General
The Ziegler Companies, Inc. (the "Parent" and, collectively with its wholly owned and partially owned and controlled subsidiaries, the "Company") is a financial services holding company incorporated under the laws of Wisconsin in 1993 which owns operating subsidiary companies in three segments -- Capital Markets, Investment Services and Corporate. See Note 16 to the Company's Consolidated Financial Statements for information concerning the Company's three reportable segments. A list of the Company's subsidiaries is filed as Exhibit 21.1 to this Form 10-K. All of the Company's subsidiaries are engaged in financial service businesses. The Company's principal executive offices are located at 250 East Wisconsin Avenue, Milwaukee, Wisconsin 53202 and its telephone number is (414) 978-6400.
On October 28, 2003, the Board of Directors of the Company approved the filing of an application to voluntarily delist the Company's common shares from the American Stock Exchange (AMEX). On December 12, 2003, the Company's application to voluntarily delist its common shares from trading on the AMEX was approved by the Securities and Exchange Commission (SEC). As a result of this and certain other actions, the Company's common stock is no longer registered pursuant to the Securities Exchange Act of 1934, and the Company's reporting obligations under the '34 Act will be suspended effective April 2, 2004. As of that date, the Company will no longer be filing reports with the SEC. The Company's shares now trade on the Pink Sheets, LLC, an electronic network through which participating broker-dealers make markets and enter orders to buy and sell shares. The trading symbol for the Company's common stock is currently ZCOI in over-the-counter ("OTC") trading.
CAPITAL MARKETS SEGMENT
The Capital Markets segment underwrites fixed income securities to finance senior living and healthcare providers, religious institutions, and private schools. Capital Markets' services also include risk management and financial advisory services, merger and acquisition advisory services, sales and trading of fixed income securities and preferred stock, and Federal Housing Administration ("FHA") mortgage loan origination, often in conjunction with the Company's investment banking services. Capital Markets activities are conducted primarily through B.C. Ziegler and Company ("BCZ"), except that Ziegler Financing Corporation ("ZFC") conducts FHA mortgage loan origination activities. These services are provided primarily to not-for-profit corporations, municipalities, and to a lesser degree, business corporations.
INVESTMENT SERVICES SEGMENT
The Investment Services segment consists of two operating units: Asset Management and Wealth Management. (On August 31, 2001, the Company disposed of its Portfolio Consulting unit, PMC International, Inc. ("PMC"), previously a third operating unit of this segment.) Asset Management provides investment advisory services to affiliated mutual funds (the North Track Funds) and private accounts of institutional and individual clients. Wealth Management offers a wide range of financial products and financial planning services to retail and institutional clients through its broker distribution network, including equity and fixed-income securities, affiliated and non-affiliated mutual funds, real estate investment trusts, private placements, annuities and other insurance products. Wealth Management is the primary retail distribution channel for religious institution and private school bonds and other taxable and tax-exempt bonds underwritten by the Capital Markets segment. Sales credits associated with underwritten offerings are reported in the Investment Services segment when sold through the Company's retail distribution channels. Asset Management and Wealth Management activities are conducted through BCZ.
CORPORATE SEGMENT
The Corporate segment consists primarily of the investment and debt management activities of the Parent and also includes BCZ's unallocated corporate administrative activities. Certain corporate administrative expenses are allocated to the Capital Markets and the Investment Services segments using methodologies which consider the size of the operation, the number of personnel, and other relevant factors. Corporate segment investment activity includes the Company's share of the operations of Ziegler Healthcare Fund I, LP ("ZHF"), a S Investment Company ("SBIC") that is in the business of originating loans to qualified ses, primarily for-profit long-term care companies; Ziegler Healthcare Capital, LLC ("ZHC"), the management company of ZHF; and ZHP I, LLC ("ZHP"), the general partner of ZHF. The Company has an 11% ownership share in ZHF and wholly owns ZHC and ZHP. The Company also owns 68% of Ziegler Equity Funding I, LLC ("ZEF"), a private equity fund whose purpose is to provide funding for the pre-finance development needs of developmental stage continuing care retirement communities. The Corporate segment includes the Company's share of the operations of ZEF. ZEF is 32% owned by officers and employees of the Company. Each of these companies is consolidated into the Company's financial statements.
DISPOSITIONS
On August 31, 2001, the Company exchanged its 100% interest in PMC for a minority interest in the EnvestNet Group, Inc. ("EnvestNet"). EnvestNet is a closely held mid to late stage development company engaged in the business of providing managed account and performance reporting services. The Company received the following consideration in exchange for its investment in PMC: $9,500,000 in EnvestNet common stock, $4,500,000 in notes receivable, and $3,500,000 in cash at closing. Given that the combined entity was unprofitable at the date of disposition and that the securities received had no established market, the Company deferred $5,596,000 of gain on the transaction, recognizing portions on an installment basis only as cash was received. The amount of deferred gain has been reclassified as a valuation allowance against the carrying value of the EnvestNet securities.
Since the date of disposition, the Company has received principal payments on the notes receivable. Accordingly gains were recorded as follows:
Date Note Payment Gains Realized ---- ------------ -------------- 8/31/2001 $3,500,000* $1,399,000 8/31/2002 1,500,000 600,000 8/31/2003 1,000,000 400,000 *Cash at closing
Originally, $3,000,000 of principal on notes receivable was scheduled for payment on August 31, 2003. However $2,000,000 of that balance was restructured in the first quarter of 2003 resulting in a revised maturity date of August 31, 2004. Interest payments on all notes receivable are current as of December 31, 2003.
As of December 31, 2003 EnvestNet had not yet achieved profitability, although the enterprise has made continuous progress in reducing its monthly cash deficits. Given that the goal of achieving profitability has taken longer than originally projected in the business plan, EnvestNet has engaged in several rounds of raising capital typically from venture capital investors. Those capital raises have involved the issuance of preferred shares and notes senior to those held by the Company with the end result that the Company's investment has been diluted.
The valuation of the EnvestNet securities owned by the Company is subject to accounting judgment. Relevant factors include the amount of dilution the Company has experienced, EnvestNet's progress toward achieving profitability,
EnvestNet's continued ability to raise capital, and market conditions for gathering and retaining assets under administration. Based upon events to date, it appears likely that the remaining $2,000,000 in notes receivable will be paid with interest by August 31, 2004, in accordance with the current maturity schedule. The value of the common stock, however, is uncertain. At December 31, 2003, the EnvestNet common stock held by the Company was carried in the consolidated financial statements at $9,500,000 less the remaining valuation allowance of $4,596,000. The net carrying value of $4,904,000 compares favorably to the last EnvestNet arms length capital raise in the first quarter of 2003 and to recent sales of similar enterprises. Nevertheless, in light of the uncertainties at December 31, 2003, the Company adopted the policy of reporting no further gains from EnvestNet barring a significant improvement in its operations. Based upon all information known to date, management has determined that the carrying value of the EnvestNet securities net of the valuation allowance approximates its fair value. Should it become evident that the investment has become impaired below the net book value, it will be written down accordingly.
BUSINESS FACTORS
The general level of interest rates, credit quality trends of the Company's investment banking clients, the prospects for a general economic recovery and economic growth, valuations in the equity markets, national healthcare policies, and many other economic factors impact the investment and financing decisions of the Company's customers, both institutional and retail. The reductions in prevailing interest rates, the growing need for health care and senior housing, and, to some extent, the desire to refinance higher interest rate debt contributed to increased bond underwriting volumes in 2002. The favorable interest rates continued into 2003 with only small increases. Issuance volume of debt securities by the Company's investment banking clients continued to increase in 2003. There were 72 transactions totaling $1.94 billion in 2003 compared to 81 transactions totaling $1.81 billion in 2002. There were 67 transactions totaling $1.70 billion in 2001.
Historically, the Company experiences uneven bond underwriting activity during the year. In general, the Company's underwriting activity is slower during the early months of the year with higher levels of activity experienced in later months as issuers attempt to finalize financing activity before the end of the calendar year. Given the sometimes sporadic timing of the completion of underwriting projects, the demand for new bond issues can change quickly with changes in economic or political conditions. Complementary services of the Capital Markets segment are frequently performed coincident or in conjunction with bond underwritings and may follow similar patterns. Other activities such as FHA mortgage loan origination may actually diminish during a low interest rate environment with the increased availability of low interest borrowing alternatives to clients.
The Investment Services segment is affected by the investment expectations and demands of its clients. Increases in the sale of annuities, church and school bonds, equities, and private placements occurred in 2003 as compared to 2002. The sale of mutual funds, both North Track and other funds, increased in the second half of 2003. Total assets added to the North Track Funds followed a similar pattern with increases to assets under management in the last half of the year from both net sales and market value increases.
The Asset Management business has seen a recovery in market values in its assets under management during 2003, as well as increases in assets due to sales of North Track mutual funds and separate account asset management services. Fees for this business unit are earned based upon the value of assets under management. Total assets under management increased approximately $515 million during 2003. Total assets under management started the year at just over $1.8 billion and was approximately $2.4 billion at December 31, 2003. The increases in 2003 are approximately evenly split between increases due to net sales over redemptions and market value increases.
Both mutual fund assets and separate account assets under management may experience outflows of assets. The mutual funds may experience net redemptions if the aggregate of investor redemptions exceeds the aggregate of investor purchases. The separate account asset management business experiences asset decreases as funds are withdrawn. A large portion of the separate account asset management business is related to managing bond
proceeds on a short-term basis for clients who have issued bonds for building projects. The invested proceeds are then withdrawn, as needed, to fund the projects. There were approximately $1.2 billion of separate account assets and $1.2 billion of mutual fund assets managed by the Company at December 31, 2003, compared to $0.9 billion of assets in each of those asset groups at December 31, 2002.
In March 2003, the National Association of Securities Dealers ("NASD") directed member firms to conduct a self-assessment of their record of delivering commission discounts to customers for certain mutual fund purchases. BCZ, as a member firm, conducted this self-assessment on a statistical sample of all transactions in 2001 and 2002. Based upon the statistical sample, a $41,000 reserve was established for potential refunds to clients. Refunds have been made to all clients identified in the sample that were overcharged, and the balance of the reserve is available for future customer refunds. In January 2004, as required by the NASD, BCZ sent a letter to all clients who made certain mutual fund purchases informing them of their right to have their accounts reviewed by BCZ to determine whether any commission discounts were due. The Company is in the process of reviewing all claims submitted. Based on a review of 12% of the claims received, the number and total dollar amount of the refunds has been insignificant. Management does not believe it will be necessary to increase the reserve established based upon the claims received and reviewed through March 1, 2004. The Company continues to review all claims received and expects to complete the review of current claims received in May 2004. The remaining reserve at March 1, 2004 was $39,000.
In 2003, several states' attorneys general announced ongoing investigations of mutual funds and their managers for late trading, market timing, and other activities. The SEC has requested information about such activities, and policies pertaining to such activities, from the largest U.S. mutual fund companies. To the Company's knowledge, the Company's affiliated mutual fund family, the North Track Funds, is not among the mutual funds under investigation. Based upon an internal review of procedures, in the opinion of Company management, the procedures in place in the North Track Funds are adequate to deter the activities in question.
During 2003, the Corporate segment (whose operations include 100% of the revenues and expenses of the partially-owned, but consolidated, entities) had interest revenues increase as ZHF, the SBIC, increased its portfolio of loans. ZHF made progress in identifying SBA-qualified borrowers during the course of its first full year of operations in 2002, and continued that progress in 2003. The investment in the collateralized mortgage obligations ("CMOs") issued by certain agencies of the Federal government and held by the Corporate segment continue to decline as the result of principal prepayments. After an initial balance of $38,152,000 at the beginning of 2002, the balance declined to $21,382,000 at December 31, 2002, a decline of $16,770,000 due to sales and paydowns of principal. The balance of CMOs declined at a slower rate in 2003, declining by $7,689,000 in 2003 to $13,693,000. Through March 1, 2004, the balance of CMOs declined $6,030,000 to a balance of $7,663,000. As a result of these declines, this source of revenue from interest income has declined and will continue to decline. Should short-term borrowing rates increase or alternative financing sources be required the expected decline in net interest income will be even more significant.
Liquidity is essential to the Company's businesses. The Company's liquidity could be impaired by an inability to sell securities from its inventory, an inability to access the repurchase and securities lending markets, or an inability to sell financial assets. This situation may arise due to circumstances that the Company may be unable to control, such as a general market disruption, perceptions about the Company's creditworthiness or an operational problem that affects third parties or the Company. Further, the Company's ability to sell financial assets may be impaired if other market participants are seeking to sell similar assets at the same time.
Substantial legal liability or a significant regulatory action against the Company could have a material adverse financial impact or cause significant reputational harm to the Company's businesses, which in turn could seriously harm the Company's business prospects.
The Company, as a participant in the financial services industry, is subject to regulation by the Securities and Exchange Commission, state securities regulators, and industry self-regulatory organizations such as the National Association of Securities Dealers. Among other things, the Company could be fined or prohibited from engaging in some of its business activities as a result of administrative orders by regulators. New laws or regulations or changes in enforcement of existing laws or regulations applicable to the Company's clients may also adversely affect its businesses. To the Company's knowledge, no material adverse regulatory action is pending or threatened against the Company.
Results of Operations - 2003 Compared to 2002 ---------------------------------------------
The following table summarizes the changes in revenues and income (loss) before taxes of continuing operations of the Company.
The Years Ended December 31, Increase/ 2003 2002 (Decrease) ---- ---- -------- (in thousands) Revenues: -------- Capital Markets $29,651 $31,245 $(1,594) Investment Services Asset Management 9,969 8,373 1,596 Wealth Management 26,130 22,071 4,059 ------- ------- ------- 36,099 30,444 5,655
Corporate 8,525 5,751 2,774 ------- ------- ------- $74,275 $67,440 $ 6,835 ======= ======= =======
Income (loss) before taxes: -------------------------- Capital Markets $ 2,450 $ 2,321 $ 129 Investment Services Asset Management (217) (665) 448 Wealth Management (332) (1,604) 1,272 ------- ------- ------- (549) (2,269) 1,720
Corporate 944 2,741 (1,797) ------- ------- ------- $ 2,845 $ 2,793 $ 52 ======= ======= =======
Customers and Raw Materials
None of the Company's businesses is subject to governmental renegotiation or limitations on profits, and none is dependent on a single customer or a few customers or dependent on a single supplier of raw materials or a few suppliers of raw materials. In no case are patents, trademarks, licenses or franchises important, other than the Company's securities brokerage and investment advisory licenses under federal and state laws and the regulations of self regulatory organizations, and service marks which identify the "brands" of the Company and its affiliated mutual fund family. None of the Company's businesses are strictly seasonal, although commission income will fluctuate depending upon the condition of the US securities markets and trends in the healthcare marketplace, and investment banking activity tends to have higher volume in the last half of the year. None of the businesses engages in significant operations outside the United States of America.
Environmental Matters
Compliance with federal, state and local laws and regulations that have been enacted or adopted relating to the protection of the environment has had no material effect upon the capital expenditures, earnings and competitive position of the Company and its financial services subsidiaries.
Employees
As of March 1, 2004 approximately 310 persons were employed full time and 20 persons were employed part time by the Company and its subsidiaries.
Statement Regarding Forward Looking Disclosure
Certain matters discussed herein or incorporated by reference, including (without limitation) under Part I, Item 1, "Business -- General -- Business Factors," "Business -- Environmental Matters," Item 3, "Legal Proceedings" and under Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," contain forward-looking statements that involve risks and uncertainties, including (without limitation) the effect of economic and market conditions, such as demand for investment advisory, banking and brokerage services in the markets served by the Company, pricing of services, successful management of regulatory and legal risks and requirements which necessarily accompany various segments of the Company's businesses, interest rates, retention of key employees, profitable operations of the institutional trading desks, competition in the financial services industry, the ability to collect receivables and realize the value of investments, the Company's ability to realize the value of goodwill and other intangible assets, the Company's ability to profitably expand its business lines, national healthcare and tax policies, and the ability of the Company to underwrite and distribute securities. Forward- looking statements are subject to risks and uncertainties that could cause the Company's actual results to differ materially from those contemplated in the statements. Readers are cautioned not to place undue reliance on the forward- looking statements. When used in written documents or oral presentations, the terms "anticipate," "believe," "estimate," "expect," "may," "objective," "plan," "possible," "potential," "project," "will" and similar expressions are intended to identify forward-looking statements. The forward-looking statements and statements based on the Company's beliefs contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosure about Market Risk" represent the Company's attempt to measure activity in, and to analyze the many factors affecting, the markets for its products. There can be no assurance that: (i) the Company has correctly measured or identified all of the factors affecting these markets or the extent of their likely impact; (ii) the publicly available information with respect to these factors on which the Company's analysis is based is complete or accurate; or (iii) the Company's analysis is correct. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
