Zazove Convertible Securities Fund, Inc.
Annual Report
December 31, 1999
TABLE OF CONTENTS
Portfolio Manager's Remarks 1
Report of Independent Public Accountants 2
Statement of Assets and Liabilities 3
Schedule of Investments 4
Statement of Operations 6
Statements of Changes in Net Assets 7
Statement of Cash Flows 8
Notes to Financial Statements 9
Financial Highlights 13
This report has been prepared for the general information of
shareholders in the Zazove Convertible Securities Fund, Inc.
Portfolio Manager's Remarks
Dear Convertible Securities Fund, Inc. Shareholders:
The final year of the millenium proved to be a solid year for your
Fund with a return of +22.50%. We are pleased that the Fund was able
to have a successful year in a period marked by an enormous divergence
within the financial markets. While 1999 was one of the best ever for
most technology-related investments, it was one of the worst ever for
the bond market.
Stock Markets
While the stock market experienced a generally favorable year, the
major stock indices masked an enormous divergence within the market.
Growth stocks, particularly technology and communication companies,
experienced an extraordinary year as evidenced by the NASDAQ's
unprecedented rise. Meanwhile, the balance of the stock market had a
rather mediocre year:
* 61% of NYSE stocks declined for the year
* Within the S&P 500, more than half of the stocks were down for
the year
* The Russell 1000 Growth Index was up 32.27%, while the Russell 1000
Value Index was up only 5.38%
Technology euphoria dominated the stock market: small-cap to large,
domestic and international. The small-cap Russell 2000 had its best
year in recent memory, yet the returns were largely driven by internet
and technology companies. International markets had a very strong year
but technology was once again the theme, particularly in Europe and
Asia. In sum, 1999 proved a solid year for global equity markets in
general and for growth, technology and momentum managers specifically.
Bond Markets
The bond market provided a stark contrast to the equity market during
1999. The worldwide recovery from 1998's international crisis left
bonds in a steady decline throughout the year. The yield on the
30-year treasury rose from 5.09% to 6.48%. The result was a total
return (including income) of -14.89% for the long bond, its worst year
ever. The sell-off extended throughout fixed-income classes and
included international, high-yield, and distressed markets. The only
safe havens within the bond market were extremely short maturities and
some isolated technology-related sectors within the high yield market.
Fund Performance
The Fund's strategy can be viewed as either a high-return alternative
to bonds or a low-risk alternative to stocks. Under either view, the
Fund had a solid 1999. Our convertible strategy solidly outperformed
a terrible bond market while enjoying substantial participation in the
stock market's advances. We were able to achieve these results with a
broadly diversified portfolio and a constant focus on managing risk.
As we enter the new millenium, we will continue to implement the Fund's
long term quantitative investment strategy to achieve our goal of
protection from significant stock market declines while allowing
participation in broad stock market advances.
Please do not hesitate to call us with your questions, comments and
suggestions. We appreciate the opportunity to provide our specialized
investment strategy for your Fund and we look forward to another
successful year in 2000.
Sincerely,
Gene T. Pretti
President and Portfolio Manager
Report of Independent Public Accountants
To the Shareholders and Board of Directors
of Zazove Convertible Securities Fund, Inc.:
We have audited the accompanying statement of assets and liabilities
of ZAZOVE CONVERTIBLE SECURITIES FUND, INC. (a Maryland corporation),
including the schedule of investments, as of December 31, 1999, and
the related statements of operations, changes in net assets, cash flows
and the financial highlights for the periods indicated thereon. These
financial statements and financial highlights are the responsibility
of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on
our audits. We conducted our audits in accordance with generally
accepted auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements.
Our procedures included confirmation of securities owned as of December
31, 1999, by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights
referred to above present fairly, in all material respects, the
financial position of Zazove Convertible Securities Fund, Inc. as of
December 31, 1999, and the results of its operations, changes in its
net assets, its cash flows and financial highlights for the periods
indicated thereon, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 11, 2000
Statement of Assets and Liabilities
As of December 31, 1999
ASSETS
Investment securities, at market value
-- cost $37,815,086 (Note 1) $ 35,963,414
Cash and cash equivalents 2,523
Receivables-
Dividends 50,617
Interest 304,045
Securities sold, not settled 2,768,163
Total assets 39,088,762
LIABILITIES
Securities sold short, at market value
-- proceeds $646,728 (Note 1) 666,250
Payables-
Redemptions 2,344,298
Margin account due to brokers 5,273,982
Accounting fees 22,000
Margin interest 10,309
Other 5,102
Total liabilities 8,321,941
Net Assets $ 30,766,821
ANALYSIS OF NET ASSETS-
Common stock ($.01 par value; 25,000,000
shares authorized; 1,821,984 shares issued
and outstanding) $ 18,220
Paid in surplus 31,957,408
Accumulated undistributed net realized gains
on investments 837,019
Distribution in excess of net investment income (174,632)
Net unrealized depreciation on investments (1,871,194)
NET ASSETS $ 30,766,821
Net asset value per share (based on
1,821,984 shares outstanding) $ 16.89
The accompanying notes to financial statements are an integral part of
this statement.
Schedule of Investments
As of December 31, 1999
Principal/ Market
Shares Value
CONVERTIBLE PREFERRED STOCK - 38%
Carriage Service Capital Trust $3.50 45,000 $ 1,305,000
Fleetwood Capital Trust $3.00 30,000 1,012,500
Frontier Insurance $3.125 43,700 852,150
General Datacomm Industries $2.25 25,000 387,500
Hercules Inc. $65.00 1,000 778,750
Hybridon Inc. $6.50 5,345 93,538
Lab Corp of America (Class B) $4.250 18,796 1,306,322
Metromedia Int'l Group, Inc. $3.625 45,000 1,350,000
Newell Financial Trust 1 $2.625 21,000 801,948
Prologis Trust $1.75 18,200 450,450
Sovereign Capital Trust $3.750 20,000 992,500
Treev PIK $0.84 163,800 1,535,625
** Village Roadshow $3.25 7,500 316,875
Walden Residential Prop (Class B) $2.29 24,400 588,650
Total convertible preferred stock
(cost -- $12,288,335) 11,771,808
CONVERTIBLE BONDS - 78%
+ APP Finance VI Mauritius, 0.000%
Due 11-18-12 $ 3,800,000 684,000
** APP Finance VII Mauritius, 3.500%
Due 04-30-03 1,245,000 919,744
* Altos Hornos De Mexico, 5.50%
Due 12-15-01 500,000 200,000
Alza Corp., 5.000% Due 05-01-06 1,000,000 1,052,500
BankAtlantic Bancorp Inc., 6.750%
Due 07-01-06 1,235,000 1,086,800
Cox Communications (PCS), 6.859%
Due 11-15-29 8,000 776,000
DRS Technologies Inc., 9.000%
Due 10-01-03 140,000 159,250
EBRD BK Reconst & Dev/MATAV, 0.750%
Due 07-02-01 1,000,000 1,087,500
Elan Corp., 4.750%
Due 11-15-04 1,000,000 1,023,120
+ Four Seasons, 0.000%
Due 09-23-29 2,800,000 868,000
Gener S.A., 6.000%
Due 03-01-05 1,200,000 1,231,500
General DataComm Industries Inc., 7.750%
Due 09-30-02 1,000,000 1,245,000
Interpublic Group Co. Inc., 1.870%
Due 06-01-06 600,000 684,000
** Inversiones y Representaciones SA, 4.500%
Due 08-02-03 200,000 225,000
Magna Int'l Inc., 5.000% Due 10-15-02 1,200,000 1,150,500
NCS Healthcare Inc., 5.750%
Due 08-15-04 700,000 249,988
+ Network Associates Inc., 0.000%
Due 02-13-18 1,200,000 439,500
+ News America Holdings, 0.000%
Due 03-11-13 1,000,000 786,250
North American Vaccine, 6.500%
Due 05-01-03 640,000 496,000
Personnel Group, 5.750%
Due 07-01-04 1,000,000 812,500
Phoenix Investment Partners Ltd., 6.000%
Due 11-01-15 444,500 474,504
Quadramed Corporation, 5.250%
Due 05-01-05 900,000 441,000
Rite Aid Corporation, 5.250%
Due 09-15-02 2,500,000 1,715,625
SpaceHab Inc., 8.000% Due 10-15-07 250,000 185,000
Telefonos de Mexico, 4.250% Due 06-15-04 600,000 783,000
** Thermo Fibertek Inc., 4.500% Due 07-15-04 1,290,000 1,032,000
+ Triarc Companies, 0.000% Due 02-09-18 $ 7,000,000 $ 1,601,250
U.S. Diagnostic Labs Inc., 9.000%
Due 03-31-03 1,505,000 940,625
** U.S. Diagnostic Labs Inc., 6.500%
Due 06-30-01 630,000 434,700
+ Wellpoint Health Network, 0.000%
Due 07-02-19 1,900,000 1,223,124
Total convertible bonds (cost -- $24,900,863) 24,007,980
COMMON STOCK - 1%
Ascent Assurance, Inc. 52,573 93,645
Treev Inc. 28,180 88,943
Total common stock (cost -- $625,888) 182,588
OTHER - 0%
Hybridon Class A Wts (cost -- $0) 29,6711,038
Total investment securities (cost -- $37,815,086) 35,963,414
SHORT STOCK - (2%)
Sprint Corp. (proceeds -- $646,728) (6,500) (666,250)
Other assets less liabilities -- (15)% (4,530,343)
Net assets -- 100% $ 30,766,821
The above percentages were computed as a percentage of net assets.
+ Nonincome producing
* This security is currently in default and interest is not being
accrued on the position.
** These securities are subject to contractual or legal restrictions
on their sale. At December 31, 1999, the value of these
securities was $2,928,319, representing 8% of investment
securities at market value.
The accompanying notes to financial statements are an integral part of
this statement.
Statement of Operations
For the Year Ended December 31, 1999
INVESTMENT INCOME:
Interest $ 1,109,103
Dividends 902,147
Other 30,426
Total investment income 2,041,676
EXPENSES:
Management fees (Note 4) 571,016
Margin interest 167,752
Restructuring expense 19,094
Professional fees 25,701
Transfer agency fees 54,467
Custodian fees 6,891
Director fees 6,000
Other 6,049
Total expenses 856,970
Net investment income 1,184,706
NET REALIZED AND UNREALIZED GAINS ON INVESTMENTS:
Net realized gains on investments and
short securities 2,829,776
Net change in unrealized depreciation of
investments and short securities 2,402,748
Net gains on investments 5,232,524
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 6,417,230
The accompanying notes to financial statements are an integral part
of this statement.
Statements of Changes in Net Assets
For the Years Ended December 31, 1999 and 1998
1999 1998 *
OPERATIONS:
Net investment income $ 1,184,706 $ 1,301,386
Net realized gains (losses) on
investments and short securities 2,829,776 (1,421,181)
Net change in unrealized depreciation
of investments and short securities 2,402,748 (58,050)
Net increase (decrease) in net
assets resulting from operations 6,417,230 (177,845)
DISTRIBUTIONS PAID:
From net investment income (1,184,706) -
In excess of net investment income (174,632) -
From net realized gains (1,992,757) -
Net decrease in net assets resulting
from distributions paid (3,352,095) -
CAPITAL SHARE TRANSACTIONS:
Proceeds from-
Shares sold 2,314,323 -
Shares from reinvestment of dividends 3,329,203 -
Payments for-
Shares redeemed (8,989,426) -
Net partnership interests withdrawn ** (5,335,970) -
Net decrease in net assets resulting
from capital share transactions (8,681,870) -
PARTNERS' CAPITAL TRANSACTIONS:
Contributions - 7,028,279
Withdrawals - (7,814,546)
Net withdrawals - (786,267)
Net decrease in net assets (5,616,735) (964,112)
NET ASSETS, beginning of year 36,383,556 37,347,668
NET ASSETS, end of year (including
distribution in excess of net investment
income of $174,632) $ 30,766,821 $ 36,383,556
* Figures are those of Zazove Convertible Fund, L.P., see Note 1 for
more information.
** January 1, 1999 Zazove Convertible Fund, L.P. activity.
The accompanying notes to financial statements are an integral part of
this statement.
Statement of Cash Flows
For the Year Ended December 31, 1999
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase in net assets resulting from operations $ 6,417,230
Adjustments to reconcile net increase in net assets
resulting from operations to cash provided by operating
activities-
Net change in unrealized depreciation of investments
and short securities (2,402,748)
Net realized gains on investments and short securities (2,829,776)
Decrease in dividends receivable 5,979
Decrease in interest receivable 49,756
Decrease in other assets 4,113
Decrease in management fee payable (54,384)
Increase in redemptions payable 2,344,298
Increase in margin interest payable 3,777
Decrease in other payables (1,824)
Net cash provided by operating activities 3,536,421
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash received from-
Sale of investment securities 77,954,356
Securities sold short 882,033
Securities sold in prior period, settled this period 1,427,878
Cash paid-
To purchase securities (75,582,328)
To cover short sales (211,500)
Net cash provided by investing activities 4,470,439
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from-
Shares sold 2,314,323
Shares from reinvestment of dividends 3,329,203
Payments for-
Shares redeemed (8,989,426)
Net partnership interests withdrawn ** (5,335,970)
Dividend distribution (3,352,095)
Increase in margin account due to brokers 4,029,182
Net cash used in financing activities (8,004,783)
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,077
CASH AND CASH EQUIVALENTS, beginning of year 446
CASH AND CASH EQUIVALENTS, end of year $ 2,523
** January 1, 1999 Zazove Convertible Fund, L.P. activity.
The accompanying notes to financial statements are an integral part of
this statement.
Notes to Financial Statements
December 31, 1999
1. SIGNIFICANT ACCOUNTING POLICIES:
Zazove Convertible Securities Fund, Inc., a Maryland corporation
(the "Fund") is registered under the Investment Company Act of 1940 as
a non-diversified management investment company that operates as a
closed-end interval Fund. The Fund's investment objective is to realize
long-term growth, current income and the preservation of capital. The
Fund will pursue this objective primarily through investing in a
portfolio of convertible securities. The convertible strategy will
focus primarily on opportunities in the United States, although the
Fund may invest abroad. Zazove Associates, LLC, is the Fund's Investment
Advisor. The Fund initially acquired its portfolio pursuant to a merger
whereby the Zazove Convertible Fund, L.P., a Delaware limited
partnership registered under the Investment Company Act of 1940, was
merged into the Fund on January 1, 1999.
The following is a summary of significant accounting policies:
Security valuations
Securities traded on national securities exchanges are valued at the
last reported sales price or, if there are no sales, at the mean between
the bid and ask prices. Securities traded over the counter are valued
at the average of the highest current independent bid and lowest current
independent offer reported upon the close of trading on that day. If
the market for a security exists predominantly through a limited number
of market makers, the security is valued by attaining an independent bid
and offer from at least two market makers in the security and valuing
the security at the mid-point of the quote that, under the circumstances
and in the good faith judgment of the Board of Directors, represents the
fair value of the security. Securities for which market quotations are
not available are valued at a fair value as determined in good faith by
the Board of Directors.
Cash and cash equivalents
For purposes of the statement of cash flows, cash and cash equivalents
include cash and money market investments. Total interest payments
during 1999 were $157,443.
Other policies
The accounts of the Fund are kept on the accrual basis of accounting.
Security transactions are recorded on the trade date. Realized gains
or losses from sales of securities are determined on the first-in,
first-out cost basis. Dividend income is recognized on the ex-dividend
date. Interest income and expense are recognized on the accrual basis.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of increases
and decreases in net assets from operations during the reporting period.
Actual results could differ from those estimates.
2. DIRECTORS AND OFFICERS
The overall responsibility for the management and operation of the Fund
is vested in the Board of Directors (the "Board"). The Board consists
of five directors: Gene T. Pretti, Steven M. Kleiman, Andrew J. Goodwin
III, Jack L. Hansen, and Peter A. Lechman. Each of the three directors
who are not affiliated with the Investment Advisor will receive $2,000
annually for their service to the Fund.
Gene T. Pretti, President and Steven M. Kleiman, Secretary and Treasurer,
are the principal officers of the Fund and are responsible for the day to
day supervision of the business and affairs of the Fund. Except for
certain actions requiring the approval of the shareholders or the
directors, the principal officers of the Fund have the power and
authority to take all actions deemed necessary and appropriate to pursue
the Fund's objective.
Shareholders in the Fund will be unable to exercise any management
functions. Management of the Fund is vested exclusively with the Board.
There will not be any shareholder vote unless required by the Investment
Company Act of 1940.
3. SHARES
The Fund is authorized to issue up to 25,000,000 shares of common stock,
$0.01 par value. Shareholders are entitled to one vote per share on all
corporate issues put to vote of the shareholders, although the Fund does
not contemplate holding annual meetings to elect directors or for any
other purpose.
Shares may be purchased as of the first business day of each month upon
approval of the Directors at the then net asset value per share. All
subscription funds received after the first business day of the month
will be added to the general funds of the Fund at the beginning of the
following month.
On a quarterly basis, the Fund will offer to repurchase no less than 5%
and no more than 25% of the Fund's outstanding shares at the then net
asset value per share. Notice of the terms and conditions of each
quarterly repurchase offer are sent to the shareholders in advance of
the offer.
The Fund may impose a 2% fee on the redemption of fund shares held for
less than one year, which fee is intended to compensate the Fund for
expenses related to such redemption. Shares are redeemed by treating
the shares first acquired by a shareholder as being redeemed prior to
shares acquired by such shareholder thereafter.
In the case of the termination of the Fund, distributions to the
shareholders will be made in proportion to their respective share
ownership after the payment of all Fund creditors.
Analysis of changes in Shares/Units
1999 1998
Shares Units*
Subscriptions/Contributions to fund 138,738 426,730
Issued in reinvestment of distributions 211,512 -
Redemptions/Withdrawals from fund (535,148) (499,916)
Net partnership interests withdrawn ** (344,923) -
Net decrease (529,821) (73,186)
Shares/Units outstanding at the beginning
of year 2,351,805 2,424,991
Shares/Units outstanding at the end of year 1,821,984 2,351,805
* Units for 1998 are those of Zazove Convertible Fund, L.P., as
discussed in Note 1.
** January 1, 1999 Zazove Convertible Fund, L.P. activity.
4. MANAGEMENT ARRANGEMENTS
Zazove Associates, LLC has been engaged as the Fund's Investment
Advisor pursuant to the terms of an Investment Advisory Agreement. As
Investment Advisor to the Fund, Zazove Associates, LLC will receive
management fees based on the following management fee schedule.
Management fees are computed and paid on a monthly basis.
Net assets First $20,000,000 Net assets in Net assets in
in net assets excess of excess of
$20,000 up to $70,000,000
$70,000,000
Annual Management
Fee Rate 2.00% 1.50% 1.00%
5. EXPENSES
The Fund bears all normal costs and expenses of its operations
including: management fees; brokerage commissions; custody fees;
transfer agency fees; legal, audit, accounting and tax preparation
expenses; applicable state taxes and other operating expenses such as
regulatory filing fees and costs for communications with shareholders.
The Fund will not incur costs and expenses associated with offering
shares in the Fund. No portion of the Investment Advisor's or its
affiliate's general overhead costs will be allocated to the Fund. The
custodian fees are paid to UMB Bank, N.A. and the transfer agent fees
are paid to Sunstone Financial Group, Inc.
6. INCOME TAXES
The Fund has elected to be treated and to qualify each year as a
"regulated investment Company" under Subchapter M of the Internal
Revenue Code of 1986, as amended and therefore will not generally be
liable for Federal income taxes to the extent taxable income is
distributed on a timely basis.
7. INVESTMENT TRANSACTIONS
For the year ended December 31, 1999, purchases of investment securities
(excluding short-term securities) were $75,793,828 and proceeds from
sales were $81,604,552. For federal income tax purposes, at December 31,
1999, the gross unrealized depreciation on investments was approximately
$4,264,759, and the gross unrealized appreciation was approximately
$2,231,292. The cost of investments for federal income tax purposes was
$37,330,631 at December 31, 1999.
8. OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
The Fund engages in the short sale of securities. Securities sold short,
not yet purchased, represent obligations of the Fund that result in
off-balance-sheet risk as the ultimate obligation may exceed the amount
shown in the accompanying financial statements due to increases in the
market values of these securities.
At December 31, 1999, the three largest industry concentrations were as
follows (as a percentage of investment securities at market value):
Medical Services 11.55%
Computer Software & Services 6.97%
Telecommunications 5.20%
Since the Fund does not clear its own investment transactions, it has
established an account with a third party custodian (UMB Bank, N.A.)
for this purpose. The resulting concentration of credit risk is
mitigated by the custodian's obligation to comply with the rules and
regulations of the Securities and Exchange Act of 1934. In addition,
the Fund has established an account with a brokerage firm (Bear Stearns
Securities Corp.) for the purpose of purchasing securities on margin.
At December 31, 1999, the Fund owed the brokerage firm $5,273,982 for
securities purchased on margin. The Fund has pledged sufficient
securities as collateral for the margin account held by the custodian.
The Fund pays interest on any margin balance, which is calculated as
the daily margin account balance times the broker's margin interest
rate.
ZAZOVE CONVERTIBLE SECURITIES FUND, INC.
FINANCIAL HIGHLIGHTS
For the Years Ended December 31, 1995 through 1999
Per Share/Unit Operating Performance
1999 1998(*) 1997(*) 1996(*) 1995(*)
Net Asset Value,
beginning of year $15.47 $15.40 $14.09 $11.29 $8.96
Income from investment
operations:
Net investment income 0.63 0.54 0.70 0.54 0.51
Net realized and unrealized
gains or losses on
investments 2.71 (0.47) 0.61 2.26 1.82
Total from investment
Operations 3.34 0.07 1.31 2.80 2.33
Less Distributions
From net investment income (0.63) N/A N/A N/A N/A
In excess of net investment
Income (0.15) N/A N/A N/A N/A
From capital gains (1.14) N/A N/A N/A N/A
Total distributions (1.92) N/A N/A N/A N/A
Net Asset Value, end of year $16.89 $15.47 $15.40 $14.09 $11.29
Total return 22.50% 0.45% 9.30% 24.80% 25.90%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year
$30,766,821 $36,383,556 $37,347,668 $34,774,671 $24,938,913
Ratio of expenses to average
net assets 2.16% 2.16% 2.00% 2.31% 2.23%
Ratio of net investment income
to average net assets 3.72% 3.43% 4.57% 4.51% 5.07%
Portfolio Turnover rate 222% 365% 405% 276% 155%
(*) Figures are those of Zazove Convertible Fund, L..P. see Note 1 for
more information.
N/A - Not applicable as all income and capital gains were allocated
directly to the partners' capital accounts.
ZAZOVE CONVERTIBLE SECURITIES FUND, INC.
DIRECTORS Andrew J. Goodwin, III
Jack L. Hansen
Steven M. Kleiman
Peter A. Lechman
Gene T. Pretti
OFFICERS Gene T. Pretti
Steven M. Kleiman
INVESTMENT ADVISOR Zazove Associates, LLC
940 Southwood Blvd., Suite 200
Incline Village, NV 89451
CUSTODIAN UMB Bank N.A.
928 Grand Avenue
Kansas City, MO 64106
INDEPENDENT ACCOUNTANTS Arthur Andersen, LLP
33 W. Monroe Street
Chicago, IL 60603
DIVIDEND-DISBURSING Sunstone Financial Group, Inc.
AND TRANSFER AGENT 207 East Buffalo Street, Suite 400
Milwaukee, WI 53202
