ("THE PROCEDURES") AND EVALUATED THEIR EFFECTIVENESS. BASED ON THEIR REVIEW, SUCH OFFICERS DETERMINED THAT THE PROCEDURES ENSURE THAT INFORMATION REQUIRED TO BE DISCLOSED BY THE REGISTRANT ON FORM N-CSR IS RECORDED, PROCESSED, SUMMARIZED AND REPORTED WITHIN THE TIME PERIODS REQUIRED BY THE SECURITIES AND EXCHANGE COMMISSION'S RULES AND REGULATIONS. (b) Disclose any change in the registrant's internal control over financial reporting (as defined in Rule 30a-3(d) under the Act (17 CFR 270.30a-3(d)) that occurred during the registrant's last fiscal half-year (the registrant's second fiscal half-year in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. THERE WERE NO CHANGES IN THE REGISTRANT'S INTERNAL CONTROL OVER FINANCIAL REPORTING DURING THE REGISTRANT'S LAST HALF-YEAR THAT HAVE MATERIALLY AFFECTED, OR ARE REASONABLY LIKELY TO MATERIALLY AFFECT, THE INTERNAL CONTROL OVER FINANCIAL REPORTING. Item 10 - Exhibits (a) File the exhibits listed below as part of this Form. (a)(1) Any code of ethics, or amendment thereto, that is the subject of the disclosure required by Item 2, to the extent that the registrant intends to satisfy the Item requirements through filing of an exhibit. (ATTACHED) (a)(2) A separate certification for each principal execute officer and principal financial officer of the registrant as required by Rule 30a-2(a) under the Act (17 CFR 270.30a-2(a)), exactly as set forth below: (ATTACHED) (b) If the report is filed under Section 13(a) or 15(d) of the Exchange Act, provide the certifications required by Rule 30a-2(b) under the Act (17 CFR 270.30a-2(b)), Rule 13a-14(b) or Rule 15d-14(b) under the Exchange Act (17 CFR 240.13a-14(b) or 240.15d-14(b)), and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350) as an exhibit. A certification furnished pursuant to this paragraph will not be deemed "filed" for the purposes of Section 18 of the Exchange Act (15 U.S.C. 78r), or other wise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference. (ATTACHED) SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Legg Mason Income Trust, Inc. By: /s/ Mark R. Fetting --------------------------------- Mark R. Fetting President, Legg Mason Income Trust, Inc. Date: 2/20/04 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Mark R. Fetting ------------------------------- Mark R. Fetting President, Legg Mason Income Trust, Inc. Date: 2/20/04 By: /s/ Marie K. Karpinski ---------------------------------- Marie K. Karpinski Treasurer, Legg Mason Income Trust, Inc. Date: 2/20/04