N-30D 1 tmar.txt W&R ADVISORS TAX MANAGED ANNUAL REPORT Waddell & Reed Advisors Tax-Managed Equity Fund Annual Report ------------- June 30, 2001 CONTENTS 3 Manager's Discussion 6 Performance Summary 8 Portfolio Highlights 9 Investments 12 Statement of Assets and Liabilities 13 Statement of Operations 14 Statement of Changes in Net Assets 15 Financial Highlights 19 Notes to Financial Statements 24 Independent Auditors' Report 25 Income Tax Information 26 Directors & Officers This report is submitted for the general information of the shareholders of Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. It is not authorized for distribution to prospective investors in the Fund unless accompanied with or preceded by the Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. current prospectus and current Fund performance information. MANAGER'S DISCUSSION June 30, 2001 ---------------------------------------------------------------- An interview with Cynthia P. Prince-Fox, portfolio manager of Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. This report relates to the operation of Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. for the fiscal period ended June 30, 2001. The following graphs and tables provide you with information regarding the Fund's performance during that period, while the following discussion provides you with information regarding the Fund's performance during the twelve months ended June 30, 2001. The Fund's board of directors recently approved a change in the Fund's fiscal year-end from December 31 to June 30. How did the Fund perform during the last twelve months? The Fund was impacted by the extremely difficult environment for stocks during the latter half of 2000 and early 2001. The Fund's Class A shares declined 26.43 percent during the year, compared with the Lipper Large-Cap Growth Funds Universe Average (generally reflecting the performance of the universe of funds with similar investment objectives), which declined 31.01 percent over the same period, and the S&P 500 Index (reflecting the performance of securities that generally represent the stock market), which declined 14.87 percent over the same period. It should be noted that, in the comparison charts, the value of the investment in the Fund is impacted by the sales load at the time of the investment, while the values for the benchmark index and the Lipper category do not reflect a sales load. Why did the Fund lag its benchmark index during the last twelve months? We believe that the Fund lagged its benchmark index primarily due to our exposure to the technology sector. We felt at the time that technology company fundamentals would generally remain intact. However, given the rapid deterioration in customer orders due to an uncertain economic picture, it seems that many technology companies were caught by surprise and had to revise their outlook for profits down substantially. What other market conditions or events influenced the Fund's performance during the last twelve months? The economic weakness that we experienced in the latter part of 2000 was only a prelude to the weakness that we have seen so far in 2001. We believe that this, in part, has been the result of a dramatic increase in earnings pre- announcements. Compounding this problem has been a return to more normal valuation parameters. Most technology stocks had enjoyed peak valuations on peak profitability when the markets assumed that they were immune to overall economic trends. With that trend changing, we have begun to see many stocks go into a free fall. What strategies and techniques did you employ that specifically affected the Fund's performance? We established positions in the financial, health care and energy sectors where we felt the fundamentals would remain somewhat insulated to an economic downturn. However, it appears that even these stocks have come down with the whole market, due in large part to extended economic uncertainty and a compression in the valuation measures. What industries or sectors did you emphasize during the last twelve months, and what looks attractive to you going forward? Over the course of the year, as mentioned, we primarily emphasized technology stocks because we believed, and continue to believe, that the long-term prospects for technology remain solid. While we continue to emphasize this sector, we have harvested some losses where we felt that the recovery would take longer than we originally anticipated. Going forward, we feel that the consumer should start to benefit from declining rates, which should favor such areas as retail and consumer durables. We intend to review these areas for possible future investments. Respectfully, Cynthia P. Prince-Fox Manager Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. Comparison of Change in Value of $10,000 Investment Waddell & Reed Advisors Tax-Managed Equity Fund, Inc., Class A Shares, the S&P 500 Index and the Lipper Large-Cap Growth Funds Universe Average Waddell & Reed Advisors Lipper Tax- Large-Cap Managed Growth Equity S&P Funds Fund, Inc., 500 Universe Class A Index Average --------- --------- ---------- 3/31/00 Purchase $9,425 $10,000 $10,000 6/30/00 9,991 9,716 9,509 9/30/00 9,595 9,619 9,472 12/31/00 9,038 8,864 7,827 3/31/01 7,401 7,815 6,192 6/30/01 7,798 8,271 6,560 ===== Waddell & Reed Advisors Tax-Managed Equity Fund, Inc., Class A Shares* -- $7,798* ++++ S&P 500 Index - $8,271 *+*+ Lipper Large-Cap Growth Funds Universe Average - $6,560 *The value of the investment in the Fund is impacted by the sales load at the time of the investment and by the ongoing expenses of the Fund and assumes reinvestment of dividends and distributions. Average Annual Total Return+ Class A Class B Class C Class Y ---------------------------------------------- Year Ended 6-30-01 -26.43% -25.73% -22.63% -21.88% Since inception of Class++ through 6-30-01 -18.05% -17.67% -14.94% -15.08% +Performance data quoted represents past performance and is based on deduction of the maximum applicable sales load for each of the periods. Class A shares carry a maximum front-end sales load of 5.75%. Class B and Class C shares carry a maximum contingent deferred sales charge (CDSC) of 5% and 1%, respectively. (Accordingly, the Class C shares reflect no CDSC since it only applies to Class C shares held for twelve months or less.) Total returns reflect share price appreciation (depreciation), including reinvestment of all income and capital gains distributions. Investment return and principal value will fluctuate and an investor's shares, when redeemed, may be worth more or less than their original cost. +3-31-00 for Class A, Class B and Class C shares and 4-19-00 for Class Y shares (the date on which shares were first acquired by shareholders). Past performance is not predictive of future performance. Indexes are unmanaged. SHAREHOLDER SUMMARY OF TAX-MANAGED EQUITY FUND ------------------------------------------------------------------ Tax-Managed Equity Fund GOAL To seek long-term growth of capital while minimizing taxable gains and income to shareholders. Strategy Designed for investors seeking long-term capital appreciation, but who are also seeking to minimize Federal income taxes resulting from their investment. The portfolio will primarily be invested in common stocks of large to medium sized U.S. companies. Founded 2000 Scheduled Dividend Frequency Annually (December) PERFORMANCE SUMMARY -- Class A Shares Per Share Data For the Fiscal Period Ended June 30, 2001 ----------------------------------------- Net asset value on 6-30-01 $8.24 12-31-00 9.55 ------ Change per share $(1.31) ====== Past performance is not necessarily indicative of future results. SHAREHOLDER SUMMARY OF TAX-MANAGED EQUITY FUND Because of ongoing market volatility, the Fund's performance may be subject to substantial short-term fluctuation and current performance may be less than the results shown below. Please check the Waddell & Reed website at www.waddell.com for more current performance information. Average Annual Total Return (A) Class A Class B ----------------------- ----------------------- With Without With Without Period Sales Load(B) Sales Load(C) CDSC(D) CDSC(E) ------ ---------- ---------- ----------- ---------- 1-year period ended 6-30-01 -26.43% -21.95% -25.73% -22.63% 5-year period ended 6-30-01 --- --- --- --- 10-year period ended 6-30-01 --- --- --- --- Since inception of Class (F) -18.05% -14.07% -17.67% -14.94% (A)Performance data represents share price appreciation (depreciation), including reinvestment of all income and capital gains distributions. Performance data represents past performance and is no guarantee of future results. Share price, investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. (B)Performance data is based on deduction of 5.75% sales load on the initial purchase in the periods. (C)Performance data does not take into account the sales load deducted on an initial purchase. (D)Performance data reflects the effect of paying the applicable contingent deferred sales charge (CDSC) at a maximum of 5.00% upon redemption at the end of the period. (E)Performance data does not reflect the effect of paying the applicable CDSC upon redemption at the end of the period. (F)3-31-00 for Class A shares and Class B shares (the date on which shares were first acquired by shareholders). Average Annual Total Return(A) Class C(B) Class Y(C) ------ ---------- ---------- 1-year period ended 6-30-01 -22.63% -21.88% 5-year period ended 6-30-01 --- --- 10-year period ended 6-30-01 --- --- Since inception of Class (D) -14.94% -15.08% (A)Performance data represents share price appreciation (depreciation), including reinvestment of all income and capital gains distributions. Performance data represents past performance and is no guarantee of future results. Share price, investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. (B)Performance data reflects the effect of paying the applicable contingent deferred sales charge (CDSC) at a maximum of 1.00% which declines to zero at the end of the first year after investment. (Accordingly, these returns reflect no CDSC since it only applies to Class C shares held for twelve months or less.) (C)Performance data does not include the effect of sales charges, as Class Y shares are not subject to these charges. (D)3-31-00 for Class C shares and 4-19-00 for Class Y shares (the date on which shares were first acquired by shareholders). SHAREHOLDER SUMMARY OF TAX-MANAGED EQUITY FUND PORTFOLIO HIGHLIGHTS On June 30, 2001, Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. had net assets totaling $55,916,121 invested in a diversified portfolio of: 96.80% Common Stocks 3.20% Cash and Cash Equivalents As a shareholder of Waddell & Reed Advisors Tax-Managed Equity Fund, Inc., for every $100 you had invested on June 30, 2001, your Fund owned: $30.47 Manufacturing Stocks 20.15 Services Stocks 15.66 Transportation, Communication, Electric and Sanitary Services Stocks 13.98 Finance, Insurance and Real Estate Stocks 10.37 Wholesale and Retail Trade Stocks 6.17 Mining Stocks 3.20 Cash and Cash Equivalents THE INVESTMENTS OF TAX-MANAGED EQUITY FUND June 30, 2001 Shares Value COMMON STOCKS Amusement and Recreation Services - 1.29% Walt Disney Company (The) ................ 25,000 $ 722,250 ----------- Building Materials and Garden Supplies - 1.67% Home Depot, Inc. (The) ................... 20,000 931,000 ----------- Business Services - 15.89% Amdocs Limited* .......................... 18,400 990,840 AOL Time Warner Inc.* .................... 48,900 2,591,700 CheckFree Corporation* ................... 15,800 555,528 eBay Inc.* ............................... 36,300 2,482,013 Interpublic Group of Companies, Inc. (The) 25,000 733,750 Microsoft Corporation* ................... 21,300 1,529,979 ----------- 8,883,810 ----------- Chemicals and Allied Products - 12.24% Amgen Inc.* .............................. 13,800 830,553 Forest Laboratories, Inc.* ............... 7,800 553,800 King Pharmaceuticals, Inc.* .............. 24,300 1,306,125 Merck & Co., Inc. ........................ 16,300 1,041,733 Pfizer Inc. .............................. 27,300 1,093,365 Pharmacia Corporation .................... 20,000 919,000 Schering-Plough Corporation .............. 30,400 1,101,696 ----------- 6,846,272 ----------- Communication - 12.48% AT&T Wireless Group* ..................... 76,400 1,249,140 Cox Communications, Inc., Class A* ....... 28,700 1,271,410 Fox Entertainment Group, Inc., Class A* .. 44,100 1,230,390 SBC Communications Inc. .................. 19,100 765,146 Telefonaktiebolaget LM Ericsson, ADR, Class B ........................... 114,000 616,740 Viacom Inc., Class A* .................... 2,300 121,992 Viacom Inc., Class B* .................... 16,900 874,575 Worldcom, Inc. - WorldCom group* ......... 60,000 850,500 ----------- 6,979,893 ----------- See Notes to Schedule of Investments on page 11. THE INVESTMENTS OF TAX-MANAGED EQUITY FUND June 30, 2001 Shares Value COMMON STOCKS (Continued) Depository Institutions - 1.11% Citigroup Inc. ........................... 11,700 $ 618,228 ----------- Electronic and Other Electric Equipment - 3.28% Sony Corporation, ADR .................... 10,300 677,740 Texas Instruments Incorporated ........... 36,700 1,156,050 ----------- 1,833,790 ----------- Food Stores - 1.57% Kroger Co. (The)* ........................ 35,200 880,000 ----------- Furniture and Fixtures - 2.38% Lear Corporation* ........................ 38,100 1,329,690 ----------- General Merchandise Stores - 5.41% Dollar General Corporation ............... 44,800 873,600 Kohl's Corporation* ...................... 12,100 759,033 Target Corporation ....................... 40,200 1,390,920 ----------- 3,023,553 ----------- Health Services - 2.97% HCA - The Healthcare Company* ............ 36,800 1,662,992 ----------- Industrial Machinery and Equipment - 3.70% Cooper Cameron Corporation* .............. 23,200 1,294,560 Dell Computer Corporation* ............... 29,600 774,188 ----------- 2,068,748 ----------- Instruments and Related Products - 4.00% Agilent Technology, Inc.* ................ 30,000 975,000 Medtronic, Inc. .......................... 27,400 1,260,674 ----------- 2,235,674 ----------- See Notes to Schedule of Investments on page 11. THE INVESTMENTS OF TAX-MANAGED EQUITY FUND June 30, 2001 COMMON STOCKS (Continued) Shares Value Insurance Carriers - 6.79% American International Group, Inc. ...... 19,700 $ 1,694,200 Berkshire Hathaway Inc., Class B* ........ 350 805,000 MGIC Investment Corporation .............. 17,900 1,300,256 ----------- 3,799,456 ----------- Nondepository Institutions - 4.24% Financial Federal Corporation* ........... 51,100 1,479,345 Morgan Stanley Dean Witter & Co. ......... 13,900 892,797 ----------- 2,372,142 ----------- Oil and Gas Extraction - 6.17% Anadarko Petroleum Corporation ........... 22,500 1,215,675 Apache Corporation ....................... 21,800 1,106,350 Burlington Resources Incorporated ........ 28,200 1,126,590 ----------- 3,448,615 ----------- Petroleum and Coal Products - 1.44% Exxon Mobil Corporation .................. 9,200 803,620 ----------- Printing and Publishing - 1.50% New York Times Company (The), Class A .... 20,000 840,000 ----------- Security and Commodity Brokers - 1.84% Charles Schwab Corporation (The) ......... 56,000 856,800 Goldman Sachs Group, Inc. (The) .......... 2,000 171,600 ----------- 1,028,400 ----------- Transportation by Air - 2.01% Northwest Airlines Corporation, Class A* ............................... 44,800 1,125,600 ----------- Transportation Equipment - 1.93% Lockheed Martin Corporation .............. 29,100 1,078,155 ----------- Water Transportation - 1.17% Carnival Corporation ..................... 21,400 656,980 ----------- See Notes to Schedule of Investments on page 11. THE INVESTMENTS OF TAX-MANAGED EQUITY FUND June 30, 2001 Shares Value COMMON STOCKS (Continued) Wholesale Trade -- Nondurable Goods - 1.72% Enron Corp. .............................. 19,600 $ 960,400 ----------- TOTAL COMMON STOCKS - 96.80% $54,129,268 (Cost: $55,102,691) TOTAL SHORT-TERM SECURITIES - 3.21% $ 1,795,000 (Cost: $1,795,000) TOTAL INVESTMENT SECURITIES - 100.01% $55,924,268 (Cost: $56,897,691) LIABILITIES, NET OF CASH AND OTHER ASSETS - (0.01%) (8,147) NET ASSETS - 100.00% $55,916,121 Notes to Schedule of Investments *No income dividends were paid during the preceding 12 months. See Note 1 to financial statements for security valuation and other significant accounting policies concerning investments. See Note 4 to financial statements for cost and unrealized appreciation and depreciation of investments owned for Federal income tax purposes. STATEMENT OF ASSETS AND LIABILITIES TAX-MANAGED EQUITY FUND June 30, 2001 (In Thousands, Except for Per Share Amounts) ASSETS Investment securities - at value (Notes 1 and 4) ................................. $55,924 Cash ............................................ 1 Receivables: Fund shares sold ................................ 163 Dividends and interest .......................... 17 ------- Total assets .................................. 56,105 LIABILITIES ------- Payable to Fund shareholders ...................... 163 Accrued transfer agency and dividend disbursing (Note 3) 8 Accrued service fee (Note 3) ..................... 6 Accrued accounting services fee (Note 3) ......... 3 Accrued distribution fee (Note 3) ................ 3 Accrued management fee (Note 3) ................... 2 Other ............................................ 4 ------- Total liabilities ............................. 189 ------- Total net assets ............................. $55,916 NET ASSETS ======= $0.001 par value capital stock: Capital stock ................................... $ 7 Additional paid-in capital ...................... 68,364 Accumulated undistributed income (loss): Accumulated undistributed net investment income . 38 Accumulated undistributed net realized loss on investment transactions .................... (11,520) Net unrealized depreciation in value of investments ................................... (973) ------- Net assets applicable to outstanding units of capital ............................. $55,916 ======= Net asset value per share (net assets divided by shares outstanding): Class A .......................................... $8.24 Class B .......................................... $8.17 Class C .......................................... $8.17 Class Y .......................................... $8.24 Capital shares outstanding: Class A .......................................... 5,795 Class B .......................................... 688 Class C .......................................... 312 Class Y .......................................... 3 Capital shares authorized ........................ 1,000,000 See Notes to Financial Statements. STATEMENT OF OPERATIONS TAX-MANAGED EQUITY FUND (In Thousands) For the period For the fiscalfrom March 31, period ended 2000* through June 30, December 31, 2001 2000 INVESTMENT INCOME (LOSS) ------------ ------------ Income (Note 1B): Interest and amortization ............ $ 120 $ 527 Dividends ............................ 109 32 ------- ------- Total income ........................ 229 559 Expenses (Note 3): ------- ------- Investment management fee ............ 197 128 Registration fees .................... 92 38 Service fee: Class A ............................ 53 22 Class B............................. 7 4 Class C............................. 3 2 Transfer agency and dividend disbursing: Class A............................. 36 17 Class B............................. 6 3 Class C............................. 3 2 Distribution fee: Class A ............................ 7 3 Class B............................. 23 14 Class C............................. 11 7 Accounting services fee .............. 18 11 Audit fees ........................... 9 7 Custodian fees ....................... 5 6 Legal fees ........................... 1 5 Shareholder servicing - Class Y ...... ---** ---** Other ................................ 43 37 ------- ------- Total ............................... 514 306 Less expenses in excess of voluntary waiver of management fee (Note 3) ......... --- (47) ------- ------- Total expenses .................. 514 259 ------- ------- Net investment income (loss) .. (285) 300 REALIZED AND UNREALIZED LOSS ON ------- ------- INVESTMENTS (NOTES 1 AND 4) Realized net loss on investments ....... (10,975) (545) Unrealized appreciation (depreciation) in value of investments during the period ..... 2,136 (3,109) ------- ------- Net loss on investments .............. (8,839) (3,654) Net decrease in net assets resulting from ------- ------- operations ........................ $(9,124) $(3,354) ======= ======= *Commencement of operations. **Not shown due to rounding. See Notes to Financial Statements. STATEMENT OF CHANGES IN NET ASSETS TAX-MANAGED EQUITY FUND (In Thousands) For the For the period from fiscal March 31, period 2000* ended through June 30, December 31, 2001 2000 ---------- ------------ INCREASE (DECREASE) IN NET ASSETS Operations: Net investment income (loss) ..... $ (285) $ 300 Realized net loss on investments . (10,975) (545) Unrealized appreciation (depreciation) 2,136 (3,109) ------- ------- Net decrease in net assets resulting from operations ..... (9,124) (3,354) ------- ------- Distributions to shareholders from net investment income (Note 1E):** Class A ........................ --- (300) Class B ........................ --- --- Class C ........................ --- --- Class Y ........................ --- ---*** ------- ------- --- (300) ------- ------- Capital share transactions (Note 6) ......................... (14,804) 83,398 ------- ------- Total increase (decrease) ..... (23,928) 79,744 NET ASSETS Beginning of period ............... 79,844 100 ------- ------- End of period ..................... $55,916 $79,844 ======= ======= Undistributed net investment income ......................... $38 $--- ==== ==== *Commencement of operations. **See "Financial Highlights" on pages 15 - 18. ***Not shown due to rounding. See Notes to Financial Statements. FINANCIAL HIGHLIGHTS TAX-MANAGED EQUITY FUND Class A Shares For a Share of Capital Stock Outstanding Throughout Each Period: For the For the fiscal period from period 3-31-00* ended through 6-30-01 12-31-00 -------- -------- Net asset value, beginning of period ........... $ 9.55 $10.00 ------ ------ Income (loss) from investment operations: Net investment income (loss) ... (0.03) 0.04 Net realized and unrealized loss on investments .. (1.28) (0.45) ------ ------ Total from investment operations ...... (1.31) (0.41) ------ ------ Less distributions from net investment income ........... (0.00) (0.04) ------ ------ Net asset value, end of period .... $8.24 $9.55 ====== ====== Total return** ..... -13.72% -4.11% Net assets, end of period (in millions) ........ $48 $67 Ratio of expenses to average net assets ........... 1.57%*** 1.15%*** Ratio of net investment income (loss) to average net assets ....... -0.82%*** 1.63%*** Portfolio turnover rate ............. 30.09% 16.89% *Commencement of operations. **Total return calculated without taking into account the sales load deducted on an initial purchase. ***Annualized. See Notes to Financial Statements. FINANCIAL HIGHLIGHTS TAX-MANAGED EQUITY FUND Class B Shares For a Share of Capital Stock Outstanding Throughout Each Period: For the For the fiscal period from period 3-31-00* ended through 6-30-01 12-31-00 -------- -------- Net asset value, beginning of period ........... $ 9.52 $10.00 ------ ------ Income (loss) from investment operations: Net investment income (loss) ... (0.06) 0.01 Net realized and unrealized loss on investments .. (1.29) (0.49) ------ ------ Total from investment operations ...... (1.35) (0.48) ------ ------ Less distributions from net investment income ........... (0.00) (0.00) ------ ------ Net asset value, end of period .... $8.17 $9.52 ====== ====== Total return ....... -14.18% -4.80% Net assets, end of period (in millions) ........ $6 $9 Ratio of expenses to average net assets ........... 2.40%** 2.08%** Ratio of net investment income (loss) to average net assets ....... -1.63%** 0.67%** Portfolio turnover rate ............. 30.09% 16.89% *Commencement of operations. **Annualized. See Notes to Financial Statements. FINANCIAL HIGHLIGHTS TAX-MANAGED EQUITY FUND Class C Shares For a Share of Capital Stock Outstanding Throughout Each Period: For the For the fiscal period from period 3-31-00* ended through 6-30-01 12-31-00 -------- -------- Net asset value, beginning of period ........... $9.51 $10.00 ------ ------ Income (loss) from investment operations: Net investment income (loss) ... (0.06) 0.01 Net realized and unrealized loss on investments .. (1.28) (0.50) ------ ------ Total from investment operations ...... (1.34) (0.49) ------ ------ Less distributions from net investment income ........... (0.00) (0.00) ------ ------ Net asset value, end of period .... $8.17 $9.51 ====== ====== Total return ....... -14.09% -4.90% Net assets, end of period (in millions) ........ $3 $4 Ratio of expenses to average net assets ........... 2.40%** 2.09%** Ratio of net investment income (loss) to average net assets ....... -1.64%** 0.66%** Portfolio turnover rate ............. 30.09% 16.89% *Commencement of operations. **Annualized. See Notes to Financial Statements. FINANCIAL HIGHLIGHTS TAX-MANAGED EQUITY FUND Class Y Shares For a Share of Capital Stock Outstanding Throughout Each Period: For the For the fiscal period from period 4-19-00* ended through 6-30-01 12-31-00 -------- -------- Net asset value, beginning of period ........... $ 9.55 $10.07 ------ ------ Income (loss) from investment operations: Net investment income (loss) ... (0.03) 0.04 Net realized and unrealized loss on investments .. (1.28) (0.51) ------ ------ Total from investment operations ...... (1.31) (0.47) ------ ------ Less distributions from net investment income ........... (0.00) (0.05) ------ ------ Net asset value, end of period .... $8.24 $ 9.55 ====== ====== Total return ....... -13.72% -4.70% Net assets, end of period (in thousands) ....... $21 $32 Ratio of expenses to average net assets ........... 1.44%** 1.17%** Ratio of net investment income (loss) to average net assets ....... -0.70%** 1.41%** Portfolio turnover rate ............. 30.09% 16.89%*** *Commencement of operations. **Annualized. ***For the period from March 31, 2000 through December 31, 2000. See Notes to Financial Statements. NOTES TO FINANCIAL STATEMENTS June 30, 2001 NOTE 1 -- Significant Accounting Policies Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. (the "Fund") is registered under the Investment Company Act of 1940 as a diversified, open-end management investment company. Its investment objective is to seek growth of capital. Effective for the fiscal period ended June 30, 2001, the Fund changed its fiscal year end for both financial reporting and Federal income tax purposes to June 30 from December 31. The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements. The policies are in conformity with accounting principles generally accepted in the United States of America. A. Security valuation -- Each stock and convertible bond is valued at the latest sale price thereof on the last business day of the fiscal period as reported by the principal securities exchange on which the issue is traded or, if no sale is reported for a stock, the average of the latest bid and asked prices. Bonds, other than convertible bonds, are valued using a pricing system provided by a pricing service or dealer in bonds. Convertible bonds are valued using this pricing system only on days when there is no sale reported. Stocks which are traded over-the-counter are priced using the Nasdaq Stock Market, which provides information on bid and asked prices quoted by major dealers in such stocks. Short-term debt securities are valued at amortized cost, which approximates market. B. Security transactions and related investment income -- Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Securities gains and losses are calculated on the identified cost basis. Dividend income is recorded on the ex-dividend date. Interest income is recorded on the accrual basis. See Note 4 -- Investment Securities Transactions. C. Foreign currency translations -- All assets and liabilities denominated in foreign currencies are translated into U.S. dollars daily. Purchases and sales of investment securities and accruals of income and expenses are translated at the rate of exchange prevailing on the date of the transaction. For assets and liabilities other than investments in securities, net realized and unrealized gains and losses from foreign currency translations arise from changes in currency exchange rates. The Fund combines fluctuations from currency exchange rates and fluctuations in market value when computing net realized and unrealized gain or loss from investments. D. Federal income taxes -- It is the Fund's policy to distribute all of its taxable income and capital gains to its shareholders and otherwise qualify as a regulated investment company under Subchapter M of the Internal Revenue Code. In addition, the Fund intends to pay distributions as required to avoid imposition of excise tax. Accordingly, provision has not been made for Federal income taxes. See Note 5 - Federal Income Tax Matters. E. Dividends and distributions -- Dividends and distributions to shareholders are recorded by the Fund on the business day following record date. Net investment income dividends and capital gains distributions are determined in accordance with income tax regulations which may differ from accounting principles generally accepted in the United States of America. These differences are due to differing treatments for items such as deferral of wash sales and post-October losses, foreign currency transactions, net operating losses and expiring capital loss carryovers. At June 30, 2001, $322,522 was reclassified between accumulated undistributed net investment income and paid-in capital. Net investment income, net realized gains and net assets were not affected by this change. The preparation of 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. NOTE 2 -- Organization The Fund, a Maryland corporation, was organized on November 30, 1999 and was inactive (except for matters relating to its organization and registration as an investment company under the Investment Company Act of 1940 and the registration of its shares under the Securities Act of 1933) until March 31, 2000 (the date of the initial public offering). On March 2, 2000, Waddell & Reed, Inc. ("W&R") purchased for investment 10,000 Class A shares of the Fund at their net asset value of $10.00 per share. Prepaid registration expenses in the amount of $63,905 were paid by the Fund and were amortized over the twelve months following the initial public offering. NOTE 3 -- Investment Management and Payments to Affiliated Persons The Fund pays a fee to Waddell & Reed Investment Management Company ("WRIMCO"), the Fund's investment manager and a wholly owned subsidiary of W&R, for investment management services. The fee is computed daily based on the net asset value at the close of business. The fee is payable by the Fund at the annual rates of: 0.65% of net assets up to $1 billion, 0.60% of net assets over $1 billion and up to $2 billion, 0.55% of net assets over $2 billion and up to $3 billion, and 0.50% of net assets over $3 billion. However, WRIMCO has voluntarily agreed to waive its management fee on any day if the Fund's net assets are less than $25 million, subject to WRIMCO's right to change or modify this waiver. The Fund accrues and pays this fee daily. The Fund has an Accounting Services Agreement with Waddell & Reed Services Company ("WARSCO"), a wholly owned subsidiary of W&R. Under the agreement, WARSCO acts as the agent in providing accounting services and assistance to the Fund and pricing daily the value of shares of the Fund. For these services, the Fund pays WARSCO a monthly fee of one-twelfth of the annual fee shown in the following table. Accounting Services Fee Average Net Asset Level Annual Fee (all dollars in millions) Rate for Each Level ------------------------- ------------------- From $ 0 to $ 10 $ 0 From $ 10 to $ 25 $ 11,000 From $ 25 to $ 50 $ 22,000 From $ 50 to $ 100 $ 33,000 From $ 100 to $ 200 $ 44,000 From $ 200 to $ 350 $ 55,000 From $ 350 to $ 550 $ 66,000 From $ 550 to $ 750 $ 77,000 From $ 750 to $1,000 $ 93,500 $1,000 and Over $110,000 In addition, for each class of shares in excess of one, the Fund pays WARSCO a monthly per-class fee equal to 2.5% of the monthly base fee. For Class A, Class B and Class C shares, the Fund pays WARSCO a monthly per account charge for transfer agency and dividend disbursement services of $1.3375 for each shareholder account which was in existence at any time during the prior month. With respect to Class Y shares, the Fund pays WARSCO a monthly fee at an annual rate of 0.15% of the average daily net assets of the class for the preceding month. The Fund also reimburses W&R and WARSCO for certain out-of- pocket costs. As principal underwriter for the Fund's shares, W&R received gross sales commissions for Class A shares (which are not an expense of the Fund) of $224,776. During the period ended June 30, 2001, W&R received $8,980 and $1,100 in deferred sales charges for Class B shares and Class C shares, respectively. With respect to Class A, Class B and Class C shares, W&R paid sales commissions of $152,725 and all expenses in connection with the sale of Fund shares, except for registration fees and related expenses. Under a Distribution and Service Plan for Class A shares adopted by the Fund pursuant to Rule 12b-1 under the Investment Company Act of 1940, the Fund may pay a distribution and/or service fee to W&R in an amount not to exceed 0.25% of the Fund's Class A average annual net assets. The fee is to be paid to reimburse W&R for amounts it expends in connection with the distribution of the Class A shares and/or provision of personal services to Fund shareholders and/or maintenance of shareholder accounts. Under the Distribution and Service Plan adopted by the Fund for Class B and Class C shares, respectively, the Fund may pay W&R a service fee of up to 0.25%, on an annual basis, of the average daily net assets of the class to compensate W&R for providing services to shareholders of that class and/or maintaining shareholder accounts for that class and a distribution fee of up to 0.75%, on an annual basis, of the average daily net assets of the class to compensate W&R for distributing the shares of that class. The Class B Plan and the Class C Plan each permit W&R to receive compensation, through the distribution and service fee, respectively, for its distribution activities for that class, which are similar to the distribution activities described with respect to the Class A Plan, and for its activities in providing personal services to shareholders of that class and/or maintaining shareholder accounts of that class, which are similar to the corresponding activities for which it is entitled to reimbursement under the Class A Plan. The Fund paid Directors' fees of $401, which are included in other expenses. W&R is a subsidiary of Waddell & Reed Financial, Inc., a holding company, and a direct subsidiary of Waddell & Reed Financial Services, Inc., a holding company. NOTE 4 -- Investment Securities Transactions Purchases of investment securities, other than U.S. Government obligations and short-term securities, aggregated $17,794,910, while proceeds from maturities and sales aggregated $17,235,868. Purchases of short-term securities aggregated $47,823,041, while proceeds from maturities and sales aggregated $67,464,568. No U.S. Government obligations were purchased or sold during the period ended June 30, 2001. For Federal income tax purposes, cost of investments owned at June 30, 2001 was $56,897,691, resulting in net unrealized depreciation of $973,423, of which $4,462,567 related to appreciated securities and $5,435,990 to depreciated securities. NOTE 5 -- Federal Income Tax Matters For Federal income tax purposes, the Fund realized capital losses of $11,125,260 during the fiscal period ended June 30, 2001. Remaining capital loss carryovers aggregated $11,520,280 at June 30, 2001, and are available to offset future realized capital gain net income for Federal income tax purposes but will expire if not utilized as follows: $395,020 at June 30, 2008, and $11,125,260 at June 30, 2009. NOTE 6 -- Multiclass Operations The Fund is authorized to offer four classes of shares, Class A, Class B, Class C and Class Y, each of which have equal rights as to assets and voting privileges. Class Y shares are not subject to a sales charge on purchases, are not subject to a Rule 12b-1 Distribution and Service Plan and are subject to a separate transfer agency and dividend disbursement services fee structure. A comprehensive discussion of the terms under which shares of each class are offered is contained in the Prospectus and the Statement of Additional Information for the Fund. Income, non-class specific expenses, and realized and unrealized gains and losses are allocated daily to each class of shares based on the value of their relative net assets as of the beginning of each day adjusted for the prior day's capital share activity. Transactions in capital stock are summarized below. Amounts are in thousands. For the For the period from fiscal period March 31, ended 2000 through 6-30-01 12-31-00 ------------ ------------ Shares issued from sale of shares: Class A ............ 1,585 8,181 Class B ............. 129 1,056 Class C ............. 63 559 Class Y ............ 1 3 Shares issued from reinvestment of dividends: Class A ............. --- 30 Class B ............. --- --- Class C ............. --- --- Class Y ............. --- ---* Shares redeemed: Class A ............ (2,791) (1,220) Class B ............. (366) (131) Class C ............. (187) (123) Class Y ............ (1) --- ----- ----- Increase (decrease) in outstanding capital shares ...... (1,567) 8,355 ===== ===== Value issued from sale of shares: Class A ............ $13,837 $81,344 Class B ............. 1,120 10,447 Class C ............. 535 5,531 Class Y ............ 5 33 Value issued from reinvestment of dividends: Class A ............. --- 291 Class B ............. --- --- Class C ............. --- --- Class Y ............. --- ---* Value redeemed: Class A ............ (25,298) (11,832) Class B ............. (3,389) (1,247) Class C ............. (1,603) (1,169) Class Y ............ (11) --- ------- ------- Increase (decrease) in outstanding capital . $(14,804) $83,398 ======= ======= *Not shown due to rounding. INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders, Waddell & Reed Advisors Tax-Managed Equity Fund, Inc.: We have audited the accompanying statement of assets and liabilities, including the schedule of investments, of Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. as of June 30, 2001, and the related statements of operations for the fiscal period January 1, 2001 through June 30, 2001 and the fiscal period March 31, 2000 (inception) through December 31, 2000, the statements of changes in net assets for the fiscal period January 1, 2001 through June 30, 2001 and the fiscal period March 31, 2000 through December 31, 2000, and the financial highlights for the fiscal period January 1, 2001 through June 30, 2001 and the fiscal period March 31, 2000 through December 31, 2000. These financial statements and the financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of June 30, 2001, by correspondence with the custodian. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. as of June 30, 2001, the results of its operations for the fiscal period January 1, 2001 through June 30, 2001 and the fiscal period March 31, 2000 through December 31, 2000, the changes in its net assets for the fiscal period January 1, 2001 through June 30, 2001 and the fiscal period March 31, 2000 through December 31, 2000, and the financial highlights for the fiscal period January 1, 2001 through June 30, 2001 and for the fiscal period March 31, 2000 through December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP Kansas City, Missouri August 3, 2001 INCOME TAX INFORMATION Normally, dividends and/or distributions are paid to shareholders of the Fund annually in December. No dividends and/or distributions were paid to shareholders during the fiscal period January 1, 2001 through June 30, 2001. Householding If you currently receive one copy of the shareholder reports and prospectus for your household (even if more than one person in your household owns shares of the Fund) and you would prefer to receive separate shareholder reports and prospectuses for each account holder living at your address, you can do either of the following: Fax your request to 800-532-2749 Write to us at the address listed on the inside back cover for Waddell & Reed, Inc. Please list each account for which you would like to receive separate shareholder reports and prospectus mailings. We will resume sending separate documents within 30 days of receiving your request. DIRECTORS Keith A. Tucker, Overland Park, Kansas, Chairman of the Board James M. Concannon, Topeka, Kansas John A. Dillingham, Kansas City, Missouri David P. Gardner, San Mateo, California Linda K. Graves, Topeka, Kansas Joseph Harroz, Jr., Norman, Oklahoma John F. Hayes, Hutchinson, Kansas Robert L. Hechler, Overland Park, Kansas Henry J. Herrmann, Overland Park, Kansas Glendon E. Johnson, Miami, Florida William T. Morgan, Coronado, California Frank J. Ross, Jr., Kansas City, Missouri Eleanor B. Schwartz, Kansas City, Missouri Frederick Vogel III, Milwaukee, Wisconsin OFFICERS Robert L. Hechler, President Henry J. Herrmann, Vice President Theodore W. Howard, Vice President and Treasurer Cynthia P. Prince-Fox, Vice President Kristen A. Richards, Vice President and Secretary Daniel C. Schulte, Vice President The Waddell & Reed Advisors Group of Mutual Funds Waddell & Reed Advisors Accumulative Fund Waddell & Reed Advisors Asset Strategy Fund, Inc. Waddell & Reed Advisors Bond Fund Waddell & Reed Advisors Cash Management, Inc. Waddell & Reed Advisors Continental Income Fund, Inc. Waddell & Reed Advisors Core Investment Fund Waddell & Reed Advisors Global Bond Fund, Inc. Waddell & Reed Advisors Government Securities Fund, Inc. Waddell & Reed Advisors High Income Fund, Inc. Waddell & Reed Advisors International Growth Fund, Inc. Waddell & Reed Advisors Municipal Bond Fund, Inc. Waddell & Reed Advisors Municipal High Income Fund, Inc. Waddell & Reed Advisors Municipal Money Market Fund, Inc. Waddell & Reed Advisors New Concepts Fund, Inc. Waddell & Reed Advisors Retirement Shares, Inc. Waddell & Reed Advisors Science and Technology Fund Waddell & Reed Advisors Small Cap Fund, Inc. Waddell & Reed Advisors Tax-Managed Equity Fund, Inc. Waddell & Reed Advisors Value Fund, Inc. Waddell & Reed Advisors Vanguard Fund, Inc. ------------------------------------ FOR MORE INFORMATION: Contact your representative, or your local office as listed on your Account Statement, or contact: WADDELL & REED CUSTOMER SERVICE 6300 Lamar Avenue P.O. Box 29217 Shawnee Mission, KS 66201-9217 (888)-WADDELL (888)-923-3355 Our INTERNET address is: http://www.waddell.com NUR1019A(6-01) For more complete information regarding any of the mutual funds in Waddell & Reed Advisors Funds, including charges and expenses, please obtain the Fund's prospectus by calling or writing to the number or address listed above. Please read the prospectus carefully before investing.