N-30B-2 1 qtrly1202.txt QUARTERLY SHAREHOLDER REPORT DATED DECEMBER 31, 2002 [REGISTERED LOGO] B A R O N F U N D S -------------------------------------------------------------------------------- BARON FUNDS -------------------------------------------------------------------------------- "DON'T BUY UNTIL ..."........................................................1 "IT IS VERY DIFFICULT TO MAKE PREDICTIONS, ESPECIALLY ABOUT THE FUTURE."..................................................................1 "... A PICTURE IS WORTH A THOUSAND WORDS ..."................................2 "THE ONLY THING TO FEAR ...".................................................3 BARON 2003 INVESTMENT CONFERENCE..............................................4 -------------------------------------------------------------------------------- 1 BARON ASSET FUND -------------------------------------------------------------------------------- PERFORMANCE...................................................................5 "... STOCK PRICES RISE OR FALL ... BECAUSE MULTIPLES CHANGE ..."..............5 ACQUISITIONS ... IN GENERAL, WE'RE NOT FANS ..............................................................7 -------------------------------------------------------------------------------- 2 BARON GROWTH FUND -------------------------------------------------------------------------------- PERFORMANCE...................................................................9 "WHETHER YOU THINK YOU CAN ..."...............................................9 PORTFOLIO ADDITIONS..........................................................10 -------------------------------------------------------------------------------- 3 BARON SMALL CAP FUND -------------------------------------------------------------------------------- PERFORMANCE..................................................................15 -------------------------------------------------------------------------------- 4 BARON iOPPORTUNITY FUND -------------------------------------------------------------------------------- PERFORMANCE AND OVERVIEW.....................................................19 767 Fifth Avenue NY, NY 10153 212.583.2100 1.800.99.BARON BaronFunds.com This Report contains information for four funds QUARTERLY REPORT DECEMBER 31, 2002 DEAR BARON FUNDS SHAREHOLDER: "DON'T BUY UNTIL THE STREETS RUN RED WITH BLOOD ...." In the mid-1800s, Baron Rothschild, one of the wealthiest individuals in Europe, received a wire in London from his Paris staff. Rothschild's bank executives reported that share prices on the French bourse were falling sharply, the result of soldiers fighting nearby, and requested permission to purchase stock ... "Don't buy until the streets run red with blood," Rothschild wired back. Following a nearly three year bear market in United States' equity markets, we think many stocks are now cheap based upon either present earnings or projected earnings in a few years. And, they may now be trading as though the very worst had already occurred. Regardless, traders focused on a war with Iraq, as Baron Rothschild was focused on the war in France nearly 200 years ago, have become disaster focused. But, few are so capable that their judgments could be compared to Baron Rothschild's. Morty Schaja, our firm's president, recently explained to a client that ten years ago our firm "added value" by trying to find investments that others overlooked ... smaller, fast growing businesses below the radar screen of most. Today, we still focus on smaller and mid-sized growth businesses that we believe most brokerage firms find unprofitable to follow since they cannot justify the research hours that must be invested to understand these businesses relative to their potential to generate commissions or fees. In addition, we're adding value by having a different time horizon, i.e. long term vs. the next tick, than most others. "In the long term we're dead," was 18th century economist Adam Smith's fearless forecast. Which so many investors appear to have taken to heart that, in my normally optimistic mindset, I believe even more opportunities than usual abound. "IT IS VERY DIFFICULT TO MAKE PREDICTIONS, ESPECIALLY ABOUT THE FUTURE," ALBERT EINSTEIN AND YOGI BERRA, AMONG OTHERS, REMARKED AT DIFFERENT TIMES. "You can't always see around corners ... " an executive remarked to me early in my career trying to help me understand why equity investments are never a "sure thing." [PHOTO OF RON BARON] Ron Baron, Chairman George Leader is the former Governor of Pennsylvania and was under consideration to become John Kennedy's vice-presidential running mate in 1960 before Lyndon Johnson got the nod. I met George in 1977 after he and his wife, Mary Ann, had long since retired from politics. George had founded, and was then chairman, of Pennsylvania Enterprises, a holding company that owned a non-descript trucking company and an unusually attractive Pennsylvania nursing home business. I soon afterwards invested nearly my entire net worth in George's business (I was young and didn't have much of a net worth) ... which by 1980 had increased in value about 15-20 fold when it was sold first to Cenco and then to Manor Care. The profits from that investment allowed me to start Baron Capital in 1982. George later became one of the first trustees of BARON FUNDS -------------------------------------------------------------------------------- Baron Asset Fund when it was formed in 1987. Although I hadn't spoken with George for years, I immediately recognized his voice when he called in November. When I invested in his business, I am certain I spoke with him more frequently than anyone, except my wife. George and his son, Michael, often claimed they taught me all that I know about the nursing home business ... which they probably did. "Hi, Ron." "George! How are you? You don't sound any older. How old are you? How is your family? What are you doing?" "I'm 82. I'm great and so is Mary Ann. I've just sold my assisted living business to Michael. And, I've just started another assisted living business in Pennsylvania." "You're 82 and you've just sold your business to your son and now you're starting another business to compete with him? Is he o.k. with that? Did Michael forget to get a non-compete?" "Well, I won't build any homes within ten miles of his." "George, in Pennsylvania, ten miles is like next door." Which reminded me of a story I had read in a Warren Buffett annual report. Ninety-year old Rose Blumkin was feuding with her two sixty-plus year old sons about the Omaha furniture retailer Rose had founded and the sons wanted to sell while Rose did not. Buffett had heard about the family discord, had been shopping in Rose's store for his entire life, and offered to purchase the business for cash to end the dispute. Rose accepted Warren's offer, took the cash, purchased property across the street and started a competitive store. "Who knew that I should have asked for a non-compete from a ninety year old? The worst business decision I've made in a long time," Warren later complained with trademark good humor. He then bought Rose's new business, got her to sign a non-compete this time and made Rose the t.v. spokesperson for the stores. "Unfortunately," Warren relayed, "Rose, despite immigrating to America sixty years ago from Russia, never lost her deeply accented Russian-Yiddish dialect and no one could understand what she was saying! We had to use subtitles on the advertisements ... which worked well until she passed away at 102." You learn as a freshman in law school about contracts and how easy their terms are to avoid if that is the intent of one of the parties. If the person from whom you've acquired a business can easily compete against you ... regardless of his or her age ... that would certainly seem to make the business you've just bought worth less. To be a successful analyst or investor, you've got to not just discover fast growing businesses when they're selling at attractive prices. You've got to think about all sorts of risks that are not easy to predict and try to assess them. Competition from an individual who sells you his business is just one. You've also got to invest or recommend investing when many think it's not a wise time to do so. "THE RESEARCH ANALYSTS WHO FOLLOW OUR COMPANY THINK THEY'RE HEDGE FUND MANAGERS ..." That was the complaint of an executive who visited us recently as we were beginning our "due diligence" on his business. A brokerage analyst had just "downgraded" his company's share price to "fully valued" at $18 while maintaining it as a "buy" at $14. Three years ago the share price of this company reached $80 when analysts' recommendations were uniformly favorable following its initial public offering ... The December 9, 2002 issue of Business Week reported a recent university study which found brokerage analysts' lowest rated stocks during 2000-2001 outperformed their highest rated stocks by 20 percentage points per year! Which results may be an anomaly but, at least during that period, clearly show the "momentum" oriented research that had worked well for the prior few years no longer did. According to Chicago's Zack's Investment Research, brokerage firm "sell" recommendations have recently reached their highest level since the late 1980s following the 1987 "crash." Which seems especially interesting since these negative recommendations are being made after about $7 trillion market value of equity securities has melted away during the past three years and we are now slowly recovering from recession! A principle upon which our firm was founded was reliance upon our own, independent research to best judge both management capabilities and business prospects. Still, we believe much of the industry information, statistics and spreadsheets prepared by "sell side" brokerage firms shortcut our analysts' and portfolio managers' work. It's just the analyst "buy" and "sell" recommendations based upon a current quarter's earnings that we find of little value. Along with their very short term trading focus. This contrasts with trying to understand the nitty gritty of how a business operates, its competitive advantages and its long term opportunities and then trying to value those prospects. Which, we believe, effectively makes the case for investors to "investigate before you invest" ... as the New York Stock Exchange so effectively advertised when I was just beginning my career. "... A PICTURE IS WORTH A THOUSAND WORDS ..." Where is the research opportunity when so many Internet-enabled have so much information? And, why are we continuing to hire and train more analysts? Especially since we think information does not always equate to knowledge. 2 BARON FUNDS -------------------------------------------------------------------------------- We think inefficiencies in markets for smaller and mid-sized companies can be turned to our advantage with sufficient information to make informed judgments. Careful research won't always make us right ... there is judgment involved ... but it surely increases our odds of finding the 10- and 20- baggers. But, in this Regulation FD world, what do we train our analysts to look for? After we identify what we believe is a fast growing business with a long- lasting "mega-opportunity;" that has management we like; and that we can purchase at what we believe is an attractive price; our due diligence begins. We want our analysts to determine what's unique about that business. Are there important barriers to prevent competitors from usurping its opportunities? In the best of all worlds, we want its competitors to explain why our target investment has unassailable advantages, its customers to tell us that its products and services are fantastic! Some examples? Catalina Marketing prints customer discount coupons at checkout counters in 16,000 U.S. supermarkets and patient compliance information and advertisements attached to drug prescriptions at 17,000 pharmacies. After thoroughly reading "trades," we want our analysts to speak with packaged food brand managers, advertising agencies and pharma about return on investment for these promotions. We want to hear from supermarkets about the success of Catalina-operated loyalty programs, from drug stores and supermarkets about Catalina's rapidly growing "targeted" sampling efforts. CTI Molecular is the pioneer manufacturer of PET scanners that, unlike the MRI, X-ray and CAT scanners that tell doctors about the gross shape of an organ, tell the doctor how the organ's working and whether cancer is present. Our analysts' conversations with doctor imaging practices, hospitals, competitive manufacturers and managed care are intended to allow us to judge product effectiveness, pricing, distribution, service and reimbursement. With nursing home/home care provider Manor Care we want to survey state regulators regarding Medicaid reimbursement, state legislators regarding tort reform legislation, hospital discharge planners regarding the quality of Manor Care's services and managed care providers regarding cost effectiveness of Manor Care's services. We visited Manor Care in Toledo the day before Thanksgiving. When we were discussing the company's problems with tort litigation in Florida, Chairman and CEO Paul Ormond was moderately optimistic. Problems in Florida were still significant but had been sharply curtailed even before expected tort reform legislation is passed. "We now make all residents who enter our homes sign an agreement that any disputes over quality care will go to mandatory arbitration, which sharply reduces punitive damages awards." What could be more logical? With Vail we want to make sure we're reading local Vail newspapers to get a feel for environmental concerns of the citizenry. This is especially important since that town is about to undergo a several hundred million dollar facelift. I obviously could go on, but I'm sure by now you get the idea. "SHOWING UP ..." David Pottruck, Charles Schwab's President and CEO, graduated from the University of Pennsylvania in 1971. As a Wharton undergraduate David was the starting linebacker for the University of Pennsylvania's football team and, in his senior year, was all-Ivy and Penn football's MVP. David wanted to play professional football but, alas, probably because Penn is not a traditional "feeder" school for the NFL, was not drafted. Another star college linebacker David's senior year graduated from Amherst and also was not chosen in the draft. Both David and his friend were then invited to tryout for the Miami Dolphins. David believed he hadn't been chosen in the draft because he wasn't good enough, decided not to tryout and became a banker ... a very successful banker ... but a banker nevertheless ... His Amherst friend and erstwhile competitor, Doug Swift, tried out, became a starting linebacker for the Dolphins for the next ten years and played on two winning Super Bowl teams! And, went to medical school to boot. "That could have been me," David lamented recently to us explaining that the lesson he learned then and has never forgotten since was that you can't be successful if you don't "show up." Which is not a lot different from the message I try to give our analysts, "You've got to be in it to win it." You've got to invest in fast growing businesses when they're growing, regardless of market predictions by "experts," who, in my thirty-three year career, I have concluded, try to predict the unpredictable with predictable results. "... THE ONLY THING WE HAVE TO FEAR IS FEAR ITSELF ..." Repeated terror alerts, which strike fear into the hearts of our citizens and that especially vigilant subset, investors, remind me of grammar school air raid alerts during the Cold War in the 1950s. When the air raid sirens went off during a school day signaling a possible Russian nuclear attack, we were told to get under our desks and not look out the window. Even as a seven-year old I never quite understood why I would be safe if I remained under my desk and didn't look out the window at a nuclear explosion in our playground. A nuclear attack by Russia, of course, never occurred. Which is what distinguishes our current circumstances ... we have already been attacked. Vigilance and preparedness, as well as our government's belief that "a good offense is the best defense," should reduce, but not eliminate, the risk of further terror in 3 BARON FUNDS -------------------------------------------------------------------------------- the United States. But, it won't help me understand any better the group hatred that causes these attacks. One of our young analysts walked into my office late Friday afternoon. "The FBI Director and CIA Director are on television. We're on 'heightened alert' again. They say we should avoid public transportation today and consider taking a cab home tonight. Are they kidding? Have you seen some of these cabbies?!!" BARON 2003 INVESTMENT CONFERENCE. OCTOBER 3, 2003. WALDORF ASTORIA, NEW YORK CITY. The 12th Annual Baron Investment Conference will take place on October 3, 2003. The venue this year will be The Grand Ballroom of the Waldorf Astoria in New York City. Our shareholder meetings have taken place at New York's Grand Hyatt for the past four years. During the past three years, when more than 2000 of you have attended our annual meetings each year, despite valiant efforts by the Grand Hyatt staff, it has become increasingly difficult to fit our shareholders into The Grand Hyatt ballrooms. While the Hyatt service has been terrific and the food delicious, thank you, Grand Hyatt, we are opting in 2003 for a somewhat larger facility. We have also changed more than our venue. Our conference will take place this year two weeks earlier than its usual mid- October date. October 3 was the only Friday available at the Waldorf in October. I guess the Waldorf hasn't learned yet about the New York hotel recession. We're giving you early notice to make sure we don't disrupt your other plans. THANK YOU FOR INVESTING IN BARON FUNDS. -------------------------------------------------------------------------------- We understand that, for most of us, deciding how to invest your hard earned savings to pay for your children's education, to care for your parents or to fund your retirement is a very difficult decision. We're certain that due to the extended 2000-2003 "bear market" in stocks, the investment losses we have all experienced during the past three years, the modest economic recovery from recession, to date, and, the continued very negative opinions of many well respected investment advisors, this decision cannot be any easier. We hope our shareholder letters, magazine, newspaper and television interviews and annual investment conferences have helped you think about issues that have made it easier for you to decide whether stocks, in general, are an appropriate investment. And, whether Baron Funds, in particular, remains an attractive investment for you and your family. We thank you for choosing to join us as fellow shareholders in Baron Funds. We will continue to work hard to justify your confidence. Sincerely, [SIGNATURE] Ronald Baron Chairman and CEO February 12, 2003 4 [REGISTERED LOGO] -------------------------------------------------------------------------------- 1 BARON ASSET FUND -------------------------------------------------------------------------------- PERFORMANCE...................................................................5 "... STOCK PRICES RISE OR FALL ... BECAUSE MULTIPLES CHANGE ..."..............5 ACQUISITIONS. IN GENERAL, WE'RE NOT FANS ... .................................7 767 Fifth Avenue NY, NY 10153 212.583.2100 1.800.99.BARON BaronFunds.com BARON ASSET FUND QUARTERLY REPORT DECEMBER 31, 2002 [PHOTO OF RON BARON] Ron Baron, Portfolio Manager DEAR BARON ASSET FUND SHAREHOLDER: PERFORMANCE -------------------------------------------------------------------------------- During calendar year 2002, our investments in businesses like Apollo, Education Management, ChoicePoint, XTO Energy and Choice Hotels that increased their earnings performed relatively well. In fact, as I reported in our September 2002 annual report, if we had invested only in our top ten gainers in the past year, you wouldn't have believed we were in the midst of the worst bear market of my career. Companies whose earnings were negatively impacted by the economy like Charles Schwab, Robert Half and Sotheby's did not perform well last year. In the fourth quarter, however, just the opposite was the case. Many of our businesses whose income and share prices increased in value for the year as a whole, most notably our investments in education, fell in price during the December quarter. Our investments in businesses whose earnings had been hurt by the economy like Schwab, Sotheby's and Robert Half, rallied strongly in the quarter with the expectation that, as the economy improved, they could achieve outsized earnings gains. In the quarter our long term, and until this quarter, profitable, investment in specialty chemicals producer OM Group penalized our results. OM Group's share price fell sharply when its management disclosed their results were under pressure due to the depressed price of cobalt. OM has a proprietary source of cobalt in the Congo and had previously been able to achieve a stable spread between the cost of the raw material and the selling price of its finished, processed product. However, when the price of cobalt raw material fell sharply, OM apparently began to speculate that cobalt's price would recover and went "long" an unusually large amount of raw material ... that continued to fall in price. This occurred shortly after OM had added significantly to its debt to acquire a producer of platinum catalysts for cars. We sold this investment for a loss. Baron Asset Fund invests in small and mid cap growth businesses that it perceives are value priced. Since the Fund's inception nearly sixteen years ago, Baron Asset Fund has significantly outperformed the averages (see chart on page 6) and it's mid cap growth peer group as defined by Morningstar.* The Fund's performance in the December quarter, a loss of 0.21%, under performed the mid cap growth peer group which was up 4.3%. In calendar year 2002, a poor year for equities, in general, and especially for growth managers, the Fund out performed its peer group by losing less, 19.99%, compared to a loss of 27.38% for its peer group. For the five-year period ending December 31, the Fund was down 2.63% per year versus a loss of 1.04% per year for the peer group. For the ten-year period the Fund was up 9.87% per year versus 6.54% for the peer group. "... STOCK PRICES RISE OR FALL ... NOT BECAUSE EARNINGS CHANGE ... BUT BECAUSE MULTIPLES CHANGE ..." TONY TABELL, 1970. We are all captives of our times. When Tony, my boss at the time, gave me that advice in my first securities analyst job in 1970, we were four years into a sixteen year period when the Dow Jones Industrial Average traded back and forth between 600 and 1000. Tony believed in investing in cyclical growth businesses when they were cheap and selling them BARON ASSET FUND -------------------------------------------------------------------------------- when their earnings rebounded and they became "dear." That advice worked well for sixteen years. But while following it for several years allowed me to earn very good returns, it also caused me to settle for doubles and triples and miss what became 50 to 100 baggers like Hyatt, Fed Ex, Mattel, Disney and McDonalds. During the past five years, and especially during the past three years, significant "multiple compression" has depressed the share prices of stocks. Despite falling interest rates which, in theory, make earnings growth more valuable. As a result, many growth stocks now sell at what we believe are value prices. Businesses whose earnings have doubled during the past five years have just about managed to hold their share price; if their earnings have been flat, their share prices have often been halved; and, if their earnings have fallen during the period, their share prices have often collapsed. Only the rare businesses that have significantly more than doubled earnings during the past five years like ChoicePoint, Apollo, Education Management, The Cheesecake Factory and Krispy Kreme Donuts have been accorded increased stock prices by investors. Polo Ralph Lauren's earnings per share have grown from $.89 in 1997 to an estimated nearly $2.00 per share in 2003 while we believe its balance sheet and management have been strengthened and foreign expansion prospects have become more visible. Polo's share price has fallen modestly during the period as its p/e multiple has contracted from 30x to 10x. Vail Resorts became a public business five years ago valued at 11x its then $89 million annual cash flow. It is currently valued for a little more than 5.5x its current $140 million annual cash flow and its share price is lower now than then. This although it is beginning a major redevelopment of Vail Village that we believe should provide developer profits and boost recurring income from lift tickets and mountain services significantly. Ethan Allen's income per share has more than doubled during the past five years. Its share price is about unchanged. It currently sells for about 11x its next twelve months' earnings per share although its prospects for sourcing furniture from low cost China as well as expansion in that large market have become increasingly visible. Choice Hotels' income per share has increased more than 150% since 1997. This franchisor of moderate priced motels has repurchased more than a third of its outstanding shares over the period. Its share price has increased 10-15% since 1997 and it now sells for about 12x its estimated 2003 income. We think the company could continue to increase its earnings at least 10-15% per year for the next several years. Dollar Tree's earnings per share have also increased more than 150% since 1997. Despite an opportunity to nearly triple its 2200 very profitable stores, earning nearly their entire investment in their first year, and improving its margins, its shares sell for about 12.5x 2003 income. The shares have increased in price 10-15% over the past five years. Manor Care's earnings, as it has restructured its business to provide cost effective healthcare for the acutely ill, as opposed to principally residential services for the frail elderly five years ago, have advanced modestly in the past five years. Its share price has fallen in half. It now sells for about 12x 2003 earnings, and we think it probably has an opportunity to double its earnings over the next five years. [BAR GRAPHS] --------------------------------------------------------------------------------
* S&P 500 AND RUSSELL 2000 ARE WITH DIVIDENDS. THE S&P 500 AND THE RUSSELL 2000 ARE UNMANAGED INDEXES. THE S&P 500 MEASURES THE PERFORMANCE OF THE STOCK MARKET IN GENERAL; THE RUSSELL 2000 OF SMALL AND MID-SIZED COMPANIES. ** THE PERFORMANCE DATA IN THE GRAPHS DOES NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON DISTRIBUTIONS OR REDEMPTION OF FUND SHARES. 6 BARON ASSET FUND -------------------------------------------------------------------------------- Kerzner International earnings have been penalized by significant spending on growth initiatives and have advanced modestly during the past five years despite significant investment during that period in its properties. Its share price has fallen about in half during this period and now sells for a little more than 10x 2003 earnings although we believe it could double its earnings within five years. Charles Schwab's earnings per share have doubled in the past five years. Its share price is about the same as it was five years ago (although it is dramatically lower than in 2000). Schwab is now valued at about 20x depressed 2003 earnings which could be a third less than 2000 earnings. Schwab's valuation is 1.5% of its growing customer assets as it begins bank services like mortgage loans, insured deposits and electronic bill pay. Banks are commonly valued for several times that amount. DeVry's earnings per share have also about doubled in the past five years. Its share price has also changed little over the time period (although it is significantly lower than in 2000). DeVry is now valued at about 20x depressed 2003 earnings which could be about 18% less than those last year. We believe DeVry has the potential to operate about three times as many proprietary colleges as it presently does, to add students and curriculum to its present schools and to charge higher tuition. Although our very rapidly growing businesses have increased in price during the past five years, their share prices have not grown as rapidly as their earnings, and they are now selling at historically reasonable prices and offer what we believe are opportunities to continue to increase their earnings very rapidly. Apollo's earnings per share have increased more than sixfold in the past five years, its 90% owned University of Phoenix On-line even more, as Apollo's student enrollments continue to rapidly expand and tuition rate increases are implemented. Apollo's share price has about quadrupled over the period. ChoicePoint's earnings during the past five years have about tripled as has its stock price. Demand for information about individuals from this company's unique data base by insurance companies, businesses, and the government has increased strongly as we all recognize the need for greater security. Education Management's earnings have about tripled during the past five years as its student enrollments continue to grow and tuitions are increased. Its share price has about doubled. Krispy Kreme Doughnuts has increased its earnings about five times since its initial public offering in 2000. Its share price has about doubled. The Cheesecake Factory has about quadrupled its earnings in the past five years while its share price has about tripled. Weight Watchers has about doubled its earnings since its initial public offering in 2001. Its share price has increased about 25%. During the past century stocks have, in general, traded between 10x and 20x earnings whether there has been prosperity, war, depression, inflation, soaring or crashing gold prices, soaring or crashing oil prices, Presidential impeachments or just about anything else. With stock multiples halved in the past five years, we believe it is now generally pretty easy to find growing businesses valued by investors for 7x, 8x, 10x and 12x earnings or 5x or 6x cash flows. The more rapidly growing businesses we favor are at 20x projected 2003 income, historically bargain prices for very fast growth. We think it likely that during the next several years you will read about many successful investments made at current prices that have increased significantly after their earnings and multiples have both doubled. This is despite my belief that we are unlikely to return to the indiscriminately high valuations of the recent past for years and years. PORTFOLIO STRUCTURE -------------------------------------------------------------------------------- Table I Portfolio Metrics -------------------------------------------------------------------------------- Est. P/E Ratio Forward 19.5x Est. 5 Year EPS Growth Rate 26.1% Median Market Cap $1.79 billion Equity Securities 42 -------------------------------------------------------------------------------- Table II Industry Focus -------------------------------------------------------------------------------- Education 15.3% Business Services 11.2% Recreation and Resorts 11.5% Retail Trade 10.7% Financial 8.4% Consumer Services 7.6% Media and Entertainment 6.6% Hotels and Lodging 5.7% Healthcare 5.5% Other 15.3% -------------------------------------------------------------------------------- ACQUISITIONS. IN GENERAL, WE'RE NOT FANS ... THERE ARE EXCEPTIONS ... XTO Energy buys long lived gas reserves cheaply and usually gets more than it pays for. (Geoff Jones) XTO Energy made several "bolt-on" acquisitions in 2002 of properties that are adjacent to its existing fields. Historically XTO has been able to buy properties "cheap" based upon known reserves and then expand the reserves! Through several different transactions, XTO added approximately 299 Bcfe in reserves last year for a total cost of $318 million, or about $1.06 per Mcfe -- very attractive prices compared to recent deals, which have typically been about $1.25-1.50 per Mcfe of proved reserves and in some cases have topped $2.00. The sellers of properties XTO targets are typically larger energy companies which sell smaller projects to focus on areas of greater potential return or private individuals who lack the capital and desire to fully exploit their property. XTO is often the most logical buyer because of its existing presence in the area, which gives it the technical know-how to maximize returns on purchased properties. As a result of this "home field advantage," not only has XTO been able to find acquisitions at what we think are attractive prices, but it also has had great success developing additional 7 BARON ASSET FUND -------------------------------------------------------------------------------- reserves beyond those proven at the time of purchase. Consequently, the company's effective acquisition price for 2002 reserves should be even lower than $1.06 when future reserve development is included. XTO has hedged a significant portion of the 2003 production from the new properties at levels that we believe should ensure a cash-on-cash return on investment of more than 30% this year. ChoicePoint buys consumer vital records business that complements existing security businesses. (Andrew Peck) In December 2002 ChoicePoint announced one of its largest acquisitions to date, the $120 million cash purchase of VitalChek, the leading provider of vital records to consumers. Vital records include birth certificates, death certificates, marriage licenses and other important documents issued by various municipal governments throughout the United States. VitalChek has agreements with more than 250 separate government bodies, which use the VitalChek ordering and fulfillment infrastructure to provide these documents to consumers who request them for a fee. Consumers can order these records in an efficient and economical fashion directly through the VitalChek website. VitalChek then forwards the request to the appropriate government records office, where proprietary company-owned terminals are generally located. The government worker then fulfills the record request with the aid of the VitalChek software, and uses a computer- generated mailing label to distribute the document. The entire transaction may take only a few days, versus the interminable waits people often experience when requesting government documents. The service costs about $35, of which VitalChek keeps about $12, with the remainder going to the state. The company currently fulfills about 2 million transactions annually, which it believes represents 8-10% of the industry volume, and 5% of industry revenue (its fees are lower than its competitors'). In 2002, VitalChek recorded about $22 million revenues and $10 million in cash flow, a more than 30% increase from the prior year. ChoicePoint management believes there are multiple opportunities to expand the VitalChek business, while maintaining its extraordinary profitability level and free cash flow characteristics. First, three-quarters of the vital record industry is still not outsourced to private firms. This provides an obvious opportunity for VitalChek, which has the leading share among private providers, to expand the outsourcing model to the rest of the market. Second, as part of various Homeland Security initiatives, several states are considering changing the `lifespan' of vital records, making birth certificates, for instance, similar to passports which need to be renewed every ten years in order to remain valid for identification. This would immediately expand the market for these documents. Third, there's an opportunity to improve the security features in the ordering process by implementing an online identity quiz to verify that the documents are not being obtained fraudulently; ChoicePoint could leverage its other databases to create this quiz and would charge a fee to the states to administer it. Fourth, the VitalChek website currently attracts 60 million visitors per year, and there should be an opportunity to sell these visitors some of the new online consumer services that ChoicePoint is developing, such as personal insurance scores and other public records. Lastly, there may be an opportunity to increase VitalChek's prices, which are among the industry's lowest and which haven't been increased in three years. THANK YOU FOR INVESTING IN BARON ASSET FUND -------------------------------------------------------------------------------- We understand that, for most of us, deciding how to invest your hard earned savings to pay for your children's education, to care for your parents or to fund your retirement is a very difficult decision. We're certain that due to the extended 2000-2003 "bear market" in stocks, the investment losses we have all experienced during the past three years, the modest economic recovery from recession, to date, and, the continued very negative opinions of many well respected investment advisors, this decision cannot be any easier. We hope our shareholder letters, magazine, newspaper and television interviews and annual investment conferences have helped you think about issues that have made it easier for you to decide whether stocks, in general, are an appropriate investment. And, whether Baron Asset Fund, in particular, remains an attractive investment for you and your family. We thank you for choosing to join us as fellow shareholders in Baron Asset Fund. We will continue to work hard to justify your confidence. Sincerely, [SIGNATURE] Ronald Baron Chairman and Portfolio Manager February 12, 2003 * As of December 31st, 2002 the Morningstar(TM) peer group for the Baron Asset Fund is the mid-cap growth category, which currently consist of 731 mutual Funds. For the one year the Baron Asset Fund is ranked (by total return) 125 out of the 731 Funds that disclosed their data. For three years the Baron Asset Fund is ranked (by total return) 125 out of the 536 Funds that disclosed their data. For five years the Baron Asset Fund is ranked (by total return) 237 out of the 374 Funds that disclosed their data. For ten years the Baron Asset Fund is ranked (by total return) 23 out of the 125 Funds that disclosed their data. Morningstar Principia Pro does not calculate comparative performance since inception (06/12/87) of Baron Asset Fund vs. its small cap peers. The prospective performance for the companies discussed herein are based on our internal analysis and reflect our opinions only. We consider our analysis rigorous -- we visit plants, interview executives and speak with employees as well as their competitors. We evaluate virtually all publicly available information, as well as review outside research reports. We, however, make no guarantees of future performance of the securities, and our opinions are subject to change. Source of all data herein: Baron Capital, Inc. 8 [REGISTERED LOGO] -------------------------------------------------------------------------------- 2 BARON GROWTH FUND -------------------------------------------------------------------------------- PERFORMANCE...................................................................9 PORTFOLIO STRUCTURE...........................................................9 PORTFOLIO ADDITIONS..........................................................10 767 Fifth Avenue NY, NY 10153 212.583.2100 1.800.99.BARON BaronFunds.com BARON GROWTH FUND QUARTERLY REPORT DECEMBER 31, 2002 [PHOTO OF RON BARON Ron Baron, Portfolio Manager DEAR BARON GROWTH FUND SHAREHOLDER: PERFORMANCE -------------------------------------------------------------------------------- Baron Growth Fund invests in small cap growth businesses that we perceive are value priced. Since the Fund's inception seven years ago, Baron Growth Fund has significantly outperformed the averages (see chart on page 10) and its small cap growth peer group as defined by Morningstar.* The Fund's performance in the December quarter, a loss of 0.22%, under performed its small cap growth peer group, which was up 4.88%. In calendar year 2002, a poor year for equities, in general, and especially for growth managers, the Fund outperformed by losing less than its peer group. The Fund's per share value fell 12.29%, compared to a loss of 28.6% by its peers. For the five-year period ending December 31, the Fund was up 6.43% per year versus a loss of 1.12% per year for the peer group. PORTFOLIO STRUCTURE -------------------------------------------------------------------------------- "WHETHER YOU THINK YOU CAN OR WHETHER YOU THINK YOU CAN'T ... YOU'RE PROBABLY RIGHT!" Although we are no fan of the 20th century industrialist who made this comment, we certainly agree with his assessment that confidence impacts an individual's performance. We think the affect of confidence upon businesses' performance is as important. During the past few years, executives have not seen significant economic recovery materialize and this year are planning to improve profitability with little revenue growth. This means fewer people, flat capital spending and flat costs. Company after company to whom we speak is carefully scrutinizing capital budgets and hiring. And, has little appetite even for projects like special targeted sales promotions that offer two and three times paybacks in just months! Spending restraints, coupled with hiring freezes and layoffs to improve profits, have the perverse but predictable affect of slowing our recovery. Mid-twentieth century, Henry Ford was showing Walter Reuther, the President of the United Auto Workers Union, through Ford's most recently built and most highly automated factory. "Mr. Reuther, we are making so much progress automating the manufacture of Ford automobiles that soon we won't need any of your workers in our plants." "Mr. Ford," Mr. Reuther replied, "just whom do you then expect to purchase your automobiles?" Baron Growth Fund invests principally in smaller companies we think can grow significantly even if our economy does not. These businesses are principally ones that we think will benefit from long lasting "mega-trends" like increased demand for education, healthcare, security, insurance and data base marketing; expansion of gaming into new jurisdictions; tort reform; and greater use of technology to improve productivity and boost revenues. Education, since in a technology-based society we need to be educated to be secure in our jobs and better provide for our families. Efficient providers of healthcare, since it's 13% of our economy and growing faster than the economy. This as our citizens demand universal care and insurance for prescription drugs; and the segment of our citizenry that uses the most healthcare services, the elderly, is our most rapidly growing population segment. The need BARON GROWTH FUND -------------------------------------------------------------------------------- for more and better security for our citizens and businesses could not be more obvious. The expansion of gaming is a way states can narrow their budget deficits. Tort reform is a necessity for many businesses and a part of the political agenda that seems likely to achieve increasing success. Technology to improve productivity and boost revenues is cheap and getting cheaper. Due to many factors, not least the disaster of eighteen months ago, insurance rates and profits are likely to grow strongly for at least several years. Baron Growth Fund has also invested in several businesses that have been affected by slower economic growth. Travel and vacations are a large part of both our economy and lifestyles and, although their long term growth has been substantial, this is one of the few years that, for obvious reasons, the sector has lagged. We do not expect this to continue. Nor do we expect retail sales to lag for long. America is a nation of consumers. Retail strategies that offer quality, value and service should again flourish. We have also invested in businesses that we think will benefit as spending like targeted marketing to boost revenues increases. With the "multiple contraction" of the last five years, on average earnings multiples have fallen by about half during this period, and we are currently able to invest in many growth businesses at what we think are value prices. Table I Portfolio Metrics. -------------------------------------------------------------------------------- Est. P/E Forward 21.3x Est. 5 Year EPS Growth Rate 25.8% Median Market Cap $1.13 billion Equity Securities 84 -------------------------------------------------------------------------------- Table II Industry Focus -------------------------------------------------------------------------------- Business Services 11.2% Healthcare 10.6% Recreation and Resorts 8.2% Financial 8.3% Retail Trade 7.1% Media and Entertainment 6.7% Hotels and Lodging 6.4% Restaurants 6.3% Other 23.7% Cash 11.5% -------------------------------------------------------------------------------- PORTFOLIO ADDITIONS. NEW AND EXISTING HOLDINGS. During the fourth quarter Baron Growth Fund added significantly to several existing investments. The Fund increased its investment in the leading nursing home provider, Manor Care. Manor Care's share price continued under pressure as investors worried about reimbursement issues. However, we believe the company has successfully transformed itself in the past few years from a business dependent upon long term residential care for the frail elderly to a business that provides lower cost care to sub-acute rehab patients. In addition, it has increased its hospice care and home care businesses and is apparently making progress to resolving patient liability problems. Its occupancy levels have increased to a two year high despite its emphasis on shorter stay patients. The Fund also increased in January 2003, its investment in leading drug discovery company Charles River Labs as investors worried about the long term growth of their drug discovery and development services businesses. The company is the leading provider of live animals for drug research which business continues to grow at record levels. The company's toxicology businesses have slowed in the short term due to increased industry capacity but, we believe, should begin to grow more rapidly again as competitive capacity is absorbed. [BAR GRAPHS] --------------------------------------------------------------------------------
* S&P 500 AND RUSSELL 2000 ARE WITH DIVIDENDS. THE S&P 500 AND RUSSELL 2000 ARE UNMANAGED INDEXES. THE S&P 500 MEASURES THE PERFORMANCE OF THE STOCK MARKET IN GENERAL; THE RUSSELL 2000 OF SMALL AND MID-SIZED COMPANIES. ** THE PERFORMANCE DATA IN THE GRAPHS DOES NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON DISTRIBUTIONS OR REDEMPTION OF FUND SHARES. 10 BARON GROWTH FUND -------------------------------------------------------------------------------- The Fund increased its investment in the leading manufacturer and provider of PET scanners and services, CTI Molecular. Sales of PET scanners are increasing at a very rapid rate, placements were up 40% in the December 2002 quarter and backlogs reached a record $152 million, up 50%. Sales of radiopharmaceuticals used in these scans increased 31%. The company recently hired the head of competitor GE's PET scanner sales to head their self distribution efforts to non-hospital practices which seems to be meeting very good results. The stock has fallen recently as investors were concerned that this new sales effort would penalize short term profits. I thought I'd let our analysts describe in more detail several additional significant purchases during the quarter. Symyx' combinatorial chemistry experiments win increasing acceptance. (Eytan Friedman) Symyx is a pioneer in the use of high speed experiments for the discovery of new materials. Its technologies (i.e. instruments, software, methods) enable it to generate and screen thousands of unique materials at a time. It performs experiments in parallel vs. in sequence. This approach is up to 100 times faster than traditional methods and reduces the cost per experiment to as low as 1% of traditional research methods. Its customers are in the life science, chemical and electronic industries. Symyx Technologies has entered 2003 well positioned. While 2002 was a difficult year for many of Symyx's customers, Symyx was still able to grow its revenues 8% while more than doubling its operating income. We think 2003 revenues will grow between 15-30% while operating income should at least double once again to more than $9 million. Symyx continues to generate positive free cash flow and its net cash position totaled $118 million, $3.75 per share, at December 31, 2002. Symyx's industry dominance continued to grow in 2002 as its patent position increased to over 90 patents issued (compared to 42 at December 2001) with more than 390 patent applications worldwide, covering methodology, composition of matter, instrumentation and software. In early 2003, the second material discovered by Symyx, an x-ray storage phosphor, is in the process of being commercialized by the Belgium based company Agfa-Gevaert NV. A phosphor is an inorganic material that absorbs x-ray radiation and stores the x-ray. This new Symyx discovered phosphor will allow improved image quality which means that the patient will now be able to receive less radiation for an x-ray of comparable quality or can receive a similar radiation dose with improved x-ray image quality. Agfa, a Belgium manufacturer of film and imaging equipment, had been trying for 15 years to develop better x-ray phosphors. Symyx synthesized and screened over 70,000 phosphors in 1.5 years and within the 70,000 they identified the desired x-ray phosphor which will be commercialized in 2003. Agfa estimates that its x-ray plates will generate revenues of approximately $100 million per year within the next 3 years and Symyx will receive a 3% royalty on these revenues or $3 million per year. Other near-term licensing opportunities relating to materials which Symyx has discovered include a DNA separation polymer for Applied Biosystems Group. We think this polymer could generate revenues of approximately $100 million of which Symyx could receive a 10-20% royalty or $10-20 million per year. Also, we expect in 2004 Dow Chemical will commercialize a polyolefin catalyst discovered by Symyx which, over time, could generate revenues of $500 million to $2 billion per year, of which Symyx could receive a 3-5% royalty or $15-100 million per year. At December 2002, Symyx's pipeline of discovered materials (defined as materials which Symyx has discovered that have met the criteria specified by Symyx's partner) which may be commercialized totaled 23. Symyx' Discovery Tools will continue to grow in 2003 with the major driver being its newly developed Drug Polymorph System which enables the rapid discovery, identification and characterization of novel crystalline salt and polymorphic forms of drug candidates, a vital step in drug discovery. In 2002, Merck and Eli Lilly purchased three of these $8 million tools and Symyx is expecting several other pharma companies to order this tool in 2003. We believe it is likely that a majority of pharma companies will ultimately purchase this unique tool which can make the drug discovery process much more effective and efficient. Symyx also expects to sign several new collaborative research agreements in 2003 based on ongoing discussions with a number of large chemical companies. Finally, Symyx hopes to grow its intellectual property licensing segment in 2003 and is currently in discussions with at least 10 companies. Symyx started this division in mid-'02 and has signed licensing agreements with three companies to-date, including GE and Bayer. JetBlue has breakout year. (Geoff Jones) At a time when the airline industry faces a barrage of negative headlines, we believe JetBlue Airways stands apart as a company that is not just surviving but thriving after only three years of service. The company was founded in 1998 by David Neeleman, a veteran of Southwest Airlines, who began with the blueprint 11 BARON GROWTH FUND -------------------------------------------------------------------------------- of Southwest's success for a low fare airline--a point-to-point route system, a fleet of common aircraft and a dedicated workforce--and tweaked it with newer amenities such as pre-assigned seating and better on-board entertainment. After filling out its management team with several key executives, JetBlue commenced service in February 2000 as the best financed start-up in aviation history. Since that first flight, the airline industry has suffered its worst three-year period ever, but JetBlue has excelled as evidenced by its industry-leading 16.5% operating margin in 2002. At the heart of JetBlue's success is what management refers to as the "JetBlue Experience." The company has created a unique in-flight experience with its fleet of new aircraft, all leather seating and 24 channels of free live television available in every seat. However, we believe it is excellent customer service that truly defines the JetBlue Experience. We have heard numerous stories of JetBlue employees going above and beyond expectations to help its customers, such as the time a JetBlue pilot offered his cell phone to passengers when weather delays caused a late arrival. As a personal example, I recently had a JetBlue flight attendant re-pack several overhead bins in order to fit my carry-on, allowing me to avoid the aggravation of checking the bag. With such great service, it is no surprise that 90% of JetBlue's customers rate the company as "much better" or "somewhat better" than any other airline they have ever flown. In 2002 JetBlue nearly doubled its revenue and operating margin while increasing its fleet from 21 to 37 planes and adding two cities to its system. With only 20 cities served today and much of the airline industry in turmoil, we believe JetBlue should have many years of growth ahead. The company is pursuing a strategy of measured growth given the need to balance capacity gains with the ability to maintain the JetBlue Experience for customers. JetBlue intends to add about 13-15 planes annually for the foreseeable future, with growth focused on three areas. First, it will add more frequency to existing routes. JetBlue's record load factor of 83% in 2002 (compared to 71% for the industry) suggests that there should be ample opportunity to add capacity to existing routes. Second, the company will "connect-the-dots" by adding flights between existing markets such as Long Beach and Ft. Lauderdale. Third, JetBlue hopes to add one to two new markets per year, although the pace of new destinations has been slower than the company originally envisioned because the demand on its existing routes has been higher than anticipated. By managing its growth effectively, we believe JetBlue could increase its earnings per share from $0.84 in 2002 to $1.20 in 2003, $1.60 in 2004 and $2.00 in 2005. If successful and assuming modest multiple contraction, such earnings growth should allow our investment in JetBlue to increase significantly over the next three to four years. The biggest risk is competition from the major airlines, which will not easily cede market share to JetBlue. However, we believe that JetBlue has such a superior product, workforce and balance sheet, that it will not only stand up to the competition but also take advantage of opportunities created as the majors address their own financial problems. LIN Television's business strong; will benefit from deregulation if it occurs; balance sheet improves. (Geoff Jones) LIN's business continues to be healthy, even after record political advertising in 2002, and deregulation continues to move forward in Washington. The company reported a pro forma revenue increase of 20.5% in the third quarter aided by heavy political spending and an easy comparison due to the impact of the terrorist attacks in 2001. This performance topped that of the television market in general because LIN's strong news operations garnered a disproportionate share of the political dollars in their markets. Looking to the fourth quarter, the heaviest for political spending, we believe LIN's growth should again be among the highest in the industry--in the mid- to high- teens if not better. Most importantly, television advertising remained strong after the elections and into 2003, which we estimate has been up mid- to high- single digits since early November. Comparisons will be difficult this year, but we believe that LIN's management is best in its class and will do an excellent job replacing political revenues while maintaining costs below 2002 levels. On the regulatory front, the FCC continues its review of media ownership regulations with a ruling expected by late spring. Under the Telecom Act of 1996, the Commission is required to conduct a biennial review of its media ownership rules, several of which have recently been struck down or remanded back to the FCC by the U.S. Court of Appeals in Washington D.C. The most important rule change from LIN's perspective would be a relaxation of the rule regarding ownership of two television stations in the same market. LIN is a pioneer in the acquisition and development of duopoly markets, and further relaxation of this rule should allow the company to pursue new growth opportunities through acquisition. Finally, LIN has had great success improving its balance sheet since its IPO last May. The company generated an estimated $30 million in free cash flow in the second half of 2002 despite heavy spending to upgrade its television stations for digital broadcasting. As a result of sharp increases in cash flow and 12 BARON GROWTH FUND -------------------------------------------------------------------------------- decreasing levels of net debt, Moody's and S&P recently upgraded LIN's debt to just below investment-grade, which should allow the company to replace $425 million expensive debt. As a result, the company's borrowing costs for this debt should drop by approximately 600 basis points, and net interest expense for 2003 should fall by over $20 million. Gray Television's small and mid-market television stations doing well; acquisition doubles size of company; potential deregulation a plus. (Geoff Jones) Gray Television is one of the largest owners and operators of middle- to small-market television stations in the United States. On a pro forma basis, the company owns 29 stations in 25 markets, which together cover about 5.3% of total U.S. households. The television station business is characterized by steady revenue growth over the last 50 years and significant free cash flow generation. In addition, regulatory changes are likely later this year that should highlight TV station asset values, much as deregulation did for radio station values in the mid-1990s. In many ways, Gray Television is similar to our original television investment, LIN TV, only Gray operates in smaller markets. Gray shares a common strategy with LIN to operate strong local news and weather franchises in their markets and to make selective acquisitions of stations where management can improve operations. Gray operates the number one local news franchise in 23 of its 29 markets. This is important because news leaders tend to take a disproportionate share of the local advertising dollars available in a market. Local advertising tends to be more stable than national, which helps Gray outperform in weak ad markets, but news dominance also allows Gray to capture the largest chunk of political dollars during campaign seasons. Gray recently completed a major acquisition that about doubled the size of the company. Gray acquired 15 stations from Benedek Broadcasting for an attractive multiple of about 10 times current year cash flow. We believe the stations acquired by Gray fit extremely well with the company's existing portfolio of stations as they are all affiliates of one of the three major networks, have strong news operations and are located in similar sized markets (roughly 50- 200). While the Benedek stations were already well run with margins similar to those of Gray's properties, we believe there are several benefits to the transaction, including scale-driven cost savings, greater geographic diversity and increased investor awareness of the larger company. One area of difference from LIN concerns duopolies--owning two television stations in the same market. Multiple station ownership is a key part of the LIN strategy, but Gray does not have any duopolies in its portfolio, which is a reflection of the size of the markets in which it operates. Present regulations require there to be at least eight independent TV station "voices" in a market, which essentially limits duopolies to most of the top-50 markets. Thus, all of Gray's markets are too small to allow duopoly combinations, however, smaller markets also have much less competition. Of Gray's 25 markets, only seven have four or more stations, whereas the top-50 markets average about seven stations per market. As we have written before, the FCC is currently reviewing its rules related to most forms of media ownership, with decisions expected in the late spring this year. We believe that most of the television-related changes being contemplated would be beneficial to Gray, and that the chances of favorable decisions increased with Republican control of the Senate. The two potential changes most relevant to Gray (which also owns four daily newspapers representing 15% of total revenue) would be an easing of television duopoly rules and lifting of the ban on TV station/newspaper cross-ownership. If either of these occurs, Gray could make acquisitions to take advantage of the new rules, as well as become a much more attractive takeover candidate for a larger media conglomerate. TV stations have historically been free cash machines with high operating margins and low sustaining capital expenditures. Over the last five years, however, the industry has heavily invested in the government-mandated transition to digital television. While most large-market stations have substantially completed their investment, smaller-market stations were given more time to comply, and Gray's peak capex for digital television will extend through 2003. As a result, the company could see significant increases in free cash flow over the next several years as digital investments roll-off and free cash flow returns to a more normalized level. Specifically, Gray generated slightly positive free cash flow last year and we believe will have about $25 million of free cash flow this year, before ramping up to more than $50 million of free cash flow in 2004. This would equate to over $1.00 per share in free cash flow next year and at least 50% upside from the current stock price assuming a conservative multiple on that free cash flow. THANK YOU FOR INVESTING IN BARON GROWTH FUND -------------------------------------------------------------------------------- We understand that, for most of us, deciding how to invest your hard earned savings to pay for your children's education, to care for your parents or to fund your retirement is a very 13 BARON GROWTH FUND -------------------------------------------------------------------------------- difficult decision. We're certain that due to the extended 2000-2002 "bear market" in stocks, the investment losses we have all experienced during the past three years, the modest economic recovery from recession, to date, and, the continued very negative opinions of many well respected investment advisors, this decision cannot be any easier. We hope our shareholder letters, magazine, newspaper and television interviews and annual investment conferences have helped you think about issues that have made it easier for you to decide whether stocks, in general, are an appropriate investment. And, whether Baron Growth Fund, in particular, remains an attractive investment for you and your family. We thank you for choosing to join us as fellow shareholders in Baron Growth Fund. We will continue to work hard to justify your confidence. Sincerely, [SIGNATURE] Ronald Baron Chairman and Portfolio Manager February 12, 2003 * As of December 31st, 2002 the Morningstar(TM) peer group for the Baron Growth Fund is the small-cap growth category, which currently consist of 639 mutual Funds. For the one year the Baron Growth Fund is ranked (by total return) 6 out of the 616 Funds that disclosed their data. For three years the Baron Growth Fund is ranked (by total return) 46 out of the 469 Funds that disclosed their data. For five years the Baron Growth Fund is ranked (by total return) 40 out of the 336 Funds that disclosed their data. Morningstar Principia Pro does not calculate comparative performance since inception (01/03/95) of Baron Growth Fund vs. its small cap peers. The prospective performance for the companies discussed herein are based our internal analysis and reflect our opinions only. We consider our analysis rigorous -- we visit plants, interview executives and speak with employees as well as their competitors. We evaluate virtually all publicly available information, as well as review outside research reports. We, however, make no guarantees of future performance of the securities, and our opinions are subject to change. Source of all data herein: Baron Capital, Inc. 14 [REGISTERED LOGO] 3 BARON SMALL CAP FUND PERFORMANCE..................................................................15 767 Fifth Avenue NY, NY 10153 212.583.2100 1.800.99.BARON BaronFunds.com BARON SMALL CAP FUND QUARTERLY REPORT DECEMBER 31, 2002 [PHOTO OF CLIFF GREENBERG] Cliff Greenberg, Portfolio Manager DEAR BARON SMALL CAP FUND SHAREHOLDER: PERFORMANCE -------------------------------------------------------------------------------- Baron Small Cap Fund was flat in the December quarter. For the calendar year 2002, the Fund was down 9.7%. Our performance in the December quarter lagged the Russell 2000 (which was up 6%) and S&P 500 (up 8%). For the year, the Fund significantly outperformed the indexes and was one of the better performing small cap growth funds.* (Russell 2000 down 20.48% and S&P 500 down 22.15%. See more detailed performance data on page 16.) The December quarter was unusual, in my opinion. The best performing equities were beaten up, low-priced, high-beta stocks with troubled underperforming businesses. These types of stocks had done poorly in 2002 prior to the fourth quarter. As these stocks rose, often the companies whose businesses and stocks had held up best were sold to fund the rotation into stocks with near-term momentum. What still makes the most sense to me is to acknowledge the difficult economic environment and to invest primarily in what I believe are strong, well- capitalized companies, with special businesses and management teams that will enable them to grow through these tough times. We remain diligent in our research to confirm that our businesses are performing presently and are, in our opinion, well positioned to do even better in any improved economic environment. We continue to make new or additional investments in these companies when we believe their stocks are undervalued based on our long range view. We do not think this is the time to be too speculative -- that an underperforming business will turn, that a stock price has "bottomed", that earnings or cash flow multiples will expand -- unless our independent research leads us to these conclusions. And we do not feel the urge to ever rotate into the flavor of the day, but only to invest in what makes the most sense to us. Our best performers in the quarter were Iron Mountain, Fair Isaac, Hot Topic and 99 Cents Only Stores. Iron Mountain reported improving strength in its base physical storage business and great initial interest in its "digital" offerings, especially their services to help business store and manage employee emails. The early returns from Fair Isaac's acquisition of HNC Software have been very positive, as the margins of the acquired business almost doubled out of the box and the combined entity has shown the desired revenue synergies. Hot Topic's same store sales accelerated to over 10% which drove earnings growth to 20%. The company's unique merchandise and collaborative relationship with its customer base continues to drive superior returns on investments, strong sales results and solid stock performance. 99 Cents Only Stores also had terrific sales results which helped its stock in the quarter. More exciting to us are the positive results from some of the company's new merchandising efforts, such as the rollout of milk and introduction of proprietary branded shampoo and detergents. We are also excited about the planned entrance into BARON SMALL CAP FUND -------------------------------------------------------------------------------- Texas with a major store rollout. We view this as which is a prelude to the national expansion of the concept. Our worst performers in the quarter were Career Education, United Surgical Partners (USPI), ProQuest and Catalina Marketing. Career Education was weak because of concerns that its earnings would slow, either because a more robust economy would increase employment and quell demand for further education or because the company's growth had been so strong it had to decelerate. We strongly believe that the company's success has not been predicated on a weak economy but on the rewards that higher education is offering students. Career Education's success derives from its particularly relevant curriculum, student satisfaction and the high placement rate of graduates. We do believe that the company's overall earnings growth rate, which has been about 50% per year for the last 3 years, will slow, but we still expect robust 30% plus growth going forward. We are also excited about the company's nascent online education efforts which we believe is a huge growth opportunity and could add significant equity value to shareholders. USPI's stock was under pressure because of concern over Medicare funding cuts and confusion about the company's reporting of its income in surgical facility partnerships. We believe that Medicare cuts won't affect the company much and that the company will provide additional disclosure to explain its accounting. We feel the strong internal results that the company's centers are experiencing and the 80% plus returns they are generating from their new center development program will drive positive earnings growth and, as a result, a higher stock price. ProQuest reduced earnings projections for the fourth quarter and tempered estimates for `03 primarily because of tight funding in its library end markets. The stock now trades at under 9 times current year estimates. The company is in the early phase of rolling out important new growth initiatives, including online searchable versions of The New York Times and Wall Street Journal publications and digital course supplements for college professors and textbook publishers. Catalina Marketing announced that revenues in its Health Resources subsidiary, which sells advertising messages to drug companies, would be flat this fiscal year because of pharmaceutical manufacturer's unease with the regulatory environment for medical advertising. We still believe this subsidiary will be a major asset, though we admit its contribution will be delayed. Generally, we remain very enthused about the company's unique ability to enable "one-to-one" marketing and we believe they will be a strong grower in the future. PORTFOLIO COMPOSITION AND ACTIVITY -------------------------------------------------------------------------------- At the end of December, the Fund had about $744 million in assets. The Fund owned 69 securities. The top 10 positions equaled 32% of the portfolio. The industry groups with the highest concentrations were -- business services: 11%, retail: 11%, education: 11%, media and entertainment 10% and healthcare services 7%. We continue to [BAR GRAPHS] --------------------------------------------------------------------------------
* S&P 500 AND RUSSELL 2002 ARE WITH DIVIDENDS. THE S&P 500 AND RUSSELL 2000 ARE UNMANAGED INDEXES. THE S&P MEASURES THE PERFORMANCE OF THE STOCK MARKET IN GENERAL; THE RUSSELL 2000 OF SMALL AND MID-SIZED COMPANIES. ** THE PERFORMANCE DATA IN THE GRAPHS DOES NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON DISTRIBUTIONS OR REDEMPTION OF FUND SHARES. 16 BARON SMALL CAP FUND -------------------------------------------------------------------------------- actively manage the portfolio. We have added new names, increased stakes in some present holdings and sold off other stocks all together. In the quarter we added four new positions: American Tower, RH Donnelley, SkyWest and Penn National Gaming. [PIE CHART] INDUSTRY BREAKDOWN -------------------------------------------------------------------------------- Business Services 11.0% Consulting 3.7% Consumer Services 3.4% Education 10.5% Financial 4.7% Health Care Services 6.7% Health Care Facilities 4.9% Media and Entertainment 10.3% Printing and Publishing 3.7% Retail Trade 10.7% Restaurants 5.6% Other 17.8% Cash 7.0% TOP 10 EQUITY HOLDINGS -------------------------------------------------------------------------------- Career Education Corp. 6.7% ChoicePoint, Inc. 3.8% Radio One, Inc. 3.0% Iron Mountain, Inc. 3.0% Fair Isaac & Company, Inc. 2.9% Apollo Group, Inc. 2.8% Krispy Kreme Doughnuts 2.6% Charles River Labs Intl. 2.6% Weight Watchers Intl. 2.5% Casual Male 2.5% ----- Total 32.4% -------------------------------------------------------------------------------- American Tower is the largest owner of communications towers. The company is a former holding whose stock price has declined from $50 per share in early 2000 to under a dollar this fall. The stock fell because of a combination of capital structure issues and slowing antennae additions due to wireless carriers cutting capital spending. We re-entered the stock when we became convinced the company would address its liquidity concerns by selling non-core assets and restructuring certain obligations (which has been accomplished). We believe the business can still grow cash flow over 20% and we believe the stock is mispriced at under 10 times present cash flow. We purchased RH Donnelley after the company acquired the yellow page operations of Sprint Corp. Donnelley previously had been the sales agent for some of Sprint's books. Donnelley paid more than twice its former enterprise value for the acquisition and did so by taking on additional debt and selling new equity to a financial partner. Though we are wary of investing in leveraged companies these days, we feel the yellow page business is very stable and the current cash flow comfortably supports the new debt. We feel Donnelley's industry-leading management team will be able to grow cash flow nicely. The stub equity is trading under 10 times 2003 free cash flow, and, if all goes to plan, about 6 times our 2004 estimate. We believe this valuation offers us the potential for big equity returns. The airline industry is under tremendous pressure and is in a state of flux. Airline stocks have fallen because of some well publicized bankruptcies in the industry and concern over war and terrorism. And although it might not seem obvious, we believe periods of dislocation and change are buying opportunities. We continue to be excited about the prospects for our present holding, JetBlue. We believe JetBlue offers the unique combination of low fares and a preferred product. We expect the company to continue to grow rapidly and gain share, and that its success, and that of other low cost operators, is the root cause of the industry's woes. We have made additional investments in two other airlines we believe will be winners in the new environment. SkyWest is an operator of regional jets (RJ), which are smaller planes with 30, 50 and 70 seats. Major airlines are outsourcing unprofitable pieces of their route systems to the RJ operators who have substantially lower cost structures. They are contracting on a cost-plus basis, which we believe substantially reduces risk to the RJ operators. We think this model will be utilized more in the future and believe SkyWest, the lowest cost RJ operator, will be the primary beneficiary. We have also begun to buy WestJet, the low-cost, low-fare Canadian airline. Emulating the Southwest Air model, WestJet has taken huge market share and is growing rapidly. We believe it now trades at a cheap multiple because of all the turbulence in the industry. Penn National Gaming is a stock the other Baron funds have owned for a while. Generally, I am nervous about regional gaming operators because of the threat of increased competition from new jurisdictions' adapting gaming. In addition, there is a risk that states will raise taxes on existing operators to fund budget deficits. Because of this, we have sold some of our regional gaming holdings. But we are buying Penn because it is selling at less than 10 times earnings, proforma for their acquisition of Hollywood Casinos. The stock is five times potential earnings if we are correct that they will benefit from gaming at racetracks in Pennsylvania and from potential legislation granting additional slots in Illinois. In the quarter, we sold our holdings in Four Seasons and ResortQuest out of fear that the slump in the lodging industry will be protracted. This fear is based on persistent cost cutting by businesses and the pricing pressure caused by the effectiveness of the Internet as a bargaining tool. We sold Resources Connections and Entravision, which are fine companies, but traded at full multiples. We sold all of our Meridian Medical and half of our 17 BARON SMALL CAP FUND -------------------------------------------------------------------------------- TicketMaster which were acquired by other public companies during the period. OUTLOOK -------------------------------------------------------------------------------- It has obviously been a difficult market. Economic activity and related corporate earnings growth slowed in the December quarter, continuing the choppy pattern of the past few years. And now, as we wait to see how the geopolitical events play out, a new wave of fear, uncertainty and malaise seem to have enveloped the stock market. All decisions seem to be on hold, which is not good for the economy or stocks. But we expect this will pass sometime soon. When it does, it is my sense that pent-up consumer and corporate demand will drive the economy forward, aided by fiscal and monetary policy stimulus if needed. And when it does, we believe business will improve, investors will focus on the future and, as a result, stocks will perform better. We think it is a good time to invest in strong, well-positioned businesses at depressed prices. Our portfolio of niche, special companies now trades at very cheap levels when measured against our near-term and long-term profitability projections. We are optimistic about returns going forward. Very truly yours, [SIGNATURE] Cliff Greenberg Portfolio Manager February 12, 2003 * As of December 31st, 2002 the Morningstar(TM) peer group for the Baron Small Cap Fund is the small-cap growth category, which currently consist of 639 mutual Funds. For the one year the Baron Small Cap Fund is ranked (by total return) 4 out of the 616 Funds that disclosed their data. For three years the Baron Small Cap Fund is ranked (by total return) 117 out of the 469 Funds that disclosed their data. For five years the Baron Small Cap Fund is ranked (by total return) 39 out of the 336 Funds that disclosed their data. Morningstar Principia Pro does not calculate comparative performance since inception (10/ 01/97) of Baron Small Cap Fund vs. its small cap peers. The prospective performance for the companies discussed herein are based on our internal analysis and reflect our opinions only. We consider our analysis rigorous -- we visit plants, interview executives and speak with employees as well as their competitors. We evaluate virtually all publicly available information, as well as review outside research reports. We, however, make no guarantees of future performance of the securities, and our opinions are subject to change. Source of all data herein: Baron Capital, Inc. 18 [REGISTERED LOGO] 4 BARON iOPPORTUNITY FUND PERFORMANCE AND OVERVIEW.....................................................19 767 Fifth Avenue NY, NY 10153 212.583.2100 1.800.99.BARON BaronFunds.com BARON iOPPORTUNITY FUND QUARTERLY REPORT DECEMBER 31, 2002 [PHOTO OF MITCH RUBIN] Mitch Rubin, Portfolio Manager DEAR BARON IOPPORTUNITY FUND SHAREHOLDER: PERFORMANCE AND OVERVIEW -------------------------------------------------------------------------------- The iOpportunity Fund gained 14.6% during the December quarter. This performance was in line with the NASDAQ Composite (+14%), ahead of the S&P 500 (+8%) and well behind the performance of the Morgan Stanley Internet Index (+39%). Our gains in the quarter were fairly broad based as the market seemed to become a bit more optimistic about stocks in general, and technology oriented stocks in particular. Among our best performers in the quarter were Internet portal Yahoo, Internet close out retailer Overstock.com, advertising services firm Getty Images, Mediacom, a small cap cable company, Internet travel leader Expedia and Internet auction king eBay. The only significant losses in the quarter came from our video game software investments, Electronic Arts and Take-Two Interactive. Yet, while we had a profitable fourth quarter, it was far from the levels required to salvage the year as a whole and we are very disappointed to have finished 2002 with a substantial loss. For the full year, the iOpportunity Fund declined 29%, which was a bit better than the NASDAQ (-31.5%), behind the S&P 500 (-22%) and ahead of the MOX (-43%). We still had some very successful investments last year including Expedia, on-line bill payments company CheckFree, on-line educator University of Phoenix Online, Getty Images and Amazon.com. Yet these gainers were far outweighed by our poorer performers which included our cable holdings (Insight and Mediacom), Monster.com parent TMP Worldwide, electronics manufacturer Flextronics, e learning provider Skillsoft, wireless tower owner American Tower, professional services provider Accenture and financial services firm Charles Schwab. On March 1st of this year, the Fund will mark its three-year anniversary, albeit without any celebration. Certainly, much has changed in the past three years as we've weathered global unrest, economic uncertainty, shifts in political and social agendas, and, obviously, contraction in the equity markets, especially with respect to Internet and information technology companies. And yet, despite these changes, and despite our losses, we firmly believe that the purpose for which the fund was launched -- to focus on businesses that are taking advantage of the rapid changes being affected by the Internet and information technology -- remains as relevant and full of opportunity today as it was when we launched in the beginning of the year 2000. Although obviously with a lot less market excitement and enthusiasm. As we review below, despite the severe contraction in valuations across our universe, we believe that there is more proof than ever that, in a host of industries, those businesses that embrace the changes brought on by the Internet can and will take market and profit share from those that do not. And, we now have proof that they can do so profitably as, during 2002, a host of leading Internet companies generated substantial profits and/or free cash flow (some for the first time, others extending their previous profitability). We also remain convinced, that we are still in the very early innings of this BARON iOPPORTUNITY FUND -------------------------------------------------------------------------------- revolution, with the most sweeping changes in business and personal activity still ahead. Internet users and usage continues to grow and broadband penetration to the home has begun to accelerate. Wireless data services, while slower to roll out than we and others had expected, have begun to penetrate select markets. And, despite the dramatic downturn in IT spending in the past several years, businesses continue to turn to the Internet as the tool of choice to increase productivity, lower cost and improve customer service. However, while neither our focus nor our optimism for the future of the Internet has changed over the past three years, we believe that there is a striking and fundamental difference between the environment for Internet and information technology companies today and the environment in February/March of 2000 when we launched. Then, in most instances, the Internet was relatively unproved as a viable business concept with most of the companies focused on Internet-based models generating substantial losses and using capital voraciously. Yet, then, the stocks of Internet companies traded at astronomical valuations. Obviously, the stocks were ahead of themselves. This stands in stark contrast to the environment today. By the end of the year 2002, many of the surviving concepts and business plans of the late 1990's have been proved with the leading Internet companies in many industries now generating substantial profits and free cash flow and taking significant market share from their off-line competitors. And, despite the fact that many of these dreams have now become realities, valuations have normalized and, in most cases, despite high growth and accelerating profit, most of our companies are valued at substantial discounts to their proven growth rates and more in- line with the overall market (despite the market's substantially slower growth). For example, companies in our portfolio that we value on earnings as opposed to cash flow, (which represents about two-thirds of the portfolio), we believe could grow their earnings over 55%, on average, this year and over 40% again in 2004. These companies are trading at about 22x this year's earnings and 17x 2004 profits, obviously well below their growth rates. This compares to the S&P 500 which is expected to have earnings growth of about 17% this year and 12% in 2004 and is valued at about 16x this year's earnings and 14x 2004. Thus, you are paying a very modest premium to the market today, and a substantial discount to growth, for companies that have proved their business models and, in our opinion, are still growing at extraordinary rates. In fact, with cash flow accelerating and valuations normalized, many of our companies, despite their substantial growth potential, are acting like value companies in that they have begun to repurchase their own shares in the open market. Expedia, Hotels.com, CheckFree, Ameritrade, Take-Two Interactive, TMP Worldwide, Skillsoft, Stamps.com, Getty Images, Accenture, Intel and Dell have all announced and/or continued share repurchase programs in the last several months. THAT WAS THEN, THIS IS NOW To illustrate the dramatic evolution of many of our companies we thought it would be informative to contrast the current business fundamentals for many of our companies with their fundamentals of 1999 and 2000 and in [BAR GRAPHS] --------------------------------------------------------------------------------
* THE NASDAQ COMPOSITE AND THE MORGAN STANLEY INTERNET INDEX ARE UNMANAGED INDEXES. THE NASDAQ COMPOSITE TRACKS THE PERFORMANCE OF MARKET-VALUE WEIGHTED COMMON STOCKS LISTED ON NASDAQ; THE MORGAN STANLEY INTERNET INDEX OF ACTIVELY TRADED, HIGH MARKET CAP INTERNET STOCKS DRAWN FROM NINE INTERNET SUBSECTORS. ** THE PERFORMANCE DATA IN THE GRAPHS DOES NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON DISTRIBUTIONS OR REDEMPTION OF FUND SHARES. 20 BARON iOPPORTUNITY FUND -------------------------------------------------------------------------------- relation to the fundamentals for their industries. TRAVEL During 1999 gross travel bookings on the Internet were less than $8 billion. While certainly a large number, this represented less than 2% of the total bookings for the industry as a whole. At the time, Expedia was booking approximately $800 million of annualized travel sales, which generated revenue of less than $80 million. And, on this base of business, Expedia was losing approximately $100 million per year. Yet, at the end of its first day of trading (November 10th, 1999), Expedia had an enterprise value of approximately $3 billion. Contrast that with today. For 2003, Expedia is projected to book approximately $7.5 billion in travel, nearly the total for the entire on-line industry 4 years ago. On this base, we believe Expedia should generate over $800 million in revenue and produce about $150 million in net income. Today, Expedia has an enterprise value of approximately $3.5 billion (or a little more than 23x profits). The growth statistics for Hotels.com are equally impressive. During 1999, Hotels.com (then Hotels Reservations Network), sold about 1.2 million room nights and generated about $160 million in revenue. Unlike many from the dot- com era, Hotels.com was profitable from the start and in 1999 generated about $24 million of operating cash flow. For 2003, we expect Hotels.com to book nearly 12 million room nights, generate over $1.2 billion of revenue and also produce about $150 million of net income. Hotels.com, today is valued at a little over $2 billion of enterprise value or less than 15x net income. While it takes little deep analytical thought to bash the airline industry, the contrast between that 65 year old industry and the Internet travel companies is truly striking. In its history since 1938, the airline industry in this country, by the end of 2003, will have cumulatively lost money. Not one dollar of cumulative net income despite untold billions of cumulative capital investment. And, even in its best years, the average airplane flies with over 25% of its seats empty. In poor years, that number rises to nearly 40%. The hotel industry's vacancy rates have averaged over 35% in nearly every year in the last 35 years. That is a tremendous amount of wasted capacity that has been fully purchased and paid for and that must be fully staffed. And, to note that the operating costs of the airline or hotel industry are not terribly flexible is another statement of the obvious. The combination of fixed costs for these companies, such as debt service for their assets, union labor agreements, energy costs and slotting fees, makes the hurdle to reach even break even, much less generate consistent profits, staggeringly high. Today, Internet travel reservations are approximately 10% of all travel bookings and many predict that they will be +20% within a few years. This does not necessarily bode well for the travel providers (airlines and hotel owners), but offers substantial opportunity for the on-line travel agents. Given their business models and cost structures, we think Expedia and Hotels.com should continue to take both market and profit share while also generating substantial excess free cash flow for shareholders. RETAILING At the time we launched the Fund, the publicly traded on-line retailing companies had just reported their fourth quarter and full year numbers for 1999. With the exception of eBay, not one of these retail concerns reported a profit either for the quarter or for the year. As the market changed its focus to profits, in the next two years, there was a brutal contraction in the valuation of any on-line retail concern as the market apparently assumed that any business selling goods on-line was sure to end up in bankruptcy and liquidation. And surely, many did. Nevertheless, since 1999, on-line retail sales have more than doubled from about $20 billion to roughly $43 billion in 2002. As a result, on-line sales now account for an estimated 5% of retail sales in U.S. brick-and-mortar stores and growing. This doubling in 4 years represents a growth rate in on- line sales of approximately 30% annually v. a 1-3% annual growth rate for retail sales in general. Even in this year's Christmas season, which is being called the worst holiday season for retail sales in the last decade, on-line retailers grew their sales 27% from the prior holiday season. Now, obviously, this sales growth would be of little interest if on-line retailers had not made good on their promise to leverage their Internet infrastructure to also grow profits. This seemed a bit far fetched in 1999, a year in which on-line retailing leader Amazon lost close to $650 million on sales of $1.6 billion. In fact, Amazon's profitless sales and the company's ultimate viability was one of the hottest topics in media and investing circles during the past couple of years as one after another of the market pundits predicted Amazon's, and all of on-line retailing's, demise. But, as time progressed, on-line retailers' managements became more focused on profits, shoppers became more accepting of buying goods on-line, and on-line usage continued to grow. And, one after another, on-line retailers began to approach and then surpass profitability as sales continued to rise. Moreover, after building out their infrastructure to service their virtual consumers, most on-line retailers have substantially lowered their capital expenditure needs despite accelerating sales growth, leading to fast rising returns on invested capital. For example, Amazon turned profitable in the fourth quarter of 2001, was profitable for the full year in 2002 and, 21 BARON iOPPORTUNITY FUND -------------------------------------------------------------------------------- during 2002 generated over $150 million in excess free cash flow. In the current year, we think Amazon will grow revenue a further 20-25%, nearly double its profit margins and should generate over $200 million in free cash. Moreover, the company has only $200 million of inventory (a scant 5% of sales) on hand, turns its inventory 19x per year and has capital expenditures of less than 3% of sales. By comparison, the off-line retail industry expects low single digit growth in organic sales and most are characterized by shrinking profit margins. Moreover, to generate growth, off-line retailers must invest in new stores, extra labor, substantial, locally stocked inventory and elaborate distribution networks -- all of which pressure long term returns on capital. For example, to support approximately $5 billion in sales, Barnes & Noble keeps nearly $2 billion of inventory on hand (over 30% of sales). And, Amazon is not alone. We have invested in several other on-line retail companies including 1-800-Flowers.com (who lost $7m in 1999 on $293m of sales and earned $11m in 2002 on nearly $500m of sales), Overstock.com (who lost over $20 million in 2000 but earned $1m in 2002 while sales grew over 150%), and drugstore.com (who lost $150 million in 2000 but we think should be profitable by the end of this year on 40% compound annual sales growth) -- all of whom are growing substantially faster and yet have lower expense and capital needs than their off-line counterparts. In addition, although we have focused this discussion on true bricks and mortar competitors, any discussion of the success of on-line retail would be lacking without at least some mention of eBay, whose gross merchandise sales, which are not included as sales for the on-line retail industry, went from $2.8 billion in 1999 to $14.9 billion in 2002. eBay has obviously come a long way from Pez dispensers with several disparate categories including autos, computers, consumer electronics, books, videos and music and sports all surpassing the $1 billion mark in sales. A truly amazing statistic is that, as profiled in a recent Wall Street Journal article, eBay is now the world's largest used car sales venue, a business they were not even in when we launched the Fund. ON-LINE ADVERTISING In 1999-2000, on-line advertising appeared to be a booming business, both in terms of newly minted dot-comers buying ads in traditional media outlets to build their brands and many on and off-line companies testing the Internet as a place to advertise to the vastly growing user community. Nothing highlights the frenzy of the era better than the January 2000 Super Bowl, when no less than 17 dot-com advertisers spent approximately $2 million each on Super Bowl ads. On-line advertising spending peaked in 2000 at $8.25 billion although much of that spending came from other dot-com advertisers, flush with cash from the "irrationally exuberant" capital markets. Over the next few years, as banner ads ultimately proved ineffective and countless dot-com's closed their virtual doors, on-line advertising contracted dramatically. Spending on Internet advertising fell 12% in 2001 and 15% in 2002, leading many to declare the Internet dead as a viable advertising medium. However, this free fall masks the explosive growth of pay-for-performance search on the Internet which has become an integral part of the advertising budgets of both surviving on-line companies and established, large scale off- line media buyers. We have profiled pay for performance pioneer Overture in several of our previous letters yet it bears repeating that, in 1999, Overture lost about $30 million on revenues of less than $27 million and few had ever heard of pay for performance search. Yet, over the next several years, pay- for-performance search emerged as a high-return way for advertisers to reach consumers who, by conducting an Internet keyword search for a particular product or service, are signaling their intent to transact business, and Overture had solidified its standing as the clear market leader. Indeed, by 2002, Overture had over 80,000 advertisers participating in its network, and it generated nearly $670 million in revenues (a 130% annual growth rate) and $100 million of operating profit. And, recently, Overture's management indicated that it expected to cross the $1 billion revenue threshold in 2003. The success of pay for performance search has helped usher in a new interest in other forms of on-line marketing and, for the first time in several years, the on-line advertising industry is expected to grow solidly during 2003 (especially if you exclude AOL Time Warner). For example, Yahoo's non search marketing services business grew sequentially in each of the last three quarters of 2002, culminating with 20% sequential growth in the seasonally strong 4th quarter. With on-line media consumption still expected by many to grow at a 30% annual rate for the next several years, dwarfing the growth rates of traditional media, most prognosticators now expect on-line advertising growth to outstrip the overall advertising market. We agree. BROADBAND In 1999 and 2000, U.S. cable companies were in the midst of yet another upgrade cycle, spending billions of dollars to enhance their networks to offer two way communication and advanced services, such as high-speed broadband Internet access, digital TV and video on demand. Investors were concerned whether the cable upgrade cycle would ever end, 22 BARON iOPPORTUNITY FUND -------------------------------------------------------------------------------- whether cable companies would get a reasonable return on their investments in their systems, and whether cable companies would ever generate free cash flow. With regard to broadband, in particular, analysts questioned whether always- on, high-speed Internet access had broad consumer appeal at price points around $40 per month, and whether cable broadband would prove to be a profitable business. Yet, despite these concerns, in 1999 and 2000, the cable industry traded at valuations at or above 14x operating cash flow and $4,500 to $5,000 per subscriber. Again, contrast that period with today. With their rebuilds completed, cable companies are drastically reducing their capital expenditures for 2003 and Cox, Time Warner Cable, Insight, and Mediacom, to name a few, are all expecting to begin generating free cash flow during 2003 (Comcast generated significant free cash flow in 2002 and expects to begin generating free cash flow again in 2004 after a year of high spending to upgrade newly acquired systems from AT&T). In addition, these investments have begun to bear fruit as customer adoption of high-speed Internet access, in particular, has been extremely strong. Back in 2000, approximately 40% of US households were connected to the Internet and only 5.5 million homes (13% of Internet users and about 5% of households) had a broadband connection. Today, over 50% of US households have an Internet connection, with about 18 million homes (30% of Internet users and about 16% of households) having high-speed broadband. According to Nielsen/Net Ratings, over 25% of active users are now on broadband, and over half of all time on-line is via a broadband connection. Cable companies have garnered the lion's share of these broadband connections, about two thirds, as they have capitalized on their advantages against local phone companies in terms of footprint, speed, price, and ease of customer installation. Moreover, broadband has proved to be a very profitable product. Rather than lowering prices, as first feared, the price of cable broadband service has actually increased since 2000 as most of the local broadband competitors (mostly telecom firms) have exited the business. As a result, in what was originally thought to be a 25-30% margin business, many cable firms now report incremental operating cash flow margins north of 50% on their broadband products. Because we expect the number of homes taking the service to continue to grow at a 30%-plus rate for the next several years, this should be a key profit driver for the cable industry in the near future. We think this should help the cable industry accelerate both its earnings and cash flow growth into the double digits. And yet, despite this success in answering many of the concerns from three years ago, today, most cable companies trade at only 10x operating cash flow and less than $3,500 per subscriber. CONCLUSION -------------------------------------------------------------------------------- In addition to those profiled above, there are a host of other industries or industry sectors that have equally compelling case studies for market and profit share growth in the past three years as a result of the Internet. They include on-line education, the digitization of media, data and information services expansion, a cadre of financial services transitioning to the net, the explosion of wireless data services and many others. These are some of the core themes in which the iOpportunity Fund is invested and provides the basis for our continued optimism for the Fund as we enter 2003. As a whole, we believe the companies in which we're investing have high growth rates (40-50% in revenues and profits), reasonable valuations (about 20x profits and 10x cash flow) and are extremely healthy (most of our companies have substantial cash balances and little, if any, debt). We have, over the past 3 years written letters each quarter to explain our thought process and our investment strategy. And, obviously, this has been against the backdrop of a historically difficult stock market. While it is not easy to see from our performance, the evolution of the Internet has continued and many of the concepts that excited us and led to the launch of this Fund are still very much intact. We continue to believe that the Internet presents extraordinary growth-oriented investment opportunities and that we are still at the tip of the iceberg in the development of the Internet and its impact on society. We remain extremely optimistic about the future of this Fund and are working tirelessly to produce better investment returns for our fellow shareholders. Sincerely, [SIGNATURE] Mitch Rubin Portfolio Manager February 12, 2003 The prospective performance for the companies discussed herein are based on our internal analysis and reflect our opinions only. We consider our analysis rigorous -- we visit plants, interview executives and speak with employees as well as their competitors. We evaluate virtually all publicly available information, as well as review outside research reports. We, however, make no guarantees of future performance of the securities, and our opinions are subject to change. Source of all data herein: Baron Capital, Inc. 23 BARON FUNDS -------------------------------------------------------------------------------- TABLE I (UNAUDITED) -------------------------------------------------------------------------------- PORTFOLIO MARKET CAPITALIZATION -------------------------------------------------------------------------------- Baron Asset Fund invests primarily in small and medium sized companies; Baron Growth Fund and Baron Small Cap Fund invest primarily in small companies. Table I ranks the Funds' investments by their current market capitalization which often is greater than the market capitalization of the companies at the time in which they were first purchased. BARON ASSET FUND -------------------------------------------------------------------------------
Equity % of Market Cap Net Company (in millions) Assets -------------------------------------------------------------------------------- Large Capitalization -------------------------------------------------------------------------------- Charles Schwab Corp. ................................ $14,579 8.0% Medium Capitalization -------------------------------------------------------------------------------- Anthem, Inc. ........................................ $ 8,897 1.8% Zimmer Holdings, Inc. ............................... 8,098 0.5 Apollo Group, Inc., Cl A ............................ 7,691 10.0 Weight Watchers Intl., Inc. ......................... 4,881 0.9 ChoicePoint, Inc. ................................... 3,390 11.0 XTO Energy, Inc. .................................... 3,128 1.1 Dollar Tree Stores, Inc. ............................ 2,805 2.5 Robert Half Intl., Inc. ............................. 2,792 3.4 ---- 31.2% Small Capitalization -------------------------------------------------------------------------------- Cox Radio, Inc., Cl A ............................... $ 2,288 1.2% Hispanic Broadcasting Corp. ......................... 2,236 0.7 Polo Ralph Lauren Corp., Cl A ....................... 2,235 4.7 WellChoice, Inc. .................................... 2,000 0.2 Krispy Kreme Doughnuts, Inc. ........................ 1,898 0.6 99 Cents Only Stores ................................ 1,883 0.1 The Cheesecake Factory, Inc. ........................ 1,831 0.4 Manor Care, Inc. .................................... 1,793 1.9 Charles River Laboratories Intl., Inc. .............. 1,737 0.5 Harte-Hanks, Inc. ................................... 1,699 0.2 Radio One, Inc. ..................................... 1,529 0.6 Extended Stay America, Inc. ......................... 1,384 0.6 Education Mgmt. Corp. ............................... 1,326 2.5 Ethan Allen Interiors, Inc. ......................... 1,298 2.8 DeVry, Inc. ......................................... 1,161 2.7 Wynn Resorts, Ltd. .................................. 1,020 1.6 Four Seasons Hotels, Inc. ........................... 978 0.6 Southern Union Co. .................................. 917 2.2 Seacor Smit, Inc. ................................... 887 3.4 Choice Hotels Intl., Inc. ........................... 843 4.6 Penn National Gaming, Inc. .......................... 635 0.4 Kerzner Intl., Ltd. ................................. 573 2.5 Natuzzi S.p.A. ...................................... 556 0.3 Sotheby's Hldgs., Inc., Cl A ........................ 553 6.7 Vail Resorts, Inc. .................................. 534 7.0
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Equity % of Market Cap Net Company (in millions) Assets -------------------------------------------------------------------------------- Small Capitalization (Continued) -------------------------------------------------------------------------------- Saga Comm., Inc., Cl A .............................. $398 4.1% Libbey, Inc. ........................................ 385 2.7 Alexander's, Inc. ................................... 323 1.0 Smart and Final, Inc. ............................... 153 0.6 DVI, Inc. ........................................... 114 0.4 ---- 57.8%
BARON GROWTH FUND -------------------------------------------------------------------------------
Equity % of Market Cap Net Company (in millions) Assets -------------------------------------------------------------------------------- Medium Capitalization -------------------------------------------------------------------------------- Apollo Group, Inc., Cl A ............................ $7,691 1.3% Weight Watchers Intl., Inc. ......................... 4,881 0.8 ChoicePoint, Inc. ................................... 3,390 3.8 University of Phoenix Online ........................ 3,081 2.9 Dollar Tree Stores, Inc. ............................ 2,805 0.9 Robert Half Intl., Inc. ............................. 2,792 0.5 BlackRock, Inc., Cl A ............................... 2,554 1.1 ---- 11.3% Small Capitalization -------------------------------------------------------------------------------- Polo Ralph Lauren Corp., Cl A ....................... $2,235 0.6% Fair, Isaac and Co., Inc. ........................... 2,166 2.5 Community Health Systems, Inc. ...................... 2,034 0.2 Krispy Kreme Doughnuts, Inc. ........................ 1,898 3.1 The Cheesecake Factory, Inc. ........................ 1,831 1.6 Manor Care, Inc. .................................... 1,793 2.4 Charles River Laboratories Intl., Inc. .............. 1,737 1.9 JetBlue Airways Corp. ............................... 1,714 1.7 Harte-Hanks, Inc. ................................... 1,699 1.3 Getty Images, Inc. .................................. 1,638 1.0 Chico's FAS, Inc. ................................... 1,605 1.8 Waddell & Reed Financial, Inc., Cl A ................ 1,579 0.2 Radio One, Inc. ..................................... 1,529 1.2 CheckFree Corp. ..................................... 1,419 0.9 Chicago Mercantile Exchange Holdings, Inc. .......... 1,389 0.4 Extended Stay America, Inc. ......................... 1,384 2.1
24 BARON FUNDS -------------------------------------------------------------------------------- BARON GROWTH FUND -------------------------------------------------------------------------------
Equity % of Market Cap Net Company (in millions) Assets -------------------------------------------------------------------------------- Small Capitalization (Continued) -------------------------------------------------------------------------------- Petco Animal Supplies, Inc. ......................... $1,344 1.2% Education Mgmt. Corp. ............................... 1,326 0.8 Ethan Allen Interiors, Inc. ......................... 1,298 1.7 Premcor, Inc. ....................................... 1,290 0.5 LIN TV Corp., Cl A .................................. 1,227 2.9 Hilb, Rogal & Hamilton Co. .......................... 1,203 0.4 Entravision Comm. Corp., Cl A ....................... 1,196 0.1 LNR Property Corp. .................................. 1,179 0.4 DeVry, Inc. ......................................... 1,161 0.7 Jefferies Group, Inc. ............................... 1,130 1.9 CTI Molecular Imaging, Inc. ......................... 1,050 1.3 Wynn Resorts, Ltd. ................................. 1,020 2.3 Panera Bread Co., Cl A .............................. 1,014 0.5 Catalina Marketing Corp. ............................ 1,007 1.5 Linens `n Things, Inc. .............................. 996 0.5 Arbitron, Inc. ...................................... 990 2.2 Four Seasons Hotels, Inc. ........................... 978 2.6 Southern Union Co. .................................. 917 1.9 Boyd Gaming Corp. ................................... 910 0.1 Gabelli Asset Mgmt., Inc., Cl A ..................... 905 0.7 Seacor Smit, Inc. ................................... 887 1.6 Arch Capital Group, Ltd. ............................ 860 1.9 Choice Hotels Intl., Inc. ........................... 843 1.7 Anteon Intl., Corp. ................................. 824 0.7 Crown Castle Intl., Corp. ........................... 803 0.2 Cambrex Corp. ....................................... 784 0.9 Nasdaq Stock Market, Inc. ........................... 782 0.3 Ralcorp Hldgs., Inc. ................................ 755 0.2 Insight Comm. Co., Inc., Cl A ....................... 747 0.6 Kronos, Inc. ........................................ 729 1.0 AMN Healthcare Services, Inc. ....................... 727 0.3 American Tower Corp., Cl A .......................... 690 0.7 Penn National Gaming, Inc. .......................... 635 1.8 AMERIGROUP Corp. .................................... 619 0.2 Intrawest Corp. ..................................... 586 0.6 Kerzner Intl., Ltd. ................................. 573 2.1 PRG-Schultz Intl., Inc. ............................. 564 1.1 Natuzzi S.p.A. ...................................... 556 0.3 Sotheby's Hldgs., Inc., Cl A ........................ 553 0.4 ProQuest Co. ........................................ 549 0.2 Odyssey Healthcare, Inc. ............................ 539 1.0 Vail Resorts, Inc. .................................. 534 1.3 California Pizza Kitchen, Inc. ...................... 472 1.1 Spanish Broadcasting System, Inc., Cl A............................................... 466 0.2 Province Healthcare Co. ............................. 464 0.1 Advent Software, Inc. ............................... 446 0.2 Gray Television, Inc. ............................... 446 1.2 United Surgical Partners Intl., Inc. ................ 422 1.4
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Equity % of Market Cap Net Company (in millions) Assets -------------------------------------------------------------------------------- Small Capitalization (Continued) -------------------------------------------------------------------------------- AmSurg Corp. ........................................ $420 0.5% Saga Comm., Inc., Cl A .............................. 398 1.2 Symyx Technologies, Inc. ............................ 389 1.1 Viasys Healthcare, Inc. ............................. 388 0.5 Libbey, Inc. ........................................ 385 0.6 Centene Corp. ....................................... 362 1.2 Information Holdings, Inc. .......................... 339 0.2 Alexander's, Inc. ................................... 323 0.3 LendingTree, Inc. ................................... 288 0.2 Heidrick & Struggles Intl., Inc. .................... 266 0.4 Smart and Final, Inc. ............................... 153 0.4 DVI, Inc. ........................................... 114 0.2 ---- 77.2%
BARON SMALL CAP FUND -------------------------------------------------------------------------------
Equity % of Market Cap Net Company (in millions) Assets -------------------------------------------------------------------------------- Medium Capitalization -------------------------------------------------------------------------------- Apollo Group, Inc., Cl A ............................ $7,691 2.8% Weight Watchers Intl., Inc. ......................... 4,881 2.5 Westwood One, Inc. .................................. 3,964 1.6 ChoicePoint, Inc. ................................... 3,390 3.8 University of Phoenix Online ........................ 3,081 0.6 Ticketmaster ........................................ 3,056 0.9 Regal Entertainment Group, Cl A ..................... 2,814 1.0 Dollar Tree Stores, Inc. ............................ 2,805 0.7 Iron Mountain, Inc. ................................. 2,801 3.0 ---- 16.9% Small Capitalization -------------------------------------------------------------------------------- Fair, Isaac and Co., Inc. ........................... $2,166 2.9% Community Health Systems, Inc. ...................... 2,034 1.9 Krispy Kreme Doughnuts, Inc. ........................ 1,898 2.6 99 Cents Only Stores ................................ 1,883 1.7 Career Education Corp. .............................. 1,841 6.7 The Cheesecake Factory, Inc. ........................ 1,831 1.5 Charles River Laboratories Intl., Inc. .............. 1,737 2.6 JetBlue Airways Corp. ............................... 1,714 1.5 Radio One, Inc. ..................................... 1,529 3.0 Premcor, Inc. ....................................... 1,290 0.7 Interactive Data Corp. .............................. 1,259 2.3 LIN TV Corp., Cl A .................................. 1,227 1.9 Corporate Executive Board Co. ....................... 1,187 1.1 LNR Property Corp. .................................. 1,179 1.5 Waste Connections, Inc. ............................. 1,074 0.8 Wynn Resorts, Ltd. ................................. 1,020 0.9 Catalina Marketing Corp. ............................ 1,007 0.8 FTI Consulting, Inc. ................................ 955 1.6
25 BARON FUNDS -------------------------------------------------------------------------------- BARON SMALL CAP FUND -------------------------------------------------------------------------------
Equity % of Market Cap Net Company (in millions) Assets -------------------------------------------------------------------------------- Small Capitalization (Continued) -------------------------------------------------------------------------------- Gabelli Asset Mgmt., Inc., Cl A ..................... $905 1.2% P.F. Chang's China Bistro, Inc. ..................... 904 0.1 Ventas, Inc. ........................................ 903 0.5 R.H. Donnelley Corp. ................................ 871 1.1 Arch Capital Group, Ltd. ............................ 860 0.9 Anteon Intl., Corp. ................................. 824 1.9 Crown Castle Intl., Corp. ........................... 803 0.1 SkyWest, Inc. ....................................... 751 0.9 AMN Healthcare Services, Inc. ....................... 727 1.7 Hot Topic, Inc. ..................................... 711 1.8 Kroll, Inc. ......................................... 705 1.1 American Tower Corp. ................................ 690 0.8 Quiksilver, Inc. .................................... 658 1.3 Penn National Gaming, Inc. .......................... 635 0.9 Paxar Corp. ......................................... 579 0.4 Kerzner Intl., Ltd. ................................. 573 0.8 ProQuest Co. ........................................ 549 1.1 Actuant Corp., Cl A ................................. 541 0.8 Odyssey Healthcare, Inc. ............................ 539 0.9 Resources Connection, Inc. .......................... 509 0.5 California Pizza Kitchen, Inc. ...................... 472 1.4 Province Healthcare Co. ............................. 464 1.0 Cross Country, Inc. ................................. 455 1.4 Gray Television, Inc. ............................... 446 1.8 United Surgical Partners Intl., Inc. ................ 422 2.0 Kenneth Cole Productions, Inc., Cl A............................................... 397 0.6 Viasys Healthcare, Inc. ............................. 388 1.7 Aeropostale, Inc. ................................... 368 0.5 Information Holdings, Inc. .......................... 339 2.3 AMC Entertainment, Inc. ............................. 321 1.1 SkillSoft PLC ....................................... 274 0.4 Stelmar Shipping, Ltd. .............................. 253 0.7 MTR Gaming Group, Inc. .............................. 218 0.5 Overstock.com, Inc. ................................. 188 0.6 Pinnacle Entertainment, Inc. ........................ 180 0.2 Restoration Hardware, Inc. .......................... 151 1.0 Casual Male Retail Group, Inc. ...................... 132 2.5 DVI, Inc. ........................................... 114 0.2 Equity Marketing, Inc. .............................. 77 0.9 The Sports Club Co., Inc. ........................... 42 0.2 ---- 75.8%
BARON iOPPORTUNITY FUND -------------------------------------------------------------------------------
Equity % of Market Cap Net Company (in millions) Assets -------------------------------------------------------------------------------- Large Capitalization -------------------------------------------------------------------------------- Intel Corp. ......................................... $103,151 1.2% Nokia Corp. ADR ..................................... 74,150 1.1 Dell Computer Corp. ................................. 68,968 3.2 AOL Time Warner, Inc. ............................... 58,559 1.5 Comcast Corp., Cl A ................................. 30,614 2.7 eBay, Inc. .......................................... 20,938 4.3 Accenture, Ltd., Cl A ............................... 17,216 2.8 Charles Schwab Corp. ................................ 14,579 1.7 ---- 18.5% Medium Capitalization -------------------------------------------------------------------------------- Yahoo! Inc. ......................................... $ 9,661 1.3% Best Buy Co., Inc. .................................. 7,761 1.7 Electronic Arts, Inc. ............................... 7,243 3.9 Amazon.com, Inc. .................................... 7,206 1.9 Flextronics Intl., Ltd. ............................. 4,239 2.6 Expedia, Inc., Cl A ................................. 3,876 4.7 ChoicePoint, Inc. ................................... 3,390 2.8 Hotels.com, Cl A .................................... 3,158 5.2 University of Phoenix Online ........................ 3,081 4.5 ---- 28.6% Small Capitalization -------------------------------------------------------------------------------- Ameritrade Holding Corp. ............................ $ 2,435 1.1% Career Education Corp. .............................. 1,841 2.8 Getty Images, Inc. .................................. 1,638 4.1 Overture Services, Inc. ............................. 1,595 4.3 Tech Data Corp. ..................................... 1,522 2.8 CheckFree Corp. ..................................... 1,419 1.9 TMP Worldwide, Inc. ................................. 1,257 2.5 Mediacom Comm. Corp., Cl A .......................... 1,044 2.8 Research in Motion, Ltd. ............................ 1,020 0.7 Take-Two Interactive Software, Inc. ................. 962 3.0 Insight Comm. Co., Inc., Cl A ....................... 747 2.0 American Tower Corp. ................................ 690 1.4 1-800-FLOWERS.COM, Inc., Cl A ....................... 410 1.5 CNET Networks, Inc. ................................. 377 0.2 CoStar Group, Inc. .................................. 291 1.6 LendingTree, Inc. ................................... 288 2.0 SkillSoft PLC ....................................... 274 1.6 Netflix, Inc. ....................................... 243 0.3 Stamps.com, Inc. .................................... 228 0.7 iDine Rewards Network, Inc. ......................... 209 1.7 Overstock.com, Inc. ................................. 188 2.3 drugstore.com, Inc. ................................. 164 1.3 FindWhat.com ........................................ 136 0.2 SBA Comm., Corp. .................................... 21 0.9 ---- 43.7%
26 BARON FUNDS -------------------------------------------------------------------------------- TABLE II (UNAUDITED) -------------------------------------------------------------------------------- PORTFOLIO RISK CHARACTERISTICS -------------------------------------------------------------------------------- The Funds are diversified not only by industry, but also by external risk factors that might impact the companies in which the Funds invest. Table II displays some of the risk factors that are currently monitored and the percentage of each portfolio considered exposed to these factors. The Funds use this tool to avoid concentration of risk within the portfolios.
Baron Baron Baron Small Baron Asset Growth Cap iOpportunity Fund Fund Fund Fund ------------------------------------------------------------------------------------------------------------- % of % of % of % of Portfolio Portfolio Portfolio Portfolio ------------------------------------------------------------------------------------------------------------- Leverage (Debt > 40% of Market Cap.................... 14.8 16.8 14.2 7.7 Foreign Sales Dependent (Sales > 15%)....................................... 19.9 11.7 15.9 30.7 Oil Price Sensitivity................................. 17.7 13.7 4.9 9.8 Volatility (Beta > 1.2)............................... 11.1 9.9 10.1 59.5 NASDAQ Securities..................................... 18.0 30.6 33.0 70.8 Unseasoned Securities (Publicly owned for < 3 years)...................................... 5.5 25.2 27.6 19.8 (Publicly owned for < 1 year)....................................... 1.8 10.9 8.9 2.6 Turnarounds........................................... 19.0 6.4 4.8 2.4 Development Companies........................................... 3.2 3.4 3.2 2.7
TABLE III (UNAUDITED) -------------------------------------------------------------------------------- AVERAGE ANNUAL RETURNS AS OF DECEMBER 31, 2002 -------------------------------------------------------------------------------- BARON ASSET FUND
One year -20.0% -------------------------------------------------------------------------------- Two years -15.2% -------------------------------------------------------------------------------- Three years -10.3% -------------------------------------------------------------------------------- Four years -4.3% -------------------------------------------------------------------------------- Five years -2.6% -------------------------------------------------------------------------------- Ten years 9.9% -------------------------------------------------------------------------------- Since inception June 12, 1987 11.6% --------------------------------------------------------------------------------
BARON GROWTH FUND
One year -12.3% -------------------------------------------------------------------------------- Two years -0.6% -------------------------------------------------------------------------------- Three years -1.9% -------------------------------------------------------------------------------- Four years 8.1% -------------------------------------------------------------------------------- Five years 6.4% -------------------------------------------------------------------------------- Since inception January 3, 1995 16.9% --------------------------------------------------------------------------------
BARON SMALL CAP FUND
One year -9.7% -------------------------------------------------------------------------------- Two years -2.5% -------------------------------------------------------------------------------- Three years -7.8% -------------------------------------------------------------------------------- Four years 7.6% -------------------------------------------------------------------------------- Five years 6.5% -------------------------------------------------------------------------------- Since inception October 1, 1997 6.8% --------------------------------------------------------------------------------
BARON iOPPORTUNITY FUND
One year -29.0% -------------------------------------------------------------------------------- Two years -17.3% -------------------------------------------------------------------------------- Since inception February 29, 2000 -26.5% --------------------------------------------------------------------------------
The performance data represents past performance. Investment returns and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their cost. For more complete information about Baron Funds, including charges and expenses, call or write for a prospectus. Read it carefully before you invest or send money. This report is not authorized for use as an offer of sale or a solicitation of an offer to buy shares of Baron Funds unless accompanied or preceded by the Funds' current prospectus. 27 BARON ASSET FUND -------------------------------------------------------------------------------- PORTFOLIO HOLDINGS -------------------------------------------------------------------------------- December 31, 2002 (Unaudited)
Shares Cost Value ---------------------------------------------------------------------------------- COMMON STOCKS (96.98%) ---------------------------------------------------------------------------------- BUSINESS SERVICES (11.20%) 5,400,000 ChoicePoint, Inc.*# $ 64,450,172 $ 213,246,000 240,000 Harte-Hanks, Inc. 3,932,858 4,480,800 -------------- -------------- 68,383,030 217,726,800 CONSULTING (3.41%) 4,120,000 Robert Half Intl., Inc.* 16,213,908 66,373,200 CONSUMER SERVICES (7.60%) 14,448,000 Sotheby's Hldgs., Inc., Cl A# 295,802,875 130,032,000 385,200 Weight Watchers Intl., Inc.* 10,204,421 17,707,644 -------------- -------------- 306,007,296 147,739,644 EDUCATION (15.18%) 4,430,000 Apollo Group, Inc., Cl A* 46,253,806 194,920,000 3,100,000 DeVry, Inc.* 22,242,661 51,491,000 1,300,000 Education Mgmt. Corp.* 10,873,548 48,880,000 -------------- -------------- 79,370,015 295,291,000 ENERGY (4.51%) 1,500,000 Seacor Smit, Inc.*# 45,987,380 66,750,000 850,000 XTO Energy, Inc. 12,353,811 20,995,000 -------------- -------------- 58,341,191 87,745,000 FINANCIAL (8.44%) 14,363,300 Charles Schwab Corp. 40,534,628 155,841,805 1,056,400 DVI, Inc.*# 12,962,604 7,975,820 10,000 Moody's Corp. 463,600 412,900 -------------- -------------- 53,960,832 164,230,525 HEALTHCARE SERVICES (2.98%) 550,000 Anthem, Inc.* 30,294,687 34,595,000 270,000 Charles River Laboratories Intl., Inc.* 8,242,517 10,389,600 175,000 WellChoice, Inc.* 4,342,679 4,191,250 210,000 Zimmer Holdings, Inc.* 6,426,229 8,719,200 -------------- -------------- 49,306,112 57,895,050 HEALTHCARE FACILITIES (1.91%) 2,000,000 Manor Care, Inc.* 41,219,911 37,220,000 Hotels and Lodging (5.74%) 3,960,000 Choice Hotels Intl., Inc.*# 44,790,862 89,892,000 750,000 Extended Stay America, Inc.* 10,764,425 11,062,500 375,000 Four Seasons Hotels, Inc. 10,462,840 10,593,750 -------------- -------------- 66,018,127 111,548,250 MEDIA AND ENTERTAINMENT (6.61%) 1,000,000 Cox Radio, Inc., Cl A* 6,352,271 22,810,000 616,400 Hispanic Broadcasting Corp.* 4,018,393 12,667,020 290,000 Radio One, Inc., Cl A* 2,373,395 4,239,800 575,000 Radio One, Inc., Cl D* 4,119,202 8,297,250 4,240,000 Saga Comm., Inc., Cl A*# 27,365,261 80,560,000 -------------- -------------- 44,228,522 128,574,070 REAL ESTATE AND REITs (1.05%) 315,000 Alexander's, Inc.*# 20,542,256 20,333,250 RECREATION AND RESORTS (11.51%) 2,400,000 Kerzner Intl., Ltd.*# 77,808,281 48,192,000 525,000 Penn National Gaming, Inc.* 9,940,637 8,326,500 9,011,300 Vail Resorts, Inc.*# 217,335,050 136,701,421 950,000 Wynn Resorts, Ltd.* 12,348,586 12,454,500 1,459,408 Wynn Resorts, Ltd.*@ 30,030,772 18,176,197 -------------- -------------- 347,463,326 223,850,618 RETAIL TRADE (10.69%) 100,000 99 Cents Only Stores 2,809,179 2,686,000 2,000,000 Dollar Tree Stores, Inc.* 14,466,886 49,140,000 1,586,900 Ethan Allen Interiors, Inc. 45,279,203 54,541,753
Shares Cost Value ---------------------------------------------------------------------------------- RETAIL TRADE (continued) 4,175,000 Polo Ralph Lauren Corp., Cl A* $ 94,926,908 $ 90,848,000 2,040,000 Smart and Final, Inc.*# 23,797,489 10,608,000 -------------- -------------- 181,279,665 207,823,753 RESTAURANTS (0.93%) 320,000 Krispy Kreme Doughnuts, Inc.* 10,147,437 10,806,400 200,000 The Cheesecake Factory, Inc.* 6,388,948 7,230,000 -------------- -------------- 16,536,385 18,036,400 UTILITY SERVICES (2.25%) 2,650,000 Southern Union Co.* 39,303,655 43,725,000 WHOLESALE TRADE (2.97%) 2,030,000 Libbey, Inc.# 66,613,787 52,780,000 500,000 Natuzzi S.p.A. 7,782,344 5,080,000 -------------- -------------- 74,396,131 57,860,000 -------------- -------------- TOTAL COMMON STOCKS 1,462,570,362 1,885,972,560 -------------- -------------- ---------------------------------------------------------------------------------- CONVERTIBLE PREFERRED STOCKS (0.56%) ---------------------------------------------------------------------------------- EDUCATION (0.10%) 105,264 Apollo International, Inc. S-A CV Pfd.*@ 2,000,016 2,000,016 HEALTH SERVICES (0.46%) 5,753 Somerford Corp. S-A Conv. Pfd.* @ 9,000,000 9,000,051 -------------- -------------- TOTAL CONVERTIBLE PREFERRED STOCKS 11,000,016 11,000,067 -------------- -------------- ---------------------------------------------------------------------------------- WARRANTS (0.14%) ---------------------------------------------------------------------------------- REAL ESTATE AND REITs 2,127,660 Corrections Corporation of America Warrants Exp 09/29/2005*@ 0 2,647,518 -------------- -------------- Principal Amount ---------------------------------------------------------------------------------- CORPORATE BONDS (0.15%) ---------------------------------------------------------------------------------- HEALTH SERVICES $ 3,000,000 Somerford Corp. 8.50% Sub. Conv. Deb. due 04/23/2006@ 3,000,000 3,000,000 -------------- -------------- ---------------------------------------------------------------------------------- SHORT TERM MONEY MARKET INSTRUMENTS (2.91%) ---------------------------------------------------------------------------------- 6,502,917 Exxon Asset Management Co. 1.05% due 01/02/2003 6,502,917 6,502,917 49,997,083 American Express Corp. 1.05% due 01/02/2003 49,997,083 49,997,083 -------------- -------------- TOTAL SHORT TERM MONEY MARKET INSTRUMENTS 56,500,000 56,500,000 -------------- -------------- TOTAL INVESTMENTS (100.74%) $ 1,533,070,378 1,959,120,145 ============== LIABILITIES LESS CASH AND OTHER ASSETS (-0.74%) (14,318,503) -------------- NET ASSETS (EQUIVALENT TO $34.42 PER SHARE BASED ON 56,502,395 SHARES OF BENEFICIAL INTEREST OUTSTANDING) $ 1,944,801,642 ==============
--------------- % Represents percentage of net assets @ Restricted securities # Issuers that may be deemed to be "affiliated" * Non-income producing securities 28 BARON GROWTH FUND -------------------------------------------------------------------------------- PORTFOLIO HOLDINGS -------------------------------------------------------------------------------- December 31, 2002 (Unaudited)
Shares Cost Value --------------------------------------------------------------------------------- COMMON STOCKS (88.49%) ---------------------------------------------------------------------------------- BUSINESS SERVICES (11.18%) 990,000 Catalina Marketing Corp.* $ 26,108,396 $ 18,315,000 1,160,000 ChoicePoint, Inc.* 20,605,340 45,808,400 720,000 Fair, Isaac and Co., Inc. 26,866,415 30,744,000 840,000 Harte-Hanks, Inc. 14,660,830 15,682,800 312,000 Kronos, Inc.* 6,719,352 11,540,880 1,550,000 PRG-Schultz Intl., Inc.* 17,484,558 13,795,000 -------------- -------------- 112,444,891 135,886,080 CABLE (0.61%) 600,000 Insight Comm. Co., Inc., Cl A* 6,230,632 7,428,000 CHEMICAL (2.05%) 375,000 Cambrex Corp. 14,038,404 11,328,750 1,080,000 Symyx Technologies, Inc.* 16,571,171 13,597,200 -------------- -------------- 30,609,575 24,925,950 COMMUNICATIONS (0.97%) 2,500,000 American Tower Corp., Cl A* 9,256,026 8,825,000 800,000 Crown Castle Intl., Corp.* 3,043,909 3,000,000 -------------- -------------- 12,299,935 11,825,000 CONSULTING (0.91%) 310,000 Heidrick & Struggles Intl., Inc.* 5,169,079 4,547,700 400,000 Robert Half Intl., Inc.* 2,665,467 6,444,000 -------------- -------------- 7,834,546 10,991,700 CONSUMER SERVICES (1.16%) 550,000 Sotheby's Hldgs., Inc., Cl A 9,675,881 4,950,000 200,000 Weight Watchers Intl., Inc.* 5,882,958 9,194,000 -------------- -------------- 15,558,839 14,144,000 EDUCATION (5.77%) 360,000 Apollo Group, Inc., Cl A* 3,382,220 15,840,000 500,000 DeVry, Inc.* 5,592,453 8,305,000 270,000 Education Mgmt. Corp.* 2,528,484 10,152,000 1,000,000 University of Phoenix Online* 18,358,937 35,840,000 -------------- -------------- 29,862,094 70,137,000 ENERGY SERVICES (2.03%) 250,000 Premcor, Inc.* 5,563,712 5,557,500 430,000 Seacor Smit, Inc.* 17,331,488 19,135,000 -------------- -------------- 22,895,200 24,692,500 FINANCIAL (8.34%) 750,000 Arch Capital Group, Ltd.* 20,135,862 23,377,500 350,000 BlackRock, Inc., Cl A* 7,036,572 13,790,000 720,000 CheckFree Corp.* 10,197,061 11,520,720 100,000 Chicago Mercantile Exchange Holdings, Inc.* 4,003,385 4,366,000 364,800 DVI, Inc.* 5,100,020 2,754,240 299,000 Gabelli Asset Mgmt., Inc., Cl A* 4,438,566 8,981,960 110,000 Hilb, Rogal & Hamilton Co. 4,299,766 4,499,000 550,000 Jefferies Group, Inc. 23,156,033 23,083,500 200,000 LendingTree, Inc.* 2,708,066 2,576,000 401,500 Nasdaq Stock Market, Inc.* 3,844,925 4,015,000 120,000 Waddell & Reed Financial, Inc., Cl A 3,093,118 2,360,400 -------------- -------------- 88,013,374 101,324,320 FOOD AND AGRICULTURE (0.21%) 100,000 Ralcorp Hldgs., Inc.* 1,727,735 2,514,000 GOVERNMENT SERVICES (0.69%) 350,000 Anteon Intl., Corp.* 7,026,436 8,400,000 HEALTHCARE SERVICES (5.93%) 70,000 AMERIGROUP Corp.* 2,113,989 2,121,700 200,000 AMN Healthcare Services, Inc.* 3,035,952 3,382,000 450,000 Centene Corp.* 12,104,617 15,115,500 600,000 Charles River Laboratories Intl., Inc.* 18,081,728 23,088,000 650,000 CTI Molecular Imaging, Inc.* 12,288,985 16,029,000 340,000 Odyssey Healthcare, Inc.* 9,195,533 11,798,000 500,000 Rigel Pharmaceuticals, Inc.* 3,480,893 545,000 -------------- -------------- 60,301,697 72,079,200
Shares Cost Value --------------------------------------------------------------------------------- HEALTHCARE FACILITIES (4.65%) 325,000 AmSurg Corp. $ 8,078,543 $ 6,639,750 140,000 Community Health Systems, Inc.* 3,228,091 2,882,600 1,600,000 Manor Care, Inc.* 29,918,923 29,776,000 80,000 Province Healthcare Co.* 1,461,836 778,400 1,050,000 United Surgical Partners Intl., Inc.* 22,423,897 16,402,050 -------------- -------------- 65,111,290 56,478,800 HOTELS AND LODGING (6.39%) 890,000 Choice Hotels Intl., Inc.* 11,016,555 20,203,000 1,750,000 Extended Stay America, Inc.* 21,958,596 25,812,500 1,120,000 Four Seasons Hotels, Inc. 36,162,395 31,640,000 -------------- -------------- 69,137,546 77,655,500 MEDIA AND ENTERTAINMENT (6.70%) 70,000 Entravision Comm. Corp., Cl A* 587,566 698,600 1,500,000 Gray Television, Inc. 12,375,000 14,625,000 1,425,000 LIN TV Corp., Cl A* 31,605,631 34,698,750 275,000 Radio One, Inc., Cl A* 2,801,501 4,020,500 700,000 Radio One, Inc., Cl D* 7,400,336 10,101,000 775,250 Saga Comm., Inc., Cl A* 6,930,347 14,729,750 360,000 Spanish Broadcasting System, Inc., Cl A* 1,859,561 2,592,000 -------------- -------------- 63,559,942 81,465,600 MEDICAL EQUIPMENT (0.47%) 385,000 Viasys Healthcare, Inc.* 7,345,896 5,732,650 PRINTING AND PUBLISHING (3.54%) 790,000 Arbitron, Inc.* 26,317,446 26,465,000 380,000 Getty Images, Inc.* 7,729,005 11,609,000 187,400 Information Holdings, Inc.* 4,942,101 2,908,448 104,900 ProQuest Co.* 2,625,820 2,056,040 -------------- -------------- 41,614,372 43,038,488 REAL ESTATE AND REITs (0.73%) 60,000 Alexander's, Inc.* 4,501,290 3,873,000 140,000 LNR Property Corp. 4,786,725 4,956,000 -------------- -------------- 9,288,015 8,829,000 RECREATION AND RESORTS (8.18%) 100,000 Boyd Gaming Corp.* 1,172,300 1,405,000 540,000 Intrawest Corp. 9,241,143 6,696,000 1,250,000 Kerzner Intl., Ltd.* 29,852,921 25,100,000 1,400,000 Penn National Gaming, Inc.* 25,481,327 22,204,000 1,080,000 Vail Resorts, Inc.* 19,610,637 16,383,600 537,677 Wynn Resorts, Ltd. *@ 11,063,956 6,696,498 1,600,000 Wynn Resorts, Ltd. * 20,761,838 20,976,000 -------------- -------------- 117,184,122 99,461,098 RETAIL TRADE (7.06%) 1,140,000 Chico's FAS, Inc.* 11,750,605 21,557,400 450,000 Dollar Tree Stores, Inc.* 4,898,828 11,056,500 585,000 Ethan Allen Interiors, Inc. 15,303,824 20,106,450 282,500 Linens `n Things, Inc.* 6,832,678 6,384,500 625,000 Petco Animal Supplies, Inc.* 12,210,298 14,649,375 340,000 Polo Ralph Lauren Corp., Cl A* 7,136,041 7,398,400 900,000 Smart and Final, Inc.* 8,221,462 4,680,000 -------------- -------------- 66,353,736 85,832,625 RESTAURANTS (6.27%) 550,000 California Pizza Kitchen, Inc.* 12,351,307 13,860,000 1,100,000 Krispy Kreme Doughnuts, Inc.* 29,464,748 37,147,000 180,000 Panera Bread Co., Cl A* 6,502,412 6,265,800 525,000 The Cheesecake Factory, Inc.* 17,561,947 18,978,750 -------------- -------------- 65,880,414 76,251,550 SOFTWARE (0.20%) 175,000 Advent Software, Inc.* 2,314,808 2,385,250 TRANSPORTATION (1.67%) 753,450 JetBlue Airways Corp.* 17,203,017 20,343,150
29 BARON GROWTH FUND -------------------------------------------------------------------------------- PORTFOLIO HOLDINGS -------------------------------------------------------------------------------- December 31, 2002 (Unaudited)
Shares Cost Value --------------------------------------------------------------------------------- COMMON STOCKS (continued) ---------------------------------------------------------------------------------- UTILITY SERVICES (1.91%) 1,403,000 Southern Union Co.* $ 19,381,035 $ 23,149,500 WHOLESALE TRADE (0.87%) 280,000 Libbey, Inc. 8,084,057 7,280,000 320,000 Natuzzi S.p.A. 5,658,569 3,251,200 -------------- -------------- 13,742,626 10,531,200 -------------- -------------- TOTAL COMMON STOCKS 952,921,773 1,075,502,161 -------------- --------------
Principal Amount ---------------------------------------------------------------------------------- SHORT TERM MONEY MARKET INSTRUMENTS (11.23%) ---------------------------------------------------------------------------------- $ 99,994,167 American Express Corp. 1.05% due 01/02/2003 99,994,167 99,994,167 36,455,833 Exxon Asset Management Co. 1.05% due 01/02/2003 36,455,833 36,455,833 -------------- -------------- TOTAL SHORT TERM MONEY MARKET INSTRUMENTS 136,450,000 136,450,000 -------------- -------------- TOTAL INVESTMENTS (99.72%) $ 1,089,371,773 1,211,952,161 ============== CASH AND OTHER ASSETS LESS LIABILITIES (0.28%) 3,461,642 -------------- NET ASSETS (EQUIVALENT TO $26.90 PER SHARE BASED ON 45,178,868 SHARES OF BENEFICIAL INTEREST OUTSTANDING) $ 1,215,413,803 ===============
--------------- % Represents percentage of net assets @ Restricted securities * Non-income producing securities 30 BARON SMALL CAP FUND -------------------------------------------------------------------------------- PORTFOLIO HOLDINGS -------------------------------------------------------------------------------- December 31, 2002 (Unaudited)
Shares Value ------------------------------------------------------------------------------- COMMON STOCKS (91.43%) ADVERTISING (1.14%) 290,000 R.H. Donnelley Corp.* $ 8,499,900 BUSINESS SERVICES (10.99%) 325,000 Catalina Marketing Corp.* 6,012,500 725,000 ChoicePoint, Inc.* 28,630,250 500,000 Fair, Isaac and Co., Inc. 21,350,000 675,000 Iron Mountain, Inc.* 22,281,750 150,000 Resources Connection, Inc.* 3,481,500 ------------ 81,756,000 COMMUNICATIONS (0.92%) 1,600,000 American Tower Corp.* 5,648,000 152,000 Ascent Media Group , Inc.* 170,240 267,400 Crown Castle Intl., Corp.* 1,002,750 ------------ 6,820,990 CONSULTING (3.70%) 250,000 Corporate Executive Board Co.* 7,980,000 290,000 FTI Consulting, Inc.* 11,643,500 412,500 Kroll, Inc.* 7,870,500 ------------ 27,494,000 CONSUMER PRODUCTS (0.90%) 500,000 Equity Marketing, Inc.*# 6,685,000 CONSUMER SERVICES (3.40%) 325,000 Ticketmaster* 6,896,500 400,000 Weight Watchers Intl., Inc.* 18,388,000 ------------ 25,284,500 EDUCATION (10.54%) 475,000 Apollo Group, Inc., Cl A* 20,900,000 1,250,000 Career Education Corp.* 50,000,000 1,000,000 SkillSoft PLC (formerly SmartForce PLC ADR)* 2,750,000 133,333 University of Phoenix Online* 4,778,655 ------------ 78,428,655 ENERGY SERVICES (1.35%) 225,000 Premcor, Inc.* 5,001,750 335,000 Stelmar Shipping, Ltd.* 5,045,100 ------------ 10,046,850 ENVIRONMENTAL (0.78%) 150,000 Waste Connections, Inc.* 5,791,500 FINANCIAL (4.66%) 225,000 Arch Capital Group, Ltd.* 7,013,250 198,600 DVI, Inc.* 1,499,430 299,000 Gabelli Asset Mgmt., Inc., Cl A* 8,981,960 1,250,000 Interactive Data Corp.* 17,187,500 ------------ 34,682,140 GOVERNMENT SERVICES (1.94%) 600,000 Anteon Intl., Corp.* 14,400,000 HEALTHCARE SERVICES (6.64%) 750,000 AMN Healthcare Services, Inc.* 12,682,500 500,000 Charles River Laboratories Intl., Inc.* 19,240,000 750,000 Cross Country, Inc.* 10,462,500 201,500 Odyssey Healthcare, Inc.* 6,992,050 ------------ 49,377,050 HEALTHCARE FACILITIES (4.91%) 700,000 Community Health Systems, Inc.* 14,413,000 750,000 Province Healthcare Co.* 7,297,500 950,000 United Surgical Partners Intl., Inc.* 14,839,950 ------------ 36,550,450
Shares Value --------------------------------------------------------------------------- MANUFACTURING (1.23%) 134,300 Actuant Corp., Cl A* $ 6,238,235 200,000 Paxar Corp.* 2,950,000 ------------ 9,188,235 MEDIA AND ENTERTAINMENT (10.32%) 900,000 AMC Entertainment, Inc.* 7,965,000 1,350,000 Gray Television, Inc. 13,162,500 575,000 LIN TV Corp., Cl A* 14,001,250 1,550,000 Radio One, Inc., Cl D* 22,366,500 335,000 Regal Entertainment Group, Cl A* 7,175,700 325,000 Westwood One, Inc.* 12,142,000 ------------ 76,812,950 MEDICAL EQUIPMENT (1.70%) 850,000 Viasys Healthcare, Inc.* 12,656,500 PRINTING AND PUBLISHING (3.41%) 1,100,000 Information Holdings, Inc.*# 17,072,000 425,000 ProQuest Co.* 8,330,000 ------------ 25,402,000 REAL ESTATE AND REITs (2.01%) 325,000 LNR Property Corp. 11,505,000 300,000 Ventas, Inc. 3,435,000 ------------ 14,940,000 RECREATION AND RESORTS (3.43%) 315,000 Kerzner Intl., Ltd.* 6,325,200 425,000 MTR Gaming Group, Inc.* 3,383,000 400,000 Penn National Gaming, Inc.* 6,344,000 250,000 Pinnacle Entertainment, Inc.* 1,732,500 500,000 The Sports Club Co., Inc.* 1,150,000 500,000 Wynn Resorts, Ltd. * 6,555,000 ------------ 25,489,700 RETAIL TRADE (9.45%) 465,000 99 Cents Only Stores 12,489,900 350,000 Aeropostale, Inc.* 3,699,500 2,353,000 Casual Male Retail Group, Inc.*@# 9,105,874 200,000 Dollar Tree Stores, Inc.* 4,914,000 599,500 Hot Topic, Inc.* 13,716,560 225,000 Kenneth Cole Productions, Inc., Cl A* 4,567,500 325,000 Overstock.com, Inc.* 4,225,000 375,000 Quiksilver, Inc.* 9,997,500 700,000 Restoration Hardware, Inc.*@# 3,331,650 850,000 Restoration Hardware, Inc.*# 4,258,500 ------------ 70,305,984 RESTAURANTS (5.63%) 425,000 California Pizza Kitchen, Inc.* 10,710,000 575,000 Krispy Kreme Doughnuts, Inc.* 19,417,750 25,000 P.F. Chang's China Bistro, Inc.* 907,500 300,000 The Cheesecake Factory, Inc.* 10,845,000 ------------ 41,880,250 TRANSPORTATION (2.38%) 412,500 JetBlue Airways Corp.* 11,137,500 500,000 SkyWest, Inc. 6,535,000 ------------ 17,672,500 ------------ TOTAL COMMON STOCKS (Cost $551,450,598) 680,165,154 ------------
31 BARON SMALL CAP FUND -------------------------------------------------------------------------------- PORTFOLIO HOLDINGS -------------------------------------------------------------------------------- December 31, 2002 (Unaudited)
Shares Value -------------------------------------------------------------------------------- WARRANTS (0.27%) -------------------------------------------------------------------------------- RETAIL TRADE AND RESTAURANTS 1,407,353 Casual Male Retail Group, Inc. Warrants Exp 04/26/2007 (Cost $2,117,151)*@# $ 2,026,500 ------------
Principal Amount --------------------------------------------------------------------------- CORPORATE BONDS (1.33%) --------------------------------------------------------------------------- HEALTH SERVICES (0.04%) $3,250,000 U.S. Diagnostic, Inc. 9.00% Conv. Sub. Deb. due 03/31/2003 * 300,000 PRINTING & PUBLISHING (0.28%) 7,000,000 Penton Media, Inc. 10.375% Sr. Sub. NT due 06/15/2011 2,100,000 RETAIL TRADE AND RESTAURANTS (1.01%) 7,500,000 Casual Male Retail Group, Inc. 12.00% Senior Sub. Notes due 04/26/2007@ 7,500,000 ------------ TOTAL CORPORATE BONDS (Cost $12,245,349) $ 9,900,000 ------------
Principal Amount Value ------------------------------------------------------------------------------ SHORT TERM MONEY MARKET INSTRUMENTS (7.60%) -------------------------------------------------------------------------------- $56,500,000 Exxon Asset Management Corp. 1.55% due 10/01/2002 (Cost $56,500,000) $ 56,500,000 ------------ TOTAL INVESTMENTS (100.63%) (COST $622,313,098) 748,591,654 LIABILITIES LESS CASH AND OTHER ASSETS (-0.63%) (4,685,540) ------------ NET ASSETS (EQUIVALENT TO $13.37 PER SHARE BASED ON 55,656,937 SHARES OF BENEFICIAL INTEREST OUTSTANDING) $743,906,114 ============
--------------- % Represents percentage of net assets @ Restricted securities # Issuers that may be deemed to be "affiliated" * Non-income producing securities 32 BARON iOPPORTUNITY FUND -------------------------------------------------------------------------------- PORTFOLIO HOLDINGS -------------------------------------------------------------------------------- December 31, 2002 (Unaudited)
Shares Value ------------------------------------------------------------------------------ Common Stocks (89.95%) ------------------------------------------------------------------------------- ADVERTISING (4.54%) 19,000 FindWhat.com* $ 151,810 100,000 Overture Services, Inc.* 2,731,000 ------------ 2,882,810 BUSINESS SERVICES (5.29%) 45,000 ChoicePoint, Inc.* 1,777,050 140,000 TMP Worldwide, Inc.* 1,583,400 ------------ 3,360,450 CABLE (7.40%) 75,000 Comcast Corp., Cl A* 1,694,250 100,000 Insight Comm. Co., Inc., Cl A* 1,238,000 200,000 Mediacom Comm. Corp., Cl A* 1,762,000 ------------ 4,694,250 COMMUNICATIONS (3.21%) 250,000 American Tower Corp.* 882,500 45,000 Nokia Corp. ADR 697,500 35,000 Research in Motion, Ltd.* 459,200 ------------ 2,039,200 CONSULTING (2.84%) 100,000 Accenture, Ltd., Cl A* 1,799,000 CONSUMER PRODUCTS (0.74%) 100,000 Stamps.com, Inc.* 467,000 CONSUMER SERVICES (9.25%) 75,000 AOL Time Warner, Inc.* 982,500 45,000 Expedia, Inc., Cl A* 3,011,859 100,000 iDine Rewards Network, Inc.* 1,062,000 50,000 Yahoo! Inc.* 817,500 ------------ 5,873,859 EDUCATION (8.95%) 45,000 Career Education Corp.* 1,800,000 368,370 SkillSoft PLC (formerly SmartForce PLC ADR)* 1,013,018 80,000 University of Phoenix Online* 2,867,200 ------------ 5,680,218 ENTERPRISE HARDWARE (7.15%) 75,000 Dell Computer Corp.* 2,005,500 50,000 Intel Corp. 778,500 65,000 Tech Data Corp.* 1,752,400 ------------ 4,536,400 FINANCIAL (6.74%) 125,000 Ameritrade Holding Corp.* 707,500 100,000 Charles Schwab Corp. 1,085,000 75,000 CheckFree Corp.* 1,200,075 100,000 LendingTree, Inc.* 1,288,000 ------------ 4,280,575 HOTELS AND LODGING (5.16%) 60,000 Hotels.com, Cl A* 3,277,800 MANUFACTURING (2.58%) 200,000 Flextronics Intl., Ltd.* 1,638,000 MEDIA AND ENTERTAINMENT (7.09%) 50,000 CNET Networks, Inc.* 135,500 50,000 Electronic Arts, Inc.* 2,488,500 80,000 Take-Two Interactive Software, Inc.* 1,879,200 ------------ 4,503,200
Shares Value ------------------------------------------------------------------------------ PRINTING AND PUBLISHING (4.09%) 85,000 Getty Images, Inc.* $ 2,596,750 REAL ESTATE AND REITs (1.60%) 55,000 CoStar Group, Inc.* 1,014,750 RETAIL TRADE (13.32%) 150,000 1-800-FLOWERS.COM, Inc., Cl A* 937,500 65,000 Amazon.com, Inc.* 1,227,850 45,000 Best Buy Co., Inc.* 1,086,750 350,000 drugstore.com, Inc.* 840,000 40,000 eBay, Inc.* 2,712,800 20,000 Netflix, Inc.* 220,200 110,000 Overstock.com, Inc.* 1,430,000 ------------ 8,455,100 ------------ TOTAL COMMON STOCKS (Cost $55,174,716) 57,099,362 ------------ ------------------------------------------------------------------------------- Principal Amount ------------------------------------------------------------------------------- CORPORATE BONDS (0.85%) ------------------------------------------------------------------------------- COMMUNICATIONS $ 1,000,000 SBA Comm., Corp. 10.25% Sr. NT due 02/01/2009 (Cost $545,000) 540,000 ------------ ------------------------------------------------------------------------------- SHORT TERM MONEY MARKET INSTRUMENTS (9.59%) ------------------------------------------------------------------------------- 6,084,999 Exxon Asset Management Co. 1.05% due 01/02/2003 (Cost $6,084,999) 6,084,999 ------------ TOTAL INVESTMENTS (100.39%) (COST $61,804,715) 63,724,361 LIABILITIES LESS CASH AND OTHER ASSETS (-0.39%) (244,206) ------------ NET ASSETS (EQUIVALENT TO $4.16 PER SHARE BASED ON 15,259,787 SHARES OF BENEFICIAL INTEREST OUTSTANDING) $ 63,480,155 ============
--------------- % Represents percentage of net assets * Non-income producing securities 33 [REGISTERED LOGO] B A R O N F U N D S 767 Fifth Avenue NY, NY 10153 1QR03