Z-SEVEN
ANNUAL REPORT
DECEMBER 31, 1996
1. Accounting Procedures:
Reliability & Conservatism
2. Consistency of Operating
Earnings Growth
3. Strength of Internal
Earnings Growth
4. Balance Sheet:
Working Capital
5. Balance Sheet:
Corporate Liquidity
6. Recognition:
Owner Diversification
7. Value: P/E Under 10
<PAGE> 1
Z-SEVEN'S
STATEMENT OF PURPOSE
Our investment discipline is what begins to separate the Z-Seven Fund
from other publicly traded investment companies (closed-end funds) and other
investment companies (mutual funds) as well as other publicly traded companies
(stocks). The cover is designed to highlight the principles behind a
discipline that has weathered the ups and downs of economies, stock markets,
industry trends, and countless predictable factors because it is based upon
common sense solutions diligently applied from lessons learned by making
mistakes and the dedication not to repeat these errors not just for one year,
three years, or five years but by the founder of Z-Seven, Barry Ziskin,
throughout the thirteen-year history of Z-Seven. In fact, Mr. Ziskin began
utilizing this current discipline early in his Wall Street career, long before
the idea of his beginning a closed-end fund. His criteria for selecting high
quality, undervalued growth stocks have stood the test of time many times over
a span of more than 20 years.
As you read further into the Annual Report, it will become quickly
obvious, for those who do not already know to expect it, that "Mistakes and
Disappointments" is a regular feature of our Letter to Our Shareholders, for
it is through the lessons learned by these mistakes that we continue to evolve
as better investors. Our "Criteria for Stock Selection" and, just as
importantly, "Sell Discipline" sections once again promise to bring the theory
to life through real and meaningful examples in our portfolio of investments.
The application of discipline, which greatly reduces risk, while
searching for rare and profitable investment opportunities, is our stated
purpose. "How" we state this purpose through the information provided in the
Annual Report reveals yet another purpose: to share with you not only our
growth but also our thoughts, concerns, and lessons learned in the hopes of
making us all better investors.
<PAGE> 2
TABLE OF CONTENTS
LETTER TO OUR SHAREHOLDERS 3
1996 INVESTMENT RESULTS 3
1996 Net Asset Value 4
Fourth Quarter Net Asset Value 4
1996 Capital Gains Distribution and Dividend 4
1996 Share Price 5
Comparison Charts 6
Good News in 1996 8
Mistakes and Disappointments in 1996 9
1997 Outlook 11
STOCK PURCHASE CRITERIA AND SELL DISCIPLINE 14
Accounting Procedures: Reliability and Conservatism 14
Consistency of Operating Earnings Growth 15
Strength of Internal Earnings Growth 15
Balance Sheet: Working Capital 16
Balance Sheet: Corporate Liquidity 17
Price/Earnings Multiple and Owner Diversification 18
Sell Discipline: Based Upon the Same Common Sense
Criteria as for Stock Selection 22
HOW HAS OUR PORTFOLIO PERFORMED? 24
Performance of the Largest Twelve Investments in 1996 24
Performance and Financial Information (Twelve Largest Investments) 27
Bonus/Penalty Performance Incentive 28
Z-SEVEN TAX INFORMATION STATUS 30
INVESTMENT POLICIES AND OBJECTIVES 31
OTHER INFORMATION 32
FINANCIAL REVIEW 33
<PAGE> 3
LETTER TO OUR SHAREHOLDERS
The twelve months ended December 31, 1996, was a landmark period for the
U.S. stock market, the European markets, and the Z-Seven Fund. The Dow Jones
Industrial Average soared past the 6,000 mark and indexes in London, Paris,
and Zurich also hit record highs. In the following pages, we discuss the
extent to which Z-Seven participated in the rally.
Specific stock sector performance varied widely in the volatile market
environment. Our approach is not to chase the stocks that the market is
rewarding at any one moment, but to stick to our discipline of investing.
This discipline may result in short-term periods of underperformance.
However, over longer periods of time, we believe the market will continue to
reward our long-term growth style of investing.
We would like to express our gratitude for your confidence in our
investment philosophy. Most of all, we are thankful for the love, strength,
and wisdom given to us by our heavenly creator and caring shepherd.
1996 INVESTMENT RESULTS
Z-Seven's thirteenth year closed with an 18% annual return on our
investment portfolio (before expenses). This increase amounts to $2.47 per
share.
During the last five years, through 1996, Z-Seven's portfolio investment
return was 63%. Over the last decade, Z-Seven's investments generated a
return of 150%. Most important is long-term performance, and for our
thirteen-year history, our investments generated a 413% investment return.
1996 NET ASSET VALUE
During the year, expenses amounted to $.56 per average share outstanding.
Deducting this $.56 per share from the $2.47 per share return on our
investments, our net asset value is up 11%, from $17.48 a year earlier, to
$19.39 before our $2.99 distribution to shareholders of realized capital gains
and net investment income. As a result, our net asset value closed at $16.40
after our distributions.
In the latest three years, the return on net asset value (after expenses)
amounted to 34%. For the latest five years, our per share net asset return
was 33% cumulatively. Over Z-Seven's latest ten years, our net asset value
return equaled 74%. In fact, over our thirteen-year history, we enjoyed a
213% return on our net asset value.
<PAGE> 4
FOURTH QUARTER NET ASSET VALUE
Our year ended on an up note. This is the fourteenth quarter out of the
past seventeen in which our net asset value has posted a gain. Our net asset
value rose during the fourth quarter of 1996, gaining $.28 per share from
$19.11 to $19.39, before our net investment income and capital gains
distributions to shareholders of $2.99 per share.
1996 CAPITAL GAINS DISTRIBUTION AND DIVIDEND
A combination of higher interest rates and poor broad stock market
behavior in the United Kingdom caused us (see "Sell Discipline" criterion #5)
to eliminate British investments that no longer met all of our purchase
criteria. These sales resulted in substantial realized gains which were
distributed through a $2.80 per share payment to shareholders. In addition,
we made a remainder distribution of $.19 from the previous year. The
remainder distribution consisted of $.06 ordinary income and $.13 capital
gains.
1996 SHARE PRICE
Our National Market System (over-the-counter NASDAQ Symbol: ZSEV) closing
price was $20.50 at year-end 1996. After considering our combined
distributions ($2.99 per share), net realized capital gains and the dividend
paid in 1996, Z-Seven's shareholders earned a return on their investment of
$1.24 per share, or 6% for the year.
See how we compare with other funds of our type in comparison charts on the
next three pages.
<PAGE> 5
Z-SEVEN'S SHARE PRICE PERFORMANCE FOR THE FIRST SEVEN YEARS OF THE 1990S IS
BETTER THAN EVERY OTHER CLOSED-END AND OPEN-END FUND WHICH INVESTS PRIMARILY
IN EUROPE.
We ranked #1 among all domestic general equity closed-end funds,
according to The Complete Guide to Closed-End Funds by Frank Capiello, with a
total return of 168%, including distributions, for the second half of the
1980s (we went public in 1984). In early 1989, we sold most of our domestic
portfolio and reinvested the proceeds in European shares, which offered much
better value.
Our European investments prior to 1989 were few, although they were
among our largest. These early European investments were successful, as
eleven of the twelve registered gains ranging from 22% to 172%, annually
compounded (the only loss was a mere 3%). Altogether the average gain was
62%.
Financial markets were hit hard in 1990. The recovery in Europe took
place later than in the U.S., but has continued to strengthen in 1996. Our
portfolio has been dominated (70% to 98%) by European shares for more than
seven years.
Even in 1990, when markets at home and around the world were depressed,
Z-Seven turned in a considerably better defensive performance than all other
European invested closed-end funds. While many may think our performance in
the year of 1995 (#1 among all 98 overseas invested closed-end funds according
to Lipper Analytical) made it our best year of the 1990s, it was for us an
easy year. We consider that holding our loss to just 2% in 1990, while our
competitors lost 16% - 67% (an average of 41%), was an even greater
accomplishment.
Z-Seven Fund, up 58% over the last seven years, is one of only three
European invested closed-end funds to have profited at all in the 1990s.
<TABLE>
<CAPTION>
THE UP & DOWN MARKETS OF THE 1990s
LIST OF ALL U.S. BASED CLOSED-END FUNDS WHICH INVEST PRIMARILY IN EUROPE*
DOWN UP UP & DOWN
MARKET MARKET MARKETS
Stock Stock % Change Stock % Change % Change
Price Price 1 Year Price 6 Years Total 7 Years
12/31/89 Fund 12/31/90 12/31/90 12/31/96 12/31/96 12/31/96
- --------- ------------------------ --------- --------- --------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
$ 13 Z-Seven Fund $ 12 3/4 - 2% $ 20 1/2 + 61% + 58%
15 1/8 Swiss Helvetia 11 7/8 - 21 19 7/8 + 67 + 31
10 3/4 U.K. 9 - 16 13 7/8 + 54 + 29
13 3/8 First Iberian 7 3/4 - 42 11 + 42 - 18
17 Portugal 9 1/4 - 46 13 3/4 + 49 - 19
19 1/4 Germany 11 - 43 12 5/8 + 15 - 34
17 Italy 10 1/4 - 40 8 3/4 - 15 - 49
20 1/2 Austria 10 - 51 9 - 10 - 56
31 3/4 Spain 10 5/8 - 67 11 3/8 + 7 - 64
--------- --------- --------------
AVERAGE (excluding Z-Seven Fund) - 41% + 26% - 23%
<FN>
* Includes funds which have been public prior to December 31, 1989, so that a full 7 years of
share price data can be measured over up markets as well as down markets.
SOURCE: Dow Jones (Wall Street Journal).
Does not include dividends or any other distributions for Z-Seven or any other funds.
Past performance is no guarantee of future results.
</TABLE>
<PAGE> 6
TOTAL INVESTMENT RETURN
The chart on the previous page simply shows the changes in year-end share
prices in percentages. However, share price changes which are not adjusted
for distributions reflect only part of the total investment return.
Therefore, in the chart below, we added applicable distributions to the share
price changes to arrive at total investment return percentages.
Z-Seven's total investment returns rank #1 among all U.S. based
closed-end funds which invested primarily in Europe for the first seven years
of the 1990s.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS FOR THE 1990s
LIST OF ALL U.S. BASED CLOSED-END FUNDS WHICH INVEST PRIMARILY IN EUROPE*
DOWN
MARKET
1990 Total 1991-1996
Stock Stock Dividends/ Investment Return Stock Dividends/
Price Price Capital Gains 1 Year Price Capital Gains
12/31/89 Fund 12/31/90 Distributions** 12/31/90 12/31/96 Distributions**
- --------- ------------------------ --------- ---------------- ------------------ --------- ----------------
<S> <C> <C> <C> <C> <C> <C>
$ 13 Z-Seven Fund $ 12 3/4 $ .13 - 1% $ 20 1/2 $ 6.53
10 3/4 U.K. 9 .59 - 11 13 7/8 3.87
15 1/8 Swiss Helvetia 11 7/8 .05 - 21 19 7/8 2.97
13 3/8 First Iberian 7 3/4 .96 - 35 11 .91
19 1/4 Germany 11 .35 - 41 12 5/8 3.42
17 Portugal 9 1/4 .12 - 45 13 3/4 .48
17 Italy 10 1/4 1.18 - 33 8 3/4 1.08
20 1/2 Austria 10 .42 - 49 9 .40
31 3/4 Spain 10 5/8 1.29 - 63 11 3/8 1.20
------------------
AVERAGE (excluding Z-Seven Fund) - 37%
UP UP & DOWN
MARKET MARKETS
Total Total
Stock Investment Return Investment Return
Price 6 Years Total 7 Years
12/31/89 12/31/96 12/31/96
- --------- ------------------ ------------------
<S> <C> <C>
$ 13 + 112% + 109%
10 3/4 + 97 + 71
15 1/8 + 92 + 51
13 3/8 + 54 - 4
19 1/4 + 46 - 15
17 + 54 - 16
17 - 4 - 35
20 1/2 - 6 - 52
31 3/4 + 18 - 56
------------------ ------------------
AVERAGE + 44% - 7%
<FN>
* Includes funds which have been public prior to December 31, 1989, so that a full 7 years of share price data
can be measured over up markets as well as down markets.
SOURCE: Dow Jones (Wall Street Journal).
** According to Standard & Poors.
Past performance is no guarantee of future results.
</TABLE>
<PAGE> 7
TOTAL INVESTMENT RETURN LESS CURRENCY GAINS
Z-Seven is one of the few overseas invested U.S. mutual funds that rely
solely on its investments, that is, not gambling on currency rate
fluctuations. To the best of our knowledge, of nine U.S. based closed-end
funds investing predominantly in Europe, we are the only one that regularly
protects the value of the European currency rates vs. the U.S. dollar. While
some of the others have been fortunate to have had windfall profits during the
past seven years, a currency reversal (stronger dollar) will negatively affect
their future results. We, on the other hand, did not benefit from the
weakened dollar in recent years, and therefore continue to be protected from
damage should the tide turn, as it may have already begun to do.
The following chart adjusts the total investment returns on the previous
page for currency gains or losses.
<TABLE>
<CAPTION>
ADJUSTED TOTAL INVESTMENT RETURNS FOR THE 1990S
LIST OF ALL U.S. BASED CLOSED-END FUNDS WHICH INVEST PRIMARILY IN EUROPE*
------------ DOWN MARKET --------------- ------------ UP MARKET
Total (Less) Adjusted Total Total (Less)
Inv. Return % Change Inv. Return Inv. Return % Change
1 Year In Major 1 Year 6 Years In Major
Fund 12/31/90 Currency** 12/31/90 12/31/96 Currency**
- -------------------------------- ------------ ----------- --------------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Z-Seven Fund - 1% 0 (h) - 1% + 112% 0 (h)
U.K. - 11 + 20 - 31 + 97 - 11
Swiss Helvetia - 21 + 22 - 43 + 92 - 5
First Iberian - 35 + 12 *** - 47 + 54 - 19 ***
Portugal - 45 + 10 - 55 + 54 - 11
Italy - 33 + 13 - 46 - 4 - 26
Germany - 41 + 13 - 54 + 46 - 3
Spain - 63 + 13 - 76 + 18 - 26
Austria - 49 + 13 - 62 - 6 - 3
---------------
AVERAGE (excluding Z-Seven Fund) - 52%
--------------- --------------------- UP & DOWN MARKETS ----------------------
Adjusted Total Total (Less) Adjusted Total
Inv. Return Inv. Return % Change Inv. Return
6 Years Total 7 Years In Major Total 7 Years
Fund 12/31/96 12/31/96 Currency** 12/31/96
- -------------------------------- --------------- ---------------------- ------------------ -----------------------
<S> <C> <C> <C> <C> <C>
Z-Seven Fund + 112% + 109% 0 (h) + 109%
U.K. + 108 + 71 + 7 + 64
Swiss Helvetia + 97 + 51 + 16 + 35
First Iberian + 73 - 4 - 10 *** + 6
Portugal + 65 - 16 - 3 - 13
Italy + 22 - 35 - 16 - 19
Germany + 49 - 15 + 9 - 24
Spain + 44 - 56 - 17 - 39
Austria - 3 - 52 + 9 - 61
--------------- -----------------------
AVERAGE (excluding Z-Seven Fund) + 57% - 6%
<FN>
* Includes funds which have been public prior to December 31, 1989, so that a full 7 years of share price data
can be measured over up markets as well as down markets.
SOURCE: Dow Jones (Wall Street Journal).
** vs. U.S. Dollar.
*** Average of Spanish Peseta and Portugese Escudo changes.
(h) Z-Seven Fund's currency exposure is fully hedged.
Past performance is no guarantee of future results.
</TABLE>
<PAGE> 8
GOOD NEWS IN 1996
In 1995, twelve investments, in the portfolio for one year or over,
increased more than 20%. In 1996, we had fourteen holdings that qualified to
be included in the "Good News" section. We will discuss each of these by
order of size in the Fund.
The largest, Swedish drug giant ASTRA AB, had an increase of 25% which
included a 20% acceleration in the last quarter due to the approval from the
FDA and European authorities for several new drugs. Astra has been active in
formulating treatments for asthma and hypertension as well as safe anesthetics
used in childbirth.
The next largest investment, GETRONICS NV, produced an exceptional 153%
gain, the highest percentage increase in the entire fund. The company is a
Dutch provider of software and consulting services for the information
processing and telecommunications industries, and partly due to the
acquisition of a former rival, Getronics has shown impressive sales growth.
Operating profits improved 68% in the first half of 1996. In the fourth
quarter, Getronics bought a Dutch state-owned payroll processor enabling it to
actively assist other European countries with complex technical services.
L'OREAL, our biggest French investment, achieved a 49% gain. Sales have
been very strong due to the acquisitions of Maybelline in the U.S. and Jade in
Germany. It has aggressively pursued the Chinese market and in 1996
inaugurated its first Chinese factory. L'Oreal purchased a cosmetic company
in Poland to meet the vigorous demand generated by eastern Europe. Its
strategy is to expand in areas virtually ignored by other beauty-product
firms.
The Swiss company, NOVARTIS AG (a merger of Sandoz AG and Ciba-Geigy AG),
had a share-price advance of 45%. Novartis is the second largest
pharmaceutical company in the world with a focus on health-care, agribusiness,
and nutrition. It has strong upside potential based on cost savings from the
merger as well as expectations for new products in the pipeline. The company
received FDA clearance on its treatment for hypertension making it the first
new pharmaceutical product since the merger.
CALLAWAY GOLF CO. was up 27%. Sales increased more than 25% over last
year and through the third quarter were up over 50%. We see no reason why the
share price should not go higher in the long term. Its innovative and
successful development and marketing of new products has led to a major
problem -
<PAGE> 9
the pirating of their famous line of golf drivers including Big Bertha.
Callaway has taken court action in California and the U.K. to defend its
patents. It has already won injunctions to stop illegal production and sales.
LINDT & SPRUNGLI AG, the Swiss premium chocolates company, was up 32% for
the year. Lindt & Sprungli enhanced their competitiveness by acquiring an
Austrian company that provides them with a local production facility. They
have since 1993 embarked on an extensive investment program to upgrade their
manufacturing equipment and to advance their technology. This program, funded
entirely from internal cash flows, will produce new efficiencies and
strengthen operating profits.
LVMH MOET HENNESSY LOUIS VUITTON, the world's leading luxury goods
company, scored a 42% gain this year. LVMH is the largest producer of
champagne, which recently set a new record high in sales volume. Income from
operations is up 15%. Part of the large increase in share price could have
been fueled by speculation concerning the approval by the U.S. Trade
Commission of its purchase of the retail chain, Duty Free Stores. Paris
newspapers reported that LVMH's 1997 profit could increase 30% if this
acquisition is completed.
Shares of AIR LONDON INTERNATIONAL PLC, the aircraft charter broker, rose
54%. Sales and profits benefited from improved business with established
clients, a higher level of fee-only business (which improves margins), plus a
positive contribution from its French unit, Air Partner International.
TT GROUP PLC'S share price increased 26%. New acquisitions complementing
their diesel generator division contributed to increases in sales and profit
margins. The conglomerate has interests in electronics, packaging, building
materials, and industrial products. Orders have been stimulated by
competitive pricing brought about by cost reduction measures and the ability
to reduce lead times resulting from operational changes.
POLYPIPE PLC, the manufacturer of plastic pipes and fittings and other
domestic type products, had a share-gain of 32%. In the fourth quarter,
Polypipe acquired a company that designs and produces plumbing products. The
market reacted favorably and boosted its share price 19%.
Our next holding qualifying for this section was CARLSBERG AS, the Danish
brewing company. Its annual earnings surprised the market in a positive
manner and the share price responded by rising 28%. The company is expanding
<PAGE> 10
into Poland and China. Carlsberg is committed to retain its position among
the foremost players in the international brewing industry. We expect
continued steady growth.
AUTOPISTAS C.E. SA, our only Spanish holding, is involved in the
construction, maintenance, and operation of the Mediterranean and Ebro toll
highways. The company's share price climbed 30% for the year, while it
continues to achieve consistent profit growth.
ABBEYCREST PLC, U.K.'s largest designer and manufacturer of gold and
silver jewelry, grew 35%. The company's 1996 profit margins were helped by
the 1995 reorganization and the latest reported earnings increased 67%.
WESTFAIR FOODS LTD., a North American retail grocery chain, was down at
the end of the third quarter, but recovered and was up 72% for the year. The
company experiences wide share-price fluctuations, driven by litigation
expectations concerning the rights and obligations associated with its Class A
shares.
This concludes our "Good News" section. However, we would like to
mention one more company that had a good year in 1996, but is not part of our
year-end portfolio. The company, Airtours PLC, has been one of our holdings
for over seven years. Its share price vaulted 35% in the fourth quarter on
news it was buying an Italian cruise line with its partner Carnival Corp. For
the whole year it gained 123% sparked by record profits. The Airtours shares
were sold in our U.K. selling program as they no longer met all of our
criteria.
MISTAKES AND DISAPPOINTMENTS IN 1996
For the purpose of objectivity, we also talk about the investments, held
for over twelve months, which lost 20% or more in their market prices. This
year, two companies belong in this category. The biggest mistake and
disappointment was DAY RUNNER, INC., whose price came down 43%. We did not
foresee the impact of logistical problems with Wal-Mart, and the short-fall in
revenue and earnings the company announced late in December.
Day Runner's profit before taxes consistently increased in double-digit
numbers during the last six years. In 1996, it showed 43% growth. Day
Runner's management increased gross profit margins from 50.2% in 1995 to 52.0%
this year, while sales growth slowed to 2.3%. In a rising sales environment
profit margins are expected to
<PAGE> 11
increase. However, when sales are flat or declining, increases in profit
margins are achieved through superb management. To resolve the Wal-Mart
problem, Day Runner plans to create new easier-to-stock displays, and to
implement a pro-active program in which its own employees will inventory,
restock, and reorder products for Wal-Mart.
For the full 1997 fiscal year (ending in June), Day Runner still expects
earnings to exceed those of 1996. Day Runner has an excellent, debt-free
balance sheet enabling management to respond quickly to problems. Therefore,
this year's "Mistakes and Disappointments" might have a way of turning into
next year's "Good News."
The other mistake and disappointment was UDO HOLDINGS PLC, our smallest
position. This group sells services, materials, and equipment to the
construction and civil engineering market. The flat U.K. construction market
contributed to earnings erosions and its share price declined 26%. UDO is
being sold under our U.K. selling program.
1997 OUTLOOK
Large capitalization stocks in the U.S. are in the midst of a vigorous
rally that we hope will be followed by small capitalization shares here and by
markets in Europe. Interest rates are the most significant predictor of stock
market performance. As long as the U.S. discount rate stays at its current
level and we think it will, at least for the short-term, things continue to
look good for the long-running U.S. bull market. Clearly overvalued share
prices are likely to become even more so.
British interest rates have begun to rise. The new highs in the market
indexes are not supported by the advance/decline line and a bear market in the
U.K. might be forthcoming. Subsequently, we took the necessary steps to sell
U.K. positions in our portfolio that no longer qualify under all seven
criteria. Regardless of macro conditions, we are a bottoms-up value/growth
fund. Preparing for the worst and hoping for the best, we might have new
buying opportunities in the near future.
French, Swedish, and Spanish interest rates declined last quarter, and
interest rates in Denmark have the potential to fall, so our holdings may
continue to
<PAGE> 12
benefit from monetary easing in these countries. The majority of our
portfolio is still invested in European equities of companies that continue to
achieve consistent operating results. Therefore, the outlook for 1997 is
quite favorable.
All too often, the Z-Seven Fund might appear to you as a one-man show.
While my personal involvement is demonstrated through my share ownership and
through my willingness to be compensated on the basis of my performance, my
greatest incentive and blessing comes through the investments in Z-Seven by
my family, my friends, and your families. You provide invaluable inspiration
to me.
I would like to thank all those who have demonstrated confidence in my
growth/value discipline. At Z-Seven, I have been very fortunate to work with
some of the best and brightest people that I could have hoped for: Carol (our
Corporate Secretary and Regulatory Compliance Officer), Laurie (our Treasurer
and Chief Financial Officer), Cindy, Aleshia, Jordan, Carolyn, and Cynthia.
Likewise, our Attorneys: Susan, Rey, and Louis; Accountants: John, Tom,
and Darryl; Graphics people: Kathy, Dennis, and Barbara; Brokers: Dennis,
Francis, Josh, and Bill; FX Currency Hedger: Bob; Conference people: Kim,
Charles, Deborah, and Karen; Bankers: Aletha and Nat; and even Garth and
Victor (our daily U.P.S. men) have all lived up to the term "professional" and
then some.
Finally, our directors, Rochelle, Tom, and Jeff, have each had a
significant portion of his/her financial portfolio invested in Z-Seven.
Through their caring support, they each make Z-Seven even better.
Sincerely,
Barry Ziskin February 6, 1997
P.S. Congratulations to Sir John M. Templeton on his fifteenth appearance as
the special guest on Louis Rukeyser's Wall Street Week. We have all benefited
from your wisdom and experience as the pioneer of global investing.
P.P.S. Congratulations to my daughter on her twelfth birthday.
Our Buy and Sell Disciplines Are Detailed Next.
<PAGE> 13
STOCK PURCHASE CRITERIA AND SELL DISCIPLINE
Among the features which set the Z-Seven Fund apart are its carefully
developed and closely followed seven criteria for stock selection, and its
strict sell discipline. The seven criteria were developed by Barry Ziskin to
reduce risk in the stock selection process. Thousands of publicly held
companies throughout the developed world are analyzed yearly. To provide
meaningful examples, we use only our biggest investments to illustrate our
criteria. This way, we provide new information on our largest positions and,
at the same time, bring our criteria to life.
ACCOUNTING PROCEDURES:
RELIABILITY AND CONSERVATISM
"Companies must not defer operating expenses or prematurely realize
revenues and must have an auditor's report on financial statements that is
unqualified in all material respects."
Without the credibility of conservatively reported earnings and balance
sheet information the other criteria would be meaningless. For this reason,
we take the time and effort to make the stock selection process as valid as
possible through manual analysis.
The average investor can determine the difference between conservatively
reported profits for income tax purposes vs. profits reported to shareholders
(book income) by reviewing the income tax footnote of an annual report (SEE
BOX BELOW).
Tax actually paid is called "current tax." The extra tax, which would
have been paid if the company paid taxes using the same accounting practices
as used in reporting earnings to the public, is called "deferred tax." Adding
the "deferred tax" to the "current tax" gives us the total income tax we see
reported to shareholders.
Example: Current tax $30 million
Deferred tax 10 million
-----------
Total tax $40 million
This company actually paid only $30 million of the $40 million of the tax
it reported on its income statement. In our analysis we adjust earnings
downward to reflect the more conservatively reported figures.
Deferred taxes usually are the result of "temporary differences."
Different depreciation methods are used for tax purposes vs. financial
reporting. The "accelerated" method, used for tax purposes, will show a
higher depreciation expense and, therefore, lower earnings.
<PAGE> 14
For financial reporting purposes, a straight-line basis is used and a lower
depreciation expense is shown which results in a higher net income.
Watch out for those differences in recognizing income and expenses which
cause deferred taxes to increase consistently year after year. Becoming
familiar with the companies' individual accounting practices and their impact
on your existing holdings, as well as your prospective investments, is well
worth the time involved in learning and applying good common sense to protect
your financial assets.
In some European countries such as France and Switzerland, the
"Provisions" note to the "Group Consolidated Balance Sheet" is the only source
of deferred-tax information. In Italy and Germany, only a handful of public
companies make this disclosure which tells how conservatively earnings are
being reported. If this vital data is not available, we simply do not invest
in that company.
During the previous decade (the 1980s), the earnings reported to the
shareholders by the average S&P 500 company were 23% higher than earnings
reported to the IRS!
Callaway Golf was our best example for reliable and conservative
accounting procedures last year. We mention them again, because their
conservatism is most evident in how they understate their reported earnings.
CALLAWAY GOLF CO., our tenth largest investment, has no debt and ample cash.
Both are signs of conservative management. Since going public, Callaway has
done just the opposite of most companies. It actually reported, on average,
17% more conservatively to its shareholders than it has to the IRS. Although
the year just past has not yet been reported, our guess is that it will be
year #5 of ultra-conservative accounting.
This year, we have an example of a company that, in its latest annual
report, did not disclose all the financial information that we require in
regards to deferred taxes. GETRONICS NV, our seventh largest holding, stated:
"As at year end, the Group has extensive deferred tax debits not accounted for
in the balance sheet" Getronics is not fully disclosing the deferred tax
information. Therefore, its shares will be sold. If we feel we can no longer
trust a company's numbers, then it is irrelevant whether the numbers presented
are good. Getronics has been a good performer over the years, with a ten-year
compounded growth rate of over 30%. The last couple of years, Getronics'
share price has increased dramatically. However, we are committed to our
<PAGE> 15
carefully determined set of rules designed to reduce risk. We will invest
only in companies that disclose their financial situation fully. We will not
take the chance if we can not rely on a company's numbers.
CONSISTENCY OF OPERATING
EARNINGS GROWTH
"At least 10% growth in adjusted pre-tax income in each of the six most
recent years."
As we search for the best managed companies, we look for companies that
have predictable earnings growth regardless of changes in the economy, or
their particular industry or product area. We only invest in those companies
that do well in difficult and prosperous times.
The S&P 500 Index has suffered four years of down earnings over the
latest decade of reported earnings (1985-1995). By contrast, the companies in
our portfolio have averaged less than one down year during the same period.
We believe the consistent strength of corporate earnings growth within our
portfolio will result in higher long-term results.
When we say "growth in adjusted pre-tax income," we mean operating growth
after adjusting for interest and investment income and extraordinary items.
We also adjust for tax accounting to put each year on comparable and
conservative footing.
We do not adjust for interest expense, which is a cost of doing business,
whether for financing inventories or long-term interest on mortgage and public
debt (bonds). Management needs to be held accountable for adding debt, along
with its costs and risks.
Many companies appear to have consistent growth due to their planned
timing of significant accounting events which have nothing to do with the true
operating picture. The extra work we put into the analysis is worth the
effort to find companies that are, in fact, the best managed.
ASTRA AB, the leading Swedish pharmaceutical manufacturer, is our fifth
largest holding. Over the last six years, Astra's adjusted pre-tax income has
grown more than 22% each year. In both 1992 and 1993, growth was over 35%.
In the most recent two years, Astra increased their research and development
investments by 40% and 29%. While this slowed growth for these years, they are
positioning themselves for accelerated future profit growth.
<PAGE> 16
Astra has several niche products which dominate their markets. The
fastest growing product, anti-ulcer wonder drug Losec, has received
international recommendation and approval in thirty countries as the
first-line therapy, used in combination with antibiotics, for the treatment of
ulcers. The previously recommended remedy, Glaxo's Zantac, was by far the
largest selling drug of any type in the world. As Losec replaces Zantac,
Astra should continue to grow as fast or faster than any other drug company.
STRENGTH OF INTERNAL EARNINGS GROWTH
"Adjusted pre-tax income, exclusive of acquisitions and divestitures,
must have grown at an annually compounded rate of at least 20% for the most
recent six-year period."
Over a six-year period each company must triple its operating profits to
qualify as an investment. During the 1970s, high inflation made it appear
that earnings were growing at a phenomenal rate. Today, with virtually no
inflation to hype the numbers, companies must achieve true growth on their
own.
The criterion for accounting procedures assures us that we have credible
reported figures. Let us define quality growth companies. Our criterion of
consistency in operating earnings growth identifies companies with predictable
earnings growth regardless of the state of the economy, industry, or product
cycle. The criterion of strength in internal-earnings growth further reduces
risk by seeking companies that meet all the previous criteria and in addition
show an extraordinary earnings-growth track record.
Many brokers strive to sell "emerging growth" companies based on future
earnings expectations, rather than his-
<PAGE> 17
toric results, which substantially increases the investment risk. The losses
many investors suffered in these "emerging growth stocks" during the periods
1969 to 1974, and 1983 to 1984, as well as at other times, brings back painful
memories. Growth does not necessarily mean increased risk. Quality growth
companies can be profitable investments during bull as well as bear markets.
How can there be risk in consistent and slow growth? Even if a company
meets all the other criteria for quality and value, slow growth is a risk
factor which needs to be addressed by the successful investor. The following
chart examines two stocks, the average S&P 500 company ("Company Y") and the
average Z-Seven Fund holding ("Company Z").
Example on following page.
<PAGE> 18
<TABLE>
<CAPTION>
"HOW STRONG GROWTH REDUCES RISK"
Both stocks are bought at a price of $24 (eight times current year earnings of $3 a share).
Company Y Company Z
<S> <C>
This stock meets all of our criteria This stock meets all of our criteria with no
except that earnings only grow at an exceptions. Earnings growth averages
average rate of 9%, annually compounded, 36%, annually compounded, the more
just as the S&P 500 does. This Company conservative (excluding Callaway) average
does not move cyclically like the S&P for companies in Z-Seven's portfolio. Since
500, and therefore we will project two it meets all of our criteria, "Company Z"
consecutive years of earnings growth. It not only has much stronger growth, it also has
does not hype its reported earnings the way consistent growth and conservatively
the average S&P 500 company does, so reported earnings. We will also project
we will not have the need to adjust them. two straight years of earnings growth in
this example.
Year One of a Two-Year 1973-1974 Style Bear Market:
Company Y's earnings grow from $3.00 Company Z's earnings grow from $3.00
to $3.27 a share and the P/E ratio drops to $4.08 a share and the P/E ratio still
from 8 to 6. drops from 8 to 6 despite the strong
growth.
Year Two of a Two-Year 1973-1974 Style Bear Market:
Company Y's earnings only grow from Meanwhile, Company Z's earnings grow from
3.27 to $3.56 per share. Its P/E falls fur- 4.08 to $5.55 per share. Its P/E will probably
ther from 6 to 4 times earnings. Some hold up better. Still, we will assume that this
bear markets actually are this brutal worst-case scenario bear market shows no
This multiplies ($3.56 x 4) out to a share mercy , driving even Company Z's P/E from 6
price of only $14.24 at the end of the down to 4 times earnings. This results in a
second year. share price of $22.20 ($5.55 x 4).
A 41% loss in a two-year investment Capital preservation ($22.20 vs. a $24
($14.24 down from $24) is suffered even starting price two years earlier) in Company Z
though the stock was bought at an shares, in this worst-case scenario bear market,
undervalued price (eight times earnings), is the result of reducing risk through value,
the accounting was conservative, and quality, and 36%, annually compounded, growth in
earnings continued to grow consistently. earnings!
Clearly the biggest risk factor in Company
Y shares was that earnings growth at the
S&P rate of 9% a year is just too slow!
</TABLE>
<PAGE> 19
The company we selected to demonstrate the internal growth criterion is
NATIONAL DENTEX CORPORATION, our sixth largest holding. National Dentex is
one of the large chains of dental labs. Since 1988, National Dentex has
experienced a compounded growth rate of 44%. Over the last six years, its
earnings have grown substantially. Four of the six years had earnings growth
of over 40%. Their growth strategy involves buying small labs to expand
geographic coverage as well as local market share. This strategy should
provide continued strong earnings growth in the future.
BALANCE SHEET: WORKING CAPITAL
"One of these three conditions must be met: a) 2:1 or better current
ratio, b) 1:1 or better quick asset ratio, or c) working capital in excess of
market valuation (total shares outstanding times current market price)."
"Current ratio" means current assets divided by current liabilities.
"Quick asset ratio" means current assets, excluding inventories, divided by
current liabilities. "Working capital" means current assets less current
liabilities.
For a retailer or wholesale distributor, the current ratio is the best
measure of working capital since their businesses have high inventory
requirements. For a service company, there are no inventories thus the quick
asset ratio should be used. Because different types of businesses have
varying needs, we use alternative balance sheet criteria. Still, do not
confuse this flexibility with a lack of discipline since most companies do not
meet any of our alternative requirements.
DAY RUNNER, INC., our largest holding, has an excellent balance sheet.
The company has no long-term debt and cash flow covers all of its liabilities.
Day Runner meets both ratios, a current ratio of 5.39 and a quick asset ratio
of 3.97. With a strong balance sheet and healthy cash flow Day Runner is in
an excellent position to pursue sensible acquisition opportunities.
BALANCE SHEET: CORPORATE LIQUIDITY
"Long-term debt must be less than either: a) working capital, b) cash
and cash equivalents, or c) latest 12 months' cash flow. 'Cash flow' means net
income plus depreciation, amortization, i.e., the difference between revenues
and all cash expenses (including taxes)."
<PAGE> 20
The average S&P 500 company has massive debt (both long-term and
short-term) totaling more than ten times its working capital.
While many companies in our portfolio have no debt at all, the total debt
of the average Z-Seven stock is only 61% of its working capital, even
including Seton Healthcare PLC.
LLOYD THOMPSON GROUP PLC, our third largest investment, has a very
strong balance sheet with no long-term debt. In analyzing companies, we find
that strong balance sheets, with high current and quick asset ratios, usually
go hand-in-hand with good corporate liquidity (low or zero long-term debt).
Lloyd Thompson is an extremely good example of this criterion. The company
reached an agreement with JIB Group to merge their insurance businesses. The
new company will be renamed Jardine Lloyd Thompson Group PLC. The proposed
merger is structured to be implemented without affecting corporate liquidity
through a stock trade. The merger is believed to bring significant strategic
advantage to the businesses, enhancing international operations, allowing the
development of new products, and increasing revenue growth.
PRICE/EARNINGS MULTIPLE AND
OWNER DIVERSIFICATION
"Shares must sell for less than 10 times our estimated earnings per share
for the current fiscal year."
"Less than 10% of outstanding shares must be held by investment companies
other than Z-Seven."
The Price/Earnings Multiple and Ownership Diversification criteria are
discussed together because greater institutional buying results in a higher
price/earnings multiple, while the opposite is true when institutions sell.
Institutional ownership data is now more available than it has been in the
past. The Price/Earnings Multiple criterion is the more relevant of the two
requirements. The following examples will therefore focus only on value using
the price/earnings ratio.
In periods of general undervaluation in the marketplace, a greater number
of stocks meet all seven criteria since more stocks sell for under ten times
earnings. The opposite has held true during a period of general
overvaluation.
Currently, a greater number of stocks meeting all our criteria are found
in Europe. We believe that the U.S.
<PAGE> 21
market at this time offers very few quality growth stocks at undervalued
prices. This belief is confirmed by in-depth research which discovered only a
few stocks that met all seven criteria.
When we looked for value this year, where did we find it?
This year, most of the value we found was in the United Kingdom. Four
new investments were added from the United Kingdom and only one from the
United States. More than three-quarters of our portfolio is invested in
Europe, although we still have several large domestic holdings.
As examples of our "Price/Earnings Multiple" (value: price/earnings
under ten) criterion, we are using two of our British holdings which are among
our seven largest.
Z-Seven's second largest holding is FAIRWAY GROUP PLC. The company has
three divisions: print facilities management, print finishing, and
educational supplies. First-half profits for 1996 were held back due to
difficult market conditions in the print finishing and educational supplies
divisions. In addition, the development costs to set up the archiving
business of Metrofile were higher than anticipated and there was a temporary
constraint on its ability to absorb available new business. But, sluggish
1996 results should provide a springboard for easy 1997 comparisons. For this
reason, we think earnings will approach 9 pence in the new year. Its market
shares traded at 75 pence, eight times earnings at year-end. New acquisitions
increase Fairway Group's market share and widen its range of activities. As a
comparison, we want to talk about Domino Printing Sciences, another U.K.
company in the same industry. Their earnings have been very inconsistent over
the last six years. Even after a sharp drop from their 1995 profit margins,
they still trade at 44 times earnings. Fairway Group is quite a bargain with
a ten-year compounded growth rate of 34%.
WASSALL PLC, our fourth largest position, was trading at 319 pence at
year-end. That is over nine times our 1997 estimated earnings. The earnings
were estimated based on an earnings increase of 36% at the half-year point.
Wassall has a ten-year compounded growth rate of over 91%. SpecTran, a U.S.
company in the cable industry comparable to General Cable, Wassall's cable
division, has a price/earnings multiple of 45. This company offers little
value with earnings down over 84% in 1994 and current earnings levels still
under its 1993 profits. By comparison, Wassall's pre-tax profits have been up
<PAGE> 22
over 35% annually for the last six years through tight management, clear
direction, and a highly effective acquisition strategy. We are adding
Wassall shares to our portfolio to bring the holding to a full-size (ten
percent) position, since it is a real value company.
There is plenty of value in Z-Seven's portfolio besides Fairway Group and
Wassall. According to our earnings estimates, Z-Seven's average
price/earnings ratio is just eight times our estimate of 1997 earnings.
By sharp contrast, the S&P 500 companies (index at year-end 1996 was
740.74) had an average market value of more than eighteen times the $40.71
"Top Down" estimate of 1997 earnings made by the Institutional Brokers
Estimate System (I/B/E/S). The current price/earnings multiple of 8 for
Z-Seven's portfolio offers outstanding value at a 56% discount to the S&P 500
price/earnings multiple of 18.
There are, however, significant differences in the quality of reported
earnings. For the decade of the 1980s, S&P 500 companies reported earnings to
the financial community, on average, 23% higher than the more conservative set
of books used for income tax reporting. Adjusting the estimated $40.71
earnings for the S&P 500 companies to conform with conservative tax accounting
results in only $33.10 in estimated earnings for 1997. Thus, the S&P 500
companies were selling for more than 22 times their estimated tax-purpose 1997
earnings at year-end 1996.
On the other hand, Z-Seven's companies report their earnings just as
conservatively to the public as they do for tax purposes. Comparing S&P 500
companies using the more conservative tax basis of reporting earnings, shows
that Z-Seven's portfolio is an even greater bargain than it might first
appear. On the basis of conservative tax accounting, Z-Seven's adjusted
price/earnings multiple is 8, which is actually a 64% discount to the S&P
500's price/earnings multiple of 22 times.
Over the last ten years, Z-Seven's companies have increased their
earnings at a 43% rate, annually compounded. Even without Callaway, our
portfolio has achieved a 36% growth rate, which is four times the 9% growth
rate for S&P 500 earnings.
Is there still something missing from the picture? Absolutely! The
answer is obvious: investing in the S&P at its year-end close of 740.74 is
by no means a free ride! Sure you get their $33.10 (tax basis) in earnings.
What you may not have counted on is that you also get their 19.93 in net debt
(over and above cash).
<PAGE> 23
Since the S&P 500 companies have 19.93 more debt than cash, the S&P 500
is really selling at more than it appears, as this hidden debt load means that
at 740.74, you are really paying 760.67 (adding in 19.93 in net debt over
cash) for the S&P 500's earnings. The price/earnings multiple on the net
debt-adjusted S&P 500 of 760.67 is nearly 23 times their 1997 estimated
tax-purpose earnings of $33.10.
WHAT ABOUT Z-SEVEN'S PREMIUM TO NET ASSET VALUE?
At year-end, buying Z-Seven shares meant paying a premium of 25% over
net asset value. Adjusting our portfolio companies' earnings to the more
conservative tax basis, and adjusting the price/earnings multiples in our
portfolio taking into account the excess of debt over cash on our companies'
balance sheets (and doing likewise for the S&P 500 companies) means that even
paying a 25% premium on Z-Seven's net asset value can be a bargain!
Especially, if you have to pay over four times the S&P 500 companies' book
value (net asset value) to buy the S&P 500, which means paying a premium of
325%.
SELL DISCIPLINE: BASED UPON THE
SAME COMMON SENSE CRITERIA AS
FOR STOCK SELECTION
Investors often comment that portfolio managers and analysts have many
reasons why to purchase shares in a company and never come to terms with which
ones to sell and why. Not being disciplined in when to sell can be even more
dangerous than leaving buy decisions to chance and emotion.
Our stock selection criteria are designed to minimize investment mistakes
by not repeating them. This is a concept which has been the guiding principle
for Barry Ziskin as a money manager.
There are seven events which will cause us to IMMEDIATELY ELIMINATE
shares from our portfolio:
1. ANY BREACH OF OUR "ACCOUNTING PROCEDURES" CRITERION. Once the
company begins to hype their reported figures or stops disclosing enough
information to make a determination as to how conservatively earnings are
reported, it has removed the most important foundation upon which reasonable
analysis can be built. We rarely find this rule breached, as nearly all
companies which have once met this most important criterion continue to do so.
<PAGE> 24
While other criteria may cease to be met without having to eliminate the
holding, the "Accounting Procedures: Reliability and Conservatism" criterion
is the foundation upon which the quality, growth, and value characteristics
we seek are based.
2. THE BREACH OF OUR "CONSISTENCY OF OPERATING EARNINGS GROWTH" CRITERION
WILL ALSO RESULT IN IMMEDIATE ELIMINATION OF OUR HOLDING unless we see good
reason to expect this breach, whether realized or anticipated, to be minor or
short-term in nature. We look for early warning signs so that if it is
necessary to sell the shares we try to do so before the bad news is out and
the price drops.
A long-term change in our companies' profitability and growth happens
infrequently, so, like our first rule for immediate elimination, we rarely
need to implement it. More often than not, if one of our companies is slowed
down by a recession, it represents a temporary flattening out or "blip" in an
otherwise excellent long-term growth record. These companies tend to quickly
return to their successful performance. Therefore, it is our desire to
maintain smaller positions in these companies.
We still take immediate and prudent risk-reduction action even in these
cases, and, in those markets still benefiting from lower interest rates, we
reduce most of our exposure by cutting back these investments to just one
third of our targeted position size for stocks which continue to meet all the
purchase criteria. Why do we not just eliminate them immediately and reinvest
all of the proceeds into those stocks which continue to meet all of the
criteria?
Most often, alarm bells do not ring! Unfortunately, by the time we are
aware that there will be an interruption in a company's growth pattern, the
market price of its shares and the lack of buyers in some thinly traded issues
does not offer the seller a real opportunity. In many instances, the stock is
at a bargain price due to an overreaction by the market. This most often
occurs in bear markets and during recessions when panic runs rampant.
3. THE BREACHING OF OUR "CONSISTENCY OF OPERATING EARNINGS GROWTH"
CRITERION CAN RESULT IN ELIMINATION OF THE POSITION IN ITS ENTIRETY WHEN THE
COMPANY'S MANAGEMENT LOSES CREDIBILITY. The position will be eliminated when
reported results are significantly worse than we were led to believe. We can
make no reasonable determination of long-term growth potential if we are
misinformed by the company in the short-term. Following this rule has saved
us money several times over the years.
<PAGE> 25
4. THE BREACHING OF OUR "BALANCE SHEET: WORKING CAPITAL" CRITERION WILL
RESULT IN THE ELIMINATION OF THE INVESTMENT IN THAT COMPANY IF NEGATIVE
WORKING CAPITAL IS REPORTED. This rule, while it is important, has very
rarely been implemented.
A nominal (non-deficit) breach in our working capital criterion due to
the seasonal nature of some businesses or temporary shifts between short-term
and long-term debt is not a serious worry, as long as our other criteria are
met. Still, the nominal breach requires the immediate reduction of our
exposure to risk by selling the position to one half of the targeted size for
stocks which meet all our other criteria.
5. RESTRICTIVE MONETARY POLICIES AND EARLY WARNING SIGNS TO FUTURE STOCK
PRICES PROVIDED BY DIVERGENT TRENDS IN MAJOR STOCK MARKET INDEXES (BLUE CHIPS)
VS. INDIVIDUAL STOCKS (THE BROAD MARKET) REQUIRES US TO ELIMINATE HOLDINGS
WHICH HAVE EVEN A SLIGHT INTERRUPTION IN ANNUAL OPERATING EARNINGS GROWTH
CONSISTENCY.
As we explained under "Sell Discipline" criterion #2, an inconsistency in
operating earnings growth results in a reduction to a one-third position. The
remaining position will be completely eliminated, if both monetary policies
and divergent market trends occur. It would take these companies six years to
requalify regardless of their ability to achieve continuous growth in
operating profits.
During 1996, conditions in the United Kingdom caused us to reduce and
ultimately eliminate holdings which no longer met the "Consistency of
Operating Earnings Growth" criterion. In the case of Airtours, the earnings
consistency criterion was breached in the 1995 fiscal year and the position
was reduced. In 1996, its market price was at a high and we sold the
remaining shares at a substantial gain.
6. WHEN NEGATIVE MONETARY AND DIVERGENT TREND SIGNALS PERSIST, WE
ELIMINATE ALL REMAINING INVESTMENTS WHICH NO LONGER MEET THE PURCHASE
REQUIREMENTS. ALL THOSE CONTINUING TO MEET ALL PURCHASE CRITERIA REMAIN IN
OUR PORTFOLIO AS VALUABLE LONG-TERM INVESTMENTS REGARDLESS OF GENERAL ECONOMIC
AND STOCK MARKET FACTORS.
As part of the 1996 United Kingdom selling program, we reduced TT Group
PLC because of a breach in the "Balance Sheet: Working Capital" criterion.
Polypipe PLC and Tomkins PLC were reduced because they no longer met our
"Price/Earnings Multiple" criterion.
<PAGE> 26
7. SOMETIMES WE HAVE NO CHOICE! IN THE EVENT OF A TAKEOVER OR GOING
PRIVATE TRANSACTION, OUR DESIRED HOLDING PERIOD, WHICH IS FOREVER FOR
WELL-MANAGED COMPANIES WHICH CONTINUE TO MEET ALL OF OUR CRITERIA, IS CUT
ABRUPTLY SHORT.
The high quality growth companies in Z-Seven's portfolio are attractive
for potential acquisitions. The companies which meet our stringent criteria
for consistency and magnitude of earnings growth, working capital, corporate
liquidity, and accounting procedures, are the very best publicly owned
businesses we can find. When the shares of some of these companies are
trading at less than ten times current year earnings, potential acquirers may
also take notice. In addition, these values may stimulate insiders to take
over the company in a management buy-out.
While the acquiring company always pays the exiting shareholder a higher
price than current market (to make us believe we are getting a good deal),
there is every motivation on their part to buy our shares for less than they
are really worth. In the case of going-private transactions, if the insiders
already control the votes, they can practically "steal" their own company
because the control block prevents any competition in bidding.
In 1996 we had the unusual situation, that none of our holdings were
taken over or went private.
"How Has Our Portfolio Performed?" - See next page for details.
<PAGE> 27
HOW HAS OUR PORTFOLIO PERFORMED?
PERFORMANCE OF THE LARGEST TWELVE INVESTMENTS IN 1996
Two of our "Golden Dozen" (largest twelve) are new investments, Fairway
Group and Protean. Our top dozen investments represent 70% of our portfolio
at December 31, 1996.
Seven out of twelve were up 14% or more. Among these, Getronics led
with a 153% gain, followed by L'Oreal and Novartis with 49% and 45%
respectively, and Callaway with 27% and Astra 25%.
1. DAY RUNNER, INC. is our biggest position at year-end, accounting for
over 8% of our net asset value. Day Runner is one of the largest
manufacturers of paper-based organizers for the retail market. We began
buying Day Runner in December 1995. At that time, reported earnings were
accelerating and earnings per share were up 63% compared to 55% in the prior
reporting period. So, why did the share price fall 43% in 1996?
At the end of March 1996, Day Runner reported quarterly results that were
up only 10%, which did not meet analysts' expectations. Subsequently, the
share price dropped 25%. The next quarter's earnings were up 55%, but the
share price was unchanged. The quarter ended September 1996, resulted in a
16% increase in earnings and the market price dropped about 10%. In late
December 1996, the company warned of a 15% earnings shortfall and analysts
accordingly reduced their estimates. The market reacted with the fall in
price that resulted in the 43% decline for the entire year.
In a mature bull market, short-term market prices are driven by
expectations. Although earnings are up, the market price can fall due to
earnings that do not meet the market's expectations. In the long-term, market
prices are driven by actual earnings. Day Runner's fiscal year results for
1995 were up 29% and for 1996 were up 43%. Although Day Runner reported a
down quarter ending December 1996, it was better than expected. The share
price as of this writing has increased about 17%.
2. FAIRWAY GROUP PLC, one of our new investments, was first purchased in
September 1996. Fairway is a U.K. company providing print facilities
management for large corporations, finishing services for the printing
industry, and distribution of educational supplies. Difficult market
conditions required Fairway to announce that earnings would be above last
year, but significantly lower than current market expectations. The market
reacted
<PAGE> 28
unfavorably and Fairway's share price has dropped 23% since we bought it.
Fairway has a history of good management that has produced consistent results.
A strong balance sheet should assist Fairway's management in resolving current
problems and building future business.
3. LLOYD THOMPSON GROUP PLC, the international insurance broker, had a
share-price increase of 14%. This British company participated in the recent
industry-wide consolidations by agreeing in late December to merge with
another London firm, Jardine Insurance Brokers. The anticipated merger should
result in significant strategic advantages and create a leading international
reinsurance business. Future earnings will benefit from cost savings in their
London market operations.
4. WASSALL PLC, the British industrial conglomerate with diverse
interests, was up 18%. Its divisions are involved in the manufacture and
distribution of copper wire and cable, adhesives and sealants, bottle
closures, office furniture, and travel goods. Shares in Wassall were lifted
by positive comments from its chief executive as well as a substantial
increase in profits. With a strong balance sheet and healthy cash flow,
Wassall continues to be in an excellent position to pursue acquisition
opportunities.
5. ASTRA AB, one of the fastest growing pharmaceutical companies in the
world and part of our "Good News" section, had a gain of 25%. This Swedish
company is very strong among leading competitors in many markets - Europe,
North America, Australia, and Asia - and across a number of products. Astra
plans to continue its long-term growth by expanding outside Europe through a
number of strategic marketing agreements and the development of new drugs.
6. NATIONAL DENTEX CORPORATION, the leading U.S. dental lab, was down
only 18% due to a modest gain in the last quarter which took it out of the
"Mistakes and Disappointments" section. This decline consolidates the
unusually strong 1995 advance of 158% to a two-year advance of 141%. The
company has a good track record in buying smaller regional labs and improving
their performance. In the short term, profit margins usually dip during the
turnaround process as the company merges personnel and updates systems. We
have confidence that their past history will show good results for the future.
7. GETRONICS NV, already mentioned in the "Good News" section, rose
153%, resulting from exceptional sales and profit growth. We first began
buying
<PAGE> 29
this Dutch service and maintenance firm six years ago and have been rewarded
with consistent earnings growth. However, Getronics did not disclose all the
financial information that we require in their latest annual report and its
shares will be sold (see our "Accounting Procedures: Reliability and
Conservatism" criterion).
8. L'OREAL, our largest French investment, showed a gain of 49%.
Profits are accelerating for the world's largest cosmetics and hair care firm.
For further details, see the "Good News" section.
9. NOVARTIS AG, our largest Swiss investment, had a substantial market
price increase of 45%. Novartis, formed in December 1996, by the merger of
Sandoz and Ciba-Geigy, has yet to report their first financials as a merged
company.
10. CALLAWAY GOLF CO. was up 27% for the full year. Callaway
introduced the new Bobby Jones Series putters and aims to be the number one
supplier of golf putters within the next year.
Callaway demonstrates attractive qualities including ultra-conservative
accounting and underreporting of its earnings (see our "Accounting Procedures:
Reliability and Conservatism" criterion), a debt-free balance sheet, and rapid
and consistent earnings growth.
11. WEETABIX LTD., one of Britain's largest breakfast cereal companies,
is down 9%. About 25% of its sales are in the U.S. market where competition
has been fierce and a price war resulted in pressures on profit margins.
Another factor of concern is the rising world-wheat price. As of this
writing, the share price is up almost 14%.
12. PROTEAN PLC, one of our new investments, is the last of our "Golden
Dozen." This United Kingdom water purification and laboratory equipment
supplier had a decline of 34%. The sharp drop in its market price was due to
the deteriorating financial performance of a German unit. The Protean board
of directors evaluated the situation and promptly replaced the manager of the
German division with the managing director (fluent in German) from its
successful U.K.-based unit. We believe the underlying strength of this
fundamentally sound investment will produce a turnaround in the future.
Protean is up almost 18% as of this writing.
<PAGE> 30
<TABLE>
<CAPTION>
Performance and Financial Information
For performance, earnings growth, and balance sheet statistics on our twelve largest investments (comprising 70% of our
12/31/96 portfolio market value), we have put together the following table for your convenience:
Earnings Growth Current Balance Sheet
(1985-1995)(a) Total Debt
# of Annually (long and short -term)
Down Compounded as%of
Years Earnings Working
for Earnings Growth Rate Cash Capital
------------- ------------ ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
1. Day Runner, Inc. 0 (b) +64% (b) NO DEBT!
2. Fairway Group PLC 2 +34% 1,086% (n) 205%
3. Lloyd Thompson PLC 0 +23% NO DEBT!
4. Wassall PLC 1 +91% 159% 58%
5. Astra AB 0 +28% 11% 10%
6. National Dentex Corp. 0 (b) +44% (b) 7% 4%
7. Getronics NV 0 +30% 2% 2%
8. L'Oreal 0 +17% 120% 82%
9. Novartis AG 0 +19% 74% 73%
10. Callaway Golf Co. 0 (j) +180% (j)(m) 4% 2%
11. Weetabix Ltd. 0 +14% 23% 25%
12. Protean PLC 1 +29% 119% 56%
Z-Seven Average (Total Portfolio) 1 (l) +43% (m) 325% (n) 61% (o)
S&P 500 4 +9% 321% 1,004%
-------------- Share Price --------------
Year End Year End %
1995 1996 Change
--------------- ------------------ ---------------
<S> <C> <C> <C>
1. Day Runner, Inc. 34 1/2 19 1/2 -43%
2. Fairway Group PLC NEW INVESTMENT (c)
3. Lloyd Thompson PLC 167(d) 190 +14%
4. Wassall PLC 270 (d) 319 +18%
5. Astra AB 263 (e) 329 +25%
6. National Dentex Corp. 24 1/2 20 1/8 -18%
7. Getronics NV 18 3/5 (f)(g) 46 9/10 +153%
8. L'Oreal 1,311 (h) 1,954 +49%
9. Novartis AG 1,056(i) 1,533 +45%
10. Callaway Golf Co. 22 5/8 28 3/4 +27%
11. Weetabix Ltd. 2,650 (d) 2,400 -9%
12. Protean PLC NEW INVESTMENT (k)
Z-Seven Average (Total Portfolio) +25%
S&P 500 615.93 740.74 +20%
<FN>
(a) Companies which have fiscal years already reported for 1996 have been updated to 1986-1996 information.
(b) 1988 was first profitable year.
(c) Made in September 1996.
(d) Prices in British Pence per share.
(e) Prices in Swedish Crowns per share.
(f) Adjusted for 4-for-1 stock split in 1996.
(g) Prices in Dutch Guilders per share.
(h) Prices in French Francs per share.
(i) Prices in Swiss Francs per share.
(j) 1989 was first profitable year.
(k) Made in January 1996.
(l) Average (weighted) is 0.63.
(m) Excluding Callaway Golf, Z-Seven weighted average earnings growth rate is reduced to 36%.
(n) Excluding Fairway Group and Seton Healthcare, Z-Seven weighted average total debt as percentage of cash is 51%.
(o) Excluding Seton Healthcare, Z-Seven weighted average total debt as percentage of working capital is 41%.
</TABLE>
<PAGE> 31
BONUS/PENALTY PERFORMANCE INCENTIVE
Z-Seven's net asset value performance (after expenses) must exceed the
S&P 500 by ten percentage points (15% for Z-Seven vs. 5% for the S&P 500) for
the Advisor to earn a minimum quarterly bonus of one quarter of one percent.
If the S&P 500 gains 5% over the latest twelve months, Z-Seven Fund's net
asset value performance must show a return of 105% (beating the market by a
full 100 percentage points) in order for the Advisor to earn the maximum
quarterly bonus of 2 1/2%.
This unique bonus/penalty arrangement between Z-Seven Fund and its
Advisor is not just theoretical; it is one resulting in actual payments to or
by Z-Seven Fund's Advisor. For example, in 1992, British small cap stocks
and other European-traded shares underperformed compared to U.S. blue chip
stocks, a result of a selling panic due to uncertainty over the European
Union's Maastricht Treaty. Though it might have been more appropriate to
compare Z-Seven Fund's performance to London's Unlisted Securities Market
Index (since most of the Fund's portfolio was invested in the U.K.), it was
instead compared to the S&P 500, as per the arrangement. This comparison
resulted in the Advisor paying penalties to the Fund in excess of $230,000.
OUR UNIQUE BONUS/PENALTY PERFORMANCE INCENTIVE TABLE FOLLOWS.
<PAGE> 32
<TABLE>
<CAPTION>
Bonus/Penalty Performance Incentive
Trailing 12 months Quarterly
Percentage Point Difference Bonus Or Penalty
<S> <C>
0 to 9.9 0%
10 to 14.9 1/4 of 1%
15 to 19.9 3/8 of 1%
20 to 24.9 1/2 of 1%
25 to 29.9 5/8 of 1%
30 to 34.9 3/4 of 1%
35 to 39.9 7/8 of 1%
40 to 44.9 1%
45 to 49.9 1 1/8%
50 to 54.9 1 1/4%
55 to 59.9 1 3/8%
60 to 64.9 1 1/2%
65 to 69.9 1 5/8%
70 to 74.9 1 3/4%
75 to 79.9 1 7/8%
80 to 84.9 2%
85 to 89.9 2 1/8%
90 to 94.9 2 1/4%
95 to 99.9 2 3/8%
100 or more 2 1/2%
<FN>
Performance Comparison:
Fund Net Asset Value (even after all ordinary expenses) vs. expense-free S&P
500 Index for latest 12-month period.
</TABLE>
<PAGE> 33
Z-SEVEN TAX INFORMATION STATUS
In 1996, the Fund declared a distribution of $2.80, which represented
estimated long-term capital gains for 1996, and $.19, which represented
undistributed net investment income and long-term capital gains for 1995.
For years in which the Fund retains and pays taxes on realized capital
gains, tax paying shareholders must include in their gross income their
portion of the Fund's realized capital gains and they are entitled to claim a
credit (or a refund for non-tax paying shareholders) for the tax paid by the
Fund on such gains. In addition, shareholders are entitled to increase the
tax cost basis of their shares by the remaining undistributed gains (the net
amount retained by the Fund after it pays the tax). Following is a history of
undistributed capital gains and the related taxes paid by the Fund:
<TABLE>
<CAPTION>
PER SHARE AMOUNT
Undistributed Z-Seven's
Capital Payment of Tax Cost
Gains - Taxes = Write-up
------------------------ ----------- ---------
<C> <S> <C> <C> <C> <C>
1984-85 $ 0 $ 0 $ 0
1986 1.65 .44 1.21
1987 2.11 .68 1.43
1988 3.10 1.05 2.05
1989 .54 .18 .36
1990-92 0 0 0
1993 1.28 .45 .83
1994 .14 .05 .09
1995-96 0 0 0
---------
Total Tax Cost Write-up $ 5.97
</TABLE>
For an original shareholder, the initial purchase cost of $15 per share
is first adjusted to $10 per share for the stock split in 1986. Then, the
total of $5.97 per share in tax cost write-up is added to the split adjusted
$10 per share cost to allow the shareholder a $15.97 per share tax cost basis
on his/her Z-Seven shares.
<PAGE> 34
INVESTMENT POLICIES AND OBJECTIVES
Since the last filing by the Fund of an update to Form N-2, the Board of
Directors has adopted and approved the following changes to the Fund's
investment policies and objectives:
FOREIGN SECURITIES
The Fund may invest up to 100% of the value of its total assets in
securities of foreign
issuers. At December 31, 1996, the Fund had total assets in the amount of
$22,912,244 with 1,392,617 shares outstanding. Approximately 65% of its
total assets (78% of its portfolio) at December 31, 1996, were invested in
foreign securities.
OPTIONS ON STOCK INDEX FUTURES
The Fund may consider from time to time (but at present has no intention
to pursue) the purchase and sale of call and put options on stock index
futures traded on a recognized domestic, national or foreign stock exchange or
board of trade as an alternative method of hedging market fluctuations;
purchases and sales of options will also be made to close out open option
positions. The Fund's Board of Directors has approved these special
investment techniques as an alternative means of protecting the portfolio,
when in the Advisor's opinion, such hedging transactions may reduce risk in
anticipation of adverse price movements. No such transactions occurred during
1996 or the previous seven years.
FOREIGN EXCHANGE CONTRACTS
The Fund engages in hedging as a means of risk protection against losses
due to adverse currency fluctuations. To this extent, the Fund engages in
transactions using forward exchange contracts. Since there is no initial
payment or any cash payments on daily mark-to-markets using foreign exchange
contracts, this additional hedging method gives the Fund the ability to invest
all of its assets in common stocks, including assets that were previously
unavailable when hedging with put options.
<PAGE> 36
OTHER INFORMATION
REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS
In 1996, the Fund implemented a dividend and capital gains distribution
reinvestment program. Shareholders who wish to participate in the program and
have physical possession of their share certificates (holders of record)
should contact ChaseMellon Shareholder Services, our Transfer Agent, at (800)
851-9677. Shareholders who do not have physical possession of their share
certificates (street name) should call their broker.
SHARE REPURCHASES
In accordance with Section 23(c) of the Investment Company Act of 1940,
as amended, notice is hereby given that the Fund may purchase shares of its
capital stock in the open market, from time to time, when the Fund shares are
trading at a discount from the net asset value of the shares, or in order to
increase the net asset value of the shares, or both.
The Fund's policy is to repurchase its own shares when they are selling
at a discount to net asset value. This practice tends to create a floor for
the share price just under the net asset value and can achieve maximum value
for the shareholders. In 1996, the Fund's price performance was extremely
strong, so there were no share repurchases.
<PAGE> 36
Intentionally left blank.
<PAGE> 37
<TABLE>
<CAPTION>
Z-SEVEN FUND, INC.
SCHEDULE OF INVESTMENTS
at December 31, 1996
Percent (a) Common Stock Shares Value
- ----------- ---------------------------------------------- --------- -----------
<S> <C> <C> <C>
1.56% BUILDING MATERIALS & SUPPLIES
Polypipe PLC 88,200 350,330
UDO Holdings PLC 1,700 5,348
-----------
355,678
-----------
5.78% ELECTRONIC COMPONENTS & SERVICE
Getronics NV 30,804 836,144
Zilog, Inc. (c) (d) 18,500 483,312
-----------
1,319,456
-----------
6.43% FINANCIAL SERVICES
City of London PR Group PLC 7,500 10,012
Lloyd Thompson Group PLC 448,600 1,459,296
-----------
1,469,308
-----------
7.28% FOOD, CONFECTION, AND BEVERAGE
Carlsberg AS 4,100 276,906
Lindt & Sprungli AG 403 664,154
Weetabix Ltd. 17,550 721,094
-----------
1,662,154
-----------
11.62% HEALTH & PERSONAL CARE PRODUCTS
Astra AB Class B 22,500 1,081,305
L'Oreal Ord. 2,157 812,330
Novartis AG (formerly Sandoz AG) 666 761,356
-----------
2,654,991
-----------
6.15% LUXURY & DESIGNER PRODUCTS
Abbeycrest PLC 20,800 52,874
Callaway Golf Co. 26,200 753,250
LVMH Moet Hennessy
Louis Vuitton 2,145 599,036
-----------
1,405,160
-----------
9.49% MEDICAL SERVICES & SUPPLIES
National Dentex Corporation (c) (d) 51,000 1,026,375
Protean PLC 266,300 706,760
Seton Healthcare Group PLC 55,800 434,682
-----------
2,167,817
-----------
11.06% MULTI-INDUSTRY
TT Group PLC 83,900 488,382
Tomkins PLC 129,000 596,238
Wassall PLC 264,100 1,442,250
-----------
2,526,870
-----------
17.50% PRINTING & BUSINESS SERVICES
Day Runner, Inc. (c) (d) 96,300 1,877,850
RCO Holdings PLC 93,300 351,368
Fairway Group PLC 1,377,500 1,768,710
-----------
3,997,928
-----------
1.21% RETAILING
Essex Furniture PLC 155,100 265,531
Westfair Foods Ltd. 360 11,558
-----------
277,089
-----------
3.59% TRAVEL
Air London International PLC 192,300 543,248
Autopistas C.E. SA 19,992 275,630
-----------
818,878
-----------
1.47% MISCELLANEOUS 63,000 334,341
-----------
83.14% TOTAL COMMON STOCK 18,989,670
(Cost $15,638,086) (b) -----------
16.86% CASH, RECEIVABLES AND OTHER
ASSETS, LESS LIABILITIES 3,851,814
-----------
100.00% NET ASSETS
(equivalent to $16.40 per share based on
1,392,617 shares of capital stock outstanding) $22,841,484
===========
<FN>
(a) Percentages indicated are on net assets of $22,841,484.
(b) Aggregate cost for federal income tax purposes was $15,638,086 at
December 31, 1996. Net unrealized appreciation for all securities was
$3,351,584. This consisted of aggregate gross unrealized appreciation
($5,531,038) of securities with an excess of fair value over tax cost, and
aggregate gross unrealized depreciation ($2,179,454) of securities with
an excess of tax cost over fair value.
(c) Non-income producing investment (no dividends were paid on this
stock in 1996).
(d) All of this stock was pledged as collateral for a line of credit.
See accompanying notes to financial statements.
</TABLE>
<PAGE> 38
<TABLE>
<CAPTION>
Z-SEVEN FUND, INC.
SCHEDULE OF INVESTMENTS
at December 31, 1996
COMMON STOCKS BY COUNTRY December 31, 1996
Percent Country Value
- -------- --------------------- ----------
<C> <S> <C>
50.19% United Kingdom 9,530,464
27.94% Europe (non U.K.) (e) 5,306,861
21.87% United States 4,152,345
- -------- ----------
100.00% 18,989,670
======== ==========
<FN>
(e) The Z-Seven Fund does not invest in Eastern European companies.
</TABLE>
<TABLE>
<CAPTION>
Z-SEVEN FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
at December 31, 1996
ASSETS
- ----------------------------------------------
<S> <C>
Investments in securities
at value (identified cost
$15,638,086) $18,989,670
Cash 3,382,092
Receivables:
Dividends and interest 55,576
Securities sold 325,486
Other 144,132
Other assets 15,288
------------
Total assets 22,912,244
------------
LIABILITIES
- ----------------------------------------------
Due to investment advisor 16,305
Other accrued expenses 54,455
------------
Total liabilities 70,760
------------
NET ASSETS $22,841,484
============
NET ASSETS REPRESENTED BY
- ----------------------------------------------
Capital stock, $1.00 par value:
7,700,000 shares authorized,
1,634,429 shares issued $ 1,634,429
Additional paid-in capital 19,847,133
Treasury stock, 241,812 shares, at cost (4,233,355)
------------
17,248,207
Accumulated net realized gains on investments
and currency transactions 1,842,378
Net unrealized appreciation on investments
and currency translations 3,285,872
Undistributed net investment income 465,027
------------
Net assets (equivalent to $16.40 per share
based on 1,392,617 shares of capital
stock outstanding) $22,841,484
============
<FN>
See accompanying notes to financial statements.
</TABLE>
<PAGE> 39
<TABLE>
<CAPTION>
Z-SEVEN FUND, INC.
STATEMENT OF OPERATIONS
For the year end December 31, 1996
- ----------------------------------------
<S> <C> <C>
INVESTMENT INCOME:
Dividends, including foreign
exchange gains of $13,753
and net of nonreclaimable
foreign taxes of $89,295. $549,849
Interest 72,966
---------
$ 622,815
EXPENSES:
Investment advisory base fees 326,831
Performance penalty (65,366)
Compensation and benefits 169,532
Transfer agent fees 7,572
Professional fees 60,383
Custodian fees 37,000
Printing and postage 76,136
Office and miscellaneous expenses 38,248
Insurance expense 3,558
Directors' fees and expenses 11,104
Dues and filing fees 10,867
Shareholder relations and
communications 40,585
Interest expense 48,773
Rent expense 11,623
---------
Total expenses 776,846
------------
Net investment loss resulting
from dividends and interest
less total expenses (154,031)
------------
REALIZED AND UNREALIZED GAIN
ON INVESTMENTS:
Net realized gain on
investment and currency
transactions 6,351,691
Net unrealized depreciation of
investments and currency
translations during the year (3,570,885)
------------
Net gain on investments 2,780,806
------------
Net increase in net assets resulting
from operations $ 2,626,775
============
<FN>
See accompanying notes to financial statements.
</TABLE>
<TABLE>
<CAPTION>
Z-SEVEN FUND, INC.
STATEMENT OF CHANGES IN NET
ASSETS
For the For the
year year
ended ended
Dec. 31, Dec. 31,
1996 1995
<S> <C> <C>
Net assets,
beginning of year $24,219,524 $25,241,133
- --------------------------------- ------------ ------------
DECREASE IN NET ASSETS:
From investment activities:
Net investment
income (loss) (154,031) 236,601
Net realized gain
on investment
and currency
transactions 6,351,691 4,210,464
Net unrealized
appreciation
(depreciation)
of investments
and currency
translations (3,570,885) 1,105,641
------------ ------------
Net increase
in net assets resulting
from operations 2,626,775 5,552,706
Distributions to
shareholders from
net investment
income (85,160) (1,205,515)
Distributions to
shareholders from
net capital gains (4,055,357) (3,006,858)
Increase (decrease) in net
assets resulting from
capital share transactions 135,702 (2,361,942)
------------ ------------
Decrease in net assets (1,378,040) (1,021,609)
------------ ------------
Net assets, end of year
(including undistributed
net investment income of
$465,027 at December 31,
1996, and $81,957 at
December 31, 1995). $22,841,484 $24,219,524
============ ============
<FN>
See accompanying notes to financial statements.
</TABLE>
<PAGE> 40
<TABLE>
<CAPTION>
Z-SEVEN FUND, INC.
The following represents selected data for a share outstanding throughout the year.
Data has been adjusted to reflect the three-for-two stock split declared on April 22, 1986.
FINANCIAL HIGHLIGHTS (includes thirteen years of information - since Fund inception)
- ----------------------------------------------------------------------------------------------
Year ended December 31, 1996 1995 1994 1993 1992** 1991
- ------------------------------------------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of year $ 17.48 $ 16.65 $ 17.00 $ 15.12 $ 17.65 $ 12.16
----------- ----------- ----------- ----------- ----------- -----------
Net investment income
(loss) resulting from
dividends and interest
less total expenses (.11) .11 (.16) .11 .04 (.18)
Net realized and unrealized gains
(losses) on investments and currency
transactions before income taxes 2.02 3.76 (.14) 2.22 (2.57) 5.67
----------- ----------- ----------- ----------- ----------- -----------
Total increase (decrease)
from investment operations 1.91 3.87 (.30) 2.33 (2.53) 5.49
Distributions to shareholders
from net investment income (.06) (.87) -0- -0- -0- -0-
Distributions to shareholders
from net capital gains (2.93) (2.17) -0- -0- -0- -0-
Income taxes on capital gains
paid on behalf of shareholders -0- -0- (.05) (.45) -0- -0-
----------- ----------- ----------- ----------- ----------- -----------
Net increase (decrease) in
net asset value (1.08) .83 (.35) 1.88 (2.53) 5.49
----------- ----------- ----------- ----------- ----------- -----------
Net asset value, end of year $ 16.40 $ 17.48 $ 16.65 $ 17.00 $ 15.12 $ 17.65
=========== =========== =========== =========== =========== ===========
Per share market value, end of year $ 20.50 $ 22.25 $ 16.50 $ 18.25 $ 17.00 $ 21.50
Total investment return* 8.93% 58.34% (9.30%) 10.17% (20.93%) 68.63%
Ratio of expenses before performance
bonus/penalty to average net assets 3.22% 2.86% 2.74% 2.86% 3.50% 3.38%
Ratio of total expenses to average
net assets 2.97% 1.99% 2.99% 2.13% 2.35% 4.33%
Ratio of net investment income (loss)
to average net assets (.59%) .90% (.78%) .74% .24% (1.09%)
- ------------------------------------------- ----------- ----------- ----------- ----------- ----------- -----------
Portfolio Turnover Rate 66.35% 36.12% 17.45% 42.13% 17.94% 44.12%
Average Commission Rate .0361 .0392
- ------------------------------------------- ----------- ----------- ----------- ----------- ----------- -----------
Number of shares outstanding,
end of year 1,392,617 1,385,649 1,516,129 1,594,129 1,634,429 1,285,324
Net assets, end of year (in 000's) 22,841 24,220 25,241 27,097 24,714 22,687
- ------------------------------------------- ----------- ----------- ----------- ----------- ----------- -----------
<PAGE> 41
Year ended December 31, 1990 1989 1988 1987 1986 1985 1984
- ------------------------------------------- ----------- ----------- ----------- ----------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of year $ 13.25 $ 14.33 $ 15.23 $ 16.09 $ 11.89 $ 8.67 $ 9.20
----------- ----------- ----------- ----------- ----------- ----------- ---------
Net investment income
(loss) resulting from
dividends and interest
less total expenses .15 .45 .01 (.14) (.35) (.16) .01
Net realized and unrealized gains
(losses) on investments and currency
transactions before income taxes (1.11) (.80) .14 (.04) 4.99 3.38 (.54)
----------- ----------- ----------- ----------- ----------- ----------- ---------
Total increase (decrease)
from investment operations (.96) (.35) .15 (.18) 4.64 3.22 (.53)
Distributions to shareholders
from net investment income (.13) (.45) -0- -0- -0- -0- -0-
Distributions to shareholders
from net capital gains -0- -0- -0- -0- -0- -0- -0-
Income taxes on capital gains
paid on behalf of shareholders -0- (.28) (1.05) (.68) (.44) -0- -0-
----------- ----------- ----------- ----------- ----------- ----------- ---------
Net increase (decrease) in
net asset value (1.09) (1.08) (.90) (.86) 4.20 3.22 (.53)
----------- ----------- ----------- ----------- ----------- ----------- ---------
Net asset value, end of year $ 12.16 $ 13.25 $ 14.33 $ 15.23 $ 16.09 $ 11.89 $ 8.67
=========== =========== =========== =========== =========== =========== =========
Per share market value, end of year $ 12.75 $ 13.00 $ 16.63 $ 15.25 $ 20.13 $ 10.00 $ 9.33
Total investment return* 1.92% (20.24%) 17.04% (20.83%) 106.58% 7.14% (6.67%)
Ratio of expenses before performance
bonus/penalty to average net assets 3.61% 3.49% 3.53% 3.00% 2.65% 3.50% 3.77%
Ratio of total expenses to average
net assets 2.63% 1.16% 2.73% 3.23% 4.22% 3.50% 2.82%
Ratio of net investment income (loss)
to average net assets 1.44% 3.33% .04% (.74%) (2.30%) (1.58%) .12%
- ------------------------------------------- ----------- ----------- ----------- ----------- ----------- ----------- ---------
Portfolio Turnover Rate 42.82% 87.29% 4.73% 23.34% 30.56% 24.22% 32.87%
Average Commission Rate
- ------------------------------------------- ----------- ----------- ----------- ----------- ----------- ----------- ---------
Number of shares outstanding,
end of year 1,295,924 1,375,724 1,470,974 1,498,474 1,504,174 1,548,424 1,548,424
Net assets, end of year (in 000's) 15,756 18,231 21,083 22,827 24,210 18,417 13,429
- ------------------------------------------- ----------- ----------- ----------- ----------- ----------- ----------- ---------
<FN>
*Based on market price per share with dividends, distributions, and deemed distributions reinvested at lower of net
asset value or closing market price on the distribution date.
**Calculations based on weighted average number of shares outstanding for the year of 1,294,188.
See accompanying notes to financial statements.
</TABLE>
<PAGE> 42
Z-SEVEN FUND, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - Significant Accounting Policies
Z-Seven Fund, Inc. (the "Fund") is registered under the Investment Company Act
of 1940, as amended, as a nondiversified, closed-end management investment
company incorporated under the laws of Maryland on July 29, 1983, and became a
publicly traded company on December 29, 1983. The following is a summary of
significant accounting policies followed by the Fund in the preparation of
financial statements.
Security Valuation - Securities traded on national securities exchanges are
valued at the last sale price or, in the absence of any sale, at the closing
bid price on such exchanges or over the counter. If no quotations are
available, the fair value of securities is determined in good faith by the
Board of Directors. Temporary investments in short-term money market
securities are valued at market. Quotations of foreign securities in foreign
currency are converted to U.S. dollar equivalents at the date of valuation.
Federal Income Taxes - It is the Fund's policy to comply with the requirements
of the Internal Revenue Code applicable to regulated investment companies.
The Fund intends to distribute substantially all of its net investment taxable
income, if any, annually.
Distributions to shareholders - Dividends and distributions of net capital
gains to shareholders are recorded on the ex-dividend date.
Securities Transactions and Related Investment Income - Securities
transactions are accounted for on the trade date and dividend income is
recorded on the ex-dividend date. Realized gains and losses from securities
transactions are determined on the basis of identified cost for book and tax
purposes.
Foreign Currency Translation - The books and records of the Fund are
maintained in U.S. dollars. Foreign currency amounts are translated into U.S.
dollars on the following basis:
(i) market value of investment securities, assets and liabilities at the
closing daily rate of exchange, and
(ii) purchases and sales of investment securities and dividend income at the
rate of exchange prevailing on the respective dates of such transactions.
Investment companies generally do not isolate that portion of the results of
operations that arises as a result of changes in exchange rates from the
portion that arises from changes in market prices of investments during the
period. When foreign securities are purchased or sold, the Fund acquires
forward exchange contracts as of the trade date for the amount of purchase or
proceeds, and no exchange gains or losses are thus realized on these
transactions. Dividends are shown net of foreign exchange gains or losses
which represent currency gains or losses realized between the ex and payment
dates on dividends and interest.
Forward Currency Contracts - As foreign securities are purchased, the Fund
enters into forward currency exchange contracts in order to hedge against
foreign currency exchange rate risks. The market value of the contract
fluctuates with changes in currency exchange rates. The contract is
marked-to-market daily and the change in market value is recorded by the Fund
as an unrealized gain or loss. When the contract is closed, the Fund records
a realized gain or loss equal to the difference between the value of the
contract at the time it was opened
<PAGE> 43
and the value at the time it was closed. Realized gains and losses from
contract transactions are included as a component of net realized gain on
investment and currency transactions in the Statement of Operations.
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires the Fund's management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from these estimates.
NOTE 2 - Treasury Stock Transactions
From 1993 through 1995, the Board of Directors authorized the following
purchases of the Fund's capital shares on the open market:
<TABLE>
<CAPTION>
Number of
Year Shares Cost
- ---- --------- ----------
<S> <C> <C>
1995 130,480 $2,361,942
1994 78,000 1,308,710
1993 40,300 674,425
--------- ----------
248,780 $4,345,077
========= ==========
</TABLE>
In 1996, the Fund established a distribution reinvestment plan to allow
shareholders to reinvest their distributions in shares of the Fund. If the
Fund is selling at a premium, distributions will be reinvested at the greater
of net asset value or 95% of the market price. If the Fund is selling at a
discount, distributions will be reinvested at market price. On December 31,
1996, 6968 shares of the Fund were distributed to plan participants at $19.475
per share (95% of the market price). This distribution increased the Fund's
total net assets by $135,702.
In December, 1992, the Fund reissued all of its existing treasury stock in
addition to newly issued stock in a private placement of shares to Agape Co.,
S.A. in exchange for securities which were generally the same as those
contained in the Fund's portfolio. A total of 349,105 unregistered Fund
shares were issued to Agape in the transaction at a slight premium to net
asset value. The federal income tax basis of the securities received by the
Fund in this transaction was equivalent to the market value of those
securities on the date of the transaction. The Fund is obligated to register
these shares for sale in the open market if and when requested by Agape.
Agape has requested that the Fund consider repurchasing these shares as an
alternative to registration. The Fund's Board of Directors has preliminarily
approved the repurchase of all or some of these shares subject to negotiating
satisfactory terms and conditions with Agape and satisfaction of regulatory
requirements. The Fund expects any repurchases, or other disposition, of
these shares to be conducted in an orderly fashion over a period of time. In
the event the Fund is asked to register these shares, or agrees to repurchase
them, the Fund may incur legal fees of approximately $30,000 to $50,000 in
connection with obtaining the necessary regulatory approvals and related
matters.
NOTE 3 - Purchases and Sales of Securities
Purchases and sales of investment securities (excluding short-term money
market securities) during the year ended December 31, 1996, were:
<TABLE>
<CAPTION>
Common Treasury
Stocks Bills
----------- ----------
<S> <C> <C>
Purchases $16,335,635 $5,934,756
Sales $22,364,020 $5,973,510
</TABLE>
NOTE 4 - Foreign Exchange Contracts
At December 31, 1996, the Fund had contracts maturing on November 28, 1997, to
sell $15 million in foreign currency ( 7 million Swiss francs, and 6 million
British pounds). These contracts were marked-to-market on December 31,
resulting in a net unrealized loss of $65,713. This unrealized loss is
included as a component of receivables from securities sold, in the
accompanying Statement of Assets and Liabilities.
<PAGE> 44
NOTE 5 - Investment Advisory Fees and Performance Bonus/Penalties
Under an agreement between the Fund and the Advisor, the latter supervises the
investments of the Fund and pays certain expenses related to employees
principally engaged as directors, officers or employees of the Advisor. The
agreement provides for a base management fee equal to .3125% per quarter
(equivalent to 1.25% per annum) of the average daily net assets of the Fund.
For the year ended December 31, 1996, the base management fee aggregated
$326,831.
In addition to such base management fee, the Advisor will receive a bonus for
extraordinary performance or pay a penalty fee for underperformance. The
bonus/penalty performance arrangement uses the S&P Index of 500 Composite
Stocks ("S&P 500 Index") as a measure of performance against which the
performance of the Advisor will be measured. The bonus/penalty is payable at
the end of each calendar quarter and will not exceed 2.5% of the average daily
net assets in the calendar quarter. The performance penalty fee can exceed
the base management fee. Furthermore, the bonus/penalty arrangement will not
become operative unless the performance of the Advisor exceeds, either
positively or negatively, the S&P 500 Index percentage change during the same
period of time by more than 10%. For the year ended December 31, 1996, the
performance penalty aggregated $65,366.
The Agreement also provides that if the Fund's expenses on an annual basis
(including the base management fee, but excluding any bonus or penalty
payments, taxes, interest, brokerage commission and certain litigation
expenses) exceed 3.5% of the average daily net assets up to $20,000,000 plus
1.5% of the average daily net assets in excess of $20,000,000, the Advisor
shall reimburse the Fund for any such excess up to the aggregate amount of the
basic advisory fee. For the year ended December 31, 1996, an expense
reimbursement was not required.
NOTE 6 - Distributions to Shareholders
On September 6, 1996, the Board of Directors declared a distribution of 6.14
cents per share of investment income and 12.67 cents per share of long-term
capital gains, for a total distribution of 18.81 cents per share. These
amounts represented undistributed net investment income and long-term capital
gains for 1995. Additionally, on November 22, 1996, the Board of Directors
declared a distribution of $2.80 per share which represented estimated
long-term capital gains for 1996. These distributions were paid on December
31, 1996, to shareholders of record on December 20, 1996. The Fund intends to
distribute the balance of long-term capital gains and net investment income
for 1996 on or before December 31, 1997.
Income dividends and capital gain distributions are determined in accordance
with income tax regulations which may differ from generally accepted
accounting principles. These differences are primarily due to differing
treatments of income and gains on foreign denominated assets and liabilities
held by the Fund, timing differences, and differing characterizations of
distributions made by the Fund. Due to the differing treatment for tax
purposes of certain income and capital gain items, as of December 31, 1996,
the Fund has reclassified $622,261 from accumulated net realized gains to
undistributed net investment income.
<PAGE> 45
NOTE 7 - Federal Income Taxes
For federal income tax purposes, in 1996, the Fund experienced a net capital
gain of $5,656,482 and investment company taxable income of $473,627. The
Board of Directors elected to distribute substantially all of the 1996 net
capital gain, accordingly, there is no tax provision for 1996.
NOTE 8 - Related Parties
Directors of the Fund who are not officers or otherwise affiliated with the
Advisor are paid $500 per meeting plus out-of-pocket expenses.
At December 31, 1996, Barry Ziskin, an officer and director of the Fund, owned
306,534 shares of the Fund's capital stock. He is also an officer and
director of the Advisor.
NOTE 9 - Line of Credit
The Fund has a $2 million line of credit with its custodian bank which is
secured by certain investment securities with an aggregate market value of
$3,387,537 at December 31, 1996. Borrowings against the line are charged
interest at a rate of prime plus 1/2%. The maximum amount outstanding against
the line in 1996 was $1,850,000. The line of credit expires September 18,
1997.
The purpose of the line is to enable the Advisor flexibility in selling shares
of portfolio investments at such time and price as is consistent with the
investment discipline employed and is in the best interest of the
shareholders. If the full amount of the line of credit were utilized, it
would represent less than 10% of the net assets of the Fund at year end.
RESULTS OF VOTING (UNAUDITED)
Pursuant to the Proxy Statement mailed to Shareholders in conjunction with the
Annual Meeting of Shareholders held on November 22, 1996, three proposals to
be voted upon at the meeting were presented. Those proposals included:
Proposal 1: Election of Directors. All Directors were nominees to the Board of
Directors at this meeting. The Directors elected will hold office until the
next Annual Meeting of Shareholders or until his or her successor is duly
elected and qualified.
<TABLE>
<CAPTION>
Nominee For Withheld
- ---------- --------- --------
<S> <C> <C>
T. Lee 1,316,698 23,490
J. Shuster 1,309,052 31,136
B. Ziskin 1,316,698 23,490
R. Ziskin 1,316,439 23,749
</TABLE>
Proposal 2: Approval of selection of KPMG Peat Marwick LLP as independent
accountants to report on the Financial Statements of the Fund for the fiscal
year ending December 31, 1996.
<TABLE>
<CAPTION>
For Against Abstain
- --------- ------- -------
<S> <C> <C>
1,333,768 1,685 4,873
</TABLE>
Proposal 3: Authorize the Proxies, in their discretion, to vote upon such
other business as may properly come before the Annual Meeting of Shareholders.
<TABLE>
<CAPTION>
For Against Abstain
- ------- ------- -------
<S> <C> <C>
789,359 13,928 537,037
</TABLE>
<PAGE> 46
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF Z-SEVEN FUND, INC.
We have audited the accompanying statement of assets and liabilities of
Z-Seven Fund, Inc., including the schedule of investments as of December 31,
1996, and the related statement of operations for the year then ended, and
statement of changes in net assets and financial highlights for each of the
years in the two year period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits. The accompanying financial
highlights of Z-Seven Fund, Inc. for each of the years in the six year period
ended December 31, 1994, and for each of the years in the five year period
ended December 31, 1988, were audited by other auditors whose reports thereon
dated January 30, 1995, and February 3, 1989, expressed unqualified opinions
on those financial highlights.
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, 1996, 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 1996 and 1995 financial statements and financial
highlights referred to above present fairly, in all material respects, the
financial position of Z-Seven Fund, Inc. as of December 31, 1996, and 1995,
and the results of its operations for the year then ended, and its changes in
net assets and financial highlights for each of the years in the two year
period then ended, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Phoenix, Arizona
January 17, 1997
<PAGE> 47
<TABLE>
<CAPTION>
<S> <C>
BOARD OF DIRECTORS CUSTODIAN
Chase Manhattan Bank
Barry Ziskin New York, NY
President:
Z-Seven Fund, Inc. TRANSFER AGENT
TOP Fund Management, Inc. ChaseMellon Shareholder Services
Ziskin Asset Management, Inc. 85 Challenger Road
Overpeck Centre
Thomas W. Lee Ridgefield Park, NJ 07660
President, San Francisco Advertiser, Inc. 1-800-851-9677
Principal, Pet Club
INDEPENDENT ACCOUNTANTS
Dr. Jeffrey Shuster KPMG Peat Marwick LLP
DDS PC Phoenix, AZ
Private Practice
GENERAL COUNSEL
Rochelle Ziskin Kramer, Levin, Naftalis & Frankel
Assistant Professor New York, NY
University of Missouri,
Kansas City, MO Kilpatrick & Cody
Atlanta, GA
INVESTMENT MANAGER
STOCK LISTING
TOP Fund Management, Inc. NASDAQ (NMS)
Symbol: ZSEV
OFFICERS Pacific Stock Exchange
Symbol: ZSE
Barry Ziskin
President CORPORATE OFFICE
2651 W. Guadalupe Rd., Suite B-233
Carol F. Kahanek Mesa, AZ 85202
Secretary (602) 897-6214
Fax (602) 345-9227
Laurie S. Doane
Treasurer
</TABLE>
