Z
SEVEN
ANNUAL REPORT
DECEMBER 31, 1998
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> FRONT COVER
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, as well as countless predictable factors because it is based
upon common sense solutions diligently applied from lessons learned by the
making of 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 fifteen-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 beginning a closed-end fund. HIS CRITERIA FOR SELECTING
HIGH-QUALITY, UNDERVALUED GROWTH STOCKS HAVE STOOD THE TEST TIME OVER A SPAN
OF MORE THAN 25 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 a discussion of
our poorer performing stocks is a regular feature, for it is through the
lessons learned by mistakes that we continue to evolve as better investors.
Our "Criteria for Stock Selection" section once again promises to bring the
theoretical to life through real and meaningful examples in our portfolio of
investments, and is followed by an in-depth look at our "Selling Discipline."
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> INSIDE FRONT COVER
TABLE OF CONTENTS
LETTER TO OUR SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . 3
1998 Portfolio Investment Results . . . . . . . . . . . . . . . . . . . . 4
1998 Net Asset Value . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1998 Fourth Quarter Net Asset Value . . . . . . . . . . . . . . . . . . . 5
1998 Dividend Distribution . . . . . . . . . . . . . . . . . . . . . . . . 5
1998 Federal Income Tax Paid on Your Behalf . . . . . . . . . . . . . . . 5
1998 Share Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
1998 Share Repurchases . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Total Investment Return Comparison . . . . . . . . . . . . . . . . . . . . 8
1999 Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
BARRY ZISKIN'S PROMISE . . . . . . . . . . . . . . . . . . . . . . . . . . 12
THIS YEAR'S BEST QUESTION . . . . . . . . . . . . . . . . . . . . . . . . 12
STOCK PURCHASE CRITERIA AND SELL DISCIPLINE . . . . . . . . . . . . . . . 15
Accounting Procedures: Reliability and Conservatism . . . . . . . . . . . 15
Consistency of Operating Earnings Growth . . . . . . . . . . . . . . . . . 16
Strength of Internal Earnings Growth . . . . . . . . . . . . . . . . . . . 17
Balance Sheet: Working Capital . . . . . . . . . . . . . . . . . . . . . 20
Balance Sheet: Corporate Liquidity . . . . . . . . . . . . . . . . . . . 20
Price/Earnings Multiple and Owner Diversification . . . . . . . . . . . . 21
Sell Discipline: Based Upon the Same Common Sense Criteria
as for Stock Selection . . . . . . . . . . . . . . . . . . . . . . . . . . 26
A NEW LOOK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
The Strongest Seven (formerly "Good News") . . . . . . . . . . . . . . . . 30
The Weakest Seven (formerly "Mistakes and Disappointments") . . . . . . . 35
PERFORMANCE AND FINANCIAL INFORMATION . . . . . . . . . . . . . . . . . . 40
OUR GOLDEN DOZEN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
PAST PERFORMANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
SPECIAL FEATURE OF THE FUND . . . . . . . . . . . . . . . . . . . . . . . 52
INVESTMENT OBJECTIVES AND POLICIES . . . . . . . . . . . . . . . . . . . . 53
GENERAL INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
FINANCIAL REVIEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
<PAGE> 1
<PAGE> 2
LETTER TO OUR SHAREHOLDERS
THE YEAR IN REVIEW
What a year it was! At the beginning of 1998, our portfolio had the wind
at its back, both at home and across the Atlantic, as major stock markets of
the developed world got off to excellent starts. By mid-April, our portfolio
had already gained 17%. During the second quarter of 1998, the Dow Jones
Industrial Average and S&P 500 continued to achieve one new record after
another.
It is, however, never that simple. As the major market averages and
indices went through the ceiling, the ground beneath them began to quake. The
actual market for nearly all stocks was not so robust. More individual stocks
declined than advanced during the second quarter, even while the Dow achieved
new records and surpassed the 9,000 mark. To make matters even more
precarious, interest rates had been rising here and in Britain, our second
largest area of investment, and other leading nations were thought to be on
the brink of higher rates. Finally, the market did collapse in late July and
throughout August, culminating in a selling climax on August 31 when 1,183
Stocks on the New York Stock Exchange and 1,263 individual NASDAQ issues
dropped to new 52-week lows.
Partially because of panicky markets, the Federal Reserve Board, the Bank
of England, and other leading central banks came to the rescue. At first, as
is normal during a turn in monetary policy, panic continued to prevail against
logic. After a brief respite in September, another rebound of selling drove
prices to their lowest point on October 8. On this day, 1,326 NASDAQ-traded
stocks declined to new 52-week lows.
At Z-Seven Fund, our portfolio was severely impacted by this tornado
which swept across all share prices. Our primarily domestic small-cap
portfolio (more than 70% in U.S. stocks) is designed to be defensive over the
long-term; however, virtually nothing on the market is spared during short and
sharp collapses. THE RUSSELL 2000 INDEX OF SECONDARY STOCKS DECLINED 38% from
its peak in the spring, while our portfolio suffered a 33% drop from the
spring high through the bottom on October 8. The decline in prices did enable
us to capture several new investment opportunities within our strict
requirements as value/growth investors. These new holdings combined with our
existing investments, including two which were
<PAGE> 3
doubled upon at PRICES LESS THAN THE COMPANIES NET CASH PER SHARE, make me
excited about our prospects.
Even though the first six trading sessions of 1998's final quarter were
nothing short of disastrous, better monetary conditions helped the world's
major markets to recover rapidly as the quarter progressed. Although the Dow
Industrials and S&P 500 actually made new all-time records by Thanksgiving,
and the NASDAQ Index followed, THE RUSSELL 2000 INDEX, a better indication of
a broad array of secondary stocks, FINISHED THE YEAR DOWN BY NEARLY 4%. From
the October 8 bottom, we rebounded with an increase of 41%, and finished 1998
with a positive return for the investment portfolio.
==============================================================================
1998 PORTFOLIO INVESTMENT RESULTS
Thanks to the recovery of stock markets in which we are invested,
although still hindered by secondary shares being out of favor, Z-Seven's
investment portfolio finished with a positive return of 9% for 1998 (before
expenses). Normally our Fund strives towards greater profits. In this
roller-coaster year when the small-cap Russell 2000 declined, however, any
advance higher than both inflation and money market interest rates seems
noteworthy. Our pre-expense and distribution adjusted net asset value
advanced from $7.55 to $8.21, an increase of $.66. While we are thankful for
profits in a year so difficult for small-cap shares, much more important are
the long-term results for the portfolio. Below is a look at our total
portfolio return (before expenses) over the years:
<TABLE>
<CAPTION>
- ----------------------------------
Cumulative Annually
Compounded
- ----------------------------------
<S> <C> <C>
5-year 108% 16%
10-year 207% 12%
15-year 578% 14%
- ----------------------------------
</TABLE>
==============================================================================
1998 NET ASSET VALUE
As most of our shareholders know, Z-Seven Fund's Advisory fee is uniquely
adjusted for performance relative to the S&P 500 Index. Since the S&P 500
outperformed small-cap shares in 1998, penalties paid by the Advisor reduced
the Fund's expenses to $.11 per average share outstanding. Deducting this
amount from our investment return gives our net asset value an increase of
<PAGE> 4
$.55. THIS IS MORE THAN A 7% INCREASE, from $7.55 to $8.10 before deducting
actual and deemed distributions.
==============================================================================
1998 FOURTH QUARTER NET ASSET VALUE
A strong stock market rally helped our net asset value to increase more
than 18% during the fourth quarter, from $6.85 to nearly $8.10, before actual
and deemed distributions.
==============================================================================
1998 DIVIDEND DISTRIBUTION
Undistributed short-term gains and dividend income remained from November
and December of 1997. Consequently, the Fund paid AN ADDITIONAL DISTRIBUTION
ON DECEMBER 30, 1998 OF $0.1744. This reduced our net asset value from nearly
$8.10 to $7.92.
During 1997, we greatly diversified the portfolio when domestic small-cap
shares were offered at bargain prices. As more and more opportunities became
available, we cut back on recently made investments, many of which were
already quite profitable. It is our desire to hold the investments for the
long term; however, in order to generate monies to buy new stocks, we needed
to adjust the size of all our holdings. This generated short-term gains in
many cases.
==============================================================================
1998 FEDERAL INCOME TAX PAID ON YOUR BEHALF
On December 31, 1998, the Fund PAID A DEEMED DISTRIBUTION OF $0.1234 PER
SHARE, adjusting that day's net asset value from $7.92 to $7.80. The Fund
paid this amount on undistributed 1998 long-term capital gains. Because
Z-Seven pays at the corporate tax rate of 35%, your personal liability could
be lower, resulting in a tax credit not merely a deduction from your taxable
income but an net reduction of taxes due, or an increase of your refund.
Shareholders of Z-Seven are sent a Form 2439 indicating the exact amount
of the undistributed capital gains ($0.3527 per share) and the federal income
tax we paid ($0.1234 per share). If you ordinarily do not pay income taxes on
your account, such as IRAs, pension and profit sharing plans, Keoghs, and
other tax-deferred retirement and savings plans, or if you are an individual
who normally does not pay federal income tax at all,
<PAGE> 5
THE PLAN ADMINISTRATOR OR INDIVIDUAL ENTITY SHOULD FILE TAX FORM 990-T as
instructed on Form 2439 to obtain a full cash refund.
In addition, shareholders are allowed to increase the tax-cost basis of
their shares by the net amount between undistributed gains and taxes paid.
For an original shareholder, the initial purchase cost of $15 would be
adjusted to $5 after stock splits in 1986 and 1997. This cost would then be
added to the total of $4.06 per share in tax cost write-up (see chart below)
to allow you an $9.06 tax-cost basis on your Z-Seven shares.
The following is a history of undistributed capital gains and the related
taxes paid by the Fund on a per-share basis (adjusted to reflect the two-for-
one stock split in December 1997 and the three-for-two stock split in April
1986):
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Undistributed Z-Seven's Tax Cost
Years Capital Gains Tax Payments Write-up
- ----------------------- -------------- ------------- ---------
<S> <C> <C> <C>
1984-85 $ 0 $ 0 $ 0
1986 .83 .22 .61
1987 1.06 .34 .72
1988 1.55 .53 1.02
1989 .27 .09 .18
1990-92 0 0 0
1993 .64 .23 .41
1994 .07 .03 .04
1995-96 0 0 0
1997 1.30 .45 .85
1998 .35 .12 .23
---------
Total Tax Cost Write-up $ 4.06
- -----------------------------------------------------------------
</TABLE>
==============================================================================
1998 SHARE PRICE
We believe that we stand apart from many other closed-end funds in that
our responsibility to our shareholders extends beyond net asset value. While
our efforts begin with a commitment to a strict discipline of investing, the
true "bottom line" for our shareholders must be seen as the market value of
Z-Seven shares.
Unfortunately at year end, the news for our share price is not as good as
it is for our net asset value. The price for 1998 was $8.00 on the NASDAQ.
After adding in nearly $.30 per share in distributions, both actual and
deemed, the
<PAGE> 6
decline from the previous year's price of $11 to an adjusted $8.30 represents
a net reduction of approximately 24%. I believe this is somewhat distorted
due to the unusually high premium over net asset value that our shares enjoyed
at the end of 1997; by far, our highest year-end premium ever. This, of
course, makes for a difficult year-end comparison, illustrating again that a
long-term perspective is necessary when evaluating performance. Our share
price, including distributions, has generated the following net returns:
<TABLE>
<CAPTION>
- ----------------------------------
Cumulative Annually
Compounded
- ----------------------------------
<S> <C> <C>
5-year 59% 10%
10-year 89% 7%
15-year 262% 9%
- ----------------------------------
</TABLE>
==============================================================================
1998 SHARE REPURCHASES
Partially responsible for the strong long-term performance in our share
price is the fact that we repurchase our own shares when they sell at a
discount. This practice tends to create a floor for our share price just
under our net asset value.
During 1998, we repurchased 127,500 shares on the open market. These
repurchases were always made when the price was below net asset value, in
accordance with Rule 10b-18 of the Exchange Act of 1934 and Rule 23c-1 of the
Investment Company Act of 1940. Buying in this way insures that the net asset
value is not diluted. To the contrary, these purchases (at small discounts)
benefit our net asset value to some extent.
The problems of selling at large discounts have long plagued the closed-
end fund industry, but most funds choose not to do this because it decreases
the advisor's fee by shrinking the pool of capital. We feel that REPURCHASING
IS ANOTHER EXAMPLE OF Z-SEVEN PLACING THE INTEREST OF OUR SHAREHOLDERS FIRST,
by reducing advisory fees and maximizing shareholder value.
<PAGE> 7
TOTAL INVESTMENT RETURN COMPARISON
In 1997, as our portfolio moved more heavily into U.S. stocks, we began to
compare Z-Seven Fund with multi-country equity funds. Our two-year total
investment return ranks us #12 out of 30. Prior to 1997, our
European-dominated portfolio was compared to European closed-end funds.
Please see next page for details.
<TABLE>
<CAPTION>
1997-1998 TOTAL INVESTMENT RETURN
List of multi-country closed-end equity funds (a)
- --------------------------------------------------------------------------------------------
Fund Stock Price at 12/31/98 (b) Total Inv. Return
2 Years - 12/31/98(c)
- --------------------------------------------------------------------------------------------
<S> <C> <C>
European Warrant Fund 17.1875 131
Clemente Global Growth 12.8750 83
Gabelli Global Multimedia Trust 10.9375 83
Invesco Global Health Sciences 18.8125 75
Scudder New Europe 17.6250 64
Europe 18.5625 52
Royce Global Trust 4.8750 28
Global Small Cap 12.6875 15
Foreign & Colonial Emerging Middle East 13.5000 15
Latin American Discovery 6.1875 9
Central European Equity 13.3125 1
Z-Seven 8.0000 -1
Canadian World Fund Ltd. 4.3000 -1
Third Canadian General Inv. Trust Ltd. 16.2500 -2
Emerging Markets Telecomminications 8.9375 -4
Templeton Emerging Markets Appreciation 9.0625 -6
Templeton Emerging Markets 9.6250 -11
Central European Value (d) 10.3125 -14
Herzfeld Caribbean Basin 4.3750 -16
Scudder New Asia 9.3125 -20
AIM Eastern Europe (e) 6.1250 -20
Morgan Stanley Emerging Markets 8.1250 -25
Latin America Investment 8.3125 -27
Morgan Stanley Asia Pacific 7.0000 -28
Emerging Markets Infrastructure 7.2500 -29
Fidelity Advisor Emerging Asia 9.3125 -31
Latin America Equity 7.1875 -38
Asia Tigers 6.5625 -39
Asia Pacific 6.7500 -40
Templeton Dragon 7.3750 -42
- --------------------------------------------------------------------------------------------
<FN>
(a) List compiled by Closed End Fund Digest.
(b) Price and Performance Sources: Barron's, Reuters, Closed End Fund Digest.
(c) Adjusted for distributions.
(d) Formerly Czech Republic Fund.
(e) Formerly GT Global Eastern Europe Fund.
Past performance is no guarantee of future results.
</TABLE>
<PAGE> 8
What about comparable performance in the past? Z-SEVEN'S SHARE-PRICE
PERFORMANCE FOR THE FIRST SEVEN YEARS OF THE 1990S WAS BETTER THAN EVERY OTHER
CLOSED-END AND OPEN-END FUND WHICH INVESTED PRIMARILY IN EUROPE. Even before
the 1990s, 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). 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%.
By early 1989, we had sold most of our domestic portfolio and reinvested
the proceeds in European shares, which offered much better value. Financial
markets were hit hard in 1990. The recovery in Europe took place later than
in the U.S., but continued to strengthen in 1996. Our portfolio was dominated
(70% to 98%) by European shares for more than seven years. Since 1997, the
portfolio has been primarily invested in domestic small-cap growth companies
due to the abundance of value in this area.
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 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 1% in 1990, while our
competitors lost 30% to 76%, was an even greater accomplishment.
<TABLE>
<CAPTION>
1990-1996 TOTAL INVESTMENT RETURN
List of U.S. based closed-end funds which invested primarily in Europe (a)
- -----------------------------------------------------------------------------------------------------------
Adj. Total Inv. Return Adj. Total Inv. Return Adj. Total Inv. Return
Fund 1 Year -12/31/90 (c) 6 Years - 12/31/96 (c) 7 Years - 12/31/96 (c)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Z-SEVEN D - 1 % U + 112 % D + 109 %
United Kingdom O - 30 P + 107 O + 64
Swiss Helvetica W - 43 + 97 U W + 36
First Iberian (b) N - 46 M + 72 P N + 7
Portugal M - 55 A + 65 M - 13
Italy A - 46 R + 22 A A - 19
Germany R - 54 K + 49 N R - 20
Spain K - 76 E + 44 D K - 39
Austria E - 62 T - 3 E - 61
T T
AVERAGE -------------------------------------------------------------------------
(EXCLUDING Z-SEVEN FUND) - 51 % + 57 % - 6 %
- -----------------------------------------------------------------------------------------------------------
<FN>
(a) Includes funds which have been public since December 31, 1989, so that seven years of share-price data
can be measured over up markets as well as down markets. Source: Dow Jones (Wall Street Journal).
(b) Now Scudder Spain and Portugal Fund.
(c) Adjusted for distributions and currency changes. Z-Seven Fund's currency exposure is fully hedged.
Past performance is no guarantee of future results.
</TABLE>
<PAGE> 9
==============================================================================
1999 OUTLOOK
Lower interest rates should point the way to an excellent 1999 for New
York, NASDAQ, London, Copenhagen, Zurich, Paris, Stockholm, Madrid, Toronto,
and Winnipeg markets. At the current time, every market we are investing in
enjoys the benefits of lower interest rates.
How long can this go on? Of course, no one really knows for certain. It
is constructive in gaining perspective to realize that a stock market
historically continues to climb for a period of months, sometimes years, after
interest rates have already hit bottom. Even during favorable monetary
conditions, stock markets may still not ascend in a straight line. A
divergence between leading market averages, such as Dow and FTSE, and their
respective broad markets (advance/decline lines), indicates that the blue chip
Dow-type stocks have risen too far, too fast; a sideways or downward
correction will be needed to resynchronize the leaders with the broad market.
Once this process has been accomplished, a more orderly advance may have
greater longevity, hopefully carrying the troops to new highs along with the
generals.
Our investments are in companies, notwithstanding the few exceptions,
that are continuing to generate earnings growth and positioning themselves to
increase profits further into the future. Strong balance sheets are enabling
managements to take advantage of opportunities during challenging economic
times. OUR PORTFOLIO IS DEMONSTRATING EXCELLENT VALUE, WITH A CURRENT P/E OF
8 TIMES ESTIMATED EARNINGS. This is less than 6 1/2 times after deducting cash
per share (see Price Earnings Multiple Criterion, page 21). These factors,
combined with managements planning for the future, lay a solid foundation for
growth potential in our investments, not for 1999 alone, but for 1999 and
beyond.
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.
<PAGE> 10
Our wonderful directors, Rochelle, Tom, and Jeff, have each had a
significant portion of his/her financial portfolio invested in Z-Seven. Their
caring support and hard work has made our Fund even stronger. We are, of
course, saddened at the news of Tom Lee's resignation due to the current time
demands of his expanding businesses. I would like to take this opportunity to
thank Tom, on behalf of everyone, for his nearly three years of valuable
service to the Fund, and to wish him well. Tom was kind enough to continue
serving as Director through early November, when the Board was able to
nominate his very qualified replacement, Mr. Albert Feldman. In fact, we
would like to welcome both Al and our other new director, Maria De Los Santos,
to the Board. We are sure that their knowledge and experience will prove very
beneficial to the Fund.
Sincerely,
Barry Ziskin February 6, 1999
P.S. This report is dedicated to my daughter Ariana, who turns fourteen
today, and who at her young age, much like her father, has taken a keen
interest in stock picking. This report is also dedicated to my son Jacob, who
just turned 21 months, and to the memory of my late father, my most valuable
mentor.
<PAGE> 11
BARRY ZISKIN'S PROMISE
As discussed in our 1997 Annual Report, Barry Ziskin promised not to
profit from any of his businesses and investments, which primarily consist of
Z-Seven Fund, from December 1, 1996 through November 30, 1997. This is due to
Barry's personal commitment, for eight years now, to recognize our creator as
first and foremost in his life. It is a promise to be repeated every seventh
year in the spirit of letting his own financial field lie fallow, while still
taking care of your needs and giving to those who need more than any of us
(such as poverty-stricken children throughout the world, some even in our own
country).
As stated in the 1997 Annual Report, the final accounting for the period
could not be completed until October 1998. Barry made a good faith down
payment to the Fund, not in cash, but IN THE VERY SHARES WHICH ENABLE HIM TO
PROFIT - his investment in Z-Seven. the share amount of his payment was
23,600 at a net asset value of $7.55, or $178,180. After completing final
calculations, Barry's DOWN PAYMENT EXCEEDED THE ACTUAL AMOUNT PROMISED TO THE
FUND BY ALMOST $10,000. The Fund will keep this extra balance, and no further
adjustments will be necessary.
THIS YEAR'S BEST QUESTION
Not many shareholders of small public companies like Z-Seven Fund
actually attend annual shareholder meetings. At our last meeting, however, we
had the pleasure of speaking with fellow shareholders Mr. & Mrs. Scott. I
believe it was at least their third consecutive meeting attended, and I would
like to take a moment to thank Bob and Margaret Scott for their continued
interest in our Fund. We feel that the question they asked during the meeting
is an interesting and timely one. Consequently, it will be highlighted and
answered in this section as our best question of the year.
The question they asked is as follows, paraphrased to the best of my
recollection: "Are the parallels between the current stock market, after the
1998 mini-crash, and the 1929 stock market concerning you? What is the
likelihood that the inability to stimulate the Japanese economy via lower
interest rates will become an American problem leading to global investment
and economic collapse?"
In the latter 1920s, business leaders attempted unsuccessfully to
persuade the Federal Reserve Board to lower interest rates in order to avoid
an economic collapse. Unfortunately, their voices did
<PAGE> 12
not influence the Fed and rates were instead kept unusually high, helping to
bring our economy to its knees. Wild speculation on margin was also rampant.
Prior to the collapse, only 10% margin was required as a deposit by the same
Federal Reserve Board.
I would like to thank Mr. Greenspan and his other governors for sensible
policies and actions, which do not appear to jeopardize our economic
prosperity; in fact, they have acted quite to the contrary.
A large number of other investors, may often read investment newsletters
that pray on our fears with constant doomsday predictions. To me, these
tactics seem to be a marketing gimmick to keep subscribers nervous enough to
send in renewal checks, as opposed to sound investment advice. I prefer the
evidence of many economic and stock market cycles of a consistent and
repetitive nature that can verify a cause and effect. In this respect, it is
common sense that an easier monetary policy of lower interest rates stimulates
business, makes bonds and short-term money market instruments less competitive
vs. stocks, and directly influences supply and demand.
In 1998, transactions which removed companies from the marketplace
proceeded at a feverish pace. These included takeovers, going private
transactions, and partial supply reductions where the companies remain public
but purchase a portion of their floating supply in share buy-backs. Are they
all doing us investors favors out of the goodness of their hearts?
I think we all know there is no "free lunch." Unless it makes economic
sense to do so, and is justified by cheaper money (low interest rates), these
transactions simply do not occur. New records in supply reduction
transactions have been set FOUR YEARS IN A ROW, RISING 78% domestically in
1998 from the year prior. Takeovers alone amounted to an enormous $1.6
trillion in the U.S. As this is a global marketplace, it is interesting to
note that world-wide takeovers were up 54% and also reached a new record for
the fourth consecutive year.
On the other side of the coin are newly issued shares (IPOs, etc.) which
add supply to the marketplace. Both price and interest rates enter into
making a decision of whether to purchase a company (takeover) or to issue new
shares, since borrowing is another option
<PAGE> 13
for businesses which seek additional capital.
Think of buying or selling your home. When interest rates are high,
mortgage payments may rise beyond the affordability of the homebuyer, causing
a price drop in order to find a point where the buyer may bite. On the other
hand, when rates are low (as they are now), low mortgage payments make home
buying more affordable and prices of homes rise.
Low interest rates and volatile stock prices made issuing new shares an
unpopular alternative this past year. After a 22% decline the year before,
IPOs were down another 10%, totaling $35 billion. More importantly, this
amount of new supply is just a mere 2% of the $1.6 trillion of newly liquefied
investment capital and supply reduction.
The idea that lower interest rates help support a market drop and add
upside potential to the rise in a bull market is sound; however, does this
work in the real world?
In an interview with Reuters released in November, Don Hays, chief
investment strategist at Wheat First Union in Richmond, Va., commented on the
Norman Fosback trading rule: "It's a very old and reliable bullish signal for
the market that's called 'Two tumbles and a jump' rule." This refers to the
observation that every time the Fed cuts the discount rate (or another policy
setting tool) twice in a row, the stock market does in fact jump. Mr. Hays
states, "These signals come very rarely, and in the past only about once every
four years. This time, it has been even longer, since February 1, 1991," He
continues, "If you analyze all the signals post-crash, since 1932, you find
every signal created a major successful long-term buy opportunity an investor
with a time horizon of 12 to 18 months would have never lost money."
OVER 12 MONTHS, THE AVERAGE GAIN OF THE DOW JONES INDUSTRIAL AVERAGE HAS
BEEN OVER 30%, and near 35% by 15 months time....that would mean it could rise
to near 11,000 by November of this year, if it were to follow the average
advance, and well over that by February of next year. Since it has been so
long since the last time two consecutive cuts were made to the discount rate,
the market may not just "jump" as much as its average advance after "two
tumbles." It may even rise more this time.
<PAGE> 14
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 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.
<TABLE>
<CAPTION>
- -----------------------------------
<S> <C> <C>
EXAMPLE: CURRENT TAX $30 MILLION
DEFERRED TAX 10 MILLION
-----------
TOTAL TAX $40 MILLION
- -----------------------------------
</TABLE>
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 by most
companies for tax
<PAGE> 15
purposes vs. financial reporting. The "accelerated" method used for tax
purposes, will show a higher depreciation expense in the earlier years and,
therefore, lower earnings. For financial reporting purposes, a straight-line
basis is used, resulting in a lower depreciation expense and a higher net
income.
Watch out for differences other than depreciation 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 1980s, the earnings reported to the shareholders by the
average S&P 500 company were 23% higher than earnings reported to the IRS!
SYNOPSYS, INC., our sixth largest investment, is our example for reliable
and conservative accounting procedures this year. For the years of 1994
through 1998, the company reported, on average, 22% more conservatively to its
shareholders than to tax authorities. Furthermore, IT REPORTED LESS TO ITS
SHAREHOLDERS THAN TO THE IRS EVERY SINGLE YEAR OF THESE FIVE YEARS.
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 both prosperous and difficult times.
<PAGE> 16
The S&P 500 Index has suffered three years of down earnings over the
latest decade of reported earnings (1987-1997). By contrast, the companies in
our portfolio have averaged less than one-half down year during the same
period. We believe the consistent strength of corporate earnings growth
within our portfolio gives us the potential for good long-term results.
When we say "growth in adjusted pre-tax income," we mean operating growth
after adjusting for non-operating items, such as interest and investment
income, foreign currency movements, special reserves, and other non-recurring
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.
JARDINE LLOYD THOMPSON GROUP PLC, the British insurance broker, is our
largest holding. Over the last six years, Jardine's pre-tax income has grown
more than 12% each year. In five out of the last six years, adjusted pre-tax
income was up over 23%.
Jardine Lloyd Thompson was formed by the merger of JIB Group and Lloyd
Thompson two years ago. Before the merger, earnings for Lloyd Thompson grew
each year from its 1982 inception through 1996. Since the merger, adjusted
growth has been over 60%.
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 a company must triple its operating profits to
qualify as an investment. During the 1970s,
<PAGE> 17
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 that we have credible
reported figures. Our criterion of "Consistency of Operating Earnings Growth"
identifies companies with predictable earnings growth regardless of the state
of the economy, industry, or product cycle. The criterion "Strength of
Internal Earnings Growth" further reduces risk by seeking companies that meet
all the previous criteria and in addition show they can grow at a pace
tripling their profits over a six-year period.
Many brokers strive to sell "emerging growth" companies based on future
earnings expectations, rather than historical results. This substantially
increases the investment risk. The losses many investors have suffered at
various times in these "emerging growth stocks" bring 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").
SEE EXAMPLE ON FOLLOWING PAGE. =>
<PAGE> 18
"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
This stock meets all of our criteria except earnings only grow at an
average rate of 9%, annually compounded, just as the S&P 500 has from 1987 to
1997. This Company does not move cyclically like the S&P 500, and therefore
we will project two consecutive years of earnings growth. It does not hype
its earnings the way the average S&P 500 company does, so we will not have to
adjust them.
COMPANY Z
This stock meets all of our criteria with no exceptions. EARNINGS GROWTH
AVERAGES 44%, ANNUALLY COMPOUNDED, the ten-year average (1987-1997) for the
current Z-Seven portfolio. Since it meets all of our criteria, Company Z not
only has much stronger growth, it also has consistent growth and
conservatively reported earnings. We will also project two straight years of
earnings growth in this example.
YEAR ONE OF A TWO-YEAR BEAR MARKET:
Company Y's earnings grow from $3.00 to $3.27 a share and the P/E ratio
drops from 8 to 6.
Company Z's earnings grow from $3.00 to $4.32 a share and the P/E ratio
still drops from 8 to 6 despite the strong growth.
YEAR TWO OF A TWO-YEAR BEAR MARKET:
Company Y's earnings only grow from $3.27 to $3.56 per share. Its P/E
ratio falls further from 6 to 4 times earnings. This multiplies to a share
price of only $14.24 ($3.56 x 4) at the end of the second year.
A 41% LOSS IN A TWO-YEAR INVESTMENT ($14.24 down from $24) is suffered
even though the stock was bought at an undervalued price (eight times
earnings), the accounting was conservative, and earnings grew consistently.
The biggest risk factor in Company Y shares is that earnings growth at the S&P
rate of 9% a year is just too slow!
Meanwhile, Company Z's earnings grow from $4.32 to $6.22 per share. Its
P/E ratio will probably hold up better. Still, we will assume that this
worst-case scenario bear market shows no mercy, driving even Company Z's P/E
ratio from 6 to 4 times earnings. This results in a share price of $24.88
($6.22 x 4).
Capital preservation ($24.88 vs. a $24 starting price two years earlier)
in Company Z shares, in this worst-case scenario bear market, is the result of
reducing risk through value, quality, and 44%, annually compounded, earnings
growth!
<PAGE> 19
The company we selected to demonstrate the internal growth criterion is
POMEROY COMPUTER RESOURCES, INC., our second largest domestic investment and
fourth largest holding overall. Since 1987, Pomeroy has experienced a
compounded growth rate of 45%. In three of the last six years, the company
had earnings growth of over 60%.
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.
BENCHMARK ELECTRONICS, INC., our seventh largest investment, has a strong
balance sheet. The company meets both ratios, where it only needs to meet
one, with a current ratio of 2.3 and a quick asset ratio of 1.2.
BALANCE SHEET: CORPORATE LIQUIDITY
"Long-term debt must be less than either: a) working capital, b) cash and
cash equivalents, or c) latest twelve months' cash flow. 'Cash flow' means net
income plus depreciation, amortization, i.e., the difference between revenues
and all cash expenses (including taxes)."
The average S&P 500 company has massive debt (both long-term and short-
term) totaling more than twelve times its working capital.
While some companies in our portfolio have no debt at all, the total debt
including short-term debt (not part of
<PAGE> 20
this criterion) of the average Z-Seven stock is 135% of its working capital.
FIRST CONSULTING GROUP, INC., our largest domestic and third largest
holding overall, is the result of the merger with Integrated Systems
Consulting Group, Inc. Integrated Systems had an excellent balance sheet with
no debt at all, long-term or short-term. While the combined balance sheet
with First Consulting is not completely debt-free, the small amount of debt it
shows is less than one percent of its working capital.
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). Integrated Systems was an extremely
good example of this criterion with no long-term debt, and a current and quick
asset ratio (no inventories) both at 4.6. The combined current and quick
asset ratio of First Consulting Group and Integrated Systems is 2.2, still
more than double the requirement.
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.
<PAGE> 21
When we looked for value this year, where did we find it? This year,
most of the value we found was in the United States. Twenty-seven new
investments were added from the U.S., two from the United Kingdom, and one
from Denmark. More than seventy percent of our portfolio is invested in the
United States, almost entirely in small caps. Almost a fifth is invested in
the United Kingdom, and the balance in other European holdings, and in Canada.
As examples of our "Price/Earnings Multiple" (value: price/earnings under
ten) criterion, we are using a British holding and a domestic one.
Z-Seven's second largest holding is RATHBONE BROTHERS PLC, the British
asset management and broking company.
We believe earnings will approach 60 pence next year. Its shares traded
at 540 pence, just nine times earnings at year-end. Adjusting the company's
price for their net cash (425 pence), RATHBONE BROTHERS TRADES UNDER TWO TIMES
the earnings estimate for next year. In comparing this remarkable value with
other companies outside our criteria, we can see the benefits of this low
price/earnings multiple in the effort to reduce volatility in our investments.
The main goal is to avoid getting swept up in short-term gains that can come
crashing down with great unpredictability.
Let's take a look at another small British portfolio management company,
Brewin Dolphin Holdings Plc. Brewin Dolphin is roughly the same size as
Rathbone Brothers and also has a good track record. Formed in 1992, however,
Brewin Dolphin has not been tested over nearly as many economic and financial
market cycles as Rathbone has. Still, to their credit, Brewin just completed
their fifth complete year of consecutive profit growth, and has stirred up
attention from investors. This, in turn, has caused an increase in the stock
price that even its strong earnings may not keep pace with. As the disparity
between share price and earnings increases, so does the risk.
At year-end, Brewin Dolphin shares traded for over twenty times their
last full-year earnings reported (1997), and seventeen times annualized nine-
month figures just announced. After factoring another year of growth in 1999,
Brewin shares are still at nearly thirteen times estimated earnings for the
new year.
<PAGE> 22
While this company has an excellent balance sheet, deducting net cash still
leaves these shares at almost nine times prospective earnings. When we
consider our quite profitable investment in Rathbone, priced (also after cash
adjustments) at less than two times prospective earnings, the value and
long-term potential is apparent.
In fact, Rathbone Brothers is quite a bargain with a ten-year compounded
growth rate of 28%. Its earnings have been growing to new records for at
least eighteen years in a row (as far back as public information goes), and we
believe there is a good probability that they just completed another up year
in 1998!
For our domestic comparison, BALLANTYNE OF OMAHA, INC., our fifth largest
position, was trading at nearly $9 at year-end. That is under nine times our
1999 estimated earnings of $1.00.
Ballantyne is the dominant supplier of complete movie projection systems
and competes against only much smaller manufacturers, all privately owned.
The cinema industry continues to expand rapidly in the U.S. with a trend
towards bigger and better mega cinemaplexes that is extremely positive for
Ballantyne. The company is currently doubling its shipments to Regal Cinemas,
the industry leader which was recently taken over, and is in the process of
obtaining a commitment for 100% of AMC Entertainment's business (up from 80%).
The future for Ballantyne looks exceptionally bright with industry growth,
international expansion, broader product line, and, particularly for 1999,
fewer shares outstanding after a major repurchase program late in 1998.
With all the growth and promise of this investment sector, why not buy
the more popular, high profile stocks, like AMC? The answer is, of course,
value. AMC Entertainment is expected (according to Zacks' consensus estimates)
to multiply earnings five-fold next year. While this is impressive, AMC would
still close 1998 at over 400 times earnings estimated for next year. Building
theaters requires a lot of debt, and AMC has about twenty-two times as much
debt as cash. Ballantyne manages to rake in the dough, and has about ten
times more cash than debt! Ballantyne closed 1998 at under nine times our
estimate of earnings for the new year; the
<PAGE> 23
CLEAR CHOICE FOR VALUE AND RISK MANAGEMENT IN THIS GROWTH INDUSTRY.
There is plenty of value in Z-Seven's portfolio besides Rathbone Brothers
and Ballantyne of Omaha. According to our earnings estimates, Z-Seven's
average price/earnings ratio is just eight times our estimate of 1999
earnings.
By sharp contrast, the S&P 500 companies (index at year-end 1998 was
1229.23) had a P/E ratio of twenty-six times the $46.88 "Tops Down" estimate
of 1999 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 69% DISCOUNT to the S&P 500 price/earnings multiple of
26.
There are, however, significant differences in the quality of reported
earnings. For 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 $46.88 earnings for the S&P
500 companies, to conform with conservative tax accounting, results in only
$38.11 in estimated earnings for 1999. Thus, the S&P 500 companies were
selling for 32 times their estimated tax-purpose 1999 earnings at year-end
1998.
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 75% discount to the S&P
500's price/earnings multiple of 32 times.
Over the last ten years, Z-Seven's companies have increased their
earnings at a 44% rate, annually compounded, which is nearly five 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 1229.23 is
by no means a free ride! Sure you get its $38.11 (tax basis) in earnings.
What you may not have counted on is that you
<PAGE> 24
also get their 20.68 in net debt (over and above cash).
Since the S&P 500 companies have 20.68 more in debt than cash, the S&P
500 is really selling at more than it appears. This hidden debt load means
that, at 1229.23, you are really paying 1249.91 (adding in 20.68 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 1249.91 is almost 33 times their 1999 estimated
tax-purpose earnings of $38.11.
Z-Seven's price/earnings multiple is just over six times earnings when we
consider the extra cash of the companies we are invested in. This brings
Z-Seven's price/earnings ratio of prospective earnings to a discount of 82%
compared to that of the S&P 500.
WHAT ABOUT Z-SEVEN'S PREMIUM TO NET ASSET VALUE? At year-end, buying
Z-Seven shares meant paying a premium of 3% over net asset value. This is a
relatively small premium compared to our average, and particularly to our
unusually high premium a year earlier. Taking our portfolio companies'
conservative tax-adjusted earnings and net cash adjusted price/earnings
multiples in consideration, (and doing likewise for the S&P 500 companies),
means that paying a 3% premium on Z-Seven's net asset value can be a bargain!
Especially IF YOU HAVE TO PAY OVER SIX AND ONE-HALF TIMES the S&P 500
companies' book value (net asset value) to buy the S&P 500, which means paying
a premium of 553%.
NOT ONLY DO WE HAVE A BUYING DISCIPLINE, BUT ALSO A SELLING DISCIPLINE.
PLEASE SEE NEXT PAGE. =>
<PAGE> 25
SELL DISCIPLINE: BASED UPON THE
SAME COMMON SENSE CRITERIA AS
FOR STOCK SELECTION
Investors often comment that portfolio managers and analysts have many
reasons for purchasing shares in a company and never deal with the terms of
selling. 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 that has been the guiding principle
for Barry Ziskin as a money manager.
There are seven events which will cause us to IMMEDIATELY REDUCE OR
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 most companies
which have once met this most important criterion continue to do so.
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
necessary, we may try to sell the shares 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, or simply has unusually high profits to compare against,
it represents a temporary flattening out or "blip" in an otherwise excellent
long-term
<PAGE> 26
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. 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! We, of course, look for warnings: substantial
unloading of shares by key officers; disconcerting conversations with
management and others in its industry; new inexperienced operating management
replacing successful key people; as well as a multitude of other signs.
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, and continued to in 1998.
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
<PAGE> 27
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 are negative. It would take these companies six
years to requalify regardless of their ability to resume continuous growth in
operating profits.
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.
Companies which are well above our buying price, but still continue to
show consistent operating earnings growth, are reduced to one-half positions.
If the negative monetary signals continue to exist we eliminate those holdings
that no longer meet all our purchase criteria.
7. SOMETIMES WE HAVE NO CHOICE! IN THE EVENT OF A TAKEOVER OR GOING-
PRIVATE TRANSACTION, OUR DESIRED LONG-TERM HOLDING PERIOD FOR WELL-MANAGED
COMPANIES, WHICH CONTINUE TO MEET ALL OF OUR CRITERIA, IS CUT 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
<PAGE> 28
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 1998, we had three companies that were taken over, following many
others over the years. The first was LABORATORY SPECIALISTS OF AMERICA, INC.
The company was acquired by the Kroll-O'Gara Company. The Kroll-O'Gara
Company did not meet several of our purchase criteria; therefore, Laboratory
Specialists' shares were sold prior to the merger in December.
The next merger was between INTEGRATED SYSTEMS CONSULTING GROUP, INC. and
First Consulting Group, Inc. In this case, we exchanged our shares for the
First Consulting Group stock. Based on Integrated Systems' closing price
before the agreement to merge was announced, this deal had a premium of 29%.
VALLEY FORGE CORPORATION was the last of our companies that was taken
over in 1998. It was acquired by Key Components, LLC in what was actually a
going-private transaction. They offered to pay $19 per share, valuing the
company at $82.1 million. This was a gain of 23% from the price we first paid
for Valley Forge just over a year ago.
NEXT, SEE A NEW LOOK FOR OUR "GOOD NEWS" AND "MISTAKES AND DISAPPOINTMENTS"
SECTION. =>
<PAGE> 29
A NEW LOOK
For those of you looking for the "Good News" and "Mistakes and
Disappointments" section of this Letter to Our Shareholders you have found it!
In our third quarter report, we discussed quarterly price fluctuations of
modern markets which can be volatile and very misleading. Consistent with our
long-term fundamental approach to investing in the best companies at bargain
prices, we decided to limit performance analysis of individual holdings to a
yearly outlook. Our research team will continue to monitor the Fund's
portfolio with the same comprehensive standards, particularly its several new
positions. Our expansion into domestic small-cap companies over the last two
years has made Z-Seven's portfolio the most diversified it has ever been.
Consequently, we believe the outlook for earnings growth and profitable
investing is excellent for the future.
In this section, we will discuss our Strongest Seven, the portfolio's top
seven gainers in percent return, ranked from the largest investment holding to
the smallest. This will be followed by a discussion of the seven lowest
performing stocks, our Weakest Seven, in the same order. Obviously the
largest investments in the Fund contributed the most to our successful year of
bucking the lower trend of small cap stocks, and should receive the spotlight
first. In keeping with our commitment to long-term analysis, we will continue
to include only holdings that have been in the portfolio for the entire year.
==============================================================================
THE STRONGEST SEVEN
1. BENCHMARK ELECTRONICS
Benchmark Electronics is one of several U.S. small-cap investments we
made in the fourth quarter of 1997. During that time, the panic in Hong Kong
and other markets in Asia caused worries over electronics businesses here at
home, giving us opportunities to buy some fine small and medium-sized growth
companies at bargain prices. The cloud still hung over the industry during
the first half of 1998. Even when most other stocks were up, Benchmark
suffered a mild decline by mid-year. In unlikely fashion, this stock went the
other way again, regaining its lost ground (and then some) during the third
quarter, when other stocks were decimated. The positive turn went into higher
gear at the close of the year, as
<PAGE> 30
Benchmark gained most of its 64% annual advance in the fourth quarter.
What turned the market's taste for Benchmark in the second half of the
year? We believe its small size of less then $24 million in pre-tax profit
for the most recent full-year report and the thin market have kept many
institutional investors away despite the company's excellent track record for
consistent earnings growth and a strong balance sheet. As it grew from a
company making an annual profit of less than $10 million two years ago,
interest began to gather, but was put on hold due to Asia currency and price
competitive concerns. After Benchmark had its best two years ever in 1996 and
1997, with 52% and 65% profit growth, respectively, bottom line growth slowed
down noticeably this year, causing some concern about the future trend.
Now that relatively flat earnings have been reported for the past three
quarters, giving perspective to the strong results of the prior year, the most
difficult comparisons seem to be over for Benchmark. This is an encouraging
trend for future results. Also encouraging is the fact that the cost of
assimilating its huge acquisition this year of Lockheed Commercial Electronics
now seems to be near completion, and the profit potential for the larger
combined company may soon be realized. The 68% rate of revenue growth for the
most recently reported quarter may give us a hint towards this potential.
2. NCI BUILDING SYSTEMS
The next largest of our best 1998 performers is NCI Building Systems.
Last year, this company was one of our biggest holdings and highlighted for
its outstanding P/E of a mere 8 times earnings. If you are asking why this
company, with a 58% plus stock-price rise in 1998, is not still one of our
most important holdings - good question! In order to reach for further
earnings growth this year, NCI bought Metal Building Components. While a
subsequent near doubling in the size of the company adds to its earnings
potential, this move does not come risk-free.
At one point during the year, NCI planned to dilute its earnings with an
offering of shares which would have increased its total shares outstanding by
about 20%. According to the CEO, the "volatile stock market conditions and
its negative impact on stock prices in the building supply sector" caused NCI
to change its mind near the market bottom
<PAGE> 31
of 1998. They decided it would be better to finance the deal with debt than
to give away their shares at rock-bottom prices. The problem involves just
how much debt they needed to borrow to make this move. At one time, NCI
boasted a strong balance sheet to help protect it from the potential cyclical
characteristics of the building components industry. Now, they miss both of
our balance sheet criteria, and not by a small amount either. Instead of
working capital (current assets less current liabilities) more than covering
debt, debt now multiplies net current assets by a whopping nine-fold.
This increased risk at NCI is much more than we should have in one of our
most important holdings. The shares of NCI sold this year earned Z-Seven a
good profit over our cost. Most of our gain on NCI has taken place during the
full year of 1998. We bought these shares during the second quarter of 1997,
and, after more than one-and-a-half years, NCI is up 88% for us (adjusted for
a 2-for-1 stock split).
3. L'OREAL
The next largest performer is also our longest-held company among the
Strongest Seven. L'Oreal is our only holding in France. It is also, as the
world's largest hair care products company, an exception to our mostly
small-cap portfolio. It is the only large cap among our best performers, and
the only company from continental Europe, which, combined with Britain,
dominated our portfolio for many years.
Nine years ago, we were fortunate to find value in L'Oreal by purchasing
non-voting, common equivalent ("C.I.") shares at only seven times estimated
earnings. These shares were exchanged in 1993 for higher valued ordinary
shares. Since our first investment, L'Oreal has grown almost 18 times over
for Z-Seven. We profitably reduced this holding late in 1998, in order to
purchase new bargains and decrease current holdings, such as L'Oreal, which
were no longer bargains and produced higher risk. Its shares now trade for
over 4,000 French francs per share, up nearly 72% in 1998 alone, helped by
enthusiasm over the merger of its partly-owned pharmaceutical affiliate,
Synthelabo with Sanofi.
4. DUDLEY JENKINS GROUP
From the giant L'Oreal, we turn to tiny Dudley Jenkins Group. This
British mailing list broker and database service
<PAGE> 32
company may be small in size (it generated total revenues of L25 million in
fiscal 1998), but its shares have brought big profits to Z-Seven. During the
bear market this past year, U.K. small caps fared the worst, even worse than
both bigger British companies and U.S. small-cap stocks. But this little
company bucked the downward trend. Even during a time when most U.K.
businesses dependent on their home market had seen their sales and profits
growth slow or go down, Dudley Jenkins has been able to deliver solid growth
in earnings and gain a bit of a following in "The City" (London's version of
Wall Street). New buying interest can go a long way with such a small
company, whose shares trade very thinly. Earnings per share grew more than
45% on operating profits up approximately 30% during the 1998 fiscal year,
with good margin expansion in both divisions. Still, the best return came to
shareholders with share price up 88% for the year, more than 90% for the full
year when you add in dividends.
We have now held Dudley Jenkins for about-one-and-a-half years and have
more than doubled our cost. Once a much larger holding, we have taken some
very good profits, selling most of our shares while the base lending rate of
the Bank of England was on the rise, Dudley Jenkins' P/E ratio for this year's
estimated earnings rose over four times the maximum of our value criterion for
purchase, and new and better bargains were becoming available. While we have
been very pleased with this investment, it may have a limited life span in our
portfolio. The company has recently announced that it will be acquired at
just 16% over its year-end price.
5. CYBEX COMPUTER PRODUCTS
We now head back home across the Atlantic for our next largest holding
among the best performers this year. Cybex Computer Products has many
similarities with Dudley Jenkins. They are both tiny companies; Cybex had
adjusted operating profit of just over $11 million during 1998 fiscal year, up
from less than $400,000 only seven years ago. Both are stocks that rose
despite hard times; Dudley through the drop in small-cap British shares, and
Cybex being an electronics manufacturer and a U.S. small-cap stock. Also,
Cybex no longer meets our value criterion (its shares now sell for over
fourteen times projected earnings for 1999), yet has been a profitable source
to fund new bargain
<PAGE> 33
investment opportunities within a year-and-a-half of being purchased.
Earnings growth also sets Cybex apart from its peers this past year, with
tax-adjusted operating profit up 54% in 1998 as demand grows for their
products here at home and, even more so, in Europe. Most sells of our Cybex
shares have been over the last four months. Adjusted for two stock splits
during 1998, Cybex soared 170% this year, and is near to tripling our cost in
just a year-and-a-half. We hope to hold our remaining Cybex for many years to
come, and continue to grow with this tiny, but cash-rich, diamond in the
rough.
6. INSIGHT ENTERPRISES
The sixth largest of our best performers appropriately follows Cybex, the
manufacturer of computer switches. Insight Enterprises, Inc. sells and
markets computer products, along with accessories and related items. This
company has also proven that it can grow despite competitive markets and
nervous investors that needed to be convinced to take a serious look at
small-cap stocks when the sector was out of favor.
Insight does a lot of things right and appears to have many similarities
to Airtours Plc, our most successful investment ever. Both companies are
driven by hard work and an entrepreneurial creativity in marketing. While
Insight has experienced great success in a fiercely competitive market, it
continues to push itself from within and, through acquisitions, to gain market
share in a very fragmented industry. It has also demonstrated the ability to
thrive during tough times.
Insight's share price more than doubled in 1998, with a 107% return on
its share price. At the end of the year, the company announced that it would
post its fourteenth consecutive quarter of sequential growth. This has no
doubt impressed not just myself, but others as well. Since we first made this
investment almost two years ago, we have more than quadrupled our cost. Like
L'Oreal, Dudley Jenkins, and Cybex, Insight is not the bargain it once was and
offers higher risk. Its shares now sell for more than twenty-eight times our
estimate of earnings for the new year. Consequently, we have sold most of our
shares at huge profits to fund the purchase of more good bargain buying
opportunities in other well-managed growth companies.
<PAGE> 34
7. WESTFAIR FOODS
Our smallest holding in the Strongest Seven is also our very best
performer, with a 212% gain in share price. Westfair Foods, Ltd. is a very
successful Canadian retailer that is controlled by the much larger firm of
Loblaw. Westfair's shares are traded on the tiny Winnipeg Stock Exchange. A
huge spread exists between the bid and ask price, driven by litigation
expectations concerning the rights and obligations associated with its Class A
shares.
While its balance sheet has not met our criteria for some time, this
holding accounts for only one-tenth of one percent of our net assets. Our
risk, therefore, is minimal and seems worth the potential profit.
In summary, the smallest increase among our seven best performers in 1998
was more than 58%; the average increase was 110%.
==============================================================================
THE WEAKEST SEVEN
The following stocks have the dubious distinction of being our least
performing for 1998. Again, we will be discussing them in order of size
within our portfolio.
1. MOTORCAR PARTS & ACCESSORIES
The largest among our least productive holdings in 1998 is Motorcar
Parts, a domestic small cap suffering from the hangover of a poorly received
secondary share offering made a year earlier to fund an important acquisition.
During the latest reported quarter, the company disappointed some followers,
as the acquisition is not yet contributing to earnings. Even though sales
rose 25% in the latest quarter, most of this was due to the acquisition which
broadened Motorcar Parts from primarily foreign to domestic autos as well.
Motorcar Parts is still a bargain. So, when we needed cash in early
autumn to diversify into new bargains, we did not sell most of our shares, the
way we did for several other stocks. Our holding of Motorcar Parts has been
trimmed by 29%; but we prefer to look at this cup as more than 70% full.
Bought in the last half of 1997, we feel that our loss is potentially behind
us. At a P/E of 6 1/2 on prospective earnings for the fiscal year to begin in
April, Motorcar, down almost 32% in 1998, may indeed be one of our best
performers in years to come.
<PAGE> 35
2. HUMMINGBIRD COMMUNICATIONS
Our next largest holding among the lowest performers is Hummingbird
Communications. This company is our only significant investment in a Canada.
Although traded on the Toronto Stock Exchange, the main market for Hummingbird
is on NASDAQ. When considering the fundamentals, it is hard to believe that a
company with nearly $140 million in cash, that is debt-free with less than $4
million in payables, and is a well-managed growth company which dominates its
niche would sell for such an undervalued price. Hummingbird is currently
selling for less than eight times estimated earnings, another victim of
unfavorable conditions for small caps with earnings slowdowns, and saw a stock
decline of less than 38% in 1998. Let's take a look at the possible reasons.
Fourth-quarter earnings were down slightly and, according to the company,
a flat year is in store for the new year. The company is using some of its
vast cash resources to invest in the future, as its traditional network
software, made to link large business mainframes with PC- based company
systems, is maturing into the futuristic arena of "intelligence software."
This long-term plan will cost Hummingbird this year; but the basis for its
current business should be able to hold on to its huge profit margins and
cash-flow generation , and should help fund the company's growth without any
noticeable pain to its outstanding balance sheet.
Business intelligence does not seem to have high-profit prospects in the
very near future; however, the fast pace with which this area seems to be
growing could change the potential for profit considerably. If the company
does turn out to be conservative on its flat earnings forecast for this year,
we will take advantage of any opportunity to add to our holding. I believe
that this company is in a very good position to turn into one of our best over
the long term.
3. NATIONAL DENTEX
Our next most significant position among the Weakest Seven is another
tiny company. In fact, like most of the companies we've been discussing, it
would be considered a "micro-cap" stock. Like Hummingbird, this company's
price drop during 1998 made it an unattractive sell to fund new purchases for
our portfolio. Only 5 1/2% of our original investment (made four years ago)
was sold, doubling or tripling our cost on most sales. The sub-par year for
Dentex's
<PAGE> 36
share price in 1998, down 24%, combined with the slowdown in operating pre-tax
profit growth, has made the relatively small following of the company nervous.
David Brown, long-time CFO, is taking the helm of this New England-based chain
of dental fixture laboratories. This should maintain continuity and the
conservative financial structure despite its expansion via the cash
acquisition of smaller labs.
If 1998 meets our Consistency of Operating Earnings Growth criterion,
National Dentex may become a candidate for additional investment if current
bargain prices are still available when the earnings outlook is resolved.
Even at its current depressed price, our relatively small holding (less than
1 1/2% of net assets) has nearly doubled since we first started to buy its
shares four years ago. Our total annually compounded return is far better
since most shares were sold about one year later at higher prices.
4. DAY RUNNER
The next holding in this section is Day Runner. We first purchased this
company at the end of 1995, and it has never been boring! At the end of 1996,
nervous investors and low earnings mercilessly depressed the stock price,
causing it to be our biggest decline for that year. In 1997, however, the
company delivered on its projections of increased profits. Its strong
earnings, fueled by new products and share repurchases, helped Day Runner to
become our best performing stock for that year.
Looking at 1998, I think Yogi Berra said it best; "It's like deja vu, all
over again." Reminiscent of 1996, Day Runner has made a pre-announcement
about second quarter earnings that caused a substantial share price decline in
the final two weeks of 1998. Fortunately, we had already sold the majority of
our holding at decent gains. While high inventories are reportedly the
culprit, Day Runner's acquisition of Filofax, a U.K. company, should provide
reinvigorated growth within a couple of years, after initial costs are
absorbed. Right now, however, there is no positive statement being issued
about the second half of its fiscal year, and we are now watching the company
carefully for signs of a rebound. Its 1998 year-end price declined 28%;
however, it appears worth holding at a bargain P/E of eight times potential
earnings of their fiscal year starting July 1, 1999.
<PAGE> 37
5. TT GROUP
TT Group is a small, but well-managed, British manufacturer of capital
and electronic goods with a history of recession-beating growth. It accounts
for just over 1% of our net assets. With the U.K. manufacturing sector in a
deep downturn and short-sighted British analysts wanting to stay away from the
"unpopular" small industrial companies despite their potential, TT Group saw a
23% decline in share price (less than 20% with the 1998 dividend included).
For the first half of 1998, TT Group focused on profit margins from recently
acquired wire and cable divisions and demand from luxury auto firms for its
specialty electronic sensors and systems. This strategy has paid off, and in
their most recent report, the company reported operating profits up 18%,
adjusted for currency exchange rates on the consolidation of foreign
subsidiaries' earnings. TT Group's chairman has also reported that its board
will consider a buy back of its shares, which is most unusual for Britain, and
will seek shareholder approval for further buy backs.
Currently, TT Group has little long-term debt, but its liabilities exceed
quick assets and are greater than 50% of total current assets (a bit of a
backward analysis of our "Working Capital" criterion). Therefore, even with
strong recent profit growth, we cannot increase our holding unless the balance
sheet re-strengthens and the quick ratio improves almost 20%.
6. POLYPIPE
Our next largest holding in this list, less than 1% of our portfolio, is
Polypipe. Like, TT Group, this company is a small, well-managed British
manufacturer of capital goods, diversified with an emphasis on plastic pipe
and construction materials, and is also a victim of the current prejudice
against small industrial companies. Its last full fiscal year report showed
Polypipe with a better than 10% increase in tax-adjusted operating profit
(likewise currency adjusted). The rate of growth did slow in the second half
of 1998, and the share price saw a decline of 35%. With an enviable
performance history for any business, Polypipe made confident statements on
its outlook, and just announced the purchase of the German Pagette. Many U.K.
companies have made mistakes acquiring German companies, and let us hope that
Polypipe does not get added to that list. A good first half for 1999,
demonstrating its ability to keep
<PAGE> 38
growing at a 20% annually compounded rate, is all that is necessary for this
company to get back to qualifying for further investment. Its balance sheet
is back to more quick assets owned than current liabilities owed.
7. NORTHERN TECHNOLOGIES
INTERNATIONAL
Along with Polypipe, Northern Technologies International is one of our
smallest holdings. We first invested in this company almost one-and-a-half
years ago, and have sold nearly all our shares during this past December.
This is a result of Northern Technologies' management reporting that the new
fiscal year would be exceedingly difficult, particularly in the first quarter,
after flat earnings in 1998. Our research staff will be keeping a close eye
on the company. The stock price declined 33% in 1998, but if the company can
reposition itself for earnings growth later in the year, and adjusted profits
reveal that it continues to qualify under our "Operating Earnings Growth"
criterion, we may build our investment up again at bargain prices.
In summary, several of our Weakest Seven have been greatly reduced in
importance before profits vanished. Of course, we are always looking for that
weakest stock that may become strong; or at least has the potential for
substantial price rebounds. The average decline among our Weakest Seven was
30%, which pales by comparison to the average gain of our Strongest Seven for
1998 at +110%!
FOR INFORMATION ON OUR LARGEST HOLDINGS, SEE THE TABLE ON THE NEXT PAGE,
FOLLOWED BY "OUR GOLDEN DOZEN." =>
<PAGE> 39
PERFORMANCE AND FINANCIAL INFORMATION
For performance, earnings growth, and balance sheet statistics on our
twenty-four largest investments (comprising 60% of the portfolio's market
value), we have put together the following table for your convenience:
<TABLE>
<CAPTION>
EARNINGS GROWTH CURRENT BALANCE SHEET
(1987 - 1997) (a) Total Debt
# of Annually (long- and short-term)
Down Compounded as % of SHARE PRICE
Years Earnings Working Year End Year End %
for Earnings Growth Rate Cash Capital 1997 1998 Change
------------ ------------- ---------- ---------- ---------- ------------ -------
<S> <C> <C> <C> <C>
1. Jardine Lloyd Thompson 0 + 26% 6% 32% 1.81 (m) 1.93 (m) +7%
2. Rathbone Brothers 0 + 28% NO DEBT! 4.00 (m) 5.40 (m) +35%
3. First Consulting Group 0 (b) + 82% (b) 1% 1% New Investment (n)
4. Pomeroy Computer Resources 0 + 45% 497% 11% New Investment (n)
5. Ballantyne of Omaha 0 (c) + 53% (c) 6% 0% New Investment (n)
6. Synopsys 0 (d) + 89% (d) 3% 4% New Investment (n)
7. Benchmark Electronics 0 + 48% 545% 66% 22.3125 36.625 +64%
8. Strattec Security 1 (c) + 26% (c) NO DEBT! New Investment (n)
9. Dave and Buster's 1 (c) + 119% (c) N/A (k) N/A (k) New Investment (n)
10. Brightpoint 0 (e) + 131% (e) 754% 75% New Investment (n)
11. LSI Industries 2 + 16% 11% 3% New Investment (n)
12. Kronos 0 + 42% NO DEBT! New Investment (n)
13. Technitrol 2 + 26% 82% 41% 30 31.875 +6%
14. Barratt Developments 2 + 4% 28% 4% New Investment (n)
15. AFC Cable Systems 1 (f) + 28% (f) 8% 5% New Investment (n)
16. SeaMED 0 (g) + 44% (g) 53% 17% New Investment (n)
17. Roxboro Group 0 (h) + 37% (h) 46% 38% New Investment (n)
18. The Men's Wearhouse 0 + 41% 554% 17% New Investment (n)
19. VT Holding 0 + 17% 108% 56% New Investment (n)
20. Grow Biz International 2 (f) + 81% (f) N/A (l) 556% 12 13 +8%
21. Computer Horizons 1 + 25% 3% 1% New Investment (n)
22. Anchor Gaming 0 (i) + 74% (i) NO DEBT! New Investment (n)
23. Vertex Communications 0 + 26% 7% 1% New Investment (n)
24. Motorcar Parts and Accessories 0 (c) + 88% (c) 610% 23% 16.75 11.4375 -32%
Z-SEVEN WEIGHTED AVERAGE 0 (j) + 44% 177% 135% +19%
(Total Portfolio)
S&P 500 STOCK INDEX 3 + 9% 348% 1,265% 970.43 1,229.23 + 27%
<FN>
Please refer to the following page for accompanying notes.
<PAGE> 40
NOTES FOR PERFORMANCE AND FINANCIAL INFORMATION
(a) Companies which have fiscal years already reported for 1998 have been
updated to 1988-1998 information.
(b) Result of merger with Integrated Systems Consulting Group in December
1998. 1991 was Integrated Systems first reported year.
(c) 1991 was first reported year.
(d) 1989 was first profitable year reported.
(e) 1989 was first reported year.
(f) 1988 was first reported year.
(g) 1992 was first reported year.
(h) 1990 was first reported year.
(i) 1990 was first profitable year reported.
(j) Weighted average is 0.42.
(k) Read "Our Golden Dozen" section for more information.
(l) Grow Biz repurchased about 67% of its shares in an attempt of two top
executives to take the company private. As a result the company
exhausted its cash to a miniscule amount.
(m) Prices in British pound sterling per share.
(n) Made in 1998, fifteen of the eighteen are already profitable for us.
They had an average return of 27% for the partial year, not even
including dividends. All eighteen new investments had an average return
of 20% for the partial year, not including dividends.
</TABLE>
<PAGE> 41
OUR GOLDEN DOZEN
1. Our largest investment, JARDINE LLOYD THOMPSON PLC, (JLT) is also our
oldest "Golden Dozen" veteran. Originally purchased when it was a one-office
insurance wholesale broker, its merger with JIB Group expanded the company
into Hong Kong and nearby Asia Pacific. While this may have seemed a negative
during such uncertain times for that area of the world, cost savings on
combining London offices and other efficiency moves have been a help to last
year's earnings growth. Earnings per share rose 16% on operating income
growth of 17% for the first half of 1998 for this fine company with good
performance history. When growth does return to the Asia Pacific region, the
merger should reap the benefit and give relief to the worldwide insurance
industry, which has been very competitive and difficult for quite a few years
now. Still, this company has been able to achieve consistent growth. While
management should be rewarded for their hard work and good results, JLT shares
have been ignored by investors.
Already a large holding, we added to this position during the first half
of 1998, when this well-performing company was valued at less than zero. We
really could not ask for a better low-risk growth investment than one priced
for less than its net cash! While the share price did rise above its net cash
by the end of the year (JLT was up 7% in 1998) it is still a bargain at just
11% over its cash. The company has been so profitable to be able to grow its
earnings and its cash while also paying a large dividend each year. Including
the dividend, our total return was over 12% for the year, even though most
small-cap U.K. shares were down. For the three years held in our portfolio,
JLT is up 22%, and over 40% including dividends. We strongly feel that there
are good reasons to hope for more in the long term.
2. RATHBONE BROTHERS PLC is the second half of our "twin towers." No, we
are not talking about the world trade center, nor is this about a basketball
team with two centers on the floor. Our "twin towers" are our two largest
holdings of the best London-based financial service companies. We increased
both positions in 1998, when we had the opportunity to buy them for less than
their net cash. While JLT serves the insurance market, Rathbone makes its
money by making money for others on their investments. While at first, this
may seem like a very volatile business, Rathbone
<PAGE> 42
has never had a down year as far back as the public records show. During the
first half of 1998, the company's earnings per share rose 32% on a 44% jump in
pre-tax profit. Some of this growth has been achieved via the increase of
money managers, and a recent acquisition should give them further growth
potential.
Rathbone's share price was able to buck the down year for London's small
caps with an increase of 35%. Over just more than a year and a half, when we
purchased most of our holding, the shares are already up more than 74%.
3. Like Jardine Lloyd Thompson, FIRST CONSULTING GROUP, INC. is the result
of a merger of two good companies. We first bought Integrated Systems
Consulting Group, Inc., a specialized developer of computer software
applications and systems engineering consultant for the pharmaceutical/life
sciences industry. After holding the stock for just half a year, we now have
the benefit of the merger. Even though First Consulting's name was chosen to
survive, most of the new company comes from the original firm we invested in.
Combined on a pro-forma basis, earnings growth and balance sheet strength
still exist. However, a much less conservative reporting of earnings by First
Consulting has given us a cause for concern in the long term. As a result of
this new merger causing a breach in our most important criterion, First
Consulting will be one of our first sources of cash this coming year when we
need to fund new investments. At the current time, we have enough cash for
new buys, and the company has been reporting strong earnings growth. This
performance has been a help to the stock price, which rose 32% in the less
than eight months we have held it.
4. Our fourth biggest investment, POMEROY COMPUTER RESOURCES, INC., is a
tiny high-tech related growth stock that we were able to pick up at bargain
prices when such companies fell out of favor this past year. Most of
Pomeroy's business has traditionally been the sale of computers to small
businesses. However, the company has been very successful in diversifying
away from this high-competition, low-margin sector into computer systems
services. The service business is far more profitable and has become
Pomeroy's focus. Their success in this new area is underlined by the fact
that, while total revenues grew
<PAGE> 43
by 31% for the nine months of last year reported thus far, service revenues
have been up 60%. Due to tough competition in computer sales and the cost of
building their service business, earnings per share only rose 18%. Operating
income for the last reported quarter grew only 21%, after growing at rates of
40% to 140% over the last five years and close to 40% for the first half of
this past year. Long term, the strong growth in services should make its
contribution more and more to Pomeroy's overall earnings.
In its most recently reported year, Pomeroy reported even less earnings
to its shareholders than it did to the IRS. We were able to buy Pomeroy when
the market was near its low, at even less than seven times our estimate of
earnings for the new year, and have made 48% on our holding in just four
months, thus far.
5. BALLANTYNE OF OMAHA, INC., a developer and manufacturer of state-of-
the-art motion picture projection equipment and systems, is a big fish in a
small pond. Prior to our investment, its stock nose-dived half way through
1998, after the company announced it would have a disappointing second
quarter. While its next report was considerably better, the stock price
failed to recover significantly; we took advantage of the opportunity provided
in December by the vacuum of supporters.
Up until 1998, Ballantyne's poorest year had an operating pre-tax profit
increase of 27%. While 1998 probably enables Ballantyne to continue to meet
our Consistency of Operating Earnings Growth criterion, its second-quarter
drop probably means that the increase will be below 27%. An easier comparison
in 1999, particularly in the second quarter, appears to predict a return to
accelerated earnings growth.
Ballantyne beautifully combines conservatism in reported earnings,
quality, and a nearly debt-free balance sheet with product engineering and
technology that leads the industry. The movie theater industry is the
company's market. During the first week of 1999, they signed a letter of
intent to supply a minimum of 2,000 complete projection systems to Regal
Cinemas (#1 in the industry) over the next two years. This will more than
double the company's sales to Regal. Despite the maturity of its multi-cinema
concept, rapid growth in North America continues to be Ballantyne's biggest
market; and development of new concepts adds further
<PAGE> 44
domestic potential. Ballantyne's superb reputation for technical superiority
and reliability is placing them head and shoulders above the competition.
They have been selected to supply AMC Entertainment's first multi-cinema
complex in Hong Kong, and should be the beneficiary of the significant
expansion in the Pacific Rim.
All of this potential was purchased by the Fund at eight times our
estimate of 1999 earnings. No wonder we already see the shares 22% higher in
barely two weeks ownership at year-end. Of course, this short-term gain is
only impressive when added to the growth which seems to be in Ballantyne's
future.
6. How fitting that SYNOPSYS, INC. should follow Ballantyne in the list of
our largest holdings. Both were bought in December, and both are relatively
small companies which enjoy big prospects. Synopsys holds an excellent
reputation for the engineering, designing, and testing of "systems on a chip,"
solutions to the rapidly changing high-tech microprocessor and its related
industries. This company is the brain behind nearly all of the new
breakthroughs in the electronics and semiconductor industries, accelerating
the design-to-market process of these modern wonders. That's why Synopsys
earns a phenomenal 87% gross-profit margin and invests in excess of 20% of its
sales in research and development. Fortunately for us, the margins are
heading higher! At year-end, Synopsys held $600 million in cash and
short-term investments, compared to approximately $20 million in long-term and
short-term debt combined. All this from a company that didn't even break into
double-digit profits (in millions) until 1993. The 10% increase in Synopsys'
share price is unimportant, since any results under one month are meaningless.
We believe, however, that this company is a superbly managed enterprise
carving out an unusually profitable future.
7. While Synopsys may be the brain behind some of the world's most
important electronics engineering, BENCHMARK ELECTRONICS, INC. is the brawn.
It is responsible for conducting the small trial runs of new micro-circuitry
for some of the most advanced electronic firms that develop new products for a
variety of industries. Unfortunately for Benchmark, brawn is not the most
rewarded asset, as evidenced by the differ-
<PAGE> 45
ence between Synopsys' 87% gross-profit margin and Benchmark's of
approximately 11%. Fortunately for the Fund, the company does make up for
this with good volume growth and a more diversified base of customers than it
had a few years ago.
Benchmark's stock price finished 1998 with an increase of 64% for the
full year (see Strongest Seven, page 30). It continues to be strong, reaching
all-time highs early this new year - even on down days for Wall Street.
8. STRATTEC SECURITY CORPORATION is one of the nine new investments in our
Golden Dozen. It is in the forefront of auto security, making a variety of
locks and related security systems for the major auto manufacturers, both
domestic and foreign. Its new relationship with Mitsubishi will, hopefully,
mean more growth ahead for Strattec in Japan and Europe.
A General Motors strike reduced the company's sales to GM by 22%
year-to-year in Strattec's first fiscal quarter. Despite this, good cost
control, new business, and continued business with Ford and Chrysler were all
factors that helped turn flat sales into a 24% increase (year-to-year) in
operating profit for the first quarter of Strattec's fiscal year. We like
management that can perform even under adverse circumstances!
At this time, they have just reported on the next quarter. They had an
easy time on a 10% rise in sales, as pre-tax profits rose approximately 39%
year-to-year. While part of the rise in earnings may have come from the low
price of zinc (their main raw material), the rest is just good management.
We are not the only ones who see value here; the company is buying back
its shares on the open market. Even after a 9% rise for us in less than nine
months of holding in 1998, Strattec shares still sell for only
seven-and-one-half times estimated earnings for the coming year.
9. DAVE AND BUSTER'S, INC. is also a new investment, made four months ago.
Unfortunately, that is about all it has in common with our other new holdings
discussed in this section. This is a rapidly expanding company with a unique
dining/entertainment concept that spends a great deal of cash opening new
units. They have even made new expansion commitments in some foreign markets.
In the past, they successfully financed with new shares in their 1995 IPO,
and
<PAGE> 46
second offering in late 1997; however, this year's volatile stock market
caused them to go to their bank instead. The result is that they no longer
come close to meeting either of our two balance sheet criteria, just six
months after meeting both with ease.
Growth is strong, as the company has now just announced that sales for
the fiscal year, ended January 31, rose 40% on higher-than-expected fourth
quarter volumes and sales. Our investment return rose over 13%. Cash is
gone, however, and is being replaced with debt. We will keep a close eye on
both the balance sheet's negative trend and the less-than-conservative
reporting of earnings, cutting or eliminating our risk if necessary.
10. We have been asked many times if some of our very thinly traded stocks
of small companies are more volatile, or riskier, than those more heavily
traded. While this may be true in some cases, our next largest investment,
BRIGHTPOINT, INC., proves that there is no rule. This is a very actively
traded stock which, more often than not, will trade a million or more shares
in one day. It is also a large company, for our portfolio, recently reporting
sales of over $1.6 billion; and yet, we have rarely seen a stock as volatile
as Brightpoint.
We really never thought there would be an opportunity for us to buy this
stock when we first looked at the company. Sure, it met the growth and
quality criteria. The stock price, however, was at fifty-six times what they
would earn the next year. Although Brightpoint has no manufacturing risk from
falling currencies in Asia a year earlier, its stock was amazingly cut in half
in less than a week, when the high-tech U.S. stocks went into a nose-dive
after a mini-crash in Hong Kong. As a leading distributor (inventory manager)
of headsets and related products and parts to the global wireless
telecommunications industry, lower prices means more volume and serves to help
Brightpoint's business. As we were told by their CEO, "the trend is our
friend." Still, even at half the price, twenty-eight times earnings isn't
even close to what we would pay for our investment. Fortunately, during 1998,
the stock was cut by more than half again. We were able to buy Brightpoint at
less than one-fourth of the price it sold at less than a year before, even
though earnings continued to grow, and pay only seven times estimated earnings
for the new year.
<PAGE> 47
We have been impressed with the company's conservative reporting methods.
In 1997, Brightpoint's reported earnings to the public were one-fourth less
than what they paid taxes on. It was the fourth straight year of
underreporting. This conservatism combined with good value and the
development of custom services will enhance profitability. Held for just four
months, Brighpoint rose 48% above our purchase price by year-end.
11. Our next largest investment, LSI INDUSTRIES, INC., has two things in
common with Brighpoint: ultra-conservative accounting and strong earnings.
Only twice in the last seven years has LSI reported earnings to the public
above the profit declared to the IRS. Only twice in this seven-year period
has LSI not achieved operating profit growth of 20% or more. In the first two
quarters of fiscal 1999, LSI has increased its sales 22% and 17%,
respectively, while earnings per share increased 29% and 24%, respectively.
Fortunately, the similarities between LSI and Brightpoint do no include
volatile stock activity. LSI is very thinly traded, and its share price is
quite steady. Our biggest concern is its cyclical earnings behavior in the
1991 and 1992 U.S. recession. Bought two weeks before the end of our third
quarter, LSI is up 17% in a period too short to be meaningful. It is still at
a bargain price of approximately seven times estimated earnings for fiscal
year 2000.
12. The final "Golden Dozen" stock is KRONOS, one of the newer
investments. It is considered to be a technology stock, but more
appropriately described as a progressive and proprietary leading developer of
human resource management systems. As productivity and efficiency are the
aspiration of U.S. and international companies in a highly competitive global
economy, Kronos is the pioneer of new systems that provide information and
solutions to manage labor costs in a variety of industrial applications.
There have been no previous cyclical problems at Kronos. The company has
very conservative reported earnings, along with an aggressive stock buy-back
program. Newly broadened product lines, and fewer shares, enhance current
earnings potential. When we combine all these characteristics, and add a
balance sheet with no long-term or short-term debt, and superb profit margins,
<PAGE> 48
Kronos nearly tops our list of the quality companies we're invested in.
Bought mid-way through the third quarter, Kronos is already up about 25%.
We are certainly hopeful that strong investment results are merely the
beginning in Z-Seven's twelfth largest position.
While we normally prefer to view our returns with no shorter than annual
frequency, nine of our twelve largest holdings are investments first made in
1998. In fact, nine of the next twelve largest holdings are new, as well. We
would not expect 23 out of these 24 to be up in the roller-coaster year of
1998; but we certainly won't complain, since that is the case!
SEE NEXT PAGE FOR A LOOK AT OUR PORTFOLIO'S PAST PERFORMANCE. =>
<PAGE> 49
PAST PERFORMANCE
The following is an historical look at our portfolio's performance, year by
year, through the 1990s. All investment returns are calculated before
including corporate expenses, but after deducting commissions.
PERFORMANCE IN 1997
During the year, the Fund reduced exposure to troublesome monetary and
broad market conditions in the U.K. by eliminating many British holdings that
no longer met the criteria. Most of the new investments made in 1997 were
domestic small caps, and gave us a well-diversified portfolio. Z-Seven's
fourteenth year closed with a 21% annual return on our investment portfolio in
a market that greatly favored blue-chip stocks and bonds.
PERFORMANCE IN 1996
This year was a landmark period for U.S. and European markets, with
record highs and a volatile environment for specific stock sectors. While the
mature bull market of this year saw prices driven by expectations, our
approach focused on long-term growth investing, designed to avoid chasing
after the latest market trends. Z-Seven's thirteenth year closed with an 18%
annual return on our investment portfolio, which was dominated by U.K. and
Western European stocks.
PERFORMANCE IN 1995
Our 1995 portfolio was primarily invested in the U.K. and Western Europe,
and increased each and every quarter along with our net asset value. Out of
98 World Equity Funds, Z-Seven was ranked #1 by Lipper Analytical Services for
that year (as reported in January 1, 1996 Barron's), despite holding
substantial cash reserves as U.K. interest rates were rising for a large
portion of 1995. Our Fund's twelfth year closed with better than 32% growth
in our investment portfolio.
PERFORMANCE IN 1994
We started 1994 with nearly 22% in domestic holdings, and by the close
held only 2% in the U.S. We accomplished the feat of not losing money during
that year, while most comparable funds were not nearly so fortunate. All in
all, Z-Seven's eleventh year closed with better
<PAGE> 50
than 1% growth in our investment portfolio.
PERFORMANCE IN 1993
Europe battled against a recession in 1993 with low interest rates. This
created a positive environment for the European markets, which represented
nearly 80% of Z-Seven's holdings. Our investment portfolio and per share net
asset value grew for all four quarters of 1993. Our Fund's tenth year closed
with 19% growth in our investment portfolio.
PERFORMANCE IN 1992
In 1992, European secondary issues, which made up nearly 80% of our
portfolio, suffered a severe blow when Denmark voted against the Maastricht
Treaty (designed to stabilize economic and political relationships in the
European community). This caused a five-month decline in the market prices of
most European investments in our portfolio. Our ninth year as a public
company was our least productive, with a more than 12% loss in our portfolio.
PERFORMANCE IN 1991
The year of 1991 brought wonderful news to our portfolio. About two
thirds of our investments were invested in the U.K. Z-Seven Fund was the
performance leader for that year among all closed-end and open-end funds
invested primarily in Europe. Our eighth year as a public company was our
most productive, with a 54% gain in our portfolio.
PERFORMANCE IN 1990
While we were excited with the returns in 1991, it was the defensive
performance in the bear-market year of 1990 that we are most pleased with. By
the end of 1990, our search for exceptional value gave us a portfolio invested
67% in the U.K. and Western Europe, and 28% in the U.S. In a very difficult
year for markets around the world, the Fund was able to minimize portfolio
losses to just over 5%. Relative to other closed-end funds invested primarily
in Europe, Z-Seven was the performance leader at year-end, based on market
value (see chart on page 9).
<PAGE> 51
SPECIAL FEATURE OF THE FUND
BONUS/PENALTY PERFORMANCE INCENTIVE
Z-Seven's net asset value performance (after expenses) must exceed the
S&P 500 by ten percentage points (as an example: 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.
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. The
performance arrangement compares Z-Seven's net asset value (even after all
ordinary expenses) vs. an expense-free S&P 500 Index for the latest 12-month
period.
Special bonus/penalty incentive:
<TABLE>
<CAPTION>
- -------------------------------------------
Trailing 12 months Quarterly
Percentage Point Difference Bonus/Penalty
- --------------------------- --------------
<S> <C>
0 to 9.9 0%
10 to 14.9 1/4%
15 to 19.9 3/8%
20 to 24.9 1/2%
25 to 29.9 5/8%
30 to 34.9 3/4%
35 to 39.9 7/8%
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%
- -------------------------------------------
</TABLE>
<PAGE> 52
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of the Fund is long-term capital appreciation
through investment in quality growth companies whose shares are undervalued.
FOREIGN SECURITIES
The Fund may invest up to 100% of its total asset value in securities of
foreign issuers. ONLY DEVELOPED MARKETS, not emerging markets, ARE CONSIDERED
SAFE FOR OUR GLOBAL DIVERSIFICATION. As a result, in our own Western
Hemisphere, we invest in the U.S. and Canada only (not in Latin America). In
Europe, we invest only in Western and Northern nations, not in Eastern
countries. In the Pacific, we have only invested in Japan and Australia. We
do not invest in Africa or Asia (other than Japan).
OPTIONS ON STOCK INDEX FUTURES
The Fund may consider from time to time the purchase and sale of call and
put options on stock index futures traded on U.S. or foreign stock exchanges
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. One such transaction occurred during October of 1998. At this
time, the portfolio was fully invested, and the abundance of value argued
against raising cash the way we would normally reduce risk.
FOREIGN CURRENCY CONTRACTS
THE FUND CURRENTLY 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 currency exchange contracts. Since
there is no initial payment or any cash payments on daily mark-to-markets
using foreign currency contracts, this 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> 53
GENERAL INFORMATION
THE FUND
Z-Seven Fund, Inc. is a non-diversified, closed-end management investment
company whose shares trade on the Nasdaq National Market System and on the
Pacific Exchange.
The Fund is managed by TOP Fund Management, Inc., (the Advisor), whose
president is Mr. Barry Ziskin.
SHAREHOLDER INFORMATION
Net asset value and market price information about the Fund shares are
published each Monday in Barron's and The Wall Street Journal. For a current
quote of the stock price, shareholders can contact any brokerage house, or
contact the Fund directly for prices and latest net asset value.
Very often shares can be bought or sold for a more advantageous price on
either (but not both) of the markets. Be sure to get quotes on both the ZSEV
(Nasdaq) and ZSE (Pacific) before you place your order.
REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS
A dividend and capital gains reinvestment program is available to provide
shareholders with automatic reinvestment of their dividend income and capital
gains distributions in additional shares of the Fund's common stock.
Shareholders who wish to participate in the program and have physical
possession of their share certificates (holders of record) should contact
Norwest Bank Minnesota, Shareowner Services, our Transfer Agent, at (800)
468-9716. Shareholders who do not have physical possession of their share
certificates (street name) should call their broker or custodian.
Deemed distributions of taxes we pay on long-term capital gains are not
part of this plan.
SHARE REPURCHASES
Notice is hereby given, in accordance with Section 23(c) of the
Investment Company Act of 1940, as amended, that the Fund may purchase, at
market prices, from time to time, shares of its common stock in the open
market.
Please, see "Share Repurchases" on page 7 of the Letter to Our
Shareholders.
<PAGE> 54
PLEASE SEE Z-SEVEN'S SCHEDULE OF INVESTMENTS, FINANCIAL STATEMENTS, AND NOTES
TO THE FINANCIAL STATEMENTS, NEXT. =>
<PAGE> 55
<TABLE>
<CAPTION>
Z-Seven Fund, Inc.
SCHEDULE OF INVESTMENTS
at December 31, 1998
- ----------------------------------------------------------
Common Stocks (a) SHARES VALUE
- ----------------------------------------------------------
<S> <C> <C>
APPAREL & ACCESSORIES - 5.3%
Abbeycrest Plc 10,000 $ 16,620
The Men's Wearhouse, Inc. (c) 11,400 361,950
Nautica Enterprises, Inc. (c) 17,700 265,500
Quiksilver, Inc. (c) 6,800 204,000
Tarrant Apparel Group (c) 5,100 202,725
----------
1,050,795
----------
AUTOMOTIVE & TRANSPORTATION - 4.5%
Autopistas C.E. SA 9,740 161,979
Motorcar Parts
and Accessories, Inc. (c) 29,200 333,990
Strattec Security Corporation (c) 13,600 408,000
----------
903,969
----------
BUILDING & MATERIALS - 5.4%
American Homestar
Corporation (c) 16,550 248,250
Barratt Developments Plc 103,000 396,962
NCI Building Systems, Inc. (c) 9,400 264,375
Nobility Homes, Inc. (c) 12,800 164,006
----------
1,073,593
----------
BUSINESS SERVICES & SUPPLIES - 2.5%
Day Runner, Inc. (c) 17,500 253,750
Dudley Jenkins Group Plc 28,400 234,868
----------
488,618
----------
COMMUNICATION - 4.8%
AVT Corporation (c) 7,200 208,800
Brightpoint, Inc. (c) 29,400 404,250
Vertex Communications
Corporation (c) 21,200 336,550
----------
949,600
----------
COMPUTER & RELATED - 19.6%
CIBER, Inc. (c) 7,200 201,154
Computer Horizons
Corporation (c) 13,000 346,125
Cybex Computer Products
Corporation (c) 7,650 224,719
Hummingbird
Communications Ltd. (c) 15,300 300,263
Insight Enterprises, Inc. (c) 4,125 209,859
First Consulting Group, Inc. (c)(b) 27,300 559,650
Kronos, Inc. (c) 9,100 403,248
- ----------------------------------------------------------
Common Stocks (a) SHARES VALUE
- ----------------------------------------------------------
Oracle Corporation (c) 4,400 189,750
Pomeroy Computer
Resources, Inc. (c) 19,900 447,750
Rainbow Technologies, Inc. (c) 3,500 65,846
Smart Modular
Technologies, Inc. (c) 8,700 241,425
Synopsys, Inc. (c) 7,700 417,725
Zebra Technologies Corporation (c) 9,900 284,625
----------
3,892,139
----------
ELECTRICAL & ELECTRONICS - 9.1%
AFC Cable Systems, Inc. (c) 11,700 393,412
Benchmark Electronics, Inc. (c) 11,200 410,200
LSI Industries, Inc. 18,000 403,884
Roxboro Group Plc 100,500 382,302
TT Group Plc 61,900 218,569
----------
1,808,367
----------
FINANCIAL SERVICES - 8.3%
Jardine Lloyd Thompson Group Plc 269,100 858,967
Rathbone Brothers Plc 88,500 790,393
----------
1,649,360
----------
FOOD & BEVERAGE - 1.4%
Carlsberg A/S 2,700 155,542
Lindt & Sprungli AG 46 120,568
----------
276,110
----------
HEALTH & PERSONAL CARE - 4.8%
Astra AB 10,586 215,266
L'Oreal 325 234,938
Nature's Sunshine Products, Inc. 20,600 314,150
Novartis AG 99 194,612
----------
958,966
----------
LEISURE - 5.9%
Anchor Gaming (c) 6,000 338,250
Ballantyne of Omaha, Inc. (c) 48,100 423,905
Dave and Buster's, Inc. (c) 17,600 405,909
----------
1,168,064
----------
MEDICAL SERVICES & SUPPLIES - 3.4%
National Dentex Corporation (c) 17,100 286,425
SeaMED Corporation (c) 34,500 388,125
----------
674,550
----------
<FN>
See accompanying notes to financial statements.
</TABLE>
<PAGE> 56
<TABLE>
<CAPTION>
Z-Seven Fund, Inc.
SCHEDULE OF INVESTMENTS
at December 31, 1998 Continued
- --------------------------------------------------------------------
Common Stocks (a) SHARES VALUE
- --------------------------------------------------------------------
<S> <C> <C>
MULTI-INDUSTRY - 5.8%
Kaydon Corporation 5,200 208,328
Technitrol, Inc. 12,600 401,625
Tomkins Plc 42,666 199,720
VT Holding A/S 10,565 347,314
-----------
1,156,987
-----------
PLASTICS - 1.6%
Northern Technologies
International Corporation 23,300 148,537
Polypipe Plc 88,200 166,257
-----------
314,794
-----------
RETAIL - 1.9%
Grow Biz International, Inc. (c) 26,700 347,100
Westfair Foods Ltd. 360 29,421
-----------
376,521
-----------
MISCELLANEOUS - 2.3% (C) 45,000 451,975
- --------------------------------------------------------------------
TOTAL COMMON STOCKS - 86.6%
(Cost $15,675,794) (d) $17,194,408
- --------------------------------------------------------------------
CASH, RECEIVABLES, AND OTHER ASSETS
LESS LIABILITIES - 13.4% 2,660,460
- --------------------------------------------------------------------
NET ASSETS - 100.0%
(Equivalent to $7.80 per share based
on 2,545,031 shares of capital stock
outstanding) $19,854,868
====================================================================
<FN>
(a) Percentages are based on net assets of $19,854,868.
(b) Result of merger with Integrated Systems Consulting Group, Inc.
(c) Non-income producing investment.
(d) Aggregate cost for federal income tax purposes was $15,680,241
at December 31, 1998. Net unrealized appreciation for all
securities was $1,514,167. This consisted of aggregate gross
unrealized appreciation of $3,410,772 of securities with an
excess of fair value over tax cost and aggregate gross
unrealized depreciation of $1,896,605 of securities with an
excess of tax cost over fair value.
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------
COMMON STOCKS BY COUNTRY
- ------------------------------------
Percent Country Value
- ------------------------------------
<C> <S> <C>
70.8% United States $12,169,847
19.0% United Kingdom 3,264,658
2.9% Denmark 502,856
1.9% Canada 329,684
1.8% Switzerland 315,180
1.4% France 234,938
1.3% Sweden 215,266
.9% Spain 161,979
- ------------------------------------
100.0% $17,194,408
====================================
<FN>
See accompanying notes to financial statements.
</TABLE>
<PAGE> 57
<TABLE>
<CAPTION>
Z-Seven Fund, Inc.
STATEMENT OF ASSETS AND LIABILITIES
at December 31, 1998
<S> <C>
ASSETS
Investments in securities, at value
(identified cost $15,675,794) $17,194,408
Cash 588,515
Receivables
Dividends and interest 85,991
Securities sold 2,443,779
Due from investment advisor 70,800
Other 16,558
Other assets 27,631
------------
Total assets 20,427,682
------------
LIABILITIES
Payables
Securities purchased 199,580
Income taxes 314,128
Other 59,106
------------
Total liabilities 572,814
------------
NET ASSETS $19,854,868
============
NET ASSETS REPRESENTED BY
Capital stock, $1.00 par value:
7,700,000 shares authorized,
3,268,858 shares issued $ 3,268,858
Additional paid-in capital 21,050,898
Treasury stock, 723,827 shares, at cost (6,077,626)
------------
18,242,130
Accumulated net realized gains on
investments, currency transactions
and options 122,000
Net unrealized appreciation on
investments and currency translations 1,490,738
Undistributed net investment income 0
------------
NET ASSETS (EQUIVALENT TO $7.80 PER
SHARE BASED ON 2,545,031 SHARES OF
CAPITAL STOCK OUTSTANDING) $19,854,868
============
</TABLE>
<TABLE>
<CAPTION>
Z-Seven Fund, Inc.
STATEMENT OF OPERATIONS
Year Ended December 31, 1998
<S> <C>
INVESTMENT INCOME
Dividends, net of nonreclaimable
foreign taxes of $32,526 $ 228,068
Interest 34,369
-----------
Total investment income 262,437
-----------
Expenses
Investment advisory base fee 258,381
Performance penalty (476,146)
Compensation and benefits 138,194
Transfer agent fees 18,480
Professional fees 107,783
Officer indemnity 87,662
Custodian fees 37,000
Printing and postage 26,213
Office and miscellaneous expenses 39,853
Insurance expense 2,247
Directors' fees and expenses 18,653
Dues and filing fees 15,870
Shareholder relations & communications 10,717
Interest expense 5,400
Rent expense 12,235
-----------
Total expenses 302,542
Expenses reduced through offset
arrangements (4,200)
-----------
Net expenses 298,342
-----------
Net investment loss (35,905)
-----------
REALIZED & UNREALIZED GAIN ON INVESTMENTS
Net realized gain on investments and
currency transactions 1,483,371
Net realized loss on options (174,496)
Provision for income taxes on
realized gain (314,128)
Change in unrealized appreciation of
investments and currency translations 146,341
-----------
Net gain on investments, currency
transactions and options 1,141,088
-----------
Net increase in net assets
from operations $1,105,183
===========
<FN>
See accompanying notes to financial statements.
</TABLE>
<PAGE> 58
<TABLE>
<CAPTION>
Z-Seven Fund, Inc.
STATEMENT OF CHANGES IN NET ASSETS
Years Ended December 31, 1998
and December 31, 1997
1998 1997
------------ ------------
<S> <C> <C>
NET ASSETS,
Beginning of Year $20,161,112 $22,841,484
------------ ------------
OPERATIONS
Net investment income (loss) (35,905) 273,005
Net realized gain on
investments, currency
transactions and options 994,747 3,694,931
Change in unrealized
appreciation (depreciation)
of investments and
currency translations 146,341 (1,941,475)
------------ ------------
Net increase in net assets
from operations 1,105,183 2,026,461
------------ ------------
DIVIDENDS AND DISTRIBUTIONS
From net investment income (146,606) (131,265)
From net realized gain on
investments, currency
transactions and options (300,388) (3,692,101)
------------ ------------
Decrease in net assets from
dividends and distributions (446,994) (3,823,366)
------------ ------------
SHARE TRANSACTIONS
Treasury stock purchases (980,119) (1,007,031)
Reinvested dividends and
distributions 15,686 123,564
------------ ------------
Decrease in net assets from
share transactions (964,433) (883,467)
------------ ------------
Net Decrease in Net Assets (306,244) (2,680,372)
------------ ------------
NET ASSETS,
End of Year (including
Undistributed net investment
income of $0 and
$433,630, respectively) $19,854,868 $20,161,112
============ ============
<FN>
See accompanying notes to financial statements.
</TABLE>
Z-Seven Fund, Inc.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Z-Seven Fund, Inc. (the Fund) is registered under the Investment Company
Act of 1940, as amended, as a non-diversified, 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,
other than the London Stock Exchange, 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, except VT Holding A/S which is valued at the midpoint between the
bid and the ask. Securities traded on the London Stock Exchange are valued at
the mid-close price. 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 based
on quoted third-party prices. 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.
<PAGE> 59
DISTRIBUTIONS TO SHAREHOLDERS - Dividends and distributions of net
capital gains to shareholders are recorded on the ex-dividend date.
Investment income 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, 1998, the Fund has reclassified to paid in capital, $<251,119>
from undistributed net investment income and $262,488 from accumulated capital
gains.
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-dividend and
payment dates on dividends.
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 and the value at the time it was closed.
Realized gains and losses from contract transactions are included as a
component of net realized gains on investments 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
<PAGE> 60
assets, liabilities, and contingent 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 January 1, 1997 through December 31, 1998, the Board of Directors
authorized the following purchases of the Fund's capital shares on the open
market:
<TABLE>
<CAPTION>
Average
Year Number of Cost Discount
Share Per Share
- ---- --------- ---------- ---------
<S> <C> <C> <C>
1998 127,500 $ 980,119 $ 0.10
1997 106,400 $1,007,031 $ 0.06
</TABLE>
In 1996, the Fund established a distribution reinvestment plan to allow
shareholders to reinvest their distributions in shares of the Fund. When the
Fund is selling at a premium, distributions will be reinvested at the greater
of net asset value or 95% of the market price. When the Fund is selling at a
discount, distributions will be reinvested at market price. On December 30,
1998, 1,995 shares of the Fund were distributed to plan participants at $7.86
per share (net asset value). This distribution increased the Fund's total net
assets by $15,686.
In 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 698,210 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 upon Agape's request. Agape has requested that the Fund
repurchase these shares as an alternative to registration. The Fund agreed,
subject to regulatory approval, to repurchase the Agape shares over an
18-month period, at a price of one-half of one percent below the net asset
value at the time of each repurchase, provided that the Fund's shares are
trading at or above net asset value. On July 31, 1997, the Fund filed an
application with the Securities and Exchange Commission (the "SEC") seeking
the necessary regulatory approval. On September 15, 1998, the SEC published a
notice to the effect that an order granting the application would be issued
unless the SEC ordered a hearing. A request for a hearing was made to the
SEC, which the Fund opposed. The SEC is currently reviewing the request for a
hearing and the Fund's opposition to it to determine whether to order a
hearing, or alternatively, issue the order granting the application without a
hearing.
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, 1998, were:
<TABLE>
<CAPTION>
Common Stocks Treasury Bills
-------------- ---------------
<S> <C> <C>
Purchases $ 14,319,714 $ 4,472,277
Sales $ 18,450,640 $ 4,487,409
</TABLE>
NOTE 4 - FOREIGN CURRENCY CONTRACTS
At December 31, 1998, the Fund had contracts, maturing on February 16,
1999, and
<PAGE> 61
November 16, 1999, to sell $5 million in foreign currency (2 million Swiss
francs, 2 million British pounds, and 1/2 million Canadian dollars). These
contracts were marked-to-market on December 31, 1998, resulting in a net
unrealized loss of $27,876. This unrealized loss is included as a component
of receivables from securities sold, in the Statement of Assets and
Liabilities.
NOTE 5 - OPTIONS TRANSACTIONS
The Fund may from time to time purchase and sell call and put options on
stock indexes which are traded on national securities exchanges as a method of
hedging market fluctuations. The Fund may liquidate the call and put option
purchased or sold by effecting a closing sale transaction (rather than
exercising the option). This is accomplished by purchasing or selling an
option of the same series as the option previously purchased or sold. There
is no guarantee that the closing sale transaction can be effected. The Fund
will realize a profit from a closing transaction if the price at which the
transaction is effected is greater than the premium paid to purchase the
option. The Fund will realize a loss from a closing transaction if the price
is less than the premium paid.
An option may be closed out only on an exchange which provides a market
for options on the same index and in the same series. Although the Fund will
generally purchase or sell only those options for which there appears to be an
active market, there is no assurance that a liquid market on the exchange will
exist for any particular option, or at any particular time. In such event, it
might not be possible to execute closing transactions in particular options,
with the result that the Fund would have to exercise its options in order to
realize any profit.
During the year ended December 31, 1998, the cost of option contracts
purchased, and the proceeds from option contracts sold, were $455,070 and
$280,574, respectively.
NOTE 6 - LEASE COMMITMENTS
The Fund is obligated under a three-year operating lease, for its Mesa,
Arizona corporate office, which expires on June 30, 2001. Minimum lease
payments due are as follows:
<TABLE>
<CAPTION>
Year ended December 31:
<S> <C>
1999 $23,426
2000 23,807
2001 11,999
-------
Total minimum lease payments $59,232
</TABLE>
Rent expense for the year ended December 31, 1998 was $12,235.
NOTE 7 - INVESTMENT ADVISORY FEES AND PERFORMANCE BONUS/PENALTIES
TOP Fund Management is the Fund's investment advisor (the "Advisor").
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 base management fees 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, 1998, the base management fees aggregated
$258,381.
<PAGE> 62
In addition to the base management fees, the Advisor will receive a bonus
for extraordinary performance or pay a penalty 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 can exceed the
base management fees. 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 sam2e
period of time by more than 10%. For the year ended December 31, 1998, the
performance penalty aggregated $476,146.
The agreement also provides that if the Fund's expenses on an annual
basis (including the base management fees, 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, 1998, an expense
reimbursement was not required.
NOTE 8 - DISTRIBUTIONS TO SHAREHOLDERS
On September 15, 1998, the Board of Directors declared $0.1744 per share
remainder distribution. This represents undistributed net investment income
and short-term capital gains for 1997. These distributions were paid on
December 30, 1998, to shareholders of record on December 21, 1998. The Fund
intends to distribute short-term capital gains and net investment income for
1998 on or before December 31, 1999.
NOTE 9 - FEDERAL INCOME TAX INFORMATION
For federal income tax purposes, in 1998, the Fund realized net capital
gains of $897,508 and investment company taxable income of $121,963. The
Board of Directors elected to retain 1998 net capital gains and provided
federal income taxes of $314,128 on these retained gains.
NOTE 10 - 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, 1998, Barry Ziskin, an officer and director of the Fund,
owned 604,628 shares of the Fund's capital stock. He is also an officer and
director of the Advisor.
In March 1998, the Board of Directors granted the request from Barry
Ziskin, an officer and director of the Fund, to indemnify certain costs
incurred in the defense of a legal action relating to the management of the
Fund. The total amount of the indemnity equaled $87,662 (3.3 cents per share)
and is included in the Statement of Operations.
On December 31, 1997, the Fund received a contribution of 23,600 shares
of Z-Seven Fund stock from Ziskin Asset Management, an
<PAGE> 63
affiliate of the Fund. The shares are included in the Treasury Stock balance.
NOTE 11 - LINE OF CREDIT
The Fund has a $1,300,000 line of credit with its custodian bank which is
secured by investment securities with an aggregate market value not to exceed
15% of the value of the Fund's total assets. Borrowings against the line are
charged interest at a rate of prime plus 1/2%. The maximum amount outstanding
against the line during the twelve months ended December 31, 1998, was
$500,000. The line of credit expires August 7, 1999.
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 December 31,
1998.
NOTE 12 - EXPENSE OFFSET ARRANGEMENT
Through an arrangement with Standard & Poor's Securities ("S&P"),
commissions paid to S&P earn soft dollar credits. The Advisor may direct S&P
to use the credits to pay certain Fund expenses. For the year ended December
31, 1998, the Advisor applied $4,200 of these soft dollar credits towards the
payment of office and miscellaneous expenses of the Fund.
<PAGE> 64
Z-SEVEN'S FINANCIAL HIGHLIGHTS ARE NEXT. =>
<PAGE> 65
<TABLE>
<CAPTION>
Z-Seven Fund, Inc.
FINANCIAL HIGHLIGHTS
The following represents selected data for a share outstanding throughout the year. All share
and per share data has been adjusted to reflect the two-for-one stock split in December 1997, and
the three-for-two stock split in April 1986. Financial Highlights include fifteen years of
information - since Fund inception.
- ---------------------------------------------------------------------------------------------------
For the year ended December 31, 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net asset value, beginning of year $ 7.55 $ 8.20 $ 8.74 $ 8.32
-------- --------- -------- --------
Net investment income (loss) -0- 0.11 (0.06) 0.06
Net realized and unrealized gains (losses) on investments
and currency transactions before income taxes 0.55 1.05 1.01 1.88
-------- --------- -------- --------
Total increase (decrease) from investment operations 0.55 1.16 0.95 1.94
Distributions to shareholders from net investment income (0.06) (0.05) (0.03) (0.44)
Distributions to shareholders from net capital gains (0.12) (1.38) (1.46) (1.08)
Income taxes on capital gains paid on behalf of
shareholders (0.12) (0.45) -0- -0-
Capital contribution -0- 0.07 -0- -0-
-------- --------- -------- --------
Net increase (decrease) in net asset value (0.30) (0.65) (0.54) 0.42
-------- --------- -------- --------
Net asset value, end of year $ 7.80 $ 7.55 $ 8.20 $ 8.74
======== ========= ======== ========
Per share market value, end of year $ 8.00 $ 11.00 $ 10.25 $ 11.13
Total investment return (a) (24.5%) 34.0%(d) 8.9% 58.3%
Ratio of expenses before performance bonus/penalty to
average net assets (c) 3.8% 3.0% 3.2% 2.9%
Ratio of expenses to average net assets (c) 1.5% 1.0% 3.0% 2.0%
Ratio of net investment income (loss) to average
net assets (0.2%) 1.1% (0.6%) 0.9%
- ---------------------------------------------------------------------------------------------------
Portfolio turnover rate 73.1% 111.3% 66.4% 36.1%
- ---------------------------------------------------------------------------------------------------
Number of shares outstanding, end of year (in 000's) 2,545 2,671 2,785 2,771
Net assets, end of year (in 000's) 19,855 20,161 22,841 24,220
- ---------------------------------------------------------------------------------------------------
<FN>
(a) 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.
(b) Calculations based on weighted average number of shares outstanding of 2,588,376 for the year.
(c) Ratios reflect expenses gross of expense offset arrangement for the years ended December 31,
1995 through December 31, 1998.
(d) Total investment return without the capital contribution would have been 33.2%
</TABLE>
<PAGE> 66
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
1994 1993 1992(b) 1991 1990 1989 1988 1987 1986 1985 1984
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
8.50 $ 7.56 $ 8.83 $ 6.08 $ 6.62 $ 7.16 $ 7.61 $ 8.04 $ 5.94 $ 4.33 $ 4.60
- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(0.08) 0.06 0.02 (0.09) 0.08 0.23 0.01 (0.07) (0.18) (0.08) -0-
(0.07) 1.11 (1.29) 2.84 (0.56) (0.40) 0.07 (0.02) 2.50 1.69 (0.27)
- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(0.15) 1.17 (1.27) 2.75 (0.48) (0.17) 0.08 (0.09) 2.32 1.61 (0.27)
-0- -0- -0- -0- (0.06) (0.23) -0- -0- -0- -0- -0-
-0- -0- -0- -0- -0- -0- -0- -0- -0- -0- -0-
(0.03) (0.23) -0- -0- -0- (0.14) (0.53) (0.34) (0.22) -0- -0-
-0- -0- -0- -0- -0- -0- -0- -0- -0- -0- -0-
- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(0.18) 0.94 (1.27) 2.75 (0.54) (0.54) (0.45) (0.43) 2.10 1.61 (0.27)
- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
8.32 $ 8.50 $ 7.56 $ 8.83 $ 6.08 $ 6.62 $ 7.16 $ 7.61 $ 8.04 $ 5.94 $ 4.33
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
8.25 $ 9.13 $ 8.50 $ 10.75 $ 6.38 $ 6.50 $ 8.32 $ 7.63 $ 10.07 $ 5.00 $ 4.67
(9.3%) 10.2% (20.9%) 68.6% 1.9% (20.2%) 17.0% (20.8%) 106.6% 7.1% (6.7%)
2.7% 2.9% 3.5% 3.4% 3.6% 3.5% 3.5% 3.0% 2.7% 3.5% 3.8%
3.0% 2.1% 2.4% 4.3% 2.6% 1.2% 2.7% 3.2% 4.4% 3.5% 2.8%
(0.8%) 0.7% 0.2% (1.1%) 1.4% 3.3% 0% (0.7%) (2.3%) (1.6%) 0.1%
- ------------------------------------------------------------------------------------------------------------
17.5% 42.1% 17.9% 44.1% 42.8% 87.3% 4.7% 23.3% 30.6% 24.2% 32.9%
- ------------------------------------------------------------------------------------------------------------
3,032 3,188 3,269 2,571 2,592 2,751 2,942 2,997 3,008 3,097 3,097
25,241 27,097 24,714 22,687 15,756 18,231 21,083 22,827 24,210 18,417 13,429
- ------------------------------------------------------------------------------------------------------------
<FN>
See accompanying notes to financial statements.
</TABLE>
<PAGE> 67
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,
1998, and the related statement of operations for the year then ended, and
statement of changes in net assets for each of the years in the two-year
period then ended, and financial highlights for each of the years in the four-
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, 1998, by correspondence with the custodian and
brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights for
1995 through 1998 referred to above, present fairly, in all material respects,
the financial position of Z-Seven Fund, Inc. as of December 31, 1998, and the
results of its operations, its changes in net assets and financial highlights
for each of the periods indicated above, in conformity with generally accepted
accounting principles.
KPMG LLP
Phoenix, Arizona
February 5, 1999
<PAGE> 68
YEAR 2000 (UNAUDITED)
Many computers and computer programs use only two digits to identify a
year in the date field. As a result, these systems may be unable to
recognize, calculate or accurately process information having dates on or
after January 1, 2000. This issue associated with the Year 2000 (Y2K)
concerns virtually all companies, and is currently being addressed by the
Fund.
The Fund's technology needs are primarily dependent on third party
vendors and service providers. The Fund has completed an inventory of systems
in use, and has identified core business activities, classified as Y2K
"mission-critical." The Fund is in the process of contacting its vendors, and
has received some written responses indicating the status of their respective
products' Y2K readiness. The Fund has also been in contact with its service
providers, and has identified mission-critical activities among those
performed by the Fund's Custodian and Transfer Agent. Both providers have
released information indicating that their respective plans for Y2K compliance
are on schedule and expected to be completed in a timely manner. Based upon
current information obtained from the Fund's third party vendors and service
providers, management does not believe at this time that Y2K compliance will
present a material problem for the Fund's internal computer systems or
activities.
At this time, management has targeted June 30, 1999 for the completion of
testing and implementation of any systems or software necessary for Y2K
compliance. The Fund has not incurred any costs to date as a result of its Y2K
compliance efforts. Due to the Fund's reliance on third party vendors and
service providers, management does not anticipate any material Y2K compliance
costs prior to the Year 2000. No assurance can be given that all service
providers will not be materially affected by Y2K-related problems or that
replacements for deficient products or service providers can be obtained in a
timely manner and without additional expense to the Fund.
Contingency plans for the Fund are expected to be completed after final
evaluation of information supplied by its service providers and third party
vendors. It is the goal of the Fund to complete this process by June 30,
1999. There can be no assurance that any failure of the Fund, its service
providers, or vendors to be Y2K compliant will not have a material adverse
effect on the Fund's financial condition and results of operations.
There are many factors that could affect the successful management of the
Fund's Y2K issues, such as: the ability of the Fund to identify systems and
programs affected by Y2K; the extent of testing required for internal systems;
the cost of installation, programming, and systems work necessary for the
upgrading or replacement of programs affected; and, above all, the success of
the Fund's service providers, third party vendors, and other external industry
entities in their efforts of managing potential Y2K problems. Failure among
any of these factors could have a material adverse effect on the Fund's
financial condition and results of operations. Any inability to operate due
to Y2K issues may subject the Fund to legal claims and/or governmental fines
or sanctions that could adversely effect the Fund's ability to do business or,
in some cases, require the Fund to cease operations.
<PAGE> 69
RESULTS OF VOTING (UNAUDITED)
Pursuant to the proxy statement mailed to shareholders in conjunction
with the annual meeting of shareholders held on December 11, 1998, 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>
Withheld/
Nominee For Against
- ------------------ --------- -----------
<S> <C> <C>
M. De Los Santos 2,505,289 15,568
A. Feldman 2,503,976 16,881
J. Shuster 2,503,976 16,881
B. Ziskin 2,505,289 15,568
R. Ziskin 2,502,042 18,815
</TABLE>
Proposal 2: Approval of selection of KPMG LLP as independent auditors to
report on the financial statements of the Fund for the year ended December 31,
1998.
<TABLE>
<CAPTION>
For Against Abstain
- --------- ------- -------
<S> <C> <C>
2,512,751 2,036 6,070
</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>
2,474,435 31,281 15,141
</TABLE>
<PAGE> 70
<PAGE> 71
<PAGE> 72
BOARD OF DIRECTORS
Barry Ziskin
President:
Z-Seven Fund, Inc.
TOP Fund Management, Inc.
Ziskin Asset Management, Inc.
Albert Feldman
Retired, San Francisco Advertiser, Inc.
Dr. Jeffrey Shuster
DDS PC
Private Practice
Rochelle Ziskin
Assistant Professor
University of Missouri,
Maria De Los Santos
Controller, DDC-I, Inc.
INVESTMENT ADVISOR
TOP Fund Management, Inc.
OFFICERS
Barry Ziskin, President
Barbara Perleberg, Secretary
Laurie S. Doane, Treasurer
CUSTODIAN
Chase Manhattan Bank
New York, NY
TRANSFER AGENT
Norwest Bank Minnesota, N.A.
Shareowner Services
161 N. Concord Exchange Street
South St. Paul, MN 55075
(800) 468-9716
INDEPENDENT AUDITORS
KPMG LLP
Phoenix, AZ
GENERAL COUNSEL
Kilpatrick Stockton LLP
Atlanta, GA
STOCK LISTINGS
Nasdaq National Market System
Symbol: ZSEV
Pacific Exchange
Symbol: ZSE
CORPORATE OFFICE
1819 S. Dobson Road
Suite 109
Mesa, AZ 85202
(602) 897-6214
Fax (602) 345-9227
<PAGE> INSIDE BACK COVER
Z-SEVEN FUND INC.
1819 S. Dobson Road
Suite 109
Mesa, AZ 85202
(602) 897-6214
Fax (602) 345-9227
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
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